Slight delay

Well, I was supposed to get funding for my next LLC last week. The money was coming from an escrow which closed last Monday. However, rather than have the money wired to their bank account, my investors opted to have a check mailed to them. So we have postal delays, there will probably be a delay in waiting for the check to clear, and then I will be out of town next week. So it looks like the LLC won't be up and running until the first week of January.

How To Ensure You Get The Best Rates Possible

I've survived Thanksgiving and am now gearing up for Christmas. My weekends are booked through the end of the year and, as a result, there probably won't be much real estate-related activity going on for me. Well, at least not until my next LLC gets funded sometime after December 13th. Of course, I'll always make time for a great deal...

One year after Congress passed the FACT Act, a bill requiring the three major credit reporting agencies to give people a free copy of their credit report, those reports are just now starting to become available. Begining today, residents of Western states (Alaska, Arizona, California, Colorado, Hawaii, Idaho, Montana, Nevada, New Mexico, Oregon, Utah, Washington, and Wyoming) can request their copy. On March 1, 2005, residents of the Midwest (Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Missouri, Nebraska, North Dakota, Ohio, South Dakota, and Wisconsin) can request theirs. Residents of the South (Alabama, Arkansas, Florida, Georgia, Kentucky, Louisiana, Mississippi, Oklahoma, South Carolina, Tennessee, and Texas) have to wait until June 1, 2005. Those in the East (Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, North Carolina, Pennsylvania, Rhode Island, Vermont, Virginia, and West Virginia) have to wait the longest - September 1, 2005.

To get yours, visit www.annualcreditreport.com. They are free and you can get one every 12 months. You are NOT required to buy anything or pay any amount to get it.

There is a good article about this on the Motley Fool website.

Why should everyone do this? As Robert Kiyosaki says, your banker never asks for your report card. He asks for your financial statement. A big part of that financial statement is your credit report. Go over this report to make sure there are no errors on it. And I guarrantee you will find errors. I first reviewed my credit report over a decade ago and found at least 5 errors, including incorrect former addresses, old credit card data, and incorrect student loan information. When I got married, I reviewed my wife's report and discovered some credit card accounts that she thought she had closed were still open.

Your credit report has a major influence on the terms you can get on mortgages, car loans, insurance, credit cards and lots of other products. You want the best terms possible, so make sure your report is correct.

Good news!

The investors that will be funding my next LLC have sold their property in California. It's scheduled to close escrow on Dec. 13. At that point, the funds will be used to finance my LLC and we can start flipping properties!

My Views Are Confirmed By Professionals

I recently received an email from Diane Kennedy’s free e-mail list that confirms what I have been saying for a couple of months now. Diane is a CPA and founder and owner of DKA, a tax strategy and accounting firm in the Phoenix area. She is also a co-author of a couple books in the Rich Dad series of financial education books. Many of her clients are high net worth individuals. Her website can be found at www.taxloopholes.com (you can sign up for the free newsletter there as well).

In her newsletter, she talks at great length about the declining value of the dollar and how to position yourself to profit from it. One suggestion she makes is investing in real estate outside the U.S. This is beyond the means of most people reading this blog (and myself). However, she also states many of her clients are moving towards cash. Why? If the dollar is declining, this doesn’t make sense! They are doing it because they are expecting an increase in U.S. interest rates of around 2%. When this happens, the real estate market will become flooded with newly available properties for two major reasons:

Novice investors have been buying real estate like crazy for the last year or so. The low interest rates helped those properties be cashflow positive, despite the inflated prices paid for them. When rates rises, the investors will start losing money and will need to dump their properties quickly.

Homeowners have been encouraged by banks to get as big of a loan as they can qualify for and to buy an expensive house. Again, while interest rates were low, these homeowners could make the payments without any problems. With rates rising, more people are going to default on their mortgages, which will lead to more foreclosures.

These two situations have one thing in common – the end result of both will be a glut of cheap houses on the market for those ready to swoop in and snatch them up. That is why her clients are beginning to position themselves in cash.

It’s nice to hear a professional echo the same sentiments I wrote about here two months ago!

Remember, when there is a big change in the direction of a market, there is money to be made. When the predicted increase in foreclosures happens, expect newspapers and television news shows to be filled with doom and gloom stories of bursting real estate bubbles and how everyone is bailing out or losing money hand over fist. Ignore them! Smart money will go against the trend during this time and pick up properties at substantial discounts. Start positioning yourself now to take advantage of this opportunity!

How To Get Started In REI For Under $400

I often see messages from people who have decided they want to get involved in real estate investing but they don't have any money, or don't have much money. They don’t know where to start. Here are my suggestions for getting started in real estate for under $400.

(Note: This post was originally written in 2004. It is now 2008 and I've gone and updated the prices. The new total works out to just over $400.)

1. Make a commitment to invest your time. This is the most important step! Educate yourself. Read books and websites. I spent over a year reading the discussion boards almost daily at www.richdad.com before I bought my first rental property. I still made some mistakes, but I felt much more confident and less scared. If you become active on the boards, they also double as a support group. Cost: $0.00

2. Read Rich Dad, Poor Dad, by Robert Kiyosaki. This is NOT a how-to book. Treat it as an inspirational book and you'll get much more out of it. Cost: $11.86 $16.95

3. Read The Richest Man In Babylon by George S. Clason. This is the classic book for money management. Entertaining and educational, it's a small book that contains invaluable lessons. For example, one recommendation it gives is to always set aside 10% of your income for investing purposes, before any other bills are paid. I've been doing this ever since I read the book and it's amazing how fast the money accumulates. You'll also be surprised on how little you miss that 10%. (This book also makes a great gift for grads.) Cost: $6.99

4. Read Rich Dad's Guide To Investing by Robert Kiyosaki. This book provides the basis for becoming a successful investor, from the terminology to strategies. Cost: $13.97 $19.95

5. Read Who Took My Money? by Robert Kiyosaki. If you needed any more reason to stop parking your money in a mutual fund and hoping it will increase, this is the book for you. It explains how to keep your money moving to generate higher returns. Cost: $11.87 $16.95

6. Buy CashFlow 101. This is the ultimate game of investing and will teach you tons about accounting, finance, and investing. The board game version is $195 and the electronic version is $99 (but for multi-player on-line games, you'll need a subscription, which runs around $100 a year). I recommend starting with the board game first because you are forced to write down figures and do your own calculations. You also have to play face-to-face with other people, which encourages discussion. Play this game AT LEAST 50 times. Play with different people. Play until you can win using any of the supplied professions. Finally, play the game using YOUR real life profession and YOUR real life paycheck and savings. See how you can get out of the rat race using your very own real life data. The board version includes a video tape and several audio tapes. The electronic version features these in electronic format. Cost: $195.

7. After you've mastered CashFlow 101, buy CashFlow 202 and play it many times. This expands the world of CashFlow 101 and teaches you how to handle all kinds of market conditions, how to use options and is much harder (but teaches you more). Again, this comes in a board version ($95) and an electronic version ($49). Both versions require the purchase of the corresponding version of CashFlow 101. It also includes 4 new audio tapes. Cost: $95.

8. Read Flipping Properties: Generate Instant Cash Profits in Real Estate by William Bronchick. "Flipping" has gotten a bad rap lately due to many people illegally and artificially raising housing prices (and as a result, the term "quick turning houses" is starting to replace "flipping houses"). Bronchick distinguishes between legal and illegal flipping and gives detailed instructions on how to get into this area of investing, including how to get started with no or very little money. This is the book where you will find some detailed instructions on what to do. Cost: $13.27 $12.89

9. Read The Millionaire Next Door by Thomas Stanley. This book was written based on interviews with many millionaires and talks about how they made their money and how they live life. The results are surprisingly mundane and show that becoming a millionaire is within anyone's grasp. The book is a bit heavy on statistics, but the analysis backs up the conclusions and is worth wading through. Cost: $10.50 $10.20

10. Buy 50 sheets of Avery printer postcards, 4 x 6 inches, two per sheet, and one 100-stamp roll of postcard stamps. Perhaps the quickest way to get the cash needed to buy rental properties is to start by flipping properties, or being a "bird dog." And one way to do that is to buy houses that are about to be foreclosed. Your county recorder publishes a list of such properties, probably daily. Find out how to locate them (and many offices have internet sites where you can search for this data from the comfort of your home). Learn to identify good candidates, and mail them a postcard. The Bronchick book has samples, or you can see the ones I used here and here and here. Response is generally low, so this is a numbers game. Don't get discouraged. Cost: $43.67 $41.55.

Total cost: $402.13 $415.48 (OK, it’s not under $400, but it’s pretty close. Skip eating out one or two meals and you'll have saved the difference.)


As you can see, I put a fair amount of emphasis on Robert Kiyosaki. It's important to realize that he does not provide you with step-by-step instructions on what to do. Rather, he teaches you to think in new ways - like the rich think - and he details the advantages of real estate over many other types of investments. Changing the way you think is the most important part of being successful. You need to train your mind to think differently and to stop listening to the noise of others around you telling you why what you are doing will never work. (Are they rich? Then why listen to them?) The other items in the list follow this theme, with the exception of the last one, which is needed for taking your first steps towards actual investing. And that is an important step! Don’t fall into the trap of “analysis paralysis!” You will never know everything there is to know about real estate investing, so at some point you need to stop reading and start doing! Then your education continues!

