Real Estate investing - systems for determining profitablilty?

[Dave Kaminski]

Hey guys,

I was just working on my 5 year goals, and one of them is to own six profitable four unit apartment buildings. In Massachusetts, anything more than four units is considered commercial and I don't think I'm ready to deal with those regulations.

Anywho, I'm thumbing through the books I've bought on real estate investing, trying to put together a system with which I can evaluate the listings I come across in terms of profitablilty. I need a process I can fit in to my day to day schedule to see what's available in my area and what I should look into further. I don't want to get-rich-quick, I want to find a handfull of good investments over a five year period and place them securely in my portfolio.

Is anyone here a real estate investor? Do you own any properties, or have any tips on how to evaluate said apartment buildings? I'd really love your help, and you'd be doing me and everyone else who reads this forum a great favor. I'm asking some of my clients who are hands on as well.

Thanks guys!
Dave

[ahimel]

Check out The ABC's of Real Estate Investing. I can't remember the author, but it's a Rich Dad Advisor book, so it has that purple-and-gold cover.

He does assume you're doing commercial property, but the same rules will apply to a four-plex; you'll just have to do things in slightly different orders and use different terminology. He offers step-by-step checklists, tells you what data you need, and runs through how to calculate profitability and offer price from the data.

Also, check with local investors on how much trouble the extra regulations are for commercial. In Colorado, at least, the need for paperwork is easily outweighed by the fact that you're not personally responsible for paying for commercial property. To buy a four-plex, you have to show the bank enough income to pay the mortgage on a million-dollar property. To buy a five-plex, you have to show the bank that the property will pay for itself. Even though your intention with a four-plex or even a single family home is the same, the bank won't give you the same loan.

But that's in Colorado and (at risk of severe stereotyping) I admit that the protective, liberal, people-are-too-dumb-to-think-for-themselves attitude in Massachusetts may have made commercial property too difficult for investors.

(Note to liberals, democrats, and people in Massachusetts: please don't flame me! I voted democrat!)

My turn: Where do you find listings for four-unit apartment buildings?

[Dave Kaminski]

Where I'm finding the properties:

I assumed to look in the real estate circulars as well as ask my current computer consulting clients who are realtors. I wasn't aware of that in terms of financing - was planning on using a mortgage broker in the process of loans. I've got connections in both the buying and financing aspects of the ordeal, I just figured I needed to find the right property. Am I wrong to assume such?

I own that book ABCs of Real Estate Investing. I shy away from Kiyosaki's advisors since I read he was the financial version of James Frey. Am I wrong?

[ahimel]

Originally Posted by Dave Kaminski

I just figured I needed to find the right property. Am I wrong to assume such?

I don't think so, I've just never tried it. I figured if you had a good plan for it, I'd use yours instead of trying to create my own. Shameless mooching.

I own that book ABCs of Real Estate Investing. I shy away from Kiyosaki's advisors since I read he was the financial version of James Frey. Am I wrong?

My goodness that guy is bitter! He says he's not jealous, and I believe that he knows his emotions better than I do, but something convinced him that writing a 62-page discussion of "all the reasons that everything Kiyosaki says is wrong" was a good use of his time.

Rather than create a 62-page, point-by-point refutation, which is not a good use of my time, I'll give you my opinion on Kiyosaki and on the Rich Dad series.

Kiyosaki is a terrible writer. He admits that he hated class, and I have to assume that English was on the list of classes that he regularly failed. He has no concept of how to organize a chapter, much less a book or a series. His writing style is prosaic and repetitive. His memory is not good enough to accuratly recall conversations that took place in 1955, and his recreated dialogue is worse than George Lucas'. He learned difficult concepts through repetition and example, and has no idea how to teach them in writing, without being there to answer questions. So he resorts to repeating the catch-phrase over and over, hoping that you'll figure it out.

That being said, he has his good points. I'm sure it's true that most of the lessons he's trying to impart are generations old. (I never got the impression that they originated from "Rich Dad", only that Rich Dad had learned them, and was therefore far more competent to teach them than, say, me.) But wherever they originated and whatever their age, I didn't know them. After reading Rich Dad, Poor Dad (and, I admit quite a bit of research and thought on my own) I did know them. I call that beneficial.

For example, one thing that readers of Steve's blog will recognize, but I had never considered, was the idea that you could get paid for something other than your time. You can get paid for your knowledge -- and that's far less restrictive. You can get paid for your ideas -- if you're willing to put in the work to make them reality. You can get paid while you're sleeping? Wow!

