thomas winfield november 5, 2016 - files.meetup.comfiles.meetup.com/18528044/multifamily investing...
TRANSCRIPT
• This is not a solicitation, endorsement or offer
•Nothing in this presentation is meant to be Legal, Tax or Financial advice• Consult your Lawyer for legal advice• Consult your Tax Advisor for Tax advice• Consult your Financial Advisor for Financial advice
Our Philosophy
• Buy and Hold (2-5 Years)
• Risk Appropriate Investments• Rigorous Due Diligence
• Appropriate Leverage
• Data/Metrics Driven vs. Hype Driven
Topics
•Market Analysis
•Property Analysis/Due Diligence
• Finance
• Exit Strategy
• The Plan and the Team
Criteria for Selecting a Market
• Population Growth• Primarily from Net Migration• States With Large and Growing Populations
• Workforce• Income Growth• Educated Workforce
• Gross Domestic Product (GDP)/GSP• Diversified Economic Base• Good Debt Rating
• RE Cycle Phase• Real Estate Prices Not Volatile
Virtuous Circle for Economic Growth
Population Growth
Talented Workforce
Increase in Job OpeningsIncome Growth
A Growing Population and Talented Workforce Creates a Demand for Real Estate
The Population of the South and West is Increasing Faster Than the Northeast and Midwest
Howdy Y’all
The Real Estate Cycle Tracks the Economic Cycle
• Cycle has Peaks and Troughs
• Next Peak is Generally Higher than Past Peaks
• Goal is to Survive one Cycle
• Focus on the Trend Line
I Believe the Market Is Going to Fluctuate– J. P. Morgan
Recovery Phase
Expansion Phase
Recession Phase
Contraction Phase
Above Long Term Average Occupancy
Below Long Term Average Occupancy
Rents are Increasing Rents are Decreasing
Buy Here
Sell Here
In What Phase of the RE Cycle is Your Market
States With Best Long Term Prospect for Buy and Hold Multifamily Investors
South
• North Carolina
• South Carolina
• Florida
Western
• Colorado
• Utah
• California
• Nevada
• Washington
• Oregon
• Georgia
• Texas
Due Diligence - Definition1. An investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regards to a sale.
2. Generally, due diligence refers to the care a reasonable person should take before entering into an agreement or a transaction with another party.
Types of Due Diligence
• Sub Market
• Financial
• Physical
• Legal
Time
Market Due Diligence Should Proceed all Other Due Diligence
Important Metrics
• Cash on Cash Return
• Cap Rate
• Vacancy Rate
• Expense as a % of Income
• Median Income
• Median Rents
Financial Due Diligence-Valuation
• Appraisal/Broker Opinion of Value
• Metrics• Price Per Unit
• Price Per Square Foot
• Vacancy Rate
• Property Sales History
These values should be compared to the Market/submarket norms
Financial Due Diligence-Income• Income Statement
• Rents
• Other Income
• Rent Rolls (Past 3 years)• Review All Leases
• Tenant Background
• Obtain Tenant Estoppel Certificates
Financial Due Diligence- Expenses
• Property Tax
• Insurance Policy
• Security Deposits
• Utility Deposits
• Loan Documents (if assuming loan)
• Utility Bills
• Existing Contracts (Property Managers, Maintenance, etc.)
Legal Due Diligence• Seller Listing Agreement
• What’s Included in the Sale• What are the conditions of the
purchase
• Purchase Agreement (RIPA)• What are you Offering• What are the conditions of the
purchase
• Seller Disclosures• Title
• Who Owns Property• How is Title Held
• Deed• Covenants, Conditions & Restrictions
(CC&Rs)• Ownership Rights
• Litigation History• Liens
• Recorded• Unrecorded
Legal Due Diligence-Governing Bodies
• Zoning
• Rent Ordinances• Rent Control
• Number of Occupants
• Etc.
• Building Permits
• Easements
Is this Property Suitable for it’s Intended Use?
