Learning from Larry

On Thursday, Larry R., one of the Kagansblog regulars, taught me a ton about South LA real estate.

Larry’s an LA native who grew up on 111th St, which is a hell of a lot farther south than I’ve been in the city (besides going to the airport). Because he grew up down there and because his parents owned some rental property, he’s not at all afraid of investing. So we drove down looking for deals.

We toured interesting neighborhoods, talked business, ate burn-your-mouth-spicy BBQ at Phillips at 43rd and Leimert, and got propositioned for donations by a Black Muslim brother selling beam pies. It was awesome!
I learned first hand, from Larry, how much money you can make by investing in South LA. It’s often said that you make most of your money in real estate “on the buy”. What this means is, if you buy assets cheaply enough, it’s hard not to make money, even if you’re not great at the other aspects of the game. And boy can you buy stuff cheaply down there. There are honest-to-goodness 10% caps sitting around for anyone with cash and guts to buy.
Now, managing those kinds of properties can be tough. The neighborhoods can be dicey (though it’s important to recognize they’re not all the same at all – the area in the 40’s around Leimert Park is very different from the area around 85th St, for example), the properties can be in rough shape, and obviously you’re dealing with a different tenant base than you would be in NE LA. But Larry’s comfortable with the environment, knows how to renovate cheaply, and has a great system for picking tenants who pay the rent and don’t cause trouble.
I know Larry’s going to read this, so this is my opportunity to say a big, public “Thanks!” for educating me.
Do you know of an undiscovered neighborhood with great deals? Do you have a system for investing that works for you? I would love to learn from you, and I’m sure our fellow real estate enthusiasts would, too. Clue us in in the comments section, or send me an email at moses@betterdwellings.com!

Frank McCourt did nothing wrong

Think of the Dodgers like an investment property.

McCourt bought the property in 2004 from a bad owner (Fox) and dramatically increased the revenue.

As revenue increased, the value of the property increased (cash-generative assets are valued at some multiple of the cashflow they generate; increase the cash, increase the value). The increase in value created equity for McCourt, his compensation for taking the risk of buying the property and for managing it well.

He re-financed the property to withdraw cash for his family. The banks were willing to lend because the new, higher cashflow of the property could support higher debt service payments, and because the new, higher value of the property gave the banks increased security (if he hadn’t paid the debt, the banks presumably had the team as collateral.)

Finally, McCourt sold the property. Like any other owner, he conducted an auction and chose the highest bidder.

The amount bid was enough to pay back the debt and leave enough money to pay a big divorce settlement and leave around $1bn for McCourt.

Everything else about this story, from the bad PR around the McCourts’ divorce, to the moralizing about how he “stole” the money, to the “redemption” meme around Magic Johnson buying the team, is window-dressing designed to sell newspapers.

You may not like McCourt, but he’s just a guy who made a highly levered bet and had it pay off. He’s no different from the average couple who bought a home with a mortgage and got rich when the property market went up, like everone who bought a home in Southern California between probably 1850 and 2003.

All about FHA loans, with Justin Brown, loan broker

[MK: You really, really can buy income properties with as little as 3.5% down through FHA loans. Interested? Read on.]

We’ve spent so much time talking about FHA loans, I figured I’d bring in a pro. Meet Justin Brown of Nu Home Financial. Justin’s a loan broker who has recently done some very good work for my clients. I sent him some questions and he responded. Here they are:

What’s the minimum credit score you can work with to get an FHA mortgage? What can you do for someone with a score below that level?  

For an FHA loan it is ideal to have at least a 640 fico score, however there are programs available for credit scores down to 580, they can be very restrictive and almost impossible to get funded. For those that have a sub 640 fico score I will typically offer a free credit evaluation and give them a plan of action that will help them reach the targeted score, in some cases in as little as a month.

Is there a rule of thumb for how much personal income you need to carry a mortgage on a 2-4 unit building? How does the rent from the units play in to that?

Typically with FHA you need to have enough income so that your total reported debt obligations including the proposed mortgage payment will be less than a certain percentage of your income. Depending on your credit score and other factors your total obligations can be as high as 50-55% of your monthly gross income, or as low as 43%, however the great thing about an FHA loan on a multi unit property is that you are allowed to use the proposed rents as income, even if the units are vacant!

How many years of income do you need to see to do an FHA loan on an income property? What kind of documentation do you need?

The lender will typically need to see a 2 year work history, unless there is evidence you are a recent graduate. Typically for an employee of a company you will need to provide your most recent 2 years tax returns, most recent 2 years w2’s, and a recent 30 day period of paystubs. For those that are self employed, on a fixed income, recipient of benefits or other sources of income, the documentation will differ. Basically the lender just needs to see a 2 year history with evidence supporting it, and they need to reasonably be able to determine it is likely to continue for at least the next 3 years.

