If you stay in real estate long enough, you will likely be sued. It happens when you or your property managers dealing with so many people over any amount of time. The best thing to do is prepare for the worse through proper planning and organization of the property.
Unfortunately, dealing with legal issues is a part of the job when it comes to real estate. Just about every property manager or landlord out there has come across some legal issue and they can attest to this. For the most part, tenants are good, honest people that want to live their lives. And if they have a legitimate issue, it’s our responsibility as landlords to provide quality places for our tenants to live. However, there are some nightmare tenants. Fortunately, there are things you can do to protect yourself from unscrupulous and problem tenants. Here are the 4 things you can do to reduce the threat of suits and insulate your personal assets:
Proper Tenant Screening This is where it all begins. When it comes to avoiding lawsuits, the best thing to do is to start with the previous landlords. Call all the numbers they provided on the tenant application and speak to the tenants work ethic, character and cleanliness. Ask about unapproved subletters and pets. You want to create a demographic picture of the person to and determine if it is congruent to the person filling out the application.
Problem tenants may even have their friends pose as landlords. You may also want to verify you are speaking to the landlord by asking them questions about the property and what other properties they own. Looking them up on social media to see what groups they belong to and verify the landlord is real. All this is above your background check, where you can sometimes see past evictions, criminal convictions and other legal incidents. Finally, either you or someone from your management company, have a face-to-face discussion with the prospective tenant as this can foreshadow problems. Specifically, listen to what they complain about as they will likely have similar complaints about you down the road.
Video Record the Units & Audio Record Your Discussions One of the most frustrating things to deal with is a tenant that makes a false claim of something you said or something you didn’t say. Keep in mind that for many of the tenants you don’t want, they will say just about anything. To avoid this, make sure you record every phone call, keep every email, and scan every document. There are free mobile apps available that allow you to record automatically. If you are in an office, most phone systems will handle call recording. Certain states require you provide notice and obtain consent before recording. If you are on an office phone system, the notification may be enough, but you should talk to your attorney before recording your calls. And never make a verbal commitment to anything. At a minimum, get text message communication and make certain your messages are backed up to the cloud.
Additionally, make sure you video and take plenty of pictures of the unit before handing it over to the tenant. Even go so far as printing the photos and attach them to the lease. This will prevent the tenant from saying the the carpets were stained when they received the keys.
Always have a complete record of all communications and the chances of landing in court for frivolous reasons will disappear.
Have a Detailed and Straightforward Lease Always get a lease and walk through it with the tenant. Get a signature on it along with an initial on every page. NEVER take a tenant on with just a handshake and a key! The last thing you want to do is go to court for a non-paying tenant and not have an executed lease in your hands. If you are in a courtroom that is tenant-friendly, you will lose your case to a frivolous claim. A comprehensive, ironclad lease is your best bet to protecting yourself and your cashflow. The more you have in writing, the less opportunity there is for the tenant to wiggle their way out of what was promised. And the lesser the chance you will land in court and have them win.
Have a Great Attorney on Speed Dial The right attorney on your team goes a long way to keeping you out of court. The money spend on creating a bulletproof lease, putting the property in an LLC and protecting your assets will go a long way. This is the one thing you do not want to skimp on as the time wasted protecting yourself from a frivolous lawsuit. A good attorney that specializes in landlord-tenant law is important. If you have a lot going on, form a relationship with a good attorney and talk to them often about what is going on in the city or if there are any new statutes that can impact you as a landlord. (Maybe even take them out to lunch and pick their brain.) You can use this info in your underwriting as well.
Most tenants are good people and many landlords want to provide good housing. However, you can’t completely protect yourself from lawsuits as there are professional criminals, “victim tenants” and people that misunderstand their responsibilities as a tenant. These are the ones that will try to come after you as their mentality is “because they are a landlord, they have money”. These are the people you need to guard against. Your diligence, consistency and thoroughness will save you time and money – and your sanity.
What do you guys think? How do you keep yourself out of the courtroom? Leave a comment and let me know.
As you go through the acquisition process, you will surely encounter the need for insurance on the property. I can tell you that not all policies are created equal. If you sign up for the wrong policy and you experience a problem, it could become a major problem for you and your investors.
