Final Numbers

The appraisal has been approved and we close on Wednesday March 29th. The rental sign will go in the front yard this weekend and I have until May 15th to get it rented, which shouldn't be a problem. Just to sum the whole process up here is a timeline.

11/22/05 - Made offer
11/23/05 - Offer was accepted by seller
12/05/05 - Bank stopped the scheduled 12/06/05 foreclosure
1/31/06 - Bank accepts offer
2/16/06 - We closed on the property
2/24/06 - Begin repairs
3/1/06 - Kick off refi
3/12/06 - Repairs complete
3/16/06 - Appraisal
3/23/06 - Appraisal approved by lender
3/29/06 - Closing scheduled - "PAY DAY"

And now the numbers:

Rehab Is Complete...PICTURES!

3....2....1....Thirty days on the nose! Wow, what a job! In exactly thirty days we have taken this dumpy old shack and turned it into a beautiful home that anyone would be glad to live in. I'll go into lessons learned in another post. I just left the house a few hours ago after meeting with the appraiser and he said he should be able to get us our number and maybe even a few dollars more. That is good news, since I know the underwriters are going to cut it back anyway. You will see that we are 99% there just a few things to touch up and clean. Oh and the house is not pink on the inside, although the camera seems to think it is. So, without further ado......


















Remember the old shower....We just resurfaced it, thats it.

Rising Rates and Cooling Prices Spell Disaster...

Or opportunity for investors.

Source: RealEstateJournal.com



Millions of borrowers can expect a 10% to 50% increase in monthly mortgage payments over the next few years according to RealEstateJournal.com. Over the last several years many homeowners bought or refinanced their homes with “ultra exotic” mortgages that offered the lowest rates in this country’s history (since they have been keeping track). However, many of these rates and terms were locked for only a short period of time. Furthermore, these ultra low rates and terms allowed many people, who really had no business buying a home in the first place, to purchase bigger homes than they could otherwise afford. Now reality is upon them.

Some had extremely high credit card debt and used their home as an ATM to pay off their credit cards. The only problem was that they did not go through the pain of paying them off. Thus, many are back in the same position that they were in before the refi. Not only did they use the equity in their home to pay off debt, but they also used the equity to pay closing costs. Furthermore, there are even a few lenders out there who would allow the borrower to borrow up to 125% against the value of their house.

Result? Many of these homeowners are in a worse position today than they were in a few years ago. Lets look at the facts. The personal savings rate (the difference left over between after tax income and expenses) was negative for all of 2005 and as of January 2006 it was a negative 0.7% (that's less than 0%). The last time the savings rate was that bad for that period of time was during the Great Depression. Comparatively the savings rate used to be 10% in the period between 1974 and 1984. The savings rate does include 401k’s and Roth IRA’s, but some argue it does not include home equity. Home equity? What home equity? According to the National Association of Realtors the national median home price at the end of the fourth quarter 2005 was $213,000. At the end of 2002 it was $161,600. If someone borrowed up to 125% interest only in 2002 then they would owe $201,000 today. Thus, leaving only $11,000 to pay for the new closing costs. Could they really afford the new payment, even after a refi? I don’t think so. The only reason they would refi would be to stop the bleeding, but their payment would still be considerably higher than before. Would they even qualify today? If you run the numbers for someone who recently did this in 2003, 2004, or even 2005 then the possibilities are even worse.

Personally I think they have five options:

Refinance
I believe this is almost impossible. Even so, I think a refi would only be borrowed time just prolonging the inevitable.

Sell
If they sell, the question becomes, can they afford to. Again, in this scenario (assuming a 6% realtor commission on $213,000) the cost to sell would be $12,780. Therefore, they would have to come out of pocket $1, 780.

Second Job to Pay Off Debt (Thanks Dave Ramsey)
The only real logical option, but this would require sacrifice and a huge habit change. History shows us that only a small percentage would succeed.

Foreclosure
The majority would fall into this category

Bankruptcy
Again only borrowed time. I have not done any research as to the new bankruptcy laws. My rough understanding is the higher their income the more difficult it is to file.

