This class is taught by my partner, Kathi Jackson, and myself, with the help of Jeff Nance of Chase Home Loans. Learn how to get started investing in real estate and the basics of being a successful landlord. 

Date: 11/13/2007  (Tuesday)
Time: 6:30-8:30
Where: Monroe, WA at Monroe Junior High Rm C7  

Sign up through Sky Valley community Schools Call Kristine at 360-794-3006 or email johnstonk@monroe.wednet.edu.   You can also check the Sky Valley Community Schools website at: http://www.monroe.wednet.edu/S.V._COMM_SCH/default.html

This class is taught by my partner, Kathi Jackson, and myself, with the help of Jeff Nance of Chase Home Loans. Learn how to access the equity in your home to build your investment portfolio.

Date: 10/23/2007  (Tuesday)
Time: 6:30-8:30
Where: Monroe, WA at Monroe Junior High Rm C7  

Sign up through Sky Valley community Schools Call Kristine at 360-794-3006 or email johnstonk@monroe.wednet.edu.   You can also check the Sky Valley Community Schools website at: http://www.monroe.wednet.edu/S.V._COMM_SCH/default.html

I'm often approached by potential real estate investors about 'flipping' houses.  Like them, I've seen the myriad of TV shows on HGTV, DIY, Discovery, etc. that show individuals and companies around the country taking run-down homes, fixing them up quickly, and making huge profits.  It looks great, and it looks easy.  A recent news article, featured in the Everett Herald suggests that maybe the shows are making it look too easy.  The article focusses on charges against one of the featured flippers in Atlanta that include faking parts of the show, including the sale.   Now, I don't know how legal or illegal his actions were… its a TV show, and we would all do well to remember that shows like this are for entertainment purposes and are not news reports.  

Personally, I try and encourage new investors away from flipping houses.  And, here are some of the reasons why:  

1. Its really, really, really hard to find a house that makes a good flip.  We have a sophisticated market, and typically the problems with houses are built into their market value. If you buy a house way below 'market' (so, the house fixed up would sell for more), there is a good chance the amount below market you get it for is roughly equal to the cost of repairs and upgrades… and in fact reflects its market value.  Unless you are able to do the work, the chances are there won't be much profit in it after paying contractors for repairs.  However, buying fixer-uppers is a great way for folks with more time/skills than money to get into Real Estate, but its not a way to get rich quick.
2. Loss of tax advantages and the ability to do tax-free exchanges.   As a rule, you need to hold your investment properyt for at least a year in order to qualify for a 1031 Exchange, one of the great advantages of real estate investment. To top it off, sell too many homes to quickly and the IRS will classify you as a 'trader' and not an investor. Forget paying capital gains rates on profits… you'll be paying regular income rates!  OUCH!  Real estate is one of the most tax-advantaged investments there are, with tax-deductible interest payments, depreciation, and tax-deferred (tax free) exchanges. But, flipping loses you most all of those advantages.
3. Its capital intensive. All those repairs won't be free. Even if you do the work yourself, you still have to pay for all the materials. And, if you are buying a really rough property, how will you even finance it?  If you plan well, you might get a rehab loan, but chances are you will be looking for private financing, or coming up with cash out of pocket (or borrowed against other property).  But, if you buy real investment property, one that generates income, you can purchase it with little money (sometimes no money) out of pocket. And, once you have properties that pay for themselves, your ability to obtain more property is almost unlimited.  How many houses can you flip at the same time?
4. Flipping is work.  This is one of the biggest disadvantages of flipping. Its one-time income and it typically means you put hours in, working on the flip.  I'd much rather own an income property (or better yet, multiple income properties) that brings me cash in every month with little or no effort on my part. Income real estate is like owning stocks or bonds, only I'm betting you know more about your  neighborhood, city, state, and the real estate market than you do about the business of your favorite stock. 

Easy flipping opportunities are disappearing and we are seeing the casual 'flipper' leave the market. The past couple of years made it possible for almost anyone to buy a property, do very little to it, and sell it at a profit in just a few weeks or months.  The market is still strong, but price appreciation has slowed. If you want to flip properties, be very selective and do your homework. Most importantly, know your marketplace and make sure that killer deal is really that good.  If you are interested in putting in some sweat equity, give me a call (425-417-5389) or drop me an email. I'd be glad to show you some properties that you can get into inexpensively that could make good rentals and that will likely have good price appreciation over the next few years.

In the mean time, enjoy watching those home-improvement and house flipping shows… but don't believe everything you see…

This is an entry from the blog on my Windows Live site (http://www.jasonhershey.com/). I thought it worth repeating, since many folks don't know what a CAP rate is, how to calculate it, or how to use it. So, on to addressing that question…

What is a CAP rate and why should I care?

