Wealth Strategies Investment Series Part 2

Creating WealthBy Bill Rodriguez, Loan Consultant Cherry Creek Mortgage Company 303-877-6323 

            Thank you for joining me for this month’s edition of Creating Wealth. In the last article, I discussed the current climate of the Colorado Real Estate market and its impact on investors who employ either a fix-and-flip or buy-and-hold investment strategy. I have talked many times in previous articles about becoming a team player and bringing value to your clients as a market expert who offers sound advice. For some of you, your market expertise helps you find the right property for investors and land for developers. This is one level of service, but in order to really distinguish yourself and truly add value, you need to step in and develop success strategies with your clients and help them execute on these strategies. This month I am going talk about 2 of the 4 phases of successful fix-and-flip and development strategies. Welcome to Part 2 of the “Wealth Strategies Investment Series.”

 “I love it when a plan comes together…” 

            The most successful investors have a plan and a particular approach that they use over and over to ensure success. In the development of any plan it is important to break down a task into its smaller parts to understand how each piece fits together to form the whole. In the case of fix-and-flips there are 4 phases that an investor needs to be aware of in order to fulfill on his/her end goal of making a profit. The same applies to development projects. The 4 phases are: Market Research, Negotiation/Acquisition, Construction and Marketing and Sales. An in-depth understanding of each phase is crucial to the success of a project and as a realtor you maximize your potential to become a valued member of this team when you can help your clients understand the intricacies of each of these phases.

 Phase 1: Market Research 

            The market research portion of this process is the foundation for all other decisions concerning the project. This process is much more than simply selecting a neighborhood to buy in and understanding the overall health and condition of the market. This process begins with a question: “Why would someone want to live here?” For instance, your client’s desired target audience is willing to pay $400,000 for the purchase of their new home. You as the realtor have found two potential investments: Home 1 is in an up-and -coming urban neighborhood and the market value after repairs is $400,000 for a 1,000 square foot house.  Home 2 is in a suburban neighborhood with good schools and has the same after repair value but is 2,000 square feet. Both are great homes for a specific type of buyer. One type of buyer is a working professional who works downtown. He wants his house to be in close proximity to work while having easy access to the night life when the mood arises. Since he does not have a family, having a place where he and his friends can hang out is more important than additional bedrooms. But take this same buyer a little later in life. He has since settled down with a wife and a child going to school and another one on the way. Suddenly that house in the burbs is looking like a better fit for him. Whoever you choose as your target audience will dictate the location you choose, have an impact on the design, layout and your level and quality of finish. This is just one example of many so make sure you have addressed all of the needs of your audience properly. Oh, and by the way, trends change so make sure you’re up to date!

            Another important detail is to make sure that you have firmly established your after-repair value with comps that are the same as the subject property. If you have a hard time finding a 2 bedroom home in a neighborhood where everything on the market is a 3 bedroom, 2 bath, then you might have a problem property. Don’t think that just because it is cheaper than everything else in the neighborhood, it is a good deal. You also need to account for the “number of days on market” and seller concessions. “Days on market” will dictate your holding time and impact your financing strategy. If necessary, you should be pricing in concessions as part of your marketing and sales expense, which affects your bottom line as well.

 Phase 2: Negotiation/Acquisition 

So, you have selected your buying segment and done your due diligence on researching the comps in the neighborhood. You even have an idea of costs associated with the project based on hold times, concessions (if any) and grade and level of finish. Now it is time to go to bat and talk about the acquisition costs associated with the property. Costs vary depending on the condition and financing used to acquire the property, but your bottom line is what’s important. Here are some tricks of the trade:

 

The Magic Number: My magic formula for successful fix-and-flips is 80% of the after-repair market value minus cost of repairs and seller concessions. Example: after-repair value is $200,000 – 20%= $160,000 – $20,000 in estimated repairs and 3% in seller concessions for a total of $26,000. My bid price is $134,000.

Supply and Demand: Foreclosures are an obvious source for properties that are worth 70 cents on the dollar, but have you thought of estate sales?

On Your Mark…: Your ability to pick up the good deal is based on how ready you are to pull the trigger. It is easiest when you can pay cash because it constitutes a stronger offer over someone with financing concessions. If you don’t have the cash or lines of credit, make sure to speak to your lender before going on the hunt.

Let’s Make a Deal: As you walk through these properties, keep a watchful eye for repair issues. This will help you estimate the cost of repairs as it relates to your bottom line. Also identify items that you can use to further reduce the price on inspection resolution. Tip: If the house was built before the 1960’s, pay to have someone inspect the sewer line. Also always ask the seller for the market retail value of repairs. He doesn’t need to know that you can get it done for cheaper!

 

Need more information? Feel free to contact me at any time @ brodriguez@ccmc-net.com or (303)-877-6323. You can also access information online @ www.investtaxfree.wordpress.com.