Good luck! I’m always interested in following people’s progress, so feel free to leave comments sharing your experiences!

I Just LOVE Passive Income!

I got home yesterday and found a nice surprise waiting for me in my mailbox – a check for just over $1,000! This was a semi-annual disbursement from a private, closely held company I have invested with. The company buys foreclosures in the San Francisco area, fixes them up, and resells them. The principles raise a couple million dollars from private investors then form an LLC. The LLC exists for a period of three years, after which it is disbanded and the investment capital is returned to the investors (assuming there haven’t been losses). Disbursements of profits are made every six months. This was the fourth disbursement for this particular venture and with it, they have just topped the one million dollar total profit mark in this LLC. I have received a total return of 33.9% so far, which works out to an annualized return of 16.95%. Not bad for a completely passive investment!

I’m currently invested in two LLCs with this group. Each distributes profits every six months, so I receive a check approximately every three months. I hope to be able to increase the number of LLCs I’m in to six and that the disbursements remain staggered (something I have no control over), so that eventually I’ll be receiving a check each month.

What is there to learn from this? Network! I never would have found out about this investment group had it not been for someone on the richdad.com message boards. Of course, I did my own due diligence before deciding to invest with them and the investment is not without risk – I have a half-inch thick prospectus that details those risks in exquisite detail. However, so far it has turned out quite well for me. The returns are less that what I would get flipping properties on my own, or even renting a property on my own, but given that the total time I have invested in this is the time it took to read the prospectus and write a check (a couple hours, tops), I think this a good return.

Step by step guide to buying preforeclosures

Many people just starting out in real estate investing work at buying preforeclosures (meaning they contact people whose house has had a notice of foreclosure filed against it and attempt to buy the house and pay off the mortgage before it goes to foreclosure auction). This is mainly due to the fact that large amounts of capital are not needed - you just find a good deal, get it under contract, then sell your contract to an investor who does have the money to buy the place. People who do this are called birddogs, since they find the deals and bring them to the investor, who pays them for their work (usually a couple hundred to a couple thousand dollars, depending on the deal). Since the birddog never buys the house, he or she doesn't need any cash. Easy though it sounds, people still have questions about exactly what they need to do.

Some time ago, on the discussion boards at richdad.com, a poster named UtahInvestor gave instructions on how to do this. Unfortunately, his posts often contained lots of typos, grammar errors, and tended to jump around. Often, all the pieces needed were scattered over several different posts. I went through and gathered these posts and distilled them down to a series of steps the birddog needs to follow. I wrote out the steps for two scenarios: buying the preforeclosure yourself and selling your contract to an investor.

This information is powerful! This is all you need to take your first steps towards getting out of the rat race of your 9 to 5 job. You can thank me later :-)

For buying a preforeclosure and reselling it yourself

1. Check Recorder’s office for Notice of Trustee Sales filings. Find properties where first deed amount divided by the fair market value <= 75%. Don’t worry about second mortgages.
2. Send out postcards or call owners found in step 1.
3. For those people that are receptive, set up a face to face meeting.
4. Before the meeting, search court records for the owners – find out about divorces, criminal charges, etc. Anything that might create a need for them to sell. Use this information to stop you from offering too much.
5. Before the meeting, get a preliminary title report on the property from a title company to verify your findings of step 1.
6. At meeting, find out their pain – listen to them, determine what they need, and offer solution. Also check out condition of house and verify that your FMV appraisal in step 1 is appropriate.
7. Get quit claim signed by people on title. This should be notarized. Do not provide payment to owners at this time. They should move out immediately. Do not record the quit claim.
8. If there is a second mortgage, negotiate with mortgage holder to buy it.
9. When they have moved out, pay them. Meet them outside with their moving van. They give you the keys, you give them their money (or whatever they needed).
10. Get place cleaned, carpet shampooed, etc.
11. Place for sale ad in paper, post signs, get lockbox on door. (Or list with Realtor.)
12. Make sale. Fill out sale contract. Sign and notarize contract.
13. Take quit claim and sales contract to title company. Let them do their thing.

All above should take place in 30 days, more or less, to avoid getting more negative items on the owner’s credit report. If you need to do major repairs, you should insert step 5A where you find out the costs to bring the loan current, then make it current and keep it current until sold. In this case, you should not drag this out as the owners will not be able to get a new loan until their old one has been paid off.

For buying at preforeclosure and assigning contract to buyer

1. Same as steps 1-6 above.

7. Get sales contract with people on title. Buyer should be “your name or assigns”.
8. Notarize document.
9. Contact investor and negotiate price for contract.
10. Write assignment contract assigning your rights of the sale contract to the investor. Contract does not list amount you are being paid. Notarize.
11. Take both contracts to the title company.
12. Investor pays you either when the assignment contract is signed or when escrow closes.

This method assumes you trust the investor, as there is no document forcing him to pay you. If you do not get paid, you can file a Notice of Interest or Notice of Lien against property. If you do not trust the investor, you can have a non-circumvent agreement stating you get paid x dollars at the close of escrow. In this case, give that document to the title company as well and they will pay you directly. But keep in mind, there is usually no reason not to trust the investor - he's in it to make money and the more deals you bring him, the more he makes. Thus, it is in his best interest to treat you well.

The most important step is step 6!!!! You must establish a rapport with the home owner. Be a great listener. Find out their pain, what they need from you. These people are being deluged with offers from other people like you. Make them feel comfortable with you and you will beat out all the other people trying to get their home.

Slow week

It's been a slow week. Well, slow in terms of real estate matters. Otherwise, it seems I'm going non-stop. My daughter has an ear infection, as does my wife. Been trying to keep up with cleaning, cooking, going to the doctor, taking care of them, etc. Not getting much sleep since my daughter isn't sleeping well due to her ear... Is it Friday yet?

How REITs are helping me reach my IRA goal

As mentioned before, my goal is to accumulate enough shares of REITs in my Roth IRA so that the dividends they pay equal the amount the IRS allows me to contribute to it. For example, for 2004, the IRS allows me to contribute $3,000 to my Roth IRA, so I want to own enough stock to receive $3,000 in dividends. That, combined with my own $3,000 creates $6,000 flowing into my tax-free retirement account, double the amount the IRS allows me to contribute directly.

Let me first say, this is a purely arbitrary goal. I picked the 2X factor out of thin air. However, it presents a satisfying mental image to me. It’s like other companies are matching my contributions dollar for dollar.

This is also not an easy goal to reach. Obtaining $3,000 of dividends requires $30,000 of stock, assuming a 10% ROI, or yield, as it’s called in reference to stock dividends. Furthermore, the Roth IRA contribution limit changes each year. In 2005 through 2007, the limit will be $4,000. In 2008, it rises to $5,000. This means my goal is constantly moving upwards. Also, since I am limited to how much money I can put in each year, I am limited as to how much I can increase my dividend each year and thus, how fast I can reach my goal. Luckily, my REITs have dividend reinvestment plans, so I can harness the power of compounding.

Currently, I am almost 65% of the way to my goal: my Roth IRA is receiving a total of $1,900 in dividends a year from my REITs.

Here are my top three REITs:

SFI (iStar Financial) – This is the financially strongest REIT I have in my portfolio and the one I have held the longest. They currently are paying out $2.79 per share a year in dividends. The stock price, as of this writing, is $42.66, giving a yield of 6.5% - somewhat low by my standards. However, I started buying this stock back in 2001, when it was priced around $22, giving a yield that was closer to 11.5%. Since then, the CEO has been striving to get this stock rated “investment grade”, thus bringing it to the attention of the large mutual funds. He succeeded and the higher stock price reflects it. This company has increased its dividend every year since 1998, the first year it was a publicly traded company. iStar is a finance company focusing on commercial real estate loans. My annualized return is 27%. My total return on this stock, (change in share price plus dividends for the entire time I have held it) is 60%.

ANH (Anworth Mortgage Asset) – They are paying out a $1.32 dividend and their share price is currently $11.35, giving a yield of 11.6%. The company buys single family, adjustable and fixed rate mortgages on the secondary market that are guaranteed by the government or agencies such as Fannie Mae and Freddie Mac. Their dividend history is a bit more erratic than SFI’s, ranging from $2.00 a share to $1.32 a share over the last two years. This stock bears watching, as the company will be affected by changes in the Fed’s interest rate and possibly any problems that might turn up in the Fannie Mae and Freddie Mac investigations. My annualized return is -9.9% and my total return is -11.8%. The loss is mainly due to the drop in stock price – it has fallen a couple of bucks from where I first bought it. However, I am holding this stock for the dividends and they have so far cut my actual losses in half – I’ve lost about $2,000 via the drop in stock price but gained $1,000 in dividends. Since this is in my retirement account, I am comfortable holding on to it for a while and letting the cash income from the dividends help offset the share price drop. (That the price appears to have stabilized makes this a bit easier.)

