Pros And Cons of Section 8 For Real Estate Investors

Section 8 housing has been controversial with real estate investors since its inception in the 1930s as a response to the Great Depression. The program has evolved ever since, and today its main purpose is to provide low-income Americans with subsidized housing. There’s a lot to consider about the program in general, including the pros and cons for real estate investors.

Pro: Stable Rent Payments

This is perhaps the biggest advantage of the program. Landlords can count on getting 70%-100% of the rent from vouchers given by the government. There are, of course, glitches in the payment system at times, but while it can take time for these payments to come through, they do always come.

The real advantage here is the possibility of mitigating some of the risks in getting tenants who don’t pay reliably. The 2020 pandemic has also highlighted situations where it could be possible to have difficulty collecting rent from even the most reliable private tenants even after the most stringent background checks.

Otherwise reliable tenants are being furloughed from their jobs unexpectedly, through no fault of their own, and state governments are even issuing regulations forbidding evictions during the pandemic or putting a halt to all public hearing evictions.

Pro: Incentives

Naturally, any investor is hoping (and actively looking) for tenants who will take care of their property, but the definition of “maintain” can be open to interpretation and vary from place to place. One of the advantages of getting a Sec. 8 tenant is that their obligations are laid out specifically in the law. Since violating these regulations means a tenant risks losing eligibility for the program, there’s at least some incentive against actively damaging a unit.

Pro: Long-Term Renters

This is a general rule and not a given, but renters under this program tend to stay longer than private pay tenants, and especially if they like the management or landlord and the property itself. This can mean lower vacancy rates.

Pro: Large Pool of Renters

As of the government’s latest accounting, there are 10.4 million people and 5.4 million households participating in the program. For properties in a geographic area with a smaller pool of private paying tenants, this can be a serious advantage.

For would-be investors, it’s always wise to look for properties in locations with lots of jobs and the kind of amenities that draw a good pool of responsible private renters. For property owners who are already stuck with a property in an area where it’s difficult to rent, Section 8 may be something to consider.

Con: Dealing With Bureaucracy

Perhaps the biggest disadvantage when dealing with any government program is the vast amount of red tape involved. It can be enormously costly to qualify your property and maintain it to the standard, and all the bureaucracy is one of the biggest reasons for this. There are inspections to arrange, lots of paperwork to fill out, and some stringent owner responsibilities that have to be followed at every step.

Con: Payment Delays

While payments are reliable, there can be delays, and there’s little you can do about this. When a tenant initially moves in, the first payment from the government won’t even show up for 30-60 days. This is not in itself an insurmountable issue, of course, as the prepared investor can work around this. It is very important to be aware of this, however, and to factor it into all calculations regarding cash flow and profitability.

Con: Constant Inspections

The inspection form and checklist from the Housing Choice Voucher Program is enough to highlight this disadvantage. Even some of the best rehabbers can fail their first inspection since HUD is notoriously strict. It’s often easier to rent property to private tenants for this reason alone.

Con: Increased Wear and Tear

While the Sec. 8 rules do have specific penalties that incentivize tenants against damaging property or appliances, it’s also more common to see higher wear and tear on a property with tenants from this program.

Some tenants clearly feel less invested in a property when they pay little or even none of the rent. Naturally, there are some very careful and responsible Sec. 8 tenants just as there are unreliable private tenants: but the general trend is for greater wear and tear on properties.

Con: Difficulty Dealing With Delinquent Tenants

The positive of renting under this program is that the majority of the rent is guaranteed by the government. The downside is the difficulty of going through the convoluted and lengthy eviction process should the tenant become delinquent on whatever portion of the rent they are responsible to pay.

In these cases, it’s not unheard of for landlords to simply settle for less profit rather than try to go through the bureaucratic process of getting the tenant removed, which is followed by another lengthy navigation of red tape to get a new tenant. Private renters can also be delinquent, of course, but the process of removing a private tenant is normally going to be less costly.

Con: Little Recourse for Damage

While incentives are there to prevent major damage, that’s not the whole story. The nature of the program means that most participants will not be financially able to pay for any damage they might cause to the property. Often the only real recourse is for the landlord to charge higher rent and attempt to recoup the losses that way.

