Be a Successful Real Estate Investor
We’ve all seen ads or infomercials on late-night TV about making a fortune in real estate. There are always lots of testimonials from past seminar customers that you are supposed to believe, but no substance. If you ever went to an actual seminar, you’d find that there’s not much substance there either. They are in the business of selling books, tapes, and seminars, not making you rich.
The flaw with any program that claims it will teach you how to make lots of money (in your “spare time” no less) is that if it were so easy, they would be doing it instead of teaching it.
You can make lots of money in real estate, but the truth is that it isn’t that easy. It takes work and you have to know what you’re doing. Money helps, too. You are lucky to have found a web page that cuts through the BS and gives you the true picture. And it’s free!
The First Deal
A typical first deal of a new aspiring-millionaire-real-estate-seminar-graduate goes something like this:
He pays too much for the property because he didn’t evaluate the market value properly. He thinks it’s a good deal because he got it for very little down, and the seminar said little or nothing down is good. He underestimates the construction costs and pays too much for the remodel. He hires contractors that do a lousy job and charge too much. Half the time he doesn’t understand what they’re saying because they don’t speak English and he doesn’t speak Spanish.
In an effort to recoup his investment, he puts it up for sale for more than it’s worth, and it doesn’t sell. He refuses to reduce the price and sell it at a loss, because that would prove that he screwed up. The numbers don’t lie. So instead, he decides to rent it. According to his calculations, he’s now breaking even, but he doesn’t factor in things like taxes, insurance, maintenance, vacancy, etc. After a number of years, the house appreciates to cover most of the loss, and he sells it. Still in denial, he rationalizes that he really didn’t lose anything.
He’s embarrassed about his blunder, so he doesn’t talk about it. Or maybe he’ll be a testimonial for the seminar company and say what he originally paid for it and what he sold it for. Of course, he’ll leave out the part about the remodel costs and the 5 years in between. There’s also a good chance that his qualifications will earn him a position teaching at one of those real estate seminars.
The Flip, the Fix, and the Hold
It is useful to categorize real estate deals based on how one derives one’s profit. The “Flip” is when you buy something at less than its true value, and immediately resell it at a profit. The “Fix” is when you improve a property in such a way that its value is increased by more than you spend on the improvements. The “Hold” is the profit that comes with an increase in value over time. All real estate profits will fall into one of these 3 categories. The first common mistake is not having a clear understanding of where the profit is going to come from.
The profit in a Flip is made when the property is bought, not when it is sold. It must be bought at enough of a discount to cover all holding costs, transaction costs, and a profit based on being sold at market. You can’t assume it will sell above market in order to make your profit.
Successful Flippers spend most of their time analyzing deals. They may look at 100 deals for every one they act on. They understand values, and can “smell” immediately when a deal stinks based on a brief telephone conversation with a seller or some simple fact they uncover.
A novice may spend days analyzing a deal that a pro would dismiss in a New York second. Novices also tend to subscribe to the “greater fool” theory, which is when one looks for a fool greater than oneself to pay even more than the first fool did for an overpriced property.
Common examples of smelly deals from a Flipping standpoint:
Example 1: Seller bought the house new 2 years ago for $300,000 with a 100% loan, invested another $20,000 in landscaping and various other things, and he is now willing to sell it to you for zero down. Reality: There’s no equity, and he probably tried to sell it unsuccessfully before you found out about it. New homes almost never build up any equity in the first few years. Will probably go to foreclosure.
Example 2: A house that’s been on MLS for 30 days. Reality: If it had Flip potential, it would be gone in 1-2 days, or the Realtor would have bought it.
Example 3: A novice investor (unfortunately one of our clients – after the big mistake), bought a house from a builder in December 2005 for $325,000, and supposedly got a good deal because the builder needed to sell it before the end of the year. His plan was to resell the new home at a profit. Reality: That’s all one needs to know to figure out the investor isn’t going to make any money. The builder is likely to know more about real estate than an inexperienced investor, so I’ll bet my money on the builder. If you talk to the investor, he has it all figured out, and knows the values and the other sales in the area, etc. An experienced Flipper would have chuckled at the builder’s sales pitch. (Like most people who’s homes are overpriced and who cancel their listing with us, he didn’t appreciate our honesty and advice, and surmised that his house wasn’t selling because there was something wrong with us. He listed with another Realtor, and it was on the market a total of 483 days and never sold, even at $334,000. We estimate his loss in carrying costs alone while on the market was over $40,000. Our guess is he finally gave up and leased it, and will continue to lose money on it.)