AIGYX (Alpine Realty Income and Growth) – This is a mutual fund from Alpine that invests in dividend paying equities and securities which are principally engaged in the real estate industry. (While not technically a REIT, this mutual fund invests in them and pays dividends like them, so that’s how I think of it.) It has a 5 star Morningstar rating and has a “low” risk rating with a “high” return rating. Year to date (through August, the latest figures available), it has earned 12.4%. In both 2000 and 2003, it returned over 30%. In 2001, it returned 12.6%. Since this mutual fund can buy REITs, there is some overlap here with the individual stocks I own. For instance, this fund’s top holding, accounting for 4.35% of the fund’s assets, is SFI, which I also own outside of this fund. This bears watching because a serious problem with SFI can hurt me doubly bad. I just got into this fund a couple months ago. My annualized return is 11.6% and my total return so far is 6.3%. If you buy this fund through Schwab, there are no fees for buying or selling it.

Note: I am not a registered investment advisor. These are not recommendations to buy or sell any security. Do your own due diligence.

Real Estate In Your IRA

I’m not going to talk about buying property using your IRA. This is possible and legal using a self-directed IRA and there are many companies on the web that will help you do it. The only problem with this strategy is that all funds used must come from the IRA. So you can flip property, buy rental property, buy vacant land, or whatever using your IRA funds, but ALL costs – property costs, taxes, maintenance, insurance, etc. must be paid for from the IRA. In my area, costs for property are higher than the amount I have in my IRA, so this isn’t an option for me (unless I want to invest outside my area and I do not have the comfort level to do that yet).

But I can get a similar investment using the stock market and buying shares of publicly traded REITs. A Real Estate Investment Trust is a company that is required to pay out 95% of it’s taxable income as dividends to shareholders. Typically, a REIT will specialize in one type of real estate - shopping malls, hotels, residential units, etc. - and may also specialize further by geographic region. These companies own buildings and collect rent from the tenants, or they make real estate-backed loans and collect interest on the loan. These profits are then distributed to the shareholders. It’s not unusual to find REITs that have a 12% or higher dividend yield. Compared to the dividend of other blue chip stocks, usually in the 1% to 3% range, this is quite an improvement. (Dividend yield is the yearly amount paid in dividends divided by the stock price. It is basically your return on investment, ignoring fluctuations in the price of the stock itself.)

Unfortunately, the recently passed repeal of taxes on dividends does not apply to dividends paid by a REIT. This is because REITs themselves pay no tax and hence, the dividend does not incur the “double taxation” the law was written to eliminate. One way around this is to do what I have done – buy REITs inside of a Roth IRA. That way, all the dividends are tax-free.

By buying a REIT, you are basically investing in whatever type of real estate the REIT invests in, wherever it invests. You can thus tailor your IRA to your favorite real estate segment.

Next time, I’ll detail three of my holdings, my reasons for buying them, and the returns I have gotten. I’ll also discuss my goal: obtaining dividends equal to the amount I can put into a Roth IRA and thereby doubling my Roth growth.

Wiped out

What a week. My daughter got pink eye. We got that cleared up, then I got a sore throat. That turned into bronchitis. Then I got pink eye. Now my wife has pink eye and her throat is getting sore. I'm finally to the point where I can go about 15 minutes without coughing and last night was the first night in a long time that I got some decent sleep. As you can imagine, not much is happening in my real estate world right now...

Slow week

It's been a slow week. It seems like I've come down with a sore throat - probably something a bit worse, since it's sapped most of my strength. So I've been trying to take it easy and avoid passing whatever this is on to my wife and daughter.

My next LLC for flipping properties should be underway soon. My investors just listed a property and once that sells, they'll use the funds for my project. Average time to sell in their area is 16 days and figure a 30 day escrow on top of that, so it looks like right around Thanksgiving I'll be rolling again.

In addition to that, my savings are almost up to the point were it will be feasible for me to look into getting another rental soon.

Stay tuned!

Personal Real Estate Investor Magazine

I went to the Phoenix Home and Garden Show yesterday and picked up a couple of copies of a magazine called Personal Real Estate Investor. The cover price is $5.95, but they were giving them away for free at the show. I must say, I was pretty impressed with it. The magazine focuses mainly on the Phoenix area and it run by people who actually a real estate investors. They have good articles about the Phoenix market and emerging growth areas, as well as buying properties for flipping and for renting. There is an emphasis on buying properties below market value. They also have fix up tips and stories. Another plus for the magazine is its advertisers. You'll find plenty of companies who will do investor loans, 100% LTV loans, property management services, 1031 exchanges, and other real estate related activities. (I found a company that will install new carpet and doesn't require payment until the property is sold - very nice for conserving cash during rehabs!) But what I think is the best feature is on the last page of each issue - their "Little Black Book." This is a list of companies that the editors recommend. The recommendations are based on personal experience - not all companies are advertisers and the editors have personal experience with all the companies listed.

The magazine's website is at www.prepmag.com. Unfortunately, there aren't articles on the site, but you can order back issues and subscribe. Their Little Black Book, however, is online. If you are interested in real estate investing in the Phoenix area, this magazine is worth a look.

Buy A Put On Your House?

The current issue of Fortune Magazine has a cover story on the real estate bubble. The article is pretty decent. It points out that there has never been a decline in the housing market without a recession. It also talks about people buying new houses and reselling them a few months later to make huge amounts of money in places like Las Vegas, San Francisco, etc. It calls these people "speculators" and I would agree. They are buying at full price and hoping the price will go up. They have been lucky so far. When the market starts to drop, these people will go away, causing a glut of housing to come on the market, depressing prices, etc. The article also mention interest rates and ARMs and how foreclosures will likely rise because so many people have bought homes they can barely afford. All in all, if you are a wise investor who buys below market value, the collapse of the bubble shouldn't be anything to worry about. Indeed, it might be something to look forward to.

But what really struck me was a sidebar piece. The magazine talked with someone, I forget who, that said they were in talks with the American Stock Exchange (AMEX) to create stocks that tracks the housing markets in various areas of the country. Then, if you think you might have overpaid for your house, you could short this stock or buy a put to gain some protection from a possible decline. Interesting concept. I'm not sure if it will get off the ground, but it's something to think about. Since something similar has been done with gold, who knows...

The article can be found online at Fortune's website.

On a related topic, a newspaper article here recently talked about how developers in the greater Phoenix area are not selling new homes to investors, only to owner occupants, because the demand is so great.

(The original version of this post referred to Forbes magazine. In fact, it is Fortune.)

Fannie Mae problems

A story about the financial troubles at Fannie Mae I mentioned in my last entry is on MSNBC. The headine is Regulator: Fannie Mae accounting flawed.

Not much to report in the area of real estate dealings right now. I might be getting another LLC together sometime soon..

What could pop the real estate bubble?

I've been thinking lately about what might pop the real estate bubble and how it would affect me. I think there are a couple things that might do it:

Another scandal like the S&L mess a decade or two ago. This is probably unlikely, although there are signs of trouble at Fannie Mae and Freddie Mac (or if not trouble, at least suspicious financials).

I don't think raising interest rates will do it. I think raising rates are inevitable and yes, there will be people who will default and perhaps an increase in the foreclosure rate. However, I don' think it will be widespread enough to make a huge difference (except to those investors that recognize it and act on it).

But I think the biggest threat is the mushrooming federal deficit, coupled with the Republican tax agenda. More tax cuts for the wealthy. More tax burden on the middle class. Increased spending. The tax code will need to be changed to support the increased spending. There are proposals out there that have been looked into by the GOP (and others) to radically overhaul the tax system - create a flat tax, a national sales tax, etc. (See this Seattle Times article for details.) What these proposals have in common is "simplification." If you examine them, you realize "simplification" means eliminating deductions. And that means no tax deduction for mortgage interest.

That will kill housing. Millions of people will no longer be able to afford their homes. The market will be flooded with houses for sale and prices will plummet.

Now, to be sure, there are many interests against these plans. However, the GOP is quite good at sneaking legislation into law through misdirection, lies, and spinning the truth. These proposals bear watching.

My next project: flipping houses

My rental sold about two weeks ago and now I'm without any investment property. I feel strangely naked. I do have other passive investments, but I just feel like I'm really at the mercy of my job without some rental property. I guess that's a good thing, since it provides an incentive to get more properties.

My next project will be flipping houses. I've set up an LLC, of which I am the manager and two other investors are the main shareholders (read money suppliers). I will be buying properties, most likely foreclosures, doing minor fix up work, and reselling them. The majority of the profits will go to the investors, but I will retain a percentage of the profits as payment for my work.

The investors are currently waiting for another house to sell in California to provide me funds to get started. It's been delayed for a couple months because the house is in Leisure World, a private retirement community, and that presents all sorts of problems. There are strict regulations about what can be fixed, who has to do the fixing, how the house can be sold, etc. It looks like those have finally been cleared up though and the house can be listed fairly soon. I hope it will sell quickly, but one of the rules of Leisure World is that you cannot put the property in the MLS, nor can you put up For Sale signs or flyers. You must list the house with their agent and they get 5.5% commission. Since it's not in the MLS, I'm not sure how quickly it will sell.

My plan is to use the funds from this venture, together with the leftover funds from the sale of my last house, to get another rental property.

Bubble or just supply vs. demand?

