Over the last several weeks, I have had conversations with several investors on different investing strategies, but the recurring theme tying them all together is the title of this email – counting the true cost. I’d like to give you three situations in which real estate investors often fail to count the true cost.
The first situation is a real estate investor who is making a hard money or private loan from their self-directed retirement account to a rehabber-borrower. The rehabber-borrower is negotiating for the lowest rates and points on the loan; however, the IRA account holder needs to charge an interest rate and points that not only reflect the true risk, cost and value of their money, but also the costs associated with processing the IRA paperwork, having the money wired to the rehabber-borrower’s account, and legal fees for the preparation of all the documents such as the note, mortgage, personal guaranty, etc. All these costs are ultimately borne by the borrower, but the IRA account holder won’t know to collect them at closing unless they count the true costs and anticipate them before funding the loan.
In the second scenario, it is the buy-and-hold real estate investor who has calculated their “cash flow” to be the difference between the gross monthly rent collected less management fees and the debt service (assuming debt service includes taxes and insurance as part of the escrow payment). That buy-and-hold investor is failing to set aside money for future repairs and improvements. Let’s face it, HVAC units, roofs, windows and plumbing components will eventually wear out and need to be replaced. Anticipating the life expectancy of these components and setting aside reserves each month to have the capital on hand when it’s time to put a new roof on a house, for example, would be prudent.
Finally, there is the note investor who believes they are buying a performing, first-position note secured by good collateral. They are looking at what it will cost to buy the note versus the payment coming and use that information to calculate their yield or rate of return. What they have failed to consider are the service fees for having that note boarded with a servicer and the potential costs for someone to manage that note by watching the servicer and tracking the legal, accounting and insurance costs.
These thoughts are on my mind because earlier today, I ran into a good acquaintance of mine who is looking to sell three houses. He is open to seller financing. Since I know the quality of the rehabs he does and how well he has managed them as rentals, I’m obviously interested in the properties, but I want to sit down and count the true cost for each of these deals as I put together my proposal to buy or master lease these three houses.