Finding Money for Real Estate Deals

This is the start of a series of articles for those who are interested in obtaining real estate for investment purposes. These posts will give you a good understanding of the realities of real estate investing. As always, I welcome your feedback.

Let us begin.

Someone is always seeking a way to finance 100% of the acquisition cost for an income property. This is fueled by late-night infomercials touting “no money down” deals. The way it comes across, one would believe that all you have to do to become a millionaire in real estate is to acquire the properties with “OPM”, meaning Other People’s Money, and then just sit back and collect the big fat checks they like to flash on the screen. Television is a wonderful thing. After the story is told and the product is sold, no one in the TV cast has to stick around and collect rent.

The quest for 100% financing in real estate reminds me of that joke about a dog chasing a car; what’s he going to do when he catches it? An investor high on the “desire to acquire” – that’s the peculiar state of mind that surfaces when the target of our desires looks so good that we’ll do anything to get it regardless of the consequences.

The Desire to Acquire

In real estate, the “desire to acquire” is present when the investor is willing to do anything to get a deal, any deal. Convinced that once you own real estate you’re on your way to the good life, an investor taps home equity, or finds a seller that will owner finance, and gets a bank loan on the bank’s terms. Now, he’s in a deal, but has he thought it through? Let’s take a look at what happens when you “catch” the 100% leveraged deal.

The infomercial gurus teach that if you find the right seller, you can structure the deal so that there is no money out of your pocket. They leave the impression that there will be plenty of money in your pocket after you do the deal. More often than not, that’s not the result. Let’s say that you do find a lender that will loan 80% and a seller that will carry 20%. In all but the rarest of cases, the combined debt payments are going to eat up all but the tiniest portion of the cash flow. It has to be this way, and I can show you why. Instead of projecting how much you’re going to make from the deal, think about it terms of the occupancy level it takes to break even. Then consider the difference between economic occupancy and physical occupancy.

Economic Occupancy vs. Physical Occupancy

Let’s face it, the deals that we look at with decent prices, motivated sellers, and opportunities for turnaround or upside are usually not the cream of the crop. If it were an “A” property with well-screened tenants, it probably wouldn’t be on the market at a price that would interest us anyway. So, it’s pretty likely you’re going to inherit a less-than-stellar group of tenants. The first advice here is to factor delinquency into your projections to avoid a rude awakening later. Comparing the economic occupancy to the physical occupancy can be an eye-opening exercise. Economic occupancy differs from physical occupancy, sometimes widely so. Economic occupancy is calculated as the actual cash collected divided by the total potential rents. The answer will be a percentage and that is important, as we will see in a moment. Delinquency in apartment rent is a fact of life.

You are not going to collect 100% of the money due, on time, 100% of the time. It is not uncommon for even well-run apartment buildings to run a 5% delinquency rate, and poorly operated projects may have a 30% or higher rate. For calculation purposes, if the rent is past due beyond the due date, it is not included in rent received. In the same way, vacant apartments also are facts of life in the apartment business. Vacancies are actually phantom expenses that only show up in an economic occupancy analysis. Together, vacancy and collection losses typically are projected to run 5% of gross income. A more realistic figure is 5% for vacancy loss and 5% for delinquency and collection loss. In a twenty-unit complex with average rents of $416 per month, that’s equivalent to one apartment vacant for one year. Every investor quickly finds how easy it is to “tweak” these numbers on paper to make the bottom line more attractive. I prefer to err on the side of reality and would advise that you to “tweak at your own peril”. But, we’ll use the 5% figure for this discussion, just to save the argument and to prove the point that even using optimistic numbers a 100% leveraged deal is tough to structure.

Always Run the Numbers

Let’s use an example of a twenty-unit apartment building with potential gross income of $100,000. That works out to average rents of $416 per month. If it is a normal building, there will be about 40% expenses ($40,000), including management but not including vacancy and collection (delinquency) loss. Included in the expense estimate is a “reserve for replacement” deduction. This is an annual estimate of funds needed to perform capital improvements. An average figure is between $200 and $250 per unit per year. While many owners do not actually reserve the funds, some lenders will deduct the amount from the cash flow before calculating the debt coverage ratio. Others won’t, but that doesn’t mean the improvements won’t be required. If you use the standard projection of about 5% ($5,000) for vacancy and collection loss, the building must have an economic occupancy of 45% just to operate (40% operating expense + 5% vacancy and collection expense = 45%). That leaves a Net Operating Income (NOI) of 55% or $55,000. We call it NOI but lenders call it “funds available for debt service”.

