This is simply the traditional sage advice (buy low, sell high) applied to real estate. And if you can do it routinely and without problems with title, devastating physical problems, or the negative tax consequences of being declared a dealer by the IRS (whereby your gains are treated as ordinary income and taxable at the highest rates), this strategy can be quite fruitful.
However, finding well-located, physically sound properties that are available at below-market prices isn’t simple. Our experience is that most sellers know property values and don’t simply give away their property. We often think that the old saying “You get what you pay for” was coined by a real estate investor who just bought a foreclosure only to find it has a large unrecorded tax lien, a large commercial tenant that filed bankruptcy and can thus void their lease, or a severely cracked slab foundation.
In our experience, successful real estate investors tend to be savvy, hard-working, conscientious individuals who enthusiastically perform comprehensive due diligence before buying a property. They don’t reinvent the wheel with each deal, because they know their market niche, personal skills, and available resources. They have a vision and use their tried-and-true game plan for each property. If you develop these talents, you can uncover unique properties with value-added potential that are often missed by your competitors.
Robert refers to this method of real estate investing as the “Get-Rich-Right” strategy. The best news of all for new real estate investors is that this plan can be undertaken anywhere and initially can be done part-time. We give you ten methods to achieve a real estate fortune by using the “Get-Rich-Right” method.
Build up savings and clean up credit
We disagree with some who imply that you can begin your real estate investment career without any cash. Our experience is that the best opportunities and the most options are available to the real estate investors who have both cash and good credit. So, don’t procrastinate — begin working on this step right now.Sellers aren’t likely to provide financing to a buyer with a poor credit history; because the purchase of real estate virtually always necessitates the borrowing of funds, make sure that your credit report is as accurate and as favorable as possible. Your credit score is a key element not only in qualifying for real estate loans, but also in getting the best terms to maximize your use of borrowed capital.
Get a copy of your credit report and correct any errors — pronto! At the very least, ask the credit-reporting firm to add your comments in your file with your version of any disputes. If legitimate delinquent balances appear, formulate payment plans and send the credit reporting firm written updates showing the balance was paid or otherwise satisfactorily resolved.
As a new real estate investor you should also develop additional sources of income while holding or preferably even cutting current expenses; even if you can find properties where the seller provides all the financing, you can’t escape certain out-of-pocket expenses or the opportunity cost of lost income as you expend your time and energy tracking down properties and performing the due diligence. We have yet to find a top-notch real estate inspector or escrow company that works for free.
Most people generate wealth and achieve a higher standard of living through sacrifice and living below their means in the short term; some even do so after they have substantial real estate cash flows. For ideas on how to track and reduce your expenses, pick up a copy of the latest edition of Eric’s Personal Finance For Dummies (Wiley).
Buy property in the path of progress
Locate properties that are in the path of progress — areas that will continue to improve through new investment and economic activity. You can’t realistically physically relocate your property, so your analysis of the location and its future potential is critical. After you locate the best cities or neighborhoods, there are commonly two types of underachieving real estate assets to look for:- Those income properties that are tired and worn and have extensive deferred maintenance
- Those that are physically sound but poorly managed
Buy the right property at the best price possible
Always buy property for the best possible price. This strategy is simple and makes a lot of sense, but may be easier said than done. We suggest following certain guidelines. As a general rule, most of your real estate acquisitions should be in the fixer-upper category and priced accordingly. You want to buy those properties that offer specific challenges that match your personal talents so you can use your skills to upgrade and enhance the value of the property and increase the Net Operating Income over time.A real estate investor using the “Get-Rich-Right” method doesn’t buy a new or fully renovated property, unless it’s in the path of progress or a prime location, because the value-added or appreciation to date has already accrued to the current owner. These properties may be solid investments, but you’re limited to the market increases in rent and value only.
However, in some special situations, buying a new or fully renovated property is a good investment alternative. For example, buying a residential rental property in the first phase of an oceanfront community or another unique location that’s difficult to replicate may be a great investment in the long run. The pricing in first phases of new developments is often favorable because the developer must presell a certain number of the units before his permanent loan kicks in.
Two important characteristics of successful real estate investors are discipline and the ability to predetermine the maximum price they’ll pay for a property to ensure plenty of room for appreciation potential. You don’t want to simply lower your purchase price by the cost of the repairs, because the value you add to the property should be significantly higher than your out-of-pocket expenses, including the time and risk you take in handling this work yourself.
