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Successful real estate investors begin with the end in mind

July 3, 2012 By Erion Shehaj Leave a Comment

Most real estate investors that do it wrong, do it backwards.

They acquire a portfolio of cheap inferior properties in inferior locations with inferior schools and amenities. Then they try to figure out a way to place top notch tenants in them that will sign long term leases, will pay on time and will treat the property like they own it. And when time comes to sell the properties they acquired, then they try to figure out a way to sell them for maximum dollar.

That’s trying to fit a square peg in a round hole.

Stephen R. Covey said it beautifully in 7 Habits: Effective and successful people begin with the end in mind. So what does that mean in the real estate investing context?

You begin by thinking about the type of portfolio you would like to own. Think about it as a legacy. What type of properties you would like to pass on to your children or your loved ones? Where would they be located and what characteristics would they have? Next, what kind of tenants would you love to have in your properties? Take it one further. These types of tenants you described, what are they looking for in a rental property? Think about the location, schools, upgrades and overall condition of the homes they seek.

Then acquire properties that fit that description by paying a fair price for them. Begin with the end in mind because the assets you acquire pick the tenants you will have and the price you will fetch when you sell. It’s both a simple and powerful concept.

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How to create a six figure income with real estate investing

July 2, 2012 By Erion Shehaj 4 Comments

Have you ever thought about what your life would look like if you could create a six figure annual income from your long term real estate investments? Today’s post is about how the investments we plan and execute today could get you there at some point in the near future.

The math of creating a six figure income from your real estate investments is quite simple. Essentially, there are two, very different routes to get there:

The Blueprint Method we advocate involves fewer properties and much lower risk. The concept is simple but it requires a solid plan and the discipline to execute it. Look at it this way: each free and clear property in your portfolio produces an income of $11,000/year. In order to generate an annual income of $100k you would need to own 9 such properties. But you don’t have the capital to acquire 9 properties with cash today to produce that kind of income. Thing is, you don’t need to. We advise our clients to purchase quality assets with 20-25% down and then use the positive cashflow they produce to aggressively pay down the mortgages one at at time with focused intensity. For a more empirical illustration download the detailed analysis of this domino strategy on a portfolio of nine single family homes. In that example, the entire portfolio worth over $1.25M becomes free and clear in 12 years and produces a six figure annual income before taxes. Can your IRA or 401(k) match that kind of performance? Not only that but the speed of reaching your goal is completely up to you and how aggressive you want to be. In comparison to the Perpetual Leverage Method below this strategy involves significantly less risk for two reasons. First, the number of mortgages you undertake is less than half. Second, these mortgages get paid off quickly in 12-27 months instead of lingering in your portfolio for 30 years. The management issue is resolved as well: Any investor can easily manage 9 properties using management strategies we teach. And finally, conventional loan guidelines allow for any investor to take out up to 9 mortgages so you won’t be locked out of financing using this method.

The Perpetual Leverage Method involves more properties and higher risk. Say you acquire a property that produces $4,000 in annual income after operating expenses and mortgage payments by putting 20% down. If you want $100k in annual income using this method, you have to own 25 such properties producing the same income each. I call it the perpetual leverage method because it involves keeping the properties leveraged for 30 years according to the original loan terms and using cashflow to create the passive income. There are three major downsides to this method. First, the risk to the investor rises with each loan added to the portfolio and since the loans are being paid off on 30 year schedule, the risk is virtually unchanged, throughout three decades. Second, managing 25 homes is not easy and not for everyone. You would think this would allow you to be financially free and quit your job when in reality you’re just changed jobs and became a property manager. Last but not least, acquiring 25 properties is difficult due to loan guidelines that restrict the number of properties with a mortgage any one investor can own.

The next question then inevitably becomes: If it is so simple, why isn’t everyone doing it? Because math isn’t the real issue. It’s a planning, commitment and discipline issue. In order for our Blueprint strategy to work, you have to start with a solid plan, you have to be committed to it long term and finally you have to execute it. Twelve years might sound like a long time from now, but think about where you were 12 years ago. You might’ve started your 401(k) and IRA 12 years ago. Is there 1.2 Million in there now and is it producing six figures a year for you? It’s time to take charge of your future. That life you would live if you were financially free is within reach in a few years but only if you push Start now.

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What the Houston real estate market recovery means for real estate investors

March 21, 2012 By Erion Shehaj Leave a Comment

The Houston Association of Realtors recently released the Houston real estate market statistics for February. In a nutshell, sales were up almost 16% year over year and February was the ninth consecutive month of increasing home sales. But you don’