Great Opportunities Don’t Grow On Trees
Become an Expert Real Estate Investor
Great deals are not one-dimensional. They are more than a property that just generates cash-flow or that is located in a remarkable location. A great deal integrates a number of factors beyond cash-flow or location. What is the tenant profile, management expenses, economic factors, etc. In this article, we will attempt to provide clarity as to what makes up a good deal and what you should look for when buying your next or first property.
A “good deal ‘’ is not the same for everyone, and finding your own investment style consists of a lot of trial and error. It has taken a few attempts, some wrong turns, and some missteps, but for me, a good deal must answer four main questions:
1. Is the property in a great location?
2. Can I purchase the property below market value?
3. Are there opportunities to boost the property’s value?
4. Will this property cash-flow?
It is important that every deal I purchase answers these four questions, not as a profit-making measure, although that helps, but as a defensive effort to protect against the downside risks of investing in real estate. When I invest in property, I am looking for security; I am not speculating that the property will increase in value over the next few years, even if that does play a small factor. I want to know, to the best of my ability, if the property will return a profit I am comfortable with. By using these four questions to select my properties, I am able to comfortably and confidently make the necessary investment.
Let’s break down these four questions.
1. Is the property in a good area?
Location is by far the most important aspect of finding a good deal. Are there jobs and or future opportunities for employment? Are those jobs secure and predictable? Is the area supported by multiple economic sectors, or is it centered around a single industry/company? Is there an increasing population or projected in-migration? What initiatives is the city taking to support its future growth? Are there community programs, good schools, and recreational activities to support young families? These are only some of the questions I ask myself when I look to invest in a city.
And it doesn’t stop there. Each city will have areas of high, medium, or low quality. This information is essential, and without it, you are setting yourself up for failure. When you invest in any piece of real estate, you are not just investing in a property but the community as well. And so, before I invest in any property, I first focus on the microeconomics of the local area. I spend a great deal of time learning what areas I should gravitate towards, and what areas I should stay far away from.
Quality neighborhoods are key, and personally, I tend to lean toward high to medium quality locations, and here’s why: these locations not only have the highest income earners, they also come with the best schools, top community programs, and recreational activities, which tend to attract the highest quality of tenants. High quality tenants are easy to deal with, respectful to the property and do minimal damage, resulting in less management time, fewer maintenance expenses, and fewer vacancies. All of which, result in more money in my pocket.
Location is important because it can never be altered. A bad area, if it never evolves, will remain a bad area, while a good area has a much higher likelihood of retaining its social and economic value, if not improving, over the long run.
2. Can I purchase the property below market value?
We all like discounts, and real estate is no different. Discounted properties are everywhere, and learning how to spot these properties, or signs of potential sellers of discounted properties, is the key to investing in real estate successfully.
To find a property that will sell below market value, you first must find someone willing to sell their property for less than its projected true value. This may seem difficult until you realize that it is less about finding discounts and more about finding problems that you can solve. Maybe a homeowner needs to sell quickly, and you can close in 2 weeks. Maybe the current landlord is having trouble with a tenant, and you are willing to assume the tenant and the legal proceedings. Maybe a home has been left unmanaged or unmaintained for far too long, and you are prepared to take on the work necessary to restore the property. When you find these opportunities, the solution you offer the seller becomes their motivation to sell. Ironically, we typically refer to these sellers as “motivated sellers” instead of referring to ourselves as “problem solvers”.
Generally, I like to target properties I can buy for a 5–10% discount. Despite what you may think, I do not target buying discounted properties as a way to “save money”, although it is a nice benefit. The real reason I target these properties is to ensure the security of my investment. Aside from the immediate increase in my equity position in the property, a discount offers a buffer to the marketplace, a cushion if things take a turn for the worse. Warren Buffet, possibly the most successful investor alive today, has two rules for investing. Rule 1: Never lose money. Rule #2: Don’t forget Rule #1. Buying properties at a discount is our best way to hedge our risk by following Rule #1
3. Are there opportunities to boost the property's value?
The commonly held belief is that real estate is a great passive investment strategy, and it is, but relying on real estate this way may not provide the best returns. It is true that over time, properties will appreciate as the economy advances, cities expand, and populations increase. But praying and hoping for property values to increase is called speculation, and although speculation can make you a lot of money, by doing so you are surrendering full control to the marketplace. An unnecessary risk you can avoid.
When I look for properties, I want to know if I can boost the property’s value in some way for a moderately low injection of capital. This can take many forms. You can simply increase rents, repair or upgrade the property (interior or exterior), add sale-able features (private yard, laundry, storage, parking, etc.), add entirely new rent-able spaces, or change the use of the property all together. A good deal has the ability to adapt, and these are the properties I focus on. Personally, I target three types of properties.
1. Properties on larger lots that have the potential for future development.
2. Properties that I can and will continue to increase the available rental space for, such as adding 2nd, 3rd, or 4th units.
3. Properties where I can alter the use of a property to target the highest and best use for the land, improving the property’s performance.
The forced increase in the property value by means of property improvement, development, or change of use, is referred to as “forced appreciation,” and learning how to utilize this is a key skill of real estate investing.
Forcing the appreciation of a property is important because, by increasing the property value, I am able to improve my equity position in the property. With an improved position, I can either sell the property for a profit or, my favorite, go back to the bank and borrow against that improved property. If done correctly, I may be able to own the property with none of my own money, but rather with the forced appreciation built into equity. This may sound familiar, and that’s because I've previously discussed it as the BRRRR method.
With less of my own money invested in the deal the return against my investment skyrockets
4. Will this property cash-flow?
While I wouldn’t consider cash-flow to be the most important factor when finding a good deal, it is still an essential factor that needs to be considered. This is not to say that all good investments produce cash-flow, but personally, I choose to only focus on the ones that do. We’ve all heard the saying, “It’s not about timing the market; it’s about time in the market”, and cash-flow is an important tool to stay “in the market”.
Think of cash-flow as your safety net. When the market changes direction or unexpected expenses arise, cash-flow will keep your investment afloat. It will protect you during market fluctuations and uncertainty. Without it, you may be forced to sell the property if things take a turn for the worse.
As simple as cash-flow sounds, many people miscalculate their cash-flow. They underestimate their expenses, which can put them in trying times if things take a turn for the worst. So how do we determine if a property will cash-flow? Generally, most people consider the Big 4 Expenses: Mortgage Expense, Property Taxes, Property Insurance, and HOA Fees. Personally, that is far too little. What happens when a tenant moves out? What if you need to repair a broken/clogged toilet, replace a furnace, etc.? The list is endless. Where does the money to pay for those expenses come from? Aside from the Big 4 I also think it is important to consider the following: Additional Insurance/Coverage, Maintenance/Repairs (10% of Rent or $200/mth/unit min.), Tenant Vacancy (3% of Rent), Rental Equipment (i.e. water heater, furnace, etc.), Facility Management (Grass cutting & Snow shoveling, etc.), Property Management (12% of Rent), as well as any other expenses specific to the operation of a particular property.
Cash-flow management is your staying power, and the first step to managing your cash-flow is to consider the potential outcomes. I would rather consider the worst and be surprised with an unexpected profit than consider the best and be surprised with an unexpected loss.
Now you have a glimpse into the thoughts behind each one of my investment properties. These are the four questions I live by. I do not invest in any property that does not satisfy these questions, because for me, these four questions are the security I need to trust that my investment is sound.
Joseph Costanza
Costanza Capital Investments
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