Real Estate Investment

A real estate agent is not a real estate investor and may not understand what you are trying to do as an investor. That is okay, as real estate agents are there to help you buy and sell properties, not to make decisions on where or why to invest.  Once you understand the rental market in an area from talking to your property manager, you will want to get information on the sales market.  A real estate agent will provide you with data on the market as it relates to sales, but remember they are real estate professionals, not real estate investors. 

You can contact a real estate agent in an area where you are interested in buying and have them provide you with lists of homes available for purchase.  Give them the characteristics of the property you are looking for based on the information your property manager recommended. Through their electronic database called the Multiple Listing System, or MLS,  real estate agents can find properties quickly that match your criteria.  As a potential buyer, the services of a real estate agent are completely free.

A real estate agent can determine how long a property has been on the market and if their have been any recent price reductions.  A property that has been for sale for an extended period of time or has been recently reduced may mean the seller is getting anxious.  These circumstances should allow you to negotiate a lower price.   

A real estate agent must understand the local market from a perspective of buying and selling.  You should interview multiple agents and find one with knowledge of the area, command of trends in pricing, an understanding of what homes have the best resale potential, and an idea of the best areas to buy.  Your agent should also have a good attitude toward negotiating.  Some real estate agents are timid and do not like negotiating, and would therefore encourage you to make an unnecessary full-price offer.  If an agent is unable to provide this information or lacks the understanding of the market, move on to the next potential candidate.

When interviewing a potential candidate to serve as your real estate agent, ask the following questions:

1. How long have you been in real estate, and how long has your firm been in business?

2. How many real estate agents work in your company?

3.  What commission do you charge when selling a property?

4. Do you charge any additional transaction or MLS fees?

5. Are you able to take additional pictures of a property and email them to me since I am out of state?

6. How do you feel about attempting to negotiate a substantial reduction in sales price in potential purchases?

7. Where are the best school districts in your area?

8.  Are there any areas that are currently being revitalized?

9. In your area, does the seller or the buyer select the closing agent?

10. Are there any closing costs that are typically paid by the seller in your area?

11. What type of home seems to sell the fastest in your area? Get specifics, including number of bedrooms, bathrooms, area of town, and style of home.

12. Can you provide references of investors you currently work with who are satisfied with your performance? 

Real estate investors must surround themselves with the best real estate professionals possible.  In earlier posts, I discussed that a real estate investor should allow real estate professionals to handle the ‘leg work’ in the transaction. Having the right people doing this work is imperative.  Some of the professionals can work with you in multiple areas around the country, while others will be specific to certain geographic regions.

In the coming posts I will look specifically at each of the real estate professionals.  It is important to interview prospective candidates in each area of expertise before making a decision.  The end goal is to build a long-term working relationship with each of these professionals, so don’t settle for the first one you find in the phone book.  Through the interviewing process, your goal is to uncover strong knowledge in their field of expertise, a high level of professionalism, and an amiable personality. These qualities lead to a good relationship, both on the individual basis with you as an investor, and collectively as a strong team, working to make the best use of your money and time.

With each description of the team member, I will give sample questions to use when interviewing each professional.  This is just a basic outline, as you will want to ask your own questions to make ensure the candidate will serve as a strong member of the team.

Think about house prices in your area five or ten years ago.  No matter where you live, they would have been much lower than today.  In some areas of the country prices 10 years ago were half current prices (even after the large correction we have seen in the last 2 years).  This is because the value of housing appreciates over time.  This is what allows you to make real money with real estate.  When you buy low and sell high you make money!

There is no way to predict how much a home will go up in value, just like with stocks and other investments.  You can how ever analyze a market, and analyze the past and make a better decision about where to buy.    Also, in the same way the stock market can "crash", real estate values can to.  There are not safe bets in life.

First, you need to understand what makes a home go up in value.  Stocks go up in value when a company makes profits, or shows the potential to make profits increasing the demand for that stock.  Houses increase in value for two reasons, inflation and demand.  Inflation is the gradual increase in costs over time, and demand is based on the location of the home and the desire to live there.

Supply and Demand are basic principals in economics.  When there is a high demand and a limited supply prices will increase.  When there is too much supply available for the demand prices reduce to entice more demand.  Excess demand will increase prices, while excess supply will reduce prices, therefore they move inversely.

We can look at supply and demand in real estate on a small level and then expand the principles to larger areas.  Let’s say there is a neighborhood with 100 homes.  There are usually 5 buyers per year that want to move into this neighborhood and 5 people that wish to sell.  The supply and demand are balanced so the little appreciation that is seen will be based on inflation. 