Yesterday, there was an article in our local newspaper about the housing market here in the Phoenix area. It says the number of used homes for sale has decreased by about 30% in the last year, which means demand is high, supply is low, and therefore, prices are rising and houses are selling fast. There are various reasons suggested for this, with the most popular being that investors are buying houses to rent and that fewer people are moving. It's amazing to read that some homes are selling within hours of being put on the MLS and that some buyers are waiving inspections and putting down $10,000 non-refundable earnest money deposits. Wow.

So is this a real estate bubble or just a case of too much demand and not enough supply? It's probably a bit of both. I do think once the market cools down, we probably won't see a seller's market like this for another 15 to 20 years, short of another major catastrophe like the S & L scandal some time ago. In times like these, it's best to stick with basics - buy for at least 25% to 30% below fair market value and make sure the property makes money when you buy it - and keep a close eye on trends. Be prepared. Remember that when the market tanks is often a very good time to snap up deals.

Is there a real estate bubble?

MisterOpus had a comment about there being a bubble in the real estate market. I'm hearing that more and more these days in the mainstream media. I think I tend to agree, but I have two thoughts on that.

First, I'm looking to get into the flipping game. For that, you buy a house, fix it up, and sell it again. The typical holding time is 2-4 months. Since it's such a short holding time, it's pretty unlikely the price will collapse enough to make a difference during that time, especially when you consider the key to flipping is to buy well below current market value.

Second, if you are buying to rent for a couple years or longer, it's even more important to remember that you must buy below current fair market value. As Robert Kiyosaki says, you make your money when you buy, not when you sell. So if you buy at 25% - 30% below fair market value, you've already got a decent cushion built in. And on top of that, you have a tenant who is paying down your mortgage.

The other comment I hear a lot is that interest rates are going up. True, that will make mortgage payments higher and thus, reduce cashflow for landlords. However, I like to look at the other side of this. It also means: 1) fewer people are going to be able to afford to buy a house. This means more potential tenants. 2) A good chunk of those people who refinanced to an adjustable rate mortgage in the last couple of years are going to end up in foreclosure because they can't afford the higher payments. Thus, more houses can be had at auction. More opportunities!

So, am I worried about a bubble? A little, in an abstract way. But the bottom line is you need to learn how to invest in all market conditions to be really successful, so a bubble is just another challenge.

California though, is a land unto its own :-) I don't own any property there, but I have invested in two companies that flip houses in the San Francisco area. They continue to do well...

P.S. Before I forget, I also wanted to mention I took the electricity and gas services out of my name on the property I just sold. I also told my insurance agent to cancel the insurance. This was just paid a month or two ago for the year, so I should get about a $300 refund from that.

Legal Entity For Real Estate Investing

A reader writes:

I love this Blog-Thanks for having it. My question is: Why did you choose an LLC? What benefits does it give you? And lastly..did you obtain financing through your LLC name or your personal name? In a round about way I am also trying to find out if an LLC protects your personal assets. Are there other options beside the LLC? Thank you, Bill

Thanks for the kind words. All financing was done in my name. I have read how it is hard to get a bank to lend to a newly established LLC. You can try to get them to do it by personally guaranteeing the loan, but I didn't want to take the time to try that. Others have had success doing that however, so it's something to try. Remember, there are lots of lenders out there, so keep looking until you find one that will work with you.

An LLC will protect your assets. As with any legal entity, you need to make sure you follow the procedures correctly - never mix personal and business funds, always keep corporate meeting minutes (even if you are the only member of your company), etc. You need to treat your LLC as if it is a legitimate business. If you go to court and it looks to the judge like your company is merely an extension of your personal finances, the "corporate shield" will be pierced and your personal assets will no longer be protected.

As for the various entities, the main choices are an LLC or an S Corporation. (A C Corporation is another choice, but those are more expensive and have more legal bookkeeping requirements.) Opinions vary on which is the best, so do some research, especially research that is specific to your state. I choose an LLC because it is easy and cheap to set up (at least in Arizona), there are no yearly reporting requirements, no yearly filing fees, and it provides protection of personal assets. The IRS also considers it a "pass-through" entity. This means that, from the IRS' point of view, it does not exist. All profits and losses carry straight through to your personal tax return.

An S Corporation, on the other hand, is a tax-paying entity, so you will get double taxation of profits - once by the corporation when it earns money and once when you receive money from the corporation in the form of a distribution. There are also more legal filing requirements with an S Corporation. An S Corporation will also provide protection of personal assets.

Other entities are limited partnerships, trusts, and some others. There are a couple books in the Rich Dad series that are probably worth reading. Look for Loopholes Of The Rich by Diane Kennedy and Own Your Own Corporation by Garrett Sutton. I have not read either, but I have read stuff by both authors and respect them.

Reader's Questions

I received this email today:

Hi, I read your post on how you did the lease purchase. I looked at your website and have a couple questions for you if you don't mind. Why did you go through a hard money lender and then turn around and refinance through a regular lender? Why not go conventional to begin with? Also, you used a realtor to find you a buyer/tenent...did you have to pay 6% commission or how did that work? I do appreciate the info on exactly how you did your deal. Very helpful for those of us just getting started. Thanks - Paula

Thanks for the kind words. I went with a hard money lender for speed. This property was purchased through a foreclosure auction and, in Arizona, if you win a property at the foreclosure auction, you have to pay for it, in full, within 24 hours. A conventional bank loan just cannot be done that fast.

As for commissions, I would have had to pay 6% commission had the tenant bought the property. However, he did not. This was the deal my Realtor and I worked out. See my post here for more on that. If you go the lease option route with a real estate agent, make sure you are very clear on what will happen if the sale does not happen. The majority of lease options do NOT result in a sale, so it is important to plan for this to avoid disputes later. Explain to the agent the benefits of a lease option to an investor and why an investor would hope for a lease option to not sell. Make the agent feel like he or she is part of your investment team.

It's done! Here are the final results

Just got a call from the escrow company and they are wiring funds to me this morning. I'll get just under $27K from this deal. Not bad!

Here are the details:

ROI for year 1: 22.1%

ROI for year 2: 30.0%

These figures are looking at my monthly cashflow only. It does not include gains from selling the property. The reason I broke it out into two years is because I refinanced after 1 year to increase my cashflow. The actual ROI figure for year 2 is lower than it really was. This is because that figure was calculated including the couple thousand I put in during the last 30 days to fix the place up for sale. If I was still renting, many of those expenses would not have occurred and if you exclude them, the year 2 ROI jumps to 37.9%!

And finally...

The overall, 2 year ROI for this property, including the gain from selling it: a whopping 271.8%!!

Show me the money! And soon!

I called the escrow office at 4 PM. The buyer's loan had funded but they were waiting for the wired funds to hit their account. It was supposed to happen today. As of 5:50 PM, nothing has been put into my account. Bah. Frustrating. I can't believe how hard it is to get someone to wire you thousands of dollars! :-)

Issues resolved - waiting for funds

The air conditioner repair guy was out yesterday. It turns out, it was the condensation line that was clogged. However, it was not the one that drains to the outside. Apparently, there is another one that drains to the bathroom (which is a standard practice these days, I am told). The guy blew out the line and he said stuff just flew all over the bathroom :-) He cleaned it up though. So the good news is that it was indeed the AC that was causing the problem in the ceiling and not something more serious. The better news is this only cost me $132 to fix instead of the $300 I offered the new buyer.

I also went out to the house early this morning to fix the paint. I pulled off the paint that had bubbled up, and painted over the spot using some of the extra paint that was left in the garage from when I had the whole house repainted. It took me about 20 minutes to finish everything. I did check out the bathroom and it looked clean, so the AC guy cleaned up nicely. And, in a moment of goodwill, I also threw out some of the trash that was still in the garage. All that's left now is an old bookcase, some plywood, and a car battery.

So that should be it! Funding should happen today and this will be a done deal!

Last minute issue update

Heard from my agent. She said the buyer doesn't want to hold up escrow either and is willing to go ahead and close and take me on my word that I will get an AC guy out to fix the problem today or tomorrow. That's pretty cool of him. But he's also complaining that the condensation line issue that was raised by the home inspector (that it needed to be extended so it didn't drain into the wall) was not fixed. They claim it still looks like the picture. Well, I only have a fax copy of the picture and it's just a big black blob, so I can't judge, but this was definitely fixed. I had an elbow joint put on so now rather than the line exiting flush with the wall, it extends out a bit and turns 90 degrees down towards the ground. This guy is pretty strange.

Anyway, the good news is my agent has an AC guy that she can probably get out there today to fix it. She going to contact him for me. She's fantastic and worth much more than the 1% I'm paying her. When this is all done, she's getting some kind of gift. And the funny thing is, this is the second house I've sold through her in a year and I still have never met her in person!

Last minute issue crops up

So it's Sunday at 1:30 PM. Both myself and the buyer have signed our paperwork and we're just waiting for tomorrow to roll around for escrow to close. Then I get a phone call....

It's my agent and she tells me the buyer had his final walkthrough on Friday and found three problems. The most serious is a big paint bubble in the ceiling of one of the bedrooms. It looks like a water leak and he is concerned about a roof leak. The other two issues are a shower head that sprays water funny and some trash that is in the garage.

