Checkers vs Chess in Real Estate

While my record as a listing agent is second to none with a 107% average sale above listing price, I spend 80% of my time as a buyer’s agent. Why? Because a) we’re in a seller’s market, b) buyers tend to be younger than sellers so that c) buyers search the Internet for good information and find my blog. Therefore, you can bet I’ve talked to enough first- and second-time investors to understand the weight that this decision has on their livelihoods, futures, and all the work they’ve put into getting where they are now: at the cusp of climbing America’s class structure.

That’s why I take it so personally when a listing agent or her seller messes around in order to earn an extra $5,000 or 0.5% on their purchase price. For the seller, it’s an extra $5k. For my buyer, an entire life’s savings or inheritance is at risk. My job as an agent both on the listing and buyer’s side always involves considering my client’s larger financial picture and advising according to life plans. You can’t discuss a real estate decision without thinking about a client’s daily life and goals. It’s not a stock or bond; it’s a living, physical, very expensive investment that takes care and attention, and affects tenants’ lives directly.

So why the rant? I’ve been an agent for multifamily and single family residential real estate for four years now. Speaking honestly, there aren’t many Princeton graduates who become realtors – if I skipped college altogether I could make as much money as I do now. Real estate came into my life because of the larger picture: retiring early from my real estate investments. Most residential realtors aren’t business-minded in that way and understand that a lot of pounding pavement and making neighborhood connections and self-marketing could earn them a six-figure salary. I’m not that kind of realtor, and I never intended to be. So when a long-time realtor invokes her 20 years of experience and justifies her backhanded and illegal move by claiming “her client’s interests,” I bite my tongue while in the background I call the guild lawyer and prepare for every chess move. (I can beat you at chess. Especially if that chess game involves nuances of Southern California’s standard purchase contract.) You may have been in practice for the past twenty years but the contract has changed 10 times in the last four.

The thing is, while I never worry when it comes to my client’s legal and leveraged position since I set them up right, for a buyer, any sign of less than reputable action by the seller’s side can set nerves aflame. Buyers have enough to worry about from the property condition to title to their loan. It’s an emotional time for most buyers, and it’s easy to forget that real estate is one of the oldest businesses whose barrier to entry involves no morals nor reputation nor license. While an agent requires a license, if she is acting on her “client’s interest” she could attempt anything and justify it as such. 

When I’m selling a property, the reputation of the agent is one of the biggest qualifiers for an offer. When I’m buying, the due diligence period and the property must speak for itself. Though an agent’s checkers tactics don’t work in a game of chess, I’d rather not play games at all and work together in order to give our clients the best possible transaction experience.

On that note, I’d like to name several agents and colleagues with whom I’ve worked who have been stellar partners in this endeavor, while truly representing their clients’ best interests (in chronological order): Carlos Skubacz, Donna Rue, Francesca Zummo, Yolanda Gomez, Gavin Fleminger, Bill Rojas, Diane Herlofsky, Venus Martinez, and others. 

In multifamily real estate, a good deal for a buyer usually comes in differences of $100,000 and a secure investment. For sellers, they celebrate if they get $5,000 more than the market suggested. I contest that, in my experience, you can have it all: a wonderful transaction where both sides win. 

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Election Results, Real Estate-wise

Despite one’s personal political beliefs, a sharp turn in government is going to mean changes in the economy. You’ve already seen markets fall based on anxiety, so what does this mean in terms of real estate?

So far, since the election, more fair-priced apartment buildings have come on the market than I’ve seen since the beginning of the year. Could this be coincidence? On one hand, it would be hard for a reactionary seller to get a realtor to throw a property on the market in less than a week. However, that’s not to say they didn’t have a plan going into the election. Why would a seller want to sell now? Perhaps it’s the instability, fear, or they decide this its an apt time to move?

With a real estate mogul as president, one can assume that he might take care of his assets, tax-code-wise. Additionally, in a time of market volatility, having multifamily rental units is the most secure way to own real estate. House prices often surge and fall with the markets, but multifamily less so. When people foreclose their houses, they rent. This is the reality, for what it’s worth, from where I can see it.

