How to Set Rent

Do you want to rent out an investment property, but are not sure how to price a rental? First, you have to find the perfect rental property, then you have to figure out what to charge. Let’s take a closer look.

Finding a Good Rental Property

The ideal rental property has the following characteristics:

• A great price-rent ratio
• Minimal maintenance
• Good cash flow
• Few vacancies

The price-rent ratio is determined by dividing the annual rent into the value of the property. For example, if you can collect $1,000 a month ($12,000 a year) on a property worth $200,000, the price-rent ratio is 16.67. The inverse is the rent yield, which is 6 percent. All things being equal, the higher the rent yield, the better the deal. However, sometimes all things are not equal. A tight housing market or high interest rates can affect the yield and may create a misleading impression. It’s best to consult with a local real estate agent to help understand how to interpret the rent yield in your neighborhood.

Rent-to-Mortgage Ratio

It doesn’t make sense to charge a rent that doesn’t cover your mortgage payments. The question becomes how much above the mortgage payment should you charge in rent? The rent-to-mortgage ratio, or debt coverage ratio, should clearly be greater than 1.0 if you want a positive cash flow. And that doesn’t even take into account your other costs, such as taxes, utilities, legal fees, maintenance, etc. So, you want to set your rent high enough so that you get a decent return on investment, say 8 to 15 percent. If you plan to rent out your property for just a few years before selling it, you can consider an adjustable rate mortgage, which is cheaper in the first few years.

How Much Rent to Charge?

You should charge rent equal to about 1 percent of your property’s value. We say “about” 1 percent because it’s OK to tweak the rent so that it lies between 0.8 percent and 1.1 percent. For example, if your property is worth $250,000, you might charge a monthly rent between $2,000 and $2,750. If your property is worth no more than $100,000, charge 1 percent or higher in order to cover your costs. On the other hand, if your property’s value exceeds $350,000, reduce the rent to 0.8 percent so that you can attract renters.

You also have to check out the rents on comparable properties in your neighborhood. Whether you like it or not, folks will tend to gravitate to the best values, so you can’t get too greedy. Check out websites like Zillow and Trulia to see what the rents are like in your area.

Selling Your Rental Property

You might decide it’s time to unload your rental property, for any number of reasons. Calculate the capitalization rate (“cap” rate), which is the net rental income divided by the selling price. The net rental income is the gross income (one year of rent income for all units combined). Subtract 5 percent to account for occasional vacancies. Next, subtract operating expenses, plus another 5 percent for maintenance/repairs. Divide the result by selling price you desire. You should figure on a cap rate between 4 to 10 percent, depending on market conditions, vacancy rate, the condition of the property, etc. Adjust your selling price accordingly.

Real estate flipping provides several potential benefits, from profits to artistic expression. It’s something you can do on your own, with the help of proper financing, of course. However, the last thing you want is to take on an unexpected partner – the Internal Revenue Service. Taxes are a reality, and even if you can’t avoid them, at the very least you want to be prepared for them.

Let’s clear up some confusion right away. If you buy a home, move in, spend a couple of years fixing it up and then sell it for (hopefully) a profit, you are an investor. If you, on a continuing basis, buy a home, fix it up without taking occupancy, and sell it within a year for profit, you are a home flipper, or what the IRS calls a dealer. In other words, dealers run home flipping as a business rather than a lifestyle, and it is you we are addressing in this blog.

Here are the salient facts regarding taxation of home-flipping dealers:

1. Your properties are considered inventory, rather than capital assets. As such, you must pay ordinary income tax on any profits arising from sale – you do not get to treat the profit as a capital gain.
2. You cannot avoid income tax by “rolling over” the profits from one home flip into the purchase of another home.
3. The profits you make as a dealer are subject to self-employment tax – Medicare and Social Security tax. The rate is 15.3 percent on your annual net self-employment earnings up to $117,000. After that, earnings are subject to the 2.9 percent Medicare tax, plus an additional 0.9 percent on income in excess of $200,000 ($250,000 for joint filers).
4. You will have to file quarterly estimated payments once you earn $400 for the year. However, if you also work as an employee separate from your home-flipping business, you may be able to increase the withholding on your wages enough to avoid the quarterly estimated payments.
5. Home flipping is costly, but many of those costs must be capitalized rather than deducted as expenses. Capitalized costs are added to the purchase price of the property (the cost basis of the home), thereby reducing the amount of taxable net profit when you sell the property. Capitalized costs include:
   1. The purchase price of the property
   2. Direct labor
   3. Direct materials
   4. Equipment depreciation
   5. Indirect labor
   6. Insurance
   7. Production period interest
   8. Real estate taxes allocable to each project
   9. Rent
   10. Utilities

As you can see, home flippers must fully understand the tax implications of their business in order to comply with IRS rules. Failure to do so could get you into hot water for underpayment of taxes, which is a very bad thing. We suggest you utilize the services of an accountant, at least when you first start off, to help you understand the various tax rules, your responsibilities under them and the tax breaks you are entitled to. That way, you can make a nice profit from home flipping without arousing scrutiny from the IRS.

