5 Things You Can’t Afford to Get Wrong When Analyzing Deals (Rookie Reply)

Ashley:
Investing out of state can be scary, but we will break down the steps to make your investment a confident one.

Tony:
We’ll also cover what exactly you need to account for when analyzing a deal, along with determining the best partnership for you.

Ashley:
Okay, so we got our first question on rookie reply today. This question is, when looking at the closing disclosure and you see that rent will only cover the taxes and mortgage, if the property management fee is waived for a year, is that worth it? That would mean that the next year after the property management fee is not waived, then you’re only getting about $50 in cashflow. Would that be worth it in a not so appreciating market? So here’s some things to consider for this question. The person row, absolutely nothing else is factored in such as Cap X improvements like roofs, HVACs, usually we like to save a percentage of that, so that’s great that they called that out. They also noted this is for a turnkey provider who is providing the property management who is saying they will waive one entire year for the rental, which could be increased by only a certain amount due upon the next lease renewal. This is also a single family home in the Midwest. The rent cannot be increased right away, so I would only receive $50 cashflow after the insurance taxes a mortgage. This would not include any maintenance. Pretty much the only reason why would be anything more than $50 is because the property management fee is waived, but that’s only within the first year. Okay, so to kind of sum up this question is, is it worth it? Should they purchase this property? Tony, should we start out with kind of explaining what a turnkey provider is?

Tony:
Yeah, it’s a great call. So turnkey providers, and I believe we recently did a reply specifically about turnkey, but turnkey providers are companies who go out there, they find distressed assets, they fix them up, they place sentence inside of them, and then they sell those fully leased up units to other investors. Those are called turnkey providers because basically on day one it’s turnkey. You don’t have to do anything to it, any work, and you can really just kind of get started cash flowing on day one, hopefully. So that’s what a turnkey is. But sometimes the downside with turnkey, which is what I think we’re seeing in this situation is that your cashflow, depending on the property, depending on the market, depending on the provider, can get a little squeezed, which is 50 bucks is I think is what we’re seeing here.

Ashley:
So the next kind of question here is, well, I guess we should kind of go over expenses. What other expenses should be considered? So they mentioned that any kind of savings for CapEx, such as roofs, avac, HVACs, anything like that is not included in their numbers. So for me, a general rule of thumb is how old the property is, or if it’s been recently remodeled, saving a certain percentage. So if I’m buying a home that was built in the early 19 hundreds, hasn’t had a lot of updates or remodeling, I’m saving at least 10% to cover those improvements on the property. If it was completely remodeled, I’m may be saving 5%. Some situations, like if I did the remodel and I updated a lot, then maybe it’s only going to be knocked down to 3% of whatever the rental income is each month. But you want to factor these things in along with the maintenance.
He had mentioned any maintenance cost would basically take away that $50 of cash flow. And if you have ever had a handyman or a service tech come out, usually just for them to come out to your property is more than $50. So yeah, the maintenance, maintaining the property, so this is a single family home, so most often you’re going to have the tenant take care of the lawn care, the snowplowing, things like that. But there could be pest removal that you may have to cover or pay for depending on what the lease agreement says too. Tony, is there any other expenses that you would add? I think the last thing I can think of is bookkeeping expenses. Unless your property management company is taking into account those expenses.

Tony:
Yeah, I feel like you kind of hit ’em all right. At a business level, I think you’re right, bookkeeping tax preparation and tax filing tax strategy, if you have an LLC, any fees associated with that. So there’s always going to be some additional cost. So I mean is $50 in cashflow a lot? Obviously not. I don’t think anyone’s going to retire or get super excited off of $50, but I think the one thing we don’t have from the person answering or asking this question is why are they doing this? They’re in the Midwest. So my assumption here is that they’re not hyper-focused on appreciation. Typically in most Midwestern states, those aren’t the states that are known for appreciating. They’re typically known for better cashflow. So if you’re going into the Midwest with the focus of getting cashflow, but yet you’re only getting $50, I can’t imagine what your investment into this property is, but it would has to be a pretty small investment for that 50 bucks per month to be any sort of reasonable return on your investment.
So just from that information, that doesn’t seem like a deal to me. And the other thing too actually that I’m curious about is for the PM two waive their property management fee in the first year, obviously it’s the turnkey provider, so they’re getting money upfront just from the sale of the property to this investor. So I get that piece, but I also wonder is there any sort of long-term contract that this investor is signing up for? Because I would assume that most pns probably aren’t just going to manage for free without any sort of security that they’ll have that second year, that third year potentially. So I would think I would really just review that to make sure, because what happens if you get into year two and that first year was kind of shaky and you’re like, man, I really did not like working with these guys, but now you’re locked in for another two or three or five years. So just a couple of things that are running through my mind as I hear this question.

