5 Magic Paths to. in Real Estate. Making a Fortune JAMES E.A. LUMLEY. John Wiley & Sons, Inc.

Transcription

1 5 Magic Paths to Making a Fortune in Real Estate S E C O N D E D I T I O N JAMES E.A. LUMLEY John Wiley & Sons, Inc.

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3 5 Magic Paths to Making a Fortune in Real Estate S E C O N D E D I T I O N JAMES E.A. LUMLEY John Wiley & Sons, Inc.

4 Copyright 2000, 2004 by James Lumley. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) , fax (978) , or on the web at Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) , fax (201) Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. The publisher is not engaged in rendering professional services, and you should consult a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services please contact our Customer Care Department within the United States at (800) , outside the United States at (317) or fax (317) Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at Library of Congress Cataloging-in-Publication Data: Lumley, James E. A. Five magic paths to making a fortune in real estate / James Lumley. 2nd ed. p. cm. Includes index. ISBN Real estate investment United States. 2. Real estate business United States. I. Title: 5 magic paths to making a fortune in real estate. II. Title. HD255.L '24 dc Printed in the United States of America

5 CONTENTS Preface Acknowledgments Introduction Introduction to the Second Edition xiii xv xvii xxi 1 Five Magic Paths to Making a Fortune in Real Estate 1 The Five Magic Ways to Wealth 1 Now It s Time to Make Real Money 5 Guidelines for Getting Started 6 Combine Techniques to Ensure Success 6 Before You Roll Up Your Sleeves 7 Take Some Measurements of Your Market 8 Magic Paths FAQs 9 2 Making Money with Fixer-Uppers 12 The Fix-Up-and-Sell Strategy 12 Buying a Fixer-Upper 13 Seek Fixer-Uppers in All Price Levels 15 You May Wish to Live in Your Investment 16 Eight-Point Checklist for Making Money with Fixer-Uppers 17 Some Bargaining Ideas 19 Rehabbing: Frequently Asked Questions 20 iii

6 iv Contents 3 Finding the Fixer-Upper Bargain 25 Mining for Gold: Target a Neighborhood 25 Find Sellers with Neglected Properties 27 Screen the Seller s Motivation Using the Telephone to Advantage 28 Ways to Find Sellers 30 Don t Overlook Out-of-State Owners 33 You re Ready to Meet the Seller at the Property 33 Seek Houses through MLS or the Internet 34 Get Agents to Bird Dog Property for You 37 Have a Contact System for Agents and Prospects 37 When You re Offered a Group of Houses 38 It s All about Prospecting 39 4 Finding Foreclosed, Repossessed, or Condemned Property 40 The Perils and Rewards of Buying at Foreclosure 40 Finding Properties before Actual Foreclosure 42 Step In and Negotiate before the Foreclosure 43 Solving the Problems of a Homeowner Facing Foreclosure 43 Taking Over a Qualifying Foreclosure 44 Getting Started with Your First Auction Foreclosure 45 Deciding Whether a Deal Is Good 46 Some Reminders on Foreclosures 48 When the IRS Has a Lien on Property Being Foreclosed 48 Get Acquainted with Auction Procedure 49 Getting an REO from the Bank 50 Use Your Repair Estimate to Drive the Price Down 51

7 Contents v Find Condemned Houses in Respectable Neighborhoods 54 5 Repairs That Make You the Most Money 57 Start by Getting Accurate Estimates 58 Four Broad Areas of Repairs 58 Six Major Areas of Inspection and Repair 59 From Preliminary Outline to Finalized List 60 A First Priority: Arranging Time for the Repair Estimation 64 Early Inspections Avoid Problems Later 64 Typical Repairs You May Encounter 65 What Repairs to Avoid 66 Always Solve Code Violations 66 Getting to Know the Bricks and Mortar, or, The More You Know, the More You ll Earn 67 Special Problem of Dealing with a Cracked Foundation 69 Another Common Rehab Problem: Fire Damage 72 Six-Point Checklist for Fixing Up 72 6 Valuing Properties Is the Key to Profits 74 Judging the After Repairs Value 74 Repair Costs Lead to Finding Value 75 Getting Started in Valuing Houses 76 You Start by Finding Comparable Properties with Recent Sales 77 Doing a Mini-Appraisal 78 What to Consider in Determining Value 79 Making Adjustments to Equalize Value 80 Features to Adjust in the Mini-Appraisal 83 Pricing Adjustments Accurately Improves with Experience 85 Make Sure Comparable Sales Are Arm s-length Transactions 85 Neighborhood Prices Tend to Cluster 86

