Growing Real Estate Investment Capital With Little Or No Appreciation

Posted @ 10:27 pm - Filed under Cash Flow, Investment Lessons, Palo Alto, Purposeful Planning, Real Estate Markets, San Diego Property Owners

Just how does a real estate investor grow their capital in a stagnant market? Let’s first look at what it takes, lookin’ at the big picture. The first assumption is your market isn’t goin’ up in value. Also, you’re convinced it’s not likely to go up much at all over the next several years. What constitutes a stagnant market changes depending upon whom you’re asking. San Diego real estate investors would, ’till recently, turn their collective nose up at only 5-8% annual appreciation.

In many markets, most in fact, property values are simply not movin’ up. In fact, if they’re holding their value, owners are learnin’ to claim that as a moral victory. Tonight is for the stubborn cusses who won’t leave town with their capital ‘cuz any property not managed by their hands on, ‘control issue’ selves will die a gory death.

Here’s what the competition looks like. Prudently leveraged buys in growth regions. Even with what I call Grandpa’s Leverage, the capital growth rate at just 5% yearly will hit around 8% give or take for a five year hold. That’s sans before and after tax cash flows — only value increase + the loan’s principal reduction was used. (Hey, I said simple.) That means your capital growth rate upon executing a tax deferred exchange at the end of year five would probably exceed 10% annually. That would be after tax, or to be really picky, after ‘deferred’ tax.

Tonight let’s touch on controlling property through long term lease/options.

Very simply put, a lease/option give you the option over a finite period of time, to buy the property at a preset price. In a rising market this is a good way to go for those without capital, and frankly for those with capital if they really know how to work them. I know veterans who’ve made some very big bucks using lease/option techniques. There are as many twists as your imagination can conjure.

Here’s what yer tryin’ to accomplish. You’ll be happy to know, it’s not rocket science. It does require discipline though, and a real live Purposeful Plan.

Your capital growth must come on the front end. You’ve already established there will be little or no appreciation. Your gain must, in one way or another, be built in from Day 1.

The good news is, in stagnant markets there’s no dearth of small rental property owners who want out, and will assist you in ways you may not have expected. They’ll discount prices big time. They’ll agree to finance all or part of the ultimate purchase. You can structure the agreement so you, not them, benefit from monthly cash flow during the option period. Really. Happens way more than you’d think.

Now — what makes sense? What properties are candidates for this technique?

There are clearly many, many more factors that can make a particular property ripe for a profitable lease/option approach. Most everyone knows what properties wouldn’t be lease/option candidates.

Notice the key common denominator in real candidates. There is slam dunk, absolute, no debate, built in equity in each scenario. If I was in East Toilet Seat for example, I’d look for a $100,000 duplex I could option for $75,000. It would have two bedrooms and a bath on each side. There’d be room to add a master bedroom with a 3/4 bathroom for each unit. What that allows me to do is transform 2/1’s into 3/2’s by simply adding a modest 14 X 12 bedroom with its own bathroom.

Look at what would be accomplished.

1. You bought below the market, making $25,000 when escrow closed.

2. You significantly increased both the property and rental values with bedroom addition.

3. You now have solid, cash flow property with a nice profit built in.

4. If the owner agreed to finance, you now have tradable equity (without the need for a new loan) — rinse, repeat.

Is this a very much simplified example? Of course it is. It’s almost cartoonish in its simplicity. Yet that exact scenario has been played out across the country since lease/options became common. It’s gained almost template status. There are countless variations. I witnessed it’s execution the first time back in the about ‘74 or ‘75.

Don’t try this at home. This was done by experienced investors, working with a net, several of them in fact. They have an attorney do the actual lease/option. This is in stark contrast to Fred, across the street who went to the online ‘Forms R Us’ store, and shot himself in the foot with a .44 magnum. You’ll need help ensuring the property you found is indeed actually the ‘deal’ you excitedly think it is. Many beginners hear what they wanna hear, finding themselves stuck in a property not even really worth what they paid, much less a lot more.

Is the lease/option a simple concept? You bet. Is it simple to execute successfully over and over? Don’t kid yourself. The real work? It’s in the research, hunting for the properties, ensuring your opinion of value isn’t a fantasy. Hiring the right attorney — inspectors — contractors — and on and on…

There are folks around the country who do this almost exclusively and with great success.

But again, I implore you to ask yourself — why? Why do you insist on staying local when it just doesn’t make sense, relatively speaking? Either yer in East Toilet Seat, or somewhere on the other end of the spectrum. That’d be places like San Diego, Palo Alto, San Francisco, and the like. Make a mistake in those towns, and you could find yerself payin’ for it for quite awhile. The properties don’t cost $100-200,000 there, but the mistakes do.

Lease/options are a viable way to go, but I counsel against them when talkin’ to the inexperienced investor. And for the record, owning a rental property or two doesn’t necessarily brand you as a seasoned vet, know what I mean, Verne?

This is the part at the end where I admit I need a fix. For me that means I get to talk with new folks. I love that stuff. There’s nothing like the smell of new Purposeful Plan in the morning. (Sorry, my bad.) Anyway, send me a note, a phone number if you wish, and we’ll get things started. Have a good one.

This entry was posted on Tuesday, August 19th, 2008 at 10:27 pm and is filed under Cash Flow, Investment Lessons, Palo Alto, Purposeful Planning, Real Estate Markets, San Diego Property Owners. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.