As real estate investors, our main objective is to maximize cashflow possible. Since cashlow is a function of expenses and income, we focus on decreasing expense and increasing income as best we can. There are expenses that are out of our hands or are obligated to, such as taxes and our mortgage, but with insurance, we may have some flexibility depending on what and where we are buying.
On just about every deal I have done so far, I’ve been able to get some savings on my insurance coverage. This was because I ran the property through two or three different insurance brokers. Of course, I always did an apples-to-apples comparison between the brokers. However, it’s important to note that price is only one lever. I compare them because there are differences in the policies and you need to get the right coverage for the price as not all policies are created equally.
For example, I received 2 proposals from 2 brokers. I’ve worked with each of them before and they were always very competitive. However, Stephanie’s quote was 55% more than John’s! From there, I performed a comparison between the two policies to spot the difference. On the surface, they may look similar. A closer look will tell you that John quoted a basic form policy and Stephanie quoted a special form policy. As you can expect, a basic form policy is typically 35% less than a special form policy. So, the next thing to consider is what does each policy have, and do we need those features.
A special form insurance policy offers the greatest protection. Unless there are specific exclusions that are listed on your policy, you are covered is if you experience a loss. Typically, it will cover any type of sudden and accidental loss unless it is specifically excluded, such as sewer and drain, earthquakes and equipment breakdown, mold, or intentional tenant damage. So, if 3 of your HVAC units were stolen, they would be covered.
On the other hand, a basic form policy will cover the minimum of the property. Things like wind, hail, explosion, fire, lightning, damage by aircraft or vehicles, riot, vandalism, sprinkler leakage, and volcanic action. If someone walked away with those HVAC units I just mentioned, you would have to handle it on your own.
With that said, deciding between both policies, theft is the major driver. You need to consider what is the probability for theft at the property. The same way you perform your own crime check during due diligence, the insurance company does the same thing. They score the property and they compare it against other properties in the area and against the national average. They also look at other demographic information such as income, vacancy rate, occupancy, and income. If the location is solid and the chances of theft are slim, basic form insurance may be fine. Such a property will have low vacancy, good rent, and probably even owner-occupied. But, if the property is in an area that has a lot of theft and other crime activity, would be better served with a special form policy – this is if the insurance company even wants to cover the property.
It’s really all about risk and what you are comfortable with doing. Like I said earlier, not all insurance policies are created equal. Some offer full replacement value of the property, loss of rents, and equipment coverage. All these things will impact the cost of insurance. Spend the time to learn and understand in depth what you are getting. I would say that if you do not know what is in your insurance policy today, give your agent a call and ask them. From there, call another agent as ask them what they would insure the property for. Further, if you made improvements, such as cameras, upgrades to the electrical system to get rid of the old fuse panels, or the city improved the property, you will want to have your property re-quoted.
So, what do you guys think? Have you experienced a scenario where having better insurance saved you? Please let me know in the comments. If you are you an agent, leave your contact info so others can reach out.
If you don’t want to lose your mind during tax season or get nailed by Uncle Sam when you sell your property, you need to hire an excellent bookkeeper and CPA.
When you are looking for a CPA, you are trying to find someone that has experience working with real estate investors and syndicators. You want to know if they are already working with investors today. They need to able to not only grasp how to handle the basics of income and expenses as it relates to multifamily, but also be very well versed with all the tax advantages and specialized investor reporting.
If they know about syndication but don’t work with syndicators today, it doesn’t necessarily mean that you can’t work with them. Regardless, working with a CPA that works with syndicators already will be less expensive to start as they do not need to run up the hours – and you are paying for! They need to understand how to implement the various tax deductions and understand the syndication business model to be most effective.
Now, if they do not work with syndicators today and they are not familiar with apartment syndication – and you really want to work with them – schedule a call with them. Aside from assessing their ability to grasp the concepts, you will want to ask them how their fees are structured, are there fees if you need them to review financials for upcoming deals, what they charge to prepare a tax return and their bookkeeping fees. If you have outside investors, you will also want to know the cost to prepare quarterly and annual reports.
