Important Net Investment Income Tax Changes Coming

Important Net Investment Income Tax Changes Coming January 1, 2013

Due to Federal Health Care Reform Bill

“The 3.8% tax is imposed only on those with more than $200,000 of Adjusted Gross Income (AGI) ($250,000 on a joint return).” Read more about it here.

 

“Top 10 Mistakes that Make Deals Go Bad” Series – Part 5

# 2 Do a Deal to Keep a Contractor Busy

Our experience over the past decade of lending money to rehab investors has shown that doing a project to keep a contract busy is one of the least profitable ways to invest in real estate.  This reasoning almost always backfires on the investor, both on the current project and on future projects.  Good construction crews are hard to find; however keeping them busy does not make them better.  The investor runs the risk of overpaying and creating idle, unmotivated workers by haphazardly doing a project to keep contractors busy, thus reducing profits.  Contractors, like all people, need the proper incentives to produce good outcomes.  Projects started to keep busy have vague timetables and less specific objectives, which often do not work out in the end.  Making your contractor “fat” will provide the opposite reaction you are looking for, and might create a bad habit that becomes harder to feed.

Instead of making busy work for your contractors, incent them to do better than expected quality work in less time.  Then maybe give them a little extra compensation for a job well done.  They will thank you and come back anytime you have a worthy project ready to rehab.

#1 Fall in Love with the Place

The number one error real estate investors make is becoming emotionally involved, they forget it is a business.  This is a business. Run it like one.  This means unpleasant decisions must be made and implemented from time to time.  You might not like evicting a tenant, but the right business decision calls for it.  Yes, your tenants are humans with real feelings, but they are not your family.  Family gives family a place to stay in a bind, a real estate investors rents for income. Do not adopt your tenants.

Avoid falling in love, not in life, but in real estate. This is a business. You cannot fall in love with a property. When you are in love you are irrational and will do any and all manners of things to get your heart’s desire. The second you hear your inner voice say you HAVE to have this property, you should go back and re-examine the transaction very closely to make sure logic is in agreement with emotions.

A business requires regular attention, and the right business attitude.  Pay attention, do the work, keep it professional, and it will stay profitable.

“Top 10 Mistakes that Make Deals Go Bad” Series – Part 4

#4 Over Improving for the Neighborhood

An investor’s ability to recoup the costs of expenses of a home improvement can widely vary and depend on many important factors.  If you cannot recover the costs of improvements then you have over-improved the house.  The first factor is the future use of the property.  Is the property an upscale home in an executive style community with the intent to re-sell to a retail buyer?  Then there is less risk in over-improving.  If the property is intended for rental use then long lasting materials and less expensive finishes may be more in order.

The type of improvement also has a bearing on the ability to recover costs.  It is well known that kitchen and bath upgrades yield good returns when done well.  Appliances, countertops, cabinets and flooring can widely vary in quality and price, and generally the investor can expect an equivalent return to the investment made.  Exterior repairs such as windows, siding or a new roof can also yield good returns, especially when their current state of being are a detraction from the appearance of the house.  The return here might not be quite a strong as interiors since these items are necessary and a certain quality is generally assumed.  Again, rentals need replacement when functionally obsolete to prevent damages to the property.

Adding square footage is also good but be careful that the addition is not atypical for housing in the area.  A five bedroom house may not get the same bang per extra bedroom in a generally three bedroom community as the fourth does.  Rooms carved out of spaces which may not improve the overall layout of the interior might not be beneficial either.  Remember, appraising property is difficult enough in today’s real estate environment.  If an appraiser cannot compare the improvement to something else that has resold they will generally underestimate its value.

Finally, and most obviously, while the need to make an improvement may be the driving factor in make a home repair; the quality of the improvements weighs heavily on the ability to recoup the costs.  Poor craftsmanship, cutting corners, improper installation, and sloppy finished can have the opposite effect of the intended repair, and could end up costing you even more to correct, reverse, replace or remove after construction.

Rule #3 Forget this is a Business

One of the surest paths to failure is to forget that your real estate portfolio is a business. A sympathy attack for a tenant with a hard luck story costs you money just as if you owned a gas station and you sold your gas for $1.00 less per gallon than it cost you to a customer because he had a good story. You will be out of business quickly both ways.

Real estate becomes emotional. A commercial tenant’s dreams and livelihood are the business. A residential tenant’s home is in play. Losing either is traumatic, but that is not the landlord’s business. A landlord is not family and should not take on the costs of providing subsidized housing to some non-family member.

The landlord’s business is providing a useful property to the tenant at an agreed rate for the usage, or rent.  A land lord is not in the social work business, homeless relief, or other charitable enterprise. A landlord needs to remember that this is a business first and foremost. Lose sight of the purpose of a business, to make an acceptable profit for its owners, and you lose your profit margins. Always remember this is a business and run it as such.

“Top 10 Mistakes that Make Deals Go Bad” Series – Part 3

#6 Rehabbing Grandfathered Usage Properties

A grandfathered property tends to be a nonconforming property for which the original zoning or ordinance was not in compliance, thus the use of the property has remained the same since subsequent zoning changes were placed on the books.  Some basic categories of grandfathered properties include nonconforming use of land, nonconforming structures, nonconforming use of structures, and nonconforming characteristics of structures.  There is also a parallel line of thought dealing with historical properties which comes to bear in certain municipalities with older building’s and more extensive building’s records or housing authorities.

