Happy Hour!

Heading out to the MLS All-Star Game!

Trying to get a run in before the rain starts at Memorial park!

This is one ugly game.

Whew!! Just saved a presentation right before a power outage.

Staying Within Your Resources

"Everyone talks about growing their business, but what you don't hear enough about is the importance of not growing your business too fast."  -  Blue Man

The goal setting and planning I’ve discussed previously is not theory.  I put the plan in place and executed so well that, with the help of my family, I was able to purchase 36 properties capturing over $900,000 in unrealized equity and a passive income stream of just over $5,000/month.  I almost became a millionaire in two years and had enough passive income to retire myself from corporate America!   At the time I had accomplished, and actually surpassed my original goal of $3,000/month in passive income.  I had secured my family’s future.  All I needed to do, at a minimum, was manage my current portfolio.  Well, just when you think you have it all figured out, and your ego inflates, God finds a way to humble you.

The goal setting and planning I discussed before is not new.  It was taught to me by my mentors and from books I’ve read and studied like Rich Dad Poor Dad by Robert Kiyosaki.  I just took what they were teaching and put it on steroids in a real estate vehicle.   The problem was I put it on steroids.  I essentially grew too fast for the capital I had to work with.  If you’re a business owner, or have been thinking of starting a business, the golden rule of start-up is never go-in undercapitalized.  Cash is king.  I knew this, and although this is hard to admit, I got greedy and my ego took over.  I was hell-bent on reaching my goal in two years and not five or ten, so I took a chance and invested my reserve capital.  Bad move.

A year-and-a-half into building my business everything was going great.  I had 26 properties I owned and managed with my family.  I was actually ahead of my goals and could actually retire myself from corporate America.  I had about $50,000 in reserve capital for emergencies with very little stress.  The problem came when I was presented with a portfolio of homes to purchase. 

I had a gentleman named Paul approach me, who heard I was buying properties, and wanted to sell ten he inherited… all within two miles of each other.  At first I was not too excited about the deal.  There are a lot of people out there that say they have a “deal” for you to look at that turn out to not be deals at all.  I asked him to send me the addresses and I would research them and get back to him in about a week.   During this time he kept approaching my Dad, Ken, and letting him know he really did not want to manage them.  This indicated he might actually be motivated to sell and there might be a deal after all.  Sure enough, I ran the numbers and it was not just a good deal, it was a complete home run!  It got even better when he said he would owner finance them.  They were also 100% occupied.  The opportunity had two main problems however.   One, it would take all $50,000 I had in reserves for the down payment, and two, it broke the rule of fix everything at purchase.  When you buy a property and repair or replace everything that can essentially break, what kind of maintenance do you have to do?  Try little to none (I’ll explain in more detail another time).  The problem was that all of the properties Paul wanted to sell needed rehab except one. 

Here is where I got in trouble.  Even though I knew they all needed rehab, I rationalized that they were 100% occupied and I would just repair them when a tenant moved out and use excess cash flow to pay for it.  I thought, “How many tenants might move out at once where I would have to do multiple rehabs?”  I guessed one, but it ended up being FIVE!  What I chose to ignore was that when management changes hands, whether it’s single or multi-family, you are going to have some turnover.  I also had two other properties at the time that I was rehabbing.  So, as you can see I had a MASSIVE problem on my hands.  I had five vacancies, no money to do a proper rehab, and mortgage payments coming due.   I went from being in a great financial position to about to lose my business in a matter of a month.

You might be thinking, “Why don’t you sell some of your assets to generate some capital?”  I thought about that, but my aggressive personality, and the fact I didn’t want to sell an asset, didn’t let me do that.  I instead went out and opened three lines of credit.  Two unsecured (I had awesome credit) and one secured by a property.  My rationale was that I could sell some assets later and pay the credit lines.  I also knew that real estate is an illiquid asset… meaning you can’t sell it quick.  A quick sale in real estate is 30 days… which didn’t leave me with enough time.

Well, the story has a good ending, but it did have its consequences.  I managed to keep all my properties during this time.  The problem was that I was late on a few payments, which shredded my awesome credit (it only takes a few late mortgage payments to take an 800 credit score to 600…  YIKES!)  I’ve since been able to get it back up, but it has taken almost two years.  I have sold some of my properties to pay off the credit lines (I still have one with a balance), but without them I probably wouldn’t be in business anymore.  They allowed me to survive that time and not lose the equity and cash flow I had built.