Besides income and credit score, are there any other things that stop people from getting FHA mortgages? What are they?

Although Income and Credit Scores are the two main factors that prevent most people from qualifying, but other factors can include assets or late rent payments in the last 12 months. An example of how assets can hinder a buyer from closing, if your down payment cannot be sourced and shown to have been seasoned for 60 days it will be an issue,  i.e. selling goods for cash with no documentation or tangible proof to support it, mattress money (cash saved for years, then suddenly deposited into your bank account) assets must be able to be sourced with an official paper trail. Assets must also be seasoned for 60 days, any large deposits typically more than 1,000 will need to be explained and sourced.  If you plan on buying a home it is best to have a recent 60 day statement period with no unusual activity or large deposits. Do not make sudden transfers or deposits without first checking with your lender if you are planning on buying a home in the next few months. Also if you are currently renting make sure your rent history will not show any late payments over 30 days late this will disqualify you from buying a home for 1 year from the most recent late payment.

What is PMI? Who needs it? How much does it cost?

PMI (Private Mortgage Insurance) and MI (Mortgage Insurance) are types of insurance that protect the lender from losses resulting from a foreclosure. If not for mortgage insurance companies and providers you would not be able to purchase a home for less than 20% down, it makes loans with as little as 3% down available. For FHA loans and Conventional loans the amount of monthly mortgage insurance can vary, depending on the down payment, loan term, credit scores and other factors. Although FHA loans have had the mortgage insurance cost change quite a few times in the last couple years, as of April first for a 3.5% down homebuyer they can expect to pay an up front fee of 1.75% of the loan amount, and a monthly fee that is calculated by taking 1.25%  of the loan amount and dividing by 12.

If people want to get in touch with you to find out if they qualify for a loan, how can they do that?

A pre-approval can be a quick 5-10 minute phone call in some cases, the best way to start is by calling me at 909-833-3200 ext 2, cell 714-494-5322, or by going to my website www.nuhomefinancial.com and clicking on APPLY NOW.

What I want from this blog: a community

Right now, this blog is very much a one-way conversation: I write about income properties and you read about them. It’s kind of like this:

From benhusmann (on Flickr)

But I want more. I want this to be the kind of place that like-minded people come to discuss Los Angeles real estate. I want it to be like a virtual version of my favorite restaurant, Madame Matisse, where I have breakfast a few times a week and talk to the staff and the other customers.

I’ve already met some of the people who read this blog regularly (Hi Larry! Hi Jason!) and I know they have tons of real estate knowledge they can contribute. And I’m betting there are a LOT more of you out there with wisdom to share.

And if you’re not an expert, you have something maybe even more valuable to bring to the community: questions. It’s pretty easy for me to forget that most people only buy real estate a few times in their lives (if ever). So sometimes I gloss over things that seem obvious to me but which are totally NOT obvious to new or potential investors. That’s where you new people come in… I need you to tell me what isn’t clear, what’s confusing, what you want to learn more about.

So take the leap. Post a comment. Ask a question. Disagree with me. And let’s turn this into an awesome community full of smart people figuring out how best to secure their financial futures through investing in real estate.

Why I write this blog

You might be wondering: Why does this guy spend so much time writing about apartment buildings?

I think the financial crisis of the past few years has changed something fundamental about the relationship between young people and real estate, and I want to try to both explain that change, and help shape it and move it forward.

Before the crash, here’s how most people felt about real estate:

  • I want a big house on a big piece of property
  • I will work very hard at my job in order to afford to take out a big mortgage to afford this big house
  • While I own it, this big house will increase in value every year
  • Some day, I will sell my big house, take my profits and buy an even bigger one

Here’s what happened as a result: A lot of people ended up buried under huge mortgages, unable to sell, unable to re-finance, and facing years (maybe decades) of hard work in order to pay off loans on properties that will never be worth what they bought them for (at least, in real terms).

Sensible young people looking at this situation could come to two conclusions, both reasonable:

  1. I will never own property. It’s not worth the risk. There is value in the flexibility that renting provides. I will therefore rent. Or…
  2. I will own property, but it will be income property. I will slowly build an asset base, taking advantage of the low price of real estate, the availability of cheap debt, and the major subsidies that both the national and state tax codes provide to owners. Over time, as I save more money, I will buy more income property. And, eventually, one day, maybe 10-20 years from now, I will wake up to the fact that I have secured my family’s financial future.

I write this blog for the people who have reached conclusion two. If you are one of these people, or think you might be, get in touch.

I will help you learn for yourself how this whole thing works. And then, when you’re ready, I will help you buy your first income property. (Bonus: The whole thing is free, because, as a broker, I get paid by the sellers of property, not the buyers.)