Real Estate Investors…Get Off The Sideline And Get Into The Game In A "Slow" Market… All For Fun And Profit
For months now many Realtors have been pacing the floor wondering where their next sale was coming from. The bad news drips off the front pages reporting for all to see how bad the real estate market has become. Thickets of real estate signs explode out of the ground much like the peak of any mushroom season. Sellers are now buying into the story believing the market is slow. For buyers who just as little as six months ago were pushing prices with little cash flow properties suddenly, these same properties have become ugly overnight.
Shrewd investors always look for buying opportunities. Whether it is stocks, coins, gold, bonds, collectibles, antique cars, or real estate the investment principals apply. The typical successful contrarian looks for spots to make a move. If there isn’t any worthwhile action they simply stay liquid and move to cash. When the hand wringing begins by the general public the shrewd investor starts to lean forward on the edge of their chairs and begins to focus their collective gaze toward potential opportunities. Currently, there is a huge inventory of listed properties just sitting on the market in the Multiple Listing Services (MLS) in many areas. Some of these potential opportunities have motivated seller some do not. It is necessary to focus on the listed properties that have a motivated seller.
A lot of cash is returning to the stock market with the likes of Google and such pushing 0+ per share. Lots of “hot” stocks don’t have a lot of earnings, but have great stories and much supposed promise. Much like the dot COM companies in the 90’s there was much splash and a lot of broken hearts left in it’s wake of hype. After the stock market fall billions flowed into the real estate business as an alternative to the madness of the stock market. With ENRON and WORLDCOM fiascoes it made the decision much easier for many investors to move into real estate. Who could you trust at the time? The answer for many was to purchase and self manage their own real estate portfolios. Having saved their wounds and after taking the “cure” of property management many disillusioned investors are now moving back into the stock market. Some vacancies have risen in some areas with so many investors buying single family homes and condos the absorption for these properties slowed. The combination of higher vacancy factors and the thrill of property management precipitated an exodus back into the stock market. For many new to the game, real estate investors with a heightened desire to get back into the stock market is leading to clouded thinking and many will accept an offer that was unheard of six months ago. The shrewd investor will target those motivated sellers and make many offers to get a real estate deal that has cash flow and a chance for appreciation.
An early axiom of real estate investing is based on making money on the BUY. It does little good to over pay for a property that has little or no cash flow with some appreciation. When the market gets over valued, just like the stock market, the smart money looks for other opportunities or set on their cash and waits. In many markets, opportunity is knocking. Interest rates are currently at a very low rate for a while. The Real Estate Investment Trust (REITs) learned soon after the 1986 Tax Act that highly leveraged property without the previous shorter depreciation benefits gave little cash flow. It is the same with real estate investor. Going more that an 80% Loan-To-Value financing is asking for trouble EXCEPT in a highly appreciating area. There are a few pockets, however, they currently are far and few in between.
Looking at say a fourplex as an example it would be good to focus on properties that have the potential to command high rents in the market place with a little tweaking. Two bedrooms would be the most desirous. There are many rental customers who need the extra bedroom for in home office space and/or beginning families. One-bedroom units have limited upside as far as rent command in the market place. In some markets, for example, a fourplex might be on the market for 5,000. The rents are say in the 0/month range. This would give a gross rental income of ,400/month. With a 5% vacancy factor the Adjusted Gross Income is ,230/month. The rental customers pay their own electric, gas, cable and water and sewer with separate meters for the utilities. The taxes are 0 per month and the insurance is at 0/month. For this example let us use a 10% of the collected rents for the management cost whether self-managed or not. The investment needs to carry itself regardless. This would be 3/month for management. Utilize 0/month for maintenance and lawn care. The idea is to have well maintained properties and keep them that way to command the highest rents. This would lead to the following: ,230 adjusted gross income less-0-0-3-0=,137/month available for debt service. At this moment, with a seller paying up to 6% of the closing costs and prepaids there would be some left over to help the purchaser to buy the rate down. With 375,000 x 6% = ,500. Closing costs and prepaids with full escrows for taxes and insurance could be in the ,000 range. That leaves ,000 for a rate buy down. With an 80% Loan To Value, 5,000 x 80% =0,000 for a mortgage amount. At a rate of 6.25% at par for an investor loan on a four unit based on a fully documented loan there is a lender bump of 1% to the price for a 3-4 unit at 80% LTV. So with the buy down the purchaser can get a 30 year fixed rate at 5.75%. The principal and interest payment would then be ,750.72/month for principal and interest. This would leave an initial cash flow after debt service without benefit of interest and depreciation of ,137-,750.72/month =6.28/month cash flow. The interest deduction would be ,250/year. The depreciation with ,000 on the land the improvement at say 0,000/27.5 = ,909.09/year. Thus our after tax cash flow would be Net Operating Income: ,644/year -,250 interest deduction - ,909= (,515) tax loss. If the owner is in the 30% tax bracket this would save 4 in federal income tax. Thus the total after tax return is 6.28 x 12 = ,635.36 + tax savings of 4 = ,389.36. With a ,000 cash down payment with seller help on closing costs and rate buy down the return then would be ,389.36/,000= 7.19% After Tax Return. If a conservative 4% appreciation rate were allowed, then the initial investment of 5,000 x 4% would theoretically appreciate over time some ,000. Then the total adjusted return would be ,000 + ,389.36 = ,389.36/,000= 27.18% less say 4% for inflation or a net return of 23.18%. It should be noted this return would be muted with capital gain taxes and some depreciation recapture at the end and such. If you were self-managing then that money could go into additional upgrades or into the pocket. This is not a bad deal for an investor thinking long term. It is an example of leverage at work.
If a Certificate of Deposit was paying say 6% on ,000 that would garner ,500 and again in a 30% tax bracket the return would be ,500 x 30% = ,350 for a total return of ,500-,350 = ,150/,000 = 4.2% in comparison. However, if inflation were at 4% the net gain would be .2% with no risk. The above investment is figured with management in place.
For many shrewd investors the timing is now. With good pricing and seller help on closing costs and interest rate buy down the investment property can make some sense from an investment standpoint. The key, find a motivated seller and a property that can command top rents and make multiple offers. For buyers with challenged credit, asking for seller held second mortgages at a low rate can also make the numbers work. In any case, it is time for many real estate investors to get off the side line and move strongly into this soft real estate market with a primary goal of finding and acquiring “make sense” properties with cash flow. The market is begging for offers.
About the Author: Dale Rogers is a thirty-year mortgage veteran and frequent contributor to the Broken Credit Blog. The BCB is a free website created to assist the general public with information about credit repair and responsible mortgage lending.