(p28 - The Lazy Investor's Guide to Real Estate)
Real Estate Investing Financing Truths - Part 1 of 2
Traditional Methods of Real Estate Investing
Through years and years of transactions, the traditional method of buying and selling Real Estate investments has evolved into a market of its own and has grown into a Real Estate ¡®machine¡¯ that circulates massive amounts of money through Real Estate Agents, Real Estate appraisals, Title & Escrow Companies, Banks, and Mortgage Companies.
These once-simple real estate investments have grown from a modest fee for a professional to keep the Buyer¡¯s or Seller¡¯s best interest in mind during negotiations, to now, traditionally, 6% (or more) of the total sales price being paid to Real Estate Agents (via Brokers who often take the majority of the money), another 3 ¨C 5% being paid to Title, Mortgage and Escrow Companies for various fees, and then even more is taken for a real estate appraisal.
As if that weren't enough, then a huge amount of money is absorbed by the Bank, through the form of interest payments ¨C usually over 15 ¨C 30 years and totaling 2 ¨C 3 times the original purchase price of the initial Real Estate investment!
Down Payments go to pay a variety of fees.
Now, don¡¯t get me wrong, it certainly is possible to make money through these methods, but the ¡®traditional real estate investment system¡¯ is designed to simply ¡®break even¡¯ for the home owner in purchasing a home (the first, and perhaps, only real estate investment they will ever make) in this manner. It is really not designed for the investor, who, of course, wants every real estate investment to make money.
Traditional funding only allows the Home Owner to break even.
Example ¨C Home Owner Financing: (the numbers represented here reflect the methods, not necessarily the price structures of any given real estate investment market.)
List price on property (with Real Estate Agent) $200,000
Bank loan available (owner-occupied, 100% @ 7% interest) $200,000
Monthly payments (over 30 years) ~ $1350
Taxes, Insurance, etc. (per month) ~ $250
(This example is for an ¡®average¡¯ home in an ¡®average¡¯ neighborhood, for the ¡®average American¡¯ using an ¡®average¡¯ interest rate of 7% ¨C of course, these figures do not apply everywhere.)
Therefore, the payment for this property is approximately $1600 per month for 30 years, to be paid by the home owner living in the property.
Now, the ¡®traditional real estate investment system¡¯ allows for this home owner to have a change in their lives and decide to purchase another (usually larger) home. They have the right, and often do, ¡®rent out¡¯ the first house and move into the new one with their family.
The owner will be responsible for any additional expenses (repairs, Home Owner's Association fees, etc.) as well as their desire to make a small cash flow from this endeavor.
Their previous home now becomes a true real estate investment where they increase their 'homeonwer's' monthly payment to the ¡®renter¡¯ by an additional $200 per month, for a total price to the renter of $1800 per month.
Reasonable enough ¨C until/unless there are repairs to be made ¨C or, the renter leaves and the new ¡®landlord¡¯ has to make payments on this vacant house. Then, this $200 positive cash flow per month real estate investment doesn¡¯t look so good¡­.
But, the ¡°rent¡± has been established for that house ¨C and the ¡®comparable rent for the area¡¯ can easily be calculated using this method;
STANDARD RENT CALCULATION - (Simple Method)
Total payment for the property (includes Principle, Interest, Taxes and Insurance ¨C known as PITI at 100% loan at 7% interest)
+ cash flow for the ¡®investor¡¯ (usually $200 per month)
= ¡®Rent¡¯
Note: With several homes in the area of similar size and style, plus the fact that most homeowners in the area have similar loan structuring, we can estimate that whatever the average loan percentage is will create a ¡®standard rental rate for X model real estate investment¡¯ ¨C in this case, $1800.
A simple (and LAZY) way to remember it is;
PITI + $200 = STANDARD RENT
If an ¡®investor¡¯ (one that seriously wants to make money from buying/selling Real Estate investments) wishes to purchase the same house in the same area and for the same amount of money, the ¡®traditional real estate investment system¡¯ doesn¡¯t allow the investor to really make any money from the transaction.
Example ¨C Investor Financing:
List price on property (with Real Estate Agent) $200,000
Bank loan available (investor loan, 80% @ 8.4%) $160,000
Monthly payments (over 30 years) ~ $1250
Taxes, Insurance, etc. (per month) ~ $250
(This example is for an ¡®average¡¯ home in an ¡®average¡¯ neighborhood, for the ¡®average American¡¯ with an ¡®average¡¯ investor interest rate of 8.4% ¨C of course, these figures do not apply everywhere, but the formula is very similar.)
Therefore, the monthly payment for this investor- owned real estate investment is approximately $1500.
At first glance, seems very good, as the investor will have a ¡®cash flow¡¯ of $300 per month ¨C more cash flow per month than the homeowner-turned- investor.
However, the difference is that the 'Investor¡¯ (the one serious about making a profit from this real estate investment) has brought in cash (out of pocket) of $40,000 ¨C UP FRONT!
Plus, the investor has to pay a higher interest rate (in this example, I have included 1.4%, while a bank may charge several percent for investor loans ¨C those identified as being purchased solely for the purpose of being a real estate investment - check with your lending institution on their policies prior to finalizing your loans)!
Now, I don¡¯t know about you, but I don¡¯t know too many people with that kind of money for 1 property ¨C not to mention the fact that this person expects to make several real estate investments, repeating ¡®what works¡¯ several times.
Not only does the investor have to come up with $40,000 up front (every time they decide to make a real estate investment), but how long will it take (at $300 per month) to make enough to purchase a second investment property at this rate?
10 YEARS!! (presuming there are never any repairs, the investor never takes out a penny of the cash flow for their own use, etc)!
Investors and Homeowners get different rates.
Not what I call a ¡®wealth path¡¯, not what I teach ¨C and certainly not any way to run a business.
END Part 1 of 2
About the Author
Steve Majors has fixed stereos, been a radio DJ and owned several successful businesses - even before his wild success in Real Estate investments. Extremely well traveled (36 countries & counting), he now teaches others the secrets of Real Estate investing with his very own LAZY methods (minimum effort = maximum results). Profit from articles, news and information from one of the most creative investors on the planet! http://SteveMajors.com