Ashley:
Yeah, I definitely agree. I don’t think this sounds like a great deal, especially if you’re not getting appreciation. Maybe you need this property for the tax advantages and that’s all you care about is you want to be able to write it off, then maybe it could work for you. But I think if you’re not getting cashflow or you’re not getting appreciation, but definitely do your research on that and see if there is an appreciation play. Also, when can the rents be increased on the property or is there any kind of value add that you could do? For example, turning the dining room into another bedroom to actually increase the revenue that way? Could you rent out the garage for storage? So see if there’s any other revenue potentials, but I would say this probably isn’t an investment that I would want to do. One thing to keep in mind, if this is the only way that you can get started is by going through turnkey provider, I would go and talk to other turnkey providers and compare what their closing disclosures look like, compare what are the costs that are associated with using them, what are they charging, things like that.
So you can compare the different turnkey providers to, okay, we have to take our first ad break, but we will be back shortly.

Tony:
All right guys, welcome back. We are here with our next question in today’s rookie reply. So this question says, BP community, I’m entering the real estate investing world through partnerships. Ding, ding, ding. Alright, Ashley and I love talking about partnerships. Myself and my buddy, we’ve been friends for more than 15 years and we decided to get into real estate through a multifamily house hack. We plan on pooling our money for a down payment and closing costs. If one of us can qualify for the loan amount, then we’ll choose to only have one person apply for the mortgage. So the first question is, how does the other claim ownership on the property? My understanding is that this can be done by keeping the property in an LLC and being 50 50 partners in the LLC. Are there any other ways to claim ownership without the LLC?
What is a better way to go about this? Question number two, if we plan to buy a second property one or two years down the road, how would lenders approach the underwriting? And then question number three, do we need to watch out for any pitfalls in the future for scaling our portfolio together or separately? Lots of good questions here Before I think me and Ashley jump in. We got to give a nice plug here for our book on real estate partnerships. So for those that don’t know, Ash and I co-authored a book with BiggerPockets called Real Estate Partnerships, and you can head over to biggerpockets.com/partnerships to pick up a copy of that book. So Ashley, let’s hit the first question here, or first part of this question. If one person is on the mortgage, how the other person actually show ownership of the property?

Ashley:
So for this, I think there’s different ways that you can do it. We can kind of go into that as to how to structure is it should be in your personal name, should be in an LLC joint venture. But the way that you own the property is if you are on the deed. So you could not be on the mortgage, but you could still be on the deed. So whether you have ownership of an LLC or you have a joint venture agreement, or it’s your personal name, you need to have your name on the deed or that joint venture agreement saying that you are own part of the joint venture that owns the house. Okay, so that is how you claim ownership is having a right to the deed of the property, making sure that you’re on the deed. In this situation, this property is a house hack that they are doing together.
There’s one thing you should be cautious of. When my sister was doing her house hack, I couldn’t give her money for the down payment and say that she had to pay me back. You have to use your own funds or it has to be a gift from somebody and it has to be a family member usually. So just because you’ve been friends for 15 years, I’m not sure a standard FHA loan or conventional loan would allow if this is your primary residence for the funds to be provided by somebody else to actually close on the property, they’ll want to verify. Tony, do you know if that’s true for conventional or is that just an FHA rule that you have to use your own funds for a down payment or a gift from a family member?

Tony:
And guys, when we say conventional, we just mean anything that’s backed by Fannie and Freddie, right? The big, they’re not technically government entities, but the people that insure a lot of these mortgages that are going out to the general public. I think one of the things you made a phenomenal point ash about the mortgage and the deed being different, just one thing because they also said that, should we put this in an LLC? Just word of caution, or maybe not word of caution, but just something to think about. Typically when you’re doing a house act, the reason that people like to house act is because of the type of debt that you get access to. And Ashley just talked about that I like using an FHA, but with those types of debt, typically it’s got to be in your personal name. So even if you guys created this LLC, you can still a lot of times run the income and the expenses through that entity. But the actual deed would show Ashley and Tony, right title would be us jointly on that deed together. So I don’t know if the ownership in the LLC is necessarily going to impact the ownership claim on this property.

Ashley:
And I guess really you have to figure out how you want to finance the property because that’s going to really play into what you’re actually able to do. So if you’re both doing the house hack, if you both want this to be your primary residence, which I don’t remember, does it say they’re both to live in there?

