Insider Secrets to Financing Your Real Estate Investments: What Every Real Estate Investor Needs to Know About Finding and Financing Your Next Deal

By Frank Gallinelli

Everything real estate investors need to know about finding, financing, and closing real estate investment deals

Navigating the complexities of real estate financing can be a major obstacle for the real estate investment novice. Now this quick-reference guide arms them with a road map for finding, evaluating, and financing golden investment opportunities. From due diligence made easy, to writing winning loan proposals, to successfully negotiating with sellers, to making sense of closing statements, Insider Secrets to Financing Your Real Estate Investments covers all the bases. Using dozens of annotated forms and checklists, Frank Gallinelli tells you what you need to know about:

• Selecting the best real estate investments for individual investor needs
• What lenders are really looking for in real estate investors
• Creating winning loan presentations
• Closing statements and what to expect when the deal is sealed

• Language: English
• Publisher: McGraw-Hill Education
• Release date: Jan 21, 2005
• ISBN: 9780071465182

Frank Gallinelli

Frank Gallinelli is the founder and president of RealData, Inc. (www.realdata.com), a real estate software firm offering analysis and presentation tools for investors and developers since 1981. A graduate of Yale University, he is the author of several books on real estate investing and finance, including "What Every Real Estate Investor Needs to Know About Cash Flow..." and "Mastering Real Estate Investment." Gallinelli now serves as an adjunct assistant professor in Columbia University's Master of Science in Real Estate Development program, where he has taught real estate investment analysis since 2003.

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For Keith and Nicole.

No success in life could be as important to me as you are.

I grow more proud of you every day.

Contents

Acknowledgments

Introduction

PART I

HOW TO CHOOSE A REAL ESTATE INVESTMENT

1 Identify Your Comfort Zone

2 Where Do You Find Good Properties to Buy?

3 Line Them Up—How to Compare Potential Investment Properties

4 Don’t Get Burned—Doing Your Due Diligence

PART II

FINANCING YOUR INVESTMENT PROPERTY

5 Types, Terms, and Sources of Loans

6 How Much Can You Borrow?

7 All Cash, No Cash, or Some Borrowed Money?

8 Line Them Up Again—Comparing Loans

9 How Do You Convince a Lender to Finance Your Real Estate Investment?

PART III

THE OFFER, THE CLOSING, AND THEN WHAT?

10 What’s Negotiable?

11 The Turning of the Screws—What the Lender May Demand

12 How to Read a Closing Statement

13 Forms of Ownership

14 The Morning After—What Do You Do Now That You’re the Owner?

Appendix: Loan Tables

Glossary

Index

Acknowledgments

However much I would like to imagine that I know everything about my topic, there are moments when I stare at a blank manuscript page and it just sits there laughing at me. Those were the moments when I sent out pleas for help and I want to thank the friends and colleagues who came to my aid:

Michael P. Buckley, Director, M.S. in Real Estate Development Program at Columbia University, a veritable font of wisdom on all matters of real estate investment, development, and finance, who tolerates and even encourages my guest lectures at the University; Ken Ferrari, managing partner of Marketplace Mortgage of Plainville, Connecticut, someone who knows and cares about his profession and who helped me understand residential lending from the his side of the desk; attorneys Andy Garson and David Slepian of Fairfield, Connecticut, who always listen patiently to my convoluted deals and who set me straight when I purported to explain the fine point of closings and real estate titles; Suzanne Kliegerman, Senior Vice President, Real Estate Lending Division, Commerce Bank, New York who helped me see real estate finance through the eyes of a portfolio lender; Bill Wilson, Jr., CPA with Van Brunt, Du Biago of Stamford, Connecticut, who helps keep my books (and sometimes me) in balance.

I also want to thank several thousands of the customers of my software company, RealData. Over the past 23 years you’ve shared many vivid accounts of your real estate investment and development deals—your plans, your successes, your problems, your creative solutions. That interaction has allowed me to participate vicariously in many more deals than any one person could reasonably expect to experience in one career. You’re the best.

