PART TWO: Identifying a Really Good Deal involves Setting Emotion Aside… at least in the First and the Final Analysis

This is Part Two of a blog entry published on August 15.  I ended the discussion in the last entry with the notion of what might be an advisable mindset when searching for a great investment property.

Let me use a real example I encountered recently, without identifying anyone personally.  These people are relatively young, relatively new investors.  They work hard to save, pay their bills and seek to build a strong future for themselves and their family.  They understand that this current real estate market offers extraordinary opportunities and they want to get involved.  So we have set certain search criteria and, based on the financial factors first, we have identified some properties worthy of further investigation.  Not surprisingly, all the properties identified are REO’s (”Real Estate Owned” by a bank or other lender).  We have targeted properties that are relatively new because they will likely require less maintenance in the near term.  We have focused on good school districts because tenants who are responsible enough to research and identify good schools are also likely to be responsible lessees.  And we have researched comparable sales and active listings to make sure these properties are listed at prices that may provide some “instant equity” when they are purchased.  However, bundling all these factors together usually means that the subject property is in less than ideal cosmetic condition.  Walls may need to be painted… carpet may need to be replaced… appliances may be missing.  The property was in foreclosure, after all; it is very sad, but some people even remove light fixtures and cabinets before they vacate a foreclosed property.

These young investors and I looked at three REO’s that fit all the above criteria, and they all needed some degree of cosmetic repair, but they were priced at the lowest end of comparable properties in their subdivisions.  Then they decided they would like to take a look at a new home– actually, a home that had been built about a year prior, but that had never been lived in.  The original builder of this community had gone bankrupt and another builder bought the assets out of bankruptcy and was continuing the community.  The house was clean and smelled new… there was plastic over high traffic areas to avoid damage to carpeting… no repairs needed here!  One of these investors loved the home.  It would be easy to rent, wouldn’t it?  She did not really even want to think about the “numbers.”  The home “felt right.”

I tried to explain why I thought two of the three older homes we had seen earlier in the day presented much better value– by the numbers.  But I promised to pull up comparable sales and listings in this new community, and I did so that evening.  It turns out that the current builder had purchased this new home for about 50 cents on the dollar out of bankruptcy, along with several other inventory homes in this community.  He had them on the market at the highest list prices in this community– about twice what he paid for them.  Now, while I would not begrudge a risk-taker like the current builder from making a return on his investment, I would prefer that profit not be made at the expense of my client(s).  If they had purchased this “new” home, they would have had a very nice, neat, new house in the real estate portfolio.  But they also would have no equity in it whatsoever.  In fact, it is possible that homes in this community will decline further in value for a number of reasons before values stabilize, and if they had purchased at or near the top of the price range, they are the people who would have had the greatest risk of seeing larger declines in the value of their investment.  That kind of misfortune is really wholly avoidable in this current real estate market!

Any “old time flipper” can tell you it is possible to take almost any older home and make it look, feel and smell like new– in many cases for less money than the uninitiated might think.  In the case of the “older homes” we had seen prior to the new one described above, some paint and carpet would have transformed them.  They were otherwise only a few years old, having been built within the last 5-7 years.  But comparable properties in their communities had sold and/or were priced in excess of 25% higher than the subject properties.  Walking through a home that is dirty and has been abused may not give the prospective buyer a warm and fuzzy feeling, but it can surely pay off.  The buyer needs to look first at whether the numbers make sense.  Then he or she can consider the emotional factors.  And finally, the decision should be based largely on the financial analysis– the projected return on investment (”ROI”) during ownership and upon resale.  These things are all quantifiable, within reason.  There shouldn’t be a lot of guess work involved.

Of course, this is not only true for investors.  In this buyers’ market, the same principles hold true for owner-occupants who would like to maximize the value of their purchase.  It is likely to be the largest single investment anyone makes, after all.  In my view, it would be a terrible shame to waste the opportunities available to everyone in this market by making a decision based only– or even primarily– on emotion.  There is always plenty of room for emotional considerations.  Analyzing real estate is really as much an art as a science, but there are some pretty fundamental (and quantifiable) principles that an investor and an owner-occupant would be well advised to focus on.

