A fast back-of-the-envelope (BOE) calculation can help investors decide whether to proceed with a potential property renovation project or whether to walk away
A BOE will quickly show you if there's money to be made from an investment, or if you've entered a no go zone - that the property you're looking at is never going to make money.
Some of our best deals are those we've walked away from thanks to the BOE.
So what should you include in your BOE?
First, you need to work out the cost of buying and renovating the property. We advocate that your renovation costs should be less than 10 per cent of the purchase price.
When calculating costs, make sure you include stamp duties, insurance, bank interest during the renovation, contingencies in case of delays and marketing costs if you intend to sell when you're finished. In the latter case, you should also make allowances for tax.
You then plan what you'll do with the property. Let's say you'll add value by creating an extra bedroom under the existing roofline. You'll polish the floors, paint inside and out, replace the kitchen and re-tile the bathroom.
With that in mind, research the value of properties in the area of comparable standard to the project you intend to complete.
The BOE will tell you if you're buying a renovator or a ruin-maker..
Download my Property Analysis Tool for more detailed cashflow analysis.
Tuesday, February 23, 2010
When selling, presentation trumps renovation
Property sellers are better to concentrate on the presentation of their home rather than trying to renovate before they sell.
Renovators risk overcapitalising unless they know what they're doing, recalling one home where the owner spent $60,000 putting in a new pool, hoping it would boost her sale price substantially. She only received $30,000 more for the property.
The most financially successful jobs are smaller-scale, lower-cost renovations that improve the exterior appearance of homes.
Street appeal is king. Many people do a 'drive by' before looking inside. It's much easier to sell a house that looks good on the outside than vice versa. People make up their mind before they get to the front door whether or not they like a property.How the property looks from the outside is more important than ever.
A great-looking facade will increase the positive experience when the buyer is making enquiries.
I recommend the following five tips for anyone thinking about renovating before listing their home for sale:
1. It's better to focus on presentation rather than renovation. Getting professional advice from a property stylist will give a better result.
2. Simple things like moving furniture, extra lighting, adding artwork and cushions will improve resale value.
3. Renovations will always cost more and take longer than you budget for.
4. Don't just design what you like. If the idea is to sell it at the end, you must cater for the local market.
5. Talk to a local real estate agent to find out what price bracket you should keep the final product under (i.e. don't overcapitalise).
Download my latest guide on Landlord Best Practice
Renovators risk overcapitalising unless they know what they're doing, recalling one home where the owner spent $60,000 putting in a new pool, hoping it would boost her sale price substantially. She only received $30,000 more for the property.
The most financially successful jobs are smaller-scale, lower-cost renovations that improve the exterior appearance of homes.
Street appeal is king. Many people do a 'drive by' before looking inside. It's much easier to sell a house that looks good on the outside than vice versa. People make up their mind before they get to the front door whether or not they like a property.How the property looks from the outside is more important than ever.
A great-looking facade will increase the positive experience when the buyer is making enquiries.
I recommend the following five tips for anyone thinking about renovating before listing their home for sale:
1. It's better to focus on presentation rather than renovation. Getting professional advice from a property stylist will give a better result.
2. Simple things like moving furniture, extra lighting, adding artwork and cushions will improve resale value.
3. Renovations will always cost more and take longer than you budget for.
4. Don't just design what you like. If the idea is to sell it at the end, you must cater for the local market.
5. Talk to a local real estate agent to find out what price bracket you should keep the final product under (i.e. don't overcapitalise).
Download my latest guide on Landlord Best Practice
Tuesday, February 9, 2010
Isn’t Rehab and Keep It the smarter option?
I got this great question from a member of my discussion board. The question went something like this;
Why keep property after it’s rehabbed? Why not just sell it after the rehab and GET PAID!
Well, it depends, like so many things. It will come down to an investor’s decision.
I want to present a different way of thinking about this decision. My position is essentially this: If you don’t have an urgent need for quick cash, you’ll make more money by hanging onto the property. In most cases you can generate the most short term cash by selling a pretty, like new, rehabbed house. There are downsides though, such as giving much of it away in taxes come next April.
