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Part One: Identifying the Target
The People and Their Success
George and Marge * are thirty something and they have two children. George is an up and coming partner in one of the ten most prestigious law firms in the county. Margaret is a stay at home mom. They have been successful rental owners for about ten years, owning about fifteen units in two locations. As investors they are prudent risk takers.
They recently bought a fifty unit apartment building at about ten percent less than what most people would have believed possible. They saved more money on this purchase than they make in two years. (For privacy reasons, the exact names and precise details are modified, but the core the transaction and process are completely true.)
This article tells how they achieved that result. You can learn what to do right and how to avoid the common mistakes which many buyers make. This first article will give you five wealth creating principles you can use the next time you are ready to buy income property. The balance of their story will teach you even more tricks of the trade. Save this series.
Goals and Trade-Offs: Decide What You Want and Learn How to Achieve It
Principle # 1: Begin with the End In Mind
George and Marge first had to decide what outcome they wanted. For them, success was defined as a 10% return on their invested cash, and a purchase price one third below replacement cost. They then took the time to educate themselves about the best way to achieve their goal.
Principle # 2: Assemble or Select a Team with a History of Success.
They wanted a great deal (doesn’t everybody?). Finding great deals is time consuming. George and Marge considered whether it was best to search all the deals on their own, or to contact several agents. They had read about brokers who specialize in serving buyers and wanted to consider that idea. They realized that going about this the wrong way could result in wasted time and energy.
They talked to other investors they knew and respected. George found people who had bought investment real estate bargains. Marge did research on buyer brokerage and how to select a great agent. (If there is enough interest we can share with you what she learned. That article will come after this series.)
They learned that Ralph Nader, American Association of Retired People, AARP, and Sprint and other substantial and impartial groups advocate buyer brokerage. George and Marge became cautious about someone who was a dual agent, trying to represent both the buyer and seller at the same time. A listing agent has a responsibility to the seller to get the highest possible price for a property. By picking their own buyer’s agent, they had someone responsible for getting them the lowest possible price for the property. When they learned that the commission is almost always paid by the seller, but they have the benefit of exclusive representation, they become even more interested. Marge and George were both busy and they reasoned that having a trusted professional on their team was more effective than dealing with a bunch of people who were just trying to get a quick commission. They wanted to ensure that they received unbiased information from someone focused on their success.
“Trust and competence were vitally important. This investment was the largest we ever made and we wanted to be comfortable,” Marge explained. They decided that that the trust and expertise of their preferred agent was in their best interest. It was important that their agent, be their agent, not the seller’s subagent. They did not want someone trying to sell them. They wanted an advisor or counselor to guide them through the process.
They selected the best person for the job. This person may not have been their first choice for a dinner guest, but he was someone who would help them accomplish their goal. By asking them some direct, and important questions, they knew that this person was committed to results.
Principle #3: Identify Your Strengths, and What Problems You’re Willing to Solve.
Marge and George wanted to maximize wealth, and to increase their cash flow.
Working with the broker, they identified which areas offered the potential for achieving their goals. The broker provided written reports on recently closed transactions of the size they were considering. They drove through more than twenty zip codes and noted which were ones were too risky and which ones did not provide enough cash flow.
Marge said that they wanted the best of all worlds, high cash flow, great neighborhood and low price. However they realized there is no “eat ice cream and lose weigh diet.” They had several conversations with the broker and with other people they trusted. They had some full and frank discussions about the trade offs between “pretty” and “potential”. After two weekends of looking at properties it was obvious what areas were and were not comfortable for them.
Apartments in a working class neighborhood sell for less than $40,000 or less a unit, but at the beach they cost more than $100,000 per unit. What type of neighborhood is best for you?
What problems can and will you fix, and what risks will you accept? The market pays more for newer units, for garages, for amenities, for condo papers, for longer term financing, for better unit mixes, for properties that are fully rented and are already in good condition. How important are those items to you?
How good are your: management experience, repair and maintenance skills, leasing and marketing strengths, your income, net worth and credit history? Where do you excel? What do you like to do? If you’re not mechanically inclined, a property needing substantial rehab may not be the best for you, unless you plan on hiring a contractor. If you don’t particularly like dealing with people, you need to be honest with yourself and consider hiring professional management for your property, The broker helped George and Marge recognize their special strengths and limitations.
Principle #4: Investigate Before You Invest.
To Capture a Bargain, You Must Recognize It as a Bargain
George and Marge looked at a number of properties that had already closed escrow, not primarily properties currently for sale. This was a critical step in their educational process. By understanding the market reality for a given area, they were much more likely to recognize the good deals when they came along.
The San Diego Association of Realtors statistics show that less than 20% of the income properties in the multiple listing service, MLS, sell. The broker explained that most of the income properties sales never go through the investment MLS. George and Marge did not waste precious time and energy looking at over priced properties that would not meet their goals.
There are scores of potential buyers who are looking for deals now. The people who pay too much are always those who do not understand the market and who are working with an agent who is not knowledgeable about current values.
Even after they had defined what they were and were not seeking, George was abundantly cautious. He asked for and received every new listing in the county until they had a property under contract. He looked at the figures on more than 100 properties. Most investors are not as rigorous. He drove by about thirty properties.
Principle # 5: Decide How Much Debt Can You Accept
It’s been said, “There is no good debt, there is only bad debt and necessary debt.” Buyers will need to decide how much necessary debt they can handle. Generally speaking the market pays more for properties which require lower down payments.
George and Marge discussed which kind of deal would be appropriate for them. Their broker explained that leverage has a price. For example, which is most suitable: a price of $1,100,000 with $100,000 down with a small negative cash flow, or a price of $1,000,000 with $200,000 down with a small positive cash flow, or a price of $925,000 with $275,000 down? Financing suitability depends upon the buyer’s position and goals.
Buyers will not have such wide and dramatic financing choices on any single property. With their broker’s help George and Marge realized that financing was one of the key elements in determining which property was best for them.
Summary: The Target is Identified
“Well begun is half done.” Marge and George were set up for success and they had not yet even made their first offer. They had determined the following:
Author: Terry Moore, CCIM