Physical Due Diligence• Location
• Class/Age• A (0-15)• B (15-30)• C (30-45)
• Building Inspection Report • Roofing• Plumbing• Electrical• HVAC• Mold Inspection Report
• Capital Improvement History
• Deferred Maintenance
• Environmental Reports
• Engineering Report
• Lead Paint
Physical Due Diligence
Why Borrow Money-The Power of Leverage
Non-Leveraged
• $10,000 to Invest
• 5% Interest
• Amount Returned ($10,000*.05)=$500
• Return 5%
Leveraged Investment
• $10,000 to Invest
• 80% Loan to Value (20% Down)
• 5% Interest
• Purchase Power = $10,000/.2 = $50,000
• Amount Returned ($50,000*.05) = $2,500
• Return 25%
Time is on your Side
• Starting Early is Most Effective
• Appropriate Use of Leverage Accelerates the Effect of Compounding
Where Does Real Estate Financing Come From
• Savings• Seller Financing• Conventional Loans• Commercial Loans• Hard Money• Private Money• Portfolio Lenders• FHA/HUD Programs• Home Equity Loans and Lines of
Credit• Self-directed IRAs
• Development Loan, Construction Loan
• 1031 Exchange• Partnerships• REITS• Crowdfunding• Syndications
Sources of Funds -Direct Lenders
• Credit Unions
• Savings and Loans
• Banks
• Portfolio--loans are funded by a bank or other institutionalized lender which does not securitize or sell their loans into capital markets.
• Terms may be more flexible than a securitized loan and it is typically serviced by the lender.
• Securitized loans are pooled and sold on the secondary market.
Sources of Funds -Private Lenders
• Your Rich Uncle
• High Net Worth Individuals
• Someone’s IRA
• Crowdfunding
• Sellers
Mortgage Brokers Can Help You Find Money
• An intermediary who brings mortgage borrowers and mortgage lenders together.
• A mortgage broker collects an origination fee and/or a yield spread premium from the lender as compensation for its services.
Borrower Mortgage Broker
Lender # 1
Lender # N
.
.
.
.
.Loan Application
Borrower’s Liability
• Recourse Loan-A type of loan that allows a lender to seek financial damages if the borrower fails to pay the liability, and if the value of the underlying asset is not enough to cover it. A recourse loan allows the lender to go after the debtor's assets that were not used as loan collateral in case of default.
• Non-Recourse Loan-A type of loan that is secured by collateral, which is usually property. If the borrower defaults, the issuer can seize the collateral, but cannot seek out the borrower for any further compensation, even if the collateral does not cover the full value of the defaulted amount unless there is fraud involved
Important Metrics for Lenders
• Net operating income: The annual income, minus expenses that a property generates from its operations
• Debt service coverage: Measure of NOI relative to debt payment obligations
• Loan-to-value (LTV) ratio: A measure of the loan amount relative to the value of the property
NOI and Cash Flow
• Net operating income: The annual income, minus expenses that a property generates from its operations
NOI = Income - Expenses
• Cash Flow: The cash flow (before tax) is the net result of gross income minus expenses and debt service.
Cash Flow = NOI – Debt Service
Cash Flow
Debt Service
Higher Debt Service = Lower Cash Flow
Debt Service Coverage Ratio
• The DSCR or debt service coverage ratio is the relationship of a property's annual net operating income (NOI) to its annual mortgage debt service (principal and interest payments).
DSCR= NOI/Annual Debt Service
NOI = $225,000ADS = $115,000
DSCR = $225,000/$115,000 = 1.9
Loan to Value (LTV)
• Loan-to-value (LTV) ratio: A measure of the loan amount relative to the value of the property
LTV=(Amount of Loan)/(Value of Property)
Property value = $735,000Amount of Loan = $588,000
LTV=$588,000/$735,000=80%
The Anatomy of a Conventional Loan
• Treatment of Income (Rental vs. earned)
• Entry Cost/Issues
• Terms
• APR
• Interest Rate (Fixed vs. Adjustable)
• Fees
• Points
• Exit Cost/Issues
• Balloon Payment
• Prepayment Penalties
• Underwriting
How do Lenders Reduce Their Risk
• FHA and other Government Guarantors
• Securitizing
• Higher Down Payments
• Shorter Payback periods
• Higher Debt Service Coverage Ratios
• Seasoned Income
• Longer Investment Experience
• Recourse Loans
Owner Occupied 3 Units Purchased With FHA 3.5% Down
Address 1521 Junipero
City Long Beach
Zip 90804
No. Units 3
Year Built 1947
Building Size 2253
Lot Size 6393
Property Description
Asking Price $599,900
Price/Unit $199,967
Price/Sq Ft $266
Down Payment $20,997
Closing Cost $17,997
Loan Fees $8,684
Rehab Cost $9,000
Total Cost $56,677
Loan Amount $578,904
Annual Debt Service -$32,172
Owner Occupied
Economics of Deal Owner Occupied
GROSS SCHEDULED INCOME $28,600
Less: Vacancy & Cr. Losses $1,430
EFFECTIVE RENTAL INCOME $27,170
GROSS OPERATING INCOME $27,170
TOTAL OPERATING EXPENSES $15,719
NET OPERATING INCOME $11,451
Less: Annual Debt Service $32,172
CASH FLOW BEFORE TAXES -$20,721
Rent from Former Apartment $18,000
Effective Cash Flow -$2,721
Cash Flow Calculations
Year 1 Year 2 Year 3 Year 4 Year 5
Cash Flow Before Taxes -$20,721 -$20,005 -$15,458 -$14,698 -$13,916
Effective Cash Flow -$2,721 -$2,005 $2,542 $3,302 $4,084
Five Units Commercial Loan 30% Down
Address 1189 W. Spring St.
