Prosper Newsletter: August 2007 > Real Estate
You understand that the following information is educational in nature and is not intended to be legal, accounting, or tax advice. You are responsible for your own financial decisions and should consult your own legal, accounting, and tax advisors before making your financial decisions.
Understanding Agents
Few people do well as beginners in real estate investing without the help of a competent team of professionals. One of the most essential members of your team will be your real estate agent. You will not necessarily do all of your real estate purchases through an agent. However, when you start out as a real estate investor or begin working in a new area, you can benefit from the knowledge of an agent. An experienced agent has a wealth of knowledge about the properties in the area. The agent will know what types of properties and features are appealing to homeowners. The agent will know the market and know which areas to avoid because they are prone to environmental and legal problems. You may even benefit from their knowledge of city plans and where new growth is expected. In time, you may also become an expert in these areas if you study and pay attention, but an experienced agent can give you a head start toward more profitable deals.
Selecting an Agent
Real estate agents are a unique and often misunderstood group. They must be licensed by their state to do business because training requirements differ from state to state. Some states require longer study and more rigorous tests because agents are given more responsibility, such as handling closings. Other states require less of the agents because real estate attorneys or title companies handle closings. Even after schooling agents are often limited in what they can do on their own; so many agents work under a broker. Brokers have had additional schooling and experience. They take responsibility for all of the agents under them and ensure that they obey the state's regulations on real estate. A state board of realtors has input into these regulations and oversees licensing of both agents and brokers. Agents can lose their license by not following regulations.
Many new real estate agents struggle to learn to bring buyers and sellers together efficiently and create profit for themselves. As such, many are not able to continue as real estate agents. Because of this, experience is a substantial advantage when selecting an agent. However, since only a fraction of agents have significant experience, the experienced agents are often highly sought after and therefore are very busy. You may find it beneficial to work with a newer agent who has time to work for you. An agent who can devote more time to your needs may be even more helpful to you than an over-scheduled, highly experienced agent. The key is to find an agent with time for you and experience enough to know the local market well. In the event that the agent you are working with is too busy to meet your needs, ask the agent to refer you to another agent within the company.
Utilize Your Agent
When a seller contracts with an agent to help with the sale of a property, the agent becomes the seller's agent. The agent is then legally responsible to help the seller get the best deal possible. When you contact an agent to help you purchase a property, the agent becomes your buyer's agent. The agent is responsible to help you get the best deal. If you contact the real estate agent whose name and phone number are listed with a property, you are contacting the seller's agent. By asking them to represent you as well as the seller, you put the agent in the difficult position. Although this is allowed in most states, it is difficult for the agent to get the best deal for both buyer and seller at the same time. A dual agent may not feel they can reveal information about the seller's situation to the buyer. The agent may be reluctant to suggest conditions the buyer could place on his offer that would give him an advantage over the seller. Once you have chosen an agent for your team, work with them on any property you are considering buying to avoid the dual agent conflict of interests.
Leads
Any property that is under contract to sell with an agent in your area is generally listed on the Multiple Listing Service (MLS). The MLS gives all licensed agents in the area access to information about the property and the right to show it to prospective buyers. Your own team-member agent can show you any MLS property.
Contracts
At some point, your buyer's agent will need you to sign a contract that states that they are your agent. Without the contract, they may not be able to collect their commission. Generally, you will not want to sign the contract as it is written. It will almost always say they are your exclusive buyer's agent. This means no matter what property you buy, the agent receives a commission. The agent may get paid even if you buy an unlisted property directly from the owner without the help of the agent. When you are presented with a buyer's agent contract to sign, read through it looking for the word "exclusive." If you find it, cross it out and initial your change. Inform the agent that you reward anyone who informs you of properties. This arrangement encourages the agent to inform you of a property that may be profitable to an investor. It also means that if they fail to perform, you can look for a different agent for your team.
When you contract with an agent to help you sell a property, there will be a part of the contract that allows you to make exclusions. Exclusions can modify the contract so that if you find your own buyer you do not have to pay the commission. The exclusions may also specify under what conditions you can cancel the contract and fire your agent. Exclusions may also allow you to change the status of a property and lease it instead of selling. The contract will generally have a termination date, commonly six months after it begins. If the property takes that long to sell, it may be priced too high or the agent may not be advertising it effectively. Once the contract runs out you can renew, contract with a different agent, or change your plans entirely.
