When it comes to investment properties there are loopholes which create many options. For instance, Section 1031 of the IRS tax code permits real estate investors to sell their investment properties and in return allow a trade for comparable or similar matched investments in order to defer the tax as the capital gains amass. It seems that real estate is truly the most popular transaction permitted by this code. Something called the Triple Net or NNN otherwise known, as Leased Real Estate is considered appropriate as alternate property during such a transaction. What this really entails is a Net lease where a tenant foots the bill for all or most of the properties' active expenses over and above the rent. It is important that before we discuss the particulars of Net lease that we have an understanding of other kinds of leases as each serves a different purpose.
First there is the bond lease that makes the tenant completely accountable for active expenses encompassing the property's operating costs, which include regular maintenance, repairs and substitute costs for replacing materials etc. Second there is the Triple Net or NNN lease, which incurs actual restrictions on capital expenses. The tenant must pay for property expenses including tax, insurance and maintenance, as under this kind of lease, these are the tenants responsibility. Third taking from the NNN lease is the Net Net or NN lease. This is somewhat the same as NNN lease but returns the responsibility of the physical up keep of the structure to the landlord. They must make sure major items such as the roof are in good working order. Lastly the Modified Net lease infurs that the tenant pays for everything including utilities, maintenance, repairs and insurance. They do not pay property taxes.
For the NNN situation first the situation may allow less property management issues to be a problem for the investor. This is especially true for investors dealing with multi-family units, complexes considered commercial because they want the profit and income without the hard work or heartache. They also want to postpone their tax accountabilities without having to play the role of landlord 100% of the time. Savvy investors use NNN leases because they insure income but still allow for ownership to stay in their name and portfolio while maintaining a good level of capital. Another aspect of the NNN is that it also makes the transfer of real estate to beneficiaries easier.
It happens all the time when you engage in acquiring a new property through contract, there is not much information about the property known at that stage. All you may know is the details of the financial statement and rent payroll or you've visually inspected the place by driving around the block. This is more than enough details to make a solid educated offer on the place but it does not by any mean represent the actual value. There's a lot more information you'll need to know to determine the real value.
Really this is the job of the Due Diligence process. What is the purpose of this process? Due Diligence is an analysis by which your risk is assessed. Much like discovery in a court case, you will have at least 30 days to figure out what exactly the property entails and what owning the property requires you to be responsible for. Finally, also what kind of benefit you will receive as a result of purchasing the property. What will be your cost benefit and profit?
There are four ways risk can ruin this success and by you knowing the potential risk involved, you can steer clear of these situations. The following potential risks for these transactions are: Market, Financial, Tenant, and Physical.
If you are a real estate professional then you know about the gross income multiplier, GIM or the formula that determines the value of rental real estate. It has been used for decades. 
There are many schools of thought on how to determine the value of rental property but I always use my readings as a rule of thumb. Any real estate textbook will tell you not to invest in a property with a GIM of more than 8. The formula is simple enough: divide the price by the gross annual rents to get the GIM.
With this definition in mind it seems that particular author wants me to never pay more than 8 times the annual rent for a rental property. This helps the buyer open their eyes to mow much of a rental property they can afford to buy. It makes plenty of sense really. Seems that if a property was selling for 6 times the rental income, then that was a really good deal. I mean anything higher than 8 times the rental income and that becomes a dangerous proposition. This simple method makes it easy for the average Joe to know what they are getting into.
One important aspect of due diligence is to know your documents but specifically understanding the details of the lease, insurance policy, and title policy. The lease, out of all of these is of utmost importance because it remains the roadmap for future events concerning the property. Part of the issue with the lease is language. There is a lot of strange stuff, interesting jargon presented in the terms of a lease. Really I wonder when legal ease will be common enough for an ordinary person to understand. Such examples of strange amendments to a generic lease include: First options on purchase, the right to take over adjacent space, tenant ownership of plumbing fixtures (really!), agreements for new carpet every year. Really anything is possible.
One would think that there is a cookie cutter answer to the common lease agreement. It seems very few properties have what is commonly termed as a "standardized lease template" mainly because over the lifetime of the property management, the owner is faced with signing new leases and making concessions for each individual tenant. Some tenants will be more nit picky than others. Some tenant may agree to paint the living room or include other repairs that will amount to a profit for the owner in the long run but mainly benefits the existing tenant. A lot of the time, much goes unnoticed by property managers and it is at the owner's discretion to know the lease backward and forwards.
Every word of the lease is crucial. It is important that everything remain clear for both the owner and the tenant. It is a good idea to have an outside party review the lease and compare notes. If there are questions, please ask them and be straightforward about any concerns. This process is usually so important that I do not let anyone else handle it.
It is in my best interest that I understand every detail of every lease. Otherwise I am just setting myself up for failure with these tenants and sometimes even the owners. Sometimes the owners don't even know the specifics of each lease. That is why you need to ask questions and understand each situation. It is the nature of the job that sometimes people tell me too much and I must remain objective. Still this creates a level of honesty I have come to respect of my clients.
