What’s a new landlord to do?

I got an email the other day from someone I’m helping buy an apartment building. We’re at the stage in the process where we’ve gone from the theoretical work of modeling out different acquisition opportunities to the practical work of getting her in a position to start actually leasing out units.

Reality has set in: In a few days she’s (hopefully) going to be the proud owner of an empty building and needing to find, vet and sign up tenants to pay her mortgage. This can be a pretty daunting moment for a new landlord.

Fortunately, in Los Angeles, there’s help. I strongly recommend that any new landlord join the Apartment Association of Greater Los Angeles (AAGLA).

In addition to their advocacy work on behalf of owners (necessary work in a city full of tenants), AAGLA also provides education, services and legal forms (applications, leases, etc.) for landlords.

When you buy an apartment building, you are doing a leveraged buy-out on a small business. It’s not rocket science, but things can go wrong. So, if you’re new at it, do yourself a favor and get educated.

Multi-Family Millions: The book that started my career

If you’re interested in making money from re-positioning apartment buildings like we do, you should read Multi-Family Millions, by Dave Lindahl (that’s not an affiliate link; I don’t get paid if you buy it).

A few warnings:

  • The book is cheaply made. It feels like someone self-published it out of vanity. I recommend getting the Kindle version.
  • The author is kind of cheesy. He’s constantly trying to get you to join his mailing list so he can promote seminars or something.
  • It was written before the financial melt-down, when it was much easier to get loans, so you need to take his advice about financing with a major pinch of salt.

So, why do I like it so much? MFM was the book that taught me the basics of how apartment buildings are valued and how you can add value to them.

Armed with that information, buildings talk to you. You see a run-down building in a good neighborhood and you hear it saying “Rescue me from this stupid, lazy owner. I’ll pay you handsomely for your time!”

If you’re reading this incredibly dense blog, about a pretty dry topic, with no pictures, you’re the kind of person who understands that knowledge is powerful. And this book, cheesy and awful as it sometimes is, contains within it the knowledge needed to begin or accelerate your quest to make money from apartment buildings.

How to estimate what your property taxes will be

When you buy an apartment building, your two biggest costs will be your mortgage and your property taxes.

It’s easy enough to estimate your what your mortgage payments will be (try this calculator)… but how do you estimate your property taxes?

In California, we’re blessed with Proposition 13, which effectively limits your property taxes to approximately 1.25% of the purchase price of your property with a maximum annual increase of 2%.

What this means is that you can estimate what your property taxes will be in year one by multiplying the price you propose to pay for a building by 0.0125. So, for example, if you bought a duplex for $500,000, your property taxes could be estimated at $500,000 x .0125 = $6,250 / year or $521 / month.

But you also need to be aware of Mello-Roos (sounds like some kind of weird plague, right?).

Mello-Roos taxes are special levies designed to pay for specific improvements in a particular neighborhood. Say the neighborhood wanted to add street lighting three years ago. It issued bonds to borrow the money to install the lights, then used the Mello-Roos process to impose a property tax surcharge on each piece of property in the neighborhood to pay off the bonds.

Mello-Roos can therefore drive your property tax bill up above 1.25% of your purchase price if your property happens to be in a neighborhood with a Mello-Roos assessment. The additional amount owed is usually not too large relative to the overall tax bill, but it’s definitely important to check it out before buying your property.

It doesn’t hurt to ask your agent or the escrow company to give you an estimate in writing of what your property tax will be post-purchase. That way, you avoid any nasty surprises when your first tax bill shows up.

Why you should get pre-approved for a loan

Say you decided to sell your building and I offered to buy it. Say I offered you the following deal: I’ll buy your building for $1MM, but first I want you to guarantee you won’t sell it to anyone else for the next 45 days while I get the money together.

You would be an idiot not to check if I had the ability to get the money before allowing me to tie up your property for 45 days, right?

Most sellers aren’t idiots. They want to know that the person who is offering to buy their property at a certain price has the wherewithal to do the deal. And that’s where the pre-approval letter comes in.

A pre-approval letter is a letter from a bank or loan broker attesting to the fact that you, the buyer, are capable of getting the loan necessary for you to close. Either implicitly or explicitly, the letter assures the seller that someone knowledgable about getting loans has looked at your credit score, your tax returns, your employment history, etc. and has determined that you will be able to get the loan you need. It’s not binding (neither you nor the seller can sue the bank if they don’t end up doing the loan), but it does provide some comfort.

Incidentally, the pre-approval process is great for buy-side brokers (like me), because it filters out serious buyers from bs artists. The process of getting pre-approved isn’t terrible, but it does require that you open your kimono for a lender or loan broker. Your willingness / ability to do so is my first indication that you are worth spending my time on.

So, when you call me about buying your first property, and I immediately refer you to a loan broker, don’t be surprised. It’s the best way for everyone to gauge just how serious you are about making a deal.

OK, I want to buy a building. What do I do first?

Call me. J/k. Sort of.

The first thing you need to do is take stock of your current position. Here is what you need to get started:

  • A decent credit score. FHA will loan down to a 580 score, but ideally you’d be north of 700.
  • A stable work history. The ideal loan applicant would have worked in the same job for 2+ years with stable or rising income which is reflected in his/her tax returns.
  • A bit of cash. Depending on where you want to buy, you’ll want at least $25,000 in the bank for a minimum of two months. FHA will allow you to get the money from someone as a gift, but you’ll be better off it’s been sitting in your account for two months before you even begin the loan process.

If you’re missing one or more of the above, don’t worry. Cash can cover up a lot of sins. If you can get together enough cash to put down 20-30% of the purchase price, you’re almost definitely going to be able to get a deal done, even with bad credit or a non-traditional employment history (though the terms of the loan won’t be optimal). If you do have all of the above, or if you have a bunch of cash, you’re ready to get started.

The next thing you need to do is determine what sort of property you’re looking for. For a first time buyer who fits the loan criteria, I strongly recommend an FHA mortgage, which means you’ll be limited to 2-4 units. My advice is to be open minded, but to favor 3-4 units over two. (If you already own property, or are going to be putting down 20-30%, go with more units, since you’re not getting the benefit of a high-leverage FHA loan anyway.)

Next, you want to determine where to look. All other things being equal, I recommend areas where the rents are increasing. Buying a building for a fair price with a fixed, 30 year mortgage in an area with increasing rents will turn your good investment into a home run without you having to do much. To find increasing rents, look for gentrifying areas (in LA, try Echo Park, Highland Park, etc.).

Finally, you want to find an experienced agent… hence my semi-joke above. I am sometimes guilty on this blog of making buying buildings seem easy. But you have to remember that buying a building with a mortgage is basically equivalent to doing a leveraged buy-out on a small business. Leverage (debt) magnifies outcomes. This means that, if you do a good deal, you do very well. But if you do a bad deal, you can do very badly. You wouldn’t do a leveraged buy-out without getting advice from someone who knows what they’re doing. Don’t make that mistake with an apartment building!

So find an agent you trust. Tell him/her what your resources are, what kind of building you’re looking for, and where. And listen very carefully to what he/she tells you. You’re probably 60-90 days away from buying your first cashflowing asset.