If you keep it, you stand to make quite a bit more! In addition, you get to enjoy some killer benefits such as a tax break, cash flow, and a nice payday once you eventually sell the property thanks to natural appreciation. Most times you stand to make some cash within a few months of buying the property when you refinance the property out of your hard money (at 70% loan-to-value) to long term financing (at 85% or 90% loan-to-value). Refinancing will have to wait until after you’re finished with the rehab, and most lenders insist on it being occupied by a renter before approving the refinance.
As you’ll see in the below example, a rehab real estate investor will make considerably more by holding onto a property. But, it’s not all wine and roses. You have to be a landlord, and you have to decide if you want to do that. Some folks refuse to be a landlord. I personally think it can be done correctly on my own, or I can hire someone to do the day-to-day administration. The difference in money over time is substantial enough that it behooves me to figure out how to landlord, or hire someone to do it for me.
Let me illustrate the difference in profit between rehabing and selling, and rehabbing and renting types of investing with an example;
First we have to make some assumptions. Let’s assume appreciation is 5% in your area and the average price of a rehabbed property is $100,000. Let’s also assume there are two real estate investors named John and Mike.
John sells his properties right after rehabbing and makes around $15-18,000 per house.
Mike hangs onto his rehab projects and cash-out refinances, and usually pulls out $10,000 per house within 3-6 months of owning. (Mike trades his 70% loan-to-value (LTV) ratio hard money for long term, 30-year mortgages at a lower interest rate with an 85-90% loan-to-value ratio. The difference between what it costs him to pay off the hard money and the new mortgage goes into his bank account. (Again, around $10,000 per property.)
John (rehab and sell) makes a great living by all standards. Ten houses per year is $150,000-$180,000 per year…nice cash! The downside is that John has to maintain a steady flow of rehabbed properties to maintain his standard of living year-after-year. He also pays taxes on all that money as regular income (ouch!) because of the short time he owns them… So his $150,000 per year is somewhat less after the IRS takes their cut.
Mike (the rehabber) makes a great living as well. Ten houses per year nets him $100,000 in tax free, spendable cash. Mike controls a million dollars in real estate and it’s going up in value as time passes. Mike pays no taxes on that money he nets from the cash-out refinances. Since it’s part of a mortgage, it must be paid back eventually and it not considered income! That’s the best part!
Let’s look at what Mike’s doing year-by-year.
If Mike bought 10 houses this year valued at $100,000 each, he owes $90,000 on each one (after the 90% cash out refinance), so he controls $1,000,000 in property. If he keeps them 5 years (assuming a low appreciation rate…which is pretty conservative):
Purchase year – 10 houses x $100,000 = $1,000,000
Year 1 – Same 10 houses X $105,000 = $1,050,000
Year 2 – Same 10 houses X $110,250 = $1,102,500
Year 3 – Same 10 houses X $115,762 = $1,157,620
Year 4 – Same 10 houses X $121,550 = $1,215,500
Year 5 – Same 10 houses X $127,627 = $1,276,270
Essentially, Mike makes an extra $50,000 per year for hanging onto and renting 10 properties. That’s almost like making $50,000 for waking up! If he sells them after 5 years of ownership, he puts $276,000 in his pocket.
Things to keep in mind with this example…
• There are areas of the country that appreciate much faster than 5%. Some areas will double in value in the next 5 years!
• I did not include the tax advantages of owning an extra ten homes in this example. That equates to thousands of dollars in real income each and every year.
• This example runs the numbers for a single ten-house year. What if you want to “top out” at owning 40 properties. In a few short years your buying can slow down to a trickle and you can start selling and cashing out of properties. How many ten-house years to you need before you have attained your financial goals?
• Forget the 5 year hold. What if you hold these houses 10 years? The numbers get pretty crazy!
I don’t want to work forever. You probably want to reach a point where you won’t HAVE to do too much unless you want to. If so, holding properties for a few years makes a lot of sense, especially if you don’t have much personal money invested in them.
So what of John? I suspect that John will come around and start holding properties once he satisfies his urgent need for cash.
To try my latest Property Software or to become an Affiliate goto Property Pro
Why keep property after it’s rehabbed? Why not just sell it after the rehab and GET PAID!
Well, it depends, like so many things. It will come down to an investor’s decision.
I want to present a different way of thinking about this decision. My position is essentially this: If you don’t have an urgent need for quick cash, you’ll make more money by hanging onto the property. In most cases you can generate the most short term cash by selling a pretty, like new, rehabbed house. There are downsides though, such as giving much of it away in taxes come next April.
