Buying & Selling Investment Real Estate
If You're A Real Estate Investor We Speak Your Language . . .
Real estate investing can be very lucrative but it can also be an expensive learning curve as many a novice investor will tell you. If you're looking to buy investment real estate, the key is to do your homework first and answer all the important questions, so you're going into the purchase with your eyes wide open. And if you're thinking of selling an investment property, there are plenty of questions to answer, too, before putting up a for sale sign. Sound preparation is the key.
We hope this overview will help you get started, but it's by no means comprehensive. So if you're ready to take the next step and buy or sell real estate investment property in our Solano or Contra Costa County market area, feel free to contact us for a complimentary consultation to make sure you haven't overlooked anything and see if we can assist you. (There's absolutely no obligation.) We've helped a number of real estate investors over the years and are always happy to share our knowledge and experience with new clients.
If You're Buying Investment Property...
Buying investment real estate requires a decidedly different approach than buying a home to live in. Things that might matter to you personally are often negligible from an investment standpoint. It's all about the numbers. If they pencil out, it's a good investment. Otherwise, it doesn't matter how much you like the house, the location or the cute amenities. Depending on your investment goals there are different strategies, too. Are you looking for appreciation or cash flow? Both are nice, but for many investors, one strategy is often more important than the other.
And If You're Selling Investment Property...
And if you're planning to sell a current investment property, what is your exit strategy. Are you looking to liquidate or might you be willing to carry paper (and if so, are you aware of the stringent seller-financing laws)? If you're looking to buy more investment real estate, are you aware of the potential benefits of a 1031 tax-deferred exchange? What's the current condition of the property? Would it appeal more to another investor or an owner-occupant? Is the property currently tenant-occupied? Be sure you know the answers to these and other important questions before you sell.
Important Tips & Considerations For Real Estate Investors
Many new real estate investors approach the buying process the same as they would if they were looking for a place to live for themselves. Whether a home has your preferred type of flooring, cabinetry or counters doesn’t matter. What matters is how the location, finishes and amenities will appeal to a wide cross-section of prospective tenants. There’s no such thing as the perfect home. Do the numbers pencil out? Will the property attract plenty of would-be tenants? Will it be easy to maintain? Will it be relatively easy to sell again down the road? These are some of the important questions you should be asking yourself.
Just because there are glowing comments in the multiple listing service doesn’t mean that the property is a plum. If it’s really a great investment property, why are the owners selling it? Is it because they’ve had a hard time keeping it rented? Or because the property needs a lot of work? If so, those could be red flags. But perhaps they’re selling simply to liquidate or because they want to buy another rental property.
But if they’re selling because the property has turned into an albatross, it’s better to find that out before you decide to buy.
Are you considering a multi-unit building where some of the units are vacant? If so, you’ll want to dig a little deeper. Is it because market rent for the property is far less than what the owner claims it to be? Is it because the landlord has a tough time keeping the units rented due to deferred maintenance or neighborhood issues? Or is it just a case of several recent unexpected move-outs? If one or several tenants vacated just before the property came on the market, it may simply be that the seller wants to allow the new owner an opportunity to set the rent and select the new tenants. In any event, find out why the units are vacant and ask for a rental history for the property going back several years. The more you know, the better you’ll able to judge whether this is a worthy investment.
As a buyer, it’s important to know exactly what you’re buying. The marketing comments may say that each unit rents for $1,800/mo. but don’t just rely on what you’re told. Ask for copies of the owner’s financial statements. If they’re truly renting for what the sales literature says, fine. But if the seller tells you he’s getting $1,800/mo. and his financials show $1,650, something’s amiss. If the numbers don’t add up, be sure to ask questions until you’re satisfied.
And if the seller doesn’t have up-to-date financials or they’re incomplete, that could be a huge red flag.
Being a landlord is rainbows and butterflies when things are going well. The tenant always pays on time, the property’s in excellent shape, the value continues to appreciate and you’re enjoying a nice positive cash flow. That’s what real estate investors dream about.
But as most landlords will tell you, tenants move out, things break and appreciation is never guaranteed. Which means that you need to go into an investment property purchase with the understanding that there won’t be any income when you’re in between tenants. And that you might need to lower the rent in the future to attract new tenants. Or that at some point you might have to get involved in resolving an issue between your tenant and a neighbor. And when the garbage disposal stops working or the roof leaks, you’re the one the tenant is going to call.
So expect the unexpected and always make sure you set aside funds to handle those unexpected occurrences when they arise.
Over the last 10 years, many homeowner’s associations have adopted policies that restrict the number of units that can be rented. Usually it’s a percentage of the total number of units. And often there’s a waiting list of existing owners who would like to rent out their units. So just because the unit you’re planning to buy is currently a rental doesn’t mean you’ll have the right to keep it as a rental. Thus, if you’re considering buying a property that’s in an HOA and you plan to rent it out after escrow closes, make sure you’ll be able to do so before making your offer.