The popularity of house flipping continues to rise, which means that the ranks of rehabbers are swelling with people of varying backgrounds, skills and resources. Those who don’t prepare properly or lack the patience to handle unexpected setbacks are going to find flipping a painful experience. However, if you can avoid these five mistakes, house flipping can be pleasurable and profitable.

1. Lack of money: Real estate development is not exactly cheap. You have to pay for the cost of acquiring property, financing the project, rehabbing and selling. You have to enhance the value of the property sufficiently to cover your costs and make an after-tax profit. Many flippers turn to hard-money loans that finance up to 70 percent of the property’s value and can be obtained in a matter of days. Real estate lenders, such as Specialty Lending Group, can help you realistically determine the money you will need, and then finance your project quickly and affordably.

2. Lack of time: Fix-and-flip projects are in a constant time squeeze. At the launch, suitable properties pop up suddenly and don’t stay on the market for long. That’s why rehabbers prefer hard-money loans with their quick turnaround. Waiting for a bank loan is hardly ever an option. Once the project is underway, it’s a race against time to finish up by the projected deadline in order to avoid extra interest costs and delayed returns on investments. Don’t even think about becoming a flipper unless you can devote the time necessary to fix up a property, have it pass inspections and selling the finished home.

3. Lack of skills: Skilled professionals, such as carpenters, electricians and plumbers, know what they are doing and can apply their experience, knowledge and skills to select a house and flip it for a profit. They understand the amount of sweat equity that will be needed to make money on the deal. If you have the skills, you can save a tidy sum by doing the work yourself. If you have to bring in a lot of specialty trades, you may end up with little or no profit. DIY rehabbers have to be handy with tools and techniques, from installing drywall to plumbing new fixtures. Realistically assess your own skills before proceeding.

4. Lack of knowledge: You need to know the right neighborhood and property to select, and the right price to pay. That means you have to research comparable properties in the neighborhood of choice and set your sites realistically. You also need to know how much rehab work is necessary, and which renovations should be skipped. Lack of knowledge can turn a fix-and-flip into a money pit.

5. Lack of patience: It takes patience to wait for the right property at the right price. Many novices rush to quickly when they buy a property or hire a contractor. Novices further rush to sell the property through an agent, but professionals do the selling themselves and pocket the sales commission. Finally, novices too often think a coat of paint and new curtains are all it takes and are impatient to cash in on their investment. Lack of patience most likely will lead to losses.

Contact SLG for information about financing your fix-and-flip strategy. Our expertise will help you avoid many of the pitfalls that novice rehabbers make.

Hard money loans are an important alternative to bank loans when you want to buy property or use a property you already own as collateral. Hard money loans are based upon the property’s value instead of the borrower’s creditworthiness. Typically, you can borrow up to 70 percent of a property’s value via a hard money loan, although it varies with circumstances. Normally, the term of a hard money loan is a year or less, but sometimes a longer loan can be set for two to five years. You make monthly payments of mostly or exclusively interest, and a balloon payment at the end.

So why use a hard money loan instead of going to a bank? There are two answers: speed and access.

1. Speed: Companies like SLG can arrange a hard money loan in about a week. If you go to a bank, you’ll probably be cooling your heels for 30 to 45 days or longer. If you are buying a primary residence, are not in a rush and have good credit, by all means take out a mortgage from a bank. But for developers and builders who need to move quickly, hard money loans are an ideal solution.

2. Access: Banks perform an exhaustive credit check on potential borrowers. They want to know whether you missed a credit card payment six years ago, much less ever went bankrupt or were involved in a foreclosure. Banks are all about creditworthiness. Hard money lenders are all about collateral. All we want to know is what the property is worth. Many folks who flip houses or build new ones may not qualify for bank loans, but are more than welcome by hard money lenders.

When does speed matter? It depends on the deal. If you are looking to acquire a property to redevelop and are fending off other bidders, access to quick capital can seal the deal. There are a number of situations in which a real estate investor needs to act quickly. Whether or not you have credit issues, hard money loans make capital available quickly. Banks, not so much.

If your business is to fix and flip residential housing, you don’t want or need a 30-year mortgage to finance the property, because your plan is to get in and out in well under a year. That timing is perfect for a hard money loan. Perhaps you need a bridge loan, a land loan, or other short-term loan. Hard money loans move quickly, and because you can arrange interest-only repayments, these loans fit well when cash flows are tight.

It’s true that hard money loans have higher interest rates. That’s natural, since the lender is underwriting risk without reference to the borrower’s creditworthiness. But for many deals, the cost of these short-term loans is dwarfed by the potential for profit. Specialty Lending Group hard money loans are quick and hassle-free. When you need capital right away to finance a real estate opportunity, let SLG be your source.