I'm ignoring the last two. He's not buying a new house. If he wants the shower heads to function with a perfect spray pattern, he can go to Home Depot and buy a new one for $10. The trash in the garage consists of an old bookshelf, some plywood, some old mini blinds and two bags of trash. The garage is actually cleaner than it was when he had his first walkthrough (and none of these issues were mentioned after his first walkthrough). I honestly did try to clean up the garage. I filled both trash cans full of garbage and put them out for trash collection. I never did it a second time with the remainder of the trash because I didn't want to have to make the return trip out there to bring the empty cans back in. So I figure he can put the trash out for himself. It's not a big deal.

But the ceiling is not good. I was out there on Thursday after signing and did not see this, so it's something that is fairly recent. We have not had any rains lately, so I can't believe it's a leaky roof.

So I got in my car today and made the 45 minute drive out there to check it out. Sure enough, there is a big bubble in the paint in the ceiling, near the ceiling fan. I crawled up into the attic with a flashlight to check it out. I couldn't see any signs of water damage or spots or leakage on any of the attic walls, ceilings, or beams, so I'm really confident this isn't a leaky roof. But the air conditioner unit is directly above the bedroom where the paint bubble is. What I believe is happening is the condensation from the AC unit is either overflowing the drip pan or leaking out through a crack in the drainage line. I suspect the former because I think one of the drip pan supports has slipped, leaving one side of the drip pan lower than the other. The drip pan has very shallow walls, sort of like a big cookie sheet and the drainage outlet is at the higher end. So I believe condensation is collecting and overflowing the shallow wall at the lower end before it can exit the drain hole at the higher end.

This leaves the issue of what to do. Escrow closes tomorrow. No one I hired ever worked in the attic, so it's not like a handyman broke this. By the same token, the professional home inspector hired by the buyer did not catch this either. I could say, since it wasn't mentioned before, I'm not going to fix it, but then the buyer could back out.

What I've instructed my agent to do is to explain to the buyer what I believe the problem is and offer him $300 back to get it repaired on his own. If he doesn't want to do that, what we are going to suggest is for escrow to go ahead and close, but the escrow company will withhold some of the funds due to me. I will get the problem fixed, present the escrow company with the receipt showing it was fixed, and then they will release the remaining funds. I really prefer the former, since I'd like to be done with this house and move on to the next investment.

So my agent will contact their's today and we'll go from there. And this is the reason why I never count my money until it's sitting in my bank account.

My signing is done!

Signed the paperwork at 8 AM this morning. The escrow company did finally get hold of the buyers and they are scheduled to sign tomorrow at 2 PM. After that, the money will be wired into my account. Again, I'm going to wait until I have actually received the money before posting any numbers. I guess I just won't believe it until I have the cash!

But I did save $307.50 by getting investor rates from the escrow company. The price reductions were:

• Settlement fee to the title company went from $215 to $150.50.
• Owner's coverage of title insurance went from $810 to $567.

One thing I just can't figure out is title insurance for the seller. When I bought the place, I obtained title insurance. The title obviously transferred to me without any problems. There have been no liens, judgments, etc. since I have owned the place. Therefore, I know the title is clear. Why should I be forced to buy title insurance when selling then? I completely understand why the buyer needs it, but I can't see how a situation would arise where the seller needs it if he purchased it when he bought the place (and, of course, there has been no title-related activity since).

After signing, I stopped by the property and left the keys, mailbox keys, and garage door opener inside the house for the new tenant. I got out by running under the garage door as it closed. I must admit, it was a bit sad leaving the house for the last time. It's been pretty good to me. Guess it's time to get another one!

Mistakes in escrow - quite common

I received a preliminary copy of the HUD settlement statement for the sale this evening. There are two mistakes in it. The first is rather minor; my fee for title insurance was $810. This is too high and my Realtor called and told them to give me investor's rates. We'll see tomorrow what that drops it to.

But the second mistake is, in my experience, very common. The contract states that I was to pay for the appraisal and the buyer would pay me back at escrow. The settlement statement does not show that. This is the second time in a year that I have sold a house and had this happen. Luckily, I kept a copy of my check and the letter to the appraiser. That could have been a $400 mistake. I called the company and they verified they received the check and deposited it, so it should be a simple matter to correct.

My overall estimate of the amount of money I would receive was off by only $500. And I was off on the low side! This is pretty good, considering all the various charges that get added on. Actually, I'll be getting even a little more back once the above two problems are corrected. When escrow has closed and the money is in my bank account, I'll post the final figures of this investment.

Anyway, let this be a lesson - always go over the HUD settlement statement with a fine tooth comb, preferably before you go in to sign it. Although details may be clearly spelled out in the contract, they might have been missed when transferring that data to the final statement.

Closing on track - I think

I just called the title company and verified everything is on track. I go in tomorrow morning to sign the paperwork. They hadn't called me yet because they are having difficulty contacting the buyers. They've left several messages and have gotten no response. They've also called the buyer's agent and he is trying to get hold of them as well. Hmm..

Home warranty question

The only times I have ever seen a home warranty purchased is when a property is bought or sold. Does anyone know if these can be purchased at other times? I'm asking because it might be possible to get another stream of income going. If you asked your lease-option tenants if they wanted to purchase a home warranty, perhaps the home warranty company would pay you a commission. It would probably be legally questionable if you forced them to buy one or forced them to buy one from a specific company, but if you gave them the option, it might be ok.

Two Must-Have Items for RE Investing

Nothing much happening on the escrow front. Just cruising along - only 10 days until escrow closes.

If you want to get involved in real estate investing, there are two items you must have in order to make your life easier: a cell phone and a lockbox.

Cell phone: When I started, I did not have a cell phone, but I did have a pager. I thought that would be good enough. Well, not really. With all the people that have to visit the house during the repair process, you will be getting a lot of phone calls. And most of them will have cell phones and if they have to wait for you to return their page, they might take off. To make matters worse, I work at my "real job" from 6 AM to 3 PM, so if someone wanted to call me, I would have to give one number for before 3 PM and one for after. Once my property was rented, I got rid of the pager and used the cashflow to pay the cell phone bill. My life is much easier now.

Lockbox: These are lockable devices you hang on a door that contain a key to the property. They come in two flavors - combination dial models and push button models (which have buttons for the digits 0 through 9). Both types are available at Home Depot for about $25 and with each kind, you can set the combination to whatever you want. On the dial model, you can select three letters. On the pushbutton model, you can select as few or as many of the numbers as you want. You need these because you don't want to have to run out to the property everytime someone needs to get in for some reason. It makes things much easier for you and for them, since they can schedule their visit whenever it is convenient for them.

Here's a little tip: don't get the combination style lockbox. This was the type I originally purchased and probably 75% of the people who tried could not open it. After talking several people through the process, I discovered the problem - people do not know which direction is clockwise and which is counter-clockwise! I reached this breakthrough while on the phone with a carpet guy trying to get in. I talked him through the process twice - "turn the dial clockwise until you reach letter R, now turn counter-clockwise past the R to G, then clockwise to S." I asked if he was starting by turning clockwise first and he swore he was. Just for the hell of it, I told him to try starting in the opposite direction this time. What do you know! It opened! He made some comment about how I made a mistake in remembering how the combination worked and I let it pass. The truth was he didn't know clockwise from counter-clockwise.

This left me with a dilema. I didn't want to insult people's intelligence, but the only way I could think of to make sure people were turning the knob the right way was to say something like "grab the knob between the thumb and index finger of your right hand. Spin the dial by moving your thumb up and your index finger down. That is clockwise..." In the end, I decided to buy another lockbox, this time with the push buttons for the combination. I haven't had a single problem with that one yet.

Happy Birthday!!

Today is my birthday! Yay! I'm now mumblemumble years old.

I had to stay home yesterday morning to meet some contractors doing some repair work at my home, so I took the opportunity to call the escrow agent and make sure everything was progressing smoothly. I remember when one time I was buying a house, at about 2 PM on the day before we were supposed to close, I got a phone call from the escrow company saying I had a bunch of stuff I still needed to do, including a payment that I needed to make for something. Needless to say, I ended up doing a heck of a lot of running around and was more than a little stressed out. I don't want to repeat that. This escrow agent said everything looked good and we were on track for an August 30th closing. Just to be sure, I'll probably call again 4-5 days before we close.

I also had to follow up with the company that repaired the sprinkler system. They still haven't mailed me my receipt.

Oh.. I got a nice surprise yesterday. I received a letter from a title agency saying they had issued me a check back in April of 2003 that had not cleared yet. I guess when I refinanced the rental property, there was some sort of refund I had coming that I missed. Anyway, they are going to send me a new check. It's only $70, but it's still a happy little bonus.

Increasing my cashflow

After about a year of renting and getting around $150 a month, I decided I wanted to try to increase that. (I got a cell phone and the bill was $90 a month, so that ate up most of the cashflow.)

Interest rates had continued to fall since my original mortgage was opened and I had finally overcome my fear of adjustable rate mortgages. I think I overcame this just from being more and more immersed in real estate, as well as having a clearer understanding of my goals. When I first bought the property, I had envisioned holding on to it forever, renting it out again and again. Considering I rented it on a lease option, this was an interesting view, since any tenant could buy it. (With lease options though, the vast majority don't buy.) Anyway, I had come to the realization that I would probably sell the house in 5 to 10 years and then buy another property or two. Given that, it really made no sense for me to have a 30 year mortgage.