If you keep it, you stand to make quite a bit more! In addition, you get to enjoy some killer benefits such as a tax break, cash flow, and a nice payday once you eventually sell the property thanks to natural appreciation. Most times you stand to make some cash within a few months of buying the property when you refinance the property out of your hard money (at 70% loan-to-value) to long term financing (at 85% or 90% loan-to-value). Refinancing will have to wait until after you’re finished with the rehab, and most lenders insist on it being occupied by a renter before approving the refinance.
As you’ll see in the below example, a rehab real estate investor will make considerably more by holding onto a property. But, it’s not all wine and roses. You have to be a landlord, and you have to decide if you want to do that. Some folks refuse to be a landlord. I personally think it can be done correctly on my own, or I can hire someone to do the day-to-day administration. The difference in money over time is substantial enough that it behooves me to figure out how to landlord, or hire someone to do it for me.
Let me illustrate the difference in profit between rehabing and selling, and rehabbing and renting types of investing with an example;
First we have to make some assumptions. Let’s assume appreciation is 5% in your area and the average price of a rehabbed property is $100,000. Let’s also assume there are two real estate investors named John and Mike.
John sells his properties right after rehabbing and makes around $15-18,000 per house.
Mike hangs onto his rehab projects and cash-out refinances, and usually pulls out $10,000 per house within 3-6 months of owning. (Mike trades his 70% loan-to-value (LTV) ratio hard money for long term, 30-year mortgages at a lower interest rate with an 85-90% loan-to-value ratio. The difference between what it costs him to pay off the hard money and the new mortgage goes into his bank account. (Again, around $10,000 per property.)
John (rehab and sell) makes a great living by all standards. Ten houses per year is $150,000-$180,000 per year…nice cash! The downside is that John has to maintain a steady flow of rehabbed properties to maintain his standard of living year-after-year. He also pays taxes on all that money as regular income (ouch!) because of the short time he owns them… So his $150,000 per year is somewhat less after the IRS takes their cut.
Mike (the rehabber) makes a great living as well. Ten houses per year nets him $100,000 in tax free, spendable cash. Mike controls a million dollars in real estate and it’s going up in value as time passes. Mike pays no taxes on that money he nets from the cash-out refinances. Since it’s part of a mortgage, it must be paid back eventually and it not considered income! That’s the best part!
Let’s look at what Mike’s doing year-by-year.
If Mike bought 10 houses this year valued at $100,000 each, he owes $90,000 on each one (after the 90% cash out refinance), so he controls $1,000,000 in property. If he keeps them 5 years (assuming a low appreciation rate…which is pretty conservative):
Purchase year – 10 houses x $100,000 = $1,000,000
Year 1 – Same 10 houses X $105,000 = $1,050,000
Year 2 – Same 10 houses X $110,250 = $1,102,500
Year 3 – Same 10 houses X $115,762 = $1,157,620
Year 4 – Same 10 houses X $121,550 = $1,215,500
Year 5 – Same 10 houses X $127,627 = $1,276,270
Essentially, Mike makes an extra $50,000 per year for hanging onto and renting 10 properties. That’s almost like making $50,000 for waking up! If he sells them after 5 years of ownership, he puts $276,000 in his pocket.
Things to keep in mind with this example…
• There are areas of the country that appreciate much faster than 5%. Some areas will double in value in the next 5 years!
• I did not include the tax advantages of owning an extra ten homes in this example. That equates to thousands of dollars in real income each and every year.
• This example runs the numbers for a single ten-house year. What if you want to “top out” at owning 40 properties. In a few short years your buying can slow down to a trickle and you can start selling and cashing out of properties. How many ten-house years to you need before you have attained your financial goals?
• Forget the 5 year hold. What if you hold these houses 10 years? The numbers get pretty crazy!
I don’t want to work forever. You probably want to reach a point where you won’t HAVE to do too much unless you want to. If so, holding properties for a few years makes a lot of sense, especially if you don’t have much personal money invested in them.
So what of John? I suspect that John will come around and start holding properties once he satisfies his urgent need for cash.
To try my latest Property Software or to become an Affiliate goto Property Pro
Monday, February 1, 2010
Property Development Risk Management.
Risk
If the property to be developed is currently owned by a discretionary family trust and the trust also owns other valuable assets, you should look at strategies to protect the other assets and ensure that the development vehicle is a separate entity.
