Turning poor cash flow properties into great cash flow properties - part 3

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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Tip #3

This is the third post in a mini series on how to turn a negative cash flowing property in to one that is cash flow positive. Many people get into real estate without fully understanding how cash flow works. For more information on calculating cash flow, please read my other blogs on the subject. If, however, you are in a place where things aren't going well for you and your property and you need to think of something that will help you right now, this may be the place to start.

Lease/Option Contracts

Rent to own deals are made up of two contracts. The first is a regular lease (or rental agreement) contract and the second is an option contract. A lease agreement is something you should already have in place if you are renting out a place and this contract can stay the same if it is strong. A rental/lease agreement should always be run past your real estate lawyer so that it is both strong and protects both you and your tenant. The option contract is extremely simply when well understood. An option is simply a contract that gives the purchaser of the contract the legal right to purchase the property within a certain period of time for a set amount of money. So, I chat with my tenant and we decide and agree that we will exchange the property for X amount of dollars at any time within the next X amount of months. I typically like having options no longer than 24-36 months for multiple reasons (maybe that'll be another post at some point). This should be of benefit to both the purchaser and the vendor/seller. The vendor doesn't want the property and the purchaser does but cannot qualify for or afford it just yet. A good rent to own contract and deal should benefit both parties and I cannot emphasize this enough. If you ever take advantage of someone's situation and hurt them in the process please get out of the real estate investing industry because you give a bad name to all of those who are providing a basic human need in a reasonable way to families.

These deals have a significant strength as well as a potential disadvantage. The greatest strength is that you can turn a cash flow negative property into a cash flow positive property. In a typically rent to own contract I will be actually charging more, per month, for a family to live in the property. The way it works is the family will be the normal market rent for a property, and then will pay an extra amount of rent that is being put toward the eventual down payment. I find that it really does help families to pay the entire down payment before the end of the deal comes around because it helps them save money (which is often one reason they haven't been able to purchase a home in the past). So, if they are purchasing a $200,000 house and the down payment is going to be 5%, they will need $10,000 by the end of the deal. They pay this in two forms. The first is an up front cost (often called the option consideration because it is money used to purchase the option contract, which gives them legal rights to the property). This option consideration should be enough to cover some risk and give up some of your rights to the property (with this 200k deal I would probably ask for at least $5,000 up front so that the family doesn't simply leave the deal in the next few months; they have skin in the game). They can pay the other $5,000 spread out over the next 24 months ($208 of rental credit per month). 

This type of deal is providing two things for you, the investor. The first is a lump sum of cash up front and the second is an extra $200+ of cash each month while the deal lasts. This solves your cash flow negative problem.

The Potential Drawback

The weakness to this strategy is that you now need to sell the property when the family exercises the option contract and purchases the house from you. If you had wanted to keep the property you may want to read my first two posts on the subject. This drawback can actually be a blessing for an owner who wants to get out of a property but the property may not be worth what you need out of it just yet. In an up trending market, you can gain an increase in cash flow now and still sell the property at a future date for the money it is worth then.

 A Caution

Rent to own deals aren't the simplest of all real estate transactions. It is best to speak with your mortgage broker as well as a good real estate lawyer to learn what to be careful with in your own community and the potential difficulties in these deals. A rule of thumb is that you need to be structuring this deal to help both yourself and the tenant family. If you have fantastic intentions and you are willing to learn and receive help from a lawyer you can truly create a win-win situation. Another note I will mention here is that if you are unsure how to move forward but this is the deal that best fits your situation... find a real estate investor who specializes in these deals in your community. Often they are willing to help you out for a commission. You can pay them for a few hours of their time to review your documents and how you are going about the deal or you can pay them to advertise and market the property for you. While this will cost some of the option consideration (the up front money), it could make the difference between a good deal and something you wish you had never entered into. Always take your time and make sure due diligence has been covered before entering real estate transactions. I believe real estate is the best investment class on the planet for many reasons (again, look at the series I put together on this subject), but like everything you invest money into you need to be aware of what you are getting into as well as how to cover risk.