Remember what I said earlier - 30 year fixed mortgages are the most expensive mortgages you can get. So when I called a mortgage broker to refinance, I looked at all options. I wanted to go with an interest only mortgage, but I wasn't quite at 80% loan-to-value yet, so those were out. I decided to go with a 5/1 adjustable 25 year loan. The interest rate was fixed for the first 5 years, then could adjust once each year after that. Since I planned on selling the property in a couple of years, I'd be done with the loan before it ever adjusted.

As with my last refinance (from a hard money lender loan to a bank loan), I rolled the costs of the refinance into the loan. This increased my loan balanced by about another $3,000, but my monthly payments still dropped. I would be getting about $260 a month cashflow with this new loan and my tenant would be paying down the higher principle, not me.

As part of the refinance, I discovered some interesting things about my tenant and my real estate agent. A new appraisal was needed by the bank, and the appraisers access to the property had to be coordinated with the tenant. Apparently, the tenant thought I was selling the house to someone else and it took several phones calls from both his agent and mine to assure him that wasn't happening. This gave me an idea of the lack of experience in real estate my tenant had.

My agent, on the other hand, was putting up what in retrospect, I can see were little warnings signs. (See my post Identifying People's Mindsets for more on this.) The appraiser had a bit of a problem because my property was still listed in the MLS. Since the sale had not actually taken place yet, my agent had left it in there. The appraiser couldn't, in good faith, not tell the bank that it looked like I was going to sell the house right away, which of course, would cause the bank to turn down the loan. So what we ended up doing was taking the house out of the MLS for about 2 weeks. Technically, I think it was put on a "not available" status. In order to do this, my agent had me sign some paperwork stating that she was still my Realtor and that I would "re-list" with her, blah blah blah. Why should I have seen this as a warning sign? Because it showed she was more focused on ensuring she got her commission than working to help me. Now we still had all our signed paperwork for the sale - the property was in escrow, don't forget, and those documents showed she would get a commission, but she still had me sign all this other stuff. As I said, it's interesting to see where people's minds are at.

Anyway, after the refinance, I had to contact the escrow company and give them the new mortgage payment info and then it was done! I had increased my cashflow about $100 a month to around $260. Piece of cake.

Another step done... and more about getting started

Another step in the process is completed. My Realtor called today and she has received the sign-off on my response to the buyer's inspection checklist. All the issues on the list that I will fix are fixed, so now, I just sit back and wait until the 30th. The termite inspection and appraisal are the last outstanding issues. I'm not paying for the termite inspection and for all I know, it might have happened already. I don't expect any problems with the appraisal - the selling price might be a bit high, but it's not out of the ballpark with the comps, so it should be ok.

I realized that in my last post, I neglicted to mention the specifics of the lease-purchase deal I had when I rented the property. (Most of the info was there, just scattered over various places.) Here's what my deal was:

Rent was $1,100 a month for two years. The buyer paid a $3,000 non-refundable option fee for the right (but not the obligation) to purchase the house anytime within those two years for a price of $125,000. The $3,000 would count towards his down payment. None of the monthly rent would be credited towards the down payment. The buyer also contributed a $1,000 earnest money deposit for the purchase of the house. This was also non-refundable. A late rent fee of $25 was due if the rent was not received by the 5th of the month. (In retrospect, this should have been done differently. Now, I would charge a $5 per day late fee for each day after the 1st that the rent is late and if rent is received by the 5th, the late fee is waived. Thus, if the rent was 5 days late, I'd still get a $25 late fee plus it would increase each day after that, but the tenant would still not have any late fees if he paid by the 5th.)

At the time, the fair market value of the house was $120,000. The selling price in the deal was $5,000 higher to account for future appreciation. As I know now, the appreciation was quite a bit more, but at the time, I was scared of going too much higher than the current FMV in case it might scare buyers away.

The $1,000 earnest money was a surprise to me. I didn't ask for it, so it was probably something either my agent or the buyer's agent recommended. If neither one had much experience with lease-options (and I don't think they did), I can see why they asked for this - it's how "normal" purchases are done. I didn't say anything. If the buyer wanted to put up more non-refundable money, that was fine with me.

I also asked my agent about crediting a portion of the rent towards the down payment. She said she hadn't seen that done before, so I went ahead and left it out. I figured if the buyer wanted it, he'd ask and I could always use that as a negotiation point. He never asked.

Everything was handled through an escrow company. The lease was recorded, as was the option to purchase the property. The escrow company's account servicing department handled the monthly details of collecting the rent from the tenant, paying my mortgage, and sending me the remaining rent. They charged $15 a month for this service, paid for by the buyer. I should note that they were not that great at servicing the account. My tenant was late a couple of times and each time, it was I who had to call the escrow company and have them notify my tenant. They sent out a letter, which was copied to me, informing him he was late and of the late charges. The also charged him $25 for sending this letter.

A lease-option (and, by the way, I use that term interchangably with lease-purchase, although purists probably wouldn't agree with me) is generally used by people with poor credit, hard to document income, or some other problems that make getting a loan difficult. This type of deal allows them to lock in a price for a home, make a small down payment, possibly earn credits towards the price via rent, and gives them 1-2 years to work on fixing their credit scores to obtain a loan in the future. I was told my tenant worked as a welder and had been at his current job for about 1 year. That was the extent of my research on him. I didn't bother with a credit check - given the reasons people typically use a lease-option, I did not expect his report to be sparkling clean and it was ok with me. $4,000 of non-refundable money was, in effect, a very large security deposit.

And that was it. It's interesting to note that I never once met the tenant. Even when he moved out, it was his girlfriend who met me at the house and gave me the keys. And using an escrow company allowed me to let them be the bad guy and be the ones to contact him when his rent was late (which only happened twice - and the second time I started the eviction process and he paid promptly).

So there you have it.. Things went super smoothly for about a year. No late payments, no maintenance calls. Just a check coming in each month for a hundred and some-odd dollars.

Coming up next - how I refinanced to increase my cashflow.

The long story of how I got started

It all started with a layoff... Not mine, but a co-worker. After being gone for a couple of months, this co-worker stopped by the office to visit. I heard him talking to the person sitting in the cube across the aisle from mine one morning. He said he was on his way to a foreclosure auction. My ears perked up! I had been reading the richdad.com website for about a year at this point and had read all the Rich Dad books. I quickly asked my friend out to lunch to find out more.

Turns out, he was buying properties, fixing them, and renting some, selling others. At the time I had lunch, he had 12 properties rented and had started a business flipping houses. I told him I was interested in getting a rental as soon as I had some financing set up. As he explained to me, the way he went about this was to buy a house below market value using a hard money lender and then do a cash-out refinance with a bank at market value. This should allow the return of most of your investment. The hard money lender he used required 20% down and 1 month's interest up front. The loan was at 18% and payments were interest only. I could use the same guy he did.

I knew I wanted to get a rental property, but the problem, even using this method, was getting the 20% down. What I decided to do was open a home equity line of credit (HELOC) on my residence. I had owned my house for a couple years and it had appreciated a good amount. So I called my bank and got a HELOC for $20K. (I asked for $25K, but they wouldn’t go that high.)

The next step, in my mind, was to form an LLC. This was the entity I was going to use to collect rents. I contacted my CPA, told her what I was planning on doing, and she got all the paperwork going to create the LLC. It cost me $800. Once that was done, I opened a business checking account under the LLC’s name and I was read to go.

All of these steps took a couple of months and when they were completed, I called my friend again. It just so happened that he had a property he just bought and was starting to fix up. This was a 3 bedroom, 2 bath house built in 1993. I went out to look at it.

Wow.. What a mess. I was a bit shocked to see the condition of the house – there were huge holes in doors, trash was everywhere, walls were filthy, light fixtures were missing, the backyard was overgrown with weeds, broken furniture was everywhere... Right then, I had some doubts about what I was getting into. However, the handyman my friend had hired was already working on the place and that was encouraging. The house had a huge backyard, but it backed up to a major street. It wasn’t too noisy though.

I decided to go through with the purchase. It would cost me $98K for the house, which had a market value of about $120K, plus a $1,346 finder’s fee to my friend. (I can’t remember why such an odd amount.) The 20% down payment, plus loan origination fee, plus first month’s interest that I had to pay to the hard money lender came to just under $23K. Since my HELOC was only for $20K, I used some cash I had saved plus a cash advance on my credit card to cover the rest. (I knew I still had fix up costs, so I didn’t want to put all my cash towards this.)

So I made a couple trips to the bank – first to the bank that had my HELOC and I drew against that. Got a cashier’s check and went to my LLC’s bank and deposited it. They wanted to put a hold on it for 14 days, which I could have, since I had to pay really quickly. I explained that the reason I got a cashier’s check was so that there would not be a hold on it. After the teller consulted with the branch manager, they agreed to not put a hold on the check.

The next day, I met my friend at my office. He had a bunch of paperwork for me to sign. The way this worked was the hard money lender was my “bank” and I was buying the house using him as the mortgage holder. After signing some papers, we went into escrow. I took several trips to the bank to get stuff notarized, but finally everything was done and I owned the house.

