The Absolute Beauty of Real Estate Investing

There are many investment choices out there these days. From cash, to treasury bills, stocks, bonds, gold, emerging markets, art, start-ups, your own business, defaulted debt, etc. The options are quasi limitless, and for each investment type there is a salesman or two that will tell you why their investment of choice is the best investment type. It makes sense that wherever you place your investment dollars you should be fairly well versed and knowledgeable. You have been diligently putting the money away for something right? Would be nice to know you had some sort of control of the outcome of the money being socked away for those post daily grind years.

The sad truth is that most work hard for their money for years, but are too tired to really invest the time and effort to understand their investment options and strategies and simply pawn it off on the portfolio advisor that was able to sell their company on a plan or the first decent person to walk through the door with an investment strategy. Some actually go the distance to seek out a recommendation from a friend or colleague. The true litmus test is, have you ever has someone go out of their way to tell you about an advisor that really blew their socks off, and I mean someone who is not related to this person or has a financial incentive to get you on board. There is a subtle but very important difference between someone who is content with their advisor and someone who is going to bend your ear at lunch for half an hour about how great their advisor is. The vast majority fall into category one, and probably the vast majority of category one is probably telling themselves they are happy simply because they don’t want to feel foolish for placing so much trust and their financial future with someone they are not really enthused about.

Let’s talk about Real Estate. Some of the tremendous advantages to Real Estate over other investment choices are the following.

1) It is a tangible, touchable, feelable, smellable, livable asset,

2) It is insurable,

3) It is leveragable,

4) It is depreciable,

5) Value can be increased in multiple manners,

6) ROI can be had through increased equity and Cash flow,

7) It is not illegal to buy or sell right using insider information,

Here is an example of how you can use all of these benefits on one property.

The other day I got a tip about a man who inherited a property through succession but was having personal money issues. Well, the property was doing the man no good, because it was illiquid at the time. He need cash within days and no matter how nice this inherited house was, it was actually a burden to the man, simply because it one, did not solve his problem, two was something else he had to take care of. This is a little bit of what you would call inside information. The general public does not know of this man’s situation, nor will it be in any paper, nor do I plan on sharing this information with anyone, and this is great news for me, and perfectly legal. As Martha Stewart can contest, this is not how the stock market operates.

Now, I did a little research and figured the house was worth about $175,000. I called this man up and explained to him that I was a real estate investor and had heard that he recently inherited a property that he may not have any use for and wanted to see if he would discuss possibly selling the property to me. He said he was, and went about explaining the ins and outs of the property to me. I simply asked a few more questions about why he would sell such a nice house and he came out and told me about his financial woes and how the property was like a huge weight on his shoulders. I sympathized with the man and got him to tell me that we do purchase properties all cash, can close very quickly if need be at a discount. I further explained that we have to be able to sell the house quickly ourselves and make a profit for the deal to work for us. He indicated he needed about $75,000 to cure his financial woes and give him some breathing room and he had hoped to sell the house to simply give him a fresh start. I let him know that based on what he had told me about the property we could offer him $100,000 cash and could close as quickly as the title was clear and he jumped all over it. Now, to be fair I probably could have said $75,000, which was his number and he would have jumped at that as well, but we are not in the business of taking advantage of people. No matter what the situation had been, that would have been my offer, because that is a fair spread for the property for our business.

So, just by having some good inside information, we CREATED $75,000 in equity day one. To top it off, his property was an older home and had three bedrooms and one bath. Updated homes in the area with three beds and two baths, preferably one in the master bedroom are selling for $225,000. So for about $15,000 in paint, carpet, relatively minor kitchen and bath updates (mostly just re-glazing tile a more modern white) and reconfiguring some odd space on the first floor I was able to turn this property into fresh and clean three bed two bath home that was in demand in the area. With a little vision and $15,000 I was able to create an additional $50,000 in equity, or a $35,000 net positive impact to my bottom line in less than a month’s time. So far we have $110,000 in equity in the property and financially we are all in for about $115,000 plus taxes and insurance costs of a couple thousand dollars.

I am not nearly done yet with this one. I have a handful of investors that understand the power of real estate and want in on the action, but don’t want to get their hands dirty. They will loan me up to 70{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} of the After Repaired Value (“ARV”) of the property, $157,500, ($225,000 x 70{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676}) utilizing either liquid funds they have available or money from their IRA, see the chapter on IRA investing. As a practical matter we will only take up to 70{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} of the after repaired value on a property because it gives everyone a 30{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} cushion should there be a shake up in the market, or something unforeseen happens there is still plenty of equity to pull out of the deal and make a profit. Additionally, I insure the property for the full ARV in the event an act of God completely destroys the property so everyone gets their money, and profit back as promised. Our investors also get a first mortgage position recorded with the county.

