Becoming A Battle Hardened Real Estate Veteran Without All The Scars: Seven Steps That Real Investors Make
BATTLECALL GUEST EXPERT: Chris Anderson, Phd.,
PreConstructionProfits.com
As part of a new web site that we just launched, I get repeated requests
asking if a particular deal is good or not. While we can't answer this for
individual projects, we can certainly look at what HAS to get done by the
investor to dramatically increase the odds of a successful transaction.
Step 1 is always to determine the fair market value(FMV). As
a real estate investor, you can always buy properties at the FMV. My question is
why would anybody want to do that? Through careful selection, you can always
find properties that are priced below FMV, regardless if they are existing or if
they are a preconstruction project. The best way to determine FMV is to work
with someone already familiar with the area or determine yourself through local
websites showing recent sales histories.
Step 2 is to then determine the market trend for the area for which
there are two critical pieces: 1) is the average price
increasing AND 2) is the volume of sales increasing. If both are moving
in your favor, then you have the comfort of knowing that the right trend is in
place to keep prices moving forward. In stock market investing, there is the
saying that the trend is your friend and traders frequently observe price and
volume data to confirm the trend. If a hotly priced real estate market shows
signs of dropping in volume, be very careful.
Step 3 is to learn about supply, especially in the preconstruction
marketplace. In some areas, there are very few projects on the books
and in others, there are 15,000+ units expected to emerge within 1 zipcode, in 1
year. Same is true for investing in houses. In you are competing with a bunch of
new houses that are coming on-line, then rapid price escalation may be limited.
For most savvy investors, they like to see lots of demand with very little
supply which is nothing more than common sense.
Step 4 is to make your OWN opinions of the macro conditions of the
local and regional marketplace. So, for example, if you are a strong
believer that real estate is overvalued in the target area, why would you ever
consider investing? On the other hand, if you believe that market forces will
continue to escalate in the market, then why would you not be actively looking?
As an example, some people believe that the graying of America is just now
starting to drive people to warm, more attractive climates. Even though property
values are high in these areas right now, are we going to see 20+ years of
additional migration to them? You have to decide for yourself because we won't
know the answer for another 20 years!
Step 5 is one of the most important risk management tools available
to the investor in real estate. Each property has typically an inherent
rate at which it can be rented, even if that is not your intent. By looking at
rental rates, relative to the amount of principle, interest, taxes, and
insurance (PITI) that you will have to pay, then you can understand the amount
of cashflow that may be required to support the property. If your objective is
to produce cashflow, then you need to be cashflow positive very quickly. If your
objective is capital gains and the cashflow is negative, then you now understand
what you may have to support on a monthly basis if things don't work out.
Deferred maintenance then becomes our Step 6. For an existing property, how
much maintenance has the previous owner neglected that you will need to catch
up? Be careful here since this can be one of the major places to get nasty
surprises.
And now I saved the best for last: Step 7 is to determine your own personal
risk tolerance. Some new investors look at a deal and only see the positive.
This is a huge mistake. EVERY REAL INVESTOR I KNOW HAS LOST MONEY IN A DEAL but
they gladly will do more. Why? They understand their risk's going in, they
understand how to limit their downside, and the gains are much larger than the
risks they are taking. If you were standing beside them and saw what they saw,
you would gladly take the risk as well and rapidly ignore any small losses that
you experience.
Hopefully this has given you a good start at learning how to analyze a
potential opportunity. Obviously each of these steps requires additional work or
training but they are what separate the new investor from the seasoned, battle
tested veterans.
Discuss this topic in the Warrior Discussion Forum...what do you think?
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