How Much Contingency Expense Should Real Estate Investors Add to Their Budgets?

New real estate investors frequently neglect a critical element on their budgets. It's the contingency expense. A contingency is the amount of money set aside for unplanned expenses. While it's important to include a contingency in the budget before purchasing any investment property, adding a contingency expense is crucial before starting a major construction or home improvement project.

It's risky to purchase a home as an investment without budgeting for unexpected costs. It could become necessary to find additional funding to complete its renovation. Worse, the home could fail to net a positive return on investment. Experienced real estate investors typically use a percentage of the overall rehab budget to set the amount of the contingency fund. The number they choose for the percentage depends on whether the renovation project is minor, moderate, or major.

Minor Improvements

The contingency fund can be set from 5 to 7 percent if the property only needs minor improvements. Such homes are in good condition but could benefit from cosmetic improvements. Minor repairs do not require a licensed professional or permits. Interior painting, new faucets, planting flowers, or replacing the carpet are examples of what sort of improvements most investors would consider minor. An increase in the cost of materials or a need for additional materials are frequent reasons investors need to tap their contingency during a minor renovation.

Moderate Repairs

Adding 10 percent for contingency is typical for properties requiring moderate repairs. These types of repairs require permits and licensed contractors. Homes in this category need at least one substantial upgrade like a completely renovated kitchen or bathroom. Discovering an unforeseen problem when the walls open up is common with these homes.

A Major Rehab

Budgeting 15 percent for contingency is traditional when the home needs major improvements. These homes require extensive repairs such as addressing foundation problems, rewiring the house, or replacing the roof. Also, these properties are likely to have problems that were not visible before purchase.

The Takeaway

Budgeting a contingency expense of 5 to 15 percent is prudent before buying an investment property. No matter how well an investor estimates repair costs, unexpected expenses can arise during minor, moderate, or major improvement projects.

Pros / Cons of Financing New Properties by Refinancing Others

Credit is the lifeblood of modern society. Wise real estate investors know how to make the most of available credit, and they know when not to put their assets at too high a risk. Lenders use the term "cash-out refinance" when an owner uses equity in a property to invest in a new acquisition.

The Pros of Refinancing

The main reason for a cash-out refinance is to add to your portfolio. In most cases the longer you have owned a property, the greater the equity. Rental income will have reduced the principal balance and market forces will have increased the property's value. Together, the rental unit is worth more than the unpaid principal, so that equity can be used to invest in another unit to rent out. That new unit will generate rental income and, all being well, will increase in market value.

Two units generating income, and appreciating in value, together, will enable a third to be purchased.

The Cons of Refinancing

The cons of growing an investment portfolio by refinancing are three-fold:

• The initial costs may be too high. The new loan to provide the cash to reinvest, and the closing costs on the new investment may negatively affect cash availability. Unanticipated major repairs on existing properties added to the refi and acquisition costs may create an immediate problem.
• The market may drop as it did in the 2000s. Falling market values may result in a lender calling in a portion of outstanding loans in order to keep the loan to value (LTV) percentage at the original level.
• Vacancy rates may increase, resulting in poor cash flow compared to the ongoing fixed costs which still have to be paid.

Working the Strategy

If the current and potential income plus the likely market value make refinancing to reinvest a sound idea, then working the strategy is fairly straightforward. Know the rules and the project should succeed.

• Underwriting is more stringent for a cash-out, re-investment, so it pays to understand the basics, and it also pays to shop around. Some lenders work to Fannie May or Freddie Mac standards, and some maintain in-house loan portfolios.
• Lenders may require a higher FICO score, depending on the amount of the cash-out refi.
• Know the cash reserves your chosen lender may require, excluding anything received from the transaction. Some lenders may want a cash reserve equal to up to 12 months of the new repayment figure.
• Depending on how many other properties are owned, both primary residence and investment properties, the lender may want an amount of the unpaid existing loan balances held in reserve.
• Any existing properties currently for sale, may have to be taken off the market if their equity is being used as collateral against the new loan.
• If the property being used for the refi was a fixer-upper, and the work done has generated the increased value that will act as collateral for the new loan, a lender may require a waiting period before releasing the loan, so committing to a purchase before the loan has been approved may be a mistake. There are exceptions to this, for example, if the fixer-upper was inherited, not purchased.

Final Comment

Using current equity to grow an investment portfolio may make sound business sense. Consider the pros and cons, the know the standards lenders work to, and shop around. Get the financing in place before making an offer to avoid finance delays and an unhappy seller.

How to Calculate Turnover Expense

What is Turnover Expense?

Basically, it is the cost landlords incur during the period when one tenant moves out, post- and pre-tenancy work is done, and the new tenant moves in. Knowing how to calculate turnover expense helps you to plan a long way ahead. Simple economics says that the higher the turnover rate in any given period (e.g. one year, two years, five years) the higher the overall turnover expense will be.

