Just find me a good deal

Dated: July 21 2019

Views: 238

The two questions I hear the most often from clients and friends alike are, “How’s Business?”  and “Can you find me a good deal”. The good news is that both questions indicate to me that I am most likely talking to a future client. The “How’s business” question is generally a reason for me to probe the questioner into why they are asking: Are they a buyer? Seller? Investor?   Of course there is no one answer to this question, but I always look forward to it because I love to get into a discussion about my clinets perspective of the business and I wind up getting as much information about them as they get information from me.

It’s the second question I want to talk about today. “Can you find me a good deal?”

Short answer is “yes”.  But where I have trouble is when I ask a follow up question, I often discover that the future investor has trouble verbalizing what a “good deal” is to them. This article should help.

For the purposes of this article I will limit my discussions to a real estate investment deal. We can assume that a personal use “good deal” is a home that meets all their needs, rings all their bells, and is at what is perceived to be at a “below market” price.

For an investor, price is not my first question.  My discussion with an investor starts with me asking probing questions about their investment objectives, their income needs, and their ability to spend additional time and or money on a project. I will want to know what other investments they have and like, and what investment they have made that they did not like.

Real estate should be part of any thorough investment plan, not the be all and end all.

Most of us like real estate investments because we understand them. We can touch real estate, we can drive by it, and when we talk about it, our friends understand it as well.

If I said to you, “How about a rental property located in an appreciating area, with good rents, that requires little maintenance, is only a few years old,  can be bought below current area comparables, you would be proud to own and tell your friends about it, plus the bank will loan money to you to buy it at a rate that is below what the annual cap rate is?”

Bingo, I think that one rings all the bells.

Your next question would be, “How Much”, right?  Well it might be too good to be true, as there is always an uncertainly factor (risk) involved in each of these bells we rang. I will enumerate them below to help you understand each one. I have put links to other articles, but you may want to come back to them after you finish this one.

 

Appreciation

               “Past results have no indication of future performance.” 

Ever hear that one? Sure, you have. Whether or not a property will appreciate is a best guess situation. You, as the investor, with the aid or your professional team, will have to make your best guesstimate on this.  Generally, if you can get, say a 9% CAP rate on a rental property (which is high in most markets), it is because there is either no appreciation, there is actual financial depreciation, or there has been deferred maintenance on the property. High CAP rates are an indication, or indeed an  incentive to the buyer to invest in a less than stellar property with higher than normal risk. (Click here to read an article that will help you understand CAP rates). In my world the best real estate investments have a good balance between income and appreciation another good article here)

Long life

               The life of the investment is related to appreciation but also speaks to functional obsolescence. Keep in mind that outdated features will depreciate a dwelling.  The quality of construction also plays a major role here. Let us say you buy a brand-new wood fame, cheaply built home, and keep it as a rental for ten years. The wear and tear may have taken too large a toll on the home by the end of that period. Better to pay more for a higher quality home that will last with minor regularly scheduled maintenance.  Make certain your ASSET has value after you have made your INCOME.

Low cost to maintain

               A new property will need less up-keep than an older one. CBS (Concrete Block on Slab needs less than frame, and other quality items like good faucets, toilets and AC all are important considerations.  One mistake I constantly see is lack of regularly planned, low cost maintenance in favor of a “if it ain’t broke, don’t fix it, strategy”.  Better to replace a working ten-year-old water heater when you have time to shop and schedule, than replace an eleven year old one that leaks on a Sunday morning while you are on vacation.

Return on investment - long term

The ROI (return on investment)  on a long term investment takes into consideration the NET income you made while you own the property, plus the profit you made when you sell it.  I can help you calculate this based on certain assumptions.  I will need to know what you feel is a good return, and then we can discuss whether this is attainable. 

I gave up a long time ago telling others what a good return is. I had a client tell me one time that he was doing very well with an investment he made on a beach front condo he bought. His net income after all expenses was $14,000 on an investment he made for $435,000. But he was very happy because he had frequent personal use of the condo and the net rents paid his taxes.  (This brings up another point – deferring some of the expenses of a second home – but this is a topic for another article)

Return on investment[GF1]  - short term

If you are looking for short term gains, you need to look at below market properties that you can physically or financially improve in the short term and then sell.  Rental income is not your driver here. In most cases the cost of buying and selling make these deals a hard to come by – but if you can make your improvements VERY quickly, you can do well. Too much risk for most of us.

Pride

If you don’t like owning it, don’t buy it. Pretty simple.  I will not argue that there is definite value in pride of ownership. Owning a few duplexes in a crime ridden area may pay well, but not make us feel good. You have to be happy with your investment

Security

Most of us like and need certainty. We like the predictability of low risk investments, but we need to balance that with our need for decent returns. This is a discussion you need to have with your professional real estate agent. One example here is investing in a restaurant building with a restaurant as a tenant. The food service business is very risky. You will want risk mitigation factors like national chains, personal guarantees, and long leases. There are mitigation factors and ways to manage risk in many investments, but wishes and hope are not among them.

Sweat equity growth

This one is my favorites. When I starting buying rental properties, I drove my own pickup. I mowed my own lawns, did most of my own maintenance, and collected the rents in person. My time was not on my financial statement and often it is the personal involvement that makes the deal “work”.  Then, as appreciation starts to be significant, the rewards are great.

Marketability

You make money when you buy, not when you sell. ( read that again)  Only YOU decide when you will buy. Someone else decides when you will sell. You better make sure what you buy is not so unique only you would buy it. Remember real estate may be liquid, but maybe not at the price you would accept.

Bankable

Will a bank finance the property?  Keep in mind they WILL NOT if it is not insurable. Please read my article about four point inspections that are required to get insurance ( and hence financing).

Negative Cash Flow

Let me conclude by discussing negative cash flow.  In some situations, negative cashflow is acceptable. For me, it’s for the investor that has one investment, say a second home or one rental property. If the predicted appreciation will exceed the negative cash flow and the negative cash flow will turn positive as rents increase, then this may be a sound play. 

Let’s assume you buy a home for $230,000 that you feel will appreciate at 5% per year ($958/month for the first year, $1006 the second year and indeed more every year thereafter due to compounding). Once you figure all your costs deducted from your rents, you are short $500/month (The negative cash flow). If you can put $500 a month into a savings plan, why not put it into this investment?  Your $6000 a year negative cash flow will get you $11,500 in appreciation the first year.

 

If I can help you with your real estate investment planning, call me.


Gregg



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Gregg Fous

Real estate has been my passion since I took my first Al Lowery class on real estate investing in the 1970’s. I vowed during that class that I would buy one property a year. Over the next five ....

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