Tony:
I believe so. It seems that way.

Ashley:
Yeah. So if you’re both living there, then I don’t see a problem with you both splitting the down payment, you both going onto the deed, you both being, you can have one person on the mortgage. So even with my sister’s house hack, I’m on the deed, but I’m not on the mortgage and I gifted her the down payment fund. So you can definitely do it where you’re on the deed and you’re not on the mortgage with one of you if one person qualifies. And I really like that strategy that you’re going to try and do it that way. Just make sure you have some kind of agreement where it states that you both are responsible for the mortgage because whether it’s you or the other person that’s putting the debt in their name, ultimately if someone doesn’t pay you, say the mortgage is in your name and your friend or whatever stops paying, it’s going to be you personally that the mortgage is going to go after and say they foreclose on the house. You’re both losing out on the house, but it’s going to affect your credit score and hurt your credit if mortgage payments are missed. So make sure you have some kind of protection or security against that too, or you really, really trust the person.

Tony:
And I think that kind of ties in nicely to the second part of this question. So it’s like if we plan to buy a second property one or two years down the road, how would lenders approach the underwriting? So like Ashley mentioned, if one person is on the mortgage, both of you’re on the deed, one person’s on the mortgage, both of you’re on the deed. When you go to get that next property, even though both of you’re on the deed, only the person who’s on the mortgage only their debt to income will be impacted by this first house S act. So if Ashley and Tony buy a duplex together, but it’s just Ashley who’s on the mortgage, we’re both on the deed. When we go to buy that second property, my DTI is going to show zero in terms of mortgages and Ashley will show the house act that we have together.
Now, say both of you go on the mortgage together because maybe you can’t qualify by yourselves when you go to buy that next property, since both of you’re on the mortgage, and actually check me if I’m wrong here, but since both of you’re on the mortgage, underwriting doesn’t split that in half. If the mortgage is 2000 bucks, it doesn’t say, okay, Ashley’s liable for a thousand bucks per month and Tony’s liable for a thousand bucks per month. It says Tony’s liable for 2000 bucks per month and Ashley’s liable for 2000 bucks per month, even though both of you are sharing that cost. And the reason why is because the lender who’s doing the underwriting, they’re like, well, we don’t know who this other person is, right? Even though both of you guys technically apply together, they’re like, we don’t know who this other person is. You are always responsible at the end of the day for making sure that mortgage payment is made. So that’s why it is very, it’s helpful if you guys can get approved individually, otherwise you’ll both get double dinged for those mortgages.

Ashley:
Yeah, that’s 100, correct. So it kind of stinks because now that’s being accounted against both of you. So if you do go and get another property, they’re looking at it as you both are responsible for $2,000 each instead of a thousand and a thousand. So it can affect your debt to income on the property. And then the last question here is do we need to watch for any pitfalls in future for scaling our portfolio together or separately? So the thing that I would want to have in place is some kind of operating agreement or joint venture agreement. Even if you are doing this in your personal name, have some kind of agreement in place where you are writing out what happens in the future. And Tony, I always use what you have done as an example, as in when you take on a partner, you put in there a five year exit plan. So do you want to explain to everyone what that is and how this person should use this to protect themselves from many falling outs or pitfalls?

Tony:
Yeah, the five year exit plan I think is one of the smartest things we’ve done in our real estate business in terms of partnering with other investors. Again, part of the way that we built our portfolio was finding really good deals and then soliciting those deals to folks that we felt might be good partners for us. And a lot of these people we’d never met before, these are people who we would meet in different places through different means. So even though we had a good initial conversation, who knows if down the road we would enjoy continuing to work together? So that was the genesis of the partnership kind of five-year clause. So basically what it states is that at the end of the fifth year of the partnership, the default option, the kind of default action that needs to be taken is that we sell the property. The only way that the cell is avoided is if both parties, both partners agree to extend for another year and then 12 months later the same thing happens. So every year, thereafterwards, we have another opportunity to reevaluate that partnership to see if it makes sense to move forward. We actually haven’t needed to leverage that at all yet. Most of our partners that we have are actually pretty solid people. But it is good to have just in case things do go south, there’s an easy exit for both of you.