In addition, there are specific factors that can reduce or increase turnover expense.

What May Be Included in Turnover Expense?

Basic Turnover Expenses

• Deep cleaning the property, so it is attractive to potential tenants.
• General maintenance work on fixtures and fittings, paint touch-up, etc.
• Marketing the property to find a new tenant.
• Interviewing potential tenants.
• Carrying out all the credit and other checks on potential tenants.
• Drawing up the new lease agreement.

Other Turnover Expenses

• Delayed maintenance work. This may be a big job that the previous tenant did not want to have done while they lived there, but should be done before a new tenant moves in. E.g. roof repair, replacing the A/C or furnace units, refurbishing the kitchen or bathroom, repainting walls.
• Unexpected repairs and maintenance. These could be normal wear and tear not reported, or accidental or intentional damage caused during the move-out.
• Optional upgrades to add market value and to enable higher rent to be charged.
• Eviction and other legal expenses.

How to Calculate Turnover Expenses

Turnover expenses boil down to three main factors. Landlords who plan ahead, who specifically choose their rental market and take such expenses into account, can keep them as low as possible.

Factor #1: Age and condition of the property. Older and lower quality properties may be purchased for less money, but, without improvements being done, a landlord will only be able to charge a lower rent, may find the tenants are unhappy and move out sooner than expected resulting in loss of rental income.

Factor #2: The chosen market. Every rental property competes with comparable properties in comparable areas for tenants. Short-term and long-term rental markets have their own market forces.

Factor #3: Choosing tenants wisely. Some tenants will be perfect, others may cause damage, fail to pay their rent on time, or disturb the neighborhood.

The Bottom Line

The longer an ideal tenant stays, the lower the turnover expenses. Taking potential turnover expenses into account before buying an investment property will help to keep them at a minimum. Choosing repair and replacement items which are "good enough" to attract the right new tenants will also keep turnover expenses down. A landlord who is fully hands-on should use the factors listed above to plan ahead to maximize their profit. The alternative is to use a well-respected management company which has:

• A supply of good potential tenants on their books.
• Work with real estate lawyers to ensure landlord-positive leases are drawn up.
• Work with contractors to handle maintenance, repair and refurbishment jobs quickly and less expensively.

Precautions to Take When Your Rental Property has a Pool

Having a swimming pool can make your rental home more enticing than others on the market. At the same time, it also comes with a few challenges. Here are 4 precautions every landlord should take when renting out property that features a swimming pool.

#1. Fencing in the pool

As a landlord, you could be held responsible if tenants or their guests become injured in their pool. You might also be liable for anyone who is hurt while trespassing on your property. The best way to protect yourself is with childproof fencing that contains a self-closing, lockable gate.

#2. Anti-Skid Decking

Wet concrete increases the risk of slip-and-fall accidents. For added safety, install a non-skid coating to the surrounding patio, and reapply on an annual basis or as needed.

#3. Check Local Building Permits

If renters will be occupying your property, you need to make doubly sure that your swimming pool meets all local building codes. The best way to do this is to check the original permit to ensure it was installed correctly. Check with your county's building inspector to see if there have been any updates to the code, and then make improvements if needed.

#4. Have an Inspection

Ensure your fence and gate are in good condition and inspected on a regular basis for any necessary repairs. You should also have your swimming pool inspected at the beginning of each season to see that its working components are operating as they should.

Keeping your pool in great condition will help you attract better quality tenants. As such, the extra effort that comes with managing a rental property that has a swimming pool could be well worth it in the long run. For help with real estate investments, including how to manage properties that have swimming pools, please feel free to contact us.

Your Checklist for Buying Rental Properties

You've found a property you like after a hectic house hunting process. You're excited; it is time to put an offer on the table, and you reach an agreement with the seller. All's not done.

Due diligence forms the vital part of the property purchasing, whether it's buying a single-family home or that 100-unit apartment building. The process is tiring, intimidating, and stressful, especially if you haven't done it before.

This is the opportunity to decide if exactly this the kind of property you want to buy.

What is Due Diligence?

In real estate, due diligence is the buyer's obligation to do an in-depth analysis of the property. The buyer needs to establish whether she/he is satisfied with the conditions of the property before entering a transaction.

Why is Due Diligence Essential?

Purchasing and owning real estate is a risky business; you have to make sure you get the value for your money. During this time, you review documents, investigate possible neighborhood downfalls.

In many states, you get the chance to back out of the deal if you find too many issues with the property. If you feel there are too many potential risks and costs, you get to cancel the agreement and go back to happy hunting.

