Multifamily Investing for Newbies. Thomas Winfield November 5, 2016

Transcription

1 Multifamily Investing for Newbies Thomas Winfield November 5, 2016

2 This is not a solicitation, endorsement or offer Nothing in this presentation is meant to be Legal, Tax or Financial advice Consult your Lawyer for legal advice Consult your Tax Advisor for Tax advice Consult your Financial Advisor for Financial advice

3 Buy and Hold (2-5 Years) Risk Appropriate Investments Rigorous Due Diligence Appropriate Leverage Data/Metrics Driven vs. Hype Driven Our Philosophy

4 Topics Market Analysis Property Analysis/Due Diligence Finance Exit Strategy The Plan and the Team

5 Market Analysis

6 Criteria for Selecting a Market Population Growth Primarily from Net Migration States With Large and Growing Populations Workforce Income Growth Educated Workforce Gross Domestic Product (GDP)/GSP Diversified Economic Base Good Debt Rating RE Cycle Phase Real Estate Prices Not Volatile

7 Virtuous Circle for Economic Growth Population Growth Income Growth Increase in Job Openings Talented Workforce A Growing Population and Talented Workforce Creates a Demand for Real Estate

8 The Population of the South and West is Increasing Faster Than the Northeast and Midwest Howdy Y all

9 Follow the People States with higher net migration are best for real estate investors

10 The Real Estate Cycle Tracks the Economic Cycle Cycle has Peaks and Troughs Next Peak is Generally Higher than Past Peaks Goal is to Survive one Cycle Focus on the Trend Line I Believe the Market Is Going to Fluctuate J. P. Morgan

11 In What Phase of the RE Cycle is Your Market Sell Here Expansion Phase Contraction Phase Above Long Term Average Occupancy Below Long Term Average Occupancy Recovery Phase Rents are Increasing Recession Phase Rents are Decreasing Buy Here

12 States With Best Long Term Prospect for Buy and Hold Multifamily Investors South North Carolina South Carolina Florida Georgia Texas Western Colorado Utah California Nevada Washington Oregon

13 Property Analysis and Due Diligence

14 Due Diligence - Definition 1. An investigation or audit of a potential investment. Due diligence serves to confirm all material facts in regards to a sale. 2. Generally, due diligence refers to the care a reasonable person should take before entering into an agreement or a transaction with another party.

15 Types of Due Diligence Sub Market Financial Physical Legal Time Market Due Diligence Should Proceed all Other Due Diligence

16 Important Metrics Cash on Cash Return Cap Rate Vacancy Rate Expense as a % of Income Median Income Median Rents

17 Long Beach Sub Markets Price Per Unit Long Beach Market Median Price is $200K Per Unit

18 Long Beach Sub Market Price Per Square Foot Long Beach Market Median Price is $275 Per Square Foot

19 Rents and Vacancies

20 Financial Due Diligence-Valuation Appraisal/Broker Opinion of Value Metrics Price Per Unit Price Per Square Foot Vacancy Rate Property Sales History These values should be compared to the Market/submarket norms

21 Financial Due Diligence-Income Income Statement Rents Other Income Rent Rolls (Past 3 years) Review All Leases Tenant Background Obtain Tenant Estoppel Certificates

22 Financial Due Diligence- Expenses Property Tax Insurance Policy Security Deposits Utility Deposits Loan Documents (if assuming loan) Utility Bills Existing Contracts (Property Managers, Maintenance, etc.)

23 Legal Due Diligence Seller Listing Agreement What s Included in the Sale What are the conditions of the purchase Purchase Agreement (RIPA) What are you Offering What are the conditions of the purchase Seller Disclosures Title Who Owns Property How is Title Held Deed Covenants, Conditions & Restrictions (CC&Rs) Ownership Rights Litigation History Liens Recorded Unrecorded

24 Legal Due Diligence-Governing Bodies Zoning Rent Ordinances Rent Control Number of Occupants Etc. Building Permits Easements Is this Property Suitable for it s Intended Use?

