Real Estate 029: Financing Rentals with 15 vs 30 year mortgages?

There are a lot of nuances when it comes to real estate investing, and one important decision is financing. Once you have decided that you are going to use good debt to leverage other people's money and scale your portfolio, you must also decide the terms. Investors typically finance their properties through conventional loans (secondary mortgages with Fannie Mae, Freddie Mac guidelines), as such, they decide between 20% or more in downpayment, or 15 or 30 year mortgage terms.

In simplistic terms, 15 year mortgages will generally have better interest rates as they are being amortized over a shorter period of time and seen as less risk to the bank. To the borrower, it may seem beneficial because you have a smaller interest rate, and less interest paid during the 15 years vs the 30 years. However, once you step back and look at the bigger picture, you may want to take into consideration other intangible factors such as flexibility, potential for interest rates to increase, and the ability to use good debt when your returns are expected to far exceed the debt service (Note: if your property is not covering the debt and leaving you with a healthy amount of cash flow each month, you are taking on a big risk as the property may not be self-sustaining from day 1).

Lets take a look at some of the savings on a rental property with a 15 year vs 30 year mortgage:

Purchase price: $100,000

Down payment: 20%

Scenario A: 15 year mortgage with 5.5% interest

This will leave you with a monthly payment of principal and interest of $653. Over the course of 15 years, the total amount disbursed will be as follows:

Total payment: $117,725.95

Principal: $80,000.00

Interest: $37,725.95

Scenario B:  30 year mortgage with 6% interest

This will leave you with a monthly payment of principal and interest of $479. Over the course of 30 years, the total amount disbursed will be as follows:

Total payment: $173,083.40

Principal: $80,000.00

Interest: $93,083.40

This results in additional interest of $55,357.45 ($93,083.40 - $37,725.95).

Looking at $55,000 of interest savings may make you think this decision between scenario A and B is a no brainer, however if we take a closer look there are various factors to consider:

• Additional interest can be converted into tax savings across rental portfolio

• Opportunity cost of fast loan paydown vs re-investing the difference

For example, the monthly PI of scenario A is $653 - scenario B of $479 results in a monthly PI delta of $179 that could be used to reinvest for a higher return or used as additional payments as conventional loans typically do not have pre-payment penalties. Lets take a look at how interest payments would change if we used the $179 to make additional payments toward the 30 year loan:

Total payment: $123,515.78

Principal: $80,000.00

Interest: $43,518.13

Now the difference in interest is only $5,792.18 ($43,518.13 - $37,725.95) all the while maintaining flexibility to change directions if you wanted to, instead of locking yourself into a decision for 15 years. In addition, the $179 in savings in scenario B may come in handy when other rentals in your portfolio are not performing or may be negative $200. The extra cash flow from a 30 year mortgage may be used to offset these fluctuations.

Lets take another example and say that you use your monthly $179 PI difference from a 15 year vs 30 year and combine it with savings to purchase a turnkey rental property with a cash on cash return of 12% (These are actual deals I am seeing in the midwest for a C class neighborhood).

With a $179 starting balance and contributing $179 monthly at 12% returns, you will end up with $632,034 after 30 years when you will have paid off your home in scenario B. Without even calculating, the difference is clear. Although this is just an example, investors must understand these variables and opportunity costs when they decide to forego one for another.  There is not real benefit to paying off your mortgage from a numbers perspective. 

I do believe that risk needs to be managed and am not looking to maximize the debt across all of my rental properties, however, depending on what season you are at life: 20-30s "grow", 40-50s "maintain", 60s+ "enjoy", you may find yourself wanting to lower risk and have peace of mind. 

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Real Estate 028: Motivated Seller Questionnaire

A great way to build equity and rental portfolio in a competitive market is to find a motivated seller. A motivated seller is someone who doesn't want to sell, but needs to sell due to their personal circumstances (e.g. death, divorce, inheritance, debt, etc.). Chad Carson wrote on the BiggerPockets blog on the importance of hustle by sharing the following metaphor: “Every morning in Africa, a gazelle wakes up. It knows it must run faster than the fastest lion, or it will be killed. Every morning, a lion wakes up. It knows it must outrun the slowest gazelle, or it will starve to death. It doesn’t matter whether you’re a lion or gazelle. When the sun comes up, you’d better be running.“

Similarly to the lion or gazelle that is running, a savvy investor must be on the lookout for great deals through their marketing efforts in identifying motivated sellers. Once you have found a motivated seller through a lead generation software (e.g. bandit signs, flyers, postcards) or referrals from brokers or property managers, having a motivated seller questionnaire or intake script is useful for screening those leads. 

