Real Estate Investors – Get off the sidelines and into the game in a "Slow" Market


For months, many real estate agents have been pacing the ground wondering where their next sale would come from. Bad news is leaking from the front pages for all to see just how bad the real estate market has become. Groves of real estate signs explode from the ground like the height of mushroom season. Sellers are now buying into the story, believing the market is slow. For buyers who just six months ago were suddenly pushing prices with low cash properties, those same properties turned ugly overnight.

Savvy investors are always looking for buying opportunities. Whether it’s stocks, coins, gold, bonds, collectibles, vintage cars or real estate, the principles of investing apply. The typical successful contrarian looks for places to move. If there is no valid action, they simply remain liquid and switch to silver. When the general public begins to wring their hands, the savvy investor begins to lean forward on the edge of their chair and begin to focus their collective gaze on potential opportunities. Currently, there is a huge inventory of properties listed on the market in Multiple Listing Services (MLS) in many areas. Some of these potential opportunities motivated the seller, others did not. Focus on listed properties that have a motivated seller.

Lots of money is coming back to the stock market with companies like Google and others pushing over $500 per share. Many “hot” stocks don’t have a lot of earnings, but have great stories and a lot of supposed promise. Much like the dot COM companies in the 90s, there was a lot of splash and a lot of heartbreak in the wake of the hype. After the stock market crash, billions were invested in the real estate sector as an alternative to the stock market madness. With the ENRON and WORLDCOM fiascos, it has been much easier for many investors to get into real estate. Who could you trust back then? The answer for many was to buy and manage their own property portfolios themselves. After saving their wounds and taking the “cure” in property management, many disillusioned investors are now turning to the stock market. Some vacancy rates have increased in some areas with so many investors buying single-family homes and condos that absorption of these properties has slowed. The combination of higher vacancy factors and property management excitement precipitated a return to the stock market. For many new to the game, real estate investors with an increased desire to return to the stock market lead to clouded thinking and many will accept an offer that was unheard of six months ago. The savvy investor will target these motivated sellers and make many offers to secure a real estate transaction that has cash flow and a chance for appreciation.

One of the first axioms of real estate investing is based on making money on the PURCHASE. There is no point in overpaying for a property that has little or no cash flow with some appreciation. When the market is overvalued, just like the stock market, smart money looks for other opportunities or bets on its money and waits. In many markets, opportunities arise. Interest rates are currently at a very low rate for some time. Real estate investment trusts (REITs) learned shortly after the 1986 Tax Act that highly leveraged assets without the earlier shorter amortization benefits yielded little cash flow. It is the same with the real estate investor. Going further than 80% Loan-To-Value financing is asking for trouble EXCEPT in a highly valued area. There are a few pockets, however, they are currently very rare in between.

Looking at a quadruplex as an example, it would be good to focus on properties that have the potential to generate high market rents with a few adjustments. Two bedrooms would be most desirable. Many renters need an extra bedroom for a home office and/or starter families. One-bedroom units have a limited advantage when it comes to commanding market rents. In some markets, for example, a fourplex might be on the market for $375,000. Rents are around $850/month. This would give a gross rental income of $3,400/month. With a vacancy factor of 5%, the adjusted gross income is $3,230/month. Tenants pay their own electricity, gas, cable, water and sewer with separate meters for utilities. Taxes are $350 per month and insurance is $220/month. For this example, let’s use 10% of the rents collected for the management cost, whether it is self-managed or not. The investment must stand independently. That would be $323/month for management. Use $200/month for lawn care and upkeep. The idea is to have well-maintained properties and keep them that way to get the highest rents. This would lead to the following: $3,230 adjusted gross income minus -$350 -$220 -$323 -$200 = $2,137/month available for debt service. Right now, with a seller paying up to 6% of closing costs and prepayments, there would be some left over to help the buyer lower the rate. With 375,000 x 6% = $22,500. Closing costs and prepayments with full escrow for taxes and insurance could be in the range of $12,000. That leaves $10,000 for a rate buyout. With a loan to value of 80%, $375,000 x 80% = $300,000 for mortgage amount. At a rate of 6.25% at par for a four-unit investor loan based on a fully documented loan, there is a 1% lender increase on the price of a 3-4 unit at 80% LTV.

Thus, with the redemption, the buyer can obtain a fixed rate of 30 years at 5.75%. The principal and interest payment would then be $1,750.72/month for principal and interest. This would leave an initial cash flow after debt service without interest or amortization of $2,137 at $1,750.72/month = cash flow of $386.28/month. The interest deduction would be $17,250/year. The depreciation with $75,000 lands the improvement to say $300,000/27.5 = $10,909.09/year. So our after-tax cash flow would be net operating income: $25,644/yr – $17,250 interest deduction – $10,909 = ($2,515) tax loss. If the owner is in the 30% tax bracket, this would save $754 in federal income tax.

So the total after-tax return is $386.28 x 12 = $4,635.36 + $754 tax savings = $5,389.36. With a down payment of $75,000 in cash with seller assistance on closing costs and purchase rate, the return would then be $5,389.36 / $75,000 = 7.19% after-tax return . If a conservative appreciation rate of 4% were allowed, the initial investment of $375,000 x 4% would theoretically appreciate over time by approximately $15,000. Then the adjusted total return would be $15,000 + $5,389.36 = $20,389.36/$75,000 = 27.18% minus, say, 4% for inflation or a net return of 23.18 %. It should be noted that this return would be mitigated with capital gains taxes and some recapture of depreciation at the end etc. If you were self-managed, this money could be invested in additional upgrades or in the pocket. Not a bad deal for an investor thinking long term. This is an example of leverage at work.

If a certificate of deposit paid, say, 6% on $75,000, it would return $4,500 and again in a 30% tax bracket, the return would be $4,500 x 30% = $1,350 for a total return of $4,500 to $1,350 = $3,150/$75,000 = 4.2% in comparison. However, if inflation were 4%, the net gain would be 0.2% without risk. The investment above is calculated with the management in place.

For many savvy investors, now is the time. With good prices and help from the seller on closing costs and interest rate, buying an investment property can make sense from an investment perspective. The key is finding a motivated seller and a property that can command high rents and make multiple offers. For buyers with troubled credit, applying for seller-owned second mortgages at a low rate can also make the numbers work. Either way, it’s time for many real estate investors to step out of the sidelines and into this soft real estate market with a primary focus on finding and acquiring “meaningful” properties with cash flow. The market is waiting for offers.

Source by Dale Rogers

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