By Bob Cain
2000 Cain Publications, Inc., used by permission
found an investment property that looks great. You can see the dollar
signs in front of your eyes and you imagine the figures in your bank
account starting to climb. The good faith estimate from the real estate
agent looks good and you have more than enough money to close.
are excited. That's your first pitfall. Whatever you have to do, try to
keep emotion out of your buying decision. Always buy investment
property by the numbers, by how it will perform for you. Never buy it
because "it's so cute!" or "I just love the
the day to sign the papers comes and the title company calls you with the
amount of money you'll need to bring to closing. It is far more than what
you expected and will all but drain your cash reserves, or even worse is
more cash than you have. You have been trapped by one of the pitfalls of
things can happen to mess up what looked originally to be a terrific
investment. There is no need for you to get caught in one of these if you
know what to look for and you take a few simple precautions to avoid them.
real estate agents and sellers
estate agents may be good at selling things, but all too often they don't
really understand the importance of accurate figures. I have seen many
listings for investment property that have no income or expense figures
whatsoever. When you ask them about it, they say, "Oh, do you want
them? I'll have to get them from the seller."
may be good at fixing up and at managing property, but all too often they
are haphazard with their calculations and record keeping. When you ask for
specifics you get a reply such as "Oh, I've got them here
this is the case with agents who don't normally sell rental property, just
owner-occupied. They don't seem to have a clue that your profit or loss on
a property can depend on just a few dollars one way or the other. They
don't own any rental property of their own. Too many times you hear them
say, "I did once, but I could never make any money on it."
you hear statements like the above, you'll know you have to be extra
careful in all your dealings and will have to check every figure three
will not be the case with a specialist in the sale of investment property,
you will see that every figure is as close as he or she can get it. You
will find these folks selling the large apartment complexes and may have
the designation CCIM (Certified Commercial Investment Member) after their
names. These are the cream of the crop. You will also find them selling
plexes and small apartment complexes, too. You know that everything will
be in order when you deal with these folks. Other specialists in the sale
of investment property will also see that everything is in order.
that mean you can just rely on what the agent or seller tells you, if you
trust their figures? Absolutely not. Real estate is the one investment
that allows you to personally verify every operating figure and aspect of
your potential investment, and you should, if you expect to come out alive
figures do sloppy agents and sellers mess up? All of them, of course, but
we'll look at the most common ones here.
are assuming an existing loan or land sale contract. You will be paying
the difference between the loan balance and the sale price to the seller.
The listing agent or seller him or herself give you a figure that has lots
of zeros. When you ask about it, you'll get an answer such as, "oh,
it's about that much."
are words that can cost you thousands of dollars and possibly make the
deal fall through. "About that much" could have a $10,000 to
$20,000 difference between stated and actual. The higher the loan balance,
the less money you have to bring to closing; the lower the loan balance,
the more you have to bring. I know this can cost you a lot, because I fell
into this trap. It only ended up costing me about $5,000 extra, though.
sellers really don't have truly accurate figures. But they can get them.
You need to know within $100 how much is owed on the property if you are
assuming an existing loan or contract. So write into the sales agreement
the following language: "Subject to the actual balance of existing
loan being no less than $x."
expenses can use you up and drive you into bankruptcy. I looked at a
property once that showed a great gross income, but actually lost money.
Fortunately, in this case all the figures were on the listing for
potential buyers to see.
don't want to rely on the figures in the listing, though. You want to see
the actual expenses on the property as reported on the seller's tax
return. But even there the classifications aren't broken down into enough
detail. Possibly the seller paid some operating expenses out of his
personal checking account and forgot to include them in his figures.
printout from Quicken or Quickbooks or some other software, or, as is the
case with most landlords, a copy of a hand-written ledger is a must. Once
you have the printout, start looking for things that don't make sense or
for omissions. Here are items that should appear on a list of
expenses: property taxes, rental taxes, insurance, electricity, gas,
oil, water, garbage, management costs, repairs and maintenance,
advertising, telephone. In many cases tenants pay their own utilities, so
you wouldn't find those expenses, but if they don't appear on the expense
report, ask about it.
