Building Wealth in a Down Market

Someone posed this very question to me last week, and since this seems to be the "buzz" topic recently, I thought I'd share my humble thoughts on the subject.

What a Financial Planner Would Tell You


It's intriguing to me, as if you would have asked me this question back before I was introduced to real estate, in my banking days, I'd have told you what every other financial planner would have told you: save money, pay off debt, build your retirement savings through maximizing your IRA contributions & take full advantage of 401K match incentives, provided by your employer. "Re-adjust your portfolio allocation" (most people would look at me with three heads when I would say this to them), or "put your credit card in a block of ice in the freezer". (Hah - I forgot about that one..)

These ideas are still excellent ones. The only problem I have with these ideas, is they keep middle class people, well, middle class. They were growing their retirement, so they'd be just OK when they turned 65, but in the meantime they were still slaving away at their JOB and are unable to explode their wealth so that could enjoy everything life had to offer, before their retirement. I mean, let's face it... retirement is such a wonderful dream. But life is short - why wait to fill your dreams?

Building Wealth Through Real Estate Investing

According to this article, the "Top 7 Ways to Get Rich," Alen Korber makes the case for why investing is one of the smartest ways to grow your wealth. Being that he is a reseller of a stock market analysis strategy, he discredits real estate, claiming real estate tends to grow only at 10% per year, and requires a large down payment, so it's "hard to get rich quick that way." I would argue that anyone who invests in real estate to "get rich quick", HOPING it goes up in value the average 10% per year, and who puts down a lot of cash to do it, does not quite understand the real methods at all. It is possible to explode your wealth through real estate, but anyone in this business can tell you it certainly is NOT a get rich quick plan you'll see on those infomercials. I might call it a "get rich sooner" plan. And I still am uncomfortable throwing my money in the stock market, or anywhere else I cannot control what happens to it, or where it can sink to zero.

Want To Know How It's Done?

There are a few different strategies, but they usually end the same way - invest for CASHFLOW, NOT market appreciation. Don't even look at this factor, when you begin your investing business. You can choose to be an active or a passive investor (passive allows you to enjoy the gains from real estate, but someone else does all the work). When I begin a coaching session for one of my students, or when I meet with one of my investors, we go over their short term and long term financial goals, just like a financial planner would. Then, it's worth choosing different real estate investing strategies to help them invest for their immediate needs, and then set up IRAs and this plan around their longer term goals.

One strategy that seems fairly common, is to invest in shorter term investments (flips, high-yielding notes) to build some cash, and then shelter this cash in a longer term investment (either a small rental building, or as part owner of a large residential complex). If you already have some cash resources, I will suggest that as my colleague & fellow apartment owner David Lindahl says, "Go bigger, faster." The faster you can get involved in a larger complex, you start to take advantage of economies of scale, excellent management, and larger cashflow numbers ("dividend yields," for those stock people out there).

For those that do not yet qualify or think they're ready yet for larger complexes, a perfectly good strategy (and exactly what the residential branch of AARE is doing right now in this marketplace) is to invest in homes below replacement cost, for rental income in depressed areas. Will these homes go nuts once the market rebounds? Most likely not... but as a true wealth investor, you are going for cashflow, and never look at appreciation.

Money Magazine recently got wind of what we are doing, and published an article on give-away priced homes in their most recent issue. Set a return you want to get for yourself. My minimum return is 12% in rental income per year (I shoot for 20% in these depressed areas), and this is after ALL expenses.



Example:

$6,900 purchase price for a 3-bedroom house
+ $12,000 rehab costs
is $18,900 "cash in" the deal. Usually these homes are not financeable, so you would either have to put in all your own cash, or go in with a couple others. But here's the return:

Rent goes for around $600 / month in this area. Estimating all expenses (including management, vacancy, maintenance, taxes, insurance, marketing costs) at around 50% of your income, you'll still be raking in $3600 / year, which comes out to be 19.05% in your annual return.

If you play your cards right, when you purchased the home, you MIGHT take into account FORCED appreciation (sweat equity)... perhaps the house in fixed up condition would actually sell for $30,000. Though we never look at this number when we invest for the long term, it's nice to know that you may have an extra bonus coming to you when you sell down the line, in 5 or ten years. Or, keep them forever, and continue to collect your 19%... which only takes a little over 5 years to get all your money back. AND... this doesn't include tax benefits, and a whole slew of other potential income benefits you can reap... GOD I love this business.

You can probably see, it doesn't take many of these to help your cashflow situation - and perhaps the day you decide to retire, you now can realize your equity in these little ATM machines, by selling or pulling it out in a refinance. Take your dream vacation in 5 years, or when you retire - all tax free, unlike traditional IRA withdrawals.

