Category Archives: Rental properties & 2nd homes

Useful information for owners of rental properties and 2nd homes.

Worried about selling with unpermitted changes to your home?

Much confusion exists with homeowners who either made significant changes or inherited a home with unpermitted changes. Are you required to have everything permitted before selling? What effect on your home’s value would obtaining permits have?

The difference between knowing and not knowing if  you have permits can be a smooth escrow or a nightmare!
Do you know if your home has permits?

In the case where you purchased a resale home and you’re not sure if permits exist, it would be a good idea to confirm whether or not the city has any records. Don’t worry — it’s not like the city’s employees are looking for homes to place “red tag” violations on. Most cities have online records on their websites.

The City of Anaheim allows residents to access permits online.
The City of Anaheim allows residents to access permits online.

A room addition can have a huge impact on value.
A room addition can have a huge impact on value.

The most significant change to a home is a room addition. The difference in square footage can complicate an escrow if not handled correctly.

If you know permits don’t exist, don’t panic. You have options:

1. Apply for permits. Depending on how drastic the changes were, costs and time can vary from a few hundred dollars and a few months to several thousand dollars and over 1 year. If the changes to your home don’t comply with local building codes, they may require further construction.

2. Sell home without permits. In this option, if the construction is done in a “workman-like” manner, homeowners can often get away with disclosing the alteration to the home along with any information they may know.

In either case, it would be best to obtain the advise of an experienced agent before you decide. If you can imagine, a home built before 1980 is likely to have changed hands several times with many unpermitted alterations and additions. Many housing tracts built in the 1950s hardly resemble their original post-war designs.

Impact on value

A seasoned Real Estate Agent can help you anticipate possible issues. They’ll know if it’s appropriate to market the home with the additional square feet or alteration. Since appraisers will often verify if permits exist, your agent will need to have measures in place to comply with conventional, FHA, or VA financing that the buyer might obtain.

In many of the North Orange County cities, losing value on a room addition can cost you around $280 per square foot if you don’t plan correctly!

How important is a tenant’s cooperation when selling a rental home?

After evaluating all your options, you’ve decided that selling is in your best interests. However, your relationship with your tenant has been shaky at best.

You can sell without their cooperation, right?

That depends. If you’re like most sellers, you want the most money the market can offer. Although most rental agreements state that the tenant must cooperate with prospective tenant or buyer showings, getting their cooperation is a totally different story.

Most lease contracts already have language saying that the tenant will cooperate with showings. However, will they?
Most lease contracts already have language saying that the tenant will cooperate with showings. However, will they?

Here are the options when selling an occupied home:

  1. “Go direct” – this tells Real Estate agents that they can show the home without an appointment. While this is the obvious option if the home is vacant, I’ve seen this work with tenants who work during the daytime or work from home and aren’t inconvenienced by buyers dropping by unannounced. Having a published showing schedule works best for this arrangement. (i.e. – “Go direct between 10 am – 5 pm, Monday – Friday.)
  2. “Call first, go direct” – this option requires Real Estate agents to call (or text) with a time of showing. It doesn’t require confirmation by agent or tenant. In most cases, the phone number provided goes into voicemail and agents leave a message.
  3. “Appointment only” – you are now entering restrictive territory for agents. If the agent calls and there is no answer, they must leave a message and wait for a return phone call prior to showing the home.
  4. “24 hour notice required” – as implied, showing the home on a whim isn’t possible. Agents must call at least 24 hours in advance and the tenant must agree.
  5. “Drive by only” – this is the most restrictive of all options. Buyers aren’t allowed to see the inside of the home unless they have an offer accepted by the seller. With this option, the fewest amount of buyers are able to view the home.

All the marketing in the world won't matter if the buyers aren't allowed to see the interior.
All the marketing in the world won’t matter if the buyers aren’t allowed to see the interior.

The whole premise of placing a home on the open market is to allow as many buyers to view the home in hopes of reaching a deal with the party who’s willing to pay the most. When you restrict showings in situations like 3-5 above, you’re likely leaving money on the table.

When I work with buyers, a great deal of my showings are spur of the moment showings where the buyer saw something online, then texted the address to me a few minutes before our appointment time of showing other homes. These impromptu showings won’t work with options 3-5.

Why would some listing agents insist on a “drive by” arrangement?  

Unfortunately, drive by listings have become more prevalent in recent years. In some markets, it’s typical for a listing agent to “block” showings of buyers who are represented by other agents. This allows the unethical agent to make more money on the sale by representing both sides. Another reason comes from less work needed by the listing agent due to less phone calls from buyers agents requesting showings.