Ashley:
Rookies, we want to thank you so much for being here and we are so close to hitting 100,000 subscribers on YouTube. We would love it if you aren’t subscribed already, if you would head over and find Real Estate Ricky on YouTube and follow us. We have to take one final ad break and we’ll be back after this. Alright, let’s jump back in. Okay, today’s last question is, Hey all I am just getting started and in my first deal I offered more than what the property appraised for. What should I be looking at when trying to consider an appropriate offer, especially if I can’t see the property since I’m investing out of state? Okay, making an offer. How do you figure out what the property is worth and then to find that disappointment of the property not appraising. So let’s kind of work through this process here.
You put an offer on a property, the offer is accepted. Usually there will be a contingency if you’re using financing that you can back out of the contract if the bank will not lend you the amount that you stated you’re borrowing. So if you put in your contract, you’re borrowing, you’re doing 80% conventional financing with the bank. If the bank says we’re only going to lend you 70%, that can be sometimes a way to get out of your contract and the contract falls apart. There’s also a spot too that your agent could fill an interest rate. So if the interest rate, if you put has to be below 6%, obviously it has to be something reasonable or else the seller is probably not going to sign it. But if all of a sudden overnight interest rates jump to 10%, you could say, look, the bank can no longer give me that rate.
I am going to get out of the deal. So this can also go for what the property appraises for. So the bank goes and does an appraisal on the property to see its value, and then it says, okay, it appraised for a hundred thousand dollars. We are doing a conventional loan of 80%, so we will lend you 80,000. Well, if the bank says, you know what? It only appraised for 90,000, so we can’t give you that 80,000, that’s when you have to make the decision, are you going to come up with the rest of the money? So make a bigger down payment on the property? Are you going to try to renegotiate with the sellers of the property or are you going to back out of the deal? So it looks like in this situation, they must have backed out of the deal because they’re wondering what to do going forward to actually figure out what an actual appropriate offer is. So Tony, the first thing that I would’ve done in this situation is dispute the appraisal. At least attempt to do that, dispute the appraisal, try to renegotiate with the sellers.

Tony:
Yeah, I agree with you 100%. And I think both of us have had experiences where appraisals came in lower than what we had anticipated. And yeah, if you believe that the appraisal was wrong, then yeah, it is very reasonable to go out and say like, Hey, here are some comps, some comparable sales that I found that I feel are better matched than the comparable sales that the arai found. Because sometimes you guys, appraisers are coming from, maybe they don’t know the area as well, right? Maybe they’re coming from somewhere a little bit further out. They just put this appraisal, they were still on work, whatever it may be, but they don’t know that area incredibly well. And sometimes you might know that area better than the appraiser does. So if you can point out, hey, you picked a comp that was three miles away that sold for less, but here’s one that sold more recently, that’s two miles away.
Now you’ve got some ammo to maybe to really contest that appraisal. And one other thing say that the appraiser says, Nope, my appraisal is perfect. Nothing here needs to change another route. You can always go down, and this is obviously a little bit more of a nuclear option, but if you change lenders, and I don’t know if this is law or maybe just best practice, but lenders can’t use the appraiser appraisal from a different lending institution. So if you change lenders immediately, there has to be another appraisal that gets ordered. Now if you’re working with the seller, typically sellers don’t want to push back closing, but if it’s, Hey, either we’re going to close a little bit later or we’re not going to close because the appraisal, they might be a little bit more willing to working with the different lender. So just another way to put some more pressure on the appraising process to make sure it gets done the right way.
Ashley, I think one other thing that you mentioned as well that’s super important is that sometimes a low appraisal can work in your favor. You just have to have the confidence to be able to leverage that as a bargaining chip with the seller because it sounds like maybe you did run your numbers and maybe it did make sense at the purchase price, so it was a good deal. So that doesn’t necessarily mean the value isn’t there, but if you ran the numbers, you liked the deal, everyone agreed, then maybe it is a good deal. But maybe it’s just the fact that the appraisal didn’t come back where you wanted it to. So I would go to the seller and say, look, Mr. And Mrs. Seller, I’m very motivated to buy your home. I love it, the numbers work. However, if I ran into this issue with my appraisal, chances are the next buyer is also going to run into this issue with their appraisal.
So what is in your best interest? Is it giving me the 10, 20, $30,000 discount on the purchase price so we can still close next week? Or do you want to go through the process again of taking the listing down, relisting it, having another buyer who can hopefully get the right appraisal? Maybe they do, maybe they don’t. And you’re in this exact same position, another 60 or 90 days from now. And a lot of times you can get sellers who, if they’re motivated enough, maybe they will come down and meet you at the price that you needed, or at least maybe give you, Hey, let’s meet in the middle. But I think you’ve got to be confident enough to ask that question. If you’ve got a good agent, I think they should be able to negotiate that conversation for you as well.