I knew that it was possible to buy ongoing expenses -- things that in addition to the initial payment, you had to keep paying monthly installments. I had no idea that you could buy things that, after the initial payment, put money IN your bank account. Given the option, I know which one seems like a better purchase.

So, I suppose that a lot of Mr. Reed's points could apply to Steve and his blog also -- that people in the forum will sometimes say that such-and-such is true because "Steve said so"; that he'll tell you that sometimes failure can be helpful, and could be considered a success if you do the right thing with it; that we don't know how much money he has, although he gives us advice on how to aquire wealth; that he claims to have tons of money but also claims to work 12 hours a day.

Frankly, I'm guessing that, if he knew about the Law of Attraction, he'd tell us that Steve is motivating us by lying to us -- it is, after all, pretty absurd to think that you can get money just by thinking about it.

The only response I can make to both of those is, "I believe my life is better for having read it." And I do.

Also, I have been significantly more impressed by the Rich Dad Advisors series than by the Rich Dad series. These are the people to whom Kiyosaki turns when he needs advice about (say) real estate, taxes, IP law, etc. Obviously, this is only true if you accept the premise that Kiyosak is actually wealthy and needs advisors, but I've found these people to be quite good and their advice worthwhile. I especially like Dolf de Roos, but most of the advisors seem to be quite competent in their field. So I'd treat those books differently from the Rich Dad series, despite the purple-and-gold cover.

I would argue vehemently with anyone who says that the Rich Dad series is all you need -- I would call it more of a starting point for the really worthwhile literature in the field. And I would not read it like a bible -- assuming that the wording was divinely inspired and must always be right. But, like stevepavlina.com, I have found it a useful source for ideas to think about and to consider incorporating into my life.

[mustard76]

Originally Posted by Dave Kaminski

I was just working on my 5 year goals, and one of them is to own six profitable four unit apartment buildings. In Massachusetts, anything more than four units is considered commercial and I don't think I'm ready to deal with those regulations.

Where in Massachusetts are you hunting for properties? I would also like to add some investment property to my investment portfolio. I live in Boston and every listing I see is _way_ too expensive for the rent to cover the mortgage, which I assumed should be a requirement when buying rental property.

Am I being unrealistic to expect the rent to cover the mortgage or am I looking the wrong neighborhoods?

[ahimel]

Originally Posted by mustard76

Am I being unrealistic to expect the rent to cover the mortgage or am I looking the wrong neighborhoods?

What's true is, market forces demand that rents be lower than mortgages in almost all cases. Suppose someone moves to Boston and is looking for a place to live. If market rent is $2000/month, but they can buy a house for $1800/month mortgage, why would they ever rent? This is clearly not the case -- overwhelmingly, people DO rent, so it must be true that overwhelmingly, it's cheaper to rent than to buy. In any market with even slightly intelligent landlords, the average mortgage will be higher than the average rent, usually significantly so.

There are several ways around this. One is to accumulate a lot of money, and eat negative cashflow each month for years, until you have enough equity in the place that you can refinance to a lower payment. Another is to start with a lot of money so that you can start with that kind of equity. One is to take out an interest-only loan, with its associated lower payments, and pray that the value of the property goes up before the loan is due. The solution that I believe is the most widely accepted by successful RE investors is to look for exceptions to the rule.

If you look at all the properties in a neighborhood, there will be a median value, and values higher or lower than this, distributed along a bell curve. Your goal is to find the one or two properties at the VERY LEFT end of this bell curve; the ones you can buy for about 60% of what the other houses are selling for. Maybe they're really run-down, but if you fix them up you can sell them for what the other houses are going for (fix-and-flip). Maybe the owner is desperate to sell, for whatever reason (divorce, lost a job, relocation) and willing to take 60% of the value if you'll just get rid of it. Maybe they inheirited the house from their parents, and they have to split it equally with their siblings, and they're tired of the phone calls saying, "Where's my money!" They'll take 60% of the value to get their siblings off their back. Maybe the bank foreclosed on them, and now the bank's sitting here holding this property that it doesn't want. They'll sell it for the balance of the loan. For whatever reason, if you buy them cheaply, you can rent them out profitably.

Dolf de Roos, who is a full-time real estate investor, says that you can eliminate most properties on the market immediately. The seller is asking something close to the market value, and has every reason to expect that they'll recieve it. If you find 100 properties that ARE worth looking at (they're asking far below market, or the seller is asking full price, but you have reason to think they'd take less), 10 will be worth looking at further, actually "crunching the numbers". Of those 10, 3 will be worth actually making an offer on. Of the 3 offers, 1 will be accepted. So after you eliminate most proprties on the market, you still have only about 1% of the rest of them that you'll end up buying. Plus, you'll probably end up looking at a lot of houses that Dolf would immediately dismiss, because you don't have his experience. So your ratio will probably be closer to .5%. Which probably means you're right on track.

