Robert Darrow, @properties

Posts Tagged ‘Investments’

Your Guide visited The Sterling on Tuesday, June 15, for a Broker Re-Introduction event. The Board of Directors has made improvements to the facilities, managed to increase owner occupancy, and improved the financial health of the community. 

In Part 3 I stopped by a couple of units for sale in the building that were open on Tuesday.  These units could be ideal investor units, and the convertible (junior one-bedroom) already has a renter in the unit that would definitely like to remain as a renter for the new owner.

Your guide is helping an overseas investor pick out a nice studio or one bedroom to purchase from far away, and hopefully move into in a few years when they come to Chicago.  They are inspired to act at this time, rather than waiting until they arrive by the temptation of some very good prices for condos in some very swanky neighborhoods. 

These buyers have been scouring the websites and sent me a list of some seemingly good deals.  Including a list of buildings that all seem to have one common characteristic.  I’ll refrain from publishing my laundry list here on the blog as I don’t want to alienate a whole bunch of other clients, other happy homeowners, or tarnish any reputations.  But I’m happy to share the same advice with my readers.

What all of these buildings have in common: they were all converted to condos around the year 2005 – give or take a couple years. Though these buildings are all different ages (some old, some middle age, some relatively new), all were apartment buildings first, then a developer decided to convert to condominium.

What happened to these buildings was a two-fold WHACK:

1. They sold a LOT of units to INVESTORS. During the late 1990′s and early 2000′s, it became normal for nearly anyone, and their grandmother, to put money down on a condo. And nearly as soon as the condo was ready, or a year or 2 later, you could "FLIP" it for a profit. And most of the time, you could rent the unit out and make money on it while you owned it.

2. Everyone who bought around that time is upside down. Starting in 2008, continuing through 2009, and up to today, real estate values dropped like a rock. This doesn’t matter much if you bought your home, condo, or other real estate a LONG TIME ago. Like 2002 or earlier. If you did, you probably still have some equity. For example, I bought my home in 2001. My price was $434,000. Prices in my townhouse complex went UP, UP, UP and at the high point it was worth $625,000. Then in late 2007, prices started falling. And now my next door neighbor has his unit for sale – exactly the same as mine – for $499,000. But I’m okay because I didn’t LOSE $125,000, I just won’t MAKE as much if I had to sell right now.

The problem: buildings like the ones these delightful overseas shoppers asked me about are filled with two types of people: (A) Investors and (B) young home buyers. Both categories of owner are currently upside down.

(A) Investors – they are having a hard time making payments because RENT doesn’t cover EXPENSES anymore. Because they can’t afford these units anymore, they are walking away from their units in great numbers. Hence the high number of foreclosures and short sales.

An interesting twist in this story: One big developer had a "Special Program" for investors to generate more sales. They would GUARANTEE the payments for investors. What they would do – sell to investors, and guarantee that the rent payments would cover the mortgage, assessments and taxes. So if a person bought a 1 bedroom at The Sterling, and the payment of mortgage + tax + assessment was $1,700, but a renter was only paying $1,500, the developer would make up the $200 per month shortfall. And the guarantee went for two years. Of course, everyone believed that rents would continue to rise at 10% per year, just like it always had. Instead, rents plummeted. And ALL those investors got stuck with condos that cost $300, $400, $500 and more, every month, than the rent paid for. That one big developer offered that same program at several buildings. This resulted in THOUSANDS of units being sold to investors who couldn’t make payments on them in the last 5 years.

(B) Young Owners – they bought a condo thinking they would make a ton of money from appreciation. But instead have seen their down-payments vanish, and their payments skyrocket as their adjustable mortgages rise.The double-whammy for Young Owners is the economy. Unemployment in Illinois is still close to 12%. Lots of these poor young buyers have lost jobs, or been forced to take pay cuts. Hence the high number of foreclosures and short sales.

What to do for my buyers?

I’m going to try a three-prong approach. 

1.  Choose carefully for some better examples from their suggestions.  A couple of the buildings they asked about really are quite lovely.  And some of my research shows that the buildings are slowly recovering from the glut of foreclosed units in the building.

2.  Recommend some alternatives.  For a building that they loved, I might suggest another more established building around the corner.  The Gold Coast and River North are filled with mature buildings whose financial outlook is rosy, yet values are down because values are down throughout the rest of the neighborhood.

