Business Plan for New R.E. Investor

General Real Estate Investing
1

Hello,

I am just now beginning to invest in real estate. I am concerned about how to plan successfully for quitting my full-time job. If I quit to early I am worried that I may not be able to obtain financing to purchase investment deals. I’ve heard (and it makes sense) that many lenders will not lend to you without a job, unless they can show that you’ve invested in real estate successfully for two years. I am confident in myself and I know that I will be able to show this. But two years is a long time to stick with a job that I hate. does anyone have any other creative means. I am a beginner so I would need 24 more months of sucessful investing before I am able to apply for financing without a regular salaried job.

2

I am concerned about how to plan successfully for quitting my full-time job. Simple. Don’t quit.

If I quit to early I am worried that I may not be able to obtain financing to purchase investment deals.
If you quit, period, you may not be able to find conventional financing for your deals. Banks like to see pay stubs. You don’t get that with investing. If investing is your only source of income, then you have to supply your income tax returns to prove income. Besides the problem that I have with showing just anybody my tax returns, if you have a good CPA working for, you should NOT be showing much income (depending on your investing style) due to the tax advantages of owning real estate. Unfortunately, they don’t teach tax return reading to loan officers, so they will think that you don’t make anything.

two years is a long time to stick with a job that I hate. does anyone have any other creative means.
Yes, find something that you don’t hate so much. Many new potential REIer’s see real estate as a means to “quit the day job” or simply “not work.” Real estate is a business and must be run like a business to succeed.

A good guideline for when you may want to consider quitting your “day” job is when your REI income is 1.5 times your regular income. You’ll need that extra to offset the health insurance and other costs associated with owning/running a fulltime business.

Raj

3

If you’re self-employed, yes, all conventional lending institutions will want to see at least two years worth of tax returns proving that you’re not just a drug dealer.

You left out a lot of information. Do you plan on buying rental units such as duplex’s and 4 families? Single family homes? Do you plan on buying properties that need a rehab done before placing in service? Do you plan on holding onto these properties, or selling?

Are you looking to build worth via sweat equity (doing most of the work yourself or with partners/employees), or are you looking to be more passive and hire sub-contractors and/or a general contractor to do the work? If you’re doing the latter, why would you need to quit your day job at all? Your profits will be substantially smaller, but you’re also not doing any of the work.

If you plan on working on units yourself, do you have your own tools? I can tell you that you’ll need to spend at a bare minimum of $5000 in tools if you do not have them already.

With all that being said, I can tell you how I started. I started out by purchasing a two-unit duplex in a low-income area for all cash. It was only $25,000, but I also needed $20,000 to bring it up to a rentable condition. As I finished one unit, I immediately rented it out to begin generating income. It took a while as I really didnt have the cash to pay others, had no partners, and did all the work myself. Eventually it was done, though, and I had both units rented out at $565 a month (2/2 duplex). I still hadn’t been self-employed long enough for a bank to give me financing for another property, so I accessed the equity by refinancing. The rehabbed value was now $85,000 according to the appraisal by the bank, and they gave me 75% of that in cash, leaving 25% equity in the house. That amounted to $63750, which I promptly used to buy another 2/2 duplex for $39,000, leaving me money to fix it up. Again, I did it myself, and again, it was worth $85,000 upon completion.

You can see the trend.

Buy a property all cash
Fix it up.
Rent out, and refinance.
Buy another property with funds from refinance.
Fix it up.
Rent it out, and refinance.

Repeat.

Each property you finish will get you another $200 or so cash flow per unit per month. After 5 duplexs this begins to add up fast, as you’ll have an extra $2000 a month coming in as passive income. Passive income is how investors get wealthy, not through rehabbing and selling. Each month those tenants are paying your mortgage down a little further, andthe cash flow continues to grow.

A reason not to grow too fast in the beginning is that you’ll face something called “seasoning” by a bank. They want to see one full year of rental income reported on Schedule E (rental income form) from a property before they’ll consider it an “asset” of yours, rather than a liability. Until a property is seasoned most banks will not factor in any income generated by rents, and they’ll view the value of the unit as whatever you purchased it for, not the fixed up price.

Many investors top out at 4 properties, and this is one of the reasons.

It is good that you’re planning this thing out, though. Another thing you’re going to want to take into account is the tax ramifications of being self-employed. In addition to ordinary business income taxes, you’ll also pay 15.3% in Self Employment tax. There are whole books written on real estate taxes and deductions, and how best to structure your holdings as a landlord. This is also something you should learn about before quitting your day job.

If you’re really gung ho and do not have the cash, a hard-money lender will lend you money at a premium interest rate on a per property basis. (They wont just give you a line of credit or unsecured loan). This may help you get started until a conventional lender will finance you.