Which meant I had an 18% loan I had to pay, plus I still had to pay the guy fixing the place up. Plus I had to find a renter. Plus I had to refinance the loan to get rid of that high interest rate.

I got the cash out refinancing going immediately by calling a mortgage broker. I ended up getting a 30 year fixed rate. In retrospect, this was not the way to go, but at the time, it was what I was most comfortable with. Adjustable rate mortgages scared me. I already knew I wanted to rent the place out on a lease with an option to purchase (a “lease option” or “lease purchase”) for a number of reasons: I would get another chunk of cash (the option fee) when the tenant moved in and I could also have the tenant be responsible for most of the maintenance, since theoretically, he would be buying the place. I rolled all the loan costs into the loan, so I ended up with a $103K mortgage. My payments were around $950. I figured I could rent the place for $1100. Only $150 a month cashflow, but it was a start and I didn’t think that was too bad for my first try. After all the loan and escrow costs, I ended up getting about $18K back from the refinance, which I used to pay down my HELOC. At this point, I had the property for about $6,000 ($23K less $18K plus about $1K for a bunch of miscellaneous expenses). Nice!

I had been running an ad in the paper for two weeks looking for a tenant. I got a couple of phone calls, but nothing ever came of them. I tried several of the things mentioned on the richdad.com boards – I left flyers and applications at the house, I posted For Rent notices on the community bulletin boards at the local grocery stores, and put up signs. (Unfortunately, I discovered the city had an anti-sign ordinance, so the signs got taken down within a day or two of my putting them up.) So I was starting to get worried. My first mortgage payment was coming due and I had no tenant yet.

As anyone who has ever bought a house knows, as soon as your mortgage is recorded, you start getting all kinds of advertisements from real estate agents you obtained your name and address from the publicly recorded mortgage docs. I grabbed one of the postcards and called the agent. We met at the house and I told her what I wanted to do. She listed the property and within 1 week, I had a tenant!

The details were all handled through an escrow company – they collected the rent, paid my mortgage, and sent me what was left. They also collected the $3000 option fee plus $1000 in earnest money for the purchase, and sent that on to me. I had my first real passive income!

Coming up next – I refinance to get a higher cashflow.

Another interested party

My Realtor called me this morning to tell me she had another agent who has someone who wants to buy the place. She told them we were already in escrow, but we have not received a response to our list of fixes yet, so a backup offer might be appropriate. She then called the agent of the current buyer, who said he didn't think there would be any problem with our fixes. She told him we need the signed document back since we have another interested party, so hopefully, we'll get it today.

On Tuesday, I mailed a check to the buyer's loan officer to pay for the appraisal and was told this was already scheduled, although I didn't ask when. I will be reimbursed for this in escrow.

So, as far as I can tell, the outstanding items are: fixing the water heater (which should be done today), the signed buyer's inspection report detailing what I will and won't fix, and the appraisal. Once all those things are done, it should be smooth sailing.

If it's not one thing, it's another

Well, the handyman got the work done and he told me the gas guy was out to turn the gas on. Turns out the water heater has a bad gas valve. So that needs to be fixed. The gas guy estimated $80 but the two people I've talked to said about $175. That will be fixed tomorrow. Does this mean my old tenants didn't have any hot water? I find that hard to believe. Maybe the valve was broken but still functional, but the gas company won't re-light it in that state.

Have not heard back from the buyer yet regarding the items I will fix.

The Fixes

Today I met with the handyman and went over what we will fix. Here is what I am replying with back to the buyer:

1. Cracks in stucco – no
2. Extend condesate drain line for the heat pump – yes
3. Sprinkler control valves - yes
4. Front sprinkler valve leak - yes
5. Trim tree in the front yard - no
6. Fuel system was not on for inspection – yes. Gas company will turn on tomorrow and light appliances.
7. GFCI electrical outlets - yes
8. Missing window screens – no. Three screens are in shed in back.
9. Smoke detectors did not respond to the test button. – When I pressed the test button, they worked. Nevertheless, we will re-check.
10. Missing smoke detector - yes
11. The drain line for the dishwasher is improperly installed. – yes. Just was not connected to overflow valve that drains to sink.
12. Stuck water shut off valves in bathrooms – yes

The sprinkler valves I had fixed Friday. The cost of that was $530. Yikes. More than I expected, but they said there was a fair bit of metal work that needed to be done. The other items above my handyman quoted me $200 to fix, including parts. He will start tomorrow morning and I don’t think it will take more than a day. So these fixes will cost me $730 total. Now I’m glad I counter-offered 1.25% cash back to their 1.75%. That got me an extra 0.5%, or $710. Enough to mostly pay for these items.

We fax the inspection checklist with my response back today. The buyer has 5 calendar days to respond.

Buyer's Inspection

OK, here's the list of items the buyer is requesting that I fix:

1. Cracks in the east side of the stucco that need to be repaired
2. The condesate drain line for the heat pump is inside the east exterior wall. It needs to be extended to keep condensation from getting behind the wall.
3. The sprinklers did not come on when the sprinkler control valve was turned on.
4. There is a leak at the front sprinkler valve.
5. The tree in the west front yard has to be trimmed away from the roof.
6. Fuel system was not on for inspection - suggest utilities company light and test all fuel appliances.
7. The electrical outlets on either side of the kitchen sink are hooked to a GFCI that did not work.
8. All the window screens are missing.
9. The smoke detectors did not respond to the test button. They were painted over.
10. The west hall smoke detector is missing from the wall.
11. The drain line for the dishwasher is improperly installed.
12. The water shut off valves are stuck open under the sinks in the master bath and the hot water valve is stuck open under the hall bath sink.

Now, keep in mind, I can fix all, some, or none of these and if the buyer doesn't like what I choose, he can back out of the sale. What would you fix?

Not quite gone yet

Of course, the second I post that nothing much is happening, something happens..

My agent called me today and faxed me a bunch of paperwork. I got copies of the earnest money check and the signed, final counter offer. I also got an info sheet to fill out for the escrow company to help them do their job - who my mortgage was with and the account number, etc. And finally, the standard residential Seller's Property Disclosure Statement.

The SPDS is a 6 page document that asks you all sorts of questions about the property. It's looking to uncover any knowledge you have about problems with the house, land, liens, etc. It also tells the buyer who provides what utilities, etc. No big deal here either. But a little birdie did give me one tip that is useful for investors - the last page of this document has a section where you can write in additional information. If the property used to be a rental, it's a good move to cover your butt by writing "Owner never occupied property. Knowledge is limited."

Also, since my contract states I will pay for the appraisal and will be reimbursed for it in escrow, I need to send a check to the appraisal company. My agent tells me she now understands why this was done. It turns out the buyer is another investor who is buying this property as part of a 1031 exchange.


This just in! While typing this, I got another call from my agent. She just received the buyer’s inspection notice. This is a document that is filled out by the buyer after the buyer or something the buyer has hired, has inspected the property. It contains a list of items the buyer wants fixed. As the seller, I can agree to fix all, some, or none of these items. If the buyer does not like my response, he can back out and still get his earnest money back. Haven’t had a chance to go over the list yet.. More later..

Gone for the weekend

Well, I'm heading out of town for the weekend, so nothing will be posted here for a couple of days. Not much is happening actually. Haven't heard from the escrow company or the real estate agents, so I'm just killing time until escrow closes..

Identifying People’s Mindsets

Well, now that I’m in escrow, things will probably be quiet for a bit. I expect nothing much will happen for 3 weeks and then, during the last week of escrow, there will be a flurry of activity as the escrow agents realize the deadline is approaching. This gives me some time to talk about various things.

If you’ve read The Cashflow Quadrant by Robert Kiyosaki, you know of the four different quadrants people operate in – E for employees, S for self-employed, B for business owners, and I for investors. Most people are in the E quadrant – they work for someone else and are dependent on that person or company for their paycheck. They are focused on paychecks. Investors, on the other hand, are focused on rates of return and how hard their money can work for them so that they don’t have to work. In the book, Kiyosaki mentions he can tell what quadrant a person is in just by talking with them for a few minutes. I had an experience recently where this difference jumped out at me.

Two years ago, when I purchased my rental property, I tried to rent it out myself for two weeks. I had no luck. I ended up calling a real estate agent. She listed it for me and within 1 week, the place was rented on a lease-option deal. My contract with the agent said I’d pay the standard 6% commission – 3% to my agent and 3% to the buyer’s agent - when the sale was complete. I asked her what would happen if the sale did not go through. She said she wouldn’t get paid. Well, as long as she knew that, I was ok with it.

As an investor utilizing a lease-option, I WANT the sale to fall through. Because when it does, I get to keep the tenant’s option fee, which is a couple of thousand dollars, plus I still have the house. I can then repeat the process, collecting another option fee, increasing the selling price of the house, and possibly increasing the rent. However, this puts me at odds with a real estate agent, who only gets paid if the house sells.