 

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Real Estate Loans

Once in a while, I like to touch on the basics. But if this is obvious stuff, skip to the next post. Here are the questions I’ll be answering:

  1. What is a real estate loan?
  2. What loan programs are available today?
  3. How do I qualify?
  4. What are the hidden costs and benefits of a loan?

1. What is a real estate loan?

A real estate loan allows you to buy a property whose purchase price (or, value) is a lot more than you have in cash. Banks and mortgage companies will lend you large sums of money so that they earn loan origination fees, plus fees for selling your mortgage to a third party, who then collects interest on your loan.

2. What loan programs are available today (as of 4/21/2016)?

For a single family home as your primary residence, you can put anywhere between 3.5% to 25% cash down, or more. If you put down less than 10% of the purchase price, you will likely have to pay hefty mortgage insurance up to 1.75% of the total loan up front, plus 1% annually. These loans are usually 30-year fixed loan (your interest rate doesn’t change for the life of the loan) and government regulated.

For a duplex the same rules apply, except you’ll pay mortgage insurance if you put down less than 20%.

For 3-4 units as your primary residence, the same rules apply, except you’ll pay mortgage insurance if you put down less than 25%.

If any of the above are investment properties only and not primary residences, you have to put down 25% minimum.

For any residential income properties with 5 or more units, you must likely put down around 50% in order to qualify for a loan, based on today’s market. For five or more units you must get a “commercial loan” which is based on the gross annual rental income, and therefore varies by how much your property currently cash flows. These loans are usually amortized over 30 years, but the interest rate is fixed for a shorter time period (usually around 7 years).

3. For 1-4 units, you qualify partially based on the rent, but mostly based on your average annual income over the past two years (the rent counts toward your income). Banks use a standard formula to determine if your annual income is enough to secure the loan, despite these loans usually being non-recourse.

By contrast, for 5 or more units, your personal income is not a factor because the loan is based on gross annual rent from the subject property. This makes these properties better for investors who can’t show regular income on their tax returns.

4. The hidden cost of your loan is obvious: all the interest and mortgage insurance you pay during the life of your loan adds up.

The hidden benefit of your loan is twofold: if your rental income is covering your mortgage and expenses, that 75% LTV (loan to value) that the bank gave you is turning into money in your pocket over the course of the loan. In other words, if your interest rate is less than the your annual return on your loan, you are making money off the loan.

Make sense? If not, feel free to ask any questions you may have at: davidlbrundige@gmail.com

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Real Estate Agent Payment Structure

Real estate agents, whether I’m representing the buyer or the seller, get paid a percentage (%) of the sale. This % is determined in a contract between the listing agent and the seller, and paid out of the seller’s proceeds once escrow closes. What are the ramifications of this payment structure?

Ideally nothing. An agent should represent his or her client to the best of his or her ability. But you have to wonder what motivation a buyer’s agent has in getting his client the best deal on a property if he’s losing 3% of $10,000 or $300 by negotiating his client a discount.

Conversely, what motivation does an agent have in getting his client $100,000 over asking on a sale if he’s only making $3,000 extra for being good at his job? After all, a relatively competent agent could sell a million-dollar house for a million dollars and make $30,000 commission. So is being a great agent really worth the extra couple grand?

From a financial perspective, the only reward for being the best agent possible is referrals. I average selling my listings for over $100k or 6.9% over asking price, for which my reward is approximately $3,000 per listing. I guarantee you that extra bit is not my main motivation. My financial motivation is to tell you, my new client, that I sell my listings at an average of over $100k or 6.9% over asking so that you will trust me with your next listing. My reputation is my most important financial resource and getting my buyers and sellers the best deal possible is always the means to that end.

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Los Angeles Vacancy Rate

I often get asked by clients whether my spreadsheets account for vacancy. If the tenants are paying below market rents, I don’t.

Let me back up. The recent census determined that L.A.’s vacancy rate is down to 2.8% from an already astoundingly low 3.7% last year, the fourth-lowest in the nation. Los Angeles has the highest percentage of renters in the U.S. at 52%, according to a Harvard Joint Center for Housing Studies study. What does this mean?

apartment vacancy 2015

It means there aren’t enough apartments. If you own apartments, they will be in demand. It’s that simple.

