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Saturday, August 14, 2004

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.

26 comments:

Anonymous said...

Shaun,
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 Herren

Anonymous said...

I was a little lost on the paragraph where you say you met your friend to sign some papers and the hard money lender was your "bank". Could you please clarify what exactly happened there? Thanks in advance.

Shaun said...

The hard money lender was acting like the bank in that he loaned me the money to buy the house, just like a bank lends you money to buy a house. With a bank, they lend you money and create a mortgage showing you borrowed x number of dollars and the house is collateral for the loan. The hard money lender did the same thing - he loaned me the money and I had a mortgage from him stating the house was collateral for the loan.

Anonymous said...

HI,

I would like to ask you what is the benefit of LLC?

If you got loss from the LLC operation, are you able
to carried over that lost ?

I heard if your AGI is too high ( > 150k) you are not
allow to deduct that loss anymore.

Shaun said...

Yes, LLC losses can be applied to your personal tax return. I am unaware of any AGI limitation. I wrote briefly about the various legal entities at http://shaunsre.blogspot.com/2004/09/legal-entity-for-real-estate-investing.html. Your best bet is to talk to a CPA and / or assest protection lawyer to find out what is best for your specific situation.

Anonymous said...

Why did you used the hard money lender instead of the bank?

Shaun said...

Time constraints. When a property is bought at a foreclosure auction in Arizona, it must be paid for, in full, within 24 hours. Traditional banks can't move that fast. Hard money lenders will also often lend on the after repair value of a home rather than the current value.

dino said...

You really have a great site! Two questions. When you burrowed the money from the hard money lender, was this loan paperwork in your name or the LLC?
Secondly, when you refinanced it, was that loan paperwork in your name or the LLC?

Thanks,
Dino

Shaun said...

Thanks for the kind words! In both cases, the paperwork was in my name. This is a common question with people just starting out. My advice: forget about LLCs for now - just get started with a property. You can always transfer it to an LLC later via a land trust or some other way later. People get hung up on the fact that banks won't lend to a new LLC, so they don't ever take the first step to start investing. Just do it.

Dino said...

I'm still puzzled by how you go about transferring it to an LLC via land trust (or something else) after the purchase. I thought there is a clause in the traditional mortgages that prohibits this. I think it's a Due-On-Sale clause or something similar. I'm just trying to make sure I go about it the right way so the lender doesn't say I am in breach. Sorry, but I am new to this stuff and definitely want to learn. I have read the first three RD books and play Cashflow. Now I am trying to learn the semantics.

Shaun said...

That is a whole lengthy topic of discussion I am not going to get into here. Consult a real estate attorney or asset protection attorney if you are that concerned about it. Bottom line is you should not let this be stopping you from getting started. Get the assests first, THEN figure out how to protect them.

Dino said...

Good point. I guess at some point I will need to build the team. I should probably get some legal advice. I guess I just want to avoid the "you should have done it this/that way" statement. Don't get me wrong, I'm sure I will make plenty of mistakes along the way. As RDPD saids, these are the gems that you learn the most from. Thanks for your quick replies. Again, great site!

D.W said...

Very motivational story Shaun. I'm starting out in a similiar situation. 3/2 all brick, tenant occupied. Hard money lender asking 95k,11k repairs,140 ARV, @ 15% with 5k down. Should I do this deal? Do you have any tips or is there anything I should consider?

bill or puss_n_boots_owner@yahoo.com said...

uh oh shaun either you missed replying to dw's 7-12-05 question or i missed your reply. to bad i dint know about this site back then. I no my opinion looks like monday nite quarter backing but I actually did a house with nearly the exact same numbers (o.0)at nearly the exact same time (about 1 or 2 months earlier
the numbers were PP 93, fix-up (f-u)17.5 (should have been around 15 but that was cuz my project manger paid for the work in full before it was completed after i told him 3 times not too but he thot he was getting a good deal from the "contractor" that said if if u pay me now i will do the extra work u need done for free !?!?! red flag to even a novice why would any one ever do work for free and actually he not only dint do the extra work for free he dint do all the work that was paid for , so learn from my PMs mistake and my loss , arv 142. sales cost (sc) of about 9 percent

recap
arv 142000
sc (9%) -12780
sbtl 129220
PP -93000
sbtl 36220
f-u -17500
net prof 18720

