We are living in unprecedented economic times right now in America.  As in all extreme conditions, some people are bound to suffer terribly, while others manage to navigate the hardships and perhaps emerge even better than when they started.  Our economy—ripe with poverty, unemployment, defaulted mortgages, and foreclosures—is under such conditions; many can do nothing but ride it out, and hope things improve before they are completely devastated.  Others, on the other hand, have realized that the down economy creates a buyer’s market—and what’s more, the record number of foreclosures provides incredible opportunities for investors of any level of experience to find great deals.

While there have always been “foreclosure cleanup businesses”—investment firms which deal only in purchasing, repairing, and reselling foreclosed and other distressed properties—the recent record number of foreclosures have caused a significant chunk of the investing population to follow this route toward success.  Like all major investments, however, foreclosures require substantial research before-hand, the ability and willingness to say “no” to a bad deal, guidance of an experienced professional, and commitment to see a major project through to completion.  It is no easy task, but the opportunities to profit are often unbelievable.

Once an investor decides to try his hand in foreclosure cleanup, the question becomes, “Where do I find these great deals, and how do I beat the hoards of other investors to the punch?”.  The short answer is that the deals are everywhere (advertised online, in newspapers, MLS, etc.).  But—as you may have already discovered—everyone has equal access to and awareness of these resources, so using them does not provide any real advantage over the field.

As an alternative to the conventional listing sources, consider using the Chamber of Commerce as a source of information and leads.  Chambers are generally local, but occur at every level of government and society—town, city, state, regional, national, international, etc.  In general, a chamber of commerce is a network of businesses meeting together to preserve and advance the interests of business (and therefore the condition of the market and economy).  Often called a board of trade, the chamber voluntarily assumes the responsibility of watching over the often-local economy like a sort of consortium of super heroes.

And, as it turns out, you’re invited!  Practically all Chambers—even the U.S. Chamber of Commerce—are membership organizations, which means that for a modest membership fee, any old real estate investor can attend and participate in these meetings, where first news of any market or community updates is broken and discussed.  If you want to succeed in a business with so much competition as foreclosure investments, then you need to be on the cutting edge.  When it comes to matters of the local economy (including foreclosed homes), the local Chamber of Commerce is the place to be.  Sitting as a fly on a wall in these meetings with a notepad or a smart phone could be your ticket to hearing about the best deals before they are publicly listed.  For those investors who take advantage, the head-start on these great foreclosure deals will be well worth the couple hundred dollars paid as annual dues for membership in the Chamber (these costs vary dramatically with the particular Chamber).  Information is almost never free; but when the information is good enough, you barely even notice the cost!

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Appreciation is a frequent term in real estate that often plays an important role in the decision to invest.  Appreciation is the increase in value of a property, which historically has held true.  However, in light of the slow economy, house prices have dropped and many properties have depreciated in value.  In order to predict if the property you are investing in will likely appreciate in value, and what that value may be, it is important to understand appreciation.  It is not as simple as thinking that house prices just go up.

Appreciation is complicated and the truth is that the general public doesn’t fully understand it.  If they did, they would not have been shocked when housing prices fell dramatically, known as the “bursting of the housing bubble”. A number of different factors caused the housing bubble; over speculation, loose lending and fraudulent practices just to name a few.  However, in my opinion, one general rule that should only be used as a general rule had become accepted by many to be an absolute truth. That general rule is that housing prices generally increase over time, this is true, but that does not mean that there are not corrections along the way. The idea that real estate generally increases over time came to be known by the inexperienced investor and even some overzealous investors as real estate always increases. Obviously that is mistaken as many have learned.  Real estate can increase in value, but it certainly doesn’t have to. The general rule should always be interpreted in the context of the current local and global environment.

Please don’t confuse appreciation with inflation. Inflation affects your salary and your daily living expenses, although inflation does increase the price of the house, the value does not increase since you get less for the same amount of money.  There is always inflation, but there is not always appreciation.

