Should I use cash or credit? ARM loan or fixed rate? Ten percent down or twenty percent? Should I pay down debt or keep a cash reserve? These are all good questions, and here’s some of the answers.

Cash vs. Credit: The Concept of Leverage

In order to understand real estate financing, it is important that you understand the time value of money. Because of inflation, a dollar today is generally worth less in the future. Thus, while real estate values may increase, an all-cash purchase may not be economically feasible, since the investor’s cash may be utilized in more effective ways. Leverage is the concept of using borrowed money to make a return on an investment. Let’s say you bought a house using all of your cash for $100,000. If the property were to increase in value 10% over 12 months, it would now be worth $110,000. Your return on investment would 10% annually (of course, you would actually net less, since you would incur costs in selling the property).

If you purchased a property using $10,000 of your own cash and $90,000 in borrowed money, a 10% increase in value would still result in $10,000 of increased equity, but your return on cash is 100% ($10,000 investment yielding $20,000 in equity). Of course, the borrowed money isn’t free; you would have to incur loan costs and interest payments in borrowing money. However, you could also rent the property in the meantime, which would offset the interest expense of the loan.

Taking leverage a step further, you could purchase ten properties with 10% down and 90% financing. If you could rent these properties for breakeven cash flow, you would have a very large nest egg in 20 years when the properties are paid off. Balance that with what you could make by investing the cash flow on one free and clear property for 20 years. And, of course, look at the potential risk of negative cash flow from repairs and vacancies on ten properties. Finally, consider the tax implications - if you have cash flow, you have taxable income; if you have increase in equity, there’s no tax until you sell.

Cash Flow vs. Cash Reserve

On a similar note, the size of your down payment will affect your cash flow on rental properties. Let’s consider two examples.

Example 1: $100,000 property with $20,000 down. $80,000 loan @ 6% interest, including taxes and insurance is about $600/month. Assuming you could rent the property for $800/month, you have $200/month cash flow or $2,400/year. Not bad.

Example 2: $100,000 with no money down. $100,000 loan @ 8% (higher rate is generally common for zero-down loans) would make your payments closer to $900/month. With zero down, you have $100/month negative cash flow.

Which is better? Well, it depends on what your goals are and what the rest of your financial picture looks like. Let’s say your goal was to hold the property for 10 years. In the first example, you have $200/month cash flow, but no cash reserve. In the second example, you would have $100/month negative cash flow, but you have $20,000 in reserve. The knee-jerk reaction of some people is that example #1 is safer. But is it really?

Think about it… in the first example, if your property becomes vacant for one month, you’d be out of pocket $600. It would take three months to make that up. In the second example, you have $20,000 in cash cushion to make up the deficit. With $20,000 in the bank, you could handle $1200/year negative cash flow for 16 years. If the property were in an appreciating market, you’d come out fine, even with negative cash flow. Another factor is the choice of loan. You could buy a property with nothing down and an interest-only loan fixed at 5% for three years. If your exit strategy is a lease/option that should cash you out within 36 months, why do a fixed-rate loan?

The point here is that you should not automatically go with a fixed-rate loan. Nor should you seek positive cash flow as the only goal. Likewise, you should not buy properties with nothing down and negative cash flow and assume that short-term market appreciation will be the only source of your profit.

Paying Down Debt

For years, our parent’s generation discouraged debt as a “bad” thing. For some investors, the goal is to own properties “free and clear,” that is, with no mortgage debt. While this is a worthy goal, it does not always make financial sense. If you have free and clear properties, you will make certain amount of cash flow and pay a certain amount of income tax. If you need more cash, you are forced to sell the asset, creating a taxable gain.

If you refinance a property, there’s no taxable event. And, since mortgage interest is a deductible expense, the investor does better tax wise by saving his cash. Think about it… the higher the monthly mortgage payment, the less cash flow, the less taxable income each year. While positive cash flow is desirable, it does not necessarily mean that a property is more profitable because it has more cash flow. More equity will obviously increase monthly cash flow, but it is not always the best use of your money. On the other hand, paying down debt may make sense if you can’t get a higher return elsewhere in the market. Also, if paying down debt can have other rewards, such as bringing a loan below 80% LTV, you may be able to cancel private mortgage insurance and save additional money.

In Short, Don’t Rely on Assumptions… Do the Math!

Finding good real estate deals is an art that takes time to master. Like any business, customers are what drive it. Your primary customer is the seller who is motivated to sell below market value. Finding motivated sellers requires advertising, marketing, salesmanship, and, like any business, keeping your nose to the ground.

Nothing happens and nothing matters in real estate until you find a deal. You cannot put together a deal without a motivated seller and you can only convince a motivated seller to do something creative or that involves a discounted price. A motivated seller is one with a very good and pressing reason to sell below market.