35% to investors that provided the money leaving me with approx 12500
we got "lucky" and caught the market in a a bidding war and actually sold for around 170,000 yahoooooo!!! or is that ka-ching~!!!!!!!!!!! but dint count on the market to bail me out ... i bot based on arv at the time i bot

originally this was suppose to be a no down deal for me but my investor got cold feet when we had to change loans company and go with a hard money loan again the numbers similar urs at 12%
at this to say yes i would have done it cuz i already did it. this was my 4th fix and flip.

things u have to consider in doing a deal are what is purpose of the deal ... rental property or fix and resell... and check the market itself (accordingly to ur purpose, the rental market if its to be a rental and the resell if to be that). tho 15% is pushing MY envelope i dont like hard money loans but if ur set up to get in and get out quickly then HM is okay (i have lost some sleep over HM) . If its your first property my suggestion would have been flip the sucka and keep doing that till you have some cash in the bank. it feel damn good having 50k in the bank and builds a SH*T load of confidence. Then start building your rental portfolio.

as for llc or corps and such i agree with shaun get out and do it then protect it with one possibble exception. look into doing ur deals set up so that ur self directed ira get all the profits (or the lion share. this money is tax free until u take it out at retirement. and even tho there is a limit to your contributions the profit ur ira can make is unlimited. this will save you 20-33% of your profit leaving u more cash to invest. check with the proper professional but i am thinking how does any one find what u have in an ira ... i am pretty sure that the SSA will not divulge that info except to another gov agency IE obviously the IRS so keep ur taxes paid :).

Not sure why i am spend like 3 hours blogging a thread that is over 2 years past its last comment... maybe shaun will read and be impresss and call me :) well shaun call me even if ur not impressed 623-845-0972 and any body else that feels like discussing RE. I am hoping this will catch enuff people's eyes that we can put together a RE group with some significant assest to make some really low ball offers.this is definitely the time to do.

bill or puss_n_boots_owner@yahoo.com said...

Shaun what is the possibility of starting a thread on educational RE courses and peoples experienc with them. I no some are decent its what got me started well got me interested ... i really had to learn to do it on my own.

I can start by warning your readers to stay away from J. B. Banks probate stuff cuz i tried it and it dont work here in AZ. what a #()#*$#@)($*@ waste of $4400

I am thinking that we could get a group of people to purchase serval course and then report the results and share the material if it works.

I no the no money works cuz i didded (sic) the thing that has hit my hot button is getting business lines of credit. i am currently looking a TOM KISH's course for about 550 but since the banks fiasco i am considering it with much fear and trepidation. have checked with one other that guarantees 100,000 and charges about 3 k for that and they do 90 percent of the work if i remem correctly your can get it for about 900 if u do most of the work yourself. any thots on this would be appreciated

Shaun said...

Bill - I've not really used any educational real estate courses, other than what I talked about in my "How To Get Started In REI For Under $400" thread. Since this blog is about my experiences, I don't really have anything to write on the subject. (I also don't believe I will ever purchase one of those courses. They are too expensive and you can get all the info cheaper or free elsewhere.) While I welcome readers' comments, I don't think a blog is really the right forum for the type of community discussion you are looking for. Try one of the message boards over at richdad.com.

Jonathan Arevalo said...

Hi Shaun,

I think your blog is very informative, well done!

Do you know where I could get an independant BPO done here in Phoenix?

Thanks Shaun,

Jonathan

Justin H said...

Shaun,

Not sure if you'll read this far back but you didn't mention anything about how much it cost for rehab or where that fit into your plan. Can you expand on that?

Justin

Shaun said...

For this first property, I really didn't have any idea of rehab costs. I knew I had a large enough cushion to handle what I saw needed to be done though. It was just a gut feeling and also some trust in my friend, whom I bought the property from. I knew he wouldn't be doing it if it was a borderline deal.

