Right strategy for this market

 

hazzi_p3066875The phone as of late has been ringing off the hook with investors looking to claim their piece of the inclining real estate market that we are experiencing. On the surface this is a great thing. The problem is that everyone has the same idea, thanks in part to the plethora of HGTV flip shows we see. Everyone wants to quit their job and flip homes for a living. Now I believe that this is entirely possible in certain markets, particularly the buyers market we just came through. Two years ago you could negotiate a great deal with an anxious seller. Now the market has shifted to the advantage of the sellers, homes sell quickly and for top dollar, often for bidding wars as inventory has dipped to near 2007 levels.

A successful flipping venture requires you to find a distressed property and purchase it at a deep discount. You then must renovate and control your costs to eventually sell at a new premium. The challenge now, is that anything cheap goes into multiple offers and contractors if you can find them at all, don’t do anything “for cheap”. This makes executing on budget and on time a real challenge. Again not impossible, you are just swimming against the current.

That aside, I want everyone reading this column to understand that you don’t flip your way to prosperity. Anyone who has created serious wealth through real estate has done so by holding properties that cash –flow. Now here comes the good news, this market that may not be so great for flippers, is a hell of a market to be a landlord in. In Kelowna, you have near a zero vacancy rate, which means you can have your pick of quality tenants willing to pay premium rent for decent units and you have mortgage rates that just got even lower making your mortgage payments well below what you can rent for.

“But AJ, I want to showcase my amazing design skills” you say, “I want the big before and after reveal.” No problem, buy a home that needs your TLC, showcase your design skills and impress the heck out of your friends, realtor, appraiser and most importantly the lucky tenant that will occupy the property for the next few years.

With a buy fix hold strategy, you still profit from your hard work, in fact you get even more sweat equity, because you don’t pay real estate commissions or capital gains tax. All of the value increase would be immediately available to you on a line of credit.

Let me illustrate:

You purchase a 5 bedroom home on a decent street for $400,000 with 20% down you invest $80,000 of your hard earned savings into the property when you purchase. You wisely spend $20,000 on the home updating floors, paint, trim, fixtures etc and raise the value of the home to conservatively $450,000. This is doable even if you paid market value for the home on the way in. This may sound like a profitable flip, but If you sold now you would at best break even after fees and carrying costs. A better plan is to hold and utilize a STEP mortgage. To remain a conventional mortgage you can access up to 80% of the appraised value.

(80% x $450,000 = $360,000)

Since your original loan was for $320,000, this means that you can draw $40,000 out. You spent $20,000 to profit $20,000. The cost to access the profit is an interest only payment on the 40k at 2.75% which equates to $91 dollars per month.

By investing in the cosmetics you attract a high quality tenant willing to pay a minimum of $500 more per month than the time warp you started with.

Example: A 5 bedroom home with wood paneling and stinky old carpet would rent for approximately 1800/mo. The same home with new floors, paint and fixtures will fetch 2300/mo. all day long.

Your annual net on the $40,000 you pulled out tax free is nearly five thousand dollars in increased revenue. ($6,000 increased annual income subtract $1,092 annual interest cost.)

So not only do you make a 100% return on the investment and receive it tax free, your $20,000 invested continues to return $5,000 per year infinitely. If all of that wasn’t sexy enough on its own, you get the massive benefit of the tenant paying down your mortgage to the tune of $10,000 per year. You get to participate in the market appreciation we are seeing this year of at least 5% approximately another $20,000.

Now add it all up:

You created $20,000 profit on the renovation

You received $20,000 in market appreciation after a year

Your mortgage got paid down by $10,000

And you saw positive cash flow of $5,000 per year even after hiring a property manager

That’s $55,000 on an $80,000 investment!

Do that twice this year and you create the magic $100,000 per year that you wanted to make only in this example you aren’t spending it as it comes. You are building an impressive net worth.

This is an important distinction and to be candid, a life lesson I learned from watching my dad in his real estate dealings over the years. To his credit, he was an amazing flipper, he made well into the 6 figures renovating ordinary homes every year that I could remember even long before I became a realtor. He was masterful at adding value and creating equity, but because he didn’t hold any of the properties, he never realized the full promise of real estate investing. He needed his profits to live so nothing ever accumulated.