The most common problem new investors face is finding bargain properties. Many who start out in real estate investing quit without ever buying their first property. They go through the motions of looking for deals for a few weeks or months and then decide it doesn’t work. They forget that finding motivated sellers is similar to the salesman finding his first customer . . . it takes persistence and hard work.

Find the Motivated Seller

At the cost of sounding redundant, the concept is simple: find motivated sellers that are willing to sell their properties at a discounted price or “soft” terms. Currently, the real estate market in some parts of the country is hot, hot, hot! Many people are complaining that the strength of the market precludes investors from finding deals on properties. The popular misconception is that in a rising market, even the most motivated seller can find a buyer for his property at full market price.

The truth is, you can find deals in ANY market. Real estate legend A.D. Kessler once said, “There are no problem properties, just problem ownerships.” The definition of a motivated seller fits squarely within Kessler’s idea. A logical person knows that time, money and effort can solve virtually any real estate problem. However, some people are too emotional about their real estate problems or have other motivating issues to deal with.

Some of these issues include:

* Divorce

* Lack of concern

* Inexperience with real estate repairs

* Time constraints

* Death of a loved one

* Job transfer

* Landlording headaches

* Impending foreclosure & other financial problems

Farming Neighborhoods

Successful real estate agents utilize a technique called “farming” to increase their business activity. They pick a neighborhood or two and focus their marketing efforts within that area. You should try the same technique. Start with a neighborhood that is relatively convenient for you.

1. Drive the Area

Spend a few weekends driving around the area. The goal for you at first is to learn about the area, the style of houses and the average prices. Over time, you may expand your farm area, but stick with areas that contain the type of homes you plan to purchase. It is not necessary to begin your investment career by learning every square mile of a large metropolitan area; it is important to learn the value of “typical” homes in your target areas. This knowledge will enable you to make quick decisions about whether a particular prospect is a bargain.

2. Attend Open Houses

Visit open houses and “for sale by owner” (FSBO) properties on weekends. Speak directly with owners and their agents. Pass out your business cards. Make friends. Word of mouth and referrals are a big part of any business.

Part of the process of finding a deal is to know how to recognize one. Take a good look at the property and its physical features. After viewing a couple of dozen open houses in the neighborhood, you will get to know the value of the properties and the different styles of houses. When someone calls you about a house in that area, you will know the value by its description.

3. Look for Ugly and Vacant Properties

While you are driving around neighborhoods, look for vacant, ugly houses. How can you tell if a house is vacant? Look in the window! Of course, this practice may get you shot, bitten by a dog or arrested. First look for the obvious signs of vacancy - overgrown grass, no window shades, boarded windows, newspapers, garbage, mail piled up, etc. If you are not certain whether the property is vacant, knock on the door. If the owner answers, be polite, respectful and ask if he is interested in selling. In many cases, it may be a rental property, so ask the occupants for the name and telephone number of the owner.

If the property is vacant, ask the neighbors if they know the owner. Most neighbors are helpful, as they know “ugly” houses hurt their own property values. In addition, ask the mailman - they know all of the empty houses on the block. Leave a business card and write down the address of the ugly or vacant properties. When you get home, look up the name and address of the owner. Finding the owner of a vacant house can be difficult, which is why the persistent people who find the information make the most money. The name of the owner can be found by calling your local tax assessor’s office or by looking up the deed recorded with the County land records.

If you want to contact the owner, it takes a little more digging. Try speaking with the neighbors or asking the post office for a copy of a change-of-address form on file for the property. Online services, such as www.infousa.com, will search public databases, such as the Driver’s License Bureau and the Department of Motor Vehicles.

Some cities, towns and counties will “tag” a house with code violations. This is often a sign of a neglected or vacant property. Ask your city if you can obtain a list of such properties or find where this information is publicly recorded.

Having run a real estate club since 1994 with 650 members and having attended 50 or more other clubs around the country to speak at, I have a few observations and insights. If you want to get the most out of a real estate club, follow these 5 rules…

Get What You Can From Every Speaker

Real estate clubs are often under-funded and not-for-profit. As such, they cannot afford to pay professional speakers a fee to speak, so most speakers who volunteer to do so have something to sell. In many cases, it is a book, tape set, mentoring or boot camp. Some people are “offended” that speakers are selling something, insisting that the speaker reveal everything he knows about a topic in a 90-minute meeting.

Understand that everyone has something to sell, whether it is a guru selling a course or a minister selling the “the word”, while passing around the collection basket. Everyone who speaks at a group has an “agenda”, otherwise he or she would not be standing on the stage speaking. Even the most hardcore “pitchmen” do offer some great ideas during their presentations, so you need to get past the “I’m not here to be sold” attitude and get what you can from the speaker. A speaker cannot reveal everything he knows in 90 minutes, otherwise he or she isn’t qualified to take the stage. So, you should expect a certain amount of stories, jokes, anecdotes and yes, a sales pitch for something. Listen carefully, however, you might also learn something!