Most lenders require a minimum 1.25:1 debt service coverage ratio (DSCR) to fund a deal. Some are higher, very few are lower. There’s a good reason for that. At a 1.25:1 DSCR, 80% of the NOI is used for debt service (1/1.25=.80). In our example, the maximum debt service would be $44,000 ($55,000 x 80%) or 44% of the gross potential rent. Add the 45% of expenses to the 44% of the debt service and you need 89% economic occupancy to break even. That leaves 11% or $11,000 for profit, pre-tax. That’s with normal deal structure and 20% to 25% cash equity. At $416 average rent, the profit margin is equal to just over the annual rent on two of the twenty apartments. Or, looked at another way, if there are two vacant apartments for twelve months, and the rest of the complex operates normally, the project is going to lose money for the owner. The lender will get paid (in theory!) but the owner won’t. And that doesn’t take into account any increases in utility costs, insurance costs, property taxes, fix-up costs for a trashed apartment, or any other of a hundred things that can and do change during the year.

Now, can you see why the lenders are so tough on debt coverage ratios?


Getting the Foundation Right: Starting Your Real Estate Business

I frequently am asked about getting into the real estate investing business. Over the course of this and the next two posts, I will cover important ground rules for laying the proper foundation for your real estate business.

Part One:

  • Building the Foundation of Your Real Estate Business
  • Looking for Properties
  • Finding the Motivated Seller
  • Finding Properties – Farming Neighborhoods

Part Two:

  • Following a Game Plan for Successful Investing in Real Estate

Part Three:

  • Setting Goals

Getting Started as a Real Estate Entrepreneur

  • Surround Yourself with Like-minded People
  • Form Your Power Team
  • Don’t Talk to Unmotivated Sellers
  • Keep Educated
  • Have a Plan
  • Treat This as a Business


Let’s get started.

Building the Foundation of Your Real Estate Business Repeatedly, people decide to start buying real estate without laying the proper foundation for success. When you decide to start buying properties, you start a business. Statistics prove that 80% to 90% of those who start businesses fail in the first 5 years. In real estate, the statistics probably would show that 80% to 90% fail in the first 3 years they are in business. The reasons people fail in business are many. People do not plan, they are undercapitalized, they lose purpose or direction, they lose focus, they do not educate themselves in the business, they have unrealistic expectations, or they fail to work hard enough or devote enough time to make their businesses successful. In every case, they do not lay the proper foundation for their businesses and they do not conduct their affairs like “real business”. Statistics show that in new business ventures where there is a franchise involved, 80% of new starts will be in existence after the first 5 years. What is the difference? The difference is that in a franchise business the new businessperson has procedures, systems, instructions, backroom support, user group association, strict financial accounting, and a road map on how to conduct the business. The new businessperson just needs to connect the dots, follow the procedures manual, and execute the plan for the franchise.If you want to increase the odds of your success in your new real estate venture, you need to put in place the same types of procedures and structures that exist in a franchise. If you will do this, you will increase your chances for success 400%.The following are items you need to accomplish or implement before you begin your new real estate business. Get your calendars and write dates besides each item to accomplish


  • Make up your mind that you are going to get started – whatever it takes.
  • Create your business entity; usually it will be a limited liability company.
  • Get a tax ID number.
  • Open bank accounts in the name of your entity (usually a business checking account and a money market account that bears a higher interest rate). Keep your excess cash in the money market account and move money from the money market account to the operating checking account when you need to pay bills.
  • Create a letterhead.
  • Create and produce a business card that you carry with you at all times.
  • Set up your office; it can be in your home or in commercial or retail space.
  • Set up your work area; this includes a computer, access to broadband internet, access to a fax machine, printer, scanner, office supplies (paper clips, stapler, pens, pencils, paper, ruler, calculator, notebooks, filing cabinet, etc).
  • Get a business e-mail address and account.
  • Read the book Getting Things Done, by David Allen.
  • Get a business phone, probably a cell phone you will use strictly for business, that has voice mail. This will be the number you place in all advertisements and on your business card. You can call your business voice mail from anywhere and retrieve your messages. The point here is to keep your personal life and business separate.
  • Set up your financial records by using QuickBooks for your entity and your business from Day One.
  • Regularly enter financial data into your accounting software.
  • Develop a useful filing system.
  • Keep records of all business expenses, including mileage.
  • Use a spiral notebook to keep up with all of your To Do Items.
  • Develop a database of all of your contacts regarding properties and owners.
  • Develop a prospect list for investors and buyers.
  • Set up bookcases to hold reference materials and books you have read.
  • Get a credit card for your business to charge your business expenses; this will prevent commingling your personal and business expenses.
  • Prepare financial statements for yourself and your business from Day One; regularly and at least annually prepare updated financial statements.
  • Prepare a business plan for your business.
  • Prepare a property notebook for each property that you acquire.
  • Make sure that you have all of the necessary insurances, such as general liability, non-owned auto, auto liability, fire, and extended coverage for all of your properties.
  • Round up as much capital as you can invest in your business.
  • Pick one strategy of real estate investing and learn about it until you become an expert.