Creating Wealth “Wealth Strategies Investment Series” Part 1

By Bill Rodriguez, Loan Consultant Cherry Creek Mortgage Company 303-877-6323 

            Thank you for joining me for this month’s edition of Creating Wealth. In the last article I discussed creating your own real estate investment club as a way to pool resources and grow your business. I received a lot of positive feedback from this article. Many of you loved the idea of creating a network that added value to your investor clients and established you as the expert, but many of you were also hesitant because you lack some of the basic knowledge of how to evaluate the potential benefits and risks of a real estate investment opportunity. Take heart, my friends, because this edition of Creating Wealth is the first in a series that I have dubbed “Wealth Strategies Investment Series.”  I am here to teach you how to evaluate those deals.

Survey says?…. 

            If you were having your doubts about a rebound in the Colorado Real Estate market, you might be happy to hear that the numbers tell us we could be turning the corner in the right direction. Transaction activity is up 3.6% as of March ‘07 over August of ‘06. From February to March of this year, Denver Metro witnessed a rise in retail home sales of 38.8% – the largest spike since March of ‘05. While these numbers are encouraging, we are not out of the woods yet as the month-over-month increase in foreclosure rates puts downward pressure on real estate prices, and changes in the Sub-prime and Alt-A markets exacerbate the foreclosure problem.

            So what impact does the current climate of the real estate market have on your investor clients? Good question.  Here’s my take: The foreclosure problem and the shake down in the Sub-prime and Alt-A markets is going to have a huge impact on whether we have seen the end of our stagnant real estate market in
Denver or we still have further to go in weathering the storm.

If your client’s interest is in buy-and-hold real estate, you will be watching this issue very closely in the coming months to time the market for maximum appreciation over the long term. In the short term, these investors will enjoy a slight decrease in vacancy rates as ex-homeowners return to the rental market. This will put upward pressure on rental rates, allowing for greater cash flow.

Investors employing the fix-and-flip strategy are challenged by this marketplace. As real estate prices drop, the emphasis is put on the trendier areas as the smart investors shy away from the unstable and depreciating markets. The increased demand for these neighborhoods increases the acquisition costs for property, which puts the pinch on profits. In markets like this, it is tough for a new investor without a lot of liquid cash to get the ball rolling because many of the real “gems” require so much work that financing becomes impossible. For the seasoned veteran, cash is still king and they have a better chance of staying profitable.

Choose, but choose wisely… 

            Whatever investment strategy you or your clients choose to employ, whether it be buy-and-hold or fix-and-flip, you need to understand the potential pitfalls in the marketplace. There are some rules of thumb that you can use to gauge the profitability of a potential real estate endeavor. I will share some of these with you here. Others you will need to look for in Parts 2 and 3 of this series.

Buy-and-hold: 

            Buy-and-hold real estate in the
Colorado market is tricky because property comes at a premium. Smart investors commit anywhere between 20-30% of their liquid cash to create cash flow, or in some instances just to break even. There are, of course, exceptions to every rule, but the days when an investor could get into an “investment property” at 95 or 100% LTV and still cash flow are over – at least for now. The changes in the mortgage arena have made these loans harder and harder to come by, and those that do exist are cost-prohibitive in my opinion. I advise my clients who are interested in buying income property to put some cash into the deal – both to insulate them from the potential for depreciation in the short term and also so that the rents can cover the carry cost while they wait for the market to turn. Where many investors go wrong is that they fail to do a proper market rent analysis. They assume that just because the current owner of a $150,000 property with some deferred maintenance has a tenant paying $1,600 a month, that they can take over, continue to be a slum lord, and laugh all the way to the bank. Rents are all over the map depending on the neighborhood, and many landlords don’t have a clue as to what the market benchmark is for their area. Therefore, what the seller is currently getting in rent could be well below or above the market. Obviously, if it is below the market, you have a better chance walking into the deal described above and making it work, but please be careful.

Fix-and-flip: 

            As I mentioned, the fix-and-flip market is a tough market to play in right now because there is so much competition for the undervalued property. Investors with the ability to pay cash have a distinct advantage because they have no financing or time constraints.  This gives these investors leverage in negotiating for the right price and terms. For investors without this cash advantage, it is critical that they sit down with a lender before looking for property and work out the details, so that when the right deal comes along they are ready to pull the trigger. I would also suggest picking a lower purchase price to start out with, and setting realistic expectations for rates of return on time and money, because there is a steep learning curve to this process. The biggest mistake I see investors make is that they bite off more than they can chew. They chase after the higher priced properties expecting the bigger margins, when in effect they have put all their eggs in one basket. It is much wiser to start out at a lower price point, tie up less cash in the acquisition of each property, and keep some cash aside for the next hot deal that presents itself. This allows the investor to stay nimble throughout the process by budgeting for unforeseen circumstances and helps to diversify risk. More to come on these strategies and others in parts 2 and 3 of this series.