What are the characteristics of a market that has potential?

Question

I'm new to real estate investing and I'm very interested in buy & holds and fix & flips. Like the majority of us on here, my overall goal is to gain financial independence through owning multi-family rental properties and also gain experience in fix & flips. I've been doing a lot of reading, listening to podcasts, and I began going to open houses to look at different houses to see what's out there. I want to settle in an area but I'm unsure of where to look and what should I look for in a market that has potential to invest in? What makes a housing market good and what should I avoid?

I hope this question makes sense!

Llewelyn A. · Answer

@Rebecca LeBrun

For those who don't already know me:

I have been investing in Real Estate for 2 Decades in Brooklyn, NY. I currently own 6 Multi-Family Investment Properties in Brooklyn, all in good neighborhoods and all with Partners who helped financed these deals. All of these properties are $1.5 Million and above.

I would first like to address Education.

Unfortunately, there is a LOT of bad and potentially criminal Real Estate Educational Companies out there. All you have to do is Google John T. Reed Real Estate. When you get there, go to his Guru Rating link where he completely analyzes the supposedly Gurus themselves.

There are some great books out there and a lot of them are never bought. The problem with most beginner investors is that they are really like Chickens that have been put in a coup. They don't really know what to do or think, but somehow they trust a lot of people mainly because the bad education had been propagated by a lot of people who already spent their money but had not yet discovered that the education really isn't working. There are a bunch of Wolves that disguised themselves as the Chicken's protectors, but they already know all they have to do is push them enough and the Chickens will be eaten right up.

There is a tremendous amount of documentation on this phenomenon, unfortunately. Even if you Googled "Trump University Fraud" you well see that even our elected President participated in it and yet Trump has self-promoted as a Real Estate Guru who can help the average person. To this date, I have not heard of anyone taking a Trump University class and used that particular education to actually become successful without that student's already high motivation to succeed. If you can, look for the Thread here on Fortune Builders. There are a lot of interesting things to read about Programs like that.

So I'm sorry about the warnings, but it needs to be said.

Here is the good part.

A lot of us who are very successful, had learned Real Estate virtually for free. Decided to buy a few good books, especially those that gave us a lot of information that seems to be unpopular, especially Math.

One really great book is "What Every Real Estate Investor Needs to know about Cashflow" by Frank Galanelli. Here is a link: Amazon What Every RE Investor Needs to Know about CF

There is also other great skills that you should learn. For instance, Spreadsheets is a MUST in my opinion.

You really need to put together a really good BUSINESS PLAN. A Business Plan really needs to have a lot of projections in exactly the way the above Cashflow books addresses.

Now, let's talk about where you should Invest.

After you really educate yourself the right way, you will then begin to understand that you must have a clear vision of about 10 years into the future.

In other words, if you only do calculations based on today, you cannot fully understand nor get a Vision of your Investment and how it will evolve over time, generally a 10 year period.

For instance, how will the Mortgage Balanced move, what about increases in Rents and Expenses, especially taxes and heating costs, etc.

Appreciation should also be a factor because you are starting out brand new and picking a place for investing. You have a completely open slate and can decide where and how you want to Invest.

There are a lot of people, both experienced and not, that will tell you never to take into account Appreciation. However, mathematically, you need to take into account at least 4 types of Calculations when it comes to Real Estate investing. They are:

1) Cashflow - The money left over after you account for Rents and Expenses. HOWEVER, since most Investors seem to only understand their cashflow for today, and only calculate a Cash on Cash Return, they fail to understand that Cashflow moves over time. I take this into my equations because it's part of the Wealth building tools of RE. It ranges from Consistent over time, to growth (negative or growth) over time. When you take time out of the equation......... you can complete miss one of the most important pieces of your Wealth building tools.... TIME. All of my properties have experienced Cashflow growth and I calculate it with conservative growth rates. But every single one of my properties have far exceeded those growth rates... for example... a building where the apts were renting for $500 per month in the year 2000 is now renting for $2,000 today. Why would you not take things like this into consideration? But hardly anyone will teach this to you.

2) Mortgage Balance Reduction - as long as your Renters are paying the Mortgage, the Balance on the Mortgage gets reduced. This is very easily calculated using an Amortization schedule. I learned this early on and it opened my eyes. Now I buy properties what don't cashflow much, but the tenants reduce my multi-million dollar mortgages so much that this alone makes me rich. If I only took the kinds of classes that were offered generally, this wouldn't even be a concept in my mind.

3) Appreciation - You really have to understand how this works. If you completely take it out of the equation, you will generally miss some incredible investments. It's generally known that some places have very good and consistent appreciation. NYC, San Francisco, etc. This forces you to think of the economics of the underlying investment. AND IT'S INCREDIBLY IMPORTANT TO THINK OF THE ECONOMICs. Imagine you bought in Detroit in the year 2000 where it was doing well and you were cashflowing nicely. 15 years later...... Detroit goes bankrupt and your investment has diminished so much that you cannot understand how you were unfortunately to have picked one of the only bad areas of investing since just about every other place had done well. However, had you thought about the FUTURE economics of the area, you would have thought about Domestic Auto Companies and Detroit's dependency on them. You would have know to be ready if there were any warning signs, and indeed there were. The rise of Foreign Auto eating into the Domestic Auto Markets was a sure sign, all you had to do was look at the stocks of each of the big 3. These are important lessons that you will only understand until you start to learn about future Appreciation and what drives it. I absolutely use this as my driving force, steering my wealth into great places that has the ability to withstand a Financial Crisis like we had in 2008 and NYC even withstood a terrible terrorist attack like 9/11. Even that could not destroy the NYC RE market.