The other possibility (again, depending on how much of a pain commercial property is in MA) is to look at commercial. Where residential property is valued based on what other houses in the neighborhood are selling for (comps), commercial property is valued based on how much money it brings in. Usually the value is C times the yearly income, where C is some constant that varies from market to market. For the ease of math, let's say that C is 10. Then if you find an apartment building that brings in $2000 cashflow/month, then the property is worth $240,000 (2K*12months*10). If the seller wants more than that (and they'll try) you negotiate with them, and offer what you can afford, based on what the property brings in. If they refuse, you move onto the next property, confident that you just avoided buying a bad deal.

Because stupid investors don't last very long, C is always a number such that you can cover the mortgage out of the rent. So with commercial properties it's not such a big deal to find them, you just have to have the patience to find properties for sale, and the money to make the down payment.

Sorry about the long, lectury post -- I'm not a good enough writer to explain it in a short space.

[mustard76]

Originally Posted by ahimel

Sorry about the long, lectury post -- I'm not a good enough writer to explain it in a short space.

Thanks for the great summary!

What type of neighborhoods do you look in for deals? I have heard people say that "working class" neighborhoods are best compared to pricier neighborhoods.

Can you recommend any more books for people just starting out? How did you get started?

[ahimel]

Originally Posted by mustard76

What type of neighborhoods do you look in for deals? I have heard people say that "working class" neighborhoods are best compared to pricier neighborhoods.

Here's what's true: property prices are very fuzzy things, and therefore malleable. You can almost always "stretch" your asking price in the direction of the median. If you buy a house slightly below median, you can ask for a slightly higher price and have a good chance of getting it. If you buy a house slightly above median, all you can ask for is a slightly lower price. For this reason, I've heard it recommended to look for the 80% of median-range neighborhoods. (For example, in Denver the median house price is $250K. The best option for me is to buy houses in neighborhoods where the prices are around $200K.)

Also, the just-below-median neighborhoods do well in all economies. If the economy is good, people from poor neighborhoods will want to move into your lower-middle-class neighborhood. If the economy is bad and people in the middle class are having to move out of their homes (which I understand is the current situation on the east coast) then they're moving into your lower-middle-class neighborhood. Whereas if you have a million-dollar house, you're really relying on someone wanting to buy a million-dollar house, which only happens in good economies.

That being said, if you find someone who will sell you a million-dollar house for $600,000, buy it. Or send their name and address to me, and I'll pay you $2,000 when I close on it.

Can you recommend any more books for people just starting out? How did you get started?

On building wealth in general
The Richest Man in Babylon
Rich Dad, Poor Dad, etc (see above link for other opinions on the series, but I still got value from it.)
Think and Grow Rich
The Power of Focus

On Real Estate Specifically
Rich Dad's Guide to Real Estate Investing Also, see if you can find audio discs from Dolf de Roos -- he's a hoot to listen too. (Probably more so for us Americans, who think aluminium is a funny word.)
The ABCs of Real Estate Investing Also a Rich-Dad book, but more practical
How to Create Multiple Streams of Income Buying Houses in Nice Areas With Nothing Down A more off-beat approach, but definitly valid.
Are You DUMB Enough to be Rich? Also non-traditional, but clear and easy to do.

Those are the ones that come to mind. Most of them have recommended reading at the back, so that should be enough to jump-start your research.

Also, I should make it clear that while I am a fount of knowledge on what people say about real estate investing, and I am currently in the mentorship program from Results Now (How to Create Multiple Streams of Income...) I have never actually completed, or even started, an investment real estate deal. So there's not actually any proof that I have a clue what I'm talking about.

[mustard76]

Originally Posted by ahimel

I have never actually completed, or even started, an investment real estate deal. So there's not actually any proof that I have a clue what I'm talking about.

That's fine. You know more than I do.

[stewhsu]

Hi Dave,

Nice realistic goals you're setting. If you're still looking for tips / ideas, I recently wrote an article on how to analyze property.

http://www.stewarthsu.com/2007/04/21...ily-homes-sfh/

If you enjoy that article, i.e. it makese sense to you and it's not too much, then send me an e-mail and I'd be happy to send you an Excel spreadsheet you can use to analyze real estate investments.

Best of luck,
Stewart