Foreclosure auctions are overrated. There are generally more people over-bidding than there are properties with any equity to bid on. To find a good deal, you need to do a lot of homework on a lot of properties and be ready to bid on any that may be able to be bought at a reasonable price.
The best deals generally have 2 qualities: There aren’t a multitude of bidders bidding against you, and there is a piece of information that you have that other people probably don’t.
A few examples of deals that smelled good right from the beginning:
Example 1: A buyer we worked with figured out that a bank foreclosure that was going to be coming on the market had a lot large enough to be subdivided into 3 parcels based on current zoning. It was valued based on price per square foot of the house. The property was bought for $325,000, and the market value “split up” was over $400,000. The buyer went on line every morning to see if it was listed yet. When it became available, he called me to put in an offer the same day, and got it. If he had missed it that day, it would definitely have been gone.
Example 2: Seller was in a chapter 13 bankruptcy. Any money that was to come out of this particular property was going to go to the bankruptcy estate for the creditors, so he had no incentive to care how much it sold for. It was undervalued, and the bankruptcy trustee approved the sale, probably because he was too busy to do any lengthy analysis. This property was bought for about 80% of it’s value.
Example 3: A neighborhood property looked dilapidated and had lots of weeds growing all over. A little inquiring led to a probate lawyer from out of town. An old man died and the proceeds of the house would be shared by 4 brothers, and only one had the power to make decisions as the executor. He lived out of town and didn’t really care about it all that much, and didn’t really care much for his 3 brothers either. This property was also bought for about 80% of its value.
Conclusion: There are countless examples of deals that somebody will tell you are great that not only won’t make money, but will cost you. The only way to really learn the Flipping game is to spend time analyzing deals and determining what a property will sell for if it were listed in MLS. There are too many individual situations, and every situation is unique, while certain consistencies will become apparent. With time, you will learn to evaluate deals quickly. There is no fast way to learn this, and no book that can teach you this. You must invest the time to learn it from personal experience.
Place an ad in the local paper that reads “Real estate investor will pay cash for good properties” or something to that effect (it doesn’t matter if you don’t have any cash). You can also copy what some of the other ads say if you aren’t very creative. Evaluate 30 deals, but don’t buy anything no matter how good a deal seems until after you have thoroughly evaluated 30 deals. The reason you avoid buying anything is that the odds are that none of the deals will be very good and you are likely to make a mistake based on your lack of experience. The objective is to learn to develop your “sense of smell”. When a really great deal does come along in the future, you want to be able to figure it out quickly so you jump on it.
Do some property searches using the Property Search link one our website. Enter search parameters to find homes with low price per square foot list prices. It’s really easy on the Dallas/Ft Worth search because you simply enter a maximum price per square foot. You can find good deals this way, but be prepared to jump on a great deal in case you find one because the best deals go quick.
Other ways to find good deals:
- “Bandit signs” These are signs you post anywhere you can get away with it, that say “We buy houses” or “Quick cash for your home equity”, or something to that effect.
- Look at some HUD homes in your area.
- Networking: Talk to people and let them know you are looking for deals. The best deals are usually the ones you find out about by accident.
- Find your niche. Try to figure out a way to find deals that not everybody else is already doing.
The profit of a Fix comes from one of 3 sources: 1) Having a price advantage in getting remodeling work done; 2) Knowing what improvements have the greatest potential of increasing property value, and 3) Seeing potential that others may not readily see.
The first question you should ask yourself is: What “edge” do I have that will make me a successful Fixer? If you are a bilingual investor who can communicate with Mexican laborers, and knows how to hire the right ones who will do a good job for very little money, you have an edge. It would help even more if you have several relatives who know construction and will help you, and will let you use their expensive construction equipment for free.
If you think you can buy something and hire a general contractor to do all the work, you are probably not going to do very well as a Fixer, unless you have some other advantage.
Look for properties with “the right things wrong.” That means buying a house or condo where well-spent fix-up dollars will add more market value than the cost. For example, fresh paint, inside and outside, is known as the most profitable home improvement you can make. Other examples of profitable home improvements include adding a second bathroom to a one-bathroom house, installing new light fixtures, adding fresh landscaping, and installing new carpets or hardwood floors.
Perhaps you have an architectural or design background, and can see some great potential in a home that was built 50 years ago and sits right in the middle of the current trendy “Yuppieville” in your city. With the right updates, a wall moved, a bathroom added, and voila! A valuable trendy new old house ripe for its new Yuppie owner.
The point is that there needs to be some reason why you deserve to make a profit as a Fixer. Most novices vastly underestimate the remodeling costs of their first project, and incur unnecessary expenses before the project is finished.