As I mentioned before, some investors prefer to be hands on, while others don't want to have anything to do with the real estate side of it. For these individuals, there are plenty of active investors out there - contact me if you'd like to get hooked in with one of them. IRA money CAN invest in real estate, despite what your current advisor tells you. We are happy to help guide you through the process, or answer your questions on this if you prefer...

The moral of the story

It IS possible to invest smart in a down market, an up market, a sideways market, whatever - just make sure you keep the right thing in mind as you invest in whatever you choose: INCOME. Investing for anything else is considered speculation, and just as risky as the Guessing Game--I mean, Stock Market.

Until next time,

Happy Investing!

Nick

3 Things NOT to do when Improving Curb Appeal

One of the questions that came in last week was from a rehabber finishing up a job he was going to flip, and was just about to put it on the market. He took a picture of it, and sent to me, asking me to give him a few pointers on what he could do to spruce up the outside of the property, to make it more appealing to buyers. His question spurred me to write it down for this topic.

1. Do NOT let your landscaping grow too long, even for one day.

Nothing says "No one cares about me" like an unkempt lawn. Potential buyers drive by your property every day. If they happen to see a lawn start to grow a bit higher than the other houses on the street, the emotional part of their brain (the one that actually makes their buying decisions) immediately turns off, and so goes the potential sale. After the initial cleanup my landscaper does, I always have the lawns cut at least once every week and a half, if not once a week.

2. Do NOT ignore your gutters & roof.

You have beautiful doors, new siding, new cement steps with beautiful wrought-iron handrails, and an excellent landscaping job. You stand back to admire your work... and realize there are rust stains all over the gutters. I want you to notice how all your attention turns away from the beauty of the house, to the ugliness of even those 4 rust spots on the gutters. Take care of them! The same goes for any fishing of roof shingles. If you notice shingles coming off or loose upon purchasing the house, it's probably a good idea to figure in a whole new roof, in your purchase price.


3. Do NOT overdo it.

It's not always necessary to tear out every tree & shrub surrounding the property, or to replace all the siding, doors & windows to give the house a new, fresh look. You want the buyers to pull up and say, "Wow. This looks better than the others I've seen in this price range."

THAT'S the key... to be the nicest looking house (inside AND out), at the lowest price in that area.

Some tips on what you CAN do:

1. Start by looking at all the other houses on that street. Do they all have vinyl siding? Do they have roofs newer than yours? DO they have white picket fences outlining their front yards, or shrubs, or nothing? The chances are good the buyers will also see your house compared with others on the street, and they will want to see at least similar features... your goal is to be the best & brightest.

2. Repaint the exterior a bright, neutral color (here is where you can look to the other houses in the neighborhood). If it's vinyl sided and is not in need of repair / replacement, power wash it. You'd be amazed how much brighter a house can look once it's been power washed. And - if it has a detached garage - remember the garage door!

3. Add fresh mulch: If there are shrubs or plants around the entryway or the street, a good way to make them stand out is to add fresh mulch around the plants. This also makes your green lawn stand out better, in the high "pride of ownership" areas.

4. Add a new mailbox. Sometimes, it IS that simple a change to make the front of a house look good. If it's a high end house, I like to use the granite columns with black mailboxes. If a lower end house, a nice wood post with a black mailbox will do. If theres no lawn, then it's more important than ever to add a nice "high-end" look to a mailbox you'll bolt to the side of the door.

5. Give it a "Wow" factor. Many times, it's as simple as going with a really nice front door from Home Depot. Make it the next model up from what everyone else on the street has. Sometimes, it's installing a containment wall with nice stone or brick, which makes it so the buyers do not see an ugly dirt hill as they approach your property. Repainting the shutters, or even adding a small hose-powered fountain are other small ideas that will give them a nice feeling as they approach.

Hope these tips were helpful to some of you rehabbers out there (and some of you wholesalers, too)! Keep those deals going, and as always,

Happy Investing!

3 Biggest Mistakes

It happened again. You wouldn't think it takes much effort to keep up with a blog, but apparently, I am still learning on the whole "Web 2.0" thing.

I thought it may be useful if I shared some of the biggest mistakes I made as a real estate investor, and hopefully you can learn from my mistakes. You hear a lot of gurus say "my blood is all over this material", and I, to a point, can empathize with them.

So hopefully at least some of this can prove helpful to others...