There are several risks for investors of grandfathered or historical properties:

  • Properties generally must be registered and are closely monitored
  • Properties generally have civic authorities, housing commissions, etc., which must weigh in on any changes to the existing structure
  • The actual nonconforming nature of the building may be limited in the investor’s plans for future use

An example comes to mind of an old house bought by an investor using a turnkey plan in a major Midwest city.  This investor had used the turnkey program on several other properties in close proximity to the subject property of this tale.  In this case, the property was grandfathered to codes requiring the original windows remain with the existing structure.  The investor had authorized the order of new windows to be replaced throughout the entire house.  Once some new windows were installed, the housing authority shut down the project because of the violation.  It was explained that only the glass inside the existing window panes could be replaced, thus the investor had unused windows which they could not use, plus the expense of replacing glass into window panes, adding tremendous expense to the project.

Invest in grandfathered property carefully (and do your homework too)!

#5 Fight Your Own Formula for Success

Successful real estate investors develop a system, or a formula, they apply when making the most crucial decision in any real estate transactions, such as how much to pay.  The formula must be specific to the area and the investor’s expertise.

Re-sell and rehabilitation purchases are the ultimate gate keepers to success. A rehabilitation project investor must know the cost of projects before starting and have a very strong knowledge of the re-sell market for that property.

When buying for cash flow, you ARE purchasing the cash flow so that is the most important variable in the proper price to pay.  The more desirable the area, the more rent it will bring.  For instance in a less than great area, a 4 unit that generates $2,000 per month, total rents might be worth $2,000 x 36 = $72,000. That exact same 4 unit in a better area generates $2,000 in rents but due to jobs, schools, location, etc… it warrants a 60 month multiplier, or  $2,000 x 60 = $120,000.

Develop your formula, apply it, and do NOT fight it.  Walk away when the formula tells you to. Remember, no deal is better than a bad deal.

“Top 10 Mistakes that Make Deals Go Bad” Series – Part 2

#8 Having a Greed Attack

Webster’s Dictionary defines greed as “A selfish and excessive desire for more of something (as money) than is needed.”  The two words that stand out seem to be more money.  It is interesting that money is the example Webster’s chose to use.  To a rehabber, more money sounds like a pricing decision for the finished product (the house) whether it is for sale or for rent.  That decision could come as early as the acquisition stage when you are trying to determine a comparable price for the finished product.  Eventually, if greed bears its ugly head, it will come to roost when you list the finished house for sale or for rent.

What’s wrong with more money?  A very popular credit card company has made that very principal the topic of a massive advertising campaign involving one of America’s funniest comics and an adorable infant girl.  But that’s all about rewards points for credit cards users; we are focusing on the affect on rehab investors.

Greed can be seen as a good thing in a world in which time stands still; otherwise, greed should be seen as time’s evil nemesis.  If you are holding out for a price above reasonable, you stand to wait more time to get it.  Basic supply and demand economics are in play here.  However, economics also teaches that there are many costs to time; two of which should be illustrated to show why greed, or certainly too much of one thing, can actually work against for profit endeavors like rehabbing and investing.

Time has carrying costs – ask yourself how much does it cost to prolong the continued activity?  Is your rehab project financed?  Then you are paying interest to your lender, property taxes to the government, and insurance premiums to your agent, all of which costs money.  Completed projects which remain vacant also cost money to maintain including the costs of utilities for basic services.  Hopefully there are not too many other fixed expenses (as salaries!) resulting from carrying an inventory of unsold houses or vacant rentals.

Opportunity cost is the cost of any activity measured in terms of the value of the next best alternative that is not chosen. In other words, it is the sacrifice related to the second best choice available.  Opportunity costs deals with concepts about scarcity and the most productive use of resources.  Are your contractors at this job when they could be at another?  What is the listing agent or property manager doing? And if you answer “That’s me” to any of the above, what else could you be doing with your time?  If your time is not being spent on the highly priced project you have got, it could be finding that next great deal.  You can’t be in two places at once.

# 7 Repairing Fire Damage without Permits

Fire damage is a specialty. Good money can be made in fire damaged homes, but NOT being trained can and will lead to unexpected surprises, delays and losses.

The first thing to be aware of when considering a fire damaged home as an investment is that the local fire, police, code enforcement, and zoning are all aware of the fire.  Fires draw attention. Because the authorities are aware of the condition of the home, past zoning issues will need to be repaired as well as the recent fire damage.  This can and will add thousands, or worse, to a project if old issues are required to be fixed before getting permission for occupancy. Permits will be required and inspections are a must, adding cost and time to the project.

Fire can cause damage not visible to the eye.  Fire can get between walls and damage the framing with minimal evidence from either side of the wall.  Without looking behind the drywall or plaster, there is no way to know.

Fire is hot. Water is cold. When the two meet regularly, the pipes will burst from the pressure of the steam build up and leak, driving up the water bill.  If this occurs outside the foundation, there is no easy way to be sure short of a very large water bill, a very wet spot or a professional plumber.

Remember that there may be more to the repairs than may meet the eye when considering a fire damaged property. Zoning and code attention will apply so know what you are getting into and how to get out of it when entering into a fire damage real estate investment transaction.