an experienced landlord and investor, you also know about how much things
should cost. Look for discrepancies in amounts between reported and
what you know to be real and for things that the seller did not spend
money on that will end up being deferred maintenance and will cost you big
time in the future.
will find things listed as expenses that should not be expenses but rather
capital improvements. Those would be non-recurring items such as new
carpeting, drapes, roof, and so on. If you see these listed as expenses
subtract them from the expenses, because you will not have to spend the
money again in the coming year or so. That will increase your bottom line.
look for figures that have a lot of zeros. If you see items such as taxes
$1,400, water $100, insurance $200 and so on, it is a signal that those
figures are wrong. Had the owner really gone through his books and added
up the amounts he actually paid, he would not end up with round numbers.
is the language for the sale agreement:
to buyer's review, verification and approval of subject property's
expenses within five days of acceptance of this offer."
need to know exactly whom you are getting, if there are existing tenants
in the property. You need to know how much rent they are paying, their
payment history, their complaint history; you also need to see copies of
all letters and notices sent to tenants.
of the ways you will be calculating the value of the property is by the
amount of rent it fetches. Too many times I have seen notes such as
"rents should be higher" in flyers and listings. Hogwash! You
have to assume that the rents are exactly where they should be.
at it this way, if you raise the rents to market rate after you buy the
property, many tenants whose rents are below market now (if that's indeed
the case) are going to move, just to get even with you if nothing else.
That will mean you have vacancies that will cost you more than the
increase in rent you would have gotten. The fact is, you are stuck with
the rents the property is getting now, no matter how much the real estate
agent or seller protest otherwise. If they should be higher, why didn't
the owner raise them?
is a lesson for landlords considering selling their properties, as well.
Experienced investors will look at current rents, not what the rents
"should" be. So get your rents up to market before you put the
property up for sale.
the clause to write into the sales agreement: "Subject to buyer's
review and approval of existing tenant records and rent schedule within
five days of acceptance of this offer."
might consider this to be a part of the tenant records, and it is, but
this is a dollar figure that can be a surprise to the uninitiated. When
you are ready to sign all the papers at the title company or lawyer's
office, you will, as buyer, have to pay the seller for all the security
and other deposits he is holding. On a large complex that can amount to
many thousands of dollars. For a duplex or triplex it could still be
$2,000 to $3,000. Factor that into your estimate of closing costs at the
beginning of your consideration of a property.
things to watch out for
that may be in the offing
seller may or may not know about them. Or he may have heard rumors, but
nothing else. But the surprise may come after you have bought the property
and you one day, six months after you took possession, get a notice that
the city is going to put sidewalks in front on your complex and you get to
liens won't show up on title reports, but they could be common knowledge
around the neighborhood. It behooves you to check with the owners of other
properties in the area to see if they know of anything in the near future
that could cost you a bundle.
agreements with tenants
will find all kinds of side agreements that owners make with tenants that
you never see in writing. He might have promised the tenant that he will
redecorate the entire apartment if he renews for a year; he might have
told the tenant his last month's rent is free for a one-year renewal. Who
need to ask the seller to certify that there are no agreements with
tenants, orally or in writing, except those he has disclosed.
for the sales agreement: "Seller certifies that he has made no oral
or written agreements with tenants that he has not disclosed in writing to
and/or first, because you may want to do it both before you write the
offer and after you get the actual figures on the property, run the
numbers through some investment analysis software to see where you stand.
I suggest Real Estate Investment Analysis Software available through Cain
Publications, but there are others out there. Looking at the numbers
using that tool can save you thousands of dollars.
is a lot of money to be made investing in real estate and a lot of money
to be lost. How you approach the purchase of it and how well you dodge the
pitfalls will determine how your investment works for you.
Robert Cain is
a nationally-recognized speaker and writer on property management and real
estate issues. For a free sample copy of the Rental Property Reporter call
800-654-5456 or visit their web site at
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