I learned a massive amount during this ordeal.  The main thing I learned is DO NOT OVER-EXTEND!  Know your limits.  Expect the best but plan for the worst.  There were a lot of sleepless nights during those months.  One of the most painful effects being the strain it put on the relationship with my family.  Although everything came out OK, it was a painful time in my life that I do not want to re-live.

I hope this helped give you an understanding of how you can get yourself into trouble if you try to grow too quickly and extend past your capital reserves.  Although I lived to fight another day, I could have easily had to file for bankruptcy… all because I didn’t want to slow my pace to match my resources. 

Although it can be argued I took too much action, there are some people that will never do anything at all to secure their financial future.  Don’t let my story scare you from taking action.  Go out, find yourself a mentor and buy just one property.  After you go through the entire process of buying, repairing, and leasing I am confident you will want to continue… as long as you stay within your resources.

Developing The Plan

“Can you think of anything more permanently elating than to know that you are on the right road at last?”– Vernon Howard

No that you have your goal, the next step is to determine where you are now, in terms of resources, and build a plan to reach your goal within a specific time frame.

Resources

First, you need to realistically look at your current situation.  More specifically I am talking about how much knowledge, money, credit, contacts, and time you have at your disposal.  The more you have of each of these resources the faster you will build your business.  Let’s start with, in my opinion, the most important resource you need.

Knowledge

You cannot be successful in building a real estate investment vehicle without educating yourself on the basics.  If you do not take the time to learn the business you might as well do what the vast majority of Americans do these days, which is to blindly invest in the stock market and expect returns at or below 6%.

One way to start building the knowledge you need is to hit the bookstore.  You will find most real estate investing books out there focus on flipping houses.  Although you may find some valuable tips in these books, I would stick to the authors who teach how to own and operate rental property.  Flippers focus on buying, fixing-up property, and then selling quickly for a profit… usually within a couple of months.  A better term for this type of investor is gambler.  A true real estate investor looks for property to buy, fix-up, rent to a good tenant, and hold for the long-term (I’ll talk more on this subject at a later time).  I highly recommend you focus your education on how to acquire and operate rental property.

Another more effective way to build your knowledge base is to join a local real estate investment club.  If you are in a major metropolitan area you will usually find one or two that have a strong educational component to what they do.  I am an active member in two groups in the Houston, TX area.  One being Lifestyles Unlimited the other is the Real Estate Investment Club of Houston.  What might take you months to learn from books, you can learn in literally days and weeks at a good investment club. 

I cannot stress enough how important it is to join an investment club.  In fact, I don’t know a single successful real estate investor who is not a member of a real estate investment club.

One more point on knowledge… your education never ends.  Markets, lending, tax laws, etc. are always changing.  What works today may not work tomorrow.  There is always something new you can learn and apply, so don’t stop improving your knowledge base.

Money

There are literally hundreds, if not thousands of books out there that discuss how to acquire property without money or credit.  Because the information is so plentiful I will not go into detail on how to structure these types of transactions, but I will hit some highlights for you shortly.  Although you can be successful in real estate without money, it sure does help to have some cash in the bank.  You will need money for down payments, closing costs, repairs, etc.  Whether it’s your money, or someone else’s money (bank loan, private money, hard money, etc.) cash is a key component to real estate investing.

Credit

Just like you can do real estate deals with no money, you can also do them with little, no, or bad credit.  It just becomes a little more difficult.  The same books that can teach you how to buy property with no money can also teach you to purchase investment property without any credit as well.  However, the better credit you have the easier and faster it will be to build your business.

Credit is what allows you to go to a bank and secure a mortgage for a loan.  The higher your credit score, the better interest rate and terms you will get from the bank.  Lower interest rates mean more money in your pocket.

Contacts

Another resource not to be overlooked is contacts. You will need to start building relationships with:

• Real Estate Agents to find good buying opportunities
• Mortgage Brokers to help secure loans
• Home Inspectors to help identify repairs
• Title Companies to help close the transaction and insure clear title
• Surveyors to make sure there are no encroachments on the property
• Contractors to help complete repairs

Most of these contacts you can find in the phone book, but a better, more targeted place to find these team members are the local real estate investment clubs.