Introduction

There’s a first time for everything. No doubt you’ve heard this threadbare cliché more than once in your life. We’re all adults here, so it’s safe to tell you: It’s true.

Among the experiences you apparently aspire to undergo for the first time (or possibly just the second or third) is to invest in real estate. That’s why you’re reading this book instead of doing something you might enjoy. I’m bringing this subject up on the very first page so that you can line up your expectations. For whom is this book written? What’s in it for you?

First of all, you are not a dummy. On the contrary, I suspect you’re quite bright and would like to apply that intelligence to a field where you can build some significant wealth. You may not expect (or even want) to get private-jet rich, but you at least want to build the kind of assets that can put your kids through college, fund your retirement, and perhaps even exempt you from the nine to five routine earlier than you had originally planned.

These are realistic goals, but to achieve them you need to take the first steps, which brings us back to the first time for everything chestnut. In whatever you now do for a living, you do it well because you first learned the basics and then built up experience. Real estate investing is no different. You need to start with the basics, not with exotic or obscure get-richquick techniques. Then you need to implement those fundamentals and develop your skills through practice.

Depending on your professional and business and life experience, some of the material in this book might be obvious to you, while other content will be entirely new and unfamiliar. Perhaps you’re not really a first-timer but have already purchased one or even a few investment properties. Is there anything here for you? There is a lot to learn about real estate investing—certainly more than can be covered in any one book—so yes, there will be some lessons in this volume for you as well. Before your habits become entrenched, see how they compare to the methods I discuss here. You want to develop a best-practices approach to investing.

I intend this book to serve as Real Estate Investing 101. I believe it makes an excellent place for you to start your investment career because it provides you with an overview of the process: where to find candidate properties; how to choose one; where and how to get financing; how to negotiate and close the deal; and how to get off on the right foot once you’re an owner. It also adds a healthy dose of tips that you might otherwise need to learn through trial and error. I’ve been a real estate investor for more than 30 years; learn from my mistakes so you can make new ones of your own.

At several places in this text I’ll refer to another book of mine, What Every Real Estate Investor Needs to Know About Cash Flow, also published by McGraw-Hill. The financial analysis of an income property is an essential part of the process of choosing a worthwhile and promising investment. Because this volume serves as an overview, I cover just the high points of financial analysis here. If you decide that you want to develop a more complete understanding of this topic, I suggest you take a look at the Cash Flow book.

As in my previous book, you’ll find that this one is liberally garnished with Rules of Thumb. These little snippets of advice represent more opinion (mine) than fact. They may not fit every place and time, so be sure to measure them against the realities of your situation.

You will also find that I provide resources online that you can use in conjunction with this book. To access them, go to realdata.com/secrets.

Now it’s time to start. What better place than at the beginning? Before you can become a successful real estate investor, you need to find some properties. And before you do that, you need to find your comfort zone. Let’s start.

PART 1

HOW TO CHOOSE A REAL ESTATE INVESTMENT

CHAPTER 1

Identify Your Comfort Zone

There is an old saying—if you don’t know where you’re going, any road will get you there. Succeeding as a real estate investor, or as anything else for that matter, requires that you develop a plan and then follow it. The very fact that you want to succeed as an investor establishes that your main purpose is not to flip properties for a quick profit but rather to select investments that will provide a meaningful return—and gain—over time.

Part of your plan should be to establish basic guidelines concerning properties you’ll try to acquire. Be proactive rather than reactive—define what you’re looking for; don’t just respond to whatever crosses your field of vision. Especially if you are working toward your first real estate investment, you want to seek out a property whose cost, location, and type will fit best with your financial resources, skills, and experience. The first step then in finding a suitable investment property is finding your comfort zone.