Natural appreciation is attributed to supply and demand. There is an ever increasing population in the United States, so the demand for land to build houses tends to outpace the actual supply of houses.  If you have experience in different housing markets, you know that this natural appreciation is not uniformly true however.  Local areas can have drastically different economies, with a surplus of vacancies or a waiting list for properties to become available.  An important distinction here is that if demand is the force behind appreciation, then it is the land which contributes more to the appreciation than the house. Houses get run down, need repairs, and become architecturally outdated.  The land, however, may be in a great community and associated with a strong educational system, which would make the location even more attractive for families. Knowing which component contributes the most to the appreciation is an important point to determine when looking for long term valuation.

Finally, there is forced appreciation.  Forced appreciation is an active process of taking a property to its highest and best use to force the value of the property up rather than allowing natural market supply and demand dynamics to play out. The two can work in tandem however. Forced appreciation happens when ever a dilapidated home is rehabbed and the property is brought up to current market value.  The value of the land has not changed much in this case, but the structure certainly has.  The value of the home has been forced up because the home has been updated and is now modern.  Natural appreciation and forced appreciation would both be in play in a situation where raw land is developed into a new strip mall.

To determine if your property will appreciate in value, you need to look at the local housing supply and demand data. Evaluate the local economy, is it growing or retracting?   Evaluate population trends, is the city growing or retracting? Where is the growth taking place? How long are houses on the market? Are there new homes being built?  Understanding this information will allow you to become more confident in your purchases. Don’t take appreciation for granted.

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Based out of Indiana, Jay Redding is a real estate entrepreneur, consultant and educator with experience in residential and commercial investing.

Real estate, like most areas of investing, is all about predicting future value.  When using statistics in order to help you predict value, the knowledge of where those statistics come from and how they are calculated could be the difference between a great investment or a disastrous one.  Remember, all calculations are subject to human error if the numbers used in the calculations have not been derived accurately.

One such important statistic is the CAP (Capitalization) rate, which is a percentage used to evaluate your property’s market value.  The Net Operating Income (NOI) divided by the CAP rate gives you the property value, and this market value is more sensitive to the CAP rate at higher NOI’s.  For example, a property with an NOI of 200,000 and a CAP rate of 10% has a market value of $2,000,000.  The same property with a CAP rate of 9.8% has a market value of $2,040,816.  That .2% difference in CAP rate is equivalent to about $41,000.  Therefore, it is important that you research how this number was determined in order to verify its accuracy.

The CAP rate used in the evaluation of your property is determined using data from other similar properties.  The key assumption in this is similar.  Somebody picked which properties were similar, meaning that this is a potential area for human error.   On what criteria were those properties chosen, and do you agree with that reasoning?   Even more importantly, the CAP rate should be the average of those similar properties.  If the CAP rate used is based only on your next-door neighbor’s property, it may not be accurate.

The CAP rate is determined by dividing the Net Operating Income by the sale price.  The Net Operating Income is a complicated number to calculate.  You must research that the expenses of the rental property include all expenses, and no hidden fees have been overlooked. You must also understand the income: is this income based on last year or an average of the previous years? Is it likely going to change in the near future?  The income is also a prediction, and therefore, is also subject to error.  It is vital to research if the future income will likely be the same as it has in the past, which can be done in various ways like researching market trends.  Remember, there is always a risk that the predicted income is wrong, which will drastically change your CAP rate.  A good idea is to have a range of predicted incomes, so you know the range of CAP rates, and thus the range of your property value.

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Based out of Indiana, Jay Redding is a real estate entrepreneur, consultant and educator with experience in residential and commercial investing.

In a heavy buyers’ market, it can be both frustrating and costly to try to sell or rent your investment property.  Most property owners are forced to a standstill during economic periods which favor a huge supply and relatively low demand.  However, the beauty of real estate is the eternal guarantee of change—people will always need to buy, sell, rent, and move.  So business is getting done, and shouldn’t your business interests move forward as well?  In order to continue doing business in a down economy, property owners must find creative ways to distinguish themselves and their properties from the field—a field which at the moment is vast, but which is targeting a relatively small population of customers.