Once you get the fees down, you will want to know who you will be dealing with at the firm. If they want to charge you top dollar, you should expect to be advised by a partner or a mid-level CPA.
If you want to take an aggressive stand on your taxes, a conservative CPA would not be a good fit. You rely on the CPA to prepare your return. You want them to apply every loophole and tax strategy available – legally and ethically of course. In some cases, you may want them to push the limits on your tax returns. The CPA should also be able to handle the IRS and any audits that may come up.
You will also want to look at the tech ability. Do they have a portal that you can access for your reports? Do they offer a portal to your investors? Do they take security seriously?
When it comes to tax planning and strategy, you want the CPA to be proactive and establish a regular meeting to discuss how the property is performing and what you can do to protect your income from the federal and state taxes.
Take the time to set the expectations for your needs. If you were not happy with your previous CPA, let the future CPA know what went wrong. If they had a communication issue or were not proactive with their tax planning strategy, point it out.
As I pointed out earlier, you want to determine if the CPA is aligned with your goals, interests and future before signing them onto your team.
Finally, as you continue building your multifamily business, you want a team that can scale. This includes your CPA. If you choose a beginner that has never handled a syndication to be your CPA and your plan is to buy properties every quarter, you may experience issues. You need someone that can grow with you. Make sure your interview questions are deep and you are comfortable with their ability to deliver.
Let me know what you think. What questions did you ask your CPA? Leave them in the comments.
In the world of multifamily real estate, people starting out focus on locating a deal or even raising money. These things are important, but one important item is often overlooked: the financing.
The wrong financing can kill a deal – or it can make it. To me, it is just as important as raising the equity to get the deal closed.
Commercial loans are very different from residential loans, that are for four units or less. Unlike residential loans, commercial loans have many different programs and options. On the residential side, you are looking at rate and term. While both are important, these are the two most familiar with people not active in the real estate space. However, when you are dealing with a specifically a commercial multi-million-dollar loan, there are many ways financing a deal that will impact cashflow.
Understanding the different parts of a loan program and how they can affect your returns is important. So, here are my 5 parts you need to know to maximize your returns.
1) Interest Rate: The Interest Rate is the amount charged by the lender, expressed as a percentage of principal, to the borrower. Interest rates are typically charged on an annual basis.
2) Loan-to-Value: The Loan-to-Value ratio (LTV) is the amount of the loan compared to the value of the property. This ratio is calculated by the lender prior to providing the loan. If the property is valued at $1,000,000, and the bank will give you $750,000, you have an LTV of 75%. This percentage will be dependent on the strength of the property and the strength of the borrower. Typically, banks will have an LTV of between 65% & 80%.
These two, the interest rate and loan-to-value, are the parts most people focus on. It gives you an idea of what the cost of borrowing the money will be, how much they will lend to you and how much you will need to bring to the table. However, the other parts are also important, so let’s continue.
3) Terms: The Terms of a loan can sometimes be flexible depending on the loan product. The term is the period until the loan becomes due and payable. A typical loan will have a 5-year term and a 25-year amortization. Your payment will contain a portion of principal plus interest over the 5 years and the payment amount would be on a 25-year schedule. Longer amortization periods typically mean smaller monthly payments.
The loan terms you will want is dependent on your business plan. If you plan on a holding a deal long-term, it will make sense to get a low rate with a 25 or even a 30-year amortization. If your business plan calls for you to add value to a property and refinance after a short period of time, a 24-month, interest-only bridge loan may be the best option for you. After you add value, you can refinance to get into some long-term debt.
3) Nonrecourse or Recourse: When it comes to residential loans, banks want someone they can go after if the loan is not paid. They want that person buying the home to personally guarantee some or all or the loan. When it comes to commercial loans, it is different. Depending on the terms of the deal, you may either have a nonrecourse or a recourse loan. If you have a nonrecourse loan and the deal goes bad, the most the lender could do is come after the property, so you would lose all your equity. Additionally, you are personally protected if you didn’t neglect the property or commit fraud against the lender.