Many experienced investors prefer to leverage their investment properties with financing rather than paying all cash. It’s all about maximizing the return on their investment.
Let’s say you bought an investment property five years ago for $200,000 that’s now worth $300,000. If you paid cash, that $100,000 profit is a 50% return on your initial $200,000 investment. And that averages out to 10% a year, which is a pretty good return.
But what if you bought FOUR $200,000 properties instead, put $50,000 down on each and financed the rest? Now you have a $400,000 profit and a 200% return on the $200,000 that you invested, which is a whopping 40% average annual return.
The lender paid 75% of the cost of each property, but you got all of the appreciation. And that is called Leverage.
A common refrain from landlords getting ready to sell goes something like this: ” I’m only charging $1,500, but I KNOW I could get $1,600 or $1,700.”
Well if you’re planning to sell, don’t expect an investment buyer to rely on that claim as fact. Rather, do your homework up-front and find out what other similar rentals in your area are selling for. And compare their property with yours objectively.
Be realistic. Is theirs fully updated and on a court while yours is on a busy street and fairly original? For just because they’re both 1,300 sq. ft. and built around the same time doesn’t mean they’re worth the same. Savvy real estate investment buyers are going to do their homework and base the value of your property on its condition, location and rental capabilities. Do the same before you sell and you’ll stand the best chance of attracting an eager investment buyer.
If you’re planning to sell an investment property and if the buyer is likely to be another investor, they’re probably going to want to see your rental paperwork before deciding whether to make an offer. They’ll want to see a profit & loss statement and copies of existing leases, utility bills and maintenance records. They’ll probably ask to see signed estoppel certificates from your existing tenants as well as disclosures of past repairs, current flaws, past or current litigation and anything else that might be considered a material fact.
Sellers who have a complete package ready for the buyer to review are like gold to an investor. Over the years, we’ve seen many a buyer quickly sour on a property when they discovered that the seller had minimal or sketchy paperwork. Investors want to feel that they’re making a good investment. You wouldn’t buy a stock or other security without researching details and performance of the company behind it. And for that same reason, real estate investors tend to shy away from properties that look promising on the surface but which are lacking the paperwork to justify it as a sound investment.
If you’re planning to sell a tenant-occupied property, be sure that each tenant fills out and signs an Estoppel Certificate. It’s a statement confirming what the tenant is paying in rent, when the lease expires, how much of a security deposit is being held and any other agreements between the tenant and the landlord. For the buyer, it’s equivalent to having an opportunity to call the tenant and confirm that everything the landlord told them is correct.
For the last thing an investment buyer wants is to get into a dispute with one of the tenants over an existing issue right after taking ownership. Comparing the lease with what the tenant declared in the estoppel certificate gives the buyer an opportunity to clarify any discrepancies. Perhaps the lease was amended or extended at some point. If so, the seller should be able to provide a copy of the signed extension form. Or maybe the landlord gave the tenant verbal assurance about renewing the lease at a different amount a year from now. If so, the buyer has a right to know about it.
So be sure to have all your tenants fill out and sign an estoppel certificate ahead of time. Your lease probably contains a clause requiring them to do so upon your request. And if you find any discrepancies between what’s in your paperwork and what they wrote on their certificate, get that resolved so that your paperwork and theirs both match up Before putting your home on the market.
Over the years, we’ve worked with clients who’ve had what they call dream tenants — tenants who’ve been renting the property for years, always pay on time and care for the home as if it was their own. If you have such a tenant and are planning to sell, that exemplary tenant history might very well translate into extra value to a prospective investor. For one of the least favorite parts of owning investment property is having the property sit vacant while searching for new tenants. Or dealing with an ongoing stream of troublesome tenants. If you’ve had a long-term dream tenant who’s paying market rent and would love to remain there for years to come, that could be like gold to an investment buyer.
Tenants can often make or break a real estate sale. If they’re cooperative, keep the place in good condition and make it easy for prospective buyers to see it, the property will usually sell quicker and at a higher price than if they keep a messy house, make it difficult to show and insist on being present when buyers are there. If you have an excellent relationship with your tenants, it might take nothing more than a simple cordial request. But if your tenant is reluctant to make the property as appealing to prospective buyers as you’d like, consider offering them a financial incentive. Temporarily reducing their rent can often turn a grouchy tenant into your biggest advocate.
Once you’re in escrow to sell an investment property, don’t enter into any new leases or extend/modify any existing leases unless your buyer approves. For any leases you sign will be binding on the new owner. And one of the surest ways of killing a deal is to make lease changes without the new owner’s blessings. Perhaps the new owner is planning to remodel a vacant unit before renting it out. Or changing the amount you’re charging in rent. Maybe the buyer already has a prospective tenant for one of the units and wasn’t planning on renewing the lease for an existing tenant.
Once you’re in contract, leave things the way they are until you close escrow. Don’t muddy the waters by bringing in a new tenant or extending or changing an existing lease. Let the new owner handle all of that after the property is theirs.