Tag Archives: real estate

The Speed of Trust in Real Estate

 

Image courtesy Franklin Covey (2007)
Image courtesy Franklin Covey (2007)

 

Real estate is a team sport. How well a team performs as a whole depends on the quality of contributions made by each individual member, as well as how each key player functions within the context of delivering results for a successful outcome; on time and under budget. The cost and speed of success depends heavily on a key ingredient that can make or break the efficiency of a team and–in turn–the success of a project. That ingredient is trust. More specifically, that ingredient is smart trust.

In a book entitled The Speed of Trust (2006), Stephen MR Covey points out that although trust is largely misunderstood, it is critically important to learn the “how” and “why” of building trust to increase good will and efficiency of the team. A compelling excerpt from Covey’s book reads as follows (Covey, 2006, p.1):

 The One Thing that Changes Everything

“There is one thing that is common to every individual, relationship,  team, family, organization,  nation, economy,  and civilization throughout the world–one thing which,  if removed, will destroy the most powerful government,  the most successful business, the most thriving economy,  the most influential leadership, the greatest friendship,  the strongest character,  the deepest love.

On the other hand,  if developed and leveraged, that one thing has the potential to create unparalleled success and prosperity in every dimension of life. Yet it’s the least understood,  most neglected,  and most underestimated possibility of our time.
   That one thing is trust.” 

When placing this idea within the context of the real estate industry, it is apparent that trust is rare; if not altogether missing.  Covey explains how trust can be established, developed, and nurtured by constantly getting better at what we do, and aligning our actions with behaviors that embody trustworthy character and competence.

Trustworthiness and credibility become self-evident. When combined with the energies of people who can see and focus on the same vision, team synergy can produce results better than the sum of all parts.

The High Cost of Low Trust

Trust has an economic impact on all areas of life and business; a trust “tax” when trust is low, and a “dividend” when trust is high (Covey, 2006, p.13). It directly affects the speed and cost of making things happen.   To illustrate the point, Mr. Covey dedcribes how the events of 911 impacted the speed and cost of the check-in and boarding process at airports worldwide, as well as the effects of the Sarbanes-Oxley Act that was passed in response to scandals such as WorldCom and Enron. (Covey, 2006, p. 13-14).

When trust is broken, it significantly raises costs and adversely impacts the speed of getting things done.  Low trust slows down the pace of accomplishing things, while increasing the cost of accomplishing those things significantly (Covey, 2006, p.13). This applies to all areas of life and business; including the real estate business.

The Process of Rebuilding Trust

Building or rebuilding trust boils down to consistently demonstrating 13 trustworthy behaviors within the context of four categories,  also called the “4 Cores of Credibility” (Covey, 2006); namely Integrity,  Intent, Capabilities, and Results (p. 43):

These 13 trustworthy behaviors (Covey, 2006, p. 136-222) include:

1. Talking straight
2. Demonstrating respect
3. Creating transparency
4. Righting wrongs
5. Showing loyalty
6. Delivering results
7. Getting better
8. Confronting reality
9. Clarifying expectations
10. Practicing accountability
11. Listening first
12. Keeping commitments
13. Extending trust (smart trust)

Relating the 13 Behaviors to Real Estate

Overall,  these 13 behaviors can be used as benchmarks to measure all kinds of situations; whether it means evaluating a contractor, a coach, or any other member of the investment team. In fact, after benchmarking against these 13 behaviors,  stark realizations may come to light. You may discover and realize that you don’t have the right people filling key roles in your organization; or on your team. When such a discovery has been made, it becomes imperative to replace untrustworthy people as soon as possible with people who strive to be trustworthy, reliable, and dependable. If not, the dynamics common to low trust cultures will adversely affect performance; increasing operating costs, decreasing the pace of progress, and ultimately devastating the outcome of the best laid plans.