Also, if an individual owns significant assets, it may not be prudent to appoint the individual as a director of the development company as it may expose the director’s personal assets to potential claims.
Return
If the borrowings will be in your name and the developer is essentially being 'free carried', your return should reflect the extra risk you assume by carrying the debt.
Also, as you own the property, there will be inherent risks associated with your ownership, which should also be factored into the profit and risk sharing arrangement.
Funding
If you use the loan funds to initially pay down the loan on your private residence and redraw the funds from the home loan to fund the development expenses as they are incurred, the interest on both the development loan and home loan will need to be apportioned for tax purposes.
As the bank is usually the primary secured creditor behind the project, it will be important to limit its recourse against your personal assets as much as practicable.
Structure
If you don't wish to be liable for acts done by the developer, you'll need to ensure that you and the developer are not parties to a common law partnership.
The absence of a common law partnership doesn't necessarily mean that there is no partnership for taxation purposes. In fact, the income tax and GST law specifically broaden the definition of a 'tax partnership' to include arrangements where parties are jointly in receipt of income.
Ownership
If a partnership is established and you're the landowner, you'll need to be careful that the formation of the partnership doesn't inadvertently cause you to dispose of some of your interest in the property.
Under an unincorporated joint venture, you as the landowner may continue to own the property in your name and enter into a joint venture agreement with the developer. Rather than having a direct interest in the property, the developer will merely be rendering property development services to you in return for a bundle of fees.
Taxation
If the property developer borrows money in their own name to fund the development project, you as the landowner won't be able to directly claim a tax deduction on the interest.
The tax costs of a project may also be affected by the type of entities used in the structure. For instance, if a unit trust is used to undertake the development project, the unit holder should perhaps be a discretionary trust, which has the flexibility of distributing any income from the unit trust to an entity that pays tax at a lower marginal tax rate.
Exit strategy
It's important to provide an exit strategy so that the parties may bring the arrangement to an end without bringing about unintended commercial and taxation outcomes.
For cost effective property management software I recommend the software I use Property PRO
To your success,
Mike
If the property to be developed is currently owned by a discretionary family trust and the trust also owns other valuable assets, you should look at strategies to protect the other assets and ensure that the development vehicle is a separate entity.
Also, if an individual owns significant assets, it may not be prudent to appoint the individual as a director of the development company as it may expose the director’s personal assets to potential claims.
Return
If the borrowings will be in your name and the developer is essentially being 'free carried', your return should reflect the extra risk you assume by carrying the debt.
Also, as you own the property, there will be inherent risks associated with your ownership, which should also be factored into the profit and risk sharing arrangement.
Funding
If you use the loan funds to initially pay down the loan on your private residence and redraw the funds from the home loan to fund the development expenses as they are incurred, the interest on both the development loan and home loan will need to be apportioned for tax purposes.
As the bank is usually the primary secured creditor behind the project, it will be important to limit its recourse against your personal assets as much as practicable.
Structure
If you don't wish to be liable for acts done by the developer, you'll need to ensure that you and the developer are not parties to a common law partnership.
The absence of a common law partnership doesn't necessarily mean that there is no partnership for taxation purposes. In fact, the income tax and GST law specifically broaden the definition of a 'tax partnership' to include arrangements where parties are jointly in receipt of income.
Ownership
If a partnership is established and you're the landowner, you'll need to be careful that the formation of the partnership doesn't inadvertently cause you to dispose of some of your interest in the property.
Under an unincorporated joint venture, you as the landowner may continue to own the property in your name and enter into a joint venture agreement with the developer. Rather than having a direct interest in the property, the developer will merely be rendering property development services to you in return for a bundle of fees.
Taxation
If the property developer borrows money in their own name to fund the development project, you as the landowner won't be able to directly claim a tax deduction on the interest.
The tax costs of a project may also be affected by the type of entities used in the structure. For instance, if a unit trust is used to undertake the development project, the unit holder should perhaps be a discretionary trust, which has the flexibility of distributing any income from the unit trust to an entity that pays tax at a lower marginal tax rate.
Exit strategy
It's important to provide an exit strategy so that the parties may bring the arrangement to an end without bringing about unintended commercial and taxation outcomes.
For cost effective property management software I recommend the software I use Property PRO
To your success,
Mike
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