So why don’t I include 2.7% as a vacancy allowance in my spreadsheets if tenants are paying below market rents due to rent control? The reason is that if one of those tenants leaves, you should jump for joy because you will be able to re-rent that unit in no time and raise the rent while doing it.

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1031 Exchange Strategy

I’ve had some very active buyers and sellers lately and it feels like everyone is in a 1031 exchange. This is a very important tax strategy in real estate, and it’s important that you know how to operate with precision when trying to execute a 1031. First I’ll explain what it is, and if you don’t need a refresher, go ahead and skip to the Strategy.

What is a 1031 Exchange?

Simply put, a 1031 Exchange is when you sell an income property, buy a new income property to replace it, and skip paying taxes on your sale.

What are the rules?

  1. They have to be income properties – essentially that means that neither property can be your primary residence. I’ve heard of some people doing some tricks like putting title in an LLC and paying themselves rent, but I’m not a lawyer and that is certainly not advice.
  2. You have to name 3 options for your replacement properties (or “uplegs”) within 45 days of your sale property (or “downleg”) closing escrow.
  3. You have to complete the purchase of your upleg(s) within 180 days of the sale of your downleg.
  4. Both the equity (cash down) in your upleg(s) and the total value (purchase price) has to be equal or greater than that of your downleg(s).
  5. All has to be accomplished within the same taxable year and to the same person(s) on title.
  6. You have to own the property for one year before selling.

These are the most common and basic rules. There are more if you strive to be more creative.

The Strategy

By skipping capital gains tax, you could save hundreds of thousands of dollars. But why sell in the first place if you’re just going to buy something else?

I’ve written about this before, but the fastest way to substantially grow your wealth through real estate is by buying and selling again and again. I’ve been a party to this and I think my clients in question would admit that I masterminded this growth for them. (And yes, when writing a blog your humility sometimes falls by the wayside.) Staying ahead of gentrifying neighborhoods, good deals and unnoticed potential is key to unlocking a property’s value that you can cash in one year later (1031 Rule #6).

Why sell that unlocked value rather than hoard it? Once you have unlocked a property’s value, you have maxed it out. And unless you have unlimited capital, you can’t simply buy more and more properties; you have to use that unlocked value to unlock even more value, and so on.

That’s the abstract. Here’s an example:

Property A, a fourplex, is selling for $780,000 in an up-and-coming neighborhood.

After closing the deal with 25% down, you fix up a vacant unit and rent it for $700/month more than the seller predicted. Another tenant moves out, and you do the same. Not only did you raise two rents in the property, but those rents are so high that you proved what the other units can get. You may or may not have the cash to renovate the other units, but who cares. You’ve implied the value in the property that no one saw before; you’ve unlocked it. Now your property is worth $1,050,000 (if  your agent knows how to present that unlocked value as current value).

You spent $50,000 to fix it up, and $220,000 on the down payment. After a year, the mortgage pay down is near negligible. But you doubled your equity to $540,000 on a $1.05M value. The bank not only won’t value your property like a buyer will, but it also won’t let you cash out enough to do it again. So you sell to a smart, more fluid, and less hands-on buyer and do it twice more with the newest gentrifying neighborhood / great deal / unnoticed potential.

If that sounded tricky, buying Properties B and C is where things can get sticky.

Because you only have 45 days to name your next properties, being sharp and aggressive during this process is absolutely essential. You make strong bids, drive by dozens of properties, and always see the forest rather than the trees.

When I have a client in a 1031 exchange, that client usually gets my ideas in their inbox first because (a) the 1031 time sensitivity and (b) they reward me with selling their property, as well as their responsiveness and aggressiveness in getting the next amazing deal.

Do you want to make one of these deals happen? I’ll tell you how you can unlock the value in your property to get top price, and guide you towards doing it again.

 

IMPORTANT DISCLAIMER: I am a licensed real estate agent, not a CPA nor a tax attorney, and nowhere on this website am I offering you tax advice.

 

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