Stephen Covey, famed author of "Seven Habits of Highly Effective People," claimed an important habit in achieving success was to "Begin With the End In Mind." This habit in real estate is critical to success of a venture! Whether you are looking to buy an income property, a fix and flip, or a hold for cash flow and long term appreciation you must first know your strategy going into the deal. It must be clear and you must stick to it!
I can't imagine buying a 1972 Ford Pinto (a very cheap economy car designed for fuel efficiency) and deciding that I wanted to transform it into a luxury sports car. Put leather, a sun roof, high end suspension system, and a supercharged engine in it, and it's still a Pinto. The car was built to compete with cheap Japanese imports taking over the American auto market, and only cost $2,000 ($12,000 in 2015 dollars). No matter how much I desire a luxury sports car, I'm working with the wrong vehicle.
Getting confused on your purpose/mission and combining strategies can be dangerous and lead to bad decisions. Being very clear up front will allow you to experience great success. Segmenting your market just as the automakers do and making sure that your product hits your key demographic audience and isn't trying to be everything to everybody is vital. If you wan
Buy & Hold High Cash Flow Deals
If very high 36-50% Cash on Cash Returns and 10-13% Cap Rates are your goals, then your best strategy is to focus on lower income working class and section 8 rentals. These properties can be purchased in our best markets for $10,000-$40,000 and require $10,000-$30,000 in renovation. Renting for around $750-850 per month these properties have potential to return your investment in two to three years. These properties are likely in C to C+ neighborhoods (when it comes to pride of ownership and crime), and will likely not sell to owner occupants, or experience strong appreciation. Your best exit strategy is likely a lease purchase or investor clientele. The properties may have instant equity if you are buying distressed assets or renovated wholesale properties where the seller is leaving some upside potential for you. However, due to few resales that are not foreclosures, comparable sales don't allow for the deep equity plays in this market segment. These homes will be in the lower rated school districts typically, or may be in the lower income areas of reasonably good school districts (our preference). Renovate systems and eliminate deferred maintenance because financing these items into a loan is much better than paying for repairs out of pocket and losing your cash flow. Don't use high end products.
Buy & Hold For Cash Flow & Appreciation
If a foreclosure in a great neighborhood with highly regarded schools that will have excellent potential for selling to an owner occupant in a couple of years after the property has experienced solid appreciation then this could be a great strategy? These homes will cost $65,000-$100,000 in our best markets and the homes will be in B - B+ neighborhoods. These homes will rent for $900 - $1,200 per month, and they attract high quality tenants that will be much easier to deal with typically and will often take a little better care of your asset. These homes may have greater equity, but you may get into bidding wars, so be careful to not overpay in this highly competitive market segment. These homes you will renovate to a higher standard, with better quality carpet, lighting, appliances (likely stainless steel), tile backsplash, and possibly granite counter tops. Often in this segment an investor will want to stay within 10% of the median home cost, and make sure that there is room to sell at a very competitive price, while being the nicest home on the market for the money. There will be great rental demand, a strong market for lease purchase or for retail buyers. Cash on cash returns will be in the 15-25% range, with cap rates of 8-9%.
Fix & Sell to Retail Buyer
The best candidates for fixing and flipping to a retail buyer will be homes in A-A+ areas in the top schools, by the newest shopping centers. These are the areas that are usually growing, have new roads being built, more new building permits, and thriving new office parks. New industry may be going in close by, the zip codes in these areas are experiencing the best population growth, the highest education and income levels, and the lowest crime levels. This strategy might include building new construction to sell to buyers seeking homes in this highly desired area. Foreclosures will be few, and winning them will be a fierce competition. Finish work on these homes will include extensive crown moldings, chair rails, high end paint, granite and stainless steel appliances (including wine cooler and ice maker) are now a must. Tile and hardwood flooring, and much higher end landscaping. Think architectural digest, interior designers and professional staging. These homes can be bought from $120,000-$500,000 and equity will be between $25,000-$100,000 depending upon the acquisition price. Homes in this market might rent from $1,200 - $3,500 per month, and often your tenant will be an upper middle management, white collar professional. Cash on Cash returns may only be 5-10% and Cap Rates will be 5-8% or possibly even lower. Appreciation can be the best in these areas as long as they are not over built, but these homes can also be the ones to take the biggest drop as demand above the median home price is lower and more affected by market volatility. These properties are best done on a short time frame and in markets that are experiencing growth. As you have many more eggs in one basket, and the capital requirements are through the roof, an investor deploying this strategy will make much lower cash flow and return on investment, but possibly a much larger capital gain.
It's not wrong to focus on any of these strategies, but know that you likely shouldn't combine elements. Figure out which market segment you want to focus on and then provide that product. A Pinto will never be a Ferrari, and the money that would be required to achieve the goal would make the attempt at automotive genius, a disaster. In the end we have a fast, ugly car that was comfortable would blow up upon rear impact collisions. (A problem that Ford Motor Company could have fixed for $11). Following this advice will help you to avoid explosions in your real estate investment aspirations.
One final point, Ford Motor Company knew about the exploding gas tanks, but decided not to fix them because they wanted to save the $11. Obviously, they failed to disclose this defect! Had they said, "Before you buy this car, please know that if you are rear ended, the gas tank may explode and spew gasoline all the way to the drivers seat, before engulfing your family in flames, and we want you to know that we can fix this for $11," I'm sure most people would have said let me pay for the $11 upgrade. When you buy income producing real estate, always make sure that your team discloses everything, so that you know what you are getting for the money! You don't have to expect a Rolls Royce property at a AMC Gremlin price, but you'll know what you are buying. This includes:
- Important Demographic Information: income levels, education levels, crime data, vacancy rates, percentage of owner occupant versus rental occupancy, median home price and appreciation for the last 25, 5, and 1 year.
- Economic data: Who are the major employers that drive the local economy, are they growing or shrinking, what is the population growth, and is it growing or shrinking? What is the unemployment rate? Are new homes being built (construction permits), new schools, new roads?
- Multiple Listing Data: How long the home might sit on the market at your expected list price, how many homes have sold in the neighborhood, for what price, and how did their conditions compare? What have foreclosures in the neighborhood have sold for? How many homes have been listed and either expired or been withdrawn after not selling?
- Rental Data: get market reports from Rent Range, Zillow and also seek a professional property managers opinion on how long it will take to rent, what price it will rent for, and how strong of an applicant will this area receive (as far as criminal background checks, credit risk, strength of employment).
- Renovation Scopes: An area where you can get burned the most, many "wholesalers" use this area to put "lip-stick on a pig" taking care of cosmetic issues so that you think you are getting a renovated home, but failing to address major and expensive systemic issues. ALWAYS get an exact renovation scope of everything done to the home, including but not limited to roofs, furnaces, electrical and plumbing systems, appliances, and hvac. Get a home inspection report whenever possible, read it and make sure issues were addressed.
If a car can look great, sound like an economically wise purchase, and have an exploding gas tank, just imagine what can happen with a house purchase, which cost a lot more than an economy car!
Original article by my business partner. Posted on LinkedIn.--https://www.linkedin.com/hp/update/6067707176221241344