25 Physical Due Diligence Location Class/Age A (0-15) B (15-30) C (30-45) Building Inspection Report Roofing Plumbing Electrical HVAC Mold Inspection Report

26 Physical Due Diligence Capital Improvement History Deferred Maintenance Environmental Reports Engineering Report Lead Paint

27 Financing

28 Why Borrow Money-The Power of Leverage Non-Leveraged $10,000 to Invest 5% Interest Amount Returned ($10,000*.05)=$500 Return 5% Leveraged Investment $10,000 to Invest 80% Loan to Value (20% Down) 5% Interest Purchase Power = $10,000/.2 = $50,000 Amount Returned ($50,000*.05) = $2,500 Return 25%

29 Time is on your Side Starting Early is Most Effective Appropriate Use of Leverage Accelerates the Effect of Compounding

30 Where Does Real Estate Financing Come From Savings Seller Financing Conventional Loans Commercial Loans Hard Money Private Money Portfolio Lenders FHA/HUD Programs Home Equity Loans and Lines of Credit Self-directed IRAs Development Loan, Construction Loan 1031 Exchange Partnerships REITS Crowdfunding Syndications

31 Sources of Funds -Direct Lenders Credit Unions Savings and Loans Banks Portfolio--loans are funded by a bank or other institutionalized lender which does not securitize or sell their loans into capital markets. Terms may be more flexible than a securitized loan and it is typically serviced by the lender. Securitized loans are pooled and sold on the secondary market.

32 Sources of Funds -Private Lenders Your Rich Uncle High Net Worth Individuals Someone s IRA Crowdfunding Sellers

33 Mortgage Brokers Can Help You Find Money An intermediary who brings mortgage borrowers and mortgage lenders together. A mortgage broker collects an origination fee and/or a yield spread premium from the lender as compensation for its services. Borrower Loan Application Mortgage Broker Lender # Lender # N

34 Borrower s Liability Recourse Loan-A type of loan that allows a lender to seek financial damages if the borrower fails to pay the liability, and if the value of the underlying asset is not enough to cover it. A recourse loan allows the lender to go after the debtor's assets that were not used as loan collateral in case of default. Non-Recourse Loan-A type of loan that is secured by collateral, which is usually property. If the borrower defaults, the issuer can seize the collateral, but cannot seek out the borrower for any further compensation, even if the collateral does not cover the full value of the defaulted amount unless there is fraud involved

35 Important Metrics for Lenders Net operating income: The annual income, minus expenses that a property generates from its operations Debt service coverage: Measure of NOI relative to debt payment obligations Loan-to-value (LTV) ratio: A measure of the loan amount relative to the value of the property

36 NOI and Cash Flow Net operating income: The annual income, minus expenses that a property generates from its operations NOI = Income - Expenses Cash Flow: The cash flow (before tax) is the net result of gross income minus expenses and debt service. Cash Flow = NOI Debt Service Cash Flow Higher Debt Service = Lower Cash Flow Debt Service

37 Debt Service Coverage Ratio The DSCR or debt service coverage ratio is the relationship of a property's annual net operating income (NOI) to its annual mortgage debt service (principal and interest payments). DSCR= NOI/Annual Debt Service NOI = $225,000 ADS = $115,000 DSCR = $225,000/$115,000 = 1.9

38 Loan to Value (LTV) Loan-to-value (LTV) ratio: A measure of the loan amount relative to the value of the property LTV=(Amount of Loan)/(Value of Property) Property value = $735,000 Amount of Loan = $588,000 LTV=$588,000/$735,000=80%

39 The Anatomy of a Conventional Loan Treatment of Income (Rental vs. earned) Entry Cost/Issues Terms APR Interest Rate (Fixed vs. Adjustable) Fees Points Exit Cost/Issues Balloon Payment Prepayment Penalties Underwriting

40 How do Lenders Reduce Their Risk FHA and other Government Guarantors Securitizing Higher Down Payments Shorter Payback periods Higher Debt Service Coverage Ratios Seasoned Income Longer Investment Experience Recourse Loans

41 Example Properties

42 Owner Occupied 3 Units Purchased With FHA 3.5% Down Owner Occupied Asking Price $599,900 Price/Unit $199,967 Price/Sq Ft $266 Property Description Address 1521 Junipero City Long Beach Zip No. Units 3 Year Built 1947 Building Size 2253 Lot Size 6393 Down Payment $20,997 Closing Cost $17,997 Loan Fees $8,684 Rehab Cost $9,000 Total Cost $56,677 Loan Amount $578,904 Annual Debt Service -$32,172