Another route may simply be to take out a HELOC (Home Equity Line of Credit) if you’re already a homeowner and have established an amount of equity or experienced a lot of appreciation since you purchased. A LOC (Line of Credit) is the most flexible and desirable option, as you only pay interest on the amount of money you currently have on the LOC, whereas if you refinance you must pay the interest on the entire amount loaned, even if you aren’t able to reinvest it all.

4

Thanks Raj for that information. I didn’t actually plan to quit my job until i started making more than what my salary was paying me, but I was still afraid of the lack of being able to secure financing. I know it is going to be hard work getting into this and maybe sticking with my job for two years is part of the sacrifice, but it just kills me day by day going in there and hating every minute of it. I appreciate the advice.

5

Hello,

Yes I plan on starting out buying single family homes and duplexes. I want to fix them up and refi to cash out some equity while renting it out to get some cash flow. I feel this is important not only for cash flow, but also for long-term asset appreciation. I do plan to do a little flipping later, but my primary focus will be fix, refi and rent out.

Also most of my work will be done by subcontracting - almost none done by me. I didn’t plan on quitting my job for lack of time, but simply because I hate it and want to get out of there.

I agree I need to get some books on the tax ramifications of real estate investing the whole thing is overwhelming to me. Do I form an s-corporation, etc, etc. ALOT of information.

Anyway, I guess I’ll be at my job for at least another 2 years. What about no doc loans?

Thanks so much.

6

You should also plan on asset protection like forming an LLC. Having an LLC where you are a managing member of should also be adequate proof of 2 years of self employment for bank financing. Once you have a successful track record it should be fairly easy for you to start getting private money from professionals that trust you.

Steve Cook says that if the deal is right you will NEVER have a problem financing it. There are a lot of people you can network with in your local REI club that would be happy to partner with you even if you do quit your job if you have an awesome deal. Most hard moneh lenders I work with invest in the deal, NOT you.

7

Hi REI Man,

Thanks for that well needed advice. Now excuse me if my questions are ignorant, but I am just started out here. Would you suggest an S Corp or an LLC or would I need both. What advantages does one hold over the other?

Thanks!

8

goto your local library and get a book out on LLC’s. Then ask your CPA.

Nolo - has great books on LLC’s and other business entities. Library is GREAT because it’s free.

Hey Visual - your post was very informative.

9

alsaxon,

Obviously, you shouldn’t even consider quitting your job anytime soon. The fact is that the vast majority of newbies in any business fail. Therefore, you need to become successful at your new REI business before you quit. The big problem with quitting isn’t that you won’t be able to get loans - the big problem is that you’ll go broke because you don’t have the income.

I have been very busy for the last couple months and haven’t posted much. In that short time, most of the posters on this site have changed. Why? Because newbies come and newbies go. A VERY SMALL PERCENTAGE of people who start out at REI ever run a full time REI business. Running ANY business is HARD WORK. If you’ve never been self-employed, I’d suggest planning on spending double the time with your new business for the next 5 years than you would spend at a regular job. Twelve, fourteen, or sixteen hour days are common for entrepreneurs. (I’ve been self-employed for about 15 years, so I know what I’m talking about)

Another big reason to keep your day job is that the popular “gurus” conveniently forget to tell newbies the truth about real world expenses. For example, the rental gurus tell you that you should take gross rents and subtract the mortgage payment, vacancy allowance, maintenance allowance, utilities, taxes, insurance, and management to get your monthly cash flow. This is exactly what visual underworld did in his post above. The problem is that this is an illusion. When you first start and only have a few rentals, you can convince yourself that these are the only expenses, but over time the real expenses become apparent.

For example, in Visual Underworld’s post, he had a duplex renting for $565 each side for $1130 total gross income. He claims to have $200 or so cash flow per side, but this isn’t right. Throughout the entire United States, operating expenses (including capital expenses) run about 50% of gross rents (yes, this includes you and me). So, in this example, real operating expenses are $565, leaving $565. Since Visual Underworld has a mortgage for $67,000, the mortgage payment is about $491 per month (30 year, 8%). That leaves a REAL positive cash flow of $74 per month or $37 per unit per month!!! OUCH!

Why can someone think that they are making $400 per month when they’re only making $74 per month? The answer is that when you first start, it takes time for all the real world expenses to show up. For example, with some work and a little luck your first tenants will stay for at least a few months and pay the rent. In my experience, about 90% of tenants are pretty good. So, if you only have 3, 4, or 5 units, it will can take quite a while to experience the bad 10%. However, as your business grows and you have 20, 30, or 50 units; you’ll be dealing with these bad apples every month. This happened to me when I started. The first year was nearly picture perfect. I believed the guru nonsense and thought that I was on the road to quick riches. HAH! I originally thought that 50 units would be enough to provide $10,000 per month positive cash flow (just as Visual Underworld said) - WRONG! As your business begins to grow and you see the real expenses, I realized that my profit projections were off by a factor of 2 and that it will take more like 100 units to make $10,000 per month.