Here's to your future of risk-averse investing!

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html

Turning poor cash flow properties into great cash flow properties - part 2

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

Remember: Please share this article if you find it enjoyable

Tip #2

A while back I began a miniseries on how to turn cash flow negative investment wannabes into actual cash flowing investments. The difference can be very small. If, after all expenses of a property over a period of a year (including maintenance fees and other costs for long term care such as saving up for the new roof you will need in 10 or 15 years) are included and you are still making money you are now cash flow positive. Tip #2 will focus on another slight change you can make to a property that may change your property into an investment.

Evaluating the potential of a suite

Every property is different and in some properties you will have difficulty putting in a suite. I personally don't invest in 2 storey houses because of this difficulty. I always want multiple risk covering strategies and putting in a suite is another way to mitigate risk. What are the properties that you can typically suite without too much difficulty? The most obvious properties are types of bungalows. If you don't know the difference between a bungalow, a bi-level, a raised bungalow, or a hillside bungalow... it is time to do some homework. Each of these types of bungalow has advantages and disadvantages. I prefer hillside bungalows and raised bungalows myself because of the variety of options I have. The reason bungalows can make better investments than 2 storeys is that you have the option to suite the property with less change. In a typical bungalow you will have a back entrance with a staircase that goes up the main floor as well as down to the basement (in a bi-level, the difference is that the staircase is in the front of the building). This allows for a separate entrance downstairs which is ideal for a suite. Raised bungalows have room and space for larger windows in the basement and hillside bungalows can even offer a walkout basement for more convenience for the family living in a suite that doesn't feel as much like a basement suite.

What does it cost to renovate a basement and suite it? It depends on your experience and the property, but I know people who have suited a basement for as low as $5,000. Many people starting out will suite a place for as much as $40,000 and there is really no limit to what you can spend. The key is providing a suite that is both safe (for example: think of window sizes for emergency exits that are big enough for a firefighter with full gear to enter and exit the basement and placed in every bedroom in the basement) and comfortable (for example: think about where the kitchen area is in the suite or where the bedrooms are located). Another thing to keep in mind for a suite is whether it is legal and compliant. It must be able to hold two families (this is a zoning issue) to be legal and must conform to codes in order to be compliant.

Its always a numbers game

Just like my first tip, lets take a look at the difference in revenue you can receive versus how much money it will cost to pay for the renovations. With an assumed 3.5-4% interest rate on a HELOC, you could borrow the $20,000 to put in a suite and the cost to you would be an average of $67 each month with an interest only payment. In an average area of Calgary right now a house that rents for $1800 with one family living in it can easily bring in around $1200 for an upstairs suite and another $900 for a downstairs suite that looks and feels good and is safe. In the suited place you are bringing in another $300 each month and your expenses have gone up by a base $67 each month. If you pay the interest  ($67) as well as another $133 each month of principle you will still end up with another $100 at the end of each month which may make that small difference between owning and managing an investment versus a liability.

Summary

When investing, the small changes in the way you think and value a property can make very large differences in the long run. It can even make the difference between keeping a property that cash flows through a downturn in the market and losing it to foreclosure because you can't keep up with the payments. If you need help in understanding the importance of cash flow, please see my earliest blogs which cover the subject in more depth. By purchasing properties that can adapt, you are covering more risk in the future. by thinking about small changes you can make to a property, you are thinking like an investor instead of a gambler whose investment strategy is 'buy, hold, and pray things go up in value' (an idea I first heard from Kiyosaki).


Here's to your future of risk-averse investing!

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html

Win/Win/Win for Rent to Own Deal

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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Mark, What's With This Win/Win/Win Stuff?