The Upshot

Overall, HUD’s housing program is a risky venture for an investor, and for most, the cons will outweigh the pros. While there are some advantages, there are even more disadvantages and risks inherent to the program. For most property investors, choosing a good location and rehabbing it well means you’re likely to make more renting to private individuals.

This doesn’t mean it’s impossible to turn a profit with the Sec. 8 program, and some landlords have done very well. What it does mean is that it’s even more important than usual to know exactly what you’re getting into, do all your due diligence (and then maybe do it again), and seek advice from experts and local landlords before entering the program.

Understanding Prepayment Penalties

Mortgage loans are expensive to originate.  It is not uncommon for consumer mortgages to cost upwards of $9,000.  Lenders typically recoup those costs through a combination of upfront fees and interest revenue over the life of the loan. 

If a borrower pays off a loan shortly after origination, the lender is at risk of losing money on the loan. Enter prepayment penalties.  A prepayment penalty is a contractual clause that states the borrower is going to pay the lender an additional fee if the borrower pays the loan off early.  This really isn’t a penalty at all.  It is a way for the lender to make sure they don’t lose money on a loan.

For example a standard prepayment penalties with a 5 year structure of 5/4/3/2/1 structure. This means that if the borrower pays off the loan in year one, they have a 5% prepayment penalty, in year two, a 4% prepayment penalty, in year three, a 3% prepayment penalty, and so forth. So, you might be wondering how this affects the borrower, and the answer is, it depends on your investment strategy. Let’s dive in.

The rental investors looking to grow a legacy of rental properties and hold on to them long term (we call these properties “permanent rentals”) are not really affected by the prepayment penalty.  Since their investment strategy focuses on the lifetime of the loan, paying off the loan in the first five years is a moot point.

On the other hand, investors looking to purchase rental properties with flexibility to sell in the foreseeable future (we call these properties “transitional rentals”) are very concerned about the prepayment penalty. These investors are interested in market conditions and want to be able to sell the property at the right time without worrying about paying a penalty fee.

Free Business And Real Estate Investing eBooks

Contact Winston Rowe and Associates

Welcome to Winston Rowe and Associates knowledge blog, scroll down to the right for posts about commercial real estate.

This is a list of free books about real estate investing, commercial real estate financing and business strategy.

We’re always on the lookout for great free books so bookmark this blog and check back for monthly updates.

These links are not affiliate marketing links, just publications that we feel may add value to people and businesses.

Commercial Real Estate Finance

The eBook Commercial Real Estate Finance, by Winston Rowe & Associates discusses the fundamentals of the different types of commercial property, the various options that are included with properties and the capabilities that you will have as a commercial property investor.

Real Estate Investing Articles

This is a link to 1226 real estate investing articles written by industry veteran’s.

25 Productivity Tips for Successful Business Owners

Productivity is critical to your success at work. Business owners, managers and executives all want to get the most from their employees. If you’re not performing as efficiently or effectively as others, your long-term job prospects could be in trouble.

Real Estate Investing: How to Find Cash Buyers and Motivated Sellers

“Real Estate Investing: How to Find Cash Buyers and Motivated Sellers” teaches real estate investors and those interested in learning to invest in real estate how to define and target ideal cash buyers and motivated sellers. The book covers absentee owners, rehab investors, Section 8 landlords, and other buyer types. Some of the marketing topics include mailing lists, postcards, both online and offline marketing strategies along with examples. Anyone who wants to wholesale a house or is curious about flipping houses should pick this book to get educated on cash buyers and motivated sellers for their real estate investing.

Real Estate – Breaking Bad How to Flip Decaying Real Estate Properties for Profit

Tired of working 9 to 5? You should think of making money with real estate! Yes, the effort is well worth it! You just have to ditch the misconceptions and embark with all the passion you have in store for this amazing trip of rehabbing old houses and giving them a new look and a new owner.  Your reward? A nice profit!

Real Estate Forms Portfolio

A FREE and ready-for-download eBook consisting of a comprehensive collection of real estate-related forms for real estate investors.