1. Identify a price range

How much cash do you have available to you? How much financing are you likely to obtain? (We’ll talk about this topic in greater detail in a later section.) If banks are offering loans at 80 percent of a property’s value and you have $50,000 to work with, then $250,000 would represent a reasonable purchase price. You might choose to look at properties with asking prices approaching $300,000.

Keep in mind that, depending on the type of property and its condition, you might be wise to hold back some cash as a reserve to deal with unanticipated repairs or with a loss of rent income.

2. Choose a location

You will certainly read somewhere about the virtues of scouring the country looking for great investment deals. As the argument goes, if you make a spectacular deal you’ll be able to afford the services of a local management company to run the property. Actually, there is a lot of truth to that argument but there is also an important caveat. If you are a relative novice at real estate investing, this is not a prudent way to start. If you have never tried to manage a property yourself, then it’s very difficult for you to have a sound, long-distance sense of how matters are going. Is the local employment market or business climate changing? Is the rental market changing? Is the management company doing an acceptable job? Is the property being kept clean and in good repair? With experience, you learn to stay attuned to these issues. However, if you start off owning properties you seldom or never see, occupied and managed by people you seldom or never see, then you miss the opportunity to develop that kind of experience.

If starting off with properties in a remote location is a bad idea, then starting off with properties nearby must a good idea. Distance is one consideration, but not the only one. Yes, the property should be close enough so you can get in your car and go there without having to pack a bag. Equally important, as the anvil salesman in Music Man says, You gotta know the territory. When you purchase an income property, it can be very valuable to understand the neighborhood dynamics and demographics. If you are looking at property in a residential area, is it characterized primarily by owner-occupants, tenants, or a mix? Is there very little turnover among rental units or is it an area favored by students, with frequent turnover? What is the typical rental rate? If the property is commercial—say, retail—are stores doing well? Are there vacancies? Is parking adequate? Do businesses seem to come and go? Is there an apparent dead spot? (Just about everyone has seen a place where a dozen restaurants have tried and failed.)

These are some but not all of the questions you want to answer about a neighborhood. The more of an expert you become in the dynamics of a given area, the more success you are likely to achieve, both in selecting and in managing income properties. In short, the more you know about the territory, the more comfort you’ll find in your comfort zone.

Sometimes, buying property locally is just not an option. During a recent lecture tour I spoke with quite a number of people who said, Real estate prices have risen so dramatically here that it simply isn’t possible to purchase anything that can even support its own financing. We have no choice but to look outside the immediate area.

If you must buy outside your area—far enough outside that you cannot visit regularly—then you need to have an alter ego or two that you trust implicitly. Essentially, this is similar to my know the territory advice except now you’ll have to rely on other knowledgeable individuals to be your eyes and ears. You will need a good local broker who will take the time to make sure you understand the dynamics of the area; and you will need a reliable property manager to rent the property and handle landlord-tenant issues. For long-distance investing to work, you have to feel confident that the broker and manager are capable and honest beyond reproach.

3. Select a type of property

You certainly don’t have to purchase the same kind of property every time, but if this is your first purchase then you should consider how a particular type of property might suit your personality and skills. If you have experience in business, you might feel right at home with commercial property. If you’re comfortable dealing with people, perhaps you’ll start with a small, multifamily property. If you’re good at delegating responsibility and measuring performance, you might do best with a larger apartment building where you use a property manager.

Let’s look at some of the most common choices along with their pros and cons:

a.   Single-family residence or condominium

Pros:

i.    Among the easiest types of property to manage because there is just one tenant.

ii.   They are abundant; you have plenty to choose from.

iii.  If you already own your own single-family home, then there should be nothing about the physical property that is unfamiliar to you.

iv.  You can negotiate a lease where the tenant is responsible for all utilities, yard care, snow removal, even property taxes. Obviously, the more extras the tenant must pay, the lower the base rent he or she will expect to pay. The difference might still be worthwhile to you as the landlord because passing these expenses through reduces your uncertainty as to operating costs and reduces your management responsibilities.

v.   At some point you might choose to move into the property yourself. Under the current tax code,