In late 2009, investing in an REO investment property may make sense if you buy right. Here are some key factors to help you buy “right.”

1) Positive cash-flow?

2) Cash-on-cash return?

3) Pay-back period?

4) Exit strategy windows?

Let’s start with number 1) Positive cash-flow. The simple equation is income from rent minus expenses. If you can rent your investment property for $1,000 per month and your mortgage is $510 per month, then your cash-flow is $500 per month. You would still need to subtract insurance, property taxes, any utilities, and a vacancy reserve.

Let’s assume:

* Insurance = $70 per month
* Property taxes = $100 per month
* Utilities = $30 per month
* Vacancy at 2 months per year = 2 * $510 = $1,020 per year = $85 per month

Total expenses outside of mortgage = $285

Total expenses = $510 mortgage + $285 = $795.

Cash-flow = $1,000 – $795 = $205 per month.

So in this example, the investment property passes our cash-flow test. We would earn $205 per month in cash-flow.

Now let’s check number 2) Cash-on-cash return. For our example, we are looking at a $100,000 house with 20% down or $20,000.

The cash-on-cash (COC) is ($205*12)/$20,000 = 12% per year

COC doesn’t mean much when you take it in a vacuum. So we compare it to what you would get had you put your money in a “safe” investment like a T-bill. Today’s 10 year T-bill rate is 3.5% according to the US Treasury. Our 12% looks pretty good compared to 3.5%.

But investing in real estate is riskier than putting our money in a T-bill. So to take it one step further, we figure out our “risk-adjusted return” or RAR.

RAR = 12% – 3.5% = 9.5%

So does this pass our cash-on-cash test? This also depends. But if we have a rule for ourselves to expect a 2-times return on the additional risk that we take then yes, this passes our test…

2 times 3.5% = 7%.

Since our RAR of 9.5% is greater than 7%, we pass our criteria.

Let’s move on to number 3) Pay-back period. A real estate investment property is a long term play. You saw that we compared our RAR to a 10-year T-bill. Expect to hold the investment for many, many years.

However, we do want to know when we will get our initial investment of $20,000 back. Based on the projected net cash-flow of $205 per month, we would get back $2,460 per year. In a little over 8 years, we will get our $20,000 initial investment back. So our payback period is 8 years. Since this is less than the 10-year T-bill maturity, I would say that we’re okay with the pay-back period test.

Our last test, number 4) Exit strategy windows is also important. Even though we may have all the right intention to hold our investment for the long-term, 8 years in this example, something can come up that would require us to shed our investment earlier than planned. Is there a way to sell the investment property without incurring a loss? Is there a way to sell it for a profit?

Ideally, you would be able to answer yes to the two questions above. Luckily, since the property passed tests 1 to 3, it will almost always be easy to sell. Why is that? Let’s take a look…

• The historic rate of return that has investors excited has been 10%. Our investment yields a COC of 12%.
• We can safely expect our investment property to go up 2% per year due to inflation. This makes it a better value over time.
• If we reinvest our cash-flow in a T-bill, we would accelerate our pay-back period. This is slightly cheating, but earning income is earned income.

This property passed test number 4.

So if real estate is such an attractive investment, why did so many people get burned?

… They violated tests 1-4.

But for investors who do follow the rules, what can they do with the $205 per month cash-flow? …

How about using that money to lease a car like a Toyota Camry? For free? For as long as they want?

Isn’t that nice? Having the right REO investment property makes this possible.

Investment property financing is a topic that many new investors do not know where to begin to learn. The first principle to consider in any type of financing though is to understand some basics. For example, what is the loan amount that you’re financing, how long of a term do you want or can get, what is the interest rate, and what are the fees to close the loan.

One other thing to consider in investment property financing is when I need to make the first payment. This is actually true for primary residence ownership as well as investment properties. However, with investment properties, you can almost stretch out a free month of income before paying your first mortgage payment.

Now to some more important issues related to investment financing. These days, it’s very difficult to get lenders to fund investment properties. They used to take all kinds of borrowers with “stated income”, some even with 5 percent down payment. Today, with the financial meltdown, these are impossible loans to get. So, you need to make sure that you have adequate credit, a sizable down payment, generally 30% is required, but there are some exceptions, and an income statement that makes sense to the lender.

What does an income statement mean in this example? It means the rent that you will be getting from the tenant minus the expenses. Expenses include: mortgage, interest, property taxes and insurance, as well as maintenance, association dues, any required fire sprinkler systems, etc.

Now investment property financing is less rigorous for single family homes than they are for apartment financing or office building financing. In a single family home, it’s almost like getting a regular owner occupied home financing, BUT the key difference is the loan rate is generally higher by about 1 percentage point.

In apartment and office building financing, the lenders really want to know the income stream from the property. So, they consider the income generated from the building minus the expenses to run the building. Lesser importance is put on the actual credit rating of the borrower. Although these days the lenders are scrutinizing those as well.

All investment property financing is contingent on an appraisal. With a single family home, the appraisals are similar to the owner occupied appraisals, with the added review of rental comparables. Rental comparables mean that they look at other homes in the area to see what they are renting for. In this way, the lenders can determine whether you will be in right ball park for income.

