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Why You Shouldn’t Ignore Zoning When Investing in Real Estate

Wealth. Legacy. Lifestyle.

 

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Don’t be afraid to take a big step. You can’t cross a chasm in two small jumps. David Lloyd George, former British Prime Minister

Why You Shouldn’t Ignore Zoning When Investing in Real Estate

Zoning is not the sexiest real estate topic. However, ignorance in this area can cost you money with both buying and selling investment real estate.

1) Understand the area’s current zoning

Before you buy a property, you want to be clear on what you can do by right or by permission. Often, you cannot rely on information from the current owner. It is best to verify this information on the city’s website or a zoning official.

Building requirements for vacant lots may vary for setbacks and the minimum width to build any structure at all. For instance, the value of a narrow lot is diminished if it is too small to build a house by zoning standards.

It is also good to know what is “in favor” at the zoning board. Parking and recovery homes bring much discussion across Delaware County and Philadelphia.

2) Stay Alert to Planned Zoning Changes

Zoning ordinances evolve to meet the strategic plan for the neighborhoods. Sometimes, this vision of the elected officials may be ahead of the current economics. If the local municipality has prohibited the highest use of your property since you bought the property, it may create a challenge when you try to sell.

In this case, the city may require you to apply for a variance to continue an approved use that has been active for decades. The variance process costs both time and money (the fees to review your application vary by municipality).

For sellers, an appeal may be worth it. Without it, a seller may be forced to hold onto a property longer than desirable. Potential quality buyers may opt to walk away rather than battle the zoning board. Often, it may be easier for the seller to go through the appeal process to plead the case for economic hardship to sidestep the existing code.

3) Document known non-conforming use

If your property does not comply with the known ordinances, register your use with your local municipality. There is no excuse to be unsure (again see #1).

For example, you have treated your property as a two-family rental, but the current zoning calls for only single-family homes. If you can show consistency in this use with no negative impact on your neighbors, you can make a good case for a variance approval. This action will allow you to market a legally approved use.

September Key Market Statistics

(Statistics shown are for rolling 12 months ending in September)

(19143) West Philadelphia-Cobbs Creek/Cedar Park

 Sept 17 Sept 18% CHG
Total Sales5055529%
Lowest Sales $7K$14K100%
Highest Sales $950K $800K-16%
Average Sales $137K$157K15%
Days On Market 5436-33%

(19104) West Philadelphia-University City/Mantua

 Sept 17Sept 18 % Chg
Total Sales 1831904%
Lowest Sales $13K$18K39%
Highest Sales $1,325K$1,250K -6%
Average Sales $250K$259K4%
Days On Market 4840-17%

(19139) West Philadelphia-Walnut Hill/Haddington/Mill Creek

 Sept 17 Sept 18% Chg
Total Sales 26232123%
Lowest Sales $5K$8K50%
Highest Sales $607K$635K5%
Average Sales $89K
$110K22%
Days On Market 5240-23%

Upper Darby

 Sept 17 Sept 18% Chg
Total Sales 1,1431,2015%
Lowest Sales $17K$20K18%
Highest Sales   $435K$435K0%
Average Sales $129K$139K8%
Days On Market 67681%

Chester

 Sept 17 Sept 18% Chg
Total Sales 21023110%
Lowest Sales $5K $5K0%
Highest Sales   $165K$255K55%
Average Sales $53K$58K10%
Days On Market 57 6720%
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Getting the Right ARV for Up-and-Coming Neighborhoods

Hipster staging in West Philly rehab
Hipster staging in West Philly rehab

Wealth. Legacy. Lifestyle.

 

Action Inspiration

Someone’s sitting in the shade today because someone planted a tree a long time ago. Warren Buffett

Getting the Right ARV for Up-and-Coming Neighborhoods

Many are chasing flip and profit dreams in areas that are more “coming” than “up.” While it is true that you make your money on the buy, you also lose money by miscalculating the After Repair Value (ARV) that a new homeowner would be willing and able to pay.

Here are some common mistakes…

  1. Expecting the market to reward you for over-improvements. As your rehab budget stretches, you may want the ARV to expand at the same rate. The reality is that the forces outside of the property can be just as significant on the value as your rehab work. Poorly maintained homes on the same block will have a negative impact on the valuation of your property. Striving to have the best house on the block is risky. Ration your choices on materials and finishes by the neighborhood.
  2. Choosing bad comps. The better you understand your target neighborhood, the more you will get the block by block nuances. Misunderstanding a block could cost you $50-100k in some areas. If the number of settled transactions have been slim over the last six months, you should look at the pending, expired, and withdrawn MLS listings to give you an idea of how prospective homeowners value the area. Don’t base your profit on overly rosy comps. Note: this applies to rentals as well. Don’t gloss over the condition of the homes on the same block and the size of the rental units. For instance, you should not base your projected revenue on a proposed three bedroom house rental on the expected rent for a two-bedroom apartment. Both types of rentals target different households.
  3. Being off in your “hipster” forecast. “Follow the hipsters” has been safe money for investors for years. When I see a lot of overtly hipster furniture staging, like in the photo for this post, the target audience is clear. But will the vintage table alone make them buy if the block screams “not yet” on the exterior? The more established the hipster community, including new coffee shops and restaurants, the more premium you can comfortably expect. Err on the side of conservatism on the timeline for true neighborhood transformation, even if that means holding as a rental for a period.