1. When flipping, start with your AFTER-REPAIRED value, FIRST.

Don't just assume you're getting a great deal because you took $30K off the list price in your negotiations. List price DOES NOT MATTER. EVER! One of my first deals in Massachusetts, I was so excited to finally be negotiating for a deal. An owner (motivated seller, of course) was selling her house in a nice section of Haverhill (for those who know MA). She was selling it for $272,000. I had learned from listening to others negotiate, that a great question to ask is "is that the best you can do?" after every counter offer. So, I was able to negotiate the seller down to $241,000, AND I got her to pay 2.6% toward the closing costs (why didn't I go for 3%, or 5%? Well, I TOLD you I had no idea what I was doing).

Sounds like a great deal! Well, I spent weeks marketing this property to my buyers list, which I was just building. I was wondering why no buyers were interested. Then, one of my buyers educated me on "ARV" (after-repaired value):

ARV on the property was around $260K at the time. Contracted for $241K (what a sweet negotiation!), needed maybe $40K in work. OOPS! Thank goodness I never closed on that property. Lesson learned - start with the ARV FIRST, then subtract all your costs from THAT number (INCLUDING your profit requirement).

How do you get an accurate ARV? You must form a relationship with an investor-friendly real estate agent, who should know what the house needs for "flare" and how to accurately price it to sell quickly. Unfortunately, I could not find an agent I could work with, so I became my own agent. Now being surrounded by them, I've found many who would have been good candidates!

2. Family members may NOT be the best partners suited for your business.

Before I continue with this story, I just want to say I have a fantastic relationship with this family member. He and I have an awful lot in common, and he's one of the smartest guys I know. However, for the task we had at hand, he was not our best choice.

We had just finished a condo conversion in Somerville, MA where we had closed on the 3-family property for $749K (this is back in 2005), and the seller wanted to lease it back from us for around $20K. Nice chunk of change to start our rehab! We had all the units rehabbed and completely redone with the stainless steel, square tile, refinished hardwood, the works. We were poised to make a good small fortune upon resale of these three units, which we turned into condominiums. (As you can see from the picture, I still attempted to do most of my own work back then - another horrible idea! My time was MUCH better spent elsewhere...)

So we decided to enlist the help of this family member to list the condos through his office. We did not check credentials or his performance / closing ratio - we just knew he was family, and that he could sell them for us. Well, it was also the top of the market here in Boston - condos sat on the market for one month... a second month... then a third... and no offers.

After three price reductions, and us switching to another agent, we lost quite a bit of money on that deal. However, it taught me the lesson to always qualify EVERYONE on my investment team. You have to know what questions to ask, and you should reciprocate the relationship with your agent (or attorney, inspector, etc) by establishing yourself as a loyal client and performer with them.

Nothing is better than if you have your entire team working for the benefit of everyone else. If you do your homework up front, your transactions go a lot smoother and you spend a lot less time!

I have some power team questions that helps qualify some team members; if you're interested, e-mail me, I'll e-mail you the attachment.

3. Property Management - Tenants LOVE to "test the waters".

My first experience as a property manager was when I closed on my first 4-unit in Haverhill, MA, which I still have today. I took over ownership, and immediately assumed that the tenants would all just continue to pay as was shown to me on the statements before I closed on the property (not really having any clue about due diligence back then, I also didn't really verify any numbers the previous owner showed me, but that's another blunder for another day!).

The tenants were notified through a letter that their management had changed hands. The first month, everyone paid; the SECOND month, one tenant was about $500 short on her rent. "My Mom went into the hospital, and I had to pay her medical bills." Well sure, how could I say anything to that excuse?

"It's OK - we'll work something out. Just do your best for now."

That was probably the WORST answer I ever could have given her.

Next month, I received NONE from her... and worse, the OTHER tenants paid a partial amount, or were 15 days late. Hmmmm... it's almost as if they knew they could get away with it!

Now having been in the business for a few years, I've heard every tenant sob story there is to hear. The truth is, everyone has priorities. Housing (at least, for me) would be a BIG priority, so I would make sure I'd pay that bill as one of my first every month. Now, I tell every tenant up front,

"This is my primary business. I don't want you to leave this community, but I have to tell you, the systems are automated; you are late by one day, and our system sends you an eviction letter."

Do I still have to send eviction letters? ABSOLUTELY. However, I will say that now when a new tenant moves in, and their third month when they are one day late, they receive that letter - and they are never late again.

You should treat your rentals as a BUSINESS, since that's just what it is. You're in the business of providing clean, affordable housing to your tenants. In return, they pay you for that service.

Of course, there have been a hundred other lessons I've learned (and continue to learn) through my investment efforts. I find that those are the best ways to learn; but, if you can avoid one or two by hearing someone else's sob story, why not?

Happy Investing!

Nick A.