There are many options for multifamily buyers that do not have recourse. If you keep the LTV between 65% to 75% and the loan is large enough, you can stay nonrecourse.
In either case, if your deal does go bad, the chances of you getting another loan and raising the capital needed to take the deal down are drastically reduced. It is important that you make solid, good deals and work deals that make sense. Don’t overpay for deals because you think the financing is cheap and the money is available.
5) Prepayment Penalty: As the name implies, if you want to pay the loan off before the set term, usually the case if you want to refi, the lender will charge you a fee. This is typically a step-down percentage depending on the term, but it can vary. For example, if you have a three-year term, you would be charged 3% in Year 1, 2% in Year 2 and 1% in Year 3. Again, if your plan is to reposition the property after 24 months and you are getting a 3-year term, having a prepayment penalty is probably not a good idea. If you tell the lender upfront of the business plan, they should be able to come up with a solution.
So that’s it. As I touched on in the final section, you need to align the goal of the project with the right financing. If the goal is to hold the property long term, then don’t get a 3 Year loan with two extensions. If your goal is to buy and reposition after 18 months, don’t get into a long-term product with a prepayment penalty. Every deal must be approached differently and the goals of your investors, your strategy and the lender must line up for the deal to be a success.
What do you think? Do you have any additional considerations? Leave a comment and let me know.
There are many opportunities for multifamily investing in secondary and tertiary markets. If you have good, strong underwriting, these markets can yield some significant benefits, but to realize the returns, you really need to assess these opportunities differently from a primary market deal.
So, here my 5 best practices for investing in secondary and tertiary markets:
1) Meeting Supply where there is Demand: In any market, you can’t ignore the fundamentals, like jobs and migration. However, the lack of multifamily housing supply in secondary and tertiary markets is not usually covered in the press. These markets attract fewer developers than the primary markets even if the fundamentals are there, such as the addition of a regional medical center or expansion of a university. It’s developments like this that can create a stable rental market.
But, getting into a market where you can pick up a B or C class value-add property to support the influx of new renters can create an opportunity for investors. It’s also worth noting that there may be a case where the local government makes it expensive to build and keeps developers out making those B’s and C’s that much more in demand.
2) Stay Close to the Property: Having “boots on the ground” at the property is a key factor. In the last recession, many out-of-town owners did not understand the market they were invested in when the market got soft. Some owners rarely visited the area and the property, so they were not in a position to address the challenges. This problem is magnified in secondary and tertiary markets.
With that said, if your plan is to buy in these markets, Driving or flying to the property on a regular basis is paramount. Doing so allows you to also meet with other local sellers and investors that like the area and gets you intertwined with the market. You will be up-to-date with what other sellers are unloading their properties at and if it’s time for you to so do. Trying to do all this remotely is difficult.
3) Don’t underestimate home-court advantage: Often, the active investor in the target area is connected to other owners, has a deep understanding of the vendors, and works closely with them. This investor knows the local politicians and attends the meetings at the country clubs with their PTA peers. While an outsider from a large city and with loads of money may be sophisticated in their underwriting and even in handling a large deal, people typically like to deal with others that are like them – or at least they are familiar with them. Staying in tune with the local market and visiting the places these investors attend will help offset the home-court advantage.
4) Unconventional ways of learning the market: When you are walking a tertiary market, getting a view from Main Street can be a telling sign of where that town is going. It’s better to see with your own eyes what is going on that to pull data from a spreadsheet from 4 states away. You will want to get in front of people to see what they think about the area and about any rumblings of new business moving to the city. A bartender at a local hot-spot may provide info on the scene and they are usually in tune with the lifestyle drivers of the city.
5) Look at the suburbs: Many local jobs have migrated to the suburbs, fueling renter demand. Typically, there is not much in the way of mass transit and can be a consideration for your target tenant – especially if it is a lower-income one. Make certain to consider jobs and proximity to bus/train lines but be wary of walkability factors until you experience the actual walkability by walking the property.
There are many renters that live in secondary and tertiary markets by choice. Treat them well and they will stick around for a long time.
What are some other best practices you employ when considering a secondary or tertiary target market? Leave them in the comments below.