City Riverside
Zip 92507
No. Units 5
Year Built 1950
Building Size 3400
Lot Size 9148
Property Description
Asking Price $500,000
Price/Unit $100,000
Price/Sq Ft $147
Down Payment $150,000
Closing Cost $15,000
Loan Fees $7,000
Rehab Cost $15,000
Total Cost $187,000
Loan Amount $350,000
Annual Debt Service -$21,281
Five Units
Economics of Five Units
Year 1 Year 2 Year 3 Year 4 Year 5
Cash Flow Before Taxes $7,647 $10,309 $11,257 $12,233 $13,238
GROSS SCHEDULED INCOME $43,500
Less: Vacancy & Cr. Losses $2,175
EFFECTIVE RENTAL INCOME $41,325
GROSS OPERATING INCOME $41,325
TOTAL OPERATING EXPENSES $12,398
NET OPERATING INCOME $28,928
Less: Annual Debt Service $21,281
CASH FLOW BEFORE TAXES $7,647
Cash Flow Calculations
Single-Family Loans
• 1 – 4 unit properties
• Owner-occupied, second home, vacation rental, rental property
• Qualified off of housing ratios / debt-to-income ratios.
• Including FHA, VA, jumbo, conventional and portfolio programs.
• Owner-Occupied Investor• 3.5% down 25% down
• 2 – 4 unit investment property O.K. Non-owner occupied
Multi-Family Loans
• 5+ unit properties
• Strictly investor properties• Amortizations of 15 and 30 Years• 3, 5, 7, 10, 15 Year Fixed Rate Terms• No Prepay Options• No Tax Return Options• Monthly/Annual Leases Acceptable• Interest Only• A, B and C Property Types Considered• Entity OK• Maximum LTV 80% / 85% CLTV• Non Recourse• A Minimum DSC of 1.15:1• 60 Day Rate Lock
Types of Loans – Fannie Mae / Freddie Mac• Conforming (Fannie/Freddie)
• Government-sponsored enterprises, give the ability to borrow more at lower interest rates than Private / Portfolio
• Maximum Conforming Loan amounts:• Loan Limits 1 – 4 units (Orange County / Los Angeles).
• 1-unit: $625,500• 2-unit: $800,775• 3-unit: $967,950• 4-unit: $1,202,925
• Loan Limits 1 – 4 units (San Bernardino / Riverside).• 1-unit: $417,000• 2-unit: $533,850• 3-unit: $645,300• 4-unit: $801,950
• Maximum investment transaction of 10; most banks will only allow up to 5 since this complicates underwriting.
Types of Loans - FHA
• FHA does not provide the loan itself, they insure banks against borrower defaults.
• Overseen by HUD – U.S. Department of Housing and Urban Development
• Provides a low down payment assistance. (3.5% down).
• Usually allows lower credit scores. (580 minimum).
• Upfront Mortgage Insurance Premium (UFMIP) – 1.75%; typically added to the loan amount, but borrower can bring amount to close and pay up front.
Example: $300,000 Loan with UFMIP = $305,250. UFMIP = (1.75% x $300,000 = $5,250)
Types of Loans – FHA (cont’d)• Annual Mortgage Insurance Premium (MIP) - .85% Annually.
• Must verify and document proposed rental income on 2-4 unit properties by obtaining an appraisal showing fair market rent in situations with limited or no history of rental income.
• FHA owner-occupied 3 – 4 unit investment. Monthly net rental income collected must be greater than - or equal to - monthly PITI. Conforming loan limitation still apply depending on county.
• Borrower must have three month’s PITI after closing on a purchase transactions. Unlike down payment, reserves cannot be derived from a gift.
• Net rental income = using the appraiser’s estimate of fair market rent from all the units, including the borrower's occupancy – the greater of the appraiser estimates for vacancies.
Debt To Income (DTI)
Formula: Total Recurring Debt / Gross Monthly Debt
• Fannie Mae / Freddie Mac: 45%
• Portfolio / Jumbo: 43%
• FHA: 56.99%
Residential Needs List
• Signed and Completed 1003 Loan Application
• Credit Authorization – Gives us the ability to pull credit
• Bank Statements (All Pages), verify assets
• W2’s or 1099’s
• 2015 – 2014 Personal Tax Returns (1040s) – Federal Only
• 2015 – 2014 Entity Tax Returns (1120, 1120S or 1065)• 1120 – Corporation
• 1120S – S-Corporation
• 1065 – Partnerships
• Insurance declaration and mortgage statements for all properties owned.