When you combine all this with the fact that the housing market is beginning to cool off (just take a look at time on the market in different cities. Thanks Empty Spaces Inc. ) the idea that equity is going to bail you out in the short term is unrealistic. However, as for investors if you wait and are savvy enough this could be a win/win opportunity.

Foreclosures

Eric's blog inspired me to write about this particular topic:

(Be forwarned....looks like I ended up writing a book this time, so go get a cup of coffee or a snack, you might need it.)

In February, foreclosures in the 13 metro Atlanta counties hit an all time high at 3,876 homes being advertised as going into foreclosure just for March. Georgia is a non-judicial foreclosure state. Therefore, once a homeowner stops making payments the only requirement of the lender is they MUST advertise the foreclosure four weeks prior to the day of the auction (always the first Tuesday of the month) in the legal newspaper for that county. This usually does not happen until the loan is at least two or three months delinquent.

An investor has three opportunities to purchase a house once the house has been advertised as going into foreclosure:

1. Pre-Foreclosure
2. Foreclosure Auction
3. REO (real estate owned).

Obviously, when you buy a house in pre-foreclosure it is easier because you can do it without any credit and with little or none of your own cash.You can purchase the property subject to or get your own loan. If there is any equity (which there usually isn't) you might even be able to get the homeowner some of their equity back.

At the steps you need all cash, no exceptions. Furthermore, you might be bidding against other investors, both seasoned and newbies, or there might not be anyone there at all. If you are the highest bidder you must turn over a cashier's check to the attorney at that time. However, in Georgia they have up to 30 days to give you possession. This law was created about two years ago to make sure that the homeowner did not punch the bankruptcy clock at 11:55 a.m and you bought the house at 11:57 a.m. The attorney would have no way of knowing that until after the auction. The only problem I have is, "IF" the homeowner filed bankruptcy at the last second, then the attorney just gives you your money back with NO interest. Therefore, your CASH is tied up for that period of time, which could be as long as 30 days.

The biggest benefit to buying at the steps is ALL junior liens are wiped out at the auction with the exception of tax liens. The IRS has a 120-day right to redemption. The attorney handling the foreclosure is to notify the IRS of the impending auction. After the auction the IRS has 120 days to claim the property. If, for any reason, they do so (they usually do not) then the IRS must reimburse you any money you had spent for the property. Thus, no need to worry about IRS liens. As far as city or county tax liens are concerned, all you need to do is contact the city and county before the auction to find out how much the back taxes are. You can then choose to pay them once you have purchased the property or you can choose to not bid on this property.

The last and final opportunity is REO. If the property does not sell at auction the bank takes ownership of the property and will list it through a local broker. You used to be able to buy these homes with deep discounts. Unfortunately, I have found it EXTREMELY difficult, because I am competing with either newbie investors who don't understand all the costs or I'm competing with money from other areas of the country. I work closely with several real estate agents and they are all telling me that investors from as far as California are buying some of these properties, site unseen. One reason is because Atlanta's real estate is so cheap compared to other areas of the country. I have made hundreds of offers on these properties only to be told by the selling agent that they are negotiating with someone close to their asking price. WHAT? There is no way. First, many of these properties are in need of a lot of work. Second, their asking price is usually close to the ARV (After Repair Value). I used to think they were lying just to get me to up my offer, but I have followed many of these houses and sure enough someone bought them at that price.

Eric made a good point in his blog that he expects to see these houses come back and he is exactly right. I have seen way to many of them come back in the form of foreclosure. I have walked through hundreds of houses where it was obvious that someone had begun to fix them up. These houses didn't even make it back to the market. One in particular stands out. This house was built in 1955 and was in complete rehab job. It was obvious what the investor was good at. The investor had installed a very high end designer kitchen with floor to ceiling cabinets, granite countertops and tile floors. It had the "Taj Mahal" for a bathroom. Floor to ceiling tile, garden tub, separate stand up shower and a levitating bowl, where water shoots out of the wall into a bowl sink. However, when you looked up there was a giant whole in the roof about 4ft. x 4ft. HELLO!!!!!! Uh, I think you should fix the roof FIRST? Furthermore, the rest of the house still needed to be gutted. This house was again foreclosed on and the bank had it listed for $150,000. There was not one single comp in the neighborhood that had sold for more than $140,000. Oh and I was actually looking at one a few doors down that had been completely rehabbed for about $115,000. That is the only reason I saw this one.

