We all know the substantial loss in value that today’s real estate market has experienced. However, there are several strategies available that can generate not only income but substantial profits—even in a down market. With record low interest rates as well as broad indicators showing a bottoming out of the market, now is the time to review new ways of investment.
Here are three new approaches as well as some first hand, real world experiences in the residential real estate market in the North East/Long Island area. The first approach is called, “Bargain Purchase.” This, as the name implies, is the purchase of real estate for at least 20% below current market value.
The second method is, “Selective Value.” Here, the purchase of the property is at its current market value, but only those with an unrealized potential, such as poor condition or is in an up-and-coming area, are chosen. Immediately after purchase, any required changes are made to increase the value of the property. In general, you need to increase the value by at least 20% to 30% within six months in order for the strategy to be worthwhile.
Third, “High Yield,” means that the purchased property has a capitalization rate of 10% or more. The capitalization rate is the net operating income (or the rent minus operating expenses but before debt service) divided by the purchase price. In other words, it is the cash-on-cash rate of return you would get if you owned the property free and clear. In the absence of a bargain purchase, double-digit cap rates are very hard to find. They generally only occur temporarily in depressed markets or in small market niches.
The most common real estate investment strategy, however, is one that has been used during the drive to the boom (and bust): buying properties which the investor believes will soon increase in value due to market-wide appreciation. Although many billions have been made by investors pursuing this strategy, they were simply lucky because no one knows which areas will really appreciate.
Here are some real world experiences focused on the rental market. The forth investment strategy might be the most useful in today’s market, and is, “Rental Income where properties were purchased to generate income, not equity.”
Updating and remodeling the properties is a great way to maximize rents, which in turn makes profits. Rental properties must take in enough of a rent roll to offset your PITI, or Principal Interest Taxes and Insurance.
With this method, it important that the property yield at least one thousand dollars in positive cash flow due to the inherent risks such as vacancies. The possibility of down time must be calculated in any yearly projections. In addition, the possibility of an eviction looms large and could not only lead to several months of no income but the probability that renovation work will be needed. This in turn could lead to a larger problem suspending your tenancy indefinitely, and lead to significant losses.
Some landlords accept as little as $100 per month in positive cash flow in the hopes that they will capitalize on the equity they will build over the years. This was a sound strategy years ago, before the market and its players such as banks, investors, Fannie Mae etc., decided to treat real estate like a commodity.
Currently, many homes are under water and to make a purchase on the hopes that you will inherit a windfall in 10 years is as risky as a stock purchase. Perhaps once the real estate market fully corrects from the inordinate amount of foreclosures still needed to vet can we stabilize and think again of potential equity gains.
Lee J. Schneider formed Richmond Equity Management, Inc. in March, 2010. Lee’s areas of concentration are to both “buy and flip” and “buy and hold” residential properties opportunities. Located in Amityville, New York, REM looks to capitalize on current and future market conditions. Originally formed in 1997, under the name LJS Realty Group, REM has acquired many properties. Starting with a one-story ranch in Amityville at a purchase price of $80K Lee J. Schneider later sold the property for $117K for a profit of 37,000. Prior to selling the property, REM rented it out for several years. With a rent roll of $1,600 and a PITI of only 800 Lee was able to see the benefits and the “power” of rental or passive income. Lee is a member of LIREIA, taught sales at previous companies and knows construction.