Don’t get me wrong. I’m committed to my REI business and I’m well on my way to reaching my goal, but REI is nothing like the gurus promise. REI is just like any other business. If you’re willing to invest several years and work very hard, you can succeed. Don’t worry about quitting you day job anytime soon - it won’t happen!!!

Good Luck,

Mike

10

Alsaxon,

Go to this site: http://www.pattarr.com/Contents/Container.aspx?ii=202
Or do a google search for Asset protection. There is enough info out there for you to learn about S-Corp and LLC

I would recommend you talk to a corporate attorney or one who deals with corporations to find out more info and NOT a CPA since their agenda is different. Attorney would be interested in protecting you and your business and to defend you when you’re attacked legally where a CPA would be interested in getting constant business from you. I have nothing against CPAs and I have a good one but I think they are used just to do the books and not give you legal advice.

11
You can see the trend.

Buy a property all cash
Fix it up.
Rent out, and refinance.
Buy another property with funds from refinance.
Fix it up.
Rent it out, and refinance.

Repeat.

hasn’t this strategy been running alot of investors into trouble as of late since values are dipping and owners refied and put the money elsewhere?

12

I use this strategy and it is fine for me…values here are still on the increase, though. As interest rates rise, the rental pool increases, too…you make your money going in, not in the middle or coming out! If you buy right to begin with, there will be ‘room’ in the deal for market corrections.

Keith

13

keith, could you explain that a little more. Thats vague a confusing to a noob like me.

thanks

14

phatman5,

Keith is talking about Buying Right. Real Estate Investing is all about buying it right which means you make your profit on the purchase of the property. In other words you buy properties way below fair market value (20% - 30% below value) so you have equity in the property going in. Buying property and WISHING/HOPING for appreciation is ridiculous and you might as well take your money to Vegas and play craps or roullette.

If the market values in the area go down you will have enough equity in the property to still sell it below what you projected and still make a profit. It’s highly unlikely that ANY area will drop 20% in value overnight but if you see a decline you will be able to react accordingly and still make a profit. This minimizes the RISK involved in most real estate investing.

I hope this is clear enough for you.

Also, good materials to learn about Real Estate Investing are (cheapest ways I know).
The Millionaire Real Estate Investor by Gary Keller
E-Myth by Michael Gerber (for your business development)
Motivate Seller Magnet by Ben Innes-Ker (Marketing is the key to ANY business)
Wholesaling for Quick Cash by Steve Cook (How to “buy it right”)

These above are the cheapest ways to get started in REI that I know of and what I’ve already done. I have also read Robert Kiyosaki’s books - Rich Dad, Poor Dad and Cashflow Quadrant. I also have Larry Goins Ultimate Buying and Selling Machine (my most expensive purchase but well worth it since it organizes your business processes).

You should prepare yourself for Continuous education as you grow as a Real Estate Investor.

15

REIMan is correct about what I said. If you buy at 70-80% of market value and property values drop, you’re still OK…if you pay 100% of retail and the market drops 15% you get ‘whacked’…

When I buy, I buy low and for cash. I fix the property up (mostly ‘heavy cosmetics’ – paint, new floring, maybe some new cabinets/vanities, etc.), then I put a renter in the property and then do a cash-out refinance based on the fixed up value. Because I bought low and did some improvements, I can refi for 80% of the new value and get all or most of my working capital (CASH!) back out and then do it over again. On the last one that I did like this, when the dust cleared I had:

(1) The property
(2) A 20%+ equity position
(3) All but $2500 of my cash back out
(4) A Positive Cashflow of over $250 a month. $250 a month = $3,000 a year so my cash-on-cash return for this property is 120% a year.

Now, go to the bank with $2500 and tell them you’d like to deposit it in their institution and tell tehm that you want 120% interest and see what they say!

Keith

16

Great explanations, thanks so much!

I guess (outside of the neighborhood I live in and ones surrounding it) I am not familiar with the FMV of properties that I see for sale on MLS and in the papers. Just something I need to get acquainted with.

17

IMO, you absolutely, positively need to know and have an appreciation for property values in your target area!

Keith

18

OK Let me restate what I mean by “WISHING/HOPING for appreciation”.

Yes, making sure you are investing in appreciating areas historically are better then investing in areas that are not appreciating but it should be treated as the “icing on the cake” or the “unexpected increase in equity/profit”. But to base your entire strategy on appreciation ALONE is not a good investment. There are alot of so called investors that have done great and got LUCKY by using that strategy but this is where it stops, it’s NOT repetitive and there is NO Contract clause that anyone will give you that guarantees it so all you’re doing is speculating, forecasting or trying to predict the future. I receive the foreclosure list and I know many other investors actually OVERPAID for homes because they were predicting future appreciation and were willing to pay more then the appraised value fo the home. Now that property is in foreclosure and they are pratically RUINED as investors or they have to start all over again and rebuild their credit.