In the coming weeks, I will be featuring a blog post about each of the 13 behaviors as they relate to real estate investing, as well as building a high-performance team of trusted advisors and professionals.  It is a way of educating the market in an effort to raise the bar in an industry that typically functions in a toxic low trust culture; where most are in it for themselves at the expense of others. In this respect,  educating the market is key.

As the market becomes more educated about trust and its 13 behaviors, the more power there will be to use benchmarking tools that will facilitate the process of building highly effective teams in the real estate sector. People will finally understand how to consciously nurture and build effective teams upon a foundation of high trust, mutual respect, and consideration starting with ourselves.

Sternlicht Sees Strong Potential in Single-Family Housing Business | REIT.com

By Sarah Borchersen-Keto

REIT.com

[APRIL 24, 2014] Starwood Capital Group Chairman and CEO Barry Sternlicht is expressing confidence that the single-family rental housing sector has the potential to become a major REIT asset class, but he acknowledges that investors remain skeptical.

via Sternlicht Sees Strong Potential in Single-Family Housing Business | REIT.com.

The Fundrise Blog — Where’s the Risk? Understanding the Phases of Real Estate

In real estate, there are essentially three phases of development:

ground up construction

value-add (rehab)

stabilized

These phases represent the natural lifecycle of a real estate deal. Each sequential phase has its own set of work and therefore risk associated with it. In other words, the more phases a project must get through, the greater the risk but also the greater the potential for growth.

via The Fundrise Blog — Where’s the Risk? Understanding the Phases of Real Estate.

 

Bruce Kasanoff | “No one wins unless everyone wins,” Four simple principles for highly effective teams | LinkedIn

Create interdependence: No one wins unless everyone wins. Period. This is the best way to get a team to function like, well, a team. It also fosters insights, flexibility, and resilience. Create shared metrics. Partner team members from different disciplines. Have members with similar skills swap tasks often, even in the middle of working on a deliverable. Share responsibilities, ideas, concerns and alternatives. If these principles make sense to you, you might want to give them a try. But I’d like to suggest you do so only on one condition: that all team members voluntarily want to adopt these principles. via Four simple principles for highly effective teams | LinkedIn.

Most homebuilders are ‘not investable’ right now: Pros

“Uncertainty is no good for these stocks, and until we get some certainty around the taper and around mortgage rates, I think they’re just going to trade up and down and probably end up in the same place,” she said. “They’re tradable but not necessarily investable.”

For homebuilders, “the impact of rising interest rates will lead to slack demand, and that’s going to translate into slow earnings growth,” said Bob Wetenhall, managing director at RBC Capital Markets.

via Most homebuilders are ‘not investable’ right now: Pros.

Multifamily Properties – Why the Cap Rate is Insufficient for Determining Investment Value

 

In the multifamily market, the cap rate or “capitalization rate” plays a dominant role in determining the market price of a property. By definition, it is the calculation used to “determine the ability of the property to carry debt as well as for a measure of overall returns” (Miller & Geltner, 2005, p. 298). However, there are drawbacks that makes the cap rate insufficient for determining investment value. Firstly, the cap rate offers a limited perspective; it only looks at the first year forecast of cash flow; it does not take into consideration the impact of financing and taxes (CCIM Institute, 2005, p. 6.6).

These are important considerations in the overall determination of investment performance. Among investors, it is a “common misconception when using the term ‘cap rate’ that some investors assume the overall cap rate is equal to the return on their invested capital; this is rarely the case” (CCIM Institute, 2005, p. 6.6). Yet, investors continue acquiring properties at 4% – 5% cap rates. It is keeping the price of properties inflated in certain markets. An investor that buys an apartment building at a 7% cap rate could still find themselves earning very low returns–or losing value–if the property does not cash flow as anticipated. Therefore a cap rate is insufficient, because it does not include important considerations such as investor preference, capital investment, or material financial information that would impact how a property performs over the term of the anticipated holding period.