In both cases, the lack of the agent taking a fiduciary stance (placing the seller’s interests above their own) can result in either the home selling at a reduced price or not selling at all.

Ok….Options 1 & 2 are the way to go. What can you do to convince your tenant?

Make arrangements so it's a "win-win" situation.
Make arrangements so it’s a “win-win” situation.

Give notice to terminate tenancy. If their lease agreement is expiring in 2 months or less, it would be best just to have give notice and inform the tenant that you will be selling. The notice would correspond to local laws and honor the current lease agreement in place. This will allow the home to be vacant and agents show by “going direct” as in option #1 above.

If a significant portion of the lease term remains, you can try to reach a mutual agreement with the tenant to amend the lease term. Sometimes, the tenant actually wants to move out and was only trying to hold up their end of the deal.

If mutual agreement isn’t reached, you can try adding incentives. You can try a variety of incentives, such as: a guarantee of full refund of the security deposit, volunteering to write a letter of recommendation, or even paying them additional money beyond their deposit.

In the case of the adversarial relationship with a non-paying tenant, you’ll want to complete the eviction or negotiation for them to move before placing the home on the market.

As you can imagine, some of these can backfire, so be careful when presenting any of these options to your tenant. If you’re thinking of having your Realtor approach the tenant(s), you’ll want to make sure they know what they’re doing and have the track record with rental homes to prove it. In my Real Estate career, I’ve dealt with a variety of situations and only one instance resulted in attempting to sell the home as “drive by only.”

Allowing showings is only one part of maximizing your sale. Preparing the home and marketing is next. 

 

Thinking of selling in 2014? How will the new 3.8% Obamacare tax affect you?

TaxesWith the passing of the new “Obamacare tax” which introduces a new, additional 3.8% tax, much confusion has transpired to homeowners who are thinking of selling in 2014.

Does this mean that all sellers will be subject to a 3.8% tax on their gain?

No. Since there are many complexities that surround this new tax, I’ll try to break it down into (3) yes or no questions:

Will waiting until 2014 end up costing you?
Will waiting until 2014 end up costing you?

1. Is the gain significant? For the individual: is the “realized gain” from the sale greater than $250,000? For couples: is the “realized gain” from the sale greater than $500,000? In a simple example, the realized gain is the selling price minus the price that you purchased the home. Of course, there are factors that can make the numbers change.

2. Is your income too high? For the individual tax filer: is your adjusted gross income greater than $200,000?  For couples filing a joint return: is your adjusted gross income greater than $250,000?

3. Is the home an investment property? If you hesitated or didn’t know how to answer this, you’ll need your tax advisor to explain if the home is a primary residence or not. 

If you answered “no” to all questions above, there’s a good chance this tax won’t affect you. For more examples, you’ll want to browse the National Association of Realtors’ publication titled, “The 3.8% Tax – Real Estate Scenarios & Examples.”

This interview I conducted with Noel Dalmacio has a few examples where a sale resulted in tax liability:

If you’re seriously considering selling, you’ll need to seek the advise of your accountant on this matter. Make sure the accountant is well versed on this new tax.

If you discovered that you have significant tax liability, one option to consider is a 1031 exchange.

Bottom Line: Yes, the new tax will end up affected many sellers who have significant equity. However, with the recent appreciation surge of the past year, most will be better off selling now vs. 1 year ago.

Thinking of cashing out your rental property or 2nd home? 6 questions that will help you decide if you should sell or wait

Is it time to cash out?
Is it time to cash out?

While it’s true that Real Estate can be one of the most safest ways to accumulating or maintaining wealth, the reality is that most become a Real Estate investor by accident. 

You have a home that you might have acquired from an inheritance or due to reluctance to sell when you purchased another home. Whatever the reason, you’re stuck with a piece of Real Estate and you don’t know if it’s a curse or a blessing.

Keep in mind that ideally, you should never sell Real Estate. There are tons of reasons why hanging on to a property indefinitely would be in your best interests.

However, we don’t live in an ideal world. Here are a few questions that can assess your situation:

1. Do you need the money from the sale now? There are other options to selling: A Cash-out refi or Home Equity Line of Credit (HELOC). Keep in mind that this is a loan and will directly affect question #3 below. If you don’t need the money now, how long can your lifestyle and bills continue to be paid until you do need a lump sum of cash?

2. If you determined a time period from answering #1, what do you think is the market outlook X years/months from now? National Association of Realtors and your local Real Estate association provide both national and local forecasts. Obviously, if you think prices are going down, it might be a good idea to sell. If you think your value will appreciate, keep in mind that a negative cash-flow situation might negate any gain.