I grew up with a father who would rather take a hit himself than cheat someone else out of something. I saw this put into practice multiple times and he has lost tens of thousands of dollars a number of times because of this mindset (I'll call it integrity). About a decade ago I approached him with the idea of renting to own and asked what he thought. He basically told me to stay as far away from rent to own deals as possible. The reason was that "The tenant will always lose out on this kind of deal because the landlord will need to protect his/her own interests". I asked for an example and he gave me a few. I left it at that. I trust my dad and his understanding of real estate in general as well as investing. It has only been in the last 2-3 years I have come across some really interesting ways of doing business and helping people who are cash rich and credit poor own a home that actually does help them.

What Does a Typical Rent to Own Deal Look Like?

Dad believed that rent to own deals all fall into a limited category. And he was right. It is a simple transaction that I will explain here, but it does have some variations that I will share as well. Typically, there is someone with a house they no longer want for various reasons and are willing to sell it within a period of time as long as that period of time is hassle free. On the other side of the deal there is a family who, again for various reasons, wants to own a home but cannot currently obtain financing from a financial institution either because they do not have money for a down payment or because the lender/bank doesn't like the family's credit score. The agreement they both sign comes in two parts

1. The lease agreement

This is basically like any other lease or rental agreement. It details how much rent will be paid each month and what will happen to protect both the tenant and the landlord

2. The option contract

The basics of an option contract are: It gives the right to the tenant to purchase the house within a  certain period of time for a certain amount of money. If the contract time limit runs out before anything is purchase, the contract is now null and void. This contract is typically purchased from the landlord for a price and this money is lost if the tenant will not or cannot purchase the house.

In the typical scenario, the tenant is left on their own to save enough money for a down payment as well as rebuild/improve their credit. The landlord receives higher than normal rent and typically hassle free management because the tenants are treating the house as their own and even does minor fixups themselves. Typically, this type of situation works out about 40% of the time (I've heard lower numbers than this as well), based on investors I have spoken with extensively on the subject. The reason these deals aren't completed is that a typically family that has poor credit also has a difficult time saving a large amount of money and doing everything right for an extended period of time so their credit score jumps. This makes sense to me... how can a family rebuild their credit if they may not even know what they must do to improve this score?

What I'm Doing Differently

The way I do rent to own is different in a few significant ways. I call it a 'tenant focused rent to own program'.

First, I only will get into a deal with tenants who have an excellent chance of qualifying for a mortgage with just a little help. 

Secondly, I only work with tenants who have enough money for a down payment TODAY. This is important because it removes a huge obstacle to home ownership

Thirdly, and possibly most importantly, I help these people all along the way so they know what they need to do in order to rebuild their credit. We work with a credit repair specialist who meets with the family a few times each year to monitor the improvements to credit as well as give homework for future improvements.

Lastly, I structure deals so that tenants can choose where they live in the city as well as the exact home they desire. This is done by finding an investor who wants a good return on her/his investment without a high degree of risk. The investor purchases the house for the tenant/future home owner for now. The tenant pays higher than normal rent to make this a good deal for the investor and at the end of a relatively short term (2-3 years) the tenant purchases the house from the investor. 

So... What's the Win/Win/Win about?

Well, when a family that desperately desire to work toward purchasing home is able to not only buy that home, but also control the house until they are able to purchase and can, in the meant time, live in that house they definitely feel like they are moving on in life (especially when they have help all along the way). 

When an investor who is dissatisfied with 2-6% returns on their investments/future retirements (and that's in a good year) receive much higher than that without any management trouble or headaches that can come with renting to others and another person takes care of the details, they know they are profitting while helping another family in need. 

When I put this deal together and work hard to make sure there are few, if any wrinkles in the deal and take care of a family with the desire to own a home as well as an investor who desires to take care of her/his family in retirement and make a profit along the way for my hard work, I absolutely win.

There it is: a win for a family, for an investor, and myself and my family; win/win/win. I love doing real estate because there are legitimate ways to take care of multiple people simultaneously. 

p.s. this type of rent to own scenario is a success over 90% of the time:)

I hope you both enjoyed and learned something from today's blog. Happy investing!


If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html