Additionally for the privilege of having access to my investors funds on short notice and to entice them to stay content as a passive investor, we pay a nice rate of return of 12{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} simple interest, assuming the investor will accept a full repayment of his outstanding balance once the property sells, or is refinanced, generally no more than a couple years, or 10{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} if they want monthly payments. I pay a 2{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} convenience fee for not having to drag the big old checkbook out every month and mail a check, and put it in my ledger and quickbooks etc. Are my investors happy? He is making 12{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} in a tangible asset that is leveraged at a max of 70{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} loan to value (“LTV”), his investment and returns are insured from catastrophe, he is the first lienholder on the property, and the term is relatively short, no more than a handful of years, plus he knows this is all I do, so as soon as we are out of this investment he can jump into the next one. I jokingly say, the worst/best case scenario is that I don’t pay him back. Instead of the 12{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} he takes the full 30{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} equity position.

But, we are still not done. I just happen to know that in this market there are folks out there whose credit cards have decreased their limits, the sputtering economy has caused a late payment or two and potentially a relocation and whose credit has been brought down ever so slightly. These are the folks, had they been born a year earlier would be first time home buyers, but simply happened to get caught up in the financial melt-down and simply can’t qualify the traditional way. Good news is that I am happy to help. These folks are anxious to get into a home of their own and are scouring the daily newspapers and online classifieds looking for three things, 1) A decent 3 bedroom 2 bath home, 2) In good area with 3) an owner who will finance. It just so happens that I have exactly that. My ad says, Attractive 3 bed 2 bath home, great neighborhood, $235,000, owner will finance with reasonable down payment. They call me, come look at the house, which I have partially staged with a minimum of a couple nice towels in the kitchens and the bath, a few freshly cut flowers staged around the home a pot of fresh coffee brewing when they come in and small radio playing some sort of soothing music. It is everything they wanted.

We set it up as a lease with an option to purchase, they put 3{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} down, which happens to be the 3{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} they were saving to qualify for an FHA loan already, and I set them up on a lease for two years (time to get their credit in order so they can purchase the property outright from me using conventional financing) and their lease payment is exactly the same as the monthly payment on a 6.5{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} loan for 97{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} of $235,000 amortized over 30 years plus taxes an insurance or $1,774. Additionally the terms of my agreement with them are the following, they will handle any repairs and maintenance to the property under $1,000, and upon the exercise of the option to purchase the property from me in two years, I will credit them their down payment as well as what would have been their principal reduction had we actually had a loan vs. a lease. Essentially in every way but on title they are homeowners. They will have equity in the property day one. For me, if they choose not to purchase the property, I have their down payment, plus the 6.5{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} interest I was effectively charging them over the two year period. Just for comparison sake, I borrowed $120,000 at 12{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} which is $14,400 per year my lease option tenants are paying me $14,817 per year in effective interest. All the expenses on the property are covered, I can put $400 in the bank each year and by the way, did you notice because I was offering owner financing I was able to mark the price up $10,000?

I am still not done. Since I am a real estate professional, I can deduct all my expenses associated with this property for tax purposes, newspaper ads, vehicle expenses, and the best of all, depreciation. Since I still own the property, I am allowed to depreciate the property as well for further tax savings. Plus, as long as I wait a year, the gain will be taxed at the capital gains rate vs. ordinary income which is another $20,000 or so that goes in my pocket.

Since I did not cross the 70{899c36ff677aa4e6f803b4d39ab9718a0ef0e8c06d97a0e7fb74af059c0b0676} ARV threshold on this investment, my return is infinite as I didn’t put a dollar into this property. My investor, contrary to banks, would probably feel cheated if I didn’t fully leverage his investment to make him the most money possible. I could have sold the property immediately for $225,000 putting $110,000 in the bank less taxes, but I chose to go another route and put some deserving folks in the house for an extra $10,000 with no additional effort plus reap the tax benefits of holding the property for the short term. It is hard not to really like the benefits of real estate. When you find and work with the right people, the sky is the limit here.

I win big time but it takes a little work. My private investors win huge, they make substantial returns with protections you can’t get in just about any other investment type. We were able to take advantage of the many benefits of real estate investing with just one property. This doesn’t even consider the benefits of multi-family housing or commercial properties which are just as many as those listed above.