With all that being said, (If you are still reading this book...), there is little or no equity in 90% of these properties that are in pre- foreclosure or are being sold at the steps. Thus, I have learned a way to solve this problem, which is how I bought the Duluth house. It's called a "short sale". Basically, you are asking the bank to sell it to you before it goes into foreclosure for less than what the current owner owes. You must be able to PROVE to the bank that you can close by either an "Approval Letter" (not "pre"-approval letter) from another lender or broker, or prove you have the cash to buy the property. Also, you need to be very patient. I put an offer on the Duluth house back in November and we didn't get an answer back until the end of January. However, the house was scheduled to foreclose on December 6th, which they didn't. So, I felt pretty good about the offer.

Finally, Georgia is #1 (wohooo, just kidding) in the country for mortgage fraud (<--see recent article). It was so bad in fact that the Georgia Legislature passed the "Georgia Residential Mortgage Fraud Act" last year. These houses are coming back into the pipeline that the bank loaned more money than the property was actually worth. Thus, over inflated beginning bid amounts and over inflated listing prices. Again, you must be patient and be at the right place at the right time. Don't get me wrong, I put an offer on EVERY single house that I look at. You never know, one day the phone will ring and they might be ready to deal.

(deep breath)......THE END! .......(exhale):))

Doors, Cabinets, and Floors..Oh, My!!!

WOW!!! What a weekend. My business partner (Salle, that's not his real name. Just a nick name we have given him) and I worked a combined 58 hours in the Duluth house over the weekend.

The plan:
1. Tear out sliding glass door and replace with french door
2. Assemble and install new cabinets and counter tops
3. Install laminate hardwood floor in the living room, kitchen, dining room, and hallway
4. Install carpet in the three bedrooms
5. Paint exterior trim on front of house
6. Burn yard debris that I ripped out last week

First of all, let me make something very clear. Salle is the construction expert. He works for himself and can handle anything from a minor repair in your house, to designing and constructing an addition to your multi-million dollar home. Pretty good guy to have around.
I, on the other hand, am only good for general labor.

I arrived on site around 9 a.m. and he arrived around 12 p.m. on Saturday and we worked in the house until about 3 a.m. Sunday morning. That was when I had to throw in the towel and retire to my sleeping quarters for the night/morning. It was wonderful accommodations (wink wink), a sleeping bag on top of carpet padding that I had installed a few hours before. Salle, on the other hand, just kept on trucking.

About 8 a.m. I awoke and found Salle still working in the kitchen. This guy is a machine! By that time we had completed the following:

Installation of the french doors.
Assembly and installation of the cabinets
Laminate floor in living room was installed
Carpet pad in the three bedrooms were installed
Counters were on the cabinets, but not cut yet

We both worked for the rest of the day until 7 p.m. Sunday night. By that time, all the floors were complete with the exception of the hall way and bathrooms. Cabinets were complete with the exception of the sink installation (oh and we decided to rip out some walls in the kitchen, so that took some of our time), one coat of paint on the exterior trim of the front of the house and most of the yard debris had been burned. Needless to say we were spent. However, the house looks great. One last push and I will be able to kick off the lender to begin the work necessary for the refinance.

Long Term Strategy

I will probably never sell a house. If I do, it will definitely be via 1031 (just ask Trisha). The following is a very simple chart of why I believe in holding onto real estate long term. While there are down sides, I am an optimist. I think you are almost required to be an optimist if you plan to be a real estate investor. The chart above assumes the following:
Purchase Price: $150,000
90% I/O Debt: $135,000
Annual Appreciation: 5% (very conservative)

This chart is if you only bought two houses in year one and stopped after that. It also assumes the debt on the property is interest only, so your balance in year 10 is the same as in year one. Obviously if you are amortizing, then the cash out in year 10 would be greater. You have to keep the houses rented and have increased the rent to stay in line with the current rents in the market place. In other words when you refinance the property in year 10 the rent should be able to cover the debt, assuming interest are not out of control, but since you will be receiving a large amount of cash, it might not matter. I think you might be able to handle some negative cash flow. LOL!!!