There are some TV shows about home remodeling that can give you some ideas. HGTV (Home & Garden TV) has all kinds of programs about design ideas and remodeling projects. TLC (The Learning Channel) has a show called “Flip That House”. It gives actual case studies of remodel projects from start to finish. The homes are usually a wreck at the beginning, then design ideas and budgets are discussed, problems and costs are reviewed, the final product gets a walk-through by the listing agent, and profits are calculated. (While it’s fun to watch, bear in mind it is a TV show, and the primary purpose is to get ratings. Note that they never talk about how the buyers managed to find such a great deal in the first place; the selling costs, carrying costs, and commissions are always left out of the equation; and “projected sales price” and “actual” can be two different things.)
If you have never hired Mexican day laborers, select an improvement project for your house, and hire some day laborers to do it with you. Gardening projects that involve lots of digging are always fun. Perhaps you need a new walkway or patio. It pays to learn how to do concrete jobs. The trick is in setting the forms properly – the rest is cheap labor and cheap material. Tell the workers you’ll pay them $8 an hour if they do a so-so job, and $10 an hour if they work real hard. (I always end up paying them $10 an hour anyway. Cash of course.)
You’ll make more money in the long run if you learn some Spanish. Get a translation book and have some fun with your workers as they help you with your new language.
If you don’t have much construction experience, go to Home Depot and browse the do-it-yourself book section. Buy some books that apply to some projects you might be doing.
More about day laborers
Usually from Mexico or another Central American country, most are probably in the US illegally and come here to make money to take back to their families. Most speak very little, if any, English. Almost all of them are very hard–working, honest, and poor. They are grateful when they get work, and very appreciative when they are treated with kindness and respect. If you don’t know where to find them, ask any contractor.
A final note: When you hire them for the day, part of the deal is that you buy them lunch. I suggest a nearby Mexican fast food place (Taco Bell is NOT a favorite – that’s for gringos). If you aren’t sure what to buy, take one or all of them along with you. They don’t want sandwiches or your home cooking; they want tacos and burritos and fajitas.
Time erases just about all investor mistakes made in failures of Flipping or Fixing. At least that’s what the investor thinks. So, you paid too much, spent too much, now you can’t sell it unless you are willing to lose $20,000? Maybe you’ll feel better if you rent it out for 10 years and then sell it after it has gained a little equity.
If you have a full-time job, don’t have the time to hunt down good deals or learn Spanish, you might be best off buying properties at market value that don’t need any work, and let time build your equity. If you are 30 years old, and can buy one house or condo every year with the goal of simply breaking even in the beginning, you will have a very substantial nest egg by the time you are 50.
Get out your calculator. Assume that whatever you buy will double in value in 15 years. Make it a goal to find 10 properties that can be purchased such that you will break even after all expenses, including a 5% vacancy factor and maintenance. It shouldn’t be too difficult to do based on 20% down payments, but see if you can find any deals where the formula works with 5% or 10% down. (The nicer the property, the more difficult it will be to make the numbers, but the appreciation will be better.)
Factor in an average rent increase of 10% per year. Although this will fluctuate, rents tend to increase by at least that much over the long run. To make sure you aren’t miscalculating the rents, put yourself in the shoes of a prospective tenant and go out and see what’s available out there.
Now assume you buy something at a price that has Flip potential, and you fix it up without spending very much. Now you have some equity. Instead of selling it, you rent it out and get a little cash flow. Maybe your calculator will tell you to refinance it and reinvest the extra money in another property. If you can master these steps with a few properties a year, you can start to see the reality of wealth coming your way.
If all this sounds like too much work, then don’t quit your day job yet. It’s human nature to wish for and to pursue the elusive “secret”. Well, the secret is that there ain’t no secret. It’s a learning curve like with anything else, and your initial goal should just be to avoid losing money. When you get good at all the things suggested in the above exercises, you’ll be able to make some money.
If you have a full time job that pays you over $80,000 a year, you will probably make more money on an hourly basis at your job than doing your typical Flips and Fixes.
Investors that have the most success generally make their profits doing a combination of Flips, Fixes, and Holds. Greed and impatience lead to mistakes and losses. Wealth comes from hard work and consistency over time.
Written by John Prell, who has over 30 years experience in various capacities in the real estate business, as an investor, hard money lender, real estate consultant, businessman, general contractor, and real estate broker. First-hand knowledge of the real estate seminar business comes from insiders and promoters of the Carlton Sheets seminars and others, as well as having dealt with numerous seminar graduates over the years.