|Becoming A Battle Hardened Real Estate Veteran Without
All The Scars: Seven Steps That Real Investors Make
As part of a new web site that we just launched,
get repeated requests asking if a particular deal is good or not. While we can't answer this for
individual projects, we can certainly look at what HAS to get done by the investor to dramatically
increase the odds of a successful transaction.
Step 1 is always to determine the fair market value(FMV). As a real estate investor, you can
always buy properties at the FMV. My question is why would anybody want to do that? Through careful
selection, you can always find properties that are priced below FMV, regardless if they are existing
or if they are a preconstruction project. The best way to determine FMV is to work with someone
already familiar with the area or determine yourself through local websites showing recent sales
Step 2 is to then determine the market trend for the area for which there are two critical
pieces: 1) is the average price increasing AND 2) is the volume of sales increasing. If both are
moving in your favor, then you have the comfort of knowing that the right trend is in place to keep
prices moving forward. In stock market investing, there is the saying that the trend is your friend
and traders frequently observe price and volume data to confirm the trend. If a hotly priced real
estate market shows signs of dropping in volume, be very careful.
Step 3 is to learn about supply, especially in the preconstruction marketplace. In some areas,
there are very few projects on the books and in others, there are 15,000+ units expected to emerge
within 1 zipcode, in 1 year. Same is true for investing in houses. In you are competing with a bunch
of new houses that are coming on-line, then rapid price escalation may be limited. For most savvy
investors, they like to see lots of demand with very little supply which is nothing more than common
Step 4 is to make your OWN opinions of the macro conditions of the local and regional
marketplace. So, for example, if you are a strong believer that real estate is overvalued in the
target area, why would you ever consider investing? On the other hand, if you believe that market
forces will continue to escalate in the market, then why would you not be actively looking? As an
example, some people believe that the graying of America is just now starting to drive people to warm,
more attractive climates. Even though property values are high in these areas right now, are we going
to see 20+ years of additional migration to them? You have to decide for yourself because we won't
know the answer for another 20 years!
Step 5 is one of the most important risk management tools available to the investor in real
estate. Each property has typically an inherent rate at which it can be rented, even if that is not
your intent. By looking at rental rates, relative to the amount of principle, interest, taxes, and
insurance (PITI) that you will have to pay, then you can understand the amount of cashflow that may be
required to support the property. If your objective is to produce cashflow, then you need to be
cashflow positive very quickly. If your objective is capital gains and the cashflow is negative,
then you now understand what you may have to support on a monthly basis if things don't work out.
Deferred maintenance then becomes our Step 6. For an existing property, how much maintenance
has the previous owner neglected that you will need to catch up? Be careful here since this can be
one of the major places to get nasty surprises.
And now I saved the best for last: Step 7 is to determine your own personal risk tolerance.
Some new investors look at a deal and only see the positive. This is a huge mistake. EVERY REAL
INVESTOR I KNOW HAS LOST MONEY IN A DEAL but they gladly will do more. Why? They understand their
risk's going in, they understand how to limit their downside, and the gains are much larger than the
risks they are taking. If you were standing beside them and saw what they saw, you would gladly take
the risk as well and rapidly ignore any small losses that you experience.
Hopefully this has given you a good start at learning how to analyze a potential opportunity.
Obviously each of these steps requires additional work or training but they are what separate the new
investor from the seasoned, battle tested veterans.
Chris Anderson, PhD
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