You will also want to start networking at these clubs to find other people who can help fill the gaps you may have in your resources.  You may not have credit, but you have the money to invest.  You may have the credit, but no money.  Either way, finding a partner you can trust who has either the money or credit will help (more on this in a minute).

With all that said, the most important contacts you will make is identifying and selecting mentors.  You can go to all the classes, read all the books, but finding someone who has done it successfully before, and learning from them is the most important contact you can make.  A good mentor knows what works and what doesn’t.  They will be invaluable to your success.  I would not recommend getting started in this, or any other business, without finding a mentor to guide you through the process.  It has saved me thousands of dollars in mistakes and headaches. 

Time

Another resource to consider when deciding to invest is time.  Surprisingly, building a real estate business does not require a great deal of time… especially if you have built up a good team.

Most of your time, once you put a property under contract, is invested in setting-up inspections, appraisals, surveys, and contractors to give you bids on the repairs.  Once you have all this information, and you decide to move forward and purchase the deal, you will invest your time managing the contractors that are doing the repairs.  Once the house if fixed-up, the next step is to rent the property to a qualified tenant.  After that there isn’t a lot to do besides collect the rent (which your tenant should mail to you every month).  You will essentially have a part time job for about a month during the acquisition and repair of the property.

After you have purchased a few properties and built up your team and your system, your time spent on inspections, appraisals, surveys, contractors, and screening tenants will dramatically decrease.

Putting the Resources to Work

Now that you know the resources necessary to start your business, let’s look at putting the plan in place from three different starting points:

• Money and Good Credit
• No Money and Good Credit
• No Money and No Credit

Let’s use $3,000/month in passive income as the goal.  I not only chose this number because it was my original goal when I first started, but it’s also the national median monthly income in the United States after taxes.

Let’s also assume you will acquire what I would call a “bread-and-butter” deal.  These are typically:           

• 3 Bedroom, 2 Bath, 2 Car Garage
•  Located in a Blue-Collar Neighborhood
• After Repair Value (ARV) of $100,000
• Purchase for $70,000
• Needs $10,000 in repairs

Money and Good Credit

Let’s assume you are starting out with a little bit of money, say $40,000 cash, and good credit.  One of the most important things you can do is to not overextend yourself.  Establish an emergency fund of at least 3 months of expenses.  In this example, you would need to put aside $9,000 and use these funds only in the case of job loss or other family emergency.  This leaves you $31,000 to invest.

Using the “bread-and-butter” example, you would need to put down 20% of the purchase price as the down payment, which would be $14,000 ($70,000 * .20).  You will also need $10,000 for the repairs, and an additional 4% for closing costs, which would be $2,800 ($70,000 * .04).  If you add-up all your costs… the down payment, repairs, and closing costs, the total cash invested is $26,800.  As you can see, this leaves you a little to spare.  Let’s do a quick analysis to see what your return on investment would be for this deal:

Cash Invested                                     $26,800

Annual Income From Cash Flow        $  2,100

Equity Capture                                   $20,000

Cash on Cash Return                                7.8% ($2,100 / $26,800)

Unrealized Capital Gain                         74.6% ($20,000 / $26,800)

Total Return                                            82.4% ( ($2,100 + $20,000) / $26,800)

Although you should always go into a deal expecting to hold the property for the long-run (5 years or longer), if you’re starting out with limited resources, it might be necessary to sell your asset after one year and re-invest your returns.  Let’s use the following sale assumptions:

Sale Price                                           $100,000

Realtor and Closing Costs                  $    8,000

Capital Gains Tax                               $    1,800

Realized Gain                                     $  10,200

Cash on Cash Return                                  7.8% 

Realized Gain Return                                38.1%

Total Realized Gain                                   45.9%

Yes, you read that right!  It is not a typo.  It’s a 45.9% realized return!  If each deal you do returns you over 45% how long do you think it would take you to hit your financial goals?  Thirty, forty years like the financial planners would like you to believe?  Try five to ten.

