Cash Flow Associated With A Bond Payment To Purchase Bond Real Estate Investors – Get Off The Sideline And Get Into The Game In A "Slow" Market

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Real Estate Investors – Get Off The Sideline And Get Into The Game In A "Slow" Market

For months, many real estate agents have been walking the floor wondering where their next sale is coming from. Bad news drips from the headlines and reports for everyone to see how bad the real estate market has become. Thickets of real estate signs explode from the ground much like they do at the peak of each mushroom season. Sellers now believe the story because they believe the market is slow. For buyers who were pushing up prices with properties with little cash flow just six months ago, those same properties turned ugly overnight.

Smart investors are always looking for buying opportunities. Whether it’s stocks, coins, gold, bonds, collectibles, vintage cars or real estate, investment principles apply. A typical successful opponent looks for places to move. If there is no worthwhile action, they simply stay liquid and go into the money. As the general public begins to throw up their hands, the shrewd investor begins to lean forward on the edge of their chair and begin to turn their collective gaze to potential opportunities. Currently, there is a huge list of properties that are listed, which is sitting on the market in Multiple Listing Services (MLS) in many areas. Some of these potential opportunities motivated the seller, while others did not. The focus should be on listed properties that have a motivated seller.

There is a lot of money coming back into the stock market with companies like Google pushing $500+ per share. Many “hot” stocks don’t have much earnings, but they have great stories and a lot of supposed promise. Like the dot COM companies of the 90s, there was a lot of splash and a lot of broken hearts left behind after the hype. After the stock market crash, billions poured into the real estate business as an alternative to the stock market madness. With the ENRON and WORLDCOM fiascos, it made the decision to move into real estate easier for many investors. Who could we trust then? The answer for many was to purchase and independently manage their own property portfolio. Many disillusioned investors who have healed their wounds and “medicated” themselves with real estate management are now returning to the stock market. Vacancies increased in some areas as so many investors bought single-family homes and condos that absorption of these properties slowed. A combination of higher vacancy factors and enthusiasm for asset management has led to an outflow back into the stock market. For many new investors to the game, real estate investors with a greater desire to return to the stock market leads to clouded thinking and many will accept an offer that was unheard of six months ago. A savvy investor will focus on these motivated sellers and make multiple offers to acquire a real estate deal that has cash flow and potential for appreciation.

An early axiom of real estate investing is based on making money by BUYING. Paying a substantial amount for a property that has little or no cash flow with some appreciation is not beneficial. When a market becomes overvalued, like the stock market, the smart money looks for other opportunities or opts to hold its cash and wait. Opportunities are knocking in many markets. Interest rates have been very low for some time now. Real Estate Investment Trusts (REITs) learned shortly after the 1986 tax law that highly leveraged real estate without the previous shorter depreciation benefits produced little cash flow. It’s the same with a real estate investor. Over 80% loan-to-value financing is asking for trouble EXCEPT in a highly valued area. There are a few pockets, but they are far and few between at the moment.

Looking at the four-plex as an example, we would do well to focus on properties that, with a few tweaks, can command high market rents. Two bedrooms would be most desirable. There are many clients who are renting and need an extra bedroom for home offices and/or new families. One-bedroom units have limited market rent advantage. In some markets, for example, a fourplex is on the market for $375,000. Rents are around $850 per month. This would make a gross rental income of $3,400/month. With a 5% vacancy factor, the adjusted gross income is $3,230/month. Tenants pay their own electricity, gas, cable and water and sewer with separate utility meters. Taxes are $350 per month and insurance is $220 per month. For this example, we use 10% of the rents collected for management costs, regardless of whether the business is self-managed or not. The investment has to pay off regardless. That would be $323/month to manage. Spend $200/month on lawn maintenance and care. The idea is to have well-maintained properties and keep them in such a way that they fetch the highest rents. This would lead to the following: $3,230 adjusted gross income minus – $350 – $220 – $323 – $200 = $2,137 / month available for debt service. At this point, with the seller paying up to 6% closing costs and down payments, there would be something left over to help the buyer lower the rate. With 375,000 x 6% = $22,500. Closing costs and down payments with full deposits for taxes and insurance could be $12,000. That leaves $10,000 to lower the interest rate. With an 80% loan-to-value ratio, $375,000 x 80% = $300,000 for the mortgage amount. At 6.25% par on an investor’s four unit loan on a fully documented loan, there is a lender jump of 1% on the price for 3-4 units at 80% LTV.

Thus, with the purchase, the buyer can get a 30-year fixed interest rate of 5.75%. The principal and interest payment would thus be $1,750.72/month for principal and interest. This would leave an initial cash flow after paying off the debt net of interest and amortization of $2,137-$1,750.72/month = $386.28/month of cash flow. The interest deduction would be $17,250/year. Depreciation from $75,000 on land, improvement to say $300,000/27.5 = $10,909.09/year. So our after-tax cash flow would be net operating profit: $25,644/year – $17,250 interest deduction – $10,909 = ($2,515) tax loss. If the owner is in the 30% tax bracket, that would save $754 in federal income tax.

So the total after the tax return is $386.28 x 12 = $4,635.36 + the tax savings of $754 = $5,389.36. With a cash down payment of $75,000 with seller help with closing costs and a reduced interest rate, the return would be $5,389.36/$75,000 = 7.19% after taxes. Allowing for a conservative 4% appreciation rate, the initial investment of $375,000 x 4% would theoretically grow by about $15,000 over time. Then the total adjusted return would be $15,000 + $5,389.36 = $20,389.36/$75,000 = 27.18% less, say 4% for inflation, or a net return of 23.18%. It should be noted that this return would be masked by capital gains taxes and some recapture of depreciation at the end and such. If you managed it yourself, that money could go into additional upgrades or into your pocket. That’s not a bad deal for the long-term investor. This is an example of leverage at work.

If the certificate of deposit paid say 6% on $75,000 that would raise $4,500 and again in the 30% tax bracket the return would be $4,500 x 30% = $1,350 for a total return of $4,500-$1,350 = $3,150/75,000 $ = 4.2% in comparison. But if inflation were 4%, the net profit would be 0.2% without risk. The above investment is anticipated with management in place.

For many shrewd investors, the time is now. With good prices and seller help with closing costs and interest rates, buying an investment property can make sense from an investment perspective. The key is to find a motivated seller and a property that can command the highest rents, and make multiple offers. For buyers with questionable credit, the numbers can also work by asking for a second mortgage that the seller has at a low rate. Either way, it’s time for many real estate investors to get off the sidelines and make a big move into this soft real estate market with the primary goal of finding and acquiring “meaningful” cash flow properties. The market is asking for offers.

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