A true reflection of investment value also takes into account the total cost of the property, which includes capital investments, the cost of capital, and the impact of taxes. A cap rate does not accomplish this. It may offer a starting point as to understanding market sentiment; but in order to make an accurate determination of how much a dollar truly earns while it is invested requires that an investor focus on “IRR,” or internal rate of return, instead of focusing on the cap rate. An investor must examine the cash flows that a property produces; they should also determine the perceived risk factor of those cash flows, assign a required rate of return for the level of risk assumed, and then apply that required rate when examining the cost of acquiring, renovating, operating, and maintaining the property. Otherwise, an investor may find themselves realizing paltry returns, if any return on investment at all.

Two properties in the same market might have the same market value by cap rate, but if one property has a higher cost of operation or requires a significant investment of capital to make it rent-ready, it will increase uncertainty and, thus, increase the risk of the cash flows. This increased risk should also increase an investors’ required internal rate of return, which is “the percentage rate earned on each dollar invested for each period it is invested” (CCIM Institute, 2005, p. 6.10). In a low cap-rate environment, many sellers cling to cap rate driven trends and many of them remain firm on price regardless of circumstances surrounding the property. While this is certainly a sellers’ prerogative, a savvy apartment buyer will not let emotion drive the investment decision. Apartment buyers must know up-front how their money will perform and only choose to invest in apartment buildings that will provide attractive internal rates of return—which should be in the range of 15% – 20% for multifamily properties—give or take—depending on the level of risk perceived and assumed by the investor.

Owning and operating an apartment building carries more risk than parking money in a CD or savings account; because of this risk, it should earn a higher return on investment, “To compensate an investor for more or less risk relative to other investment opportunities requires a change in the required rate of return” (Miller & Geltner, 2005, p. 336). Assuming more risk should be a factor in investors’ perception of investment value and what they ultimately pay for the property. If not careful, apartment buyers that rationalize acquiring properties at low cap rates may find themselves earning returns comparable to “safer” investment vehicles such as CDs and savings account. Savvy apartment buyers know that when “determining investment value of a property, the investor decides what to pay to achieve given performance objectives,” (CCIM Institute, 2005, p. 6.2); the sellers’ desire for top dollar does not come into play. Basing investment decisions on a market cap rate alone is the equivalent of catering to sellers; it leaves apartment buyers at risk of finding each dollar invested underperforming—or losing value.  Apartment buyers must be sufficiently compensated for the level of risk they assume, or else money is better off invested in a “safer” vehicle—not real estate.

In order to obtain a perspective that would allow an investor to make an informed decision, an investor would need to look beyond the first year using historical operating data within the context of the intended holding period (typically 5 or 10 years). A cap rate cannot do this, so a cap rate should not be used as the basis of establishing investment value. Investment value is “the amount that an investor would pay for a specific property, given that investor’s investment objectives, including target yield and tax position” (CCIM Institute, 2005, p. 6.3). Please notice that this definition of investment value does not include the involvement of seller preferences.

 

References

CCIM Institute. (2005). CI101: Financial Analysis for Commercial Investment Real Estate. Chicago: CCIM Institute.

Miller, N. G., & Geltner, D. M. (2005). Real Estate Principles for the new Economy. Ohio: South-Western.

 

Avoiding Multifamily Pitfalls: Verifying Tenants before Closing

The due diligence period is an important process when considering the purchase of investment properties, especially multifamily properties. Typically, buyer and seller negotiate a time-period that buyer can use to ascertain whether a piece of property is suitable enough to meet their intended purpose and/or goals. This includes inspecting and verifying leases, property condition, and ascertaining third-party vendor contracts that will transfer with the sale, among other considerations. However—¦

What happens when something unexpected occurs after the due diligence period ends, for example, when a tenant decides to move out shortly before closing and they sublet their unit to someone else, or worse, someone who ends up being a bad tenant without advising or obtaining permission from the former manager and/or the seller?