Tri-Merge Credit Report
• 3 credit repositories – score is based off the middle score• Equifax - 772
• Experian - 752
• Trans Union – 765
• Types of Credit• Revolving (Credit Cards).
• Installment (Leases).
• Mortgage.
35%
30%
15%
10%
10%
Credit Score Factors
Payment History
Debt Burden
Credit History
Types of Credit
Recent Searches
Investment Strategy
• Market and Sub Market Analysis
• Purchase• Under-Performing Properties
• High Growth Area
• Reposition• Resolve Property Issues
• Reduce Expenses
• Raise Income/Rents
• Refinance/Exchange • Minimize Taxes
• Based on Performance Metric (ROE, Cash Flow, IRR, Market Cycle)
• 1031 Exchange
• Installment Sale
• Sale
• Repeat
Owner Occupied Ten Year Performance
• 1031 Exchange Every Three Years
• $56,677 Investment Produced $609,047 Equity
Five Unit Ten Year Performance
• 1031 Exchange Every Three Years
• $187,000 Investment Produced $1,030,609 Equity
• Cash Flow = Income – Expenses• Near term concern
• Increase Income
• Decrease Expenses
• Net Worth/Equity= Asset Value - Liabilities• Longer term Concerns
• Increase Asset Value
• Decrease Liabilities
Some Basic Financial Math
We go broke in the near term. - Unknown
In the long term, we’re all dead.- John Maynard Keynes
Steps to Follow in Developing Your Plan
• Study History• Interest Rates/Financial Markets• Market Cycles• Demographic trends• Political Factors (Rent control, Zoning, etc.)
• Establish Criteria• Financial Returns (pick your metric)• Locations (All Real Estate is Local)• Condition• Holding periods/Exit Criteria
• Know your market(s)• Property Class• Cap Rates• Rent Rate• Demographics
• Locate Financing• Savings/Equity• Family• Friends• Partners• Lenders
• Establish Relationships with team• Lenders/Partners• Brokers• Inspectors/Contractors
• Find Property• Perform Due Diligence • Acquire
What to address in your Plan
• Why are you investing in Real Estate• Cash Flow• Appreciation• Tax Benefit• Leverage
• Time Horizon
• Success Metrics• Cap Rate• Return on Investment• Return On Equity• Internal Rate Return
• Use of Funds• Reserves• Expenses• Capital Improvements
• Source of investment funds• Personal Savings• Partnerships (My Brain, Your Money)• Conventional Financing• Seller Financing• Private Lenders• Cash Flow
• Exit Strategy• Sale• Exchange• Cash out Refi
“He who fails to plan is planning to fail" …Winston Churchill
You Need a Team
• Broker• Finding property• Market Analysis• Property Analysis• Broker Opinion of Value• Managing Transaction
• Attorney• Legal Due Diligence• Artificial Entities• Liabilities
• Accountant• Tax Implication• Financial Calculations• Financial Due Diligence
• Insurance Agent• Liability Coverage
• Property Manager• Expense management• Tenant Management
• Mortgage Broker/Lender• Finding Funds
• Contractor• Repairs• Remodeling• Physical Due Diligence
• Appraiser• Determine Market Value• Determine After Repair Value
(ARV)
• Network of fellow investors• Partners• Finding property
Success is where preparation and opportunity meet. (Bobby Unser)
Next Steps
• Determine Your Goals and Objectives• Why are you Investing
• What is your desired approach
• What is your time horizon
• What metrics will you use
• Select Your Market• Focus on Population Growth
• Focus on Diverse Sources of Income
• Build Your Team• Lenders and Brokers First
• Develop Property Analysis Model• Income• Expenses• Debt Service• Cash Flow
• Property Analysis• Select Three Locations
• Acquire Property
References
• What Every Real Estate Investor Needs to Know About Cash Flow … and 36 Other Key Financial Measures--- Frank Gallinelli
• Millionaire Real Estate Investor--- Gary Keller
• Apartment Building Investing--Michael Blank Podcast
• BiggerPockets Podcast: Real Estate Investing and Wealth Building• https://www.biggerpockets.com/
• US Bureau of Economic Analysis
• Bureau of Labor Statistic (bls.gov)
• Demographics• http://www.city-data.com/• US Census Bureau
• Crime Data• http://www.neighborhoodscout.com/