A big mistake made by newbie real estate investors is not being able to filter out the warm/hot leads from the cold leads and end up wasting valuable time with a person that will end up keeping their property.

Below is a list of information you want to document during the initial screening process:

Contact Information

1. Full Name

2. Phone number

3. Address

4. Spouse/Partner Name (if any)

5. Email Address(es)

6. Property Address for Sale

7. How did you find us? (Used to understand marketing efforts)

These are the basic information you need to ensure that you can get in contact with the seller in case they hang up accidentally and to follow up periodically. Next you want to screen them for motivation for selling their property:

Motivation:

1. Is property currently on the market?

2. If yes, how long has it been listed?

3. Why are you selling?

4. Have you listed your home with a real estate agent?

5. What is your plan if your house doesn't sell?

6. Do you have any written offers yet?

7. Who lives in the property right now?

8. Are your mortgage/tax payments current? 

9. Potential problem with co-owners? (Divorce, business, etc)

10. Any known severe property damage?

11. Other need for fast and immediate lump sums of money? How much?

These questions cut to the meat of why a motivated seller may decide to work directly with an investor rather than a conventional method of selling through the MLS with an agent. 

Property Details:

1. Property style: (Single Family, 4plex, ranch style)

2. Square footage

3. Age of property

4. Neighborhood Quality scale

5. CapEx useful life (Roof, Foundation, HVAC, electrical, plumbing)

6. Any other improvements needed?

These questions ask about the physical condition of the property and to a certain extent, the neighborhood. In most cases, the investor should already be knowledgeable about the surrounding areas and rough ARV to be able to quickly determine if the seller is in the ball park of an asking price. Motivated seller screening involves knowing how to ask open-ended and probing questions about the property, to get more accurate and time-saving answers. For example, instead of saying, "How is the roof? Good? Bad? Ugly?", you should ask instead, "When was the roof last replaced?"

Some landlords and property owners will call you assuming they can scam you into overpaying for their property. These people may become motivated sellers later on, but at the moment, they are not worth spending too much time with after the initial screening calls. 

Financial Data:

1. Asking Price

2. Mortgage loan balance and interest rate (Lender information)

3. Any 2nd mortgage on property? (HELOCs, Loans)

4. Mortgage loan terms and conditions

5. Are there any other liens or debts on your properties?

6. How much rent per month? Request rent rolls (if rental property)

7. Any non-rental income from property? (laundry, pets)

8. Any HOA (Homeowner's Association) fees? How much are HOA payments

9. How much is monthly PITI (Principal, Interest, Taxes, Insurance) payment?

10. Utilities costs (Gas, Electric, Water) for the past 6 months (Statements)

In conclusion, using a motivated seller questionnaire can help guide your interview process, and gives you a framework to make the screening as conversational as possible.  This information will help you determine the best way to structure this deal (wholesale, lease option, seller finance, or cash purchase) for a flip or rehab and long term hold. Using the information on this page, investors should be able to work out win-win solutions for your sellers and yourself.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Book Review 009: The 7 Habits of Highly Effective People - Stephen R. Covey

The 7 Habits of Highly Effective People: Powerful Lessons in Personal Change

Authored by Stephen R. Covey, the book titled "The 7 Habits of Highly Effective People" discusses seven principles that effective people embody, and it also teaches readers how they can build their character and shape their lives with purpose and intent. While many business and self help books may focus on developing a good personality, Covey describes how developing a good character is more important as well as productive. He is a believe that your personality will emerge naturally when your character is built well and deeply rooted in positive principles. For example, if you attempt to develop a good personality without a foundational character, it may seem like you are wearing a mask to hide your true self. This in itself will ultimately be seen by others as deceptive.

The author states that in order to first develop a sound character, one must have a new way of seeing things, a sound paradigm. As an example, in the past, surgeons did not wash their hands, and when patients died of infections, no one understood why and did not see the correlation between the two. As a result of a paradigm shift, sterile operating rooms came to existence and also opened their eyes into how disease worked. In order to create a sound character, and live a life of integrity, you must embrace the new paradigm and act consistently in accordance with the new character. Covey mentions that building a character includes building habit. As Aristotle said, we are what we habitually do. To develop the habit we must first:

• Know – Understand what you want to do and why you want to do it.

• Develop skills – Become able to do it.

• Desire – You must want and will yourself to do it.

Although we can change our outside appearance as much as we want, the most important work is the inner work. When we master our interior self, we will in turn, master what is outside of us.