Real Estate Secrets Exposed

This FREE e-Book sheds some light on the often mysterious and sometimes daunting world of real estate.

Use 1031 Real Estate Exchanges to Create Multiple Streams of Income

Discover how to use 1031 tax-free exchanges, tenants in common interests, and zero cash flow properties to create new sources of income. Learn how to offer bundled services and attract new clients. This FREE, ready for download eBook is perfect for anyone involved in real estate, taxes, mortgages, insurance, or law.  Download it now!

Make Money Through Real Estate Renovations

Download this FREE eBook and learn how a successful investor makes thousands of dollars from real estate renovations. Download it now!

Discover the Secrets of How to Fund Your Real Estate Deals with Private Lenders

Download this FREE e-Book, and discover the new secrets of funding real estate deals in the post-bubble real estate market, where traditional lending sources are getting very difficult to obtain. Download it today!

Real Estate Investing Strategy for Rehabs

This eBook is about residential rehabbing and the multiple strategies that can be used to maximize profits in this current economic climate. My goal has always been to share knowledge with folks that are truly interested in rehabbing and view it as not only for monetary gain but also see is as an “art and science” like I do. Happy Rehabbing!!

How to Be A Super Property Investor

A FREE, step-by-step guide that will help you become a super real estate property investor. Learn all the basic and some advanced investing techniques that have generated millions for property investors. Ready for download now!

Financial Terms Dictionary – 100 Most Popular Financial Terms Explained

This practical financial dictionary helps you understand and comprehend more than 100 common financial terms. It was written with an emphasis to quickly grasp the context without using jargon. Every terms is explained in detail with 600 words or more and includes also examples. It is based on common usage as practiced by financial professionals.

The Prince by Niccolò Machiavelli

Niccolò di Bernardo dei Machiavelli was an Italian diplomat, politician, historian, philosopher, writer, playwright and poet of the Renaissance period. He has often been called the father of modern political philosophy and political science.

The Science of Getting Rich by W. D. Wattles

This book is pragmatical, not philosophical; a practical manual, not a treatise upon theories. It is intended for the men and women whose most pressing need is for money; who wish to get rich first, and philosophize afterward. It is for those who have, so far, found neither the time, the means, nor the opportunity to go deeply into the study of metaphysics, but who want results and who are willing to take the conclusions of science as a basis for action, without going into all the processes by which those conclusions were reached.

Sun Tzu Art of War

Written in the fifth century B.C., Suntzu and Wutzu still remain the most celebrated works on war in the literature of China. While the chariot has gone, and weapons have changed, these ancient masters have held their own, since they deal chiefly with the fundamental principles of war, with the influence of politics and human nature on military operations; and they show in a most striking way how unchanging these principles are.

Make Extra Money Flipping Houses While On Vacation by Jason Medley

Reveals his simple and proven systems to automate, delegate and outsource nearly every function of his business except cashing his checks. He shows the exact steps that has allowed him to go on multiple vacations with his family throughout the year while having his system continue to flip houses for him.

Achieving Wealth Through Real Estate: A Definitive Guide To Controlling Your Own Financial Destiny Through a Successful Real Estate Business

Have you ever thought about making money with real estate? In Achieving Wealth Through Real Estate: A Definitive Guide to Controlling Your Own Financial Destiny Through a Successful Real Estate Business, author and entrepreneur Kirill Bensonoff takes you through the process of starting your own real estate business step-by-step, featuring his expert tips and tricks.

Business Loans Uncovered

Knowing if you qualify is one of the most important things to know when applying  for a loan of any type. Blindly applying for a loan and being declined increases the chances of you being declined again and again because you not only lower your credit score each time you apply, multiple inquires also serves a red flag to other lenders and as a result lenders put you in a high risk category and charge higher interest rates in the event of an approval Includes: ​Traditional Lenders, Government Sources, The 7(a) loan guarantee program, SBA Low Doc loan program, SBA Express loan program, Factoring, Venture Capitalists, Angel Investors.