Suddenly a new road goes in making this neighborhood very convenient to the downtown area where many people work.  For this reason instead of 5 people wanting to buy here per year, 100 people want to!  There are only 5 houses for sale per year and now there are 100 buyers competing for them.  The supply is still at 5, but now the demand is substantially higher.  With 100 people battling to own only 5 homes, prices will increase rapidly as they attempt to outbid each other to get the homes.  High demand and low or static supply results in increased appreciation and prices.

As the prices begin to increase other people will start to sell to take advantage of the new higher prices.  For some people, being close to downtown is not important so they will sell their homes in this neighborhood at the higher price and move to another neighborhood that is not in such demand.  This will increase the supply as more people are willing to sell their homes at the new higher prices.

Now the supply will increase as more homes go up for sale, so in our example we will say there are now 50 homes for sale.  As the supply increases to meet the demand the prices will start to level out.  Finally the price will be at a point that outweighs the benefit of being close to down town.  When this happens the buyers will move on to other areas reducing the demand.  Prices will level at a point when the supply and demand meet and return to normal levels of appreciation.  The reduction in demand, caused by potential buyers being discouraged by price, will ultimately cause prices to stop increasing.

This is the supply and demand cycle.  The supply and demand cycle is much different for real estate than it is for other goods.  If there was a product that suddenly came in demand the manufacturer could simply make more of it and meet the demand, or a competitor would begin to produce a the product to meet the demand.  In our example above there were only 100 homes in the neighborhood in demand.  No one can create new homes in this neighborhood so the only way to create more supply is for more people to sell.  The only way to motivate more people to sell is to increase the price.  The longer the existing owners refuse to sell in an area the faster prices will increase and the longer the increasing trend will last.  The market will continue to increase prices until they reach a point that motivates the existing owners to sell, or the price outweighs the benefit of owning in that location.

This supply and demand imbalance can be applied on a larger scale to the areas that had high amounts of appreciation in 2005.  Due to low interest rates and our aging population many people began buying homes in desirable areas such as Arizona, Nevada and Florida.  As the demand increased, the supply remained the same – for a while.  As prices increased some owners decided to sell their homes at the new higher prices, claim a profit and move to other states.  The areas that experienced the growth had large amounts of vacant land.  This allowed more supply to be created.  When we were talking about a neighborhood with a fixed amount of homes for sale the supply was easy to track, but when looking at a larger scale area with the option to create new homes things get a little more complicated.

The development and construction industries can take around 18 months to add substantial amounts of new inventory to an area.  When the demand for these areas suddenly increased the development and building communities started large scale attempts to add new supply to the market.  For the first 18 months they had no effect on the supply because of the time it takes to develop and build a new home. 

During this time the only way to meet the demand was to increase prices to motivate existing owners to leave.  This 18 month period was an appreciation spike seeing rates as high as 30+%.  It took a 30% price increase, in some areas, to motivate enough existing owners to sell.  They had to be motivated to sell to meet the demand imbalance in the markets.  Prices spiraled out of control.

The markets are efficient, although often slow.  Eighteen months after this all began the construction and development industry finally showed up with the increased supply needed to meet the demand.  Balance was restored to the market, and the appreciation spike stopped.  The demand remained the same, but the supply was finally able to catch up.  Some fear that prices will drop, but as long as the demand stays constant the previously reached prices are justified. 

The first thing a Real Estate Investor must do is to make contacts.  Your contacts will include property managers, real estate agents, mortgage brokers, insurance agents, builders and all types of real estate professionals.  An investor must utilize these contacts to do the “leg work” in purchasing and maintaining real estate.  The real estate investor’s job is to make a decision and an investment.

The decision on where and what to buy and the investment required to purchase the property.  That’s your only job; all other aspects of real estate should be handled by others.  Making the decisions is merely analyzing the potential properties that are presented by your contacts.  It is not the job of a real estate investor to contact hundreds of sellers and make offers or find buyers, these are the responsibility of real estate professionals who’s services you will utilize.  Many books and programs advocate the investor taking on these responsibilities to maximize the return on each deal; a true real estate investor would rather maximize the return on their time.  There are unlimited deals out there but we only have so much time, and once it’s gone you can never get it back.  A real estate investor understands their time is valuable and can maximize their return on time by letting the real estate professionals do their job and earn their fee.  A real estate investor trying to perform all of these functions themselves would be like a stock market investor trying to be the C.E.O of the company that bought stock in.  As an investor you job is to make decisions on buying and selling and let the professionals handle the other work.