8 vi Contents 7 Negotiate to Get Your Offers Accepted 87 How Much Profit Do You Take? 87 How to Determine Maximum Offer Price 89 Now That You Know Your Limit, Where Do You Start? 91 Use Repair Costs to Convince the Seller 94 Be Ready to Walk Away If No Solution 97 Make Offers on a Regular Basis 97 Seven-Point Strategy to Get Your Offers Approved 98 Always Use Contingent on Financing Clause Wholesale Property for Steady Gains 103 What Are the Basics of Wholesaling, or Flipping, a Property? 103 Getting Started with Wholesaling 104 Advice for a Newbie! 107 Searching for a Property to Flip 108 To Whom Do You Wholesale? 109 Run an Ad to Attract Investor-Buyers 110 Make Sure Your Wholesale Buyers Have Cash or Credit Line 110 Finding Cash Buyers for Wholesale Property 111 It s All about Establishing Relationships 112 Why a 3% to 8% Profit in Wholesaling Fixer-Uppers? 113 Contract Provisions for Wholesaling 113 Using Two Contracts to Separate Seller and Buyer 115 Problems and Solutions in Wholesaling Financing I: Working through Conventional Lenders 119 The Differences between Home and Investment Mortgages 119

9 Contents vii Down Payment and Closing Costs 120 Shop for Mortgage Loans 120 What Types of Mortgages Are Available? 121 Comparing Different Mortgages 122 Two Ways to Qualify for Fixed Rate Loans 123 Second Mortgage Financing from a Conventional Lender 123 Cash from a Home Equity Credit Line 126 Be Prudent in Risking the Equity in Your Home 129 Using a Blanket Mortgage to Cover the Down Payment 129 Consider a Construction Loan to Finance Repairs 130 Credit with a Commercial Bank Is Better than Gold 131 Rehabbing through the FHA 203(k) Loan 131 Fannie Mae HomeStyle Loan Financing II: Help from the Seller 136 Secondary Financing from the Seller 136 Seller Financing with Second Mortgage 137 When Seller Financing Is All That s Available 138 What No Money Down Really Means 138 Buying Subject to and Assuming an Existing Mortgage 139 Problems of Buying Subject to 141 Takeover with Management Agreement and Escrowed Deed 143 Using a Land Trust 143 Using Credit Cards to Help with Down Payment 144 Word of Warning 145 Title I Loan Guarantee 145 Questions and Answers on Financing 146 A Final Note 148

10 viii Contents 11 Lease/Options I: Arranging Rent-to-Own with Tenant-Buyers 150 Be a Matchmaker 152 Owner s Reasons to Participate in Lease/Option Are Varied 155 Make the Lease/Option Appeal to the Seller 155 Making a Lease/Option Offer 156 Doing the Typical Lease/Option Deal 158 Your First Lease/Option Deal 161 Making Sure You ve Got a Great Deal 162 Five Ways to Find Tenant-Buyers 165 Use a Lease/Option to Take a House with Little Equity 166 A Final Note: Keep a Working Relationship with Your Agent Lease/Options II: Arranging Contracts and Closings with Tenant-Buyers 168 Structuring a Safe Lease/Option 168 Advanced Techniques Use Lease/ Purchase/Option to Sell Fixer-Uppers for Best Price 169 What Is the Difference between an Option and an Agreement to Purchase? 172 What Should Be in Lease/Option and Lease/Purchase Agreements 174 Keep Your Right to Assign Contract with Owner 176 Whom Do You Make Responsible for Repairs? 177 When Your Tenant-Buyer Wants to Change the Terms 177 Making Sure the Lender Accepts Rent Credits 178 Does a Lease/Option Trigger a Due-on-Sale Clause in the Mortgage? 179

11 Contents ix Working Out a Simultaneous Closing 180 With Sellers You ve Got More than One Arrow in Your Quiver Buy-and-Hold I: The Single-Family 182 Buy and Sell, or Buy and Hold 182 The Buy-and-Hold Strategy 183 Buying and Renting Out the Single-Family 183 Using Quick Ratios to Value the Single-Family Rental 184 The Five Tools That Lead to Wealth 187 A Capital Gains Tax Review 189 Maintaining Investor Status with the IRS 190 Exchange of Property to Preserve Long-Term Gains 191 One Indispensable Tool The Financial Calculator 192 Example A: The Time Value of Money 193 Example B: Accumulated Interest and Loan Balance after a Specified Payment 195 Example C: Buying a Rental House 195 The Present Value of an Investment Buy-and-Hold II: The Multifamily 198 Why the Multifamily Is a Great Long-Term Investment 198 Target Properties That Throw Off Cash 200 Create an Accurate Income and Expense Statement 201 Start by Researching Rents, Vacancy Rate, and Expenses 201 Net Operating Income Is Basis for Establishing Value 208 Working with the Capitalization Rate 208 Cap Rate Is a Function of Building s Age and Condition 210