Identifying a Really Good Deal involves Setting Emotion Aside… at least in the First and the Final Analysis

We are probably experiencing the greatest “buyer’s market” in real estate in more than a generation.  For a buyer, this is probably the perfect storm.  Ridiculously low interest rates… REO (that is, foreclosed properties currently owned by lenders) properties continuing to dominate the market… list prices pushed downward by a continuing stream of distressed properties… short sales… Fannie Mae… Freddie Mac… HUD homes… all competing for a buyer’s attention.  Whether the buyer intends the purchase to be his or her principal residence, or the buyer is an investor who recognizes the opportunities this market presents, it is solid analysis that identifies great opportunities.  And in that analysis, there is little room for emotion– at least when a prospective purchase is first identified.

I have increasingly begun to represent first-time investors or investors who are in the beginning stages of building up a real estate portfolio.  Many of these people have worked very hard to build a solid credit history and accumulate some cash or other assets.  They know that placing their money into money market funds, CD’s or mutual funds can hardly be considered putting the money to good use.  There may be some security, but there is hardly any return on investment at all.  Those who had struggled and sacrificed to accumulate decent balances in 401K’s and other retirement savings may have seen those balances decrease significantly in recent years, reducing what had been considered conservative investments to a fraction of the owners’ goals and expectations.   And, of course, many people have seen the values of their homes decline with the other markets over the last several years.  There has been more than enough suffering to go around.

But the real estate market has been showing signs of reaching “a bottom” in recent months.  (Scroll back to the previous edition of this blog for details.)  The financial publications have been buzzing lately with the notion that this is the time to enter the real estate market, and many large and small investors, as well as owner-occupants, have begun to cautiously wade into the water.

As I work with new investors, one issue presents itself frequently.  New investors have a tendency to look for a home based on emotional factors first, and then try to force the financial analysis to support their conclusions.  It’s really only human nature, and it may even have commendable roots in the Golden Rule.  After all, if you are going to buy a property to offer as a rental to someone, it should be a home that you would live in yourself, shouldn’t it?  As a general proposition, the sentiment is laudable.  But as a primary factor in determining the suitability of a property as an investment, this mindset can be a big mistake.

In the next installment of this blog, I will conclude this discussion of approaching real estate and home buying in general with the right mindset.  That installment should be available on or around September 1.  In the meantime, if you have any questions, or I can assist you in any way, please do not hesitate to contact me.  You can do so via my web site: http://www.EricDorerRealEstate.com.  You can also search thousands of listings in the greater Charlotte area free of charge on my site.

PART TWO: So You Think You’re Ready to Buy a Home or Investment Property… How Do You Reduce the Risk of Making a Big Mistake?

The blog entry below is Part Two of the discussion started on July 10, 2012...

So you have access to the MLS data. What should you be looking for? There are things that will be obvious from the data, and things that will be implied. How many active listings are there in a community? How many REO’s (bank-owned properties– scroll back to an earlier edition of this blog) or short sales (scroll back to the February edition of this blog) are actively listed for sale in the community? If there are more than two REO’s and one or two short sales, values have probably not finished dropping in that community.

I generally look back six months at SOLD comps. And, again, be sure you know what you are doing when you assemble your “comps.” (Scroll back to the August 31 edition of this blog: “When performing property analysis, make sure to compare apples with apples.”) This will tell you how active sales are in a community… whether prices are still trending downward or have begun to stabilize… what sort of offer should we make? In this market, unless there is some extraordinary explanation for the lowest comparable sale price (e.g. sale to a relative), I suggest an offer below the lowest sold comp in the last six months. And, depending on the myriad of other factors, I might suggest an offer well below the lowest sold comp to make sure we have some “room” for further declines in value or for periods of vacancy in the case of investor properties.

With respect to investor properties, the MLS will allow us to see what homes or condos are currently available for rent in a particular community, what price they are offered for, what properties are currently leased, how long they were available before they were leased and what the current lease price is. There is no guarantee that your investment will lease within a certain time frame, but the historical data in the MLS system can certainly give you some solid insight into this.

Solid analysis identifies great opportunities– and can avoid big mistakes. We are currently experiencing the best “buyer’s market” in a generation or more. Anyone who is able to take advantage of it would be very wise to do so. But, for the uninformed or poorly advised, what might appear to be a good opportunity can become a costly error. As with most things in life, there is no way to eliminate risk completely.  But sound research and thorough preparation can go a long way toward limiting that risk… and toward finding one of the many great opportunities that still exist in this market.   You can start doing your research on my web site: http://www.EricDorerRealEstate.com.  And when you are ready to get a bit more serious, let me know.  I would be very happy to personally assist you.