I have spent some time recently reading the BiggerPockets investor forum, which is probably the most well-known tool for amateur and new real estate investors to learn about the process and presumably ask those with more experience for the lessons they have learned along the way.
While I do consider the internet to be a better, more educational place because the Bigger Pockets world exists, I should note that there are many contributors who understate costs, provide ethically dubious recommendations, are generally under-knowledgeable about what advice they give, and sometimes exhibit a certain naivete regarding whe actions that people being forced out of their homes (such as via foreclosure) may take on the way out.
I have compiled of some of my most notable criticisms that I would encourage any frequent user of the forum to keep in mind when browsing:
1. Most users dramatically underestimate the costs associated with being a landowner.
There is a simplistic exercise often conducted on the site where a particular person will state that they expect to collect $1,000 per month as the landlord/owner/investor for a particular property and in their mind conceptually the rental property as a $12,000 annual income stream.
That may be true, but it is dramatically different from what the net income stream will be. You will probably need a property manager, which costs 10%, and that takes you down to $10,800 in an annual income stream. Then, you will probably need premises liability insurance, so you can be protected if a personal injury occurs on the property and you get sued. That costs about $960 per year assuming you want to have coverage for a $100,000 personal injury claim, and that takes your income down to $9,840. Then, you have to property taxes on your ownership interest on the property, which if the home is worth around $120,000 or so, could take another $1,500 off your total depending upon your taxing jurisdiction. That brings you down to $8,340. Then, the old rule of thumb is that, over a twenty-year period, you will incur maintenance expenses that equal about 1.5 months rent. This takes another $1,500 off your total, which brings you down to $6,840.
Now, the one plus is that, since land may be appreciate over time, the improvements upon property (i.e. the house) depreciate over time and most owners have a depreciation schedule of 27.5 years. Assuming the property is worth $120,000, we get depreciation of about $4,363. That means, if say, the tax rate is 25% for your limited liability company, you get to deduct that $4,363 from the $12,000 so your taxable base is only $7,637 before those $5,160 in expenses. In other words, the profit you’re paying that 25% tax on is only $2,477 for about $619 that comes off the $6,840, which brings you to $6,221 that you are left with as cold, hard cash after all taxes and expenses on that $12,000 income stream.
And, it should be noted, that this assumes the property is owned without mortgage, which would also alter our inputs if included. And, it also assumes that a tenant occupies the property for twelve months and that there is no vacancy ever. During a period of eviction, you would be paying attorney’s fees while not collecting rent, which would obviously reduce these figures even more.
That is why you should pay attention to the minority of users who harp about the 50/50 rule (you should expect to keep half of whatever the monthly rental amount is) because property management fees, property taxes, maintenance expenses, and insurance costs, and mortgage payments need to be fully accounted for when thinking about owning rental properties. Often times, the minority of users that repeatedly cite to the 50/50 rule of thumb are often shut down as being too old-fashioned. They are not.
They are the only people applying an appropriate dose of conservatism such that the rental owner might actually have more income coming in than initially projected, compared to any other more aggressive projection style that will have a high chance of resulting in disappointment. During the real estate recovery, I have noticed there are many investors who cut corners on the above-referenced expenses, either because they are dealing in the world of imaginary/academic points, or they have not yet had enough experience to realize that you often pay for your cheap ways and then some at a later point.
2. Many BiggerPockets posters are ignorant of the rights of second lienholders.
Generally speaking, in most states, lien priority status is determined according to who records the lien first. The most notable exception is any type of government lien. If you do not pay your federal (usually income) taxes, your state property taxes, or your local sewer taxes, those government liens become super-priority liens that supersede all others. That is why many mortgage lenders will escrow property taxes along with mortgage payments–it’s a way for the lender to shield itself from a tax lien arising that takes foreclosure priority over its own mortgage.
With this background in mind, I am surprised at how many of the posters do not realize that a second/junior lienholder can foreclose on a property. The reason why it is relatively rare is that: (1) the superior liens must be low enough that the sale price at the foreclosure sale can pay them off in full, which may not be the case, or (2) in the event that this is not the case, the second lienholder may end up becoming the new owner of the property, as the failure to pay off the superior liens means that you take the property subject to liens of higher priority, which would scare away other buyers.
Would you want to buy a house at a foreclosure sale where the second lien is foreclosing and not only are you going to take on a mortgage of your own in order to purchase the house, but the house itself comes with a mortgage from the prior owner that must be paid as well. Of course not.
The fact that a junior lien foreclosure sale is rare is not the same thing as saying that it is impossible. For instance, let’s say someone is close to paying off his mortgage on a $300,000 house, and owes the bank about $15,000 left on it. The owner of the house is drunk driving and severely injures someone. That person successfully sues the owner/drunk driver and obtains a $100,000 judgment. That judgment will then become on a lien on any property that the owner owns in the county or state (and if it doesn’t happen automatically, then the judgment creditor might have to take the de minimis step of recording the judgment at the recorder of deed’s office for it to become a judgment lien).
This judgment creditor, who has a $100,000 lien and is in a junior position to the bank with a $15,000 mortgage, is perfectly fine foreclosing on the property. If the junior lienholder forecloses, the property only needs to sell for $115,000 at the foreclosure sale for the first lienholder to get paid off and for him to get paid off. And put another way, the second lienholder that foreclosures gets to collect on anything above that $15,000 amount up until the $115,000 amount when he is paid in full, and any sale price above that would go to the original owner whose home was in foreclosure.