Renovate property the right way
The “Get-Rich-Right” strategy depends on finding properties that are well located in the path of progress and then renovating them to increase cash flow and value. But don’t overspend on physical improvements. You only want to make those renovations or upgrades that increase the desirability of the property to your target market. Your property is a rental unit, not your own home. You may want to put premium countertops and appliances in your home, but you can’t get a good return on your investment if you over improve your rental property. Pride of ownership is important, but you’re running a business, and overspending on one property will limit your ability to save up the next down payment and build your portfolio and achieve wealth.Improvements should allow you to increase the rent or add to the property value so that you receive a return of $2 for every $1 spent on the improvements. The best fixer-upper properties for most novice real estate investors are those with simple fixes: Painting, landscaping, and minor repairs generally offer excellent results for only minor costs. These simple repairs are also within the skill set of most real estate investors, who may have developed and perfected their talents by maintaining and upgrading their own homes.
©Monkey Business Images/Shutterstock.comAlthough doing the work yourself is typically cheaper, don’t forget to look at the time and experience factors. It makes no sense to have a rental property off the market for three weeks while you spend evenings and weekends painting in a misguided attempt to save the $1,000 that a good contractor would charge for painting that would take him two days and allow you to rent it this weekend. (A good contractor will also likely do a better job than you can!)
If you use contractors, get three comparable bids from licensed, competent professionals. However, if you already know you have a competitive bid, you can expedite the process by asking the contractor whether she can lower the price by 10 percent — then you don’t have to go out and get additional bids. Of course, your most commonly used contractors may know your routine and overprice their bid by 10 percent or more. With time you can establish a good understanding of what constitutes a fair bid for all types of work that you routinely bid out.
Whether you do the work yourself or hire a contractor, make sure to obtain all required permits and meet the applicable building and occupancy codes for all improvements. The cost of the required permits and inspections will be yours, but make sure that your contract or agreement clearly states exactly who is responsible for obtaining the permits and arranging for all required inspections.Keep abreast of market rents
One of the biggest challenges for most rental property owners is determining the proper rent to charge tenants for newly renovated rental units. This aspect of property ownership and management simply requires some homework and research. Every property is unique, but your best indications of the market value of your renovated property can be found through a market survey of comparable properties.After you’ve acquired and upgraded your new rental property, immediately test the new rental rate structure by offering your vacant rental units or space at the higher market rates you determined in your rental survey. The response you receive from prospects will let you know whether you’re asking too much or whether you still have some room to give on your rents. After you install new tenants paying the higher rents, you can then make similar improvements for existing tenants and increase their rents to similar levels. One strategy is to renovate units upon turnover and offer an excellent, financially well-qualified, and stable existing tenant an opportunity to transfer to the upgraded unit at the higher rent. You then can renovate the unit they vacate. You repeat this process until all rental units in your property are fully upgraded and you have maximized your rental income.
We recommend that you keep the rent level slightly below the full market rent for existing long-term tenants to show your appreciation for their long-term tenancy and to encourage them to stay. The cost of losing a tenant is high — a vacancy results in rent loss that you’ll never get back, plus the added expense of advertising and preparing the rental property for the next tenant. For more on this topic, check out the latest edition of Robert’s Property Management Kit For Dummies (Wiley).Recover renovation dollars through refinancing
One of the key elements of the “Get-Rich-Right” strategy is to keep your capital working and use leverage reasonably while maintaining sufficient equity to weather the ups and downs of real estate cycles and local economic challenges. Acquiring and renovating your rental property required cash, but you also have increased the income, which has created additional value. You can now use this increased value to refinance the property to cover your initial costs of acquisition and renovation.Although we’re always quick to advise against borrowing too much and overleveraging your real estate investments, you also don’t want to be too conservative and underestimate your cash needs. The cost of refinancing is such that you don’t want to refinance the property more than once every several years, and if you suddenly need cash to overcome some unanticipated problems, the costs of short-term funds can be high. Borrow extra money or have an untapped line of credit available (which some lenders offer at no carrying cost to their best customers) to allow for reserves.
It can be extremely tempting in a strong real estate market to leverage over-aggressively, but don’t get carried away. Don’t borrow all the equity in your own personal residence to go out and buy investment real estate. These individuals are really real estate speculators (people who gamble on real estate) and not to be confused with real estate investors.
You should always own your own home and have (and always maintain) a good cushion of equity before looking to acquire investment real estate. As has been evident in the late 2000s/early 2010s, the lessons of a falling real estate market are difficult for all investors but are totally devastating to those few investors who borrow too much against their own homes.Remember that real estate markets have and will continue to have cycles, and you don’t want to be too aggressive and find that your real estate empire collapses to the point that you yourself can’t even afford to rent one of the apartments you used to own!