12 x Contents 15 Finding the Value of an Income Property 213 A First Deal: Using Cap Rate to Peg Value 213 You Really Want to Know How Much Cash Is Left Over 217 Valuing Future Income Discounted Cash Flow Analysis 217 Discounting Cash Flow after Financing 219 Internal Rate of Return 221 Depreciation and Interest Deductions Determine Your Taxable Income 223 Your Cash Flow after Taxes Making the Offer on the Multifamily 228 Beware of Gross Rent Multiplier 228 Using the Capitalization Rate to Know What to Offer 229 Again, Once You Decide to Buy, Make Two Offers 230 Deciding to Buy or Not to Buy 232 If It s Not Worth Selling, It s Not Worth Buying 236 Raising Rents Leads to More Value 243 Working with Agents on Multiunit Deals Financing the Multifamily 247 Cash and Skills Help Gain a Conventional Loan 247 Knowing the Lender s Guideline The Debt Coverage Ratio 248 Getting the Seller to Finance 249 After a Conventional Lender Takes the First Mortgage 249 Tax Law Promotes Seller Financing with an Installment Sale 250 Using a Land Contract to Bypass the Bank 254 Take Over a Large Mortgage 255

13 Contents xi How Long Do You Want Your Mortgage to Run? 257 Accelerated Mortgage Payments in Perspective 258 Some Financing Guidelines 259 More Creative Techniques to Make a Deal Work 260 The Roth IRA 263 When Taking In a Partner Can Make More Profit Managing Your Property 266 First Time Out: Be Your Own Landlord 266 What a Property Manager Does 267 Getting Good Tenants 269 A Landlord s Primer 269 When All Else Fails: Removing Late-Paying Tenants 273 On Looking for a Good Property Management Company 276 Your Liability as a Landlord 276 Limit Your Loan Liability to the Property 277 Should You Form a Corporation or Limited Partnership? The Magic Formula for Success: Use Flexible Strategies 279 Be Flexible Profit with Different Strategies 279 Choose the Best Technique to Create Wealth 280 Before the Finish Use an Attorney 281 Plan Ahead to Reduce the Risks of Real Estate 282 Knowledge Gives You Confidence 282

14 xii Contents Let People Know You Deal in Property 283 Work Hard to Become Known How You Benefit from the New Tax Law 285 Recent Tax Laws Keep Dollars in Your Pocket 285 Sheltering Taxable Gains from Your Home 286 Using the Gain Exclusion with Multiple Residences 288 Tax Rules for Second-Home Ownership 289 Should You Turn Your Own Home into an Investment Property or Sell It? 291 Are You a Dealer or an Investor? 293 The Tax-Deferred Starker Exchange 295 Combining the Exchange with the Exclusion 299 A Final Note 300 EPILOGUE Success Is Not about Education, or Even Hard Work It s about Following Through 302 TIPS TO REMEMBER 303 FINAL THOUGHTS 305 Index 307

15 PREFACE Five Magic Paths to Making a Fortune in Real Estate was written to help the beginning investor or anyone else interested in buying and selling real estate. The price of this book is modest compared to the cost of expensive courses and seminars, but the information here is straightforward and reliable. In this book, you re not going to be told you need to go in hock, sell your firstborn, or go to the limit on your credit cards in order to get started. You re not going to learn the latest technique to cram your deal down a seller s throat. Instead, you ll learn the basics of different ways of investing in property, the mechanics involved, methods of valuing property, how to negotiate a fair deal, and above all, how to make a profit. There comes a time when we realize we ve talked and dreamed about improving our financial position in life and never really put out any real effort to do so. That time came for me many years ago when I first attended courses on commercial and investment real estate sponsored by the National Association of Realtors the NAR. I can still remember the legendary instructor Jay Levine energetically instructing the neophytes in what seemed to us then the esoterics of capitalization rates and discounted cash flow. I bought my first apartment building in the late 1960s, and I owned outright or participated in ownership in a number of other buildings over the years. I also managed property. I ve fixed property up and resold it, and I ve wholesaled single-family houses. As a broker, I ve helped investors lease/purchase and exchange property. In recent years I ve consulted, encouraging and bringing others into the various aspects of the real estate business. This book comes from my years of experience as well as that of many others who are actively practicing today the different techniques we ll explore in this book. All the examples used in the Five xiii