New Philosophy for Poor Investors
I write this with zero condescension. And it’s really not complicated, either. If you’re an FHA buyer, especially, I used to promote that you buy the most expensive property you can qualify for, with as much leverage as possible, because if the rents securely cover the mortgage, your small down payment will balloon into the full value of the property in 30 years. I still like that philosophy and it has worked for clients; it’s just not entirely applicable in this market.
In today’s market, you need to buy with more foresight. The current strategy for poor investors is to find the future hotspots in L.A. and buy the gem of that neighborhood. Pretend that it’s the current hotspot and you’re getting an amazing deal on the best property around, if that makes you feel more comfortable. This means you might be investing a few thousand into your property for the first five years with no cash flow, but you’re banking on the appreciation, and, your own intuition. We’re searching for buildings with solid bones, a good lot, a great location for the neighborhood, and lots of potential.
If you’re not one of those investors with loads of cash, you have to do a little imagining. It’s not the most profound insight, but it’s opened a lot of doors that competitors aren’t yet entering.
Read MoreListing Agents & FHA
I’ve stopped asking agents if they’ll accept FHA loans. I had done that previously so my clients don’t waste time driving to a property they have no chance of buying. (FHA loans are sometimes less desirable because there are a few more steps to closing the deal.) While normally I give agents credit for knowing the difference, last week I actually startled a young agent with the question.
“Yeah, why not. We’ll take whatever the highest offer is.”
This is my kind of agent, I thought. I told my client that we had a good chance to get this place. She went to see it.
Two days later, we came in at the highest offer. The listing agent told me so (are we sensing something amiss?), and that the seller would accept our offer that afternoon.
Several hours of no phone calls later, I get a text saying they’ve countered a lower offer that has a higher down payment.
What could have happened between the morning and late afternoon? Did this agent Google “FHA loans” and get scared? I texted back that this property would surely assess (it had in city records already and had the rent roll to boot), but the agent didn’t want to go back to the seller and look silly.
The truth is, agents should favor FHA loans when they are higher offers, especially if the property will most likely assess. Some agents want cash only if it’s a short sale or the building’s decrepit and they don’t want assessors near the place. But this listing agent’s first instinct was actually the right one.
Now I refer to my client as “my FHA buyer” once to see if there’s a reaction, and if not, we don’t mention it again until the purchase agreement.
Read MoreFHA Loans + & –
The FHA gives hope to many future homeowners who are short on cash.
What is it?
The FHA is a government organization that insures loans. It doesn’t give loans; it insures them. This makes FHA-backed loans very safe for banks because the FHA assumes the risk. But since it acts like an insurance company, you pay a premium and the FHA might not want to insure your loan if they don’t think the property is worth what you’re paying.
Pros:
– You can put down as little as 3.5% of the purchase price.
– You can go through a normal (FHA-approved) lender.
– You have certain move-in rights as an owner-occupier, and can sometimes relocate low-paying tenants and therefore raise the value of your property.
– You get good interest rates.
Cons:
– You technically have to live there for two years.
– If no unit is vacant, you have to pay the tenants to move out (between $8,000-$20,000).
– Because the FHA appraiser is strict, there’s a chance your deal might not go through. This means many sellers will overlook your offer in favor of an all-cash or conventional loan offer. And that means your pickings are slim in Los Angeles.
– You pay an insurance premium:
– You pay a 1.25% upfront premium (UFMIP). Luckily, this can be added to your loan amount.
– Additionally, you pay 1.25% of the total loan per year as a recurring premium.
– You pay 0.25% extra if the loan amount is above $625,500.
– Thankfully, you stop paying the premium when your loan-to-value ratio lowers to 78% (and you’ve already been paying for 60 months).
So yes, there is hope. But you have to know what you’re up against. Let me know if you’re in this market because this is what I specialize in.
Read MoreHow low can I go?
$40,000. The lowest reasonable amount of cash you need in L.A. to buy an apartment building is $40,000.
Now, you’re not going to get a “nice” apartment building in a “great” neighborhood, but you can buy a cash-flowing building in a soon-to-be up-and-coming neighborhood. We’re talking Boyle Heights and Lincoln Heights – the areas just outside of downtown that haven’t quite felt gentrification yet, but are destined to.
Here’s the math:
$400,000 contract price (average 4-plex in those areas)
3.5% down = $14,000
Closing costs = $4,000
Tenant Relocation = $10,000
Renovations = $10,000
Reserves = $2,000
TOTAL = $40,000
Now, there are 2 catches:
1) The reason you can put just 3.5% down is because this is a FHA loan. The FHA insures risky mortgages (down payments below 20%) so you have the opportunity to own your first home – not income property. Home. That means they expect this to be your primary residence for at least two years. The good news is you can buy up to 4 units. And you have the right to move into one of the units with certain restrictions (I’ll post about this later).
2) You have to prove that you made an average income of about $5,500 per month for the past two years. This varies, depending on the property, but that’s about the bottom line for Los Angeles.
I’m in this boat and I have hope. So can you.
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