Through late 2004 and early 2005 there was a considerable spike in appreciation in many parts of the country.  In some areas property was appreciating at rates estimated as high as 45%.  This unprecedented increase caused many instant fortunes to be created in real estate making many people feel ‘unstoppable’ in real estate.  When appreciation rates are that high you can buy almost any property and succeed as a real estate investor.    Unfortunately this success has lead to many people forgetting the true principals Real Estate Investing.

If I presented you with the following investment what would you think?

Purchase a property worth 200,000 for a price of 220,000 (10% more than market value) with a yearly negative cash flow of 5% ($10,000 over a 12 month period).  This may sound like a terrible investment but had you purchased this deal in late 2004 in Orlando Florida and realized 44% appreciation you would have the property for 280,000.  At this price you would regain the 220,000 purchase price and the 10,000 in negative cash flow and still profit $50,000 in only 12 months!  When even a poor choice of investment such as this can generate boasts of a $50,000 profit, it’s easy for anyone to feel unstoppable in real estate.  Had this same purchase been made under times of more realistic appreciation of only 7% the ‘investor’ would have suffered substantial losses.  As appreciation rates begin to level off it will be much more important to make wise decisions in choosing real estate investment.  For that reason I developed the Appreciation Opportunity System.

    Â Â Â  44% Appreciation  Â Â Â Â Â Â  7% Appreciation

Initial Value  Â Â Â Â Â Â Â Â Â  200,000  Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â  200,000

Value in 1 Yr  Â Â Â Â Â Â Â Â  288,000  Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â  214,000

Initial Cost:  Â Â Â Â Â Â Â Â Â Â  -220,000   Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â  -220,000

Cost to Hold  Â Â Â Â Â Â Â Â Â  -10,000  Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â  -10,000

Gain/Loss`  Â Â Â Â Â Â Â Â Â Â Â  +58,000  Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â  -16,000

Even the worst real estate decision can have a positive outcome when appreciation rates are this high.  Many people who succeeded blindly under these circumstances will fail as appreciation rates return to normal levels.

Real Estate investment remains a very powerful way to build wealth.  As the market begins to level off many of the fly by night investors will move on to other things.  This will bring balance back to the market reducing the competition for investment property making it easier to find a good deal.  Real Estate fortunes are not made overnight, you should consider a twenty year plan for real estate investment.

Real Estate Investing is about owning real estate and holding it for long periods of time allowing it to increase in value.  Real Estate investing is not a full time job and never should be, that isn’t to say it can’t generate enough income that you may not need to work, but it’s never a full time job.  Do stock market investors take on full time jobs with all of the companies they invest with? No, being an investor is not about working in the business you are investing in.

As a real estate investor your job is to own the property and let others take care of finding buyers and renters and doing the leg work, like a stock investor lets the CEO and Employees of their investments run the companies.  The true power of real estate is to spend 3 to 5 hours finding and negotiating a property.  Closing on it and spending a few hours a year on accounting and tax returns while it increases in value.

If a property appreciates $20,000 a year you are earning as much as $4000 per hour – now that’s a great job!  Real Estate investing does require capital and good credit, I will talk more in later posts about how to acquire the needed capital by owning real estate (there are a few ways to buy real estate with no capital to help get you started) and how to perfect your credit profile to be able to obtain financing for your real estate investment.

Real Estate Investing is not a get rich quick scheme or a way to quit your job in the next 12 months.  There are “real estate gurus” who sell programs labeled as real estate investing with such promises.  These programs are not focused around real estate investing but actually around having full time jobs in real estate.  Many of the programs focus around flipping properties, contracts and negotiating with sellers in foreclosure, etc.  Then require that the investor sell the property themselves without utilizing a realtor (because there is not enough profit in the deal for them and a real estate commission).  At the end of the day these ‘investors’ are making hundreds of phone calls a day and showing homes to buyers and negotiating sales.  These people would be much better off just to obtain real estate licenses and become full time realtors.

Most real estate commissions are 6% and many of these flipping deals produce less average income than that.  If you are going to contact sellers based on classified ads or advertising and convince them to sell you their property so you can then flip it, as a Realtor you would have convinced them to list the property with you while you find a buyer.  If you were then going to find buyers through classified ads and advertising to buy the home, as a Realtor you would deliver this buyer to the seller and earn the full 6% commission.  Any of these real estate programs that require you to do all this work, if you were to earn any less than 6% you are giving your services away below market value.  Most programs that involve assignments of contracts, flipping and deed schemes are just creative ways to earn a real estate commission without a license.  You can make more money just getting the license and using a listing agreement instead of all the fancy and sometimes devious contracts and documents prepared by these ‘gurus’.  Again this is not real estate investing this is a career in real estate