43 Economics of Deal Owner Occupied Cash Flow Calculations GROSS SCHEDULED INCOME $28,600 Less: Vacancy & Cr. Losses $1,430 EFFECTIVE RENTAL INCOME $27,170 GROSS OPERATING INCOME $27,170 TOTAL OPERATING EXPENSES $15,719 NET OPERATING INCOME $11,451 Less: Annual Debt Service $32,172 CASH FLOW BEFORE TAXES -$20,721 Rent from Former Apartment $18,000 Effective Cash Flow -$2,721 Year 1 Year 2 Year 3 Year 4 Year 5 Cash Flow Before Taxes -$20,721 -$20,005 -$15,458 -$14,698 -$13,916 Effective Cash Flow -$2,721 -$2,005 $2,542 $3,302 $4,084

44 Five Units Commercial Loan 30% Down Five Units Asking Price $500,000 Price/Unit $100,000 Price/Sq Ft $147 Property Description Address 1189 W. Spring St. City Riverside Zip No. Units 5 Year Built 1950 Building Size 3400 Lot Size 9148 Down Payment $150,000 Closing Cost $15,000 Loan Fees $7,000 Rehab Cost $15,000 Total Cost $187,000 Loan Amount $350,000 Annual Debt Service -$21,281

45 Economics of Five Units Cash Flow Calculations GROSS SCHEDULED INCOME $43,500 Less: Vacancy & Cr. Losses $2,175 EFFECTIVE RENTAL INCOME $41,325 GROSS OPERATING INCOME $41,325 TOTAL OPERATING EXPENSES $12,398 NET OPERATING INCOME $28,928 Less: Annual Debt Service $21,281 CASH FLOW BEFORE TAXES $7,647 Year 1 Year 2 Year 3 Year 4 Year 5 Cash Flow Before Taxes $7,647 $10,309 $11,257 $12,233 $13,238

46 Mortgage Broker Hayden Harper

47

48 Single-Family Loans 1 4 unit properties Owner-occupied, second home, vacation rental, rental property Qualified off of housing ratios / debt-to-income ratios. Including FHA, VA, jumbo, conventional and portfolio programs. Owner-Occupied 3.5% down 2 4 unit investment property O.K. Investor 25% down Non-owner occupied

49 5+ unit properties Strictly investor properties Amortizations of 15 and 30 Years 3, 5, 7, 10, 15 Year Fixed Rate Terms No Prepay Options No Tax Return Options Monthly/Annual Leases Acceptable Interest Only A, B and C Property Types Considered Entity OK Maximum LTV 80% / 85% CLTV Non Recourse A Minimum DSC of 1.15:1 60 Day Rate Lock Multi-Family Loans

50 Types of Loans Fannie Mae / Freddie Mac Conforming (Fannie/Freddie) Government-sponsored enterprises, give the ability to borrow more at lower interest rates than Private / Portfolio Maximum Conforming Loan amounts: Loan Limits 1 4 units (Orange County / Los Angeles). 1-unit: $625,500 2-unit: $800,775 3-unit: $967,950 4-unit: $1,202,925 Loan Limits 1 4 units (San Bernardino / Riverside). 1-unit: $417,000 2-unit: $533,850 3-unit: $645,300 4-unit: $801,950 Maximum investment transaction of 10; most banks will only allow up to 5 since this complicates underwriting.

51 Types of Loans - FHA FHA does not provide the loan itself, they insure banks against borrower defaults. Overseen by HUD U.S. Department of Housing and Urban Development Provides a low down payment assistance. (3.5% down). Usually allows lower credit scores. (580 minimum). Upfront Mortgage Insurance Premium (UFMIP) 1.75%; typically added to the loan amount, but borrower can bring amount to close and pay up front. Example: $300,000 Loan with UFMIP = $305,250. UFMIP = (1.75% x $300,000 = $5,250)

52 Types of Loans FHA (cont d) Annual Mortgage Insurance Premium (MIP) -.85% Annually. Must verify and document proposed rental income on 2-4 unit properties by obtaining an appraisal showing fair market rent in situations with limited or no history of rental income. FHA owner-occupied 3 4 unit investment. Monthly net rental income collected must be greater than - or equal to - monthly PITI. Conforming loan limitation still apply depending on county. Borrower must have three month s PITI after closing on a purchase transactions. Unlike down payment, reserves cannot be derived from a gift. Net rental income = using the appraiser s estimate of fair market rent from all the units, including the borrower's occupancy the greater of the appraiser estimates for vacancies.