The Eviction Process: Going Through the Motions

Once closing has occurred, a new owner will have no other choice but to comply with local landlord-tenant laws when dealing with unauthorized occupants. Under the law, even unauthorized occupants have certain rights, especially if the former property owner or manager accepted even a partial payment from them. It can create an implied tenancy. In any case, unless you are dealing with blatant tresspassing, the law prescribes a certain sequence of events that must take place in order to avoid violating the law.

The whole process can take up to 6 weeks depending on the jurisdiction to obtain a proper eviction or an "Unlawful Detainer", which includes serving notices, setting court dates, and getting on the sheriffs‘ calendar when, and if, the court or commission grants the eviction. For new investors, this may seem like a daunting and unpleasant experience. However, when systematically handled, the process becomes an expected part of doing business as a multifamily investor. A good eviction service and/or a real estate attorney are ideal support systems to have during this time.

A Solution: Know What You are Taking Over before Closing


One way to ensure that tenants on the leases are the actual occupants in the units is to insert a clause in the offer that renders closing subject to verifying the tenants as current occupants. It would also be wise to include remedies within this clause in case buyer discovers the presence of unauthorized occupants during the verification process. This way, buyer and seller have pre-agreed in writing how they will handle the situation upon the discovery of unauthorized residents. Any competent real estate attorney can draft the appropriate language of such a clause, or a real estate broker can have their attorney draft the necessary language at no cost to buyer. Either way, there should be something in writing to address the issue of unauthorized tenants before closing. It is a small measure that will go a long way to reduce the chance of having to deal with an eviction process upon taking possession of an apartment building. However, depending on the experience level of an investor, taking responsibility for dealing with necessary evictions may not even be an issue.

There are some experienced investors who specialize in taking over problem properties along with all related tenant issues. These investors are aware of any problems upfront. Their experience level affords them the ability to accept responsibility for handling evictions and to take swift action in cleaning up and turning these types of properties around. They usually do so at a premium at time of purchase. This type of investor will factor the cost of taking on these problems in his or her final purchase price.

(photo: www.jdavisarchitects.com/)

Seven Fundamental Keys to Building Cash Flow in Real Estate

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Whether a person invests in real estate, paper assets (like stocks and bonds), or business opportunities, investment strategies are unique to each individual. This blog will focus on one particular type of income producing asset–real estate. While there are many ways to build an investment strategy around real estate, for example, buying fixers and selling them for a profit or purchasing bare land and developing buildings for sale or lease-the scope of this article will focus on seven keys to building a strong portfolio of cash-flowing properties.

1. Assess Your Situation

(a) Know What You Need and Want

The first item to consider is whether real estate is right for you. It is not for everyone, but if you find that real estate investment is what you want, then designing a real estate investment plan is the best place to start. From a cash flow perspective, identify what your current monthly expense requirements are and how much income you need every month to maintain your current lifestyle. Once you have this figure, consider where you want to be in five, seven, or ten years, etc. How much monthly cash flow will it take to support this future goal? Then add this to your current monthly expense figure and you will have a starting point for your cash flow goals. This figure will most likely change as you begin working your plan and making periodic adjustments to your goals.

(b) Assess Your Direction and Identify Your Preferred Property Type

Within real estate, there are different property types from which to choose from, for example, single-family rentals, multifamily rentals, office buildings, industrial office buildings, warehouses or public storage, retail properties, etc. Each property type has its own unique considerations and operational requirements.

Researching and learning how to operate that particular property type means having the knowledge to manage the management team from an informed position.

(c) Know What Kind of Financing is Available

While the mortgage market recovers from its recent meltdown, financing requirements will remain tight, but there are still options available to facilitate purchases, such as seller financing and lease options. Learning about the different financing options available is a key factor in planning a real estate investment strategy. Financing can mean the difference between a good and bad deal. Before the mortgage crisis, lenders commonly required a 1.20 DCR or “debt coverage ratio”–meaning, they would require 20 dollars of income for every dollar of debt that the property carries. With this information and a property’s net operating income, you can calculate maximum loan amounts and minimum equity requirements (aka. down payment) for any income producing property. This can also help determine whether a property is overpriced and at what price the property will yield your required rate of return.

