I don’t believe in ghosts.
I especially don’t believe in ghosts who apply to live in one of my two-bedroom apartments (I hear they are more attracted to creepy mansions). This is why when poor Miss Abileen’s name came forth on the background check I ran this week, despite her death in 1987, I didn’t immediately call the Ghostbusters. While there are a number of “protected classes” that are illegal to discriminate against, I’m fairly sure being dead is not one of them. Clearly something was wrong with the social security number provided. It was fake, probably purchased by the applicant who was lacking a social security number.
This event has made me revisit just how important screening a prospective tenant truly is. As a young investor, it is easy to want to just let a tenant move in based solely on impressions. After all, throughout high school and college we are accustomed to gauging the integrity of a person based entirely on conversations. However, properly screening tenants is the most important step in decreasing the headaches you will get while investing in Real Estate. I would even be as bold as to say 90% of all management headaches could be avoided by adequately screening. Nearly every problem I’ve ever had with difficult tenants has been from letting my standards slide when screening for them. I have learned from my mistakes and hope to teach you to avoid them as well. The following is a list of the top six things to research before allowing a tenant to move into your property.
- Valid Social Security Number: I’ll start with this, as it relates to the story above. There a number of reasons a tenant might have a fake social security number, such as immigration issues or trying to hide their shady history. While you might be tempted to allow a fake or non-existent social security number to slide – this is a terrible idea. Instead, just take all the money from your bank account and just mail it to me. Why? You are almost guaranteeing future financial problems. If they refuse to pay, trash the place, and skip town – you can’t garnish wages. If they hurt someone on your property, you can’t find them. Finally, without a social security number, you have no way of knowing who they really are and what they have done in the past. Do they have several evictions? Do they have seventeen felonies in the past year? Simply put, the risk taken when renting to tenants without valid social security numbers far outweighs the reward.
- Job Verification: Tenants may tell you they have an excellent job, but without verifying it from their employer, you have no way of ensuring that they are telling the truth. Even if they bring current pay stubs to you, it is still a good idea to call their place of employment because the job could be just a temporary position ending soon. Renting to tenants without a proper job is just asking for future evictions.
- Income Verification: I recommend setting a minimum income level for your property at 30% of the tenant’s gross income – and make this number visible from the start to avoid wasting time. I cannot tell you the number of times I have driven to a property to show a unit, only to find out that the tenant only makes $500 per month in social security and is looking to rent a $495 apartment. It is ludicrous, but it happens all too often. Tenants do not know how much they can afford, which is why you must. I now tell prospective tenants over the phone exactly our qualifications to minimize unnecessary trips to show units.
- Previous Landlord References: You do not want another landlord’s trash. Calling a previous landlord is vital to knowing the kind of tenant you might be soon renting your property to. However, do not simply just call the most recent landlord, because more likely than not, this landlord will give a positive review even if the tenant was terrible – simply because they want them gone! Instead, go back to other previous landlords and find out the quality through them. Additionally, a proper background check will include previous addresses for the prospective tenant. Make sure these addresses line up with the addresses they give you. Often times tenants will conveniently “forget” to include landlord information for the property they were evicted from.
- Credit – While understanding a prospective tenant’s credit is important, this is the only item on this list that is only necessary depending on the type of tenant you are looking for. Credit checks often just tell you one thing – they have bad credit. However, if you are renting higher income properties – by all means check credit. They way a person has paid their debts in the past is a huge indication of how they will pay you.
- Living Style: This includes a number of specific items of note about your perspective tenants that are pertinent to know before renting to the tenant. This includes items such as number of pets, other people who will be living with them, smoking status, and “how much cash do you have”. These questions will help you better determine the type of renter this prospect will be and how they will affect the condition of your home.
Screening tenants does not have to be a scary task, and can easily be subcontracted out to either a screening company or simply a trustworthy college student looking to make a little bit of money. I also strongly believe in charging a tenant for the cost of the background check. It is generally common practice and it will help weed out the tire-kickers and only get serious renters.
P.S. looking for hard money loans in California? Be sure to check out my friends over at northcoastfinancialinc.com. They have very competitive rates, can fund within a week and specialize in fix and flip loans and other hard money loans.
I do not like nuts. Pecans, almonds, peanuts, walnuts, cashews, and all other nuts make me cringe. So when I open up a gift box of assorted chocolates, I tend to panic a bit, desperately desiring the milk chocolate goodness with the soft caramel inside but fearing the dreaded trojan horse filled with nuts and evil. When I choose wrong, I spend the next hour spitting tiny shards of nuts out of my teeth and vowing never to eat another chocolate from the mystery box again. For those who know me, though, that is a short-lived promise.
Real Estate Investments are like a box of chocolates. No, not in the Forest-Gump-Never-Know-Whatcha-Gonna-Get kind of way. Rather, there are many different types of investments all within the same “investment box”. Some might appeal to one type of person, some might appeal to another type of person. However, each investment uses most of the same basic principles and fundamentals.