This last decade has been something of a rollercoaster for the fix-and-flip business. The go-go market of 2006 gave way to the real estate crash of 2008 and the slow recovery that followed. It’s only been in the last few years that life has returned to the real estate market in general, and house flipping in particular. Yet, whatever the macroeconomic circumstances, deals are always being made. The two biggest deal drivers are location and timing. The first requires knowledge, the second requires money.

Breaking In

A novice might decide to break into the fix-and-flip business for any number of reasons, from entrepreneurial spirit to love of architecture. Naturally, the common thread in all renovation deals is profit, and many a deal has failed because knowledge, money or both were lacking.

Knowledge, in this case, means understanding the numbers that make deals work. Anyone can buy a run-down home, patch it up and put it up for sale. The shock occurs when no one will bid at your asking price. Was it bad luck, bad management, or just a bad deal? Knowledge is key.

Becoming Knowledgeable

Before jumping into your first fix-and-flip, take some steps to educate yourself:

• Read about the real estate business every day
• Join a local real estate club
• Attend high-rated property seminars
• Latch on to a mentor
• Enter into a partnership with an experienced flipper

The skills you will need to pick up will ultimately boil down to math: How little can I spend to flip a house, what will it cost to fix, how much can I sell it for, and how much time will it take? A seasoned pro can probably dissect a deal in five minutes and tell you whether it makes sense, whether the numbers work. If you don’t have confidence that you understand the numbers, you are not ready to make a deal.

Financing

On the other hand, let’s assume you have become comfortable with your knowledge of the flipping business. You have a pretty good idea of what you are willing to spend to buy and flip a single-family house, and the profit you are likely to make. You’re not going anywhere however until you line up financing. And you won’t get far with financing unless you first save up some capital – cash. The reason is that unless you already have a thriving business with a great credit rating, you’re unlikely to qualify for bank financing. Even if you do, it can take so long to line up that opportunities evaporate. As we said, timing is everything. That’s why the hard-money lending business exists.

A typical hard money loan will require about 30 percent down in cash. You finance the remaining 70 percent for six months to a year. The beauty of hard money, or bridge, loans are that you can get one quickly if the deal looks good to the lender, based on the property’s ratio of debt to value, not on your credit score.

Want to know more? Contact Specialty Lending Group to arrange an appointment. We have many years’ experience making bridge loans, experience that you will find very useful if you are new (or not) to the flip industry.

 

The real estate market has been quite lively in the last few of years, creating profitable opportunities along several fronts. In this article, we’ll address three of the hottest vehicles for investment. The biggest difference among the three is the time you wish to spend in direct involvement with the investment.

 

1. Fix and Flip

This strategy involves purchasing a rundown home at a good price, renovating it and then selling it, all within a year. For hands-on rehabbers, this requires knowledge, hard work, and funding. The extent of the work is directly tied to the state of the property you buy. Dilapidated properties cost less and provide the best profit potential, but they also are the riskiest and require the most time. Fix-and-flip projects are usually time intensive, in that desirable properties often pop up with little notice, and longer projects require longer funding, meaning more interest cost. Because of these characteristics, rehabbers favor hard-money loans, which can be secured rapidly, as compared to bank mortgages that can take weeks or months to effect. This strategy appeals to folks who want to invest sweat equity in short-term projects.

 

2. Rental

This is a long-term investment that often resembles fix-and-flip, except the property is rented out instead of flipped. If the rental property needs rehab, investors might start with a bridge loan so that work can begin immediately, and then eventually replace the hard-money loan with a long-term loan or a mortgage. Whereas the aim of fix-and-flip is to earn a short-term capital gain, the rental strategy aims to earn a steady stream of rental income. Rental property usually needs initial renovation plus ongoing maintenance, so rental investors are landlords who either personally manage the properties (find tenants, collect rent, maintain the property, perform accounting, etc.) or hire out the task to property managers for a fee. The choice depends on several factors, including number of units, your availability, skills and interest, and geographic location of units.

 

3. Real Estate Investment Trust

Unlike the first two strategies, investing in a REIT is a passive long-term investment. A REIT is like a mutual fund made up of real estate properties rather than stocks and bonds. You purchase shares in a REIT to own a prorated portion of the revenues generated by the underlying portfolio of properties. REITs are professionally managed and require no participation from investors except for buying and selling their shares. REITs returns are made up of rental income and, if any properties are sold, capital gains. REIT portfolios contain properties that are residential, commercial or a mix of both. The advantage of a REIT is that it provides instant diversification over a number of properties. However, REIT investors have no control over the portfolio or its management, and annual returns on REITs are usually significantly lower than those on fix-and-flip investments. Investors normally fund their REIT investments with their own cash, though margin loans may be available from brokers for those who want to leverage their returns (and risks).

Contact Specialty Lending Group for more information about funding real estate investments.