SS116: How to Minimize Risk When Buying Your First Rental Property

SS116 How to Minimize Risk When Buying Your First Rental Property

Buying your first rental property can be an exciting and scary time for most real estate investors. In this episode, Charles discusses how real estate investors are able to minimize the risk of their first rental property.

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Transcript:

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo and today we’re going to be discussing how to minimize risk when buying your first rental property.

Charles:
Have you always wanted to invest in real estate, but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties and great locations that provide us with consistent passive income. While we wait for appreciation in the future and take advantage of tax laws while we’re waiting and unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out to investwithharborside.com. If you like the idea of investing real estate, if you like the idea of passive income partner with us at investwithharborside.com, that’s investwithharborside.com.

Charles:
So I’m gonna cover a dozen or so different ways that will help you mitigate risk when investing into your first rental property. If this is your first real estate investment, you probably will not be doing all of these, but the more of these strategies that you instill into your real estate investing career, the less risk you will carry ensuring that your real estate portfolio is profitable and growing for many years to come. Just as a side note, this episode is specifically for direct and active real estate investing. So first off, underwriting and purchasing. The number one rule for successful rental property investing is invest for cash flow, not appreciation. Make sure your property cash flows not just to cover your debt service, taxes and insurance, but your expenses and then also the funding of your reserves. Utilize conservative expense estimates. Mistakes I commonly see from new investors is that they count on future appreciation of rents, which does not occur every year. Yes, over a five or 10 year period, rents will increase, but maybe not in the next two to three years.

Charles:
While your expenses will surely increase when underwriting many expenses will be estimates. Make sure to check, verify your numbers as best you can. This includes vacancies, maintenance repairs, property management fees, property taxes, insurance, bookkeeping and accounting. Focus on buy and hold multi-family rentals. The longer you own property, the less risky it is, is much safer than flipping properties or purchasing for appreciation. Combine this with multi-family rentals and you have dramatically minimized your risk. Multi-Family rental properties are less risky than single-family homes. The more units you have, the more income streams you have, and they don’t often need to be apartments either. The second rental property I bought in 2008 was a three unit building with two garages behind it. I had five income streams from that property. The more income streams it has, the longer you own it, the lower the risk and the less volatility in case one of the income streams temporarily dries up from being vacant.

Charles:
Or if the tenant is not paying, look for below market rents. Now, don’t immediately think that once you purchase a fourplex and each unit’s paying $400 a month below rent, you’re going to resign leases with all tenants at market rate. It won’t happen. However, your property now has a lot of, of potential for rent increases into the future, usually after you have done some upgrades. Now these upgrades can be done unit by unit. As tenants move out with each upgraded unit, you can test the appetite of the renters in that market. It might make sense to not fully upgrade all the units, but just make some upgrades in order to discover the best return for you along the way and the best value for the tenant. The point being buying properties with undervalue rents lowers your overall risk as a landlord. Next is buy C plus the B properties and C plus the B areas.

Charles:
Know, avoid low end rentals, no D or C apartments. C minus apartments is really what I’m getting at here. These properties look great on paper. In reality, these properties require nonstop maintenance, daily maintenance. You have to be there all the time, even on small properties. There’s always issues. I recently read a report that the average C class tenant has less than $500 in savings. If they lose a job for even one week, the rent is not getting paid on time. If you’re lucky once these tenants get behind, there is no way for them ever to ke to catch up and avoid these properties and areas altogether. Unless you are partnering with a seasoned investor who has successfully invested in this class of property. Make it down payment of no less than 20%, preferably 25%. If you are house hacking with a low down payment.

Charles:
This is not possible, but the larger your down payment, the lower the loan of value, the less risky the investment is. So the lower the monthly mortgage payment, in addition to the fact that a property with a 50% loan of value is much easier to refinance than a property with an 85% loan to value. So if you have short term debt you have something like a variable interest rate and the value the market kind of interest rates are starting to edge up and you want to get something that’s fixed and your property value has come down and you have that 85% loan of value prior to the decrease the pullback, you might not be able to get it refinance, but if you had 50% loan of value, you probably won’t have an issue getting it refinance, even if that loan of value is now bumping up 60, 70% because the value of your property is coming down in some sort of recession.

Charles:
Long-Term fixed debt with your first couple rental properties you know, get fixed long-term debt for a two to 40 year property. This could be a 30 year mortgage, or with a five plus unit property, this could be a 10 year fixed term. Either way, longer term debt that’s fixed might be more expensive, but it is lower risk. Short term debt could be become in due during a recession making harder refinance as we already spoke about. But the problem is the value is gonna be lower during these recessions. So people always say, this is my loan to value, and, but they don’t know. No one knows what the future’s gonna hold and that value of that property during a recession is not gonna stay the same. So that means that even if you have a 20% or 80% loan of value, 20% of equity during some sort of recession that property’s gonna come down in value, which is gonna bump up your loan of value on it.

Charles:
And then when you have, and you see it all the time, whenever there’s any type of pullback, you’ll see a lot of local banks that might say, Hey, we were lending 80% loan of value, now it’s 75, or we were doing 75 and it went down to 70 small things like this. But if that goes 10% you know, goes 80% to 70%, you might be in trouble at that point because they’re gonna take the value at it right then at that point when you’re refinancing it. Not when you was a year ago or three months ago whenever the property price was higher. So try to acquire debt with a long term and that is longer than your estimated whole time, twice as long to be the safest. Next is whole property in an llc. Now buying property and LLC are quit claiming it to an LLC helps separate your rental property from your personal assets.

