Archive for November, 2010
In part I of this three-part series,we talked about how real estate investing is changing. In part 2, we discussed a key opportunity for implementing that change: land contracts. In part 3, the topic is passive investing.
Once you’ve worked hard to make your money, you want your money to work harder than you did. That’s really the concept behind passive investing: doing minimal work for maximum return. That’s everyone’s dream.
The problem, frankly, is that there are opportunity costs everywhere. The less work you do, the more work someone else is going to have to do, and you’re going to have to pay that person to do it. The trick is to find the happy medium.
There are several ways people currently conduct passive investing. You can invest in real estate investment trusts (REITs). Generally found through financial planners and regulated by the SEC, REITs tend to invest in large commercial properties. You can expect a low return (about a four-to-eight percent monthly cash distribution) and some percentage of any profit when the property is sold in three to five years). Minimum investment is usually $100,000, and you can add further investments in increments of $25,000, $50,000, or more later.
You could go to a real estate agent who does property management and invest a minimum of $50,000 to $75,000 there. You should expect to get ongoing reports about your properties. But you’ll also have to pay ongoing fees for repair and other upkeep. The fact is, if you’re going to be completely passive, other people are going to have to do more of the work, so you make less money.
In the world of distressed properties, the best model is to find a local expert and work with them to manage the sales, rental, and upkeep. You put your money in, and that person does the work. You can own it, and you’ll make more money. DBNR is focusing on this area, and we can handle the property management. There are fees involved, but because the properties are distressed, the potential profits are higher.
A couple of points that you should consider when it comes to passive investing:
- You can be as passive or as active as you want. Just make sure the people with whom you’re investing agree on the level of involvement you want to have.
- Make sure what you’re investing is discretionary income, because you will not be able to liquidate it quickly.
- Think about passive investment as a group to make your money go farther. In the 90s, a womens’ investment group met in my real-estate office, and they did pretty good.
- Remember that the IRS has specific rules regarding what constitutes passive investing, some of which relate to real estate investing and some of which relate to entities such as limited liability corporations.
My overall point is this: if you want to invest in real estate, but don’t feel you have the expertise, worry not – there are other options for you to take advantage of in this area that still have profit potential.
In part I of this three-part series, we talked about how real estate investing is changing. In part 2, we discuss a key opportunity for implementing that change: land contracts.
You don’t have to look far to find experts in the financial industry declaring today’s real-estate lending process badly broken. The evidence is extensive: the over-subscribing of worthless mortgage securities, the resulting meltdown, the foreclosure crisis, the robo-signing mess. It’s like watching a train wreck in slow motion.
How are real estate investors supposed to continue their efforts to develop equity and a strong financial foundation when the process for borrowing is so horribly mangled? One answer is to turn to land contracts, which DBNR frequently uses for its investments.
Just like it sounds, a land contract is an agreement between a buyer and a seller in which the seller agrees to give full and equitable title to the buyer once they meet certain conditions. These conditions could relate to payments, payment schedules, occupancy, repairs made, payment of back taxes and utility bills. Each contract is as different as the property it relates to.
For instance, you can set up your land contract so that the buyer makes payments, but the seller still gets the depreciation deduction. The seller hands over title at some point in the future when the buyer has fulfilled the conditions set forth in the contract, and that’s done through the traditional escrow process.
Land contracts are becoming increasingly popular for private investors who don’t want their deals mired in the quicksand of the financial industry mess. While it’s hard to estimate how many such contracts have been created over the last few years, based on the number of companies offering them and their new listings, it’s safe to say there are at least 100,000 properties being offered this way. And while we’re beginning to see some regulations put into place for these transactions, until recently, it’s been between private parties and government has been staying out of it.
It’s becoming popular because of the built-in safeguards. The seller does not transfer title initially, so if the buyer doesn’t fulfill the contract, the seller is protected and retains the house. It’s like buying property complete with a renter.
Even better, the land contact can work as either a real estate investment or a financial investment. As the holder of a land contract, you can re-sell it just as a retail store might sell a financing deal to a third-party. If you buy a land contract worth $40,000, you can get it at a 25% discount, or $30,000; there’s a quick $10,000 profit. If you want to take a bigger risk, you can take a contract with a shorter payment period and some other issues (perhaps the renter has been late with payments a couple of times) and get it for a 50% discount. Again, the options are as varied as the properties themselves.
If you want to know more about how you can benefit from land contracts, contact me.
There is a subtle transition underway in real estate investing these days. It involves a shift in the way people think about their real estate investment, a movement toward being more dispassionate, a movement toward being more quantitative than qualitative.
People traditionally look at real estate differently than they do other investments. They look at real estate with the same perspective that they look at their house – with some pride of ownership. You wouldn’t look on your technology stock with pride of ownership (unless it was Apple and you were a Macophile, I guess). But with real estate, there tends to not only be pride, but – to extend the stock analogy – a buy-and-hold mentality.
What I’m both seeing and suggesting is a shift away from that. For one thing, if you go into real estate investing with that attitude, it’ll break your heart. You can’t think about investment property with the same pride of ownership that you have for your primary residence. We are protective of our primary residences. We strive to make sure it looks good and stays that way. When tenants leave a property, it’s likely to be in less-than-pristine condition. Every time someone departs, you have to call in the painters and carpet layers.
Real estate investment, like any other investment, is about either making money or reducing your tax liability. It requires an entrance strategy, a holding strategy, and an exit strategy. It requires thinking about numbers, because it involves either time or money, or both. For instance, here are some questions real estate investors need to ask themselves:
- Are you researching available properties yourself or working with a professional? If the former, there are plenty of opportunities at sites such as Bigger Pockets and EconoHomes.
- Will you be managing the property yourself, or will you pay someone to do it?
- Do you want to buy property with little cash (i.e., be highly leveraged) or do you want to make a big down payment in order to retain more of the value and increase your passive income? Do you want to invest in residential or commercial property?
- If residential, do you want to invest in distressed properties in depressed areas that may increase in value or middle-class or upper-class properties that are more likely to hold their value?
In the transition to being dispassionate, there are even more numbers that investors need to think about, both prior to and after the investment.
- ROI. You need to think about the return on your investment – what’s your payback? Are there better ways to invest your money? Real estate isn’t the automatic jackpot it used to be.
- GRM. This statistic is the Gross Rent Multiplier, which is derived from comparing the annual income of the property to the property’s value; 10 is a good measure ($12,000 annual gross rent / property value of $120,000 = GRM of 10).
- Capitalization Rate. How much is it costing you to service your investment (i.e., paint, carpet, mortgages plus other expenses? Your cap rate comes from an analysis of costs vs. income.
Finally, there’s the exit strategy. Remember, your identity should not be tied up in this investment. You should be as dispassionate about getting rid of it as you were about acquiring it. Are you going to sell entirely, or do an exchange? Exchange is an investment term for buying up or down. In a positive exchange, you sell a $100,000 house and use the proceeds to buy a $200,000 house. In a negative exchange, you sell a $100,000 house and buy a $50,000 house. It depends on how leveraged you want to be. You can also sell the house and carry the financing yourself to get the monthly cash flow as a return on your investment.
But however you do invest, you have to do it with your head, not your heart.
In Part 2, we’ll talk about more about carrying the financing in a discussion of land contracts.