Fix-up or adding value to real estate is one of the best and safest investment strategies for ordinary do-it-yourself investors who need to earn extra income as soon as possible, don’t have a great deal of money to invest but are willing to help themselves by pitching in doing some of the “non-technical” labor to save what money they do have!
For those investors who might consider “full-time” investing, obviously, cash flow or additional income is absolutely essential if you intend to make a reasonable living from your investments. However, unless you are able to pay cash to purchase income properties, it’s extremely difficult to earn a consistent monthly income you can count on! Even with the lowest interest rates we’ve had in many years – highly leveraged properties don’t generate much net income for their owners. I’ve just described my personal situation in the early years.
All Work and No Pay
Managing and looking after my string of highly leveraged rental houses taught me a valuable lesson I’ve never forgotten! It’s very easy to own a couple dozen rental houses and still earn less net income than your paperboy who works only two hours a day folding and delivering to his customers. I worked weekends and evenings after my regular job – plus, I even used all my vacation time. Worse yet, with only two or three vacancies, I had to supplement my real estate bank account with my telephone company paycheck. I will tell you from experience – anyone bogged down with the thrill of management, but not getting paid, is headed for the coo-coo’s nest or suicide.
I have written a great deal on the subject of my switchin’ over to small multiple unit properties; so most of my readers already know that I did it for the money. It’s true, I did! But simply switching without knowing exactly where the money will come from is still somewhat of a question mark for many who could actually benefit from owning multiple unit properties. The answer is education!
Investing Involves Important Numbers
To begin with, real estate investing has a great deal to do with math, or the numbers! Almost anything bought in bunches instead of singles, commands a price break. Safeway sells cans of chili beans three for five dollars – otherwise you’ll pay $1.49 per can! Buying rental units works exactly the same way – meaning the unit price or the dwelling cost is cheaper! This means the ratio between the market rent and the unit cost results in a higher percentage. A rent-to-value ratio of 1.00% per month is a decent starting ratio ($50,000 unit/rent $500 per month), but it can get much better in the multi-unit business when certain other factors are in the mix! It’s these other factors I’d like to tell you about! Years ago I owned five small rental cottages with a 4.0% rent-to-value ratio! Needless to say – that rocks! Even a one-legged dummy can make money with numbers like that.
Ugly or Unattractive Units
The general public – which includes most small-time real estate investors, especially Mom & Pop types, judge everything they see by how it looks! If it looks like crap, that’s their judgment! In the minds of your competition, looking like crap means they believe it is crap! This single fact is worth 20 to 40% off the asking price to a ring savvy investor. Ugly and unkempt properties weaken the bargaining power for sellers and greatly reduces the number of brave buyers who will dare to come knockin’! Looks count for everything! That’s why improving the looks automatically translates to a much higher value in the minds of most buyers.
Older Units – Functionally Obsolete
In my book Gold Mind Houses – I advised readers about the lack of vision most small-time investors have! They wish to buy properties at substantial discounts, but they’re unwilling to compromise when it comes to the reasons most sellers are willing to take a discount – namely, something is wrong with their property. It’s like everyone wants to go to heaven, but nobody wants to die! Friends – you gotta give something up to get what you want. That’s the real value of having a good solid plan already worked out in your mind before you act.
Functionally obsolete would be like a plow horse prancing around on the race track – no one has a great deal of interest! For investors without vision, outdated properties will often seem obsolete, undesirable and hardly worth owning. Who wants a rental property that’s not up to snuff? What value could it possibly have? Functionally obsolete in the rental business is mostly about what shows. It’s the fixtures, countertops and floor coverings. About the worst that might happen is having to replace the main electric service box and adding a few additional circuits to accommodate all the renters’ electrical gadgets. That should be done anyway for safety! Without adequate circuits, you’ll have extension cords running everywhere, which is the number one cause of most tenant fires. You mustn’t never forget, if you turn your renter into toast, you’ll have a hard time collecting your rents!
Here’s the bottom line gang! Landlords (owners) who don’t keep their properties up to speed functionally will find themselves renting for 15-20% below the prevailing market rents. Renting at 15% under market rents could be well over $100 per month for each unit! Let’s say you’re talking about six units in a $750 rental neighborhood, bringing them up to snuff can easily increase the property value by a factor of 15 or so! For example: $100 x 6 = $600 x 12 mo. = $7200 x 15 = $108,000 value. Mom and Pop operators should be able to accomplish the upgrade task for about 30% of the newly added value.
Dealing With Large Equities or Free and Clear
Free and clear properties are certainly best when it comes to buyers and sellers having the widest range of financing options. Many older properties, the kind I buy, are free of mortgage debt and the owners who have owned them long enough to pay them off are pretty “ring-wise” about the benefits of seller financing. They are also aware that bank mortgages for more than four units fall under commercial lending policies. What this basically means – there ain’t none! This is one of the major reasons for buying older properties with five or more units! The only financing available is seller financing – which of course, creates many other benefits and profit-making opportunities that are not available with institutional mortgages.