Well as it happens with more and more questions come up things that the client remembers about the leases and something I may not have been aware of from the get go. So I cannot stress enough how important to ask lots of questions in the process. The way I see it is, this is a chance to find out about information that may not have already been discussed.
Remember to get a payment history from tenants. This does not lead to many surprises. For instance, if there is a problem tenant, someone who is consistently late with the rent, then I want to beware of that issue upfront. If it is chronic problem, I may see the need to discount the cash flow, which in turn leads to a lower price offer.
There is also the situation where the owner or property manager does not have a system to tracking the cash flow, or documentation of the rental payments, or even a way of verifying with their bank, this proves to become a much more risky situation for me and everyone involved. Here too, the risk translates to a lower bargaining price. It has been my experience that in these cases, the paperwork magically appears.
One can always tell a lot of vital information from the insurance policy, especially in the case of a building with some age. Mind you, a lot of times insurance inspectors know all the tricks of the trade and if you are able to get a hold of the last risk assessment you will be ahead in the long run. You can request this from your client usually the insured is the owner but a copy is a must. If it is at all possible, get a claims history as well. This can be a grey area because lot of times, you will have to jolt the owner's memory and this can become issue if they changed carriers every year. Here there is no real worry, people change insurance providers all the time shopping the best rate is so common but be cautious if they have failed to pay a policy. What is best in this situation is to make sure the owner can get an affidavit discussing the truth of the claims represented as being complete to the extent of his knowledge. This can be important for future possible litigation because many sellers want the warranties to survive closing.
When in doubt look to the existing title policy. This will inform you the obvious information regarding easements, rights of way, etc. Be on the lookout for any special exceptions to title. It is best to have a General Warranty deed if you can get one. A smart seller will offer a Special Warranty deed as incentive, which will only guarantee title for the time they owned the property.
To further the argument, it is also important to keep in mind the amount of resources and the type of property when completing a due diligence process because some steps may not be warranted. Really when it comes down to it, there is no other proper substitute for due diligence, but this does not stop people from not understanding its importance. No property is perfect and unfortunately there is no way of preventing this without further investigation. In the long run it protects all parties. Depending on one's needs, it is fair to say that each transaction will decide what level of due diligence is needed. There are companies out there that all they do is specializing in this practice.
For many the differences between Commercial real estate properties and residential properties can be daunting to define. It is all about assessing value. The value of a commercial property can be determined by setting an inverse proportion to the degree of risk inherent to the continuance and stability of the income stream from the property. Each type of commercial property has varying degrees of this risk to profit ratio but none more complex than the multi-tenant property, either office or retail.
The due diligence officer has the very important task to verify, verify, verify. Of course there area exceptions to the rule and one major are the true triple-net property. There's a misconception about what is a real and true triple-net property. Seems that commercial real estate professionals to the point where their definitions not only confuse the buyer but also mislead them to have thrown around a bunch of jargon and terminology.
Honestly speaking the true triple-net, multi-tenant property is an extremely rare find. What this means with a true triple-net leased property is that the tenant takes on the responsibility and expenses of operating the property and this can include a long laundry list such as property taxes; property casualty, and liability insurance; all maintenance including: structural components, mechanical systems, plumbing and drainage systems, glass, and the roof. This just does not happen with most commercial properties.
For the owner, they have a vested interest in the property, which boils down to a small amount of inclusive rights relating to real estate. The only thing this owner needs worry about is where the rent check is sent. Sounds like a property manager's dream come true. The only real way to make the property work that well for you, in the case of a multi-tenant property, is to set up a master lease for the entire building. What happens is then the lessee sublets to each individual tenant. It's almost as if the lessee acts as your agent in the continued transactions for the property.
Posted by: Investors Lounge Online in Tenant, Subject To, Sub Prime Lending, Refinance, Real Estate Investment, Owner Will Carry, Over Leveraged, Mortgage, Market Bubble, Loan To Value, lease purchase, Lease Option, Landlord, Investment, Financing, Credit Cards, Analyze on
Aug 14, 2008
There are different ways to structure real estate transactions that involve seller financing to benefit all parties. Of course the seller has concerns of protecting their property and the need for regular repayment. The following scenario explores this option in detail.
You know that your local market has many rental properties in the inventory and you have found one that meets your needs. You will be purchasing from a seller who is greatly motivated because the property has been on the market longer than a year. The property has an existing long-term fixed rate first mortgage with a balance of just $100,000. Your plan is to buy the property, rent it out and hold onto it as a long-term return on investment property. You know that the home is worth about $150,000 and the seller has it priced at a discount of $120,000.
The offer is as follows. You want to put $5,000 in cash as a down payment but also allow the seller to keep the title in their name with their first mortgage with only a balance of $100,000. The seller must also consent to taking a second lien loan for the remaining $15,000. This transaction may seem like it only benefits the buyer and the seller is left with all the risk. However due to the current lack of home sales in your area, the seller is motivated to continue the arrangement of the sales price, your down payment amount, and also is okay with you taking over the monthly payment for the first lien mortgage because they want to see the property sold in the long run. What bothers most sellers about this type of transaction and what makes it risky for them is that you are not assuming the existing loan. It still remains in their name but the title work protects them for your default. Still there is the concern of the loan remaining in their name and the $15,000 second lien is also risky for them should you fall into hard times but the goal of the sold property remains a common interest for all parties.