By adopting a Buy – Fix – Hold strategy you can have your cake and eat it too. You will utilize your god given talents to design wonderful spaces adding all kinds of value to your properties, but you will also realize the dream of building a portfolio of rentals that will, before you know it, be paid off providing a steady stream of cash-flow that will truly allow you to quit your job, not just trade it in for a more stressful one without the guarantee of a pay check.

A quick tip for knowledge thirsty folks out there, of the hundreds of books and courses I’ve devoured over the years, the book HOLD remains the authority on the strategy discussed in this article.

5 Things Every Real Estate Pro Knows

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Those who consistently make money in real estate know the market. They know the location and the history. They know what new developments are planned. They know the transportation and the schools. They know everything about the area where they invest. They have to know it all.

Staying ahead of the competition in real estate investment means doing your homework. If you are new to the business, it can be daunting, but in this article we’ll teach you five tricks that the old pros use to get ahead of the trends instead of chasing them. (To learn about the perks of real estate investing, see our Exploring Real Estate Investment Tutorial and Investing In Real Estate.)

Study Local Pricing
The first things to study are the current price trends in the area. For example, a potential investor should look to see if the price of homes is accelerating faster in one area than in others. Next, check to see if the average home price is more than in other neighboring towns. This will provide an idea of where the biggest demand is. Another reason to study these trends is that, over time, you will start to develop a sense for which prices are “fair” for certain properties and which are overpriced. For individuals looking to buy properties at the lowest cost possible, this knowledge can be invaluable.

Realtors and real estate agents are a terrific source for this information given their access to the Multiple Listing Service (or MLS). The local newspaper, the internet and the town hall may have a record of recent sale prices as well.

Look for a Catalyst
One sign that an area is up-and-coming and that it will be desirable in the future is the development of new infrastructure. When you see new roads and schools being built, it’s a sign that the community is set for a growth spurt. Investing in a growing community can be very profitable. In addition, certain types of development, like new shopping centers, may be extremely attractive to homebuyers, and may also help keep the tax base low.

Spotting new developments can be as easy as looking out your car window as you drive by. Telltale signs of land clearing, surveying or the beginnings of construction in and around major roadways are pretty big tip-offs. Also, look for widening of traffic lanes, the installation of turnaround lanes and the erection of new traffic lights. All suggest the possibility of increased traffic flow.

Next, visit town hall at the municipality or the county level, and speak with the road and the building departments. They should be aware of any major projects slated to begin in the area, and they may even be able to provide you with a connection at the state level so you can find out if any state-owned roads or properties are slated for development as well. Real estate agents also have general idea of what new projects are about to be undertaken. (For added insight, see Profit With Real Estate Land Speculation.)

Explore Low-Tax Alternatives
If there are two towns side by side – one with high property taxes (or with progressively rising property taxes) and the other with low property taxes – the one with the lower taxes will usually be more in demand.

Real estate agents can help you determine which areas have the best and worst tax structures. In addition, a simple call to the local tax assessor can reveal how much the town charges in taxes per $100 of house. The assessor can also let you know when the last time the area was evaluated by the township. Also watch to see if a reassessment is set to take place in the near future, as it may mean that property taxes are about to go up. Beware of towns and communities that are becoming overcrowded. Signs include schools filled to capacity and inferior roadways. This could mean the town will have to do some major construction to accommodate the influx of people. And how do they pay for that construction? Tax dollars. (For more on property tax, see Five Tricks For Lowering Your Property Tax and Tax Tips For The Individual Investor.)

Check the School Rankings
Nearly every state ranks its schools by how well students in each district fare on tests in math and English. Sharp-eyed investors should look for schools that are moving up or are atop the list. These areas are often desirable to parents. Access to quality education is a big selling point to new home buyers.

There are several ways to find this information. Check our your state’s board of education website. Also, PSK12.com has public school rankings for most states in its free section. Visiting the schools yourself is also a good idea. Schools that rank the highest are usually quite eager to provide information.

Watch the Outskirts
If the properties in a major city or town have become overpriced, the areas on the outer fringes most likely will soon be in demand. Areas in close proximity to major bus and rail transportation are even more desirable Nearly any area that is about to install a major train stop or a new major bus route will see its proverbial stock go up in value.

To find out what’s planned, you can check with the local railroad or bus company to see if they will be expanding service in the area. The local town hall or planning department will also have this information.

Bottom Line
It pays to do your homework and to tap local resources to determine which areas are hot now and, more importantly, which ones will be hot in the future. Much of the information is out there and free for the taking. You just have to be willing to do the leg work.