Going back to our example, after paying all the expenses associated with selling a property, you should exit approximately $10,200.  If you keep churning your assets every year, your time line would be as follows:

Year	Number of Properties Purchased	Original Investment	Realized Capital Gain	Total to Re-Invest
1	1	$24,000	$10,200	$34,200
2	1	$34,200	$10,200	$44,400
3	1	$44,400	$10,200	$54,600
4	2	$54,600	$20,400	$75,000
5	2	$75,000	$20,400	$95,400
6	4	$95,400	$40,800	$136,200
7	5	$136,200	$51,000	$187,200
8	8	$187,200	$81,600	$268,800
9	12	$268,800	$122,400	$391,200
10	17	$391,200	$173,400	$564,600

*  The closing costs of $2,800 is not included in the “original investment” column due to this being a sunk cost that is not attributed to your equity position, therefore it was removed from the calculation.

You essentially reach your goal in just over 10 years.  Keep in mind this does not take into account your cash flow from the properties or your ability to keep saving and investing additional dollars from your current job.  If you will save 10% of your income from your job and invest those dollars back into your real estate business, you can reach your goal in about 8 years… or become a millionaire in 10!

Year	Number of Properties Purchased	Original Investment	Realized Capital Gain	Cash Flow	10% From Savings	Total to Re-Invest
1	1	$24,000	$10,200	$2,100	$4,800	$41,100
2	1	$41,100	$10,200	$2,100	$4,800	$58,200
3	3	$58,200	$30,600	$6,300	$4,800	$99,900
4	4	$99,900	$40,800	$8,400	$4,800	$153,900
5	5	$153,900	$51,000	$10,500	$4,800	$220,200
6	8	$220,200	$81,600	$16,800	$4,800	$323,400
7	12	$323,400	$122,400	$25,200	$4,800	$475,800
8	17	$475,800	$173,400	$35,700	$4,800	$689,700
9	25	$689,700	$255,000	$52,500	$4,800	$1,002,000
10	37	$1,002,000	$377,400	$77,700	$4,800	$1,461,900

What is interesting about this time line is that it is very conservative.  It’s assuming you don’t go out and find private lenders (more on this shortly), less expensive properties, properties that need less work, or deals that require lower down payments.

No Money Good Credit

You may be saying to yourself, “The plan is great for someone starting our with some money, but I don’t have any money… just good credit.  What do I do?”  The plan is still very similar for you.  What I would recommend you do, through the contacts you are building, is find private money. 

Private Money

A private money lender works very similar to a bank.  They will put up all the money in exchange for a higher than normal interest rate, part of the equity position, or both.  These loans are usually short-term, maybe six months to a year in length.  However, the payment is amortized over a thirty-year period… which means your payments would be the same as if you had received a thirty-year mortgage to begin with.  You can approach private lenders and offer them, for example, 12% return with a pay-off of six months.  So, for our example the numbers would look like this:

            ARV                                        $100,000

Purchase                                $  70,000

            Repairs                                   $  10,000

            Closing Costs                          $    1,000 (costs are lower for private money)

            Total Loan Needed                 $  81,000

            Interest Rate                                   12%

            Cost of Loan                           $    4,860 ( ($81,000 * .12) /  .5 years)

           

Since you have good credit, your goal would be to do what is called a rate-and-term refinance within the six-month period before the private money note comes due.  After your repairs are complete, and you have rented out the property to a good tenant, you go to a bank to secure a conventional mortgage on the property with a more favorable interest rate and a longer term of thirty years (hence the name rate-and-term refinance).  Your refinance would look similar to this:

            Private Money Loan               $81,000

            Cost of Private Money            $  4,860

Closing Costs on New Loan     $  3,240

            Total Loan Needed                  $89,100

You would attempt to secure a new loan for $89,100 and not have any of your own money into the deal.  However, there is a problem with this scenario in today’s credit market.  Banks are only loaning up to 80% of the After Repaired Value (in some cases 75%).  In this scenario the bank would only lend $80,000… meaning you would have to come to the closing table with $9,100 cash to secure the new loan.  If you don’t have any money, which we are assuming in this example, you have a problem. 