50 Simple Secrets To Be A Happy Real Estate Investor

Discover the secrets used by successful real estate investors to create happiness in their lives and businesses. Naturally create more happiness for yourself by implementing time-tested secrets to happiness used by other real estate professional and investors just like you. Start to experience more productivity, satisfaction, and success immediately.

50 Simple Secrets To Be A Happy Real Estate Investor

Discover the secrets used by successful real estate investors to create happiness in their lives and businesses. Naturally create more happiness for yourself by implementing time-tested secrets to happiness used by other real estate professional and investors just like you. Start to experience more productivity, satisfaction, and success immediately.

Marketing Strategies for Real Estate Photography

One of the biggest problems that real estate photographers have once they have set up their business as a legal entity, obtained all the right equipment and perfected their technique is obtaining new clients.

Clients and customers are the lifeblood of any business, but how do you obtain new clients after starting your business?

By developing and executing a strategic marketing plan tailored to your business.

This short guide has been written to help real estate photographers develop their marketing plan and assist with winning new business.

It includes a series of digital and direct marketing strategies along with useful tips and lessons the author has learned from his own experiences that can save you time and money when growing your business.

A marketing action plan template has been included to help photographers execute the strategies learned in this guide book.

Books by Dr William Edward Deming

William Edwards Deming (October 14, 1900 – December 20, 1993) was an American engineer, statistician, professor, author, lecturer, and management consultant.

Educated initially as an electrical engineer and later specializing in mathematical physics, he helped develop the sampling techniques still used by the U.S. Department of the Census and the Bureau of Labor Statistics.

In his book The New Economics for Industry, Government, and Education Deming championed the work of Walter Shewhart, including statistical process control, operational definitions, and what Deming called the “Shewhart Cycle, which had evolved into Plan-Do-Study-Act (PDSA). That was in response to the growing popularity of PDCA, which Deming viewed as tampering with the meaning of Shewhart’s original work.

Deming is best known for his work in Japan after WWII, particularly his work with the leaders of Japanese industry. That work began in July and August 1950, in Tokyo and at the Hakone Convention Center, when Deming delivered speeches on what he called “Statistical Product Quality Administration”.

Many in Japan credit Deming as one of the inspirations for what has become known as the Japanese post-war economic miracle of 1950 to 1960, when Japan rose from the ashes of war on the road to becoming the second-largest economy in the world through processes partially influenced by the ideas Deming taught

Cash Flow vs. Asset-Based Business Lending: What’s the Difference?

Cash Flow vs. Asset-Based Business Lending

Whether a company is a startup or a 200-year-old conglomerate like E. I. du Pont de Nemours and Company (DD), it relies on borrowed capital to operate the way that an automobile runs on gasoline.

Business entities have many more options than individuals when it comes to borrowing which can make business borrowing somewhat more complex than the standard personal borrowing choices. Companies may choose to borrow money from a bank or other institution to fund its operations, acquire another company, or engage in a major purchase.

To do these things it can look to a multitude of options and lenders. In a broad generalization, business loans, like personal loans, can be structured as either unsecured or secured. Financial institutions can offer a wide range of lending provisions within these two broad categories to accommodate each individual borrower. Unsecured loans are not backed by collateral while secured loans are.

Within the secured loan category, businesses may identify cash flow or asset-based loans as a potential option. Here we will look at the definitions and differences of the two along with some scenarios on when one is more preferred to the other.

Both cash flow based and asset-based loans are usually secured with the pledge of cash flow or asset collateral to the lending bank.

Cash Flow Lending

Cash flow-based lending allows companies to borrow money based on the projected future cash flows of a company. In cash flow lending, a financial institution grants a loan that is backed by the recipient’s past and future cash flows.

By definition, this means a company borrows money from expected revenues they anticipate they will receive in the future. Credit ratings are also used in this form of lending as an important criterion.

For example, a company that is attempting to meet its payroll obligations might use cash flow finance to pay its employees now and pay back the loan and any interest on the profits and revenues generated by the employees on a future date.

These loans do not require any type of physical collateral like property or assets but some or all of the cash flows used in the underwriting process are usually secured.

To underwrite cash flow loans, lenders examine expected future company incomes, its credit rating, and its enterprise value.

