I have never been a huge proponent of one unit investment properties. I have heard arguments from the other side extolling the benefits of that particular investment type, but have never been fully swayed. I own one single family investment property, and while I have less maintenance, no water bill, and longer tenant stays, I still would prefer the extra income a multi family brings. That being said right now deals are popping up in all hues and flavors and I have found myself considering a single family or two as possible investments; However there is one major problem I have run into with these types of investments: Difficulty (Impossibility) of refinancing. While doing a cash out is painful in any scenario these days, refinancing an investment single family is out right tortuous.
As an investor I always take a long term prospective on deals. If I wouldn’t want to own the property 10 years from now, I won’t by it; however my business will not function without being able to pull out capital invested to fund further acquisitions. So while I will still considering a single family as an investment, it would have to be a sweet and I mean sweet deal and worth the opportunity cost of tying up substantial amounts of capital.
What do you mean? Isn’t that what banks do?
In numerous conversations with bankers over the past month, I have heard the following refrain at least a half dozen times: “We are unable to extend you credit based on real estate collateral because we just don’t have a handle on what it’s worth.” We will ignore the fact that these are finance professionals for now, but I assure you I will come back to it later. My immediate response is what’s new? Apparently banks were never able to value real estate otherwise they would never have made half the loans that are eating them alive right now. But I guess it didn’t matter when they could package them up as commodities and sell them to investors with an A grade credit rating.
Given that so banking professionals are at a loss at how to value real estate I thought I would be an upstanding member of the business community and share my secret formula for investment valuation and real estate success. I use a concept known as the present value of future cash flows. I project revenues, assume a certain expense ratio, inflation and income growth rates and discount it by my weighted average cost of capital. This gives me a rough sense of what the property is theoretically worth. I then look at other factors to fine tune my valuation estimate. I know many recognize this formula and must be thinking the same thing as me when I hear a professional banker say “We just don’t know what it’s worth right now” Aren’t you a finance professional and who is we? Are there a bunch of finance professionals at your organization who don’t know how to discount future free cash flows? I am not sure if banks really don’t know how to value real estate, or are just using that as an excuse to not lend me money. I suspect it’s the latter, or at least I hope it is.
I recently attended an informational event on programs available to investors to receive rehab funds for investment property. The program promises significant financial incentives of up to 17,500 hundred per unit if you keep rents at a certain level. Yet like most other governmental programs the devil is in the details.
First you need to work with the City to develop a scope of work. Then you will need to have the work performed by a licensed contractor. So let’s say you are looking at a property and the water heaters have been stolen. If I am not using City money I can go to home depot buy one and have it installed by myself or one of my workers for 60 dollars. If I go the City route I will have to have permits pulled and have a licensed plumber do the install to a tune of 200 dollars. Assuming I can get the city to pay half, remember the funds are provided on a matching basis, I’m out of pocket 100 dollars, 40 more than if I did it myself.
I have looked into these types of programs before and every time I chose to forego City money because I felt I could do it cheaper and quicker on my own. That being said, I think this program could be beneficial in a few different scenarios:
1. You already rely heavily on contractors
2. You are a licensed contractor with the city and can pay yourself for the work
3. The work needed would require permits to be pulled anyway (WE Energies involvement)
As an example I am looking at purchasing a 30 unit apartment building with mostly cosmetic repairs needed (no major electrical or plumbing issues). I would consider participating in this program to fund window replacements, cabinet upgrades, etc. However, before I did that I would register myself with the city as a licensed contractor.
I would love to hear from people who have participated in this program and get their feedback.
But biggest kick I got out of the event was the representative from PyraMax bank who freely passed out his card, and gave the impression that they were ready to make loans. When I told him I had just talked to their business banker Mike Bradburn 2 weeks ago and he told me the bank didn’t have an appetitive for investment loans right now, he replied “this is different because this City’s involved”. What does having the city involved have to do with me successfully completing a rehab project, out side of ensuring it’s going to take longer and cost more than if they weren’t. I suspect that many would be investors who think they just found a source of funding are going to be disappointed. As many of you may know I am currently doing a blog series on my quest to secure bank financing for investment loans so I found this particularly humorous.
A small business owner’s quest for bank financing
As any small business owner can tell you getting a loan right now is a challenge. If their business revolves around real estate it’s nearly impossible. Banks are still dealing with the consequences of the real estate melt down and are doing everything in their power to get real estate loans off of their books. Given this reality you can be of high character, possess the capacity to repay, and have a strong capital position, but if your collateral is real estate you are definitely in for a uphill battle. But I’ve never been one to let a challenge stop me. Right now people are uncertain, banks are scared, and property is out of favor. Sounds like the perfect investment opportunity!
Being an experienced real estate investor I have loans with over a half dozen banks in the area, but have been bounced from institution to institution over the past 2 years as financing has dried up. I temporarily found a home at US Bank where I got great rates, and horrible loan to value ratios (something’s better than nothing) but I was recently informed that they were no longer interested in adding more investment loans to there books (I knew that was going to happen).
So now its back to the grind to locate a lender and achieve my goal of financial independence. I will catalog my experiences in finding a lender in hopes that it will make other’s pursuit of financing more efficient and less painful than mine is sure to be.
I have been surprised at the number of property investors who have not heard about the City of Milwaukee's new Residential Rental Inspection Program. This is probably because they do not own property in the two pilot neighborhoods, but as I have mentioned previously you can be assured that the city will extend this to the rest of the city. It makes sense from an administrative and process perspective to limit the intital implementation. As I have argued earlier these types of programs, which are essentially a surtax and bureaucratic headache, will only depress property prices further. Every landlord should check out the city's website for a description of the program
Residential Rental Inspection Program . It will soon be a reality to every property investor in the city.
The City of Milwaukees Residential Rental Certificate program is a financial scheme designed to replenish shrinking city coffers. Stung by declining property assessments the city desperately needs another income stream to buttress its deteriorating financial position.
This program is initially being deployed in two designated areas: UWM and Lindsay Heights. The first thing to make clear is that without a doubt this program will be extended to the rest of the city. The only reasons why it is initially being implemented in just two areas is that administratively it would have been impossible to implement city wide and would have created a greater wave of opposition. They will work out the processes and deal with the legal challenges in the first phase of implementation, and subsequently move it out to the rest of the city.
This program is a typical bureaucratic myopic ploy to boost revenue short term, but will have a negative impact on houses values long term: Let me explain. We are moving back to valuing investment real estate based on the timing, amount and risk of the free cash flows that it generates. This model of valuation has led to a drastic correction on the housing market, and prices will not stabilize until valuations are in alignment with the cash flows they generate. That being said, from an investor stand point what does this new governmental program do to the timing, risk, and amount of the free cash flows a property generates? First at 85 dollars a unit it lowers it, but more importantly it adds more risk and uncertainty to the cash flows. As every investor knows having only pristine properties is a difficult proposition and more importantly is not practical in certain neighborhoods. So now when I am evaluating potential deals I know that I will have to allocate additional capital to ensure it meets the subjective standards of the Dept of Neighborhood services, which will subsequently lower the cash flows generated. This will result in downward pressure on housing prices, especially in areas where rental prices are not very elastic. These lower valuations will result in lowers assessments and hence lower tax collections. And then the city will come up with another brilliant idea..... I can not wait.