(d) Set Your Required Rate of Return

If you want your money to work harder than a savings account or a CD, then determine your required rate of return upfront and use this rate to calculate the investment value of a property based on its net operating income. This maximum amount will be the point where you will draw the line on any particular investment. When a seller is not agreeable to your maximum price, then it is time to walk away and find an investment that will fulfill your investment requirements.

(e) A Word About the Tenant Landlord Law

If you are considering single-family and/or multifamily rentals, then you will need to become familiar, if not well versed, in Tenant Landlord Laws. Having a set system that keeps you in compliance with the law is a wise investment of time and money. Management companies and real estate attorneys can be helpful in this area.

2. Set Minimum Property Requirements and Limits

From a cash flow perspective, the ideal situation is to start receiving rents the following rent period after closing. If you have to gut and rehab a building entirely, there will surely be a period of downtime and you may have to support the property until you are able to lease and begin receiving income. If your goal is immediate cash flow, then a major rehab project may not be the right project type to consider. Instead, a well-maintained property or one that needs a minor amount of cosmetic work with a steady tenant history is the ideal property from a cash flow perspective.

3. Assemble a Stellar Team

Assembling a team of professionals dedicated to your financial success in real estate is a key component in realizing your cash flow goals.

The Real Estate Broker – A buyer’s broker who is also an experienced investor, if you want to avoid dual agency, then find an exclusive buyer’s broker to work with.

The Mortgage Planner – A mortgage planner that specializes in investment and commercial properties

The Financial Planner – A financial planner with a positive perspective towards-and a full understanding of-real estate investments

The Real Estate Attorney – To review all loan and closing documents before signing, as well as any contracts or agreements-this is a CYA (Cover Your Assets)

The Management Company – A professional management company with a solid reputation will free your time so you can live your life and look for more properties to buy

The Property Inspector – This team member should have experience inspecting your chosen property-type.

4. Real Estate Investments Are About the Numbers

Leave Emotions at Home

Buying a real estate investment is about making money with property-not falling in love with property. This is especially bad, if the seller becomes aware of the infatuation. Investment real estate is about what it can do to bring you closer to your income goals, period.

5. Buy Properties Right

List Price Does Not Set Property Value

Regardless of the price, you see on a listing, a property’s investment value will vary between investors because his or her required rate of return will be unique to each situation. Therefore, a list price is just an asking price. Set your required rate of return and make an offer accordingly. If meant to be, the seller will either accept or open up negotiations. If not, then it will be better to walk away than to end up with a property that does not meet your investment goals.

6. Periodically Re-Assess Your Direction and Make Adjustments as Necessary

If you started out with single-family rentals, you may decide to upgrade and own small multifamily buildings. If you own small multifamily buildings, you may decide it is time to buy your first 16 or 20 unit building, etc. The point is to keep your eyes on the horizon for new opportunities to grow your knowledge and portfolio of income properties. With experience comes confidence and with confidence comes new learning opportunities that will continue on a path of limitless growth. When it comes to learning, growing, and evolving we limit ourselves by the barriers we place upon ourselves.

7
. Cash Flow Strategy: Buy Right and Hold Long-term

The key to building cash flow through real estate investments is to buy properties that satisfy your investment requirements upfront and holding them for the long term–a minimum of five years or ideally ten years. Have an exit strategy in place before the property approaches the end of its holding period. Start learning about 1031 tax-deferred exchanges and speaking to a specialist who can help guide you through the process well in advance. Being familiar with the process will ensure a smooth exchange transaction and preserve your wealth-building strategy when the time comes. Your accountant, tax attorney, or a financial advisor well versed in the area of 1031 exchanges can provide you with more information.

In closing, real estate investing can be a very rewarding experience. It requires planning and knowledge, but the end-result can secure your financial future. Education and motivation are key factors in building wealth and achieving financial independence.