Respect Other People’s Time

Many newbies always expect they can take a veteran investor out to lunch to learn the business. Most veteran investors won’t do this, unless they are fairly certain you will bring them deals. And, the “teach me the business and I’ll bring you deals” attitude doesn’t work. If a veteran investor teaches you everything he knows and you do nothing (or you do invest and don’t bring him deals), he’s wasting his time. I know this from personal experience, having taught dozens of newbies the business for free, thinking they would come bring me deals. At one point, I woke up to reality - people who don’t pay for their education rarely uses it! Many people know that I charge for mentoring and I charge quite a bit. And yet the more I charge, the more people appreciate the advice and use it.

Be willing to pay people money for other people’s time. You wouldn’t expect a doctor to let you take him out to lunch for a consultation, so why is an investor’s time any different? Keep in mind that most investors have paid thousands of dollars over the years for seminars and courses. Many feel that sharing information with others for free is simply unfair in that respect. And, most importantly, don’t waste other investors’ time trying to learn the basics. Undoubtedly, you have seen dozens of unanswered posts on investors sites from people asking general questions that can be found in a $15 book. Go to the bookstore and buy 10 paperback books and read them. If you are not willing to spend $150 and the time to read 10 basic books, you aren’t ready to be an investor - period!

Let People Know Why You Are There

If you sit in the corner drinking coffee, you aren’t networking and marketing your most valuable asset… yourself! If your club does not have big name tags, make yourself one. Make it big and colorful. Have a statement about what you do and what you are looking for. There’s one guy at our club whose nametag reads, “The Mobile Home Guy.” Everyone knows him. Everyone calls him when they need to sell a mobile. Be creative and aggressive. Ask your club leader if it is permissible to pass out flyers - bring big, colorful flyers that read “I Have Houses To Wholesale - Call Me” or “I Am Looking For Rehab Properties On the West Side - Call Me.”

Get yourself a fancy business card and hand it out to everyone. And, don’t use the cheap computer-printed garbage, go spend $50 and get some nice double-sided cards that explain who you are and what you do. In short, if you show other investors you are serious about taking action, you will get their cooperation.

Join Membership Immediately

It amazes me how many people hesitate to join membership in their local real estate associations. For a few hundred bucks, you get access to one of the best resources you can find - other investors. Why spend all your time looking for the “right” mortgage broker when you can ask other people in the club? Why run ads in the paper for your wholesale deals when you can send an email to a dozen other investors you met at the club? Heck, even the fact that you are a member of the club will give people a reason to do business with you versus someone who isn’t a member.

I’ve been running a real estate club for 9 years and I can honestly tell you that I always go to the membership roll whenever I need a deal, a partner, a recommendation or money to borrow. Also, volunteer to assist with the meeting. Volunteers often get on the “inside track” to becoming a board member, which gives you a lot of influence in the club. Offer to write articles for the newsletter on your own area of expertise that may be related to real estate. If you are an experienced investor, offer to teach a beginner’s class or host a breakfast meeting.

Respect The Rules

Be considerate others at the meetings. Every club has rules, so be mindful of them. Show up early so you don’t disrupt the meeting. Don’t pass out flyers without asking permission. Don’t stand in the back of the room and yack while the speaker is onstage. Don’t shout out questions to the speaker without raising your hand. Close the door to the room quietly when you go to the restroom. And, for Pete’s sake, turn off your cell phone!

Did you ever have to evict a tenant for non-payment of rent, then get stiffed for the bill? You may be able to collect what is owed to you, even years later.

First, you need a court-ordered money judgment. If you filed for an eviction in court, you received a judgment and order of possession. The actual name of this court order may change slightly from state to state, but it’s the same thing - a document signed by a judge that permits a local sheriff or constable to forcibly remove the tenants from the property. In most states you can also get a money judgment against the tenant, but this requires one of two things:

1) the tenant must have been personally served with the court papers or…

2) the tenant must have shown up in court. If the eviction papers (the court papers, not the notice to rent) were posted on the door of the unit and/or mailed to the tenant, you generally do not get a money judgment from the court.

What About Security Deposits?

If you have a security deposit from the tenant, you can apply that against anything he owes you for back rent or damages. However, you still must comply with state law for notifying the tenant of your intent to keep the deposit. Even if you return the security deposit, you can still sue the tenant for actual rent owed and/or damages incurred to the unit. If the tenant left before the court date or you did not otherwise get a money judgment, you can always sue the tenant in your local small claims court for money owed and any damages to the property. The process is quite simple, and does not require a lawyer. You have to file the claim before the end of the statute of limitations, which generally ranges from three to six years, depending on which state you live in.

