I’ve posted recently on the importance of real-estate to your portfolio …
… only ‘important’ of course, if you intend to retire on more than the Pauper’s Million 😉 Well, at least important enough that you probably need to find a good reason NOT to invest in it (e.g. can’t stand the stuff; market is too crappy; can’t find a deposit; etc.)
So, how do you tell a good real-estate investment from a bad one? There are so many variables:
1. Purchase Price – This varies by type of property and area
2. Deposit Required – This varies by type of property and Lender
3. Mortgage Repayments – This varies by type of property and Lender
4. Comparable Returns – What would other investments produce?
5. Comparable Risks – How risky is this investment v. other uses that you put your money to?
For the new real-estate investor, these factors are almost impossible to accurately assess, so investing in real-estate usually comes down to:
(i) What kind of real-estate appeals to me as an investor? Residential – Houses; Residential – Condos; Residential – Multifamily; Commercial – Apartments; Commercial – Offices; Commercial – Retail; Vacant Land; and the list goes on
(ii) What area/s am I interested in? For most real-estate ‘noobs’, that means their local neighbourhood, town, city, or possibly state.
(iii) What price range can I invest in? For most this is dictated by Type of Property, Deposit Available, Income available to service the loan, and the Lender’s Rules
Which is all well and good, but here is how most real-estate investors ACTUALLY invest:
They see something that they like and can afford, and:
a) They buy if they are not too chicken, or
b) They pass if they are … well, you know … cluck, cluck cluck.
Since, I am usually scratching in the yard myself, please don’t consider this an insult 🙂 I actually think that this is a perfectly reasonable way to buy real-estate IF you first (more bullet-points!) ask the $7million Questions:
A. Is the market off its high?
B. Do you at least understand the type of property that you are looking at – and, the area – and consider it a reasonable buy (i.e. you don’t think you are paying ‘top dollar’ to get in)?
C. Are Interest rates off their highs?
D. Can you can afford the payments?
E. Ideally: Will the property be cash-flow positive (or very close to it)?
F. Can you (will you!) hold on to the property for a very, very long time?
Here is the basic principle:
Certain types of real-estate (certainly the entry-level types that most beginners would look at) are virtual commodities … you can pretty easily assess their value (and, potential rents) by looking up a few databases (Zillow, RealtyTrac, Loopnet, Rent.com) and/or newspapers.
There are more intelligent people than you and I out there who actually know how to assess this type of stuff … just trust a ‘commodity market’ to price reasonably accurately and you can’t buy too wrong.
One of my first acquisitions was a simple little condo … the market had been low but was starting to appreciate (how did I know, my 20 year-old nephews told me … they had just bought two condo’s in the same area!).
I didn’t know very much about the values, but I found a condo that was going to auction (actually, the most common way that condo’s were sold in this particular location) and the real-estate agency was from out of town, so I figured that they would attract fewer buyers than an well-advertised local agent would.
The only other keen buyer appeared to be a young builder: I could tell by his overalls, ass sticking out, and his trusty tape measure in hand.
So, what did I do? I just bid at the auction until it came down to just him and I … and, I kept bidding slightly more than him, until he stopped bidding!
I figured that HE knew how to do his sums and HE would not overpay … so, the max. I could overpay is by the amount over his bid that I would have to bid. Risky: you betch’a! Did it work: you betch’a!
His advantage: any rehab would be ‘at builder’s cost’ (I at least knew this would relatively minor … kitchen / bathroom / carpet / paint / lights / knobs). My advantage: Time … I could afford to hold.
In fact, we still own this condo and it has done very nicely thanks … it’s the only single condo left in our portfolio.
But, you could do even better: if you are prepared to do what most other (lazy) people won’t do – which is turn over a lot of rocks and put in a lot of low-ball offers before one is accepted – then you might actually out-smart the so-called ‘smart investors’.
So, how and when to get started?
For those who are following along, you will realize that the current market satisfies $7m Questions A. and C. … a bit of work will help you decide on $7m Question B. … and, your Lender will pretty quickly sort you out on $7m Question D.
$7m Question E. is the one that will give you the most difficulty … as you may not know how to estimate the costs (loss of rental; utilities; Repairs and Maintenance; etc. etc. … if that’s the case, don’t worry TOO much:
TIME (which is why you hold for a long, long time) will cure most ills … and, my $7m Questions … will protect you from disaster.
Oh, and do JUST ONE ONE MORE THING:
Lock in the current low interest rate for as long as the lender will let you!
That will help TIME help the MARKET do its thing … which is get the property/s to appreciate and the rents to rise 🙂
Now, if you can do the analysis that a ‘seasoned’ real-estate investor can do … well, go do it … you will make more money / faster, if you do.
But don’t let fear and ‘paralysis by analysis’ stop you … just use the $7 Million Dollar Questions, and …
If E) shows that you are strongly cash flow positive then all the other risks are diluted down. If there is a big carrying cost associated with the property then watch out!!!
Strangely enough, one of the best times to buy is when interest rates are at or near the top of the cycle. So long as you can put up enough deposit to get to a zero cash flow position, you often end up buying at a cheap price and can sit back and watch your cash flow and equity value both rise significantly as the interest rates come back down.