There are many simple ways to make a property stand out.  The most obvious are the superficial modifications: improvements to the appearance and general “livability” of a home at the surface level.  These include updating systems, improving landscaping, repainting, etc.; and strategies like these are thoroughly explored and available from a multitude of resources.

In addition to these aesthetic improvements which will enhance your property’s curb appeal and impact upon presentation, consider offering creative transaction terms to your customers.  When a potential buyer or tenant is shopping for properties, most of their options in a broad category will appear pretty much the same—size, features, location, etc., will all probably be standardized based on the customer’s search field.  Therefore, the customer is looking for small features or details that distinguish one very similar option from another.  Many owners and managers simply offer discounts (or increase the price and then say they are offering discounts—hey, that’s business!).  Others include coupons and package deals and so forth.  These strategies are all tried and true, but common.

It is your property, which means you don’t have to follow any of the conventional rules of transactions.  Feel free to get creative—put yourself in the buyer’s shoes and consider what might appeal to you (this will probably be a function of the type of property you own, since features that are appealing will be very different between the $2 million and the $30,000 price range).  Consider what your individual business can handle.  Do you own the type of rental property where you could attract lots of business by offering dramatically reduced rental prices in return for requirements that the tenant handle repairs?  This is not a typical strategy, but it has worked in the past.  Many tenants of a certain socioeconomic class would much rather pay less now, and worry about costs in the future (and if they are contractually bound to make necessary repairs, then you hold the cards).

Obviously, this strategy will not work for many property types and many business needs.  But the point is this—get creative.  Offer something that no one else is offering, which generally means taking a bit of a loss yourself.  But it is extremely important to keep in mind that if you plan to do business in a buyers’ market, you simply will not generate the kind of income that you could under different conditions more conducive to seller profit.  That is why so many owners are stagnant in this type of economy.  But if yours is the type of business that requires perpetual motion (looking at you, landlords!), you need to maintain reasonable expectations of profits, hunker down, and offer up a sweet and unique deal for buyers/tenants.  Times are tough—but they’re not impossible.

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The Capitalization rate is a percentage, usually ranging from 6% to 12%, which is used to determine the property’s market value.  To find the market value, divide the Net Operating Income, which is the revenue minus expenses, by the CAP rate.  Your result is one way to determine the property’s market value.

For example, a property that has a Net Operating Income of $50,000 and a CAP rate of 5% would have a market value of 50,000/.05 =  $1,000,000.

Be aware that this is only one statistic used to determine property value and many other factors still need to be taken into account.  However, if you are going to use a CAP rate to assist you in your value assessment, it is important to understand how to interpret the CAP rate.

The CAP rate comes from dividing the Net Operating Income by the sale price.  So, if the Net Operating Income increases, the cap rate would increase.  If the price of the property increases, the CAP rate would decrease. It can be calculated with data from similar properties in the area or data from the desired property if it was recently sold.  It is then applied to the property in question to determine its market value.

Interpreting the CAP rate

A lower cap rate means that the property has a high selling price, indicating that the property is in demand.  This decreases the risk of the property, the risk being that you may not be able to sell the property at a profit.  A CAP rate of 5% is generally thought of as a safe investment because it is operating at it’s full potential.  It probably is in a good location, has good management, is modernized, and rent is reasonable.  This kind of property would appeal to those who are not looking to invest much time or energy in renovations, and who simply want a steady cash flow.  The property is in demand.

A CAP rate of 10% is considered to have average risk.  The property does not have as high a selling price as compared to its income as the 5% CAP rate property.  This means that there is room for improvement.  It probably has average management, is in an average location, and looks ordinary.  If you invest energy into making it appeal more to consumers, you could increase the sell price and make a nice profit.  However, there is also the risk that your improvements do not increase the demand.

A property with a CAP rate of 20% is considered a high risk investment, which could also mean high reward.  This property may be run-down, in a poor location, or under bad management, because the selling price is too low as compared to its Net Operating Income.  The investor would have to improve the property to increase demand, potentially selling the property for a large profit.  The investor could also improve the property and increase the rate of rent.  This kind of CAP rate is generally for investors who are more experienced in renovations and willing to put energy and money into the property.

