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So often beginning
investors focus on real estate investing techniques that they
lose sight of the important issue - is this a good deal? Learning to
recognize a good deal takes research, education and, above all,
experience. Here's a good formula to determine whether a potential real
estate purchase is a deal. It's a simple acronym called "C.L.E.A.R."
CASH FLOW
Ask yourself, will this
property cash flow? Well, that depends on a lot of factors, such as the
strength of the local rental market, the interest rate on the financing
and how much of a down payment you make. Also, it depends on whether it
is a single family or multi-family dwelling. All of these factors
considered, ask yourself, "will this provide income for me?"
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Also, ask the question,
"how will this property cash flow compared to other potential
properties?" For example, a $150,000 house that rents for $1,000/month
has a better income potential than a $300,000 house that rents for
$1,600/month. A four-unit building that costs $400,000 may bring in
$3,000/month in the same neighborhood.
Now, of course, whether
the property will provide income to you begs the question of whether
income is important to you. Is it? Do you earn other income? Do you
need more income now, or is future equity growth more important?
There's no right answer to these questions, but are all factors to
consider when looking at a potential purchase.
LEVERAGE
Leverage
is important in investing because the less cash you put down on each
property, the more properties you can buy. If the properties go up in
value, your rate of return goes up exponentially. However, if the
properties go down in value and you have a lot of debt on the property, this
can result in negative cash flow (see above). Since real estate is
generally cyclical, negative cash flow is only a short term problem and can
be handled if you have other income or a cash reserve to handle the
negative. "Nothing down" investing is very attractive for the high-leverage
investor, but should be approached with caution.
If you
are a long-term player, leverage will generally work in your favor if the
markets in which you invest appreciate in the long run and your income from
the properties can pay for most of the monthly debt service.
EQUITY
Does the
property you are purchasing have equity? Equity can take a number of forms,
such as:
There
are many ways to create equity, but buying INTO EQUITY is your best bet.
Find a motivated seller that wants out of his property and is willing to
give up his or equity for less than full value. Or, buy a property that
needs work that can be done for 50 cents on the dollar or less. In other
words, if the property needs $10,000 in work, make sure you get a $20,000
discount on the price or better.
APPRECIATION
Buying
in the right neighborhoods and in the right stage of a real estate cycle
will result in appreciation and profit. However, timing a real estate cycle
is difficult and can be very speculative. If you buy properties without
equity or cash flow solely for short-term appreciation, you are engaging in
a very risky investment.
Buying
for moderate long-term (10 to 20 years) appreciation is safer and easier.
Look at long-term neighborhood and city-wide trends to pick areas that will
hold their values and grow at an average 5 to 7% pace. Combine this tactic
with reasonable cash flow and buying into equity and you will be a smart
investor.
RISK
Risk is
a consideration that too few investors consider. Ask yourself, "what if my
assumptions are wrong?" In other words, do you have a "plan B"? If you
bought for appreciation and the property did not appreciate in value, can
you rent for positive cash flow? If you buy with an adjustable rate loan
and the rates go up, will this put you out of business? If you have a few
vacancies, can you handle the negative cash flow, or will it break the bank
for you? Expect the best, but prepare for the worst.
Remember,
whenever you look at a property to purchase, think "CLEAR".