3.  Search out other great deals.  There are plenty of ways to search for units that have had massive price reductions.  And even some established buildings have an occasional short sale or foreclosure.  All these criteria can be searched for in our MLS.

It seems to be Investment Week here at The Guide.

A new report from The Institute for Housing Studies at DePaul University reports on the increasing risk of foreclosures for Chicago investment property owners. 

The Institute for Housing Studies publishes research and scholarly journals and papers, statistical magazines, forecasts and trends, and a variety of conference proceedings, books, and other materials related to the housing industry.

You can read all the details of the report on this page.  The report is the first link on the page.

Foreclosures rate on multifamily properties in Chicago is rising.  Falling property values have made 30%, more than $13-billion, in Cook County multifamily mortgages at risk of default.  The report finds that there are more than 32,000 rental units in Cook County that are in foreclosure.  Loans in foreclosure on small 2-6 unit properties jumped 8.75% in the 4th quarter of 2009.

The report also says that the multi-family financing market is completely abandoned by conventional lenders.  The only two financial institutions that are making loans on multi-family properties are Fannie Mae and Freddie Mac.

Other highlights (lowlights?)

• Prices declined 46% for small rental buildings from their peak in 2006.
• Prices declined 26& for large rental buildings from their peak in 2007.
• For 1 in 8 units, revenue now falls short of operating costs for owners.

Holy smokes!  Your Guide has been seeing a lot of marketing pitches for investment buildings cross his desk in recent weeks.  But I thought one of my colleagues just happened to recognize a new avenue for business and was making a push into that marketplace.  Perhaps the increase in sales pitches for investment apartment buildings is related to owners in distress. 

I’ll be sure to write again as I check with my contacts.

A regular reader wrote with a great question, so I thought it would be a great post on what to do when you wish to convert Month-to-Month leases into standard 12 month agreements.

My father owned a 2 story house with an attic and  basement. He lived in the attic area and rented the basement, 1st and 2nd story. He recently passed away late 2008 and I have been managing his estate since that time. The middle of last month (March) the estate was finalized and I am now the new owner of the building.

There are currently 3 renters in the apartments however my Dad did not have a lease agreement with the tenants. They have been renting month-to-month. Another fact is that 2 of the renters have dogs.

Now that I am the owner of the building I want to ensure that I am in complete compliance with all the rules and regulations (thanks for all your material) required in the Chicago area.

The first think I want to do is establish lease agreement with each one of the tenants.

Questions:

1. Since they are currently month-to-month do you foresee any issue with me issuing lease agreements since now I am the new owner? How much time to I need to give them to review?
2. I would like to indicate in the agreement that pets are no longer allowed. How long do I have to allow them to comply with this new requirement? Or would I have to grandfather the existing ones?
3. Do you have any other advise that I may need to consider?

Month to month leases run from the beginning of the month to the end.  And the terms can be changed at any time before the next term ends.  For example, today is April 8.  You could send your tenants new written leases right now, and the terms would apply on May first.  You are not required to give any more notice to change the terms of the month-to-month lease than the beginning of the month.

But if you wished to demand that the tenants move, you might be required to give 30 days notice, and you can’t cut a lease term in half.  So if you wanted the tenants to move out, you could give notice any time between now and the end of April that the tenants are required to move at the end of May.

Yes, you can tell your tenants that you don’t allow dogs.  And you could tell them that the dogs are not allowed effective May 1.  In reality, your tenants are probably not going to get rid of their dogs.  And if they did, it would take longer than the next three weeks to do so.  So you may try one of two options.

1. Notify the tenants that you don’t allow pets anymore.  Their current pet is "grandfathered" in the lease.  But they are NOT permitted to get another pet, or any more pets.
2. Notify the tenants that you don’t allow pets anymore, and you want them to get rid of their pet in 30/60/90 days.  But there’s a chance the tenant won’t want to give up their pet, and they might move out.  That’s a risk.

You should deliver the new written leases as soon as you can.  Do so whether the new lease is a month-to-month or a 1-year lease.  And include a letter that tells the tenants that their current leases are terminated.  And that if they do not return the new written leases, their current leases either (a) terminate at the end of May or (2) the rent goes up by some ridiculous amount of money.  You choose one or the other. It doesn’t matter which.