The advantage of this method is that a company can possibly obtain financing much faster, as an appraisal of collateral is not required. Institutions usually underwrite cash flow-based loans using EBITDA (a company’s earnings before interest, taxes, depreciation, and amortization) along with a credit multiplier.

This financing method enables lenders to account for any risk brought on by sector and economic cycles. During an economic downturn, many companies will see a decline in their EBITDA, while the risk multiplier used by the bank will also decline.

The combination of these two declining numbers can reduce the available credit capacity for an organization or increase interest rates if provisions are included to be dependent on these criteria.

Cash flow loans are better suited to companies that maintain high margins on their balance sheets or lack enough in hard assets to offer as collateral.

Companies that meet these qualities include service companies, marketing firms, and manufacturers of low-margin products. Interest rates for these loans are typically higher than the alternative due to the lack of physical collateral that can be obtained by the lender in the event of default.

Asset-Based Lending

Asset-based lending allows companies to borrow money based on the liquidation value of assets on its balance sheet.

A recipient receives this form of financing by offering inventory, accounts receivable, and/or other balance sheet assets as collateral. While cash flows (particularly those tied to any physical assets) are considered when providing this loan, they are secondary as a determining factor.

Common assets that are provided as collateral for an asset-based loan include physical assets like real estate, land, properties, company inventory, equipment, machinery, vehicles, or physical commodities.

Receivables can also be included as a type of asset-based lending. Overall, if a borrower fails to repay the loan or defaults, the lending bank has a lien on the collateral and can receive approval to levy and sell the assets in order to recoup defaulted loan values.

Asset-based lending is better suited for organizations that have large balance sheets and lower EBITDA margins. This can also be good for companies that require capital to operate and grow, particularly in industries that might not provide significant cash flow potential.

An asset-based loan can provide a company the needed capital to address its lack of rapid growth.

Like all secured loans, loan to value is a consideration in asset-based lending. A company’s credit quality and credit rating will help to influence the loan to value ratio they can receive.

Typically, high credit quality companies can borrow anywhere from 75% to 90% of the face value of their collateral assets. Firms with weaker credit quality might only be able to obtain 50% to 75% of this face value.

Asset-based loans often maintain a very strict set of rules regarding the collateral status of the physical assets being used to obtain a loan. Above all else, the company usually cannot offer these assets as a form of collateral to other lenders. In some cases, second loans on collateral can be illegal.

Prior to authorizing an asset-based loan, lenders can require a relatively lengthy due diligence process. This process can include the inspection of accounting, tax, and legal issues along with the analysis of financial statements and asset appraisals.

Overall, the underwriting of the loan will influence its approval as well as the interest rates charged and allowable principal offered.

Receivables lending is one example of an asset-based loan that many companies may utilize. In receivables lending, a company borrows funds against their accounts receivables to fill a gap between revenue booking and receipt of funds.

Receivables-based lending is generally a type of asset-based loan since the receivables are usually pledged as collateral.

KEY TAKEAWAYS

Both cash flow-based and asset-based loans are usually secured.

Cash flow-based loans consider a company’s cash flows in the underwriting of the loan terms while asset-based loans consider balance sheet assets.

Cash flow-based and asset-based loans can be good options for businesses seeking to efficiently manage credit costs since they are both typically secured loans which usually come with better credit terms.

Business Loan Options and Underwriting

Businesses have a much wider range of options for borrowing than individuals. In the growing business of online financing, new types of loans and loan options are also being created to help provide new capital access products for all kinds of businesses.

In general, underwriting for any type of loan will be heavily dependent on the borrower’s credit score and credit quality.

While a borrower’s credit score is typically a primary factor in lending approval, each lender in the market has its own set of underwriting criteria for determining the credit quality of borrowers.

Comprehensively, unsecured loans of any type can be harder to obtain and will usually come with higher relative interest rates due to the risks of default. Secured loans backed by any type of collateral can reduce the risks of default for the underwriter and therefore potentially lead to better loan terms for the borrower.

Cash flow-based and asset-based loans are two potential types of secured loans a business can consider when seeking to identify the best available loan terms for reducing credit costs.