| The Business Owner Toolbox Part 12: Buy Real Estate Before Your Next Truck |
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| Written by George Hedley | |
| Tuesday, 20 November 2007 | |
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What’s Your Real Estate Goal?Getting involved in real estate takes a decision to make wealth building your priority. Once we decided to make real estate a part of our business plan, we set a simple goal to buy, joint venture or develop at least 20,000 square feet of commercial property every year. From that, we would generate construction profits, create passive positive cash flow from the properties and build our financial net worth. If we continued to acquire or develop 20,000 square feet of properties every year for twenty years, we would own 400,000 square feet of buildings. These buildings would generate, on average, at least $.15 per square foot monthly of positive cash flow, which equals $60,000/month net income. And owning 400,000 square feet of leased commercial property should equate to at least $20 per square foot in net asset value, which equals $8 million net worth. Not bad for only adding one small project to our portfolio every year. I often get asked for my No. 1 business tip for success. Many contractors fall in love with their equipment, tools and machines. But most never get ahead by owning lots of toys. My answer is to buy your first real estate investment before your next truck. What’s your real estate investment goal? Start Small but Start!I started investing in real estate in a small way by buying a residential duplex for $40,000, upgrading it and then raising the rent. This created additional property value and a positive cash flow. Another real estate investment I made while building my business was to buy my own building for my company. Getting started with small real estate projects reduces the fear of the unknown. You learn how to work with real estate brokers, find property, make an offer, go to escrow, get a loan, review documents, close escrow, lease out space, hire property managers, negotiate and do what successful real estate investors do everyday. Every real estate investment has a team of professionals who contribute to the overall success of the project. As a contractor, I know how to hire an architect, go to the city and build the project. But I didn’t know much about real estate contracts, making an offer, finding a construction loan or putting a project budget and pro-forma together, which would calculate whether the project made financial sense. Not knowing how to do some of the parts of the project held me back from moving forward on my plan to start a real estate investment portfolio. What is holding you back from moving forward? The real estate project team is made up of:
What part of the team do you need the most help with? You are probably building projects for customers who have lenders, brokers, attorneys, title companies and escrow officers on their team. Get their names and go meet them. Ask questions and learn. These resources are the best place to start building your team. Ask for referrals to professionals who specialize in the project types you want to pursue. Where to Start?In order to find a good real estate investment or development project, you’ve got to find the right property for you. The most important person on the project team is the developer. The developer has a business goal to find a certain type of property to purchase, in a general location, within finite financial parameters. What kind of investment property do you want to start with? You need to know:
Cash Is King!You can’t buy real estate without some cash. Have equity investors lined up and ready to write checks. Generally you’ll need between 20 to 35 percent cash equity in every property you purchase. Most lenders will finance between 65 and 80 percent of the appraised value (not the purchase price). The appraised value is based on what the property is worth after you purchase it, improve it and lease it out at market rent. If you buy a property with the intention of remodeling it, the appraised value will be based on what the upgraded property will generate in rent upon completion. In the example below, the appraised value is based on the new rents the project will generate after completion and lease-up. Current annual gross income $50,000 before expenses Current annual net income $40,000 after expenses before mortgage Capitalization rate 10% based on market conditions Current property value $400,000
Purchase price $400,000 Remodeling costs $75,000 Financing and closing costs $25,000 Total completed project costs $500,000 New gross annual rental income $66,000 before expenses New net annual rental income $55,000 after expenses before mortgage Capitalization rate 10% New property value after upgrade $550,000 appraised value Loan @ 75% of stabilized value $412,500 Equity cash investment required $137,500 Annual mortgage @ 8.5% for 25 yrs. $39,858 Net annual positive cash flow $15,142 Annual return on equity investment 11% A good way to get started is to find equity investment partners who trust you and will co-invest cash into your projects. Split the ownership with them based on who provides what percentage of the total equity investment required. The developer should get a working or promotional interest in the project from 10 to 50 percent based on the complexity, risk and project potential. And the investors should get the balance for providing the needed capital. A typical ownership split works like this: Equity Investment Ownership Developer $ 0 25% Investors $137,500 75% In the example above, the developer gets 25 percent ownership and profit sharing for finding, creating and doing the work of managing the project. The investors get 75 percent ownership for providing all the equity capital required. The developer should always invest and provide some of the cash equity and share in the investor portion of ownership as well. As an incentive to induce investors to invest in your project, all the equity investment must be paid back before any profit sharing starts. Also, offer the investors a preferred return of 8 to 10 percent on their investment before any profit sharing is distributed. Now Start Looking for a Good Deal!After identifying what type of investment property you want to acquire, the next step is to find it. Seek out the best real estate broker in the market who specializes in the kind of property you want to buy. Don’t ask a residential broker to find industrial property. Hire an expert who can assist you throughout the transaction from acquisition, feasibility, escrow and financing through leasing or sales. The best way to find a good real estate broker is to drive the areas where the property types you are looking for exist. Look at the real estate signs and the brokers who are offering property for sale or lease. Call their offices and ask for the sales manager. Explain what you are looking for and ask who would be the best broker in their office to assist in your search. Next, interview at least three brokers. All of them will tell you they specialize in every type of project, so be slow to choose the right one for your team. Select the professional who is an expert in the building type you desire and can offer the most complete services. For example, if you don’t know where to find a loan, make sure they have a relationship with several bankers. If you are weak on calculating a financial feasibility for your investment, select an experienced broker who can do that for you. If you don’t know the comparable rents in the area, make sure your broker can provide that for you as well. Find a Lending Lender!Having a great banking relationship will make you lots of money. Make it a priority to find a banker who will work with you on your real estate projects. Banks are in the business of making real estate loans. They have specialists who are experts in most types of properties and projects. Your challenge is to go out and find the one who understands your financial goals and will help you reach your dream. Make those phone calls and go see several bankers until you find the right one who you can trust to provide the financing you need. Reach Your Financial Goals!The development process is challenging but financially rewarding. It takes determination and a commitment to reach the finish line and meet your financial goals. The actual process requires steady forward momentum toward a finished project or leased-up investment property. The good news is that is doesn’t take lots of people or time to make your goals become real. You can hire most of the team members required to do the tasks required. Review the development process below and determine what things you can do yourself and where you need a professional to work for you. The Development Process
George Hedley owns Hedley Construction and Hardhat Presentations. He is the author of The Business Success Blueprint Series available in eight workbook and audio CD sets. He is available to speak on his proven system to build profits, people, customers and wealth. Call 800.851.8553 or visit his website at www.hardhatpresentations.com. Comments (0)
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