Your Guide has been fortunate to sell a lot of investment real estate over the years.  And even pick up a little condo or house here and there himself.  A couple conversations with clients has inspired me to compose a little pep talk about the fundamentals in investment real estate.

This is not intended to diminish the pain that some of you, and some of my clients are feeling.  It can be quite scary as one watches rents decline, vacancies rise and the prospect of making some mortgage payments on empty condos or apartments looms.

Three out of four fundamentals still apply

The first fundamental of investment real estate is leverage.  In most circumstances, investors buy real estate with a mortgage.  Not as large a mortgage as a home buyer.  But normally, it makes sense to borrow 50% to 75% of the cost of the property.  The reason is simple:  You’re buying something that your renters will help pay for.  This is still true in the current real estate environment.

There really aren’t many other avenues where you can buy more investment than you have cash on hand.  In the stocks and bonds universe, they call it “Buying on Margin.”  But just look at your stock broker’s face if you ask him to purchase $250,000 in stocks with only $25,000 down.  He’d say you were crazy.  And you would be to try.

The second fundamental of investment real estate is someone else pays your mortgage.  Notwithstanding the vagaries of how much you put down, your interest rate, and other expenses; generally the goal is to cover all the payments by having a renter pay more than those expenses.  And if you hold on long enough, the rent should increase while expenses stay stable.  Mostly.  And if you are truly in the game for the long term, you’ll have an investment that’s paid off.  Then starts the gravy train.  Nearly every dollar that comes in as rent is cash in your pocket.

The third fundamental of investment is the passive income and depreciation.  No where else in the tax code can you take expenses, and deduct them from income.  With investment real estate if you bring in $1,500, but spend $1,000 on your mortgage, plus $200 in expenses and another $200 in taxes, you earn $100.  That’s it.

In the real world, if you earn $30,000 in salary, but spend nearly all of it on your home, your utilities, your car, your family, your clothes, and everything else, you still get taxed on your income.  Of course it’s not quite that simple, but the comparison to investment real estate is nearly that stark.  Every dollar you spend can offset income.  Heck, if you spend MORE, you can even start making reductions in your personal income!

And real estate is depreciable.  The tax code even allows investors to rapidly depreciate investment property during the first few years of ownership affording some extremely dramatic tax benefits.

The missing fundamental in the current market is the appreciation.  In any ten-year period from around 1850 to today, you could point to a spot on the timeline and see values in Chicago double.  Sometimes more, sometimes less.  But roughly – you could count on your real estate to double every ten years.  Another way of looking at it:  every time you made a mortgage payment, you’d get another of equal value in appreciation for free.

It seems those days are over.  With the recent tumble in property values, there hasn’t been significant property appreciation in Chicago since 2005 – and we’re already at 2010.  I think this will be the “lost decade” in property appreciation.  I predict that it will take several more years before we get steady appreciation again as the recovery from the financial mess is going to take a few more years.  That takes us close to 2015 – truly a decade of lost appreciation.

Three out of four aren’t bad.  Investors have been spoiled with all the benefits to investment property ownership.  But even if you take the appreciation out of the equation, investing in real estate is still a great way to build equity and guarantee income for later years. 

To quote one of the founding fathers of Chicago, Marshall Field, “Real estate is not only the best and quickest way to make you wealthy, for the average person, it truly is the only way.”

The City of Chicago Residential Landlord and Tenant Ordinance (RLTO) requires the City Comptroller to set the rate of interest to be paid on security deposits held by landlords. The rate is calculated annually based on a formula tied to actual market rates.

The new rate for 2010 of 0.073% applies to all residential rental agreements in which the lease term begins from January 1, 2010 to December 31, 2010. The amount of interest paid on security deposits is determined by the rate in effect on the date the lease term commences.  Owner-occupied buildings of six or fewer units are not required to pay interest on security deposits.

City code requires that a general summary of the RLTO and a separate summary on security deposits, including the required rate of interest, be attached to each lease.  Revised summaries containing the new rate of interest are being printed and will soon be available from CAR. Copies of the revised summary will be sent to each CAR office as soon as they are printed. These revised summaries should be attached to each lease executed during 2010.

Your Guide’s mind reels knowing that there’s an entire city bureaucracy devoted to making sure Landlord don’t screw their tenants out of their 66 cents (on a typical $900 security deposit.)