The important item to remember is that the CAP rate is only one item of many to keep in mind when evaluating investment real estate.

What else do you evaluate when determining if a property is a good investment?

Type your response in the comment section below.

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Based out of Indiana, Jay Redding is a real estate entrepreneur, consultant and educator with experience in residential and commercial investing.

Investing in real estate—especially for those who are relatively new to the business—can be exhilarating. It is fun, exciting, nerve-racking, tense, sometimes joyful, and often bitterly disappointing. During a buyers’ market like the current one, this gauntlet of emotions shifts toward the joy and excitement side, and away from the anxiety-producing side of tension and disappointment. Great, right? The problem is—again, especially for rookies—is allowing yourself to be swept away by the fun and excitement of finding good deals everywhere you look, and forgetting why you ever worried in the first place. Too many buyers are too relaxed these days—they see a low price, they walk through the property, and they buy—only to discover later that real estate investing is still a very risky business, in any economy.

The key to reducing risk is enhancing preparation. In real estate investment, that’s easy; all the steps are laid out for you. All you have to do is not skimp or cut corners. Never pass on an opportunity to walk through the property (and never buy without being given that opportunity!), because it will offer invaluable insight as to the condition, livability, and atmosphere of the home that you could never get from a conversation or brochure. A walk through will give you a sense of the previous owner’s maintenance of the property, of what realistically needs to be done, and even what you may want to do that’s not been done before. The walk-through is your chance to meet, greet, and familiarize yourself with the property’s identity—an interview.

If the walk-through is the interview, then the inspection is the cavity search. The walk-through, while essential, is absolutely not a substitute for a proper inspection. Furthermore, a seller’s assurance that the home has been inspected (and even the inspection report itself) is absolutely not a substitute for conducting a proper home inspection (even an additional one!). An inspection, conducted by a licensed professional of your choosing (it’s important for every investor to have inspectors and other professionals that they know and trust), will provide detailed information about the guts of the home. What works, what doesn’t? What could use some repairs or updates, what will require those repairs in the future, and what absolutely needs repairs or updates immediately? Is the property up to codes and standards? Are there any features of the property that make it vulnerable or susceptible? And crucially, what will be the cost of making the repairs, improvements, updates, and modifications called for by both the buyer and the inspector?

Your walk-through will give you a sense (a gut feeling “yes” or “no”), and the inspection will provide the evidence to support or refute your feeling. The former is largely emotional and a function of perception, while the latter is strictly business. How feasible is this project going to be? Will you profit from your transaction? Too many investors, at ease perhaps due to the favorable market conditions for buyers, walk in to a property, love what they see, are floored by the low price, and simply buy it. No inspection. While some of these buyer’s may be thrilled, others may soon discover that they’ve overlooked a costly issue. Failing to properly inspect a home (or walk through it carefully) before investing is a gamble that’s simply not worth taking.

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Knowing the market value of a property is the most important item in investing in real estate. Knowing what the property should sell for, called the fair market price, will make it possible for you to know if you are buying the property at a good price. Your goal is that the price of purchase, which is called the market price, is below the fair market price. The real question is how do you determine what the fair market price is?

A simple Google search will yield multiple sites, promising to instantly appraise a property if you give an address. How do they come up with instant figures? They use data from similar units that have sold recently, a method known as the market-data method, sales-comparison method, or the comparative market analysis. These fancy names all refer to the same way of determining market value, which is researching the price of comparable properties sold within the last year. Usually, at least three properties are used to determine the market price. If comparable properties differ in some regards, like having an extra bathroom or being in a worse location, then dollar amounts are assigned to those differences. The prices of the comparable properties are adjusted so they can be directly compared with the property in question.

Sometimes, the prices of the comparable properties are averaged. However, the average should be weighted so that the most similar properties have the largest influence. If all properties are considered equally, then the average result could be different from what the fair market value actually should be.

