“Where is the best opportunity in real estate?”
I’m asked that question often. The truth is that there is opportunity in every real estate sector; even in this economy and especially in this economy. The opportunity available depends on what kind of investor you are.
If you’re a small investor, residential real estate is where there is opportunity to put money in your pocket.
Because people always need a place to live.
Want another reason?
Okay, most small investors can’t compete with bigger, commercial investors. For the smaller investor, it’s best to invest in a market where you can compete effectively. That’s the short answer to a broad question.
It’s funny, but a lot of people talk about business climates as being bad or good, or apply unrelated terms to describe the current market. I’m sure you have heard of the tech bubble, the stock market bubble, or the real estate bubble. But applying unrelated terms, generalizations and averages don’t help you determine what a good deal is.
Cycles, Not Bubbles
I’m here to tell you right now: There are no bubbles! Let me say it again: There are no bubbles!
There are, however, cycles.
All asset classes have cycles. It doesn’t matter what they are.
Take the business cycle in the economy for example; business expands for a while, and then it contracts.
An asset class is the same. The asset is up for a while, and then the economy changes, and then it’s down for a while.
Once you know this, you can look at buying or selling decisions from a smarter and more profitable perspective.
Now that you know that there have always been cycles and there always will be, you need to know what affects an asset class cycle.
What makes the value rise and fall?
This is very important because if you buy an asset at the wrong time in the cycle, you get hurt; you can lose your money.
You need to know, as much as possible, where the asset class is in its cycle…Is it rising in value, or falling? Is demand going up, or dropping?
This analysis is a more complex process, and it is not an exact science because there are many variables to consider, with some having more influence on the cycle than others. But, it is definitely possible to develop your skills and knowledge to determine pretty accurately where a given asset is in its cycle.
For example, a tight lending climate, like we have right now, limits investors’ access to money. This limits the ability of investors to buy. So does a poor economy. Fewer buyers mean less demand. That will cause prices to drop.
Or, a rise in mortgage rates may cause also prices to drop. If borrowing costs more, prices will become lower.
However, if the location is desirable or rental income is stable and high, the price may not be as impacted as it may be elsewhere.
Implicit is the importance of location as a factor in a property holding and increasing in its value over time. A very desirable location will tend to shield a property from the worst effects of a downturn, but not completely and not every time.
This brings us back to residential real estate. I see a lot of opportunity, but the next question is…
“Which type of residential real estate makes the most sense?”
Condos? Residential apartments? Duplexes?
The answer depends on a lot of factors, but the main one is you.
Your Investor Profile
What’s your investor profile?
Are you a cash investor or a credit investor?
What is the exact amount of money in your budget?
Do you plan on holding onto the property as a landlord, or do you plan on flipping it?
Can you make the necessary repairs yourself, or must you hire professionals?
If you plan to resell the property, how long can you afford to hold onto the property if it doesn’t sell?
If you are a credit investor, will you qualify for a loan? Will the rental income cover the mortgage?
If it becomes vacant, how long can you afford to pay the mortgage before you have to sell it at a potential loss? Can you afford that?
What return on investment (ROI) do you require?
These are the questions you should ask yourself; and you should know exactly what the answers are.
Chances are, your budget will determine the type of residential real estate that you will target.
Once you know your profile, then you can determine the type of acquisition you will target.
Let’s assume your goal is to acquire a duplex.
Profile the Market
You will need to analyze the duplex market in the area(s) that fit your investor profile and location.
What are the rents in the area? What is the rental history of the property? Is it stable, or have there been many short term tenants?
What are the taxes like?
What are the neighborhoods like? Are they desirable? Are businesses and schools closing? Is graffiti visible? What condition are the cars parked along the street? Are there many, or few? (Many may indicate a depressed area because few have jobs, hence their parked cars.) Are there more families in the area, or more single people?
Be sure to view the neighborhood in both and night to get a better understanding of the area.
What are wages like there? What are jobs like there?
Talk to the tenants if possible, but don’t let on that you’re considering buying the building. Tell them you’re interested in renting in the neighborhood. Ask them how they like their home, things like that. You can learn a lot just by asking a few questions.
You need to look at external factors as well.
For instance, are there city plans to widen the street or perform other major work? Is the zoning mixed use or strictly residential? If residential, what is the mix of owners and renters?
Does the owner have other duplexes for sale? If so, you may be able to buy two at a deep discount, especially if you have cash.
Once you have developed profiles for several target properties, you will have a much clearer idea of where you will be able to buy, and where you shouldn’t, and the cash flows you can expect.
Bear in mind, however, that getting the highest possible ROI is great, but don’t be led by numbers alone. They don’t always tell the whole story; sometimes they conceal the most important factors in the deal.
What you expect and what you get can be two very different things.
Know Your Seller
After narrowing your list of properties, find out as much as you can about the seller.
Why is he selling? How long has he owned the property? What repairs have been done? Is the seller retiring? If so, you might be able to leverage his desire to retire and get a better price.
Try to establish a rapport with the seller and assess his honesty. Has he put a new roof on the building? Ask him for the receipt. Ask him to verify other claims, such as rental income and vacancy rates.
If the seller gives you what you ask for, that’s a good sign that he is not trying to hide anything from you. However, if he balks or acts insulted, then a red flag should be waving before your eyes.
This brings me to another rule for investing, no matter what the asset is:
Never make a deal with a dishonest or untrustworthy person. Even if the numbers look great, if you can’t trust the person giving you those numbers, of what value are they?
Sometimes the best investment decision is to walk away from what appears to be a great deal.
Know Your Zone
If the property performs as well or better than you hoped, then everything is great.
But what if it doesn’t?
Figure out how bad it could possibly get, and how it would affect you. The area between the high and low points is your zone of nirvana.
You want to stay within your zone of nirvana.
That’s why it’s important that your investor profile is accurate and true. And in every deal, always know the worst outcome. Know your tolerances in terms of time and money and potential for loss.
Protect yourself like this every time and you’ll do fine.
All the best,