Here are two fallacies that often strike new real estate investors.   The first one bugs me only a little – the second one bugs me a lot. 

The first fallacy is the one peddled by late-night infomercial stars.  It’s the idea that it’s really not that difficult to find an old house, buy it for much less than it’s worth with no money down, and sell it for big bucks.   It’s true that some deals of this sort do happen, but they’re very rare.  If you start your real estate career thinking you’re going to get 50 deals like this on the way to that new Bentley, you’re actually on a fast track to disappointment.  (And if you really have done 50 deals like this – and have documentation, and don’t charge $1 million for people to see it – call me!)

The second fallacy is much more insidious and hits people who are much too smart to be fooled by the first one.  I’ll call it the Every Dog has its Day fallacy.  This means that any property you buy, no matter how big a loser, will eventually make money for the owner.  This view is underscored by two other views, both also erroneous:

1. All real estate rises in value over time.
2. When you own rental property, your rents go up over time, while your expenses stay the same.

We know in our hearts that this assumption is wrong, but still fall for projections that show it.

It’s certainly true that most real estate rises in value over time.  However, that’s not true everywhere.  I’ll give you two examples: Detroit, Michigan, and Buffalo, New York.  Right now in Buffalo, there are almost 800 houses listed for sale for $50,000 or less.  45 of those are listed for less than $10,000. 

 Why do you think Buffalo might have these wonderful deals?  It’s because Buffalo has been one of America’s fastest shrinking cities over the last 50 years.  The population is less than half of what it was at Buffalo’s peak in 1950.  This, coupled with the reason for the decline (there are no jobs to be found), has resulted in a huge drop in real estate values over decades.  Almost anyone who put their money in Buffalo over that time lost much of it.  By the way, this also means Buffalo rents dropped over the past few decades, so those Buffalo investors lost money every year on their way to eventually selling at a loss.

Detroit is in a similar way, with 6,900 homes for sale for $50,000 or less; 3,200 for less than $10,000; and a population less than half what it was in 1950.  Detroit’s motto, translated from Latin, is “We Hope For Better Things; It Shall Rise From the Ashes.”  I sure hope they are right!

This extraordinary hovel can be yours for $100 in Detroit.  Make an offer!

Thankfully, there are few true disasters like Detroit and Buffalo around the United States, although there are many cities where prices have risen only a little, stagnated, or dropped even before the real estate and mortgage crashes.  Even elsewhere, however, you might lose money over time because of the “expenses never go up” assumption.

 Suppose you buy a property for $100,000, with rents of $1100 per month.  Your expenses are as follows:

·         Monthly mortgage payment: $480

·         Insurance: $75

·         Taxes: $200

·         Allowance for maintenance: $100 (0.1% of purchase price)

·         Allowance for vacancies: $55 (5% of rent – assumes a 5% vacancy rate)

·         Utilities: $100

·         Legal, accounting, mileage and so on: $50

Obviously these numbers are going to vary widely for different properties.  It’s worth noting, however, that poorer communities usually have relatively high property tax rates.  They have to provide the same services as wealthy towns but with smaller tax bases.

For this example, however, your monthly expenses are $1060, which means you’re making a profit!  Congratulations!  It’s a very small profit, but should be much higher a few years from now because according to the second assumption, your rents are going to rise, and your expenses will stay the same.  Five years from now, your rents will be more like $1300, which means you’ll be making $240 per month in positive cash flow, which is excellent.  And, of course, you’re building equity.

So many new investors fall for this.  The truth is that every one of those expenses is going to go up except for the mortgage payment (assuming a fixed rate loan).  If they go up by more than about 9% per year, your monthly profit will decrease, even with inflation in rents.  And that can certainly happen.  In particular, property taxes, utilities (mostly heat and water/sewer, the two utilities most often covered by landlords), and insurance have all risen by 10% or more in many communities over the last five years.

The pinch will be even greater in communities experiencing rent stagnation or deflation.  If your rents stay the same and expenses go up even a little, your profit will fade and disappear.

That equity growth that was going to save your bacon?  That won’t happen, either.  If your monthly cash flow stays the same or decreases over a five-year period, your property will be worth about the same, or even a little less, at the end of that time.  Yes, you’ll have added a bit of equity through the principal portion of your mortgage payment, but not enough to make a major difference.