This should be raising a flag. In order for you to trust the fair market value, you must understand which comparable properties were used, the dollar amount assigned for the differences in the comparable properties, and how the prices were averaged.

Understanding the sales comparison approach of valuation will provide you the basic knowledge you need to make an informed decision on the value of a property. This approach is used extensively in determining property values in the residential market.

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Based out of Indiana, Jay Redding is a real estate entrepreneur, consultant and educator with experience in residential and commercial investing.

So you like the idea of owning a rental property, and you’d like to learn more about it.  There are some big advantages of becoming a landlord, more so than just the obvious rent.   There are at least four ways to make a profit from rental properties.

Rent

The first advantage is your rental income, which is the rent minus the mortgage and other related expenses.  This is your monthly income. It may be tempting at first to ask for a high rent, but you have to be realistic to the environment in which the property is located because you could end up with a vacant property.

Appreciation

The second advantage is appreciation. Since 1940, the U.S. census reports that real estate values have consistently appreciated over time. Of course, this is not a guarantee for any one particular year and it will also heavily depend upon the area you invest.  In Indiana for example, the appreciation values have consistently held in the 1-5 percent range.  On the West and East coasts, appreciation values can sky rocket…or plummet. When investing in these areas, investing can become more of a speculation game than an investment approach.   Make sure you conduct your research in the area you are investing in to know what appreciation rate to expect historically.  When it comes time to sell, this can add a tidy bundle in your pocket.

Leverage

Leverage is an advantage that can be used in owning any type of real estate.  Through leverage, you are able to own and control a property without investing the full purchase price up front.  Depending on the mortgage, you could pay anywhere from 10% to 25% of the purchase price up front and allow the income of the property to pay down the mortgage and property expenses.  Leverage can be used to increase your profit margins as well. For example, say you buy a property for $50,000 cash, and it appreciates at 5% per year in value. The following year the property would be worth $52,500, which means you would have a profit of $2,500.  If instead, you use that $50,000 to pay for a house that is worth $100,000. The following year the house would be worth $105,000. You would have a profit of $5,000. By using the leverage of the $50,000, you were able to increase the profit to you.  Keep in mind however this is talking only in appreciation terms.  Determining how much to leverage must take into consideration many other items concerning the property itself and the local environment. Leverage is only one factor to consider.

Tax Advantages

Another advantage is that rental properties have certain tax advantages that offset income.   If your net rental income is 0 (that is, rent is equal to mortgage plus expenses), then you don’t have to pay income taxes from the property because you have not earned a profit.  That means you are able to pay down your mortgage without paying taxes on the money used to accomplish this. If you plan properly and utilize a 1031 exchange, you can also delay paying taxes when you sell the property by investing the profit into another similar property of equal or greater value. Tax laws are very intricate, so make sure you consult with your accountant or tax attorney for guidance.

Investing in rental properties can be very profitable for the informed investor.  Remember however, it will take time and effort. Knowing some of the advantages of rental properties is an important step in determining if owning rental properties is right for you.

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The counter-offer is an integral part of any negotiating experience, and real estate investing is no different; in fact, this feature of negotiations is so standard that most of us don’t even realize how much money we have lost over time based on the cumulative marginal differences between asking price and sale price.  Doing all the necessary preparation, formulating a perfect proposal, marking a formal offer, only to place your business’ potential gains in the hands of some negotiating opponent?  It simply makes no sense to do all of that work and then leave it up to someone to decide the terms of a deal.  But, that’s negotiating—right?

Wrong.  The counter-offer, though standard and highly effective, can be easily avoided altogether with a little bit of tactful negotiation and preparation.  If I have to tell you that you should expect your first offer to be rejected and must adjust your values accordingly—well, then you shouldn’t be in real estate.  We all know this, and we do it all the time.  But what if, instead of simply buffering our initial offers, we learned to make proposals in a way that enticed our opponents to accept the initial terms?  This does not necessarily mean accepting compromises in price; rather, it is a simple but fundamental difference in the presentation of the initial offer.