Understanding the fundamentals of finance known as the time value of money is key in real estate investment. Such causes as inflation make the real value of a dollar less in the future than it is worth now. Because of this principle, buying property outright in cash does have its drawbacks, financially speaking, because another use of that cash may actually benefit the investor in the future more than it would if it was expended in an immediate purchase.
When an investment is made using funds that have been borrowed, we call this activity leveraging. It is the expressed intent of the investor to make a return on the investment. If a $100,000 property were to appreciate 10% over a 12-month period, its value would be $110,000. The return on investment (ROI) would correspond to its appreciation of 10%, not including the costs of selling the property.
For those investments made with borrowed money, the resulting ROI is actually a much higher percentage of the out-of-pocket investment. Should the investor contribute $10,000 in the purchase of a $100,000 property, and capitalize the remaining $90,000 in financed funds, a 10% increase in the value would still yield an increased equity of $10,000. However, the ROI is 100%, because of its basis on the actual out-of-pocket investment of $10,000 made by the investor. Essentially, the investor doubled his investment! Of course, in financing the remaining $90,000, costs associated with financing interest would diminish the actual yield. As a way of allaying these financing costs, a good strategy would be to rent the property to generate revenue.
All investors including ones new to the playground know that the "golden grail" to succeeding in the real estate business is location. Location is the alpha and the omega of the real estate world. The common mistake is many assume that high-end prime location property is the be-all to end-all but that is simply not the case. Although those locations are often sought after they are not always the most favorable for an investor. When evaluating a property, the investor needs factor in the property's cabability of producing a high return, regardless of the forecast prediction.
It seems like yesterday that Britney Spears was the hottest thing to hit the music scene & no one could have imagined that her stock a.k.a. her career could have dropped so quickly after riding so high and her oops so far has not been done again. The same falls true for property and the location you purchase it in as well as the potential of what you can do with it. An area can be highly desirable for five years running and just as you decide to zero in on it you notice it is like that slow leak in your tire that took a couple of weeks before it had you parked on the side of the road. It must be determined if the tire is just flat or totally shot as in what is the potential for a property in a location to rebound or will it remain in a lull for a long time to come.
It is very important to understand how critical location is in terms of how it can increase your ability to sell during what seems like an elevator that has a broken "up" button and keeps heading down floor after floor but you know eventually it is going to stop. The great news is that just like that battery that you assumed was dead but starts working like a charm after charging, the value of majority of locations will go up in time.
You don't want to end up like Evander Holyfield with the threat of losing his 54,000 square foot home expressing "I have money but I am not liquid" Whew, that is quite a statement because we know one of the bottom lines is liquidity so when you purchase that property please consider how soon you might see a return on investment, and what you can pull as profit if any when you decide to sell seeing as that your profits for a time will be held in equity. When your profits are tied up in equity, do your best to select property that can meet its forecast, produce ample returns, and provide easy liquidation, regardless of the market condition
Posted by: Elliot Barron in Analyze on
Jun 14, 2008
You can use one of a variety of approaches to analyze a real estate investment, or you can use a combination of approaches. It's just as important to choose the right way to analyze a property as it is to carefully pick the right property, since the wrong approach can mean lost profits. Below is an overview of different approaches used to assess the value and returns on a property, with notes about any drawbacks to using a particular method.
One common approach is the sales comparison approach. When you compare the property you're considering purchasing with similar properties that have been sold recently, you can come up with an estimated value per unit or per square foot.
Another approach is using a gross rent multiplier to get a working estimate of value. This is usually the approach favored by investors who buy the same types of property over and over. They take the sale price and divide by monthly potential gross rental income to determine the value of the property based on the first year's potential for rental income. The drawback is that this approach only gives you an idea of the value for the first year, and it only works if you're careful to compare properties that will have similar occupancy rates and similar expenses for operation.
A smart way to purchase property without regrets after the sale consummates, is to put safe guards in your sales contract that give you a safety net. One of these nets is to always make any offer subject to a SATISFACORY property inspection. Now, whether you can perform this yourself or hire a professional, you still have a legal way of voiding the contract to purchase if something should be revealed that could cause potential financial risk down the road for you. Finding such an inspector is not a hard task and word of mouth within the real estate community is usually the best route. But you can also locate potential inspectors on the internet as all should be licensed with their state.
You are looking for hidden or masked areas of structural, electrical and plumbing problems that the owner is purposely or inadvertently not disclosing that could be major issues down the road for you. If you feel you possess adequate expertise to perform your own inspection, be sure to pay close attention to the following list of possible trouble areas:
Another area of concern that most home buyers take for granted, is past land use that could have caused residual soil contamination. Such as, if a gas station or industrial business that typically used gas or cleaning solvents in the past or the property was used as a dumping ground for hazardous/toxic wastes of some kind.
