Real Estate Investing Risks

10 Replies

Caught up on some reading this weekend and I checked out the book the Millionaire Real Estate Investor - written in 2005. A great book and very inspiring to read. What I am curious about and it raised an interesting question for me was assuming you read this book in 2005 and got very excited about real estate and started investing then the market downturn a few years later - where are you now? Did you manage to get through this downturn? The reason I am asking is that I am starting out to invest and may make my first purchase soon. I am reviewing my risks, costs, etc. and although my guess is real estate is more stable these days you never know. But, I want a plan for the long term and am curious about what strategies help a REI weather the bad times?

@Edward A.  I don't think the answer ever changes.  You make or lose money when you purchase the property.  If you purchase at the right price, the worse that happens is that you may have to wait out a downturn, before you can liquidate.  If you purchase at the wrong price, it may not matter what the market does.  What you don't want to do is buy and hold in an over heated market.  When that bubble bursts, and it will burst, you will wait years to regain the lost value.  In over-heated markets, with runaway appreciation, I believe it's often helpful to compare property prices against the cost to build.  If properties are selling for $500k, but it would only costs $225k to build that house...well, that's probably not a very good long-term investment.  Doesn't mean it wouldn't make a great flip!  ;-)

buy a sfh and rent out some rooms.  Keep your day job. Repeat.  

Best financing on owner occupied.

You know, I saw alot of my fellow real estate investors leave the market during the RE crash.  The thing is, most of us did not foresee the severity of what took place.  Buying right to begin with helps, but if your values drop 50% there's a good possibility that you didn't buy cheap enough.  Thinking about some of the things I saw then, I'd say leverage is a key factor in surviving bad times.  Usually everyone wants to leverage as much as possible because it amplifies your return in a good market.  So buying at discounts, using lower leverage will help.  When prices dropped I had very little leverage.  I lost some of my net worth.  But it was amazing how many of the landlords around me went out of business, lost their property.  Another thing that happened in my area was that rents were under pressure for a while.  Since my leverage was low, I was able to lower my rents slightly to keep my places full.  That becomes more difficult when you're highly leveraged.

I think you should be applauded for looking at your risks.  Just remember that if you don't see a risk, you just haven't thought about it enough.  That's not intended you scare you off, just to make the point that if you can determine all your risks on a particular deal, then you can determine if those are risks that you can live with, and maybe come up with Plans B and C if those problems occur.  One other thing, alot will depend on what type of investing you're doing.  A landlord takes different risks than a wholesaler or rehabber.

When a bartender making 35K a year can buy 1.5M worth of RE with nothing down, and their only requirement is a pulse something is wrong!  Today things are quite different. If you are investing, using common sense, learning before jumping in,  buying right, and using leverage sparingly I believe your chances of success are good. The meltdown did have one positive effect: it was a great lesson. Fiscal Insanity, Inc was the market maker.

John Thedford, Real Estate Agent in FL (#BK3098153)
239-200-5600

@Kirk R.  

We do what he suggests only as personals and rent them out when we leave. I did a case study of the central valley part of where we live. As I discuss in my blog, we make sure that every house rents for at least $200+ a month than the mortgage at 0-5% down. This gives me room when I over estimate rent. The one thing that I notice when I did my case study that bah for the area didn't really change. One year it fell $100 but the next year it went right back up plus a couple extra bucks! Military BAH is a great generalization of the rent because it "should" although not always symbolize the market. So if you had bought a house that would have cash flow and rent. Even if the house lost value you would have still been able to rent your house out. The thing is those houses were hundreds of dollars above rental value. the only thing they were bidding on for the exist strategy was appreciation. While I am ALL about appreciating being important, it is important to me from day one the houses cash flow and don't cost me anything. That mean there needs to be ohshit money.

If your rent covers your expenses, it doesn't matter what the market value of the property is.

If your rent covers your expenses AND cost of leverage, it doesn't matter what the market value of the property is.

This is true for leverage UNLESS your loan terms comes to an end, and you are underwater, then you face default since a neither a refi nor sales may pay off your balance.

You can mitigate the risks of going under water by not over leveraging. One great way to do this is to buy properties below market value. If you get a 70% loan on a $100,000 house, whose market value is $130,000 the day you bought it, your LTV is actually 53%.

Another big risk is buying in a dying local economy, where population is declining, no new jobs, etc. There are cyclical changes like unemployment in California, but there are also non-cyclical changes, like what happened in Detroit or Ohio.

Also, you might want to have assets other than real estate. Cash, bonds, cds, stocks. In a down market, cash will either save you from default, or will enable you to buy when others are in default.

Thanks everyone - I think I am on the right track then. Going tomorrow to look at my fifth house - hopefully this one will meet all the criteria. I have been shopping for awhile and waiting until I see one that works numbers wise before requesting a showing. Yes, I'm using MLS for the first one - I know not that wise, but I am watching the numbers (sales price, purchase costs, rehab costs, holding costs and re-sale costs). It's not easy for sure.

I understand that there are many risks of investment. I have recently read an article where American Developers are looking for investments from Israel. Here it is...

Through local outreach and asking questions, In 2013, I formed an easygoing, let's-have-lunch relationship with a soon-to-retire RE agency broker in a neighboring county. There's a brisk demand there for SFH rentals, and entry-level prices have been at around $100-$130K (for a 3BR cape cod or rancher). I was patient, and my broker friend helped connect me with investors there who wanted to do some deals. I took out a home equity loan on my primary residence, which was enough to finance my first two properties. That move alone gave me wonderful freedom and tax benefits. One investor the broker connected me with was eager to find capital for a new business he was starting with a partner, and another was happy to offer seller financing on a place that he had used as his office and didn't need any longer for that purpose. I wouldn't have known the back stories on these deals or had the ability to establish trust as quickly as I did without the help of that broker who'd been in the community for 40 years. As a result, the properties I bought were at about 15 to 20 percent lower than market prices. I just got a contract on one of my properties ($159K for a house I bought for $124K and put $2K into fixing up), after renting it out for a year. Won't make me rich doing real estate this way..., but hey I got $1200/month for it for a year also, of course....

One other cool thing is that, due to the relationships I've now formed with other investors in that community, I'm partnering in my first flip. One investor's billboard sign brought him a very motivated seller with a house in perfect condition--selling at about 35K below market prices in that neighborhood. And he came to me to partner with him in lining up financing. Looks like we'll pull it off. :-)

And of course my broker/mentor/schmoozer friend has benefitted from the transactions too! He's now acting as a de facto property manager for me also--I still do a lot, but he often saves me the 45-minute drive, collecting rents for me and supervising/paying contractors. I think that when you begin to form relationships, all kinds of opportunities open up.

Don't mean to make it sound as though it's all been smooth sailing. I've had some nasty tenant experiences in all of this, and it's all taken a lot more of my time than I ever expected. But I do think that when relationships are formed, dozens of unexpected deal opportunities can open up. And if you can find an investor who's willing to do seller financing at a good price just to capture interest and relieve himself/herself of landlord duties, you can get your foot in the door without much hassle.

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