What you would need to do is negotiate a better deal on the front end.  One that you could roll all of your costs into and still get the deal done without any of your own money.  Instead of purchasing a property for $70,000, you would need to find a deal at a lower cost of around $60,000; or a property needing little to no repairs.  These deals are out there, but require a little more work to find because they are not as plentiful.  The deal would need to look similar to this:

  

ARV                                        $100,000                        $ 100,000

Purchase Price                       $  61,500                        $   70,000

Repairs                                   $  10,000                        $    1,500

Private Money Closing           $    1,000            or         $    1,000

Cost of Private Money           $    4,260                         $    4,260

Conventional Closing             $    3,010                         $    3,010

            Refinance Amount                 $  79,770                         $  79,770           

As you can see, you can still stay on the same investment time line without using any of your own money to do deals.  Here is the beauty of these types of transactions… if you are making an annual cash flow of $2,100 and capture approximately $20,000 in equity, what is your return on investment if you don’t have any of your own money in the deal?  It’s INFINITE!  You return is so high it cannot be measured!  How awesome is that?! 

Also, if you are not limited on how much money you need to do deals, how much faster do you think you can reach your goal of 18 houses?  It’s just a component of how fast you can find private money investors, and deals that meet the rate-and-term refinance criteria.

If you are having problems finding private money to use to invest with, there is an alternative called hard money.

Hard Money

Although hard money lenders are similar to private money lenders, there are some important differences between the two.  One, hard money lenders will usually not lend more than 70% of the after repaired value.  This means the most they would lend on the bread-and-butter example is $70,000 including repairs and closing costs.  Two, they usually charge a higher interest rate.  I’ve seen them as low as 10% and as high as 20%, but typically the interest rate hovers around 18%.  Three, they usually make you pay “points” on the loan.  These typically range between 3 and 5 points.   A point is 1% of the loan amount, so on a $70,000 loan, add $2,100 to $3,500 to the cost.  So, a hard money loan will require you to locate and negotiate an even lower purchase price to accommodate the lower loan-to-value number and additional points and interest.  A hard money loan would look similar to this:

  

ARV                                         $100,000                       

Purchase Price                        $  54,000                       

Repairs                                    $  10,000                       

Closing costs and 5 points       $    5,400                                                

Cost of Hard Money                $    5,670                                   

Conventional Closing              $    3,003                                   

            Refinance Amount                  $  78,073                        

The advantage to using hard money is that you don’t have any of your own money in the deal, and hard money lenders are easy to find.  The disadvantage is that they are expensive and can cut into your profit margins.  This forces you to find deals at a lower cost basis.  Where someone who has money and good credit can find deals 30% below market before repairs and make them work, someone who has no money and good credit has to find deals approximately 55% to 60% below market before repairs to make them viable options.

No Money and No Credit

Of course the most challenging scenario is one without any money and no credit.  However, you can still reach your financial goals.

The very first thing I would recommend you do if you have bad credit, or no credit at all, is to find a reputable credit repair stategist to help you.  Follow their recommendations to the letter so you can establish your credit as quickly as possible.  A good credit score is crucial for you to eventually acquire assets in your own name.  Until that time, you will need to partner with someone who has money and credit. 

Although you may find a private money lender or hard money lender to loan you the money to purchase and repair the properties, you will not be able to refinance once the repairs are complete into your own name.  In today’s capital markets, banks are looking for credit scores above 680.  Therefore, you need a credit partner to secure long-term financing.  Your credit partner will usually want a piece of the deal either in equity or cash flow or possibly both.

If you are giving up half the equity and cash flow in a deal, it will take you twice as long to reach your goal.  However, if you have no money out of pocket, once again, you have an infinite return on the deal; and you are still building wealth while repairing your credit.  As you build up your portfolio your credit score should be improving so you don’t need to partner in the future.  This could be months or a few years.  Either way, to build wealth as quickly as possible, you should start acquiring assets in your own name as soon as possible.   You should also be saving the cash flow from the property and any capital gains from a sale. 

  

Once you have saved some money, repaired your credit, and built a good track record, you will find people will come out of the woodwork to lend you money and partner with you.  Money, credit, and a proven track record of success equals credibility… which is a resource unto itself.  Once you have established credibility the sky is the limit as long as you don’t get greedy and practice the golden rule… “Do unto others as you would have them do unto you.”

Next time we’ll talk about what happens when you put the above into practice too fast.  How slow and steady can beat fast and furious.