Just as I tend to focus in on the caramel-filled chocolates in the box, I also have focused in on my niche in the field of real estate investments – small multifamily properties. However, you might be different. Your background, relationship to risk, family life, and your location may all affect which area of real estate you will begin investing in. The following is a brief summary of the nine major types of real estate investments.
Types of Real Estate Investments:
- Raw Land –This is as “raw” as it gets (see what I just did there!). Purchasing land usually does not produce cashflow, but can be improved to add value. Land can also be subdivided and sold as well for profit.
- Water/Mineral/Oil/Gas Rights – The cousin of investing in raw land, this is the process of buying and selling a person’s (or company’s) right to use the minerals (or water, oil, gas, etc) on a property.
- Single-Family Homes – This is the most common investment for most first time investors. Single-family homes are easy to rent, easy to sell, and easy to finance. Single-family homes may be more difficult to cashflow, and can take a significant amount of time and effort to purchase just one unit.
- Duplex/Triplex/Quads– Small multifamily properties (2-4 units) such as these are one of my favorite investment routes. These property types combine the financing and easy purchasing benefits of a single-family home with the cashflow benefits and less competition found in larger investments. Best of all, these properties can serve as both a solid investment as well as a personal residence for the smart investor. See “Getting Started Investing in Real Estate – Part 3: Creating Criteria” for more information.
- Small Apartments – Another favorite of mine, small apartment buildings are made up of between 5-50 units. These properties can be more difficult to finance, as they rely on commercial lending standards instead of residential lending standards. However, these properties are excellent in terms of cashflow. They are too small for large, professional REIT’s to invest in (see below) but too large for most novice real estate investors. Additionally, the value of these properties are based on the income they bring in. This creates a huge opportunity for adding value by increasing rent, decreasing expenses, and managing effectively. These properties are a great place to utilize on-sight managers who manage and perform maintenance in exchange for free or decreased rent. At this level, real estate can truly become 90% passive.
- Large Apartments – These buildings are the larger, nicer complexes you see all around the country, often times in upper-middle class neighborhoods in the suburbs. They often include pools, work-out rooms, full time staff, and high advertising budgets. These properties cost tens of millions of dollars to buy but can produce solid returns with minimal hassle.
- REITs– REIT stand for a Real Estate Investment Trust. At the risk of oversimplifying, a REIT is to a real estate property as a mutual fund is to a stock. Many investors pool their funds together, forming a REIT, and allow the REIT to purchase large investments such as shopping malls, large apartment complexes, and skyscrapers. The REIT then distributes profits to investors. This is one of the most hands-off approach to investing in Real Estate, but do not expect the returns found in hands-on investing.
- Commercial– Commercial investments can vary significantly in both size and style, but ultimately involve leasing property to businesses. Many commercial investors lease buildings to small local businesses, while others rent large spaces to supermarkets or big box superstores. While commercial properties often provide good cashflow and consistent payments, they also have much longer holding periods during times of vacancies. While most residential properties can be rented within weeks, commercial property can sit empty for months or even years. New investors should avoid these types of investments until they have significant cash reserves to weather the vacancy storms.
- Notes – Investing in “notes” involves the buying and selling of paper mortgages. Often times an owner of a property may choose to offer financing and “carry the mortgage”. In this case, a “note” would be created which spells out the terms of the contract. For example, an apartment owner decides to sell his property for one million dollars. He offers to carry the full note and the new buyer will make payments of 8% per year for thirty years, until the full one-million dollars is paid off. If that owner suddenly needed to get the full balance of the loan, he might choose to sell that mortgage to a “note buyer” for a discount. That note buyer will then begin collecting the monthly payments and decide if they will keep the note or try to sell it for profit.
As you can see, there are a lot of different types of investments and within each type there are sub-types as well and different roles within those sub-types. This may seem daunting, but the wide variety of different types of investments is actually a great thing, as there is a type of real estate that appeals to almost everyone. For me, I love finding under-developed small multifamily properties and adding value to increase cashflow and equity. That is my chocolate with caramel. What is yours?
P.S. looking for hard money loans in California? Be sure to check out my friends over at northcoastfinancialinc.com. They have very competitive rates, can fund within a week and specialize in fix and flip loans and other hard money loans.
This article is part three in a four part series on Getting Started Investing In Real Estate (to read part one, click here or to read part two click here) I first explored the importance of gaining an educational foundation before anything else in real estate. Next, I explained the necessity of creating a plan so you are not wandering like the Old Testament Hebrews in the desert. Today, it’s time to formulate the criteria for the house you will be searching for.