Habit 1: Be Proactive

Per Covey, highly effective people are proactive and do not limit themselves from taking action. They are able to see that they have the freedom to choose what character they will become and how they will act. Viktor Frankl was a prisoner in a Nazi concentration camp where his entire family, except for one sister, was murdered in the camps. Frankl was in a situation most people could not even imagine, but he was able to rise above the occasion and realize that he was able to be the "victor", not the "victim". “In choosing our response to circumstance, we powerfully affect our circumstance.” Through his grit and determination, he inspired other inmates and took fate into his own hands. Instead of thinking, "no, I cannot do anything", they think, "how can I do something?" or "what possibilities are out there?"

Habit 2: Begin with the End in Mind

Highly effective people think carefully about their goals and demand accountability. By creating a personal mission statement that outlines your goals and describes the kind of person you want to be, you naturally make a commitment. Remember, what can be measured, can be managed. 

Habit 3: Put First Things First

As highly effective people realize that they have the power to change who they are, they must also remember that habits are key in ensuring they meet their goals and objectives. Alot of people waste their time staying "busy" but are not "productive." We aimlessly create task lists and are unable to focus on the wildly important goals. Highly effective people must learn to prioritize their workload and not confuse urgent with important. One is easy to see, but the other is harder to discern. Remember to place emphasis on planning, developing key relationships and placing yourself in situations for more opportunities. Once you have prioritized the things in your life, remember to give each role an appropriate allotment of time on your schedule. Don’t rob Peter to pay Paul; make sure each role gets its due. Remember that effective management is putting first things first.

Habit 4: Think Win/Win

In discussing habit 4, Covey shares how successful people use "interpersonal leadership" In marriage, business or other relationships, to create win win situations. Simply put, two wins makes everyone better off; two losses places everyone in a worse situation. Furthermore, a win/lose relationship creates a victor and leaves someone injured. Highly effective people strive for win/win transactions, which incentivizes everyone to cooperate because all the parties come out on top. Highly effective people become highly effective by multiplying their allies, not their enemies. A good alliance is seen as a win/win.

Habit 5: Seek First to Understand, Then to Be Understood

Communication is a two-way street. In order to develop strong relationship, first find out what the other party desires and learn what winning means to them. Never assume that you know what they want. Use attentive listening to understand what the other party needs before you begin to outline your own objectives and share your wants. Place yourself in the other person's situation and do not argue or oppose their thoughts. For example, a good lawyer will present their strongest possible case from the lense of their opponent. Only when you truly understand the other side's motive and their point of view, can you draft the best response and get what you ultimately hope for. This is acting upon the “principles of empathetic communication.” Real self-respect comes from mastery over self.

Habit 6: Synergize

Covery understood that with synergy, 1 + 1 = 3. Creative cooperation may yield an addition bonus and multiply the effects. Just as 2 horses combined can pull a cart that is much heavier than the maximum weight each horse can pull on their own. Synergy essentially means, bringing together a whole that is greater than the sum of the parts. The most important part of synergy is the ability to communicate successfully and cooperate. This is different from "pretending" to play along nicely while hiding their true intentions. You must listen, understand, and actively cooperate with the other party to create something together, than one could not possibly create on their own.

Habit 7: Sharpen the Saw

A dull saw makes the work of cutting down a tree tiresome, tedious and unproductive. Highly effective people understand that one must sometimes take one step backward in order to take two, three steps forward. In this example, the man must take time to sharpen their tool (e.g. physical and spiritual rest, personal growth) and approach the task of cutting down the tree with a renewed self. People need to give care to their mental health by thinking positive thoughts, ensuring their mind is engaged and active. Further, successful people must also defend their heart and emotions which drive our everyday self. 

Favorite Quote: “Most people do not listen with the intent to understand; they listen with the intent to reply.” 

Below are some key areas of focus that the author tries to convey to his readers:

• Focus on developing character, not personality.

• You are what you habitually do, so adopt productive habits.

• Excellence is a habit, not an aptitude.

• You are free because you can determine how you respond to circumstances.

• Choose sound principles – integrity, dignity, quality, service, patience, perseverance, caring, courage – and endeavor to live by them.

• Write a personal mission statement to clarify your principles and set your goals.

• Think of what you want people to say about you at your funeral; try to deserve it.

• Build trust in your relationships.

• Balance the attention you give to each of your roles. Allot your time to attend fairly to each of your responsibilities and relationships.

• Understand that you have the ability to improve your habits and your life.

Hope you enjoy this book!

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The 7 Habits of Highly Effective People: Powerful Lessons in Personal Change