Don’t Believe the Hype

InvestorDirector.com

New investors should scrap “zero down” cash flow investment techniques and invest for capital gains instead

We see the appealing sales pitch all the time as featured in late night TV infomercials, on bookstore shelves and all over the Internet: “Buy houses with nothing down, rent them out and retire to a beach”. Unfortunately, this is not reality. Being manipulated by this archaic sales pitch is what gets inexperienced real estate investors into a lot of financial trouble. Behind the powerfully glamorous images of acquiring houses using no money invested and renting them out while doing very little work, there are hidden realities that need to be understood before buying real estate to hold for cash flow.

Most new investors are taught that the road to wealth is paved with some form of landlording; perhaps temporarily leasing homes to renters looking to buy their first house or renting homes to long-term tenants. This is what the majority of wealth gurus teach; so new real estate investors think this is the road to financial freedom, when in actuality, it’s a dead end. What most new investors fail to realize is that many popular wealth authors don’t invest in real estate at all. It is all but impossible to write books and market them for sale while being a full time real estate investor; both of these endeavors are very time consuming and require complete focus. There is no rule that says a real estate wealth author has to be wealthy or invest in real estate at all. And this is largely the case regarding today’s real estate information sources.

The “zero down” real estate sales pitch has been around since the 1950’s; yet most new investors buy into it thinking it’s a new “groundbreaking” way to build wealth in real estate. The reality is that the zero down sales pitch looks very appealing, especially to those just getting started in real estate. Glamorous books, seminars and courses are geared to appeal to people who have little money, hate their job, and don’t understand how to invest in real estate for profit. Who doesn’t want to read that making all the money you want from home with little time and money invested is easy?

In the real world, investors who consistently achieve good results follow a systematic approach – an approach that doesn’t involve holding property for too long, to build wealth. That wealth then allows them to eventuallyhold real estate for a cash flow, when the time is right. Through the process they learn that the zero down sales pitch is just that: a sales pitch.

New investors are taught all too often to invest for cash flow, the riskiest form of real estate investing. These investors should be investing for capital gains, which carry lighter risk factors.

Expert investors understand that the way to make money as a real estate entrepreneur – especially as a beginner, is not by purchasing property “zero down” for a hopeful monthly cash flow once rented, but by converting the available equity in houses to cash, usually through the sale of equity-bearing homes. This is called investing for capital gains, which helps new investors learn real estate investing methodically. With capital gains investing, day to day cash flow is not established but rather money is made as deals close – often by selling other people’s homes as a middleman or as a licensed Realtor at first. Capital gains investing through the sale of other people’s homes ensures no financial risk is incurred through property ownership. This form of investing also allows the investor to observe what happens after each transaction closes. This could be the most important reason why new real estate entrepreneurs should be investing for capital gains before tackling cash flow investing. I’ve personally witnessed scores of inexperienced investors lose not only money, but their creditworthiness as well, by paying attention to what happened to them afterthey bought various homes. By seeing firsthand the mistakes that can happen to other investors after they purchase homes for cash flow, you can begin to see certain pitfalls to avoid before you become a cash flow investor.

It is very important to remember that any type of real estate acquisition (including “zero down” acquisitions) either costs money up front or puts the person doing the acquiring in a position of liability where money will be needed for survival as bad things inevitably do happen to all cash flow investors. The chances are very high (especially in a poor economy) that an inexperienced landlord will lease an investment house to someone who stops paying rent. Without thousands of dollars in cash reserves built up through capital gains investing, it is unlikely this landlord will have the necessary capital to cover the mortgage payment for a few months or be able to pay an attorney to properly handle the eviction. Also noteworthy is that people who don’t pay rent usually leave thousands of dollars of property damage behind. Can you cover the bills if this happens to you? This is what cash flow investing is often like for new investors. If you cannot handle problems like these, then you’re not ready for cash flow investing.

While initially selling other people’s homes for capital gains as a middleman or a Realtor, expert investors inevitably go through a process of becoming real estate finance experts, by working hand in hand with several highly talented loan officers. Many expert investors take their learning a step further and become loan officers themselves, which creates another income stream for them. Real estate finance changes daily, therefore real estate investors need to know what they are able to do in terms of financing scores of buyers at any given moment. It’s usually buyer financing that determines if and how fast a home can sell; therefore the beginning investor’s lifeblood is his own mastery of real estate finance.

An investor needs tens of thousands of dollars in the bank to fall back on for inevitable problems. In the beginning, the easiest way to get liquid is through selling other people’s homes for a fee, brokering loans or rehabbing property for an eventual sale.

Another reason why understanding real estate finance is so essential to the development of a real estate investor stems from the need to properly screen tenants as the transition is made from capital gains investing to cash flow investing. Generally, the same documents that lenders evaluate before issuing a home loan to a borrower are the same documents a wise investor gathers before turning possession of a home over to a tenant. A potential tenant’s credit report, criminal background check, last 2 months bank statements, last 2 years tax returns or W-2’s, their driver’s license, social security card and their last 2 pay stubs are some of the common documents a seasoned cash flow investor collects and personally investigates before making an occupancy decision involving a potential tenant. “Cash flow ready” investors only turn possession of their home over for the tenant’s occupancy if these tenant-supplied items check out. This process is usually only mastered through capital gains investing as real estate finance is mastered.

Through time, capital gains investing builds an investor’s liquidity on a deal-by-deal basis, and develops the skills it takes to become a cash flow investor. Real estate elites do the exact opposite of what the popular “zero down” wealth gurus teach. They rarely (if ever) buy homes “zero down”. They establish different channels of income by mastering real estate finance, and capital gains investing techniques such as rehabbing, property wholesaling, or becoming a real estate sales agent. When they are ready to become landlords, they have money in the bank and rarely carry loan balances of more than 50% of any one of their home’s values. This allows them to sell their holdings for profit at any given moment.