What Your First Investment Should Look Like
Your first purchase should be your own home. However, in the words of Robert Kiyosaki and his Rich Dad Poor Dad book, “Your home is not an asset. It is a liability”. In other words, a typical home – while it may increase in value over time – is not an investment. It will usually end up taking money out of your pocket, not putting money into it. That’s not to say it isn’t important, but how can you combine the need for shelter with an investment that makes sense?
Simply, don’t follow the blind masses and go search for that perfect home with the white picket fence that pushes the bounds of what you can afford. You will have plenty of life ahead of you for that home and much more if you desire. However, if you want to build a solid foundation for using real estate to fund your life adventures, you need to buy the correct house that is an asset to you and fits with your investment plan.
What should I buy?
I recommend that you look into a small multifamily building such as a duplex, triplex, or 4-plex.
Why?
A small multifamily property has several distinct reasons for making it the ideal first purchase.
- Easy To Finance: Multifamily properties with 2-4 units are as easy to finance as single-family homes. You can get into a home for around 3.5% down payment and ask the bank to pay the closing costs. If the property is already filled with tenants, you will also receive the security deposits from the existing tenants when you take over.
- Easy to Gain Experience: Multifamily properties will get your feet wet in the landlord business. I’m not saying you need to be the one fixing toilets at 3 a.m. (see my 5 Tips for Hassle-Free Tenant Management). However, the experience you gain from these small units will translate into a lifetime of headache saving skills.
- Easy to Cashflow: When starting out in Real Estate, your goal should be to get your cashflow as high as possible. This means the money that goes out in bills must be much less than the money coming in. As landlord – you get to keep the difference. This is cashflow. Multifamily homes are generally much easier to get good positive cashflow on, thus they are the perfect tool to get you out of your day job and on with your life.
- Less Competition: Small multifamily houses are outside the radar to most home buyers, so the law of supply and demand is on your side in getting a killer deal. Less competition = a better deal for you.
Are you going to fail miserably if you go out and buy a typical single family home as your first purchase? No. However, the financial benefits of a multifamily home will put you far ahead in your investing career and set you up for a higher likelihood of success. Tomorrow’s post will be the last in this series and will focus on the actual steps to purchase your first home.
Leave a comment below and then click here to go to part four in this series “Getting Started Investing in Real Estate”
P.S. looking for hard money loans in California? Be sure to check out my friends over at northcoastfinancialinc.com. They have very competitive rates, can fund within a week and specialize in fix and flip loans and other hard money loans.
Investing in Real Estate at a young age requires a different approach, style, and skillset than investing at an older age. However, the principles behind sound investing do not change whether you are twenty or eighty. This article is part one of a four part series on how to begin investing in real estate at a young age. If you only read one article – let it be this one.
My brother recently received his tax rebate check of over $1000 and asked me, “I want to invest this money – how should I start?”.
He expected me to tell him the secret to buying a house with a minimal down payment or a hot new tip on investing in gold (which I am adamantly opposed to, but that is topic for another post). Instead, I told him to use that $1000 to gain education. No, I don’t mean college or a cheesy seminar with a so-called “guru”. In fact, I suggested he use his money to take a week off work and spend a week at the beach reading books.
Education is the first step to any investment dream and congratulations, by reading this blog you have already taken that first step.
There are numerous ways to learn how to invest, most which are free. The technique you use to learn greatly depends on your learning style. The following is a list of just a few. I encourage you to check out as many as you can to determine your favorite way to learn.
- Books – This learning method goes without saying, but I would like to emphasize the power of public libraries in gaining free education. This technique resonates most with my personal learning style. During the first year after I decided to get into real estate investing at twenty-one years old, I checked out every book in my library’s regional collection dealing with real estate investing – well over a hundred – and read each one cover to cover.
- Blogs – These are an amazing source of information, written by people living in the trenches of real estate. Websites such as http://www.BiggerPockets.com offer hundreds and hundreds of articles, forums, and blog posts teaching every conceivable aspect of real estate investing.
- Mentors – If I were to go back and start over, I would have started earlier with this technique. People love to share what they know, and seasoned real estate investors are no difference. Get to know who the major players in your town (ask any real estate agent or join your local real estate investment club) and offer to take them to coffee. It is amazing the number of pitfalls and regrets you will avoid by simply learning from those who have been there. In addition – these contacts you make will help you in more ways than one in developing you into a world class investor.
- Podcasts – A recent innovation in the real estate investor world, there have been a number of great Podcasts that have emerged in the last few years. My current favorite is the Real Estate Guys Radio show. If you have an iPod or Iphone, you can listen to over a HUNDRED hour long shows covering a wide variety of real estate topics whenever you want – for free.
What are your favorite inexpensive or free ways to learn?
Leave me a comment below and then click here to read part two of “Getting Started Investing In Real Estate.”
P.S. looking for hard money loans in California? Be sure to check out my friends over at northcoastfinancialinc.com. They have very competitive rates, can fund within a week and specialize in fix and flip loans and other hard money loans.
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