Once you have a money judgment, you can collect it against all non-exempt assets of the debtor. Certain assets, such as retirement accounts, are exempt from collection by creditors. Also, keep in mind that assets of the debtor’s spouse may be attached as well in states that recognize community property (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin). Cash in bank accounts is the easiest target. If you have a copy of a recent check from your tenant, you can file for a “levy of execution” on their bank accounts through the local sheriff (this is why it is a good practice to make copies of your tenants’ checks each month to make sure you know where they are banking).

If the tenant is working, you can garnish wages, but most states limit garnishment to 25% of the wages of the debtor. Still, if they have a steady paycheck, you will get your money back, plus interest. If you get a transcript and record the judgment in county records, the tenant will not be able to buy a house in that county without paying you off. If the tenant owns other real estate in his name (not likely, but always possible), the judgment will create a lien on that property as well. If you do not know where the tenants assets are located, you can start a debtor proceeding in court to make him appear in court and answer questions regarding his assets. Failure to comply may result in a warrant issued for the debtor’s arrest. Depending on the amount of money owed and likelihood of collecting, this process may not be worth your effort. But, considering a judgment may be valid for as long as 10 years and you get interest on your money, why not make it a part of your business practice?

You can deliver a mailing piece up to 3.3 ounces for between 11.6 and 12.9 cents each. You probably receive “junk mail” delivered at this rate. I get postcards, self-mailers, brochures, flyers, coupon books and local store catalogs on a regular basis delivered using the US postal service’s Enhanced Carrier Route (ECR) rates.

As a real estate investor, you can get more sellers calling you and sell your houses fast using the lowest postage rates available. It works when you want to concentrate a mailing to all homes in a certain neighborhood or area.

We already mailed an oversized postcard to sell 6 of our houses and next week will deliver my famous “advertorial” to homeowners convincing them to call if they want to sell their house quickly and easily.

After showing other investors how to use this low cost, direct mail approach, I have figured out the best way for you to research it and use it yourself. Look in your phonebook under “mailing services.” You’ll also find print shops and letter shops that can help. Tell them you want to saturate several neighborhoods with a postcard. You want to use their “standard Mail” permit or you can get your own. The cost for your own is $125 to setup and $125 a year. But the mailing house may prefer or require you use theirs. That’s good.

Tell the vendor you want to mail to all residents. This is also known as a SATURATION mailing. In some areas, instead of an address label, you can have POSTAL CUSTOMER or BOXHOLDER or RESIDENT preprinted on your postcard. In other areas you’ll need to buy a RESIDENT LIST which includes all the addresses in a certain zip code or carrier route, but not names. We checked several sources for lists and were quoted 1 cent to 3 cents each. Do pay more than 1 cent each. If you can’t get it locally then you can get it from a national company. In fact, it’s possible to do the entire job (print, address and mail) with a national company.

If addresses are required, one source you can look into is www.melissadata.com. In fact, if you go to their site, you can get a count of the number of addresses and carrier routes for any zip code you enter. Their cost is about 1 cent each for online download, CD-ROM or labels.

The key postal term to mention is Enhanced Carrier Route Walk Sequence Saturation (ECRWSS). When prepared properly, the mail carrier will deliver one mail piece to each address on the route. That is a minimum requirement, all addresses on a route.

My next mailing will be to an entire zip code has 17 carrier routes, and about 8,000 addresses. If I wanted to I could further target my project to selected carrier routes only.

The cost on my last mailing was 11.6 cent postage each. To get that rate we delivered (to each respective post office) presorted stacks of cards, one for each carrier route with the number of cards needed for each route.

If you do not deliver the cards to each individual post office, then the rate is 12.1 or 12.6 cents. I have found that the easiest way to do it is to let the mailing houses do it all. Tell them what you want and let them figure it out. Get several bids.

I suggest you put your marketing message on a double-sided 4.25″ x 8.5″ (half sheet) postcard. That way your printing cost will only be 3 or 4 cents each. Use yellow or bright yellow card stock. Your “message” should be filled with reasons why they should respond…what’s in it for them.

My first mailing was to a rural area so no labels were required. We just put POSTAL CUSTOMER below the permit imprint. That saved us from buying a list and addressing the cards. Our next mailing to a city area which requires addressing. A mailing to rural routes or postal box holders only should not require labels. Your local mailing house or letter shop should have experience with these types of mailings and can help you plan your campaign and design your postcard (i.e. the position of the permit and address info).

For more info you can search http://pe.usps.gov/ for “enhanced carrier route walk sequence saturation.”