Looking for Properties

After you have created your foundation for your business, you are ready to start looking for property. Finding good real estate deals is an art that takes time to master. Like any business, customers are what drive it. Your primary customer is the seller who is motivated to sell below market value. Finding motivated sellers requires advertising, marketing, salesmanship, research, hard work, focus, and keeping your nose to the grindstone.

Nothing happens and nothing matters in real estate until you find a deal. You cannot put together a deal without a motivated seller, and you can only convince a motivated seller to sell if you do something creative or that involves a discounted price. A motivated seller is one with a very good and pressing reason to sell below market.

The most common problem new investors face is finding bargain properties. Many who start out in real estate investing quit without ever buying their first property. They go through the motions of looking for deals for a few weeks or months and then decide it doesn’t work. They forget that finding motivated sellers is similar to the salesperson finding his first customer:  it takes persistence and hard work.

Finding the Motivated Seller

At the risk of sounding redundant, the concept is simple: find motivated sellers who are willing to sell their properties at discounted prices or on “soft” terms.

A logical person knows that time, money, and effort can solve virtually any real estate problem. However, some people are too emotional about their real estate problems or have other motivating issues to consider. Some of these issues include:

  • Divorce
  • Lack of concern
  • Inexperience with real estate repairs
  • Time constraints
  • Death of a loved one
  • Job transfer
  • Landlording headaches
  • Impending foreclosure and other financial problems.

You may need 60 days or more to locate your first bargain purchase. There is a real temptation to take a deal so you can get a deal under your belt. This is a mistake. Take as much time as you need to locate a good deal; that means you have located a motivated seller. The property does not determine the deal – the motivated seller determines the deal.

Currently, the real estate market in some parts of the country is hot, hot, hot! Many people are complaining that the strength of the market precludes investors from finding deals on properties. The popular misconception is that in a rising market, even the most motivated seller can find a buyer for his property at full market price.

The truth is you can find deals in ANY market. You have heard, “There are no problem properties, just problem ownerships”. The definition of a motivated seller fits squarely within this idea.

Finding Properties – Farming Neighborhoods

Successful real estate agents utilize a technique called “farming” to increase their business activity. They pick a neighborhood or two and focus their marketing efforts within that area. You should try the same technique. Start with a neighborhood that is relatively convenient for you.

  1. Drive the Area

Spend a few weekends driving around the area. The goal for you at first is to learn about the area, the style of houses, and the average prices. Over time, you may expand your farm area, but stick with areas that contain the type of homes you plan to purchase. It is not necessary to begin your investment career by learning every square mile of a city; it is important to learn the value of “typical” homes in your target area. This knowledge will enable you to make quick decisions about whether a particular prospect is a bargain.

  1. Attend Open Houses

Visit open houses and “for sale by owner” (FSBO) properties on weekends. Speak directly with owners and their agents. Pass out your business cards. Make friends. Word of mouth and referrals are big parts of any business.

Part of the process of finding a deal is to know how to recognize one. Take a good look at the property and its physical features. After viewing a couple of dozen open houses in the neighborhood, you will get to know the value of the properties and the different styles of houses. When someone calls you about a house in that area, you will know the value by its description.

  1. Look for Ugly and Vacant Properties

While you are driving around neighborhoods, look for vacant, ugly houses. How can you tell if a house is vacant? Look in the windows! Look for the obvious signs of vacancy: overgrown grass, no window shades, boarded windows, newspapers, garbage, and stacks of mail. If you are not certain whether the property is vacant, knock on the door. If the owner answers, be polite and respectful and ask if he is interested in selling. In many cases, it may be a rental property, so ask the occupant for the name and telephone number of the owner.

If the property is vacant, ask the neighbors if they know the owner. Most neighbors are helpful, as they know ugly houses hurt their own property values. In addition, ask the mail carrier – a mail carrier knows all of the empty houses on the block. Leave a business card and write down the address of the ugly or vacant properties. When you get home, look up the name and address of the owner. Finding the owner of a vacant house can be difficult, which is why the persistent people who find the information make the most money. The name of the owner can be found by calling your local tax assessor’s office or by looking up the deed recorded with the County land records.

If you want to contact the owner, it takes a little more digging. Try speaking with the neighbors or asking the post office for a copy of a change-of-address form on file for the property. Online services (, for one) will search public databases, such as the Driver’s License Bureau and the Department of Motor Vehicles.

Some cities, towns, and counties “tag” houses with code violations. This is often a sign of neglected or vacant property. Find out if you can obtain a list of such properties for your city or find where this information is publicly recorded.

In Part Two of Getting the Foundation Right, we’ll cover having a “Game Plan” for your business and identify roadblocks that may slow down your success.