This leads to the almost perverse incentive, from an asset protection standpoint, that everyone should be getting 3.5% down FHA loans and maintain as little liquidity in their home as possible because the mortgage holder and any other lienholders would have no incentive to foreclosure because there would not enough equity in the home to get paid. On the other hand, if someone owes no mortgage, all it takes is a judgment lien, mechanic’s lien, or some other lien asserter to come along and be able to foreclose on the property and get their money paid back quickly.
The problem is, I would say a majority of the Bigger Pockets posters who are doling out advice do not understand the functions of lien priority and what rights and restrictions exist at various lien priority levels. I get it, secured transactions can be tedious and complex, but if people are going to rely upon the advice they receive, well, it better be accurate, and that’s not always the case on the BiggerPockets forum.
3. Some posters are ignorant of the tort of negligent concealment/misrepresentation.
A common question that arises on the BiggerPockets forum is what the minimum number of items that should be disclosed in a seller’s disclosure when selling a property. Some of the posters have this idea in their head about plausible deniability, in which they claim that it is fine to omit disclosing some condition if you only suspect that it is an issue with your property but do not know it for sure.
I do not know where people get the idea that plausible deniability is a useful defense to anything, as nearly all torts, especially those relating to negligent concealemtn, apply a test that measures what you know or should know, rather than just what you know.
If you ought to know something is wrong with the house, you should of course disclose it. If it is no big deal, then it should be easy to negotiate when selling. And if it is a big deal, well, then it is probably the type of thing that would get an attorney involved and support a negligent concealment claim against you for omitting material information on a seller’s disclosure that you ought to have known.
Sometimes, advice-givers try to be too clever by half and recommend courses of action that seem to incorporate what they consider to be a realpolitik look at the world. If your conscience tells you that a piece of advice reeks of dishonesty, you should reject that counsel and move on.
4. For those who own rental properties for the purpose of generating passive income, a well-established property manager that charges 10% is usually part of the equation. I would be cautious of the investors who suggest looking for property managers that charge less.
Some newer real-estate investors think that giving away 10% of their monthly cash flow to a property manager who “just collects rent” is too much of a giveway. On a $1,000 per month rental property, the property management fee from rent alone is $1,200.
Usually, the thought of cutting out the cost of property management occurs when a tenant has been well-placed and is not moving anywhere soon, and no maintenance have occurred in a bit of time. The thought could easily become, “Why am I paying $100 per month to someone to receive the cash when it could just be sent to me?”
The problem with this line of thinking is that it assumes every relationship you enter provides linear value rather than value of great significant at intermittent periods. The value of the property manager comes when a tenant is late on payment or when a maintenance request is made that requires quick action or the hiring of a third party. Typically, property managers enter into relationship with contractors and maintenance providers at a bulk/discount rate compared to what you would find locating your own provider, and that alone could result in savings greater than whatever fee for property management is charged.
The advice to dodge property management fees are usually totally bunk unless you are someone who is a handyman and are attuned to dealing with the give-and-take of unpleasant social interactions on a semi-regular basis.
If there is an area to save money with a property manager that you hire, it’s usually in the area if you are dealing with a manager that tries to charge a fee while the property is vacant. A simple request that the fee be waived and that you’ll find a property manager who does not that fee is often enough to eliminate it. I also think it’s ethically sound because no value is being provided while the property is vacant.
5. Most posters on the Bigger Pockets forum do not realize the effect of the bankruptcy code when dealing with foreclosures.
Some of the investors who brag about foreclosures, tax sales, and other transactions that I’ll broadly describe as the category of “non-voluntary divestments of property ownership” seem to be naive about some of the tactics that someone who is about to lose their home can and do take.
For instance, if someone is about to have their primary residence be foreclosed on them, it is frequently the factual case that the homeowner is in a difficult financial position. As a result, these are the type of individuals who are often fair or even excellent candidates for a bankruptcy filing. Well, when someone files for bankruptcy, something called the automatic stay goes into effect. This means that all creditor actions against the debtor are frozen, and nothing can happen without court approval to do so, which often takes at least ninety days, and sometimes can drag out more depending upon the circumstances of the bankruptcy, the particular chapter filing, and what other creditors are out there.
This means that you could, say, buy a promissory note that is purportedly secured by a house, not get the promissory note paid, move forward with taking action to foreclose on the property, have the owner file for bankruptcy, and then you don’t get paid anything while the automatic stay is in effect. If you yourself obtained financing to purchase the note, you have to make payments on that even if the owner of the property is no longer paying back their mortgage note. That is what can happen when debt interacts with debt interacts with the bankruptcy code interacts with housing laws. Don’t shoot the messenger.
6. Speaking of mortgage notes, there is a current trend in place for individual investors to buy mortgage notes on the secondary market that some other investor does not want.
Almost always, these notes are non-performing. If someone was paying their $850 per month mortgage note every month as expected, it is unlikely that the holder would be selling it as it is fulfilling its intended purpose and the secondary mortgage transfer market for performing loans is already quite robust and has an active bidding price between banks that it is unclear why an individual investor would have the opportunity.
So if you are obtaining a non-performing note, you better know the ins and outs of your state’s foreclosure laws and be ready to pay the thousands of dollars in attorney’s fees for the eviction action, court fees, and also risking the possibility that the former owner will destroy the property on their way out of the residence as a final farewell. And, of course, all of this is occurring while you are not getting paid rent or exercising control over the property for some profitable end, which is especially problematic if the funds you used to buy the mortgage note were financed.