Nowadays, I would never do such a thing of course. I have a much clearer idea of rehab costs and can estimate them better. For more details, read about my other rehab projects. Try the links on the left for "It's done! Here are the final results" and "Final Results for House 11." You'll need to work backwards from those links unfortunately to get the whole story. And these were written before Blogger let you tag posts, so there is no easy way to search for them. Or, you can buy my ebook (link also on the left - Get My ebook!!), which presents those cases in a nice chronological order and adds some extra detail not found here in the blog.

Justin H said...

Thanks for responding so quickly Shaun. My final apprehensions about getting into REI is that some of the things that fell into place for you may not be the case for others. Buying property in the right place, rehab costs (while minimizing initial cash investment for first time REIs like me) and finding a tenant are all critical parts to the success of renting that can be hard to beat. Coming up with the 20% down payment AND money to rehab prior to having your first tennant is probably the hardest part to get past IMO.

Justin

Shaun said...

One of the biggest fears new real estate investors have to overcome is "analysis paralysis." Real estate being what it is, no deal you find will ever be exactly like one you have read about that other people have done. There will always be some unknowns and all you can do is make reasonable estimates or guesses as to how things will proceed. But a good deal will have plenty of room for error, so even if things do go not as planned, you still (hopefully) won't lose too much money.

If rehab costs and hold times worry you, you can always buy a property that already has renters in it. You won't make as much money or get as high an ROI, but you will eliminate your two biggest fears.

If you are worried about finding tenants, look in rental ads and note the names of real estate agents listing rental properties. Contact one of them to get your property listed.

If you are worried about location, talk to those same real estate agents about what areas rent quickly.

Join a local real estate investor's group. You will get lots of advice from people who are doing the same thing in your area.

If you are short of funds for a down payment, it might be worthwhile looking at flipping a property or two first to get some funds saved. (Yes, it is still possible, even in this economy.) Or be a birddog for local investors and earn money that way. Or use a private party hard money loan to do the initial purchase, then refinance to a traditional mortgage once the place is rented (which is what I did with my first property).

There will always be unknowns and the first step is always the hardest. But you will find once you have some money invested, you will have great motivation for solving problems and working things out :-)

Justin H said...

I can't tell you how awesome it is that you take time to really respond to your readers!

I saw that you used hard money lender to buy and then refi'd with a bank but you still had the down payment from the HELOC from your house. I don't understand how I could flip (still requires buying the property and rehabbing) without money down.

I'm reading about bird dogging for the first time so that part should make sense in about a day or so :)

Shaun said...

It's possible, but you need to find a good deal. For example, you find a house that is worth $100,000 after it has been rehabbed. You can buy it for $80,000. Use a hard money loan to buy it for $80,000. Rehab it. Go to a bank and refinance. The value of the house is $100,000 and you are refinancing $80,000. You have $20,000 in equity, the Loan To Value ratio is 80%. The bank will not need a down payment. Now in this scenario you will still need money for rehab costs, closing costs for the loan (although those can be added into the loan amount), etc. so it's not truly a no-money-down deal, but the money needed is minimal.

Things rarely work out this nicely though. Sometimes you'll only get an 85% or 90% LTV ratio and you may need to put in some money to refinance. But typically it's an amount much less than 20% of the price of the house.

The key to doing this is to buy below market value. If you can buy below market value, then refinance at market value, you can usually dramatically reduce the amount of your money that you need to put into the deal. This is why foreclosures are the properties real estate investors buy - they can usually be purchased for below market value.

Shaun said...

By the way.. If you are going to study what I did, I recommend looking at the other two properties I wrote about here. This was my first one and I was still learning the ropes.

Jonna Hoppon said...

It's like reading my friends story. Almost everything fits into a place.

Paul said...

Hey Shaun,

New visitor to your blog. Been poking around a little - this posts caught my eye.

Very informative and insightful! Reminds me of my early days as a landlord.

I'm trying to get my own blog going at propertymanagementscreening.com. It's brand-new. Blogging, like real estate, gets ya done sometimes, so it is nice to come across other motivating posts.

Thanks!

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