Real Estate Investment Strategies

There are three broad categories of investment strategy that I advocate:

• bargain purchase
• increase value
• double-digit cap rate.

Bargain purchase is the purchase of real estate for at least 20% below current market value.

In the increase-value strategy, you buy a property for its current market value, but you select only properties with some unrealized potential. Then, immediately after purchase, you make whatever changes are necessary to increase the value of the property. In general, you must increase the value by at least 20% within six months in order for the strategy to be worthwhile.

Double-digit cap rate means that you buy the building on terms that it has a capitalization rate of 10% or more. The capitalization rate is the net operating income (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 which I condemn: buying properties which the investor believes will soon increase in value due to market-wide appreciation. This is, in fact, pure speculation. No one knows which areas will appreciate. Many billions have been made by investors pursuing this strategy, but they were simply lucky.

Another common strategy which is advocated by most real estate gurus are various forms of finding unsophisticated sellers and using some convoluted real estate transaction to take advantage of their lack of sophistication. These strategies are unethical, immoral, and often illegal. I do not advocate them.

Holding periods

There are two broad categories of holding period:

• long-term
• flip

Long-term means you hold the property for years. Most investors do that. I used to advocate that. I no longer like long-term holding. It requires clairvoyance, a skill that humans do not possess.

Flipping means selling the property as soon as possible after you acquire it. In some cases, you can even sell it before you buy it or simultaneously with buying it. Some seminar gurus are big on advocating this, probably only because it sounds really spectacular to a novice. In fact, selling before you close or simultaneously, although theoretically possible and occasionally done, are quite difficult to do and may not be worth the trouble. When I talk about flipping I generally mean to sell as soon as possible after acquisition.

Your time available

Different strategies require different amounts of time or require that you be available for particular hours of the week. For example, rehab is extremely time-consuming. Anything involving the government, like buying at sheriff's sales or appearing in court, generally requires that you be available during business hours on week days. If you have a full-time job or do not want to give up all of your after-work hours for real estate, you must not choose a time-consuming investment strategy. If you work at a regular salaried or hourly job during business hours, you probably cannot pursue a strategy which requires you to do real estate stuff during business hours.

Cash available

Some strategies, like buying foreclosures, require huge amounts of cash. Others, like buying judgments secured by real estate or buying at builder auctions, require little or no cash. In general, cash makes your investment life much easier. Too often, the use of cash is dismissed as non-macho or some such. That's nonsense. But if you absolutely have no cash, you must either get some or use strategies which do not require any. The grandaddy of all real estate gurus, William Nickerson, wrote the book How I Turned $1,000 into $5,000,000 in Real Estate in My Spare Time and How to Make a Fortune Today Starting From Scratch. In those books, he talks a great deal about ways to save the money you need for a down payment. The concept of saving must seem downright quaint to graduates of today's real estate gurus' seminars and boot camps. They all preach the "something for nothing down" approach. I prefer the save-up-the-down-payment approach. The book The Millionaire Next Door says that real millionaires are big savers. Real estate gurus, most of whom are phony millionaires, either ignore saving or dismiss it as impossible.

Your aptitudes

I am not mechanically inclined. On the other hand, many people mistakenly think that I am a lawyer. Accordingly, it would not be a good idea for me to specialize in rehabs, but it might be a good idea for me to specialize in a legally oriented strategy like foreclosures. Similarly, you should take stock of your real estate related aptitudes and gravitate toward strategies that take advantage of your strengths and avoid your weaknesses.

People skills

Different strategies require different interactions with people. The amount of the interactions varies, as does the nature of them. If you hold long-term, you must be a landlord, and an employer if you buy multi-unit buildings. If you buy pre-foreclosures, you must negotiate over the kitchen table with people who are in financial difficulty. On the other hand, if you buy foreclosures, about the only people you encounter are the auctioneers and all you have to say to them is the high bid. In other words, there are places in real estate for the gregarious as well as for recluses. Just make sure you know which you are and that you select your strategy accordingly.

Ethics

Much of what the current crop of gurus teach is unethical. In general, it's difficult to do nothing-down or lease-option deals ethically. When pursuing bargain purchases, there is a strong temptation to lie to the seller about the market value of their property. Bribery is big in the business of increasing values by getting favorable zoning changes. Transactions between sophisticated and unsophisticated people create powerful temptations for the sophisticated to take unconscionable advantage of the unsophisticated. There are plenty of ways to do real estate investment ethically. Anyone can resist temptation. But real estate also has more than its share of ways to misbehave. Let's be careful out there.