3. How does your investment look from a cashflow standpoint? Before you make the common error of simply subtracting the mortgage payment from the market rent, keep in mind that there are other significant costs: property management fees, vacancy periods, maintenance, taxes, HOA dues, etc. You can create your own spreadsheet or use a software tool such as REAP. If your property generates income after subtracting everything, you likely have tax liability. If you have negative cashflow, can you refinance your home? Is it time to raise rent on a long term tenant?

4. What tax advantage(s) would you be walking away from? Since one of the advantages to owning Real Estate is lowering your tax liability, do you know how much additional dollars you’d have to pay in tax? Speaking of tax, you’ll want to familiarize yourself with the new Obamacare tax and how it applies to Real Estate.

5. Are you looking to obtain a loan to purchase another property? If so, your “debt ratio” is even more important than your credit score when obtaining a loan. Your cash-flow determined from #3 above would directly affect this. In most cases, the lender will only use 70% of gross rental income.

Being a landlord should be treated like owning a business.
Being a landlord should be treated like owning a business.

6. Do you want to be a landlord? Collecting monthly rent, maintenance, advertising to new tenants, evictions, bookkeeping, and tenant disputes all go with the territory of being a landlord. Even if you’re letting relatives or friends live in the home for free, you’re still a landlord.

If this evaluation has you leaning toward selling, it would be a good idea to meet with a Realtor to get some additional input. Although agents always love to sell homes, the good ones always look to keep relationships intact by advising clients and the public what’s in their best interests for the long term.

Moving? What to do with your existing home? Selling vs. Holding as a Rental

If you’re like many, you’ve been watching the Real Estate market on the sidelines and decide it’s time to make a move. What to do with your existing home? Should you keep it as an investment property? Or do you cash out the equity and use it toward your down payment? Maybe use the equity toward another type of investment?

 

When deciding to move from an existing home, you need to classify yourself in one of two categories:

 

  1. A homeowner who must sell in order to buy
  2. A homeowner who can qualify to own an additional property

 

In order to find out which category you belong to, you’ll need the help of a loan officer and Realtor. The Realtor will determine your home’s value and potential rent from today’s market conditions. After those numbers are determined, a loan officer can determine if your credit, income, and other factors will allow you purchase an additional home.

 

Without getting into too many details, some situations allow you to use potential rent as part of your income when your home has enough equity. Your income and existing debts will factor into your “debt-to-income” ratio.

 

If the loan officer determines that you can’t qualify for an additional property without selling your existing home, the analysis ends here. You need to sell before thinking of purchasing.

 

If the loan officer thinks you can qualify, this brings to the table further analysis. Not all properties should be held as a rental.

 

Most Real Estate investors take into account 3 factors when evaluating a property:

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A local investor shares his methods at a Landlord Workshop.

  1. Appreciation & rent improvement potential – does the neighborhood or local area have an upside that will outpace surrounding markets? Some examples include a new school, shopping center, rejuvenation or updating projects by government, influx of affluent neighbors, etc. Are there improvements that can be made to the home that can increase rent or value? Especially in the case where a property has 2 bedrooms or less, adding an additional bedroom can make rent and value increase significantly.
  2. Cash flow – I know several homeowners who have neglected this aspect of an investment property. In one instance, I remember a homeowner who had a negative of $2,000 per month and ended up selling when his home’s value increased by $50,000 in 3 years. He actually thought he “made money” when the truth was that he LOST money from -$72,000 in cash flow. Another common mistake is when a homeowner incorrectly calculates their expenses with only their mortgage and property taxes. Don’t forget about maintenance, your time, repairs, income taxes, and   time the home will be vacant. Some landlords simply deduct 20% from their income to estimate their “NOI”, or Net Operating Income.
  3. Acquisition price – Buying a home low and below market value is the key to everything. You probably realize that it has a direct effect on #2 above. Since you already own the home in this situation, it’s something to be mindful about on your next rental.

Meet with a local Real Estate Agent to help you plan.
Meet with someone experienced at rental properties.

It would be a good idea to sit down with someone who has investing experience. Buy them lunch or have a discussion over a cup of coffee. Their advise can go a long way. I have a friend who keeps things simple without anything fancy: “if it doesn’t have positive cash flow, it’s not worth it to me.” In contrast, I have a co-worker that has detailed spreadsheets where it looks like the stuff Fidelity would give you when you invest in one of their mutual funds. I personally use Dolf De Roos’ Real Estate software called “REAP”: http://dolfderoos.com/software/