July Key Market Statistics

(Statistics shown are for rolling 12 months ending in July)

(19143) West Philadelphia-Cobbs Creek/Cedar Park

 July 17 July 18% CHG
Total Sales44453220%
Lowest Sales $11K$14K24%
Highest Sales $1,545K $800K-48%
Average Sales $141K$154K9%
Days On Market 4637-20%

(19104) West Philadelphia-University City/Mantua

 July 17July 18 % Chg
Total Sales 15518117%
Lowest Sales $13K$14K8%
Highest Sales $2,400K$1,250K -48%
Average Sales $255K$253K-1%
Days On Market 4538-16%

(19139) West Philadelphia-Walnut Hill/Haddington/Mill Creek

 July 17 July 18% Chg
Total Sales 23227318%
Lowest Sales $5K$8K50%
Highest Sales $607K$585K-4%
Average Sales $89K
$109K22%
Days On Market 6041 -32%

Upper Darby

 July 17 July 18% Chg
Total Sales 1,0381,0925%
Lowest Sales $14K$21K50%
Highest Sales   $415K$435K5%
Average Sales $127K$139K9%
Days On Market 7156-21%

Chester

 July 17 July 18% Chg
Total Sales 2002105%
Lowest Sales $5K $5K0%
Highest Sales   $165K$255K55%
Average Sales $53K$57K7%
Days On Market 57 56-2%
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Defining Real Estate Investment Criteria-Part 3

So far, I have covered Location, Property Type,  and Type of Tenant in Part 1 and Property Condition in Part 2  in my series on defining real estate investment criteria.

In this post, I will cover the fuel to wealth creation, FINANCIAL METRICS. A grasp on the financials is what separates investors from traditional home shoppers. As a fellow investor, I know that it also helps you sleep well at night after a deal. I encourage my clients to get better at crunching more numbers on paper before even viewing a house.

There are many potential ratios and estimates to calculate, but I will start at two that are critical for the determination of profit.

1. AFTER REPAIR VALUE (ARV)
It is common for seasoned investors to say that you make your money on the buy, not the sell. When you estimate the ARV, you take a view on the future value of the property when you are ready to sell or refinance. The conservative approach is to base your estimate on recent sales with similar size and rehab condition and only modest appreciation. It is hard to make up ground after making too lofty an assumption later.

Once you understand the ARV, you can begin to determine a purchase offer strategy.  Many investors shoot for a 70-80% discount off the ARV in the Philadelphia area on rental properties and an even deeper rate for a flip to allow room to finance the expected value-added repairs. Similarly, a motivated seller targeting an investor buyer would be wise to consider an asking price strategy that leaves some of this value on the table.

In the end, you have to make sure that your rehab costs plus your purchase price don’t exceed the ARV.  Your profit wiggle room can quickly disappear if you don’t factor in a worse case scenario in your more detailed rehab estimate that includes both labor and materials. Fortunately, the older housing stock around Philadelphia allows for many opportunities to profit with value-added repairs.

2. MARKET RENT
For rental properties, the market rent defines your income ceiling. If your income forecast is based on fantasy monthly rental rates for the area, you can run into trouble. I recommend that you factor in the rent that the middle 80% of the tenants in your area are willing to pay.

Often, there is an opportunity to increase the rents from the previous owner. I have observed that many motivated sellers have tenants in place paying below market rents. One way to justify higher rents is through making cosmetic repairs. However, there are limits to the feasible rent boost based on the geography, as discussed in the first post in the series.

I encourage you to share your thoughts on your ideal targets for ARV and rents with your agent early. Instead of just saying “send me a good deal,” you can say that you say “watch out for homes in neighborhoods with properties worth $75K per unit fully rehabbed and rental rates around $1,200 a month”.

To wrap up the discussion on financial metrics and criteria, we will review two more real estate benchmarks in the next post.