OK. Time for something educational. Lets talk about CAP rates and their importance in evaluating income property.

What is a CAP rate? CAP rate is short for Capitalization Rate. Now that you know, you can forget that tidbit of info. Nobody actually uses the term "Capitalization Rate".  It is calculated by dividing the annual Net Income of a property by its current market value (its current selling price). Its a relatively simple and easy way to calcualte your rate of return on an income property.  

What is Net Income? Your annual Net Income is your Gross Income less your taxes and other expenses… not counting debt expense.  You should include a vacancy rate, also. (Vacancy rate?  Ok. figure what % of the time you won't be getting rent from your property.)  

Maybe an example will help…. Let's say you are looking at buying a small apartment building with 6 apartments. Is it a good investment?  

First lets look at income Each apartment rents for $500 per month. That gives you a gross annual income, from rent, of $36,000 (12 x 6 x $500). You also happen to have a small laundry room in the building, and the washers/dryers get you another $100 per month in income ($1200 per year).  So, your total gross income per year is $37,200. Not bad.  Now, how often are your apartments empty?  Let's say you have everyone on 12 month leases, and as a general rule, people stay more than a year. You might have a vacancy rate as low as 5% (that is less than 1 month per year per unit).  That means you can count on only $34,200 for rent($36,000 -$1800 (5% of $36K)).  So your effective gross income is actually $35,400.  

Now, what about expenses? First there are taxes, lets say those are only $3,000/yr.  Then you have insurance… so lets say that is $1500 for landlord's insurance and a personal umbrella policy (in case someone trips and falls). You also have to pay your account, the lawn maintenance person, and you have to pay for the water/electric for the laundry room and the outside of the building.  Plus, you want to save up something to replace the roof in a few years… lets say you save $500 per year for that. Those miscellaneous expenses add up to about $3000 per year.  So, your total expenses are $7,500 per year.  

And the Net Income is…. The result is.. net income of $27,900 per year.  

What is the selling price? OK. So what is the selling price?  Well, for our example, lets say the selling price is $600,000. Is that good or bad?  Well, lets calculate the cap rate.  

The CAP RATE…. The cap rate is the net income divided by the selling price, or $27,900 / $600,000, or 4.65%.    Need a calculator, try this web one.. http://www.webcalc.net/calc/business/0886.php

But, what does it mean? Well, there are several ways to use this number.  One way is to compare it to the cap rate calculated for a different property you are considering buying.  If the other property has a cap rate of 6%, then 4.65% isn't very good (higher cap rate is better, all other things being equal).   Another way to look to use it is to compare the cap rate against your borrowing rate. If you are borrowing at 6.5%, then a cap rate of only 4.65% isn't really covering your debt costs.  Now, this isn't completely accurate… it works best for high states of leverage (ie, borrowing 100% of the purchase price).   If you were paying cash or have a big downpayment, then instead compare the cap rate against your return on savings.  If you can by a Certificate of Deposit (CD) from a bank at 5% interest, then a return of 4.65% from your property isn't very attractive… especially considering the CD is virtually risk free.   In some areas of the country, you won't see investors touch anything less that 10% cap rate.  In the Pacific Northwest, for small properties, its hard to find anything higher than 6%.  The latter is due largely due to the huge appreciation in base price of property for other reasons over the past few years (see "But what about…" below).    What cap rate you look for will depend on your situation and your goals. The important thing to know for now, is what it is and how to calculate it.  I am amazed to see investors and even real estate agents, who don't know how to figure out this fairly simple number.  Of course, the final number is only as good as the inputs, so its important to remember that sellers won't always fill you in completely on what hte expenses are. Once you've put in an offer, you can get the actual financial records of the property… be sure to check them.  If you are a seller, this conversation has some important implications for you also… which we will discuss at another time.  

But what about… I know some smart aleck out there is asking… "But what about the appreciation of the property, tax savings, and all that jazz?".  That is where the 'all other things being equal' statement comes in.  The cap rate is good for checking out the value of INCOME property, based on the income.  If you are investing for tax savings, for capital gains appreciate based on the value of hte property,  or for some other reason, the cap rate starts to lose some value.  At that point you may want or need to do a more complex calculation like the Internal Rate of Return (IRR). That helps you account for all the cash flows, like tax savings, selling the appreciated property, etc.  But, with that kind of calculation you also have to deal with more variables… like the rate of inflation, savings rate, etc.  Its a necessary calculation to be able to do, but that is a lesson for another day.    

So, have some fun and grab those calculators!   -Jason