Here’s How to Mitigate Your Risk When Buying Property at Retail Prices
I’ll admit that BRRRR investing is one of my favorite real estate investing strategies! It’s BRRRR or bust, right? But what if this strategy of investing isn’t for you?
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Maybe you work long hours, travel often, or have a young family at home. Maybe you don’t have the time (or desire) to search for below-market deals, negotiate hard money or private money loans, deal with contractors, and navigate the gauntlet of a refinance to get your money back out.
Does this mean you can never invest in real estate? Definitely not! There are still ways to purchase a rent-ready property now and build your wealth. It will, however, cost you more to do so. Oh, the dilemma!
But, let me ask you this question: If you plan to hold the property forever, does it really matter if you choose to pay retail for a property from the MLS or a turnkey provider?
Know Your Risks in Buying Retail-Priced Property
A few years ago, I started building my buy-and-hold portfolio with turnkey providers or paying near retail off the MLS. I was working full time, had a young family at home, was the guardian for two family members, and had an aging mother who needed care. I was burning the candle at each end (and a few times in the middle).
I knew real estate was a proven investing model that nearly anyone could repeat with success. And I was determined to get into real estate to build my family’s wealth and financial independence.
Fast forward a few years, I’ve retooled my investment strategy to an almost all-BRRRR model. Let me tell you why. The advantage you get with BRRRR investing is massively supercharging three of the four tenets of conservative investing:
- Capital preservation by refinancing most, if not all, of your money back out.
- Cash flow by pushing greater returns with most of your money out of a transaction.
- Appreciation by capturing the forced equity of the property (rather than waiting for the market).
Now, I do not regret one bit getting into real estate paying retail prices.
However, you do need to be more diligent about your market and property in order to mitigate your risk. Because the largest difference in purchasing retail, is you are risking YOUR personal capital in the project rather than the forced equity in the property as you would in the BRRRR. However, you can still pull all of these levers of conservative investing even if you purchase property retail.
How to Mitigate That Risk
Ask any seasoned investor how to mitigate risk when purchasing a property, and you will get a long checklist of the do’s and don’ts. However, at the core, there are three major ways to mitigate your downside when purchasing a property (especially when paying retail prices).
You want to be in a market that supports your investment strategy. The No. 1 way to stack the investing cards in your favor is to evaluate your market and submarket for the following criteria:
- Decreasing unemployment (more people have jobs to pay your rent)
- Increasing population (more people to rent to)
- Good job diversity (should one employer poof, your tenants have other jobs to secure)
- Good supply and demand (are rentals actually needed)
- Located in a B-class submarket
When you have more of your own capital invested in a deal, research how many ways you have to exit the property if needed, such as:
- Hold long term
- Sell retail
- Sell to an investor
- Sell to your tenant with a lease option
- Convert into a short-term rental (vacation or corporate)
The more exit strategies you have available to you, the better you are able to preserve your capital as well.
Cash flow is queen! Yet, I see many investors sacrifice cash flow for the future hope of appreciation—a very risky proposition if you don’t know what you are doing. Cash flow will keep your portfolio stay afloat in a down market and give you choices. When purchasing retail, ensure your income comfortably exceeds all expenses, such as:
- Underwriting that rents are at least 125 percent of the expenses of the property (known as DSCR or debt service coverage ratio). When your DSCR is 1.25 or better, you will have a better chance to continue buying property with financing as well.
- Securing long-term, fixed-rate debt on the property to lock in low expenses so you will not be forced to sell in a down market.
- Accounting for all owner expenses such as HOA, utilities, insurance, and taxes (including possibly losing a homestead exemption).
- Setting aside proper reserves for a vacancy, maintenance, and capital expenditures. Most buy-and-hold investors go south in their analysis by not setting aside the proper reserves. You will have a vacancy. Water heaters will go out the day after closing. Tenants will wreck a dishwasher or a refrigerator. It’s a matter of if not when. Also, if you plan to hold forever, you will need to replace mechanicals at some point during your hold period.
When you are purchasing property retail, appreciation generally happens when the market gives it to you, and it is the icing on the cake. Know that any equity (your down payment plus market appreciation) locked up in the property is illiquid. You can only access the equity through a HELOC or sale. So, evaluate your property’s value periodically to see when harvesting equity makes sense in order to drive velocity with your money.
A Case Study
My first out-of-state rental was in a solid B-class area of Indianapolis, Ind. I purchased the property for $120,000 and rented it for $1,250. After all expenses and reserves were set aside, I was clearing about $250 a month in cash flow. Was this $250 a month life-changing money for me? Not really, but I sure as heck wasn’t complaining! My plan over time was to add 20-plus streams of income like this—and continue to scale.
What I quickly realized was that the largest risk with purchasing property retail was my ability to weather the housing market. Should the market take even a 10 percent dip, I would lose about 50 percent of my capital in that Indianapolis deal!
But…would I really lose that capital?
I would only lose that capital if I sold the property in that down market. This means that cash flow covered my expenses on the property. And because I had long-term, fixed-rate debt in place, I wouldn’t be forced to sell. This is not just blind luck.
In the case of this Indianapolis property, the value of the home actually increased to $148,000 in two short years. I cleared $23,000 after expenses on the sale, nearly doubling my initial investment of $24,000 with appreciation returns alone. (For grins, if I has BRRRR’d this project, maybe I would have cleared closer to $54,000 on a $0 downpayment).
You see, I engineered luck by purchasing a B-class asset in a solid rental market that cash flowed well. I also had a reasonable chance of appreciation, and most importantly, I could choose when I sold it.
Purchasing property retail is a viable option for investing in real estate especially if you don’t have the desire or time to invest through a different model such as BRRRR. Remember, no one will care about your money as much as you do. Purchasing property retail means you have to be smarter at snagging a good deal in a great market.
What has your experience been purchasing property retail?
Share with a comment below!