Charles:
This LLC will never do business. It is just a holding company that’s very important. So whatever llc, you buy the property and make sure it’s a new llc and then make sure it never does, never does business, right? It’s never gonna be on any of the electric bills. It’s never going to be signing leases. It’s never going to be doing any type of contracts with any type of handyman or other contractors or vendors. Next is good insurance. You know, speak to other local landlords and see what independent insurance agents they use. When you are getting quotes, make sure they cover the actual replacement value of the property. Different companies will have different thoughts on, you know, this and the cost to replace the property, but in a higher inflation environment, it’s important to check these values on each renewal. And if you think they’re low, tell them and they usually will raise it.

Charles:
And the difference is usually very minimal. I did this many years back with the property I had and I thought that the replacement value was off by like 75,000 and they changed it and the new premium was only slightly higher. And so you can kind of just because what they tell you is what you can only get if you ask them the agent will go back to the carrier and hopefully in most cases be able to change it. Next is purchase a property with only minor renovations required. This is super important. I always see new investors are not always, but I commonly will see new investors that want to take these huge projects. No fully vacated properties that have tons of deferred maintenance. You don’t want anything to do with that for your first property. You might not even want it for your second property.

Charles:
What you’re really looking for is purchase a property with minor renovations required. Buy a property with tenants already in the units paying rent. Even if the property appears turnkey, there will always be some repairs and upgrades once you purchase it. There’s always something that’s gonna be, that needs to be fixed. That’s something that should be upgraded. And you wanna make sure that you’re not getting over your head on your first rental property. Once you’ve been on landlord for a couple years, you can then start looking for major renovation projects and it because it, it’s because mainly management of those projects is pretty intensive. And secondly, you don’t have the contacts. Once you own a property and you have handyman and contractors over there and vendors and all this kind of stuff and you start networking with people in the group in your, in your neighborhood and in your market and you start getting deals because you’re using them on your properties and stuff like that, that’s when you wanna start doing larger renovation projects.

Charles:
You don’t wanna be doing renovation projects and as I call it, getting yellow page pricing. You want to get deals from people and doing that. You want to have these people that you’re getting deals from come out and quote your major renovation project down the road and then you’ll be able to manage it and you have the right people that are giving you a deal due with the work. When making renovations and repairs, make sure that they are tenant proof. And this is more important as the class of the property decreases for sea glass departments, we would use specific shower surrounds and commercial violence towel that would last for 10 plus years. No matter if there’s dogs, no matter whate, whatever’s going on in that apartment, it’s gonna last. And you want the repairs and upgrades you want to make match the class of the property in the area, which is just for, I mean, that’s when you’re flipping or renovating any property you don’t want to overbuild you don’t want to over renovate as well.

Charles:
And usually if you’re flipping a property, you’re gonna put in better finishes because it’s someone that’s owning the property. Compared to a rental property, rental properties, you really want to make it look nice, but you want it to be durable and you want it to last management. Now reserves with management. So set up a reserve savings account and start off with three plus months of expenses, including mortgage payments in your reserve account and add to it monthly. There’s not an exact correct amount, but the older the property, the more you should be adding to the savings account on a monthly basis. If you know that you have an older furnace and hot water heater that need to be replaced in three years, add additional funds to re to reserve accounts. Now the key is to add to it monthly from all your rentals and use it as a fund.

Charles:
You can pull from when rep repairs are needed. Next is about renting the tenants. So in-depth tenant screening, this is the most important. You need to check credit reports, criminal reports criminal records, eviction reports and income. And in the, I’ve been told to call past landlords, but I’ve never done this and I hear even guru saying this and who knows if they’ve ever done it, but I’ve never done it. I mean, you have no idea If you are calling as actually a past landlord, it’s their brother-in-law, it’s their Uncle Jim. You know, credit, criminal eviction income, these can be checked correctly and will give you a very accurate picture of the applicant. Utilize a salt lease that has been reviewed by an attorney. Now I’m not saying that every lease that you write for every tenant has to be reviewed by an attorney.

Charles:
This is something where initially when you’re doing it and use the attorney that you bought your property with, they’re probably a real estate attorney slash eviction attorney. This is who you wanna be using. Bring the lease to them. Maybe they’ll do a deal, maybe they’ll do it for free for you cuz you, they took care of your closing. Have them review a lease. Maybe they have one for you that they can use. And they’re going to be the ones that are most likely gonna be representing you when you have an eviction. So that’s probably something too that they want to use a lease that’s gonna make their job easier as well. Or they also know everything about it if they give you a lease and when they’re in court and they’re talking, they know exactly what’s on the bottom of page seven is what’s gonna negate this tenant’s claim.

Charles:
Automate your rent collection. There are many portals online, some free, and some are for small fee that’ll help you automate rent collection. This will make your job much easier. Back in 2012 when I stopped, man self-managing all my properties and I brought in property management, my com my properties were, I had is running really well. The most time consuming thing I had for the whole month was collecting rent. And this is back before we had a lot of portals and all this kind of stuff and I was, you know, picking up cash and mainly all cash, which is mistake. You should be getting money orders if people pay like that. But anyway, the thing though was that you, if I had automated this, it would’ve saved so much time and it was something that made my life so much easier by having a third party manager.

Charles:
But if you automate it with a portal from the beginning once your property starts getting kind of on autopilot this is really what’s gonna smooth it out. And then you don’t have to waste time worrying about people, mail them in, having to go there face to face and the time you’re gonna waste on making sure they’re home and all this kind of stuff. Get a portal, have them do it online and whatever fee that they charge you, it’s worth it. Lastly is focus on tenant retention. When you become a landlord, you will quickly realize who your good tenants are and they’re the ones that you want to retain after their lease is up. And this will increase your income and minimize headaches associated with turnover. Make sure that you quickly respond to alternate requests and fix all legitimate issues immediately. So I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics at globalinvestorspodcast.com. Look forward to two more episodes next week. See you then.

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.

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