Keep reading to get the essential due diligence to-do's tips. These tips will ensure you get the kind of real estate property you wanted.

Here's a checklist of what you need to do that ensures you get the kind of real estate property you need before closing the deal.

 

1. Have the Property Inspected

Hire a property inspector to scrutinize the property from top to bottom.

The inspector is looking for crumbling foundations, leaking roofs, faulty HVAC systems, termites, use of lead-based paint, presence of radon gas, and other problems. These kinds of repairs are sometimes very costly.

You should also check if the area has issues that could affect your property. This includes if your property lies in a flood zone, or whether it's exposed to any environmental hazards.

These are good reasons to ask for a renegotiation with the seller.

2. Do a Title Search

Purchasing a property is a legal process that involves a change of ownership. It's fundamentally important to do a title search. Get an owner's title insurance to protect you from any issue that might arise or that wasn't detected during the title search.

Doing a title search will ensure you're protected in case of a legal issue arises.

3. Check Whether the Property is Eligible for Insurance

While searching for property insurance, ensure the property meets the minimum requirements. The property may be ineligible for insurance if it doesn't meet the minimum standards.

Some insurance plans might be costly than you bargained for if the property is in fire-prone and hurricane-prone areas. Sometimes, you might not get a policy for these places. Thus, it's important to ask.

When purchasing real estate, it's fundamentally important to get property worth the money you're paying. Make it a habit to have a to-do list when conducting due diligence.

What Are Acceptable Hazards to Look for When Buying Flips

Amid the excitement of finding your first home to flip, it's important to remember selecting your flip is a business decision. As such, research should guide your choice rather than emotions. For instance, the general school of thought is move-in ready houses aren't good choices for flips. The house must need improvement if the flip is going to be profitable. However, acceptable hazards for your flip needs should be easy repairs for a new investor to deal with. Some repairs are unacceptable hazards that may become too much in terms of expense or complexity for a first-time investor to handle.

Acceptable Hazards

1. Old Carpeting. Dealing with old carpeting may be as simple as removing it to reveal the original flooring. If the flooring underneath is not in good condition, new carpeting is very inexpensive and may come with free installation with qualified purchases.

2. Dim Lighting. Well-planned lighting upgrades can help you stage the home to sell.

3. Leaking Faucets. Replacing faucets resolves the leaks and updates the home's look.

4. Overgrown Yard. Planting and trimming are easy enough to be a DIY project. If you're not interested in doing the work yourself, you should be able to hire a landscaper who can work within your budget.

5. Broken or Missing Hardware. Replacing door knobs and cabinet pulls is another way to modernize the look of the home. Also, it's a simple project you may want to do yourself. 

Unacceptable Hazards

1. Foundation Problems. Structural problems tend to be complicated, stressful, and expensive.

2. Major Roof Issues. A new roof is costly. Also, water damage inside the home often accompanies a compromised roof. 

4. Outdated Wiring. Bringing old electrical work up to code is a major undertaking for a new investor.

4. Mold Growth. Excessive mold growth requires expensive professional remediation. 

5. Collapsed Main Sewer Line. Sometimes, a blocked sewer line can be cleared for a reasonable cost. When the line has collapsed, a costly replacement is usually required. 

Why You Should Walk Through a New Property Before a Written Estimate

Purchasing a new property is a big decision--and it involves many steps. You know that, before you purchase a property, you need to get written estimates concerning what it will take to fix up the property. Before you do that, however, you should take the time to walk through the property yourself. Why walk through the new property before getting written estimates? Consider these key reasons. 

1. You can save yourself time and money by looking over the property yourself first.

If you send in the contractors first, before you have a chance to look over the property, you may spend money for their estimates. Many of them will inspect the property for you, but they do expect to be compensated for their time. You'll also waste your own time by investing heavily in a property that simply won't fit your needs. If you walk through the property yourself first, on the other hand, you'll get a better chance to decide whether the property will fit your needs.

2. When you walk through the property yourself, you'll get a better idea of what the property really needs.

Even the most trusted contractor may make errors in judgment--or may not have a full understanding of your specific budget and other needs. Different contractors may also focus on specific areas, which means they may not get an idea of the full picture of what the property needs. Instead, walk through the property yourself and make written notes of what improvements you think will be necessary before you bring in the property inspectors. 

3. Walking through the property will give you a better feel for the property as a whole.

Whether you're planning to become a landlord or to fix and flip a property, you want to be sure you're making a sound investment. Taking the time to walk through the property yourself will give you a better feel for it--and help you better decide whether this property will be an effective addition to your financial portfolio.

Are you in the process of choosing a new property? Consider walking through it yourself first, rather than sending in the contractors for their written estimates. Ultimately, you'll get a much better feel for the property, which will ultimately help you make better choices about the right property for you.