When it became clear to me that my tenant was not going to purchase the house, I spoke with my agent about putting the property up for a lease-option again. I explained the above to her and told her we needed to get our goals aligned. I offered to pay her $1,000 of her commission on signing and the rest when the house was sold. If the tenant did not buy the house, she could keep the $1,000 and we’d do it all over again. It was a win-win for both of us. Initially, she agreed. About 3 weeks later, I got an email from her, out of the blue, saying she was resigning as my agent. She said it was hard to find tenants who would pay a non-refundable option fee equal to what her commission would be if she sold the place and she couldn’t take the time to work on leases. In other words, she didn’t just want $1,000 now and the rest OR MORE later – she wanted to be paid her full commission for selling the house up front, even if the house didn’t sell! I said thanks for your time and found another agent.

Just to recap – she had an opportunity to get a good cashflow stream going. Yes, she wouldn’t immediately get a full commission (about $4,000 in my case) if the tenant didn’t buy. But she would get $1,000 and, when the next tenant moved in, she’d get another $1,000 plus commission on a higher sales price. And if THAT tenant didn’t buy, another $1,000, etc...

She was firmly in the E quadrant and so focused on her next paycheck, she couldn’t see the benefits of the deal I was offering her. And then, of course, my plans changed and I ended up selling the house anyway, so she lost out there too.

I can understand her fears. Just last week, our local newspaper had a story about real estate agents’ fees and how the once iron-clad rule of paying 6% commission is being eroded. A seller’s market not only affects housing prices, but agent prices as well. You can use a bare-bones service and get your house in the MLS for about $500. If the only way you know to earn money is from a paycheck, these are scary times to be a real estate agent.

The 2 kinds of lease options

8/1/04 9:40 AM

While I’ve got some down time this weekend, I thought I might explain the two kinds of lease options you might hear about. Unless you know there are two types, it can be confusing.

If you go buy a book on real estate and it talks about lease options or lease purchases, what they are generally referring to is this: you find a person selling a house. You work out a deal with them whereby you agree to buy the house in X years and in the meantime you rent it from them. The seller continues to own the house and but you make the mortgage payments. In turn, you lease the house out to someone else, charging them more in rent than the mortgage and you pocket the difference. You may or may not have a contract with the tenant to buy the house. If you do, they pay you a non-refundable option fee that gives them the right to buy the house for a specified price in the future. So the seller doesn’t sell the house right away, but he does get to stop making the mortgage payments and yet still receives the tax write-off for mortgage interest. This is not what I did.

The lease option method I used was to actually buy the house, then lease it to someone and they pay to have the option to buy the house for a specific price in the future. In my case, the lease was for 2 years at $1,100 a month and an option to buy the house anytime within those two years for $125,000. That option cost a non-refundable $3,000. I chose not to credit any portion of their rent towards the down payment for purchase. Some people may credit $50 - $100 of each month’s rent, but I didn’t offer that and the tenant didn’t ask. A benefit of this approach is that, since the tenant is theoretically going to buy the house, you can put it in the contract that he is responsible for all repairs – expect for major things, such as a roof caving in or something. And it works. For two years, I never had a single call to fix anything in the house. (Of course, after seeing the dishwasher when they moved out, I wish they would have called me, but oh well.) A drawback is that the house may appreciate more in value than you thought and you’ll have to sell for less than the fair market value. Had my tenant opted to buy the house, he would have had an instant $17,000 in equity – his contract was to buy the house for $125K, yet I ended up selling it to someone else for $142K.

Sold!!!!

7/30/04 2:50 PM

Just heard from my agent and they accepted my counter-offer. The house is sold!!

Phew.. I was getting a bit nervous. And my agent gave me some more good news - she said she'll tell the escrow company I am a real estate investor and I'll get investor rates! Cool! Gotta love her!

Still waiting..

7/30/04 12:40 PM

Still waiting for the response to my latest counter-offer. Getting nervous now. I think it's mostly me psyching myself out though.

Went out to the house at lunch today. I had to bring in the trashcans that I left out Wednesday for garbage collection. When I got there, some thoughtful person had already pulled them in from the curb. The good news is that the old dishwasher was finally picked up, so that eyesore isn't sitting out in the front yard anymore.

4 hours and 20 minutes until the response deadline...

My counter-offer to their counter-offer to my counter-offer to their offer (Got that?)

7/29/04 3:30 PM

No word from the 10 AM investor, so I’m replying to the original buyer’s counter offer. I wanted to go for 1.25% with an 8/13 close of escrow, but my agent thinks that might not be enough time. If we’ve got good title agents and everything goes smoothly, it could work, but I figure why chance it. Oh, if the buyer was selling a house, their offer should have stated it – if only to give them an out if their sale falls through. So I counter back with 1.25% and a close of escrow on 8/31. The extra 0.5% will cost them $710, but it will almost cover the extra mortgage payment I will need to make. If they can’t pay this, I’m hoping their agent will kick in the extra 0.5% from his commission. Better to lose $710 and still get $3,550 than lose $4,260 altogether. I’m thinking the agent might do this because, when I sold my personal residence last year, in the closing paperwork, I noticed this done. So the counter offer was sent to them and they have until 5 PM tomorrow to respond. I have to say I’m a bit anxious. I’d hate to lose this deal over $710.

So why didn't I just accept their counter? I'm not sure. I think what is boils down to is getting more negotiating experience. If they reject it, I'm betting they will still buy the place if I back down and give them the 1.75% they asked for. Plus, I figure once the inspection period starts, they're going to find more things they want fixed. At that point, I'm likely to be tired of fixing stuff and will just offer them some cash to get it fixed themselves. This gives me a bit more of a cushion.

Now it's waiting time...

The counter-counter-offer

7/29/04 10:00 AM

Got a call back regarding the counter-offer. They have given a counter-offer of their own: 1.75% cash back towards their closing costs, all else the same. We have until 5:00 PM tonight to respond. Is this a good deal? Hmm. The difference between 1% and 1.75% is just over $1,000. The factors in favor of this are, again, the large amount of cash down, indicating a serious buyer and small chance of loan troubles down the line. On the negative side, there is the August 31st closing date. That means I'd need to make one more loan payment - about $850. I'm thinking about countering with 1.25% but the closing date is to be August 13th. That might cause problems if the buyer is selling another house to get this one, so I'm still not 100% sure on this yet. The extra 0.25% would cost me $355 dollars, but I'd save $850 for not making the August mortgage payment. We'll hold off replying because...

I am told that we've got one, possibly two more offers on the property. One received last night was rejected outright. They offered $135K with 3% cash back towards closing costs, $1K earnest money, and a bunch of stuff about the deal only being good if approved by this guy's business partner in writing within 10 days. Well, in Arizona, the buyer can back out of a deal within 10 days for any reason whatsoever. So what was the point of the bit about a partner? Sounds to me like someone read a book on real estate investing and is trying to insert a "weasel clause" to allow him an out. Of course, this is not necessary given the 10 day law here (and his purchase price offer isn't low enough for this to work as a flip, which is where weasel clauses are generally used), so it just makes the offer look silly to both me and my agent. I rejected this offer without a counter. But this is another offer utilizing the "x% cash back at closing" method. I wonder if this is a new trend? Being cynical, I wonder if real estate agents are doing this to keep their commission based on the higher price. They'd still get their 3% on the full purchase price, but their client still gets the discount on the house. Hmm. In this case it means only another $127 to the agent, so I don't know.

The other offer that might come in is from an investor who is looking at the property sometime between 10 and 11 today. My agent told his that we have an offer on the table with a deadline of 5 PM, so we'd need their offer before that if they are interested.

More parts to install

7/28/04 11:00 AM

Run out to the house on my lunch break to install the light cover and filter on the range hood, which arrived yesterday. House smell is much better! Not overpowering and smells mainly like the vanilla air freshener thingies. Nice. Also put out the trashcans for pickup tomorrow. Dishwasher still in the front yard but, while stopping at McDonalds on the way back, I see the trash collectors coming around with the big crane thingy they use for the bulk items pickup, so it should be gone today.

An offer!!

7/28/04 8:30 AM

Wow. Talk about timing! Got an offer on the house – a mere three hours after worrying about no offers! And an offer for $142K - full asking price! But they want me to give them 3% back at closing to help pay for their closing costs, plus they want me to provide a home warrantee (max cost $350). I also pay for a termite inspection. Interestingly, they want me pay for the appraisal but will reimburse me for it at closing. Normally, that's something the seller pays for anyway. They put down $1K earnest money and will put down $49K cash for purchase and finance the rest. They are already qualified for a loan and we have the name and phone number of their loan officer to verify. I'm ok with the home warrantee - it saves lots of hassles if something breaks (they don't come back to me to complain and they don't have to pay to get it fixed), but the 3% cash back is a new one to me. Strange to word it this way instead of asking for $4K (about 3%) off the purchase price. Still, they've got $50K in cash to buy this thing, so this is a strong offer.

I decide to counter with accepting the home warrantee and everything else, but paying only 1% cash back. We'll see what they say.

Early morning doubts

7/28/04 5:45 AM

On the way in to work this morning, I’m trying to fight off concerns. It’s been just over 4 days and no offers. I know that’s not much time, but I sold my personal residence late last year in 3 days. However, my house was newer and in relatively excellent condition. In other cases, a friend sold his house in 7 days and my in-laws just sold theirs in 1 week. But my asking price is a bit on the high side (comps are about $137K and I’m asking $142K), so I have doubts. I tell myself to wait at least one week before doing anything.