None of this is intended to turn you off real estate investing.  Many thousands of people have done very well with their property investments – yes, even some in Detroit and Buffalo.  They avoided losses by being very, very careful about where they bought.  They looked for towns and states that were growing, particularly in employment, a leading indicator for housing growth.  They avoided towns with a history of high property tax increases.  They looked for houses in neighborhoods where people wanted to live.  And, they sought out properties where they could reduce expenses by taking responsible steps to lower maintenance, utility and insurance costs.

Finally, they made sure they could sell on their terms by making sure they had enough cash to handle emergencies and daily living.

If you're new here, you may want to subscribe to our RSS feed or sign up for our real estate social network. Thanks for visiting!

Tags: equity, housing, inflation, landlord, rental-property, stagflation, tenant

“Equity” is a word that is used a lot but in my opinion, there are a lot of people who might not understand how it can be very misleading.

Having read the responses of the board veterans, I really can’t offer any insight over & above what they have said already.

I wanted to relay a story that I think might offer another way to view “Equity.”

Two years ago, I was in the office and a woman who was a new investor, was talking to the receptionist about an REO deal she had. I overheard her say, “I got a great deal!. I got $100,000 equity on a house I bought for $300,000.”
My head spun around so fast, that I thought I would get whiplash. I said to the woman, “You didn’t close on that deal, did you?” She said she had and I shook my head and said, “You don’t have $100,000 in equity.”
She became irritated with me and said to me, “Oh really? And how exactly do you figure that? I bought it for $300,000 and its ARV is $400,000.”

I asked if she was going to rehab the house and sell it and she said she was.

I took out some paper and said, “Let me break it down for you and ask some questions.” She folded her arms and nodded, ok.

“Are you going to use a Realtor to sell it? She said, Yes.
“Ok thats 6%. On $400,000 that will be $24,000.”

“You said you already closed so, your closing costs were at least 2%, right?” She nodded, yes.
“Then thats $6,000 on a $300,000 house. But wait, you are going to sell it for $400,000. You will have to pay closing closts as the seller at the increased price. Even at 2%, thats going to be $8,000.”

“Are you going to put in carpet and have it painted? What is the square footage?” She said, yes and it was 4,000 sq feet.
“Even if you put in cheaper carpet, it will cost you around $5,000 and if you hire painters, it will be at least $5,000 to paint it.”

“Are you going to make any upgrades, repairs or improvements?” She said, yes.
“Well on a $400,000 house, you won’t be buying fixtures and such at Home Depot because a house like that will get quality materials. Considering you are going to hire the work out, you will be lucky to come in under $5,000 and that’s IF nothing unsuspected comes up.”

“Did you pay cash or get a mortgage?” She said she got a mortgage and her payments were $2,200 a month. “What is the average Days On Market?” She said around 60.
I said, “Alright, lets figure 45 days from purchase to complete the rehab and get it on the market. Add another 60 days for listed on MLS time and another three to four weeks for a buyers contract to close. So if everything goes as planned, you are looking at about five months of holding at $2,200 per month. Thats $11,000 at best, in holding costs and that doesn’t include any utilities, trash dumpster, etc.”

She looked on with a blank face as I said, “Assuming you will have the property for five months and the taxes are close to 3%, that would be another $5,000 you would face for property taxes.”

I pulled out the calculator and added it up.
$24,000 for Realtor fee’s
$14,000 + for Closing Costs
$15,000 minimum for upgrades
$11,000 minimum for Holding Costs
$5,000 for taxes and $1,000 per month thereafter
$69,000 in costs

$100,000 equity
-$69,000 costs
$31,000 estimated profit at BEST CASE scenario

I looked up at her and said, “You don’t have $100,000 in equity. You have 25% equity if you paid $300,000 and it’s worth $400,000.”
She stood there, staring at the paper, silent.

A year later, I saw her in the office and she came up to me and said, “You were right. I don’t look at any deal based off equity in dollars. I look at the equity in percentages and if it’s not at least 30%, I pass.”