Reposition property with better tenants
One of the best ways to increase the income and value of your newly renovated real estate investment is to reposition the property with new, more financially qualified tenants. So, look to upgrade your tenants by marketing to a new target tenant profile and re-leasing the property.Often your renovation efforts displace your current tenant anyway, but you probably don’t want to renew the current tenants’ leases even if you’re able to work around them. The current tenants may be the reason that the previous owner sold the property (and that it’s in need of a complete renovation)! Such tenants aren’t likely to suddenly change their ways and will continue to use and abuse the property without any regard for your investment.
Robert advises not to renew the lease of an irresponsible tenant with a pet that destroyed the current flooring. You’re better off bringing in a new tenant if you’re going to have to invest in new flooring or especially carpeting in a rental unit. Likewise, you don’t want to continue the tenancy of a tenant who won’t be able to comfortably pay the higher rent that your fully renovated property is now worth.
This is often one of the toughest challenges for rental property owners — having to stand up to the current marginal tenant and not renew his lease. Although you may find that the current tenants are financially qualified and will treat the property as their own, the reality is that some repositioned properties should start with some new tenants. At a minimum, require the current tenants to complete a rental application. Go over the lease renewal exactly as you would for a new tenant and use the same financial criteria.Another way to improve the stability of your cash flow and minimize the chance of problems with your tenants is to increase the security deposit as long as you stay within the legal maximum. However, remember that market conditions usually restrict the amount you can charge for the security deposit. (Robert co-authored Landlord’s Legal Kit For Dummies with Laurence Harmon [Wiley], which can help you with finding and retaining great tenants.)
Become or hire a superior property manager
Superior management makes the difference between average and excellent returns in the long run. After you renovate and reposition a property with new tenants at higher rents, you need to retain the tenants and minimize turnover. You can also further enhance net operating income by effectively and efficiently controlling expenses.Even if you have just acquired your new rental property, you need to consistently work your long-term investment strategy by operating and managing the property effectively to achieve maximum value as if you were going to refinance or were preparing the property for sale.
Your target buyer is going to be someone that wants to buy a turnkey property (one that’s operating optimally and doesn’t require renovation or a change in tenants) for personal use or as a prime rental unit or coupon clipping investment (steady, highly predictable stream of income like bond investors receive). Real estate appraisers will determine a higher value for properties with a strong track record of solid Net Operating Income. Remember that to achieve maximum value, you need to have consistent income with rents at market rates, stable tenancy, and reasonable expenses. But don’t go for lower expenses at the risk of decreasing curb appeal due to deferred maintenance.
Refinance or sell and defer again
Notwithstanding the decline in property values in most areas in the late 2000s/early 2010s, many rental property owners find that they have a considerable amount of equity tied up in their property because of the appreciation that has occurred over the decades throughout much of the country. Having some equity in the property is good and keeps you from faltering should the local real estate economics take a hit, but too much equity just sitting in a property lowers your overall returns.Our “Get-Rich-Right” strategy recommends that you use the equity in your current properties to expand your real estate holdings by investing in additional properties with a view toward diversifying to reduce your overall risk. You can access that equity to generate the cash you need in one of two ways: Either conservatively refinance your rental property or look to sell the real estate investment in a tax-deferred exchange.
The best option depends on market conditions. We suggest that you take advantage of favorable financing terms when available to refinance your stabilized long-term properties. You can use the proceeds to restock your capital account in order to invest in additional rental real estate or even make other investments. The best news of all is that you can pull the cash equity from your properties tax-free. Borrowing isn’t dangerous if done in moderation.
Or you can sell the property and use the 1031 tax-deferred exchange to keep your equity working. Besides excess or lazy equity, some owners prefer the tax-deferred exchange option because they can enhance their use of depreciation to shelter their real estate income. A competent accountant or tax advisor can assist you in making the right choice between refinancing and a tax-deferred exchange.
Consolidate holdings into larger properties
Fortunately, many real estate investors are able to master the concepts of buying and renovating rental real estate. However, they often become so successful that their real estate empire begins to control their lives.Although owning a diversified portfolio of rental properties has some inherent advantages, the day will come when your extensive real estate holdings create management burdens. Most long-term real estate investors find that they reach the point where their management responsibilities and duties no longer conform to the lifestyle that they can afford. They often decide to simplify their lives and hire professional property managers so that a property manager can deal with the 4 Ts: tenants, turnover, toilets, and trash.
But finding and paying for a qualified property manager for a diversified portfolio of small rental properties isn’t easy or cost-effective. The potential efficiencies of property management are diminished when you have a large number of single-family or condo and/or small rental properties dispersed over a wide geographic area. Instead, look to the tax-deferred exchange and consolidate your real estate holdings into one or a handful of larger properties that can be professionally managed. You will still enjoy the benefits of real estate ownership without having to deal with the day-to-day challenges of management.