Commissions
Commissions to real estate agents are generally 6% in the United States, but this amount may vary. Normally, half the commission goes to the buyer's agent and half to the seller's agent. Each agent will, in turn, have to share their commission with the broker they work under. To some extent commissions are negotiable. However, it may be hard for an agent to offer much of a discount because it may come entirely from their share of the commission, and not from the other agent or the broker. You may find some agents who will help you find a property for a finder's fee that is much less than a commission. However, many states have regulations that do not allow licensed agents to do this and brokers usually object as well. You are more likely to get a discount from an agent with whom you have done multiple deals. But take care of the people who are working hard for your benefit. Do not push so hard for discounts that you discourage the agent from giving you their best effort.
The time an agent spends working for you can be extensive. Not only do they take you to see property, they must also keep abreast of the market for homes. They drive through neighborhoods, tour newly listed property, contact home owners who may be considering selling, and study the inventory of homes currently available and the permits and plans for additional development. They study changes in city plans including new roads and subdivisions, zoning changes and commercial development. All these aspects may affect home prices. The more the agent knows, the better advice he or she can give you.
Comparables
Using data collected on the MLS about property sold in the area, a real estate agent can give you comparables (comps) to help estimate what a house might sell for. Comps are generally homes sold in the last 6 months in the same area as the property you are researching. Comps should be as similar to the subject property in style, size, and materials as possible. But homes are not identical. Some comps are less similar than others. You need a description of the comp as well as the price it sold for. That will allow you to adjust the estimate of the subject property sale price to take differences into account. The more comps you can get, the more likely your estimate will be accurate. If some comps were sold at exceptionally high or low prices compared to the others, it may be a good idea to disregard them. There may be a reason for the buyer or the seller to agree to an exceptional price. The low price may represent a special deal given to a friend or relative or a situation where the seller was desperate to get out of the property. The high price may reflect some urgent need of the buyer to get into a property or some exceptionally desirable unique feature.
The first time you look at a property in a new area, ask the agent to give you a Comparative Market Analysis (CMA). The CMA will include comps plus additional statistics on changes in the market in the area. One key piece of information is the days on market (DOM), which is how long it is taking for homes to sell. Investors generally want to set the price they sell a home for at a level that will sell the home in a few weeks instead of in a few months.
Rocky Mountain Highs
Tracey and I are off to a great start! Tracey wanted this cute little house across from the new town park. It was on the market for over 3 months and was listed at $160,000. And most of that time it was under contract and the people were trying to do a 1031 exchange. Tracey was very determined to get this property and kept watching for any changes or signs of the contract falling through. She had a hunch to call our realtor to see what was going on with the sale. Her timing was impeccable! They had just released it back on the market and we scheduled to go see the inside of the house. Tracey made an offer of 50,000 and the gentlemen accepted. We remodeled the property and it appraised for $165,000. We got a fixed mortgage that paid off the initial 50k for the remodel and then cashed out $40,000. We still have $60,000 in equity. We are going to rent it out and make a positive cash flow of $150 per month.
When we closed on the above property Tracey had decided that she would eventually want to buy the entire block. The two houses to the north were in pretty bad shape and one was vacant. I called the city and they gave me the number of the owner. He was living out of state. Looking at comparables we knew the two houses would go for about 110k each when fixed up. I called the owner and asked him if he would be interested in selling the two homes and he said yes. I used the coaching and didn't offer a price, but instead asked what he would be looking at to sell them. He said he wanted 80k per house. I then countered and said that we would like to pay 80k for both of them. He said he would think about it. I explained that it would take a lot of money and time and since he was out of town it might be more difficult to get them in saleable shape. He came back and said that he didn't want to haggle over price and said he would take 82k for both houses! We of course agreed and went to our lender and we decided to buy one of the houses for the entire 82k and the owner quit claimed the other to us free and clear. This saved us closing costs, because we closed on only one. When the appraisal came back it appraised at 90k. We put about 20k total into both of them and have 220k in property for only 102k.
Tracey and I just bought the fourth house on the block and now have 4 properties in less than 1 year and have made close to 250k! And the best of all we haven't used money out of our pocket. We have friends that were asking how we did it. They said that they thought we must have 500k set aside in savings. The techniques that we learned have made it possible to make more money in months than most people do in an entire year.
Brett and Tracey B.
As an investor and property owner you need to protect your assets and protect yourself from personal liability. Do this by conducting all of your business in a separate legal business entity. The more common business structures are Limited Liability Companies (LLC) and Sub-chapter S-Corporations. Consult with tax and legal professionals to set up the right entity that fits within your business and investing goals.