I asked her how she came out on the house from last year.
She shook her head a little and said in a low voice, “I lost $12,000.”

To quote the best manager I have ever worked for,
“I didn’t invent Math… I just have to use it.” -Cody Thompson

I hope this gives you another way to look at equity.
- Jim

Tags: equity, real estate, real estate investing, realestate

CashflowandEquity.com is the website of Cornerstone Investment Group, a company that has gained recognition for its specialty–offering turn-key properties to real estate investors. Simply put, this investment company promises to ease the “headaches of being a landlord.” No simple task, but the company says it can do this by providing properties that are “renovated,rented and with available property management.”

Vertically Integrated Lending Arm

To make turn-key type investments virtual no-brainers, Cornerstone offers a financing arm for properties bought through its website. The “Preferred Lender Program” -the company promises, will take any potential sting out of qualifying, which anyone who has ever purchased any property can tell you can be a consumer nightmare. But, Cornerstone says it offers fast closings and low down payments. This doesn’t mean, of course, that just anyone can benefit from the lending program:

**The potential buyer MUST have a minimum credit score of 620
**Must be 18+ years of age
**And, have a buyer debt-to-income ration not exceeding 50%

Focus on Foreign, In addition to Domestic Investors

So far, so good. These folks seem to have given much thought and have apparently covered all possible angles. For example, this is the first company I have seen that also caters to the foreign investor looking to buy property in the U.S….it does this through it website http://www.usacashflowproperties.com

Strategically Locates Properties in Affordable Western New York State

Of course, Cornerstone has a strategy: to locate properties in Western New York State. I personally believe this is a good plan since properties in this part of the country are extremely affordable at this time. But, even white clouds can have a darker lining. There is plenty of evidence that the area is not exactly on the upspring. The City of Rochester’s own estimate is that nearly 66% of the structures in the city are rental properties. And, over in ever snow-bound Buffalo, nearly 59% of the city’s structures are rental. The obvious down side to this is there is also plenty of evidence that areas with a greater concentration of home ownership,for example,tend to have residents sharing a far more attractive socio-economic profile. And, while The Economist just published a story concluding that Rustbelt cities such as Buffalo have a real chance to stage a dramatic comeback, it cautions at the same time that this is not likely to occur overnight. In part, this is due to the economies of Buffalo and Rochester which are not ,what one might call,booming. And, there has been talk and unfulfilled promises before by civic leaders that both cities would have a major turnaround. So, only time will tell.

But, one doesn’t need time to tell that all this translates into cheap properties, yes, but also properties not likely to see much appreciation in the short term.While the properties offered by Cornerstone all come complete with built in equity, investors should be made aware that it is of vital importance to closely examine and consider cash-flow.

Established Property Management

As for its much advertised property management, Cornerstone has established relationships with various companies making it possible to offer management services at 10% of collected rents. Just some of these services from management include:

• Rent Collection
• Dealing with various Rental Public Assistance Agencies (i.e., Section8 )
• Tenant Issues
• Repairs and Maintenance
• Inspections
• Tenant Placement
• Lawn and snow removal services (when needed)
• Monthly statements with Expense records

You should be as comfortable with your property manager as you are with the management company you have hired. With that in mind, we’ve assembled a few important points to consider and have gathered them here

Large Availability of Properties for Rehabbers and Landlords

This company works not only with landlords but also with other types of investors. And, since it can secure properties at wholesale prices, it can sell these properties directly to rehabbers–and, still turn a small profit. So, if you happen to be a rehabber with a yen for Western New York State, all you need to do is fill out a form and you are now in the loop to learn about upcoming deals.

Finally, the properties themselves. As of today, Cornerstone has 177 properties listed on its site. After browsing for just a minute or so, you can see there are many potential opportunities for investors large and not so large.

So, if you are in the market to pick up some affordable, cash-flow properties, I’d certainly take a serious look at Cornerstone Investment Group via its website, cashflowandequity.com. It is a company that seems to have its act together, offering deals that should make it easier for newbie and hand’s off investors alike.

NOTE: This was a paid review. If you are interested in having your site reviewed, please visit our advertising page

Tags: cashflow, equity, landlord, property, real estate investing, rehabber, turn-key, wholesaler