Properties that don’t have much equity generally offer fewer opportunities to be creative! For example; an income property with a large mortgage debt or combination of mortgages would automatically limit any discount I might be able to negotiate simply because of the high mortgage balance. Say for example, a property is listed for sale for $300,000, but has a mortgage balance owing of $275,000. Assuming the property value might even be somewhere near the asking price of $300,000 – yet, I’d like to make an offer for less! In this case, I’m actually “locked in” to an offer of $275,000 because that’s what the seller still owes. I’d like to offer $250,000, but my offer stands very little chance of success because the seller has very little equity. Let’s say instead – the seller’s mortgage debt was only $200,000, my $250,000 offer might work! As it is – for the seller to accept my $250,000 offer, he’d have to pay me $25,000 to sell me his property! Sellers rarely get drunk enough to go along with that!
Unoccupied Rental Properties – Beware
Be very careful when you don’t see anyone living at a property! There’s always a reason and it’s generally not some simple unexplained coincidence! It’s more likely the property has been “red tagged”; meaning it’s unlawful to enter or occupy! If the power or utilities have been shut off – there’s a very explainable reason. If you’re interested or just plain nosey, you can check with both the city building department and the local county authorities to find out the answer. Above all, don’t give the owner a $10,000 deposit like one of my former students did! Did he get his deposit back, you ask? I think you know the answer!
When utilities are turned off by the city of utility company, it means the building department has already been out there and determined the property is not safe – or, it’s a public nuisance. Generally, they’ve attempted to contact the owners unsuccessfully. Next, they will send out a certified letter describing what work must be done to make the property suitable for human occupancy again! They also specify that all work will require a valid building permit. Friends, bringing an old building – or multiple unit property up to current building standards is not economically feasible! Take my advice, forget about empty buildings! You’re far better off owning a property full of ugly tenants!
Always Consider The Isolation Factor
Adding value works best when your multiple unit property is isolated from other units! It’s for this reason that most of the properties I’ve owned over the years have been located in R-1 zoning (mixed in with single family houses). Tenants much prefer living in areas that are somewhat unique rather than living in a subdivision full of fourplex units that resemble a military training base. From an investor’s standpoint, owning one four or six unit building within a group of other “look alike” buildings can stymie financial growth or increasing the value! No matter how much you might improve your building; its value will always be directly tied to the other similar looking buildings around you! If your property is more or less “one of a kind” or unique in the area, your improvements and the related value increases will not be so influenced by comparing (comps) the other properties around you because there are none!
I’ve written a good deal about my “isolation factor” in books and in my other writings! It means when I’m looking to acquire a multiple unit property, I want the property to be as isolated or separated from the adjoining properties as much as possible. My two primary reasons for isolation are better control for me – and more privacy and separation from my customers (tenants).
The control issue is a very big one for me! When you own a building within a group of other buildings – say like a tract of fourplex units, all with different owners – it’s almost impossible to control the kind of tenants who will be your neighbors. For example; say you rent to young families with small children! Then right next door – the management company hired by out of town owners rents to gang bangers or lookalikes – your family tenants will likely pack up and leave! By the time you experience several turnovers a year; you’ll clearly understand what I’m telling you here. This all starts with property selection and it’s your responsibility – shop well for your customers.
The second issue somewhat overlaps the first! All renters want as much privacy as their rent dollars will buy them! I favor properties with natural barriers like rows of mature trees and shrubs down the property line or solid fences like chain link or six foot boards. The idea here is to discourage tenants from crossing over the boundary from neighboring properties easily! If the resident next door to my property wants to boogie on over to my tenant’s place to borrow a cup of sugar, I intend to make ‘em walk down the driveway and come in from the front.
A good solid fence or an evergreen hedge with sticky thorns is often all you need to stop trespassing neighbors. I’ve found that making it inconvenient for others to cross my property line makes my tenants feel a little more safe and secure. In downtown locations, often commercial buildings are located on each side of my older multi-unit properties providing excellent isolation for my tenants. A suggestion I make to every investor is to do what I do when I’m seriously considering acquiring a property! I stand back – usually across the street from the subject property and I ask myself this question. If I become owner of this property, what problems do I think I might encounter from the bordering property – or in this neighborhood? It’s well to have the answer before you buy – not afterwards!
Solving Financial Problems
Older multiple unit income properties often have several private notes or mortgages secured by the property. This happens when these older properties are sold multiple times. Typically, a small down payment is made with each subsequent sale, and each new owner provides seller carry back financing for the balance of his equity. I’ve owned properties with five separate mortgages!
When you discover a run down, poorly managed property that has multiple private mortgages with one or more in default, you might visit the owner who holds the mortgage in default – and ask if he’d be willing to sell his mortgage (note) cheap! If he’s in the 3rd or 4th position and has not received all his payments – selling his mortgage cheap might seem like the answer to all his prayers! After all, if the property is rundown and failing – he could soon lose everything! If you can acquire the mortgage cheap – you’re now in a position to demand payment of all monies delinquent – or ultimately foreclose and take over the property. I call this technique “ownership through the back door”. Works great when the opportunity presents itself!
Jay P. DeCima, aka Fixer Jay, lives in Northern California where he operates multiple rental properties. With nearly 50 years’ experience, he’s a street-wise landlord and best-selling real estate author. Jay’s recession-proof, adding value techniques are ideally suited for small-time, Mom & Pop investors seeking faster paydays and financial security. Jay’s self-help books have been voted #1 by both the Los Angeles Times and Chicago Sun during the past 12 years.