With apartment and office building appraisals, sometimes the lender will also want an environmental report. What this report tells the lender is if there are any waste hazards that they need to consider when making the loan. Waste hazards could cause liability issues for the owner and thus the lender, as well as bring the overall value of the property down.

In addition to the additional review for investment property financing, in some cases the loan term is different than a regular owner occupied home. With apartment or office building financing, the term could be as short as 5 years. What that means is that the borrower must end up refinancing again in 5 years. Not a great thing, but one that is a fact of the industry.

Financing investment property does not have to be difficult, it just different and requires a slightly different view of paperwork.

During tough economic times there are many reasons why homeowners want to sell a home fast. You may want to sell fast in order to keep from going into foreclosure and maintain your good credit rating. On the other hand, you may also believe that there are upcoming events which will make it difficult for you to stay in your home, for example losing your job, a long-term illness or being furloughed (which is an all too common occurrence right now).

First off, there are plenty of companies out there right now looking for deals. They have already done their homework; know the markets and the values of properties. They’ve also calculated how much they can pay in order to turn a profit. And, the beauty of these companies or individuals is that they pay cash. This means that you don’t have to wait for them to get bank approval. The best thing about these companies is that in order to get started they basically only need to know the property address.

Regardless of what the reasons, in order to sell a home fast, you should keep some basic things in mind. The first thing to consider is any issues with the title on your property. Clear title is probably one of the first things a new buyer or investor is concerned about. For example, if you owe back taxes or there are city or other types of liens on your property, this will surely give new buyers pause for concern. Clearing up liens makes it easier for the new buyer to not worry about paying them after he / she takes over the property.

The next big item to help sell a home fast is to really check out deferred maintenance. Have you taken care of your property? Is the roof in really bad shape or does a toilet need to be repaired? Many sellers who try to get out of a property fast are already in a bad position financially. So, they decide not to put any money into a property to fix it up. Any new buyer or investor will surely consider the cost of fixing a property before they make an offer. Some tricks would be to make simple, cosmetic repairs so at least the property “shows” well.

Who pays for what? There are many fees on a check off list, including title insurance, transfer fees, appraisal and more. Think about which ones you might be able to absorb before putting your house on the market. The reason is simple. The quicker you can make these decisions, the faster you’ll come to an agreement on the sale of your property.

Here’s a unique option to sell a home fast. If you are deep in financial difficulty (this holds true for both homeowners and investors), consider deeding it back to the bank. This is called a “deed in lieu.” It means that you want the bank to take it back (debts and all) in lieu of foreclosing on you. It may not be as fast as you’d want, but it hopefully keeps you from having to worry about finding a buyer.

Price is not always the only factor in trying to sell a home fast. It is just one factor. It is still true that location, location, location is important. However, there are plenty of examples of investors scooping up properties in bad locations, but have tenants in them already. And, if they are Section 8 tenants, it could be a marriage made in heaven. Section 8 is a government backed program that pays you, the landlord, come rain or shine, their portion of the rent.

No matter what your reason for wanting to sell a home fast, there are ways to make the sale go faster and plenty of buyers looking for the right deal. You need to make the decision to “fish or cut bait” as they say. This is often not an easy decision, but once you do, the rest becomes a whole lot easier.

The key point to remember, though, is that banks and lending institutions are very picky about re-financing. The government mandated financing options that Obama’s administration put in are really meant for owner-occupied properties, NOT investment property. In my opinion, though, there is a big hole in this one-sided approach to re-financing.

Let’s take an example of an office building. To refinance this investment property the banks really look at several factors. The first is the strength of the financial statement. On its own, does the rent cover the mortgage, property taxes and insurance, for example? In fact, of late, banks have been scrutinizing every aspect of commercial investment property ownership. They also look at the financial strength of the borrowers, as well.

Every year, the banks are going through review processes to see if the property can stand on its own financially, the current market value of the property, financial strength of the borrowers, how the general market is in that area and other things, such as whether property taxes are current and other liens that may have popped up since the initial loan was put in place.

Apartment re-financing is going through a similar process as the commercial office building. Although, if you’ve owned the property for a number of years, a number of banks seem to have less requirements, albeit still pretty intense documentation gathering.

To refinance a residential investment property, the banks do not require as much documentation as apartment buildings or commercial office buildings, BUT with the recent down turn in property values, be prepared for an appraisal. The appraisal itself could create a problem for you, especially if the LTV or loan to value has shrunk significantly. With a single family residence, the banks have less to support the income of the property as they would with a commercial office or apartment building. And, the strength of the borrower has even more weight.

Speaking of strength of the borrower … forget about what used to be fairly common … stated income. Essentially, the banks want to see what income you make. You cannot just tell them what is and expect them to nod and say ok anymore.

How can one refinance a raw land investment property? Not very easily. In fact, this one category of investment property is probably the single most difficult one to evaluate. The reasons are pretty simple. Appraisal comparisons are hard to find and there is no income generated from the raw land. How is the bank then going to evaluate your worthiness? Primarily on the strength of the borrower.

As you can gather, to refinance an investment property is one of the most difficult things to do during this economic downturn. The administration has not come up with anything for investment property owners that come close to the owner-occupied market. But even those people are having a hard time staying in their homes.