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Defining Real Estate Investment Criteria-Part 2

In the last post, we covered how investors evaluate where to invest and your options for the type of property and tenant before selecting properties. In this post, I will review how to define investment criteria and due diligence around the next criteria:

4) PROPERTY CONDITION

Unless you are considering investing in new construction (which has its own challenges), the property likely has some defects which can range from small maintenance items that the previous owner delayed addressing to major damages that may need immediate attention to pass local building code inspections. Smart investors know that repairs offer the opportunity to create value.

Here are the main questions to answer for yourself to evaluate which projects to pursue:

1)    How flexible is your repair budget? Your budget may look different if your strategy is to Buy & Hold, Buy & Flip or even Buy, Rehab & Refinance. Your budget must cover what your contracting team can easily identify as well as a buffer for more complex or harder to estimate repairs. Ultimately, you have to validate your repair budget against the estimated ARV (After Repair Value) and expected market rents to win on your investment.

2) What repairs can your current team handle? Quite frankly, many of the defect conditions I observe in homes were caused by DIY owners or low-skilled handymen. Do you have a general contractor that can manage the required specialists to rebuild a shell into a livable property? Or, do you just have a handyman that can handle mainly cosmetic repairs? The reality is that the best deals require the most rehab work. However, these jackpot deals could be out of your reach if you do not have a capable crew to complete the project on time and budget.

3) How does the condition of your target property compare with the other buildings on the same block? Real estate professionals rate both neighborhoods and buildings into a class from A to D that factors in the age of the properties and the included amenities. To maximize your return, a smart investor will match their rehab budget to the features available within the other existing housing stock on the block (i.e., put Class A amenities into a building in a Class A neighborhood). If you are an early investor on a block, you may have to rehab multiple units to justify putting in Class A amenities on a Class C block or risk a negative return on your investment.

In summary, these questions can help you:

  1. Be clear about your feasible repair budget. A mistake with your repair budget can lead to additional holding costs and reduced profit on your deal.
  2. Decide what kind of repairs to pursue. Your current team will largely dictate your decision. If you think you are ready to take on larger projects, you will need to add more experienced contractors to your team.
  3. Move through your due diligence faster. The goal is to put your negotiating chips on the table early and confidently head to the settlement table.

In the last part of this series, I will cover financial metrics.

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Defining Real Estate Investment Criteria-Part 1

A real estate agent is a valuable member to have on your team as a real estate investor. A good one will help you develop a plan to reach your financial objectives beyond just the next transaction in front of you.

To get the most out of the relationship, you must be clear on what you want. What is your list of criteria that will help you know a great opportunity when you see it? Whether you want to Buy & Hold or Fix & Flip, you need to know what a good deal looks like for YOU.

A great deal for you may not be a great deal for someone else. And a good deal for you today, may look different five years from now. As you gain experience, you may have a better feel for your risk tolerance and also which types of investments work best for you. A good agent can also help you do the heavy lifting of reviewing the market data to help you get up the knowledge curve quicker to know what are realistic criteria.

Over the next three blog posts, I will share some areas where you can define clear criteria in a way that will help others source deals for you. Here are the first three:

1) LOCATION

Real estate is still all about location. Location is also often defined block by block. You will sell a castle on a declining street for less than you would for the exact house on a more desired block. An experienced investor will zero in on targets where they can get premium rents and better sales prices upon exit. When you evaluate location also consider:

  • Future outlook-As a buy and hold investor, you are making a bet on the longer-term outlook of the neighborhood, not just what you see today. Will the rents in this neighborhood remain stable or fall? Is the local government planning any projects that may impact valuations for the better or worse?
    Focus-Within a metro market, you should choose your neighborhoods carefully. Newbies try to cast a wide net and have trouble getting to know a single neighborhood well. Since every offer does not turn into a purchase, you can gain an advantage if you focus your bidding on a target area over time.
    Proximity– Your local area may not be the best place to invest if few available properties will meet your financial objectives. In this case, long distance investing is the best option. You will need criteria for the team you need in place to make you feel comfortable turning over this control.

2) PROPERTY TYPE

You can invest in a wide range of properties, from a single-family home to a commercial property. Each property type has different financing options available.

• Small multi-families give you the unique opportunity for more favorable financing as an investor if you agree to live in the property for at least one year.
• Income-producing commercial properties sometimes have better lending rates available than residential properties.

3) TYPE OF TENANT

People typically segment tenants by income, which is often dictated by the location. There are other specialized tenant types to consider such as

  • HUD Voucher clients (previously known as Section 8)- Requires compliance to maintenance standards and processes by local housing authority
  • Student housing– Requires more complicated leases
  • Commercial– Requires managing the business risk of your tenant

These are the first three criteria to consider when developing an investment strategy. Don’t forget that everyone will not have the same list. As mentioned earlier, your criteria will be specific to your financial objectives and risk profile. In parts 2 and 3, I will cover two more criteria: the condition of the property and financial metrics.