Reality or Fantasy?

Question

Hi everyone- I am a newbie looking into real estate investing.

Over my lunch break, I stumbled into Barnes & Noble and started reading a book about investing in duplexes, triplexes and quads by Larry Loftis.

In his book, he talks about pyramiding on your investments. He lays out a wealth plan that I thought sounded a bit ‘optimistic’.

His plan showed that after 15 years, you could have $27 million in equity if you started with only a $20k investment. I believe the strategy is to purchase and refinance every two years or so to pull out the equity to purchase other properties.

His assumptions are:

• 10% down payments to purchase duplexes, triplexes and quads, which increase to 20% down payments after several years to purchase apartment buildings.  
• 10% immediate appreciation based on repairing the properties
• 7% annual appreciation

While I didn’t comb through the math, I assume it works on paper.

[u]Experienced investors-

Is this realistic in the real world?

What are the potential dangers to this strategy?

Thanks for the guidance!

-Adam

Toby Johnston · Answer

Possible yes but not a realistic/probable expectation in my opinion.  Appreciation is too optimistic and it sounds like he does not factor any economic/real estate cycles.  His numbers get that large because he is expecting it all to work sequentially to perfection so that the compounding is so powerful.  I would assume more down payment, less appreciation, and then factor in at least one or two down turns in the market during the 15 year stretch.

Mike H. · Answer

I think the equity capture of 10% is actually a bit low to be honest.  And you might even be able to pull it off with 10% down - provided you can find all the end loan financing you need.

But its the appreciation thats way out of whack unless you're talking about the really hot areas.  That being said, if you are talking about the really hot areas, good luck trying to get them to cash flow with only 10% down.

So, to me, I think some of it is possible. But the end loan financing is not going to be as easy as it seems to do.  Don't forget, while you may be able to use creative financing to buy with only 10% down, that also requires that you are getting into the deal (all in) at some pretty tight LTV's.

i.e. you need to be all in (purchase plus rehab) at 70% or better in most cases in order for a hard money lender to finance you. If you're putting in 10%, then you could say 80% or better although you have to factor in the hard money fees too.

And your end loan financing is probably going to want you to be at 70% or better as well.

Those deals just aren't piling up anywhere. They are very difficult to find. Even moreso in today's market.

Adam Shpall · Answer

Thanks for your replies!

Joel- I have a little money,  but am first wrapping my head around the whole concept of investing in real estate and making decisions regarding what strategies to use, etc.

Mark- This was a theoretical example and not something the author claimed to have achieved. I don't think he had paid down any of the mortgages so there must have been a high loan to value.

My concern with the strategy is the amount of leverage he used and the fact that he used all his equity to purchase new property leaving nothing for emergencies.

I am a newbie so I ask: Should someone using this strategy be concerned that they could have serious problems if one of the buildings turned out to have problems and they didn't have enough cash flow to pay the mortgage?

How could one mitigate these risks? In other words, is this too aggressive of a plan?

Thanks!- Adam

Mark Ferguson · Answer

Did he actually do this or is it all theory?

What loan to value is he assuming for refinancing ?

Joel Owens · Answer

Hi Adam,

Do you have any money right now to get started??

Many books are based on true experiences AT A CERTAIN POINT IN TIME. Meaning it was in a particular location or locations and a particular point in the real estate cycle when it was employed.

For instance back in 2009,2010 the market was frozen so sellers were desperate to try all kinds of things to sell their properties. Now with a more neutral market sellers are looking for more regular sales and qualified buyers. The techniques shown are probably still possible but much harder to put into place at this time in the real estate cycle.

Hope it helps.

Adam Shpall · Answer

Thanks David- All good points. As I was skimming the book, I think the author said the historical averages for appreciation were around 7%, but like you, I thought it was 3%-4%.

Looking forward to hearing others chime in!

David Morrow · Answer

I am also a noob, but I'll throw in 2 cents:

It seems to me that the assumptions are all possible to attain, but should never be counted on as common.  Said another way, those make for great criteria to look for in deals, but shoud never be relied on as assumptions.

10% down means your employing creative financing.  Traditional mortgage loans start at 20% for Non-owner-occupied properties.

10% immediate appreciation means you have to find properties that have a minimal amount of neglect, where a small investment in aesthetic improvemtents yields a big return.  Be careful that you're not looking at a more comprehensive neglect, though, where the cost of all the deferred maintenance eats you up.

The national average for appreciation is 3-4% (I think this is a rule of thumb more than an up-to-date mathmatical fact).  Therefore, you have to scout and research cities, areas, and neighborhoods to find those higher appreciation rates.

In short, all of those metrics sound very realistic to me, but none of them come without significant research and due dilligence.