Of course, in this situation you want a floating interest rate on your mortgage (which is all we can get in HK anyway).
@ Trainee – actually, there are two times to buy real-estate for maximum effect: (1) when the Real-Estate itself is cheap … as you say USUALLY at the top of the interest-rate cycle, or (2) when money is cheap (i.e. at the bottom of the real-estate cycle.
For the first time in history, both of these are depressed at the same time … will RE go lower (perhaps) … will interest rates go lower (I’d be surprised). So, when to buy?
great post AJC, really enjoyed it.
The reason I’m deterred from buying and renting it out is I can get a 5.0% FHA loan as a first time home buyer but I HAVE to live in it. I enjoy working with my hands, so I’m probably going to start flipping. Let me know what you think.
@ Joshua – aaah, real-estate as a BUSINESS, welll first you need to …
…. sorry Josh, I can’t help you … I’ve never bought specifically to flip 🙂
But, I can say a few things:
1. I’m on record as a strong supporter of buying your own home as the only way that most people will ever get their heads above water.
2. You can buy a home cheaper than a year or two ago (not necessarily cheaper than later this year … but, who knows?)
3. You can lock in historically super-low interest rates for 20+ years
4. If you find that you do the work and can’t flip, can you afford to hold (and keep paying yourself ‘rent’)?
PS if you ARE going to get into this as a business, don’t get caught in a situation where you HAVE to sell at a loss … that’s called the ‘subprime market madness’ 😉
AJC, I live in an area where the housing market is absolutely stagnant (and has been for many years, the subprime mortgage crisis hasn’t changed anything). How does one go about getting into real estate when they’re living so far away from any sort of promising locale?
And, I apologize if the question is amateurish, I’m still learning!
yea, I actually never considered the business flip idea myself until I read “The E-myth Revisited” a few months ago. It seems the principals are simple enough to apply almost anywhere.
That’s definitely an option/
@ Heidi – Look outside your own backyard – that can mean location as well as type of property. It may be that houses in somebody elses neighborhood are a better proposition than in yours. Or, it may be that other TYPES of properties are a better proposition in your own neighborhood. Tools help … I mentioned some in this post.
BTW: if looking at housing, look where jobs are growing fast …
PS: I’m still learning, too! 🙂
@ Joshua – Flipping = trading = speculation = business … the ONLY way to be successful in the long run is to treat it like a business: become THE expert in what you do; apply systems; have contingency reserves; have a plan …
The cycle is at that point in the US, but not here in Australia (your native country I think?).
@ Moom – tell me about it 😉
AJC, nice post, it reinforced much of what I think I’ve learned about REI over the last six months. I haven’t pulled the trigger on a property yet (saving the down payment right now) but intend to start shopping seriously in the near future. Like Heidi, I’ve found my local area to be difficult to start in. Fortunately I’m familiar with an area in the mid-west that appears promising.
I think starting out as a Real Estate Investor in a long distance relationship requires a good team in the area you want to invest in and reliance upon professional property management. While that will affect the bottom line a bit, I’m interested in being a real estate investor…not a property manager, so I’ll just have to make sure I’ve got a good front end deal on a good property so the PM fees won’t drag the property under.
I came across an article on an REI investment blog that you might be interested in. The author has a good grasp of REI fundamentals and touts his idea of the “Four benefits of real estate investing.”
1. Cash flow before taxes
2. Principle reduction
3. Tax benefits/depreciation
Check it out if you like: http://kcinvestmentproperty.wordpress.com/2008/06/09/real-estate-investing-benefits/
Thanks again for the great work and sorry for my lengthy comment.
@ Jeff – Not sure that #2. is an ‘essential’ although I usually do purchase both my residential and commercial RE on P&I loans (kind of a ‘forced savings’ much like the 401k) … just not necessarily the best financial decision when you could be using some of that capital elsewhere (another RE purchase perhaps?).
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How close to positive is close enough? How do you calculate against vacancies?
Should we expect 2 months out of the year which we would have to pay the entire mortgage?
Lastly, would you stay away from areas that are under rent control laws?
@ Luis – good questions … and, they deserve a f/u post, don’t you think 😉
PS Diarize for 45 to 60 days and contact me if you don’t see a response within that period.
I’m planning on much of the principle reduction to be done by my renters, so I’m willing to accept some of the limitations that come with it, because it’s someone else’s money. You’re right, the equity does kind of get locked into the property, but I’ll pull that out either at the time I decide to trade up by selling the property or better yet by refinancing the property and leveraging up a bit.
I can’t wait to get started on this phase of my investing career.
@ Jeff – Once the money is in your hands, it’s YOUR money. Having said that, paying off princple early is one RE strategy that can work quite well – it’s one that I have used myself.
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There are a lot of books, real estate gurus, real estate training companies out there. Who is the real deal? I remembered that there is a link to John T Reed’s real estate guru reviews. Do you recommend his books?
@ Mark – I’ve only read one of his books … can’t remember which one. Was Ok, but not earth-shattering. I’ve also read at least 3 or 4 of his ‘recommended’ readings from his ‘ratings’ page with mixed feelings. Finally, he doesn’t like Dave Lindahl (although, he admits that he hasn’t even read his books), but I do!
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