53 Debt To Income (DTI) Formula: Total Recurring Debt / Gross Monthly Debt Fannie Mae / Freddie Mac: 45% Portfolio / Jumbo: 43% FHA: 56.99%

54 Residential Needs List Signed and Completed 1003 Loan Application Credit Authorization Gives us the ability to pull credit Bank Statements (All Pages), verify assets W2 s or 1099 s Personal Tax Returns (1040s) Federal Only Entity Tax Returns (1120, 1120S or 1065) 1120 Corporation 1120S S-Corporation 1065 Partnerships Insurance declaration and mortgage statements for all properties owned.

55 Tri-Merge Credit Report 3 credit repositories score is based off the middle score Equifax Experian Trans Union 765 Credit Score Factors Types of Credit Revolving (Credit Cards). Installment (Leases). Mortgage. 10% 15% 10% 30% 35% Payment History Debt Burden Credit History Types of Credit Recent Searches

56 Exit Strategies

57 Investment Strategy Market and Sub Market Analysis Purchase Under-Performing Properties High Growth Area Reposition Resolve Property Issues Reduce Expenses Raise Income/Rents Refinance/Exchange Minimize Taxes Based on Performance Metric (ROE, Cash Flow, IRR, Market Cycle) 1031 Exchange Installment Sale Sale Repeat

58 Owner Occupied Ten Year Performance 1031 Exchange Every Three Years $56,677 Investment Produced $609,047 Equity

59 Owner Occupied Cash Flow Year 10 NOI =$65,000

60 Five Unit Ten Year Performance 1031 Exchange Every Three Years $187,000 Investment Produced $1,030,609 Equity

61 Five Unit Cash Flow Year 10 NOI = $98,000

62 Make A Plan

63 Some Basic Financial Math Cash Flow = Income Expenses Near term concern Increase Income Decrease Expenses Net Worth/Equity= Asset Value - Liabilities Longer term Concerns Increase Asset Value Decrease Liabilities We go broke in the near term. - Unknown In the long term, we re all dead.- John Maynard Keynes

64 Elements of a Real Estate Investment Plan

65 Steps to Follow in Developing Your Plan Study History Interest Rates/Financial Markets Market Cycles Demographic trends Political Factors (Rent control, Zoning, etc.) Establish Criteria Financial Returns (pick your metric) Locations (All Real Estate is Local) Condition Holding periods/exit Criteria Know your market(s) Property Class Cap Rates Rent Rate Demographics Locate Financing Savings/Equity Family Friends Partners Lenders Establish Relationships with team Lenders/Partners Brokers Inspectors/Contractors Find Property Perform Due Diligence Acquire

66 What to address in your Plan Why are you investing in Real Estate Cash Flow Appreciation Tax Benefit Leverage Time Horizon Success Metrics Cap Rate Return on Investment Return On Equity Internal Rate Return Use of Funds Reserves Expenses Capital Improvements Source of investment funds Personal Savings Partnerships (My Brain, Your Money) Conventional Financing Seller Financing Private Lenders Cash Flow Exit Strategy Sale Exchange Cash out Refi He who fails to plan is planning to fail" Winston Churchill

67 You Need a Team Broker Finding property Market Analysis Property Analysis Broker Opinion of Value Managing Transaction Attorney Legal Due Diligence Artificial Entities Liabilities Accountant Tax Implication Financial Calculations Financial Due Diligence Insurance Agent Liability Coverage Property Manager Expense management Tenant Management Mortgage Broker/Lender Finding Funds Contractor Repairs Remodeling Physical Due Diligence Appraiser Determine Market Value Determine After Repair Value (ARV) Network of fellow investors Partners Finding property Success is where preparation and opportunity meet. (Bobby Unser)

68 Next Steps Determine Your Goals and Objectives Why are you Investing What is your desired approach What is your time horizon What metrics will you use Select Your Market Focus on Population Growth Focus on Diverse Sources of Income Build Your Team Lenders and Brokers First Develop Property Analysis Model Income Expenses Debt Service Cash Flow Property Analysis Select Three Locations Acquire Property

69 References What Every Real Estate Investor Needs to Know About Cash Flow and 36 Other Key Financial Measures--- Frank Gallinelli Millionaire Real Estate Investor--- Gary Keller Apartment Building Investing--Michael Blank Podcast BiggerPockets Podcast: Real Estate Investing and Wealth Building US Bureau of Economic Analysis Bureau of Labor Statistic (bls.gov) Demographics US Census Bureau Crime Data