Essentially, avoiding counter-offers can be accomplished by combining the first two offers from a standard negotiation into one initial offer.  How?  You’ve probably been victimized by this strategy countless times.  It’s called the conditional discount, and we see it everywhere.  A seller will indicate a price for an item, then indicate a discounted price based on the buyer’s compliance with some minor condition (buy today, recommend a friend—anything).  I say ‘anything’ because the condition is irrelevant to the seller.  They aren’t interested in selling today versus tomorrow, or in calling your friend (although I imagine those are bonuses); what they really want is for you—the buyer—to feel as though you’re getting a steal.  In all likelihood, the cost of the item is the discounted cost.  But instead they tell you that if you scratch their back (by doing something simple and easy), they will scratch yours in the form of a discount.  That way—and this is the key—you won’t try to haggle for a discount.

Real estate works the same way.  Instead of simply making a ridiculously high initial offer (or low, if you are buying), make a ridiculously high initial offer with an option to get a lower offer by doing something easy (close within a certain time, work through a certain lender, etc.).  Effectively, you’ve anticipated your opponent’s first move, which is inevitably to probe for a discount.  Your discounted price is, of course, the price you wanted in the first place.

When the strategy is written out in plain text like this, it seems too obvious and simple to actually work.  You may say, “won’t the opponent just ask for a discount off your discounted price?”.  The key ingredient to this strategy is intangible though: it is a psychological trick.  The addition of the condition, however minor or irrelevant it may be to you, gives your opponent the impression that you are getting something extra from the deal.  More often than not, this has the opposite effect than one might think (one might think the opponent would resent the perceived additional profits and demand further discounts); however, experience shows that people assume that they are doing something for their opponent because it will get them the discount they seek, and so they accept the offer and meet the conditional requirement.  Simple, effective, and harmless to try.

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For the beginning real estate investor, the easiest types of investments to understand are rental properties and real estate wholesaling.  A rental property is when you, the investor, find a property that you would like to become the landlord of.  If it is already occupied then the tenants may remain, or it may be vacant and you will be responsible for finding new tenants.  The landlord, you, is also responsible for the mortgage, taxes and cost of maintenance. Your income will be the monthly rent.

Real estate wholesaling is buying or having a controlling interest in a property with the intent of selling it without renting.  You may have recognized the property as undervalued in the market and intend to sell it without any improvements, or you may have found a property whose selling price could exceed the cost of improvements that you are planning to make.

The first step in these kinds of investments is understanding what makes a particular property a good deal; that is, a property that is going to give you a good return for the amount of money you put in.  There are important criteria that you must consider to determine if the beautiful piece of property you found is the right investment for you.

First, what is your goal?  Are you looking to make a long-term investment, or are you looking for cash quickly? If you’re just getting started, a good way to begin is by having a few short-term investments to gain some capital, and then investing long-term.  Differentiating investments by long and short term is crucial, and it can make all the difference between a good and bad investment.

If you’re looking at a property that can be bought below market value and fixed with only a few superficial renovations, you may initially think of this as good short-term investment.  However, be aware that there are critical questions you must ask yourself before determining what kind of property this is.  Are there already tenants living there?  If so, they may make it difficult for you to complete renovations quickly, and the longer you hold on to the property, the more of an expense it is, a factor you may have initially overlooked.  If there are no tenants, why is that? Is the property unattractive? Has it been on the market for a while? If so, this may raise flags as to the rent-ability or sale-ability of the property, and you may not be able to get it off your hands quickly.

If this is your first investment, make sure to research all the added fees that come with buying a property: appraisals, legal fees, application fees, real-estate commissions, and more.  It is very important to get an accurate estimate of all the fees, because that could sway which category, long-term or short-term, the property should be classified as.  If the legal fees and renovations equal to or exceed money you saved by buying the property under market value, this may be a long-term investment rather than a short-term one.  In a long-term investment, the property will appreciate, giving you a profit when you sell it.  If it is a short-term investment, you may break even or lose money, depending on how much money you’ve put into it.

When determining if a property is a good deal, remember that the most important step is identifying your goals as a long or short-term investor.

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