If you bought two houses in year one and each house was at least worth $150,000 assuming a 5% appreciation, those houses would be worth a combined $465,398. In year 10 you could borrow 80% of the value, thus getting a new loan for $372,319. Then, you would payoff the two existing loans (a combined $270,000) leaving $102,319 cash in your pocket. Ok, ok I know you have to subtract closing costs @ 4% (which is high) rounded up to $15,000. You still have $87,309 in your pocket. Oh yeah, and did I mention that it is 100% TAX FREE?

As you can see I don't like to pay taxes. Question for you, how much income (in one year) would you have to earn today (before taxes) to put $87,309 in your pocket after taxes?

Now, ask yourself with your current lifestyle, could you live off of that money for one year? Try this yourself, just plug in what a typical deal is worth in your area and run the numbers.

The real power here is if you continued to buy just two houses a year for 10 years, then you would have 20 little houses. After that, you could refinance in year 11 the houses you bought in year two, and so on and so on. Yes, you would be a busy little landlord, but you could then retire (a.ka. quite your day job) comfortably on an annual income equivalent to a six figure income. Oh, and that is not including any monthly cash flow from rent. I LOVE THIS STUFF!!!!!!!

Flip vs. Hold

While we are all eagerly awaiting the results of my rehab I thought I would fill in the time with some examples of why I am such a big believer in the buy and hold strategy. I guess I should have named it Hold vs. Flip, oh well. First, let me be very clear that I am not at all against flipping houses. I would flip house if the numbers made sense.

However, I just wanted to point out the advantages of holding real estate long term. The numbers above are real world numbers. These are the actual numbers for my current project. I am in the process of refinance the house and we should close on March 17th. Since I bought this house on February 16th my first mortgage payment is not due until April 1st, so there are no holding costs with regards to debt in those numbers. If I keep the house and refinance it I put $11k in my pocket tax free. That is equivalent to an earned income of almost $21k. Taxes - 28% Federal, 6% State, and 15% Social Security. Furthermore, you would still have $15,000 in equity in the property. (Maybe tomorrow I will post my longterm appreciation chart to show what happens in the later years.)

If you sold the property within one year (and did not do a 1031 tax exchange) you are subject to capital gains tax. Same scenario, but as you can see after taxes you only walk away with $5,601 vs. $11,201. That's a difference of $5600 (double your money). Now some may say well, "Sell it F.S.B.O. to save the $9,000 in commission." Sure you can do that, but as you can see I did not include any holding costs. I tried to give best case scenario. If you borrowed $95,000 when you bought the house the monthly payment including taxes and insurance would be $865 a month. Assuming you sold it in four (4) months it would cost $3,460. You would save $5,540. So, you are at $11,041 four months from now (almost the same as the refi example). Furthermore, your cash is tied up for four months, so to be realistic you should be charging yourself interest for four months. Also, you are limited to the number of deals you can do unless you have a tremendous amount of cash or access to large credit lines. So if you sell, you get hit with a large tax bill, you are limited to doing any more deals that require YOUR cash, you have no house, no equity and no long term appreciation. You also don't have the headache of being a landlord...LOL!!! :))

Last, but not least, the house of which you buy and hold, needs to be at a price or the debt needs to be at a price where you can cover the monthly mortgage payment, taxes, insurance and maintenance with the monthly rent. Any questions?

Rent vs. Buy Spread

In Atlanta, due to the low affordability of housing, the spread between rent and P&I (principal and interest) share of all household income has historically been very narrow at only 3%. Due to rising interest rates and a stabilizing rental market the premium to buy is forecast to increase from 18% today to 35% by the year 2008. Unless there is an unforseen price reduction, it will be less affordable for individuals to buy a home vs. renting one. This is good news for those of us who own good, clean, affordable rental housing with long-term debt in place. It is bad news for those who have short-term debt or some sort of adjustable instrument.