Why fixer houses? As investors, each of us must make a decision on our overall strategy: Should I buy and hold for long-term appreciation and tax advantages? Or should I buy and quickly sell to collect my profits now? Nothing says you can’t do both… keep some properties for rentals and buy some for quick turnaround deals. But what are the advantages and disadvantages of each strategy?
The Buy and Hold Strategy
There are many variations of this basic strategy, but usually it entails buying a house or small apartment building with a small down payment (20% or less) and renting out the units. The holding period is at the discretion of the owner…it could be one year, one decade or forever. In the meantime, the owner is making payments on the underlying mortgage(s) and managing the property. During the holding period, profits are derived from positive cash flow (if any) and possibly tax advantages.
But the real profits of the buy and hold strategy are dependent on price inflation–the extent to which the value of the property increases over time. And, of course, the more highly leveraged the property, the higher the return on investment. For example, let’s say you own a $100,000 house with a $95,000 mortgage which you bought with a $5,000 down payment… a typical deal. Over the next five years, the house appreciates 20% or about 4% a year. The house is now worth $120,000 and the return on your $5,000 investment is $20,000 or a whopping 400% (not counting any positive cash flow or mortgage reduction). This is the power of leverage at it’s finest!
But what happens if the market stays flat…or worse yet…if the market goes down?
Unheard of? If you’re lucky and the market stays flat, you come out even…your $5,000 investment is worth $5,000, five years later. Not exactly a super-duper investment. But what if the market went down 20% and the house is worth only $80,000? You are now in a situation known as being "upside-down." You owe $15,000 more than you can get for the house. You have negative equity. Not a pretty picture.
The point is this. Local real estate prices generally move up and down over time, in cycles. Although the long-term trend may generally be increasing, the short-term trend may be devastatingly down. Where in the cycle did you buy and where in the cycle did you sell? To a large extent, this will determine your profit outlook in using the buy and hold strategy. And it is these external circumstances leave you, as an investor, with absolutely no control over the matter. Shake the dice and take your chances.
Consider this from Robert Bruss, real estate expert and syndicated columnist, who wrote in his September 8, 1996 column:
The quick-buck real estate profits are long gone. With a few "boom town" exceptions, such as Las Vegas, NV and Palo Alto and San Jose, CA, home prices in most cities are relatively stable today. Average home sale prices are appreciating about 4 percent annually on a nationwide basis, depending on whose statistics you believe, keeping pace with inflation. This "get rich slowly" economic environment has driven away the get-rich-quick real estate crowd. Instead, it’s the quiet low-profile real estate investors who are earning substantial profits today… successful investors in single-family houses, as well as commercial properties, specialize in fixer-upper properties.
Buying property in excellent condition, hoping to somehow earn a profit, is a no-win situation.
The Rehab and Sell Strategy
I strongly favor the rehab and sell strategy. Here’s why.
The essence of this investment strategy is speed… buy a fixer-upper property at a bargain price, quickly rehab and then quickly sell the property. Get in, get it fixed up and get out. A simple yet very profitable and safe strategy, regardless of external circumstances. Using this technique, profits are made when you buy at a bargain price, increased as a result of the rehab process, and converted to cash when the property is sold.
The key advantage of this strategy is that you, the investor, are in control of every aspect of the deal, from start to finish. You are not dependent on price inflation or any other external factors to make profits. You know going into a deal exactly (almost) what it will cost you to fix up the property and exactly (almost) how much the property will sell for at the end. And best of all, you know exactly what your profit will be because it is included in your buying decision. Uncertainties (and therefore risks) are controlled and thereby reduced substantially.
Are there negatives associated with this strategy? Sure… just like any other worthwhile endeavor, sustained success comes to those who have created an advantage for themselves. And typically that advantage is hard work and knowledge coupled with a system of doing business. A system that, once developed, can be repeated over and over again with predictable results.
What would such a system consist of? Well… really, you need several systems or subsystems. Ways to consistently find and buy properties at prices well below market value. Methods to get the work done by professionals, without impacting your profits. Techniques for financing the purchase and rehab work, using little or none of your own money, if possible. And finally, selling the property quickly and for top dollar. The secret to success of any business is Knowledge + Hard Work + System = $Profits$
Do not be mislead. Real estate rehab is not a get-rich-quick scheme. The necessary knowledge and a system for doing business are readily available in the marketplace. But never forget the hard work ingredient. It is required and is indispensable to make the formula work. You’re not afraid of hard work are you? My business mentor (everyone should have a mentor – do you?) recently said to me, "Most individuals do not hear when opportunity knocks, because it is disguised as hard work!"
Is Owning Rental Property A Bad Strategy?
Buying property and becoming a landlord… is this a bad investment strategy? Of course not. At one time, I owned 40+ rental units in three states. Even today, I own a few rentals. It is an excellent long-term investment strategy IF the timing of your purchase and sale is in harmony with your local real estate cycle. It’s much like investing in the stock market. Buy when prices are low and nobody wants the stock and sell when the market is hot. What is the status of your local real estate market? The answer to this question will guide you in the timing of your rental purchases.
In the meantime… Get out there and make some quick cash with the rehab and sell strategy!
Kevin C. Myers, MBA is President of a diversified group of companies in Albuquerque, NM. He is a real estate appraiser, a private mortgage lender, a real estate educator who lectures frequently at local colleges, and an active real estate investor. Kevin has renovated numerous investment properties during his 20+ years in real estate, specializing in single-family houses. He shares a great deal of his knowledge and experience in his book – Buy It, Fix It, Sell It. Kevin Myers is a regular guest speaker at CT REIA. Go here for the current list of upcoming real estate investing seminars in Connecticut.