4) Tax Benefits - So there are a great many reasons why RE is known as as tax shelter. You can write off $25k as a non-profession RE Investor against your personal income in a different Industry. A GREAT benefit. A great strategy is to buy an investment where you can get cashflow, but because of your Depreciation, write off the $25k against your salary! Imagine that.... an Investment which gives you cashflow, but can also reduce your taxes.

Anyway... I know this isn't what you wanted. You wanted a clear answer of what strategy to use and where to employ it.

However, your strategy and where to employ it depends on your education. The less educated you are in RE Investing, the more narrow your ability to Invest in all kinds of places.

Unfortunately, the only answer I can give you is to learn as much as you WANT. If you stop at as certainly level, then you can only invest in the kind of investment you have learned. If you expand your knowledge, then you open the floodgates to huge amounts of possible investments.

When I started to learn investing on my own...... I only saw what I wanted by the time I learned how to put together the 4 wealth building areas of RE and applied Future calculations.

I hope the readers of this post do not find it too confusing because the concept of Future Cashflows is one of the most difficult things to explain and also for someone to learn. But it's an absolute necessity, in my opinion, for all Investors, RE or otherwise, to learn.

There should be a bunch of BP podcasts, but I have not reviewed them myself. I would look at these as well and hopefully, they will go over the calculations.

Investor Llew

Abena Sidibe · Answer

Llewelyn A. We're newbies with similar goals.  I hope you purchase the book. It's a must have.  I now see why Llewelyn advised me to read it first before jumping into any investment deals.  We should compare notes in the near future.

Abena Sidibe · Answer

Llewelyn A.  I'm currently running numbers on how to estimate what an income property is really worth using a case study in the book (Chapter 4). Perfect timing with the spreadsheet you provided as the projections in the chapter 4 are only 5 years out for the projected selling price. I've been doing the calculations manually and with a basic spreadsheet provided by realdata.com.  I'll be moving on to the Chapter 5 by the end of the week which goes in-depth about IRR. I'd appreciate it if you can send me the spreadsheet above when you get a chance.

Llewelyn A. · Answer

@Abena Sidibe

@Rebecca LeBrun

Just so I can give you an idea on how I look at things in the future, I had a very rudimentary spreadsheet that I had used a few years ago to teach a friend only the very basics. Here is it:

Columns A and B, rows 3 to 16, calculates the Selling Price 10 years into the future given the Purchase Price and an appreciation rate of an area where the historic Appreciation Rate of the last 30 years had been averaged to 4.81%. Note, this is not NYC, and certainly not Brooklyn. Appreciation Rates go way up. In most of my cases, it exceeds 10%. This is more like a typical small city.

Columns C and D from rows 29 to 45 calculates the Investment of $25k at time of Purchase and the Sales proceeds at time of Sale, given a 10 year holding period of which the Selling price had been calculated as $160k from the Appreciation Rate.

Rents start out at $3,600 per month or $43,200 per year but will climb 2% per year. Expenses at $1,960 per month but will climb 6% per year.

The Mortgage payment was calculated in Columns J and K, rows 29 to 33 and is $480 per month.

The Focus point on of this snap shot is the table from Columns D to J and rows 6 to 16. This puts together ALL the CASHFLOWS except for Taxes. It takes into consideration the Appreciation, the Renovations, the Mortgage Payments, the Rents that grow only 2%, the Expenses which grows 6% annually, and boil it all down to a SINGLE Internal Rate of Return (IRR) in CELL J18, which is at 10.01%

The interpretation of this calculation is that if you bought a property for $100k with a Mortgage of $80k, needed $75k of renovations in year 1 and then another $10k of repairs in 2021, has rents of $1,200 for 3 apts and expenses around $1,960 per month, and assume a 4.81% appreciation rate with rents rising 2% and expenses rising 6% for the next 10 YEARS....... this boils down to a 10.01% ANNUALIZED Return for each and every year for the next 10 years.

Now, because we did this kind of calculation, you can then compare it to ANY Investment.... be it Bonds, Stocks, a Business, etc. They will all boil down to a 10 year IRR.

You can then decide where you want to put your money.

BUT, to get to this level of calculations....... requires a LOT of work. This is normally where I ask students, how motivated are you to become wealthy? If you are motivated enough to read books, are you motivated enough to do the real calculations? Then, after, are you motivated enough to pull the trigger?

Notice that all of these calculations makes you think of the future of this investment. You cannot actually do this kind of calculations without first thinking of how much you will buy the property and how much you will sell it in 10 years. It forces you to think of all the things that go into the 10 year valuation.

In other words, this kind of thinking is EXACTLY what you need to understand how to invest in ANYTHING.

Keep in mind that if you put garbage into the numbers, you will get garbage out.

Over the years, my spreadsheets got very complicated but VERY VERY accurate.

I have used an old saying.... in order to Profit from an Investment, you must PREDICT it.

If you cannot Predict it, you are buying your Investment blindly.

I hope the readers of this posting understand that I'm trying to give a different point of view than what is normally taught. What really bothers me is that a lot of courses teach very little of this kind of math but charge 10s of thousands for their courses.

However, by buying one book, "What every Real Estate Investor Needs to know about Cashflow" for only $15.... and applying yourself, you will have a world more knowledge of Investing than all the money outside of a top notch Business School.

A lot of Investors will tell me that it's too much for newbies. Maybe it is. But this is what I have taught in the past. Unfortunately, it may very well be true. Out of 500 students, only 30 were able to get to the very end to understand the IRR correctly and how to put it all together.

But, when they understood it, my students all achieved profits in the 6 figures. One student made $2 Million plus to date.

I stopped teaching in 2013. I'm just way too busy these days, but I wanted to offer the reader a perception as an alternative to what is being taught out there.

Investor Llew

What are the characteristics of a market that has potential?

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