Ashley:
Yeah, and that kind of leads into the next thing I wanted to bring up is building a team. It mentioned this person is investing out of state, so they can’t actually go and see the property, whether it’s an agent or you need some kind of boots on the ground person that will actually go into the property and be your eyes, but also take a million pictures of the property, take video of the property. We’ve had Nate Robbins on before on the podcast, when he goes to a property, he takes the pictures like you’re walking through the house basically as he takes a step, he’s taking a picture and turns around, each room takes a picture of the doorframe, so you’re entering a different room and then all of that is collected and it’s sent to his partner and then his partner builds out the scope of work in the rehab from just the picture.
So it definitely can be done, but just kind of getting an idea of this is what we should offer on the property based on what you’re seeing. And he always likes to do photos because it’s easier to zoom in on things than it is on video. But they like to have the video too, to kind of get the flow of the house as you go through it. And they do that for the interior and the exterior of the property too. So whether that’s a property manager that you find in the area that you say, Hey, I want to find a property, I want to do this through you guys. Do you have someone on your team that could walk properties for me? Maybe you do it for free wanting your business, or maybe they’ll charge a flat fee, which is definitely worth it to have the boots on the ground.
You could go to the BiggerPockets forums, you could post hate anyone in this area. And it’s not like you really have to, I guess, say trust the person. It’s not like they’re entering into your property, they’re going with your agent or they’re going along and seeing these properties looking and taking pictures and giving you their feedback. And if it’s not super detailed, then hey, you can find someone else to do it too. But I think there’s a lot of people eager to learn who would love to just go and walk houses and work with another investor to see what they’re looking for, things like that. I guess, Tony, the last thing piece I would add to this is what is the cost of a plane ticket to go and see this property? Sometimes paying 200 bucks for a round trip, airfare could be worth it to go and set up a whole bunch of properties, showings in one day or one weekend or something to fly out there and to actually look at them.

Tony:
I couldn’t agree more. Right, and obviously there’s value in long distance investing and building that team, but if it makes sense, I think there’s always value in kind of getting eyes on it yourself as well. But I guess just one last thought for me as well actually, because the question says, what should I be looking at when trying to consider an appropriate offer? You can get a good guess of what you think the property will appraise for as you can go through the process of finding comparable sales yourself, but appraising a property is part art, part sign, so it’s virtually impossible to know down to the dollar what the appraisal will come back at. So as long as you, the investor, the buyer, do your due diligence upfront, you’re using tools like the BiggerPockets calculators, you’re getting quotes from insurance agents to make sure you know what your insurance is, you’re shopping around to get the best debt that you can. As long as you’re controlling all of those things, then I feel like you are following the right process to make an appropriate offer. But don’t feel like you did something wrong simply because the appraisal didn’t come back where you wanted it to. So just a bit of a mindset shift for the rookies that are maybe experiencing a similar issue.

Ashley:
And if you want help analyzing your deal better go to the BiggerPockets calculators because they show you exactly every single expense that you should need. So if you do think it is a deal analysis thing and not actually an appraisal thing, that’s just another resource that you can kind of go, because the numbers don’t lie. As long as you’re verifying what the numbers are, go by that, and that’s what you should be making your offer on, not what you expect the property to appraise for, unless you want to go and you want to add value and then you want to flip it or you want to refinance it. But just if you’re purchasing that property, like Tony said, the appraisal could not be correct and an appraisal, it’s an art form. You could have three different appraisers go to the property and each give you different numbers on it.

Tony:
Three different, yeah.

Ashley:
Okay. Well, we have a special announcement. We have a rookie newsletter that is being sent out every single week. Tony and I writing it ourselves, and we’re trying to give you guys so much value, some reading material and some fun things to learn about real estate investing and what’s going on in the news so you guys can stay up to date as real estate investors in today’s markets. You can head over to biggerpockets.com, hit the get started tab and you’ll see newsletters and it’s got a little new shiny button next to it, hit on newsletters, and you can subscribe right there to the Rookie Newsletter. We can’t wait to hear you guys feedback. Also, if you want to respond to that email, it gets sent right back to Tony and I. So any questions or any feedback you have on the newsletter or things you would love for us to write about, please let us know. Well, thank you so much for joining us on this week’s Rookie reply. If you have questions, head over to the BiggerPockets forums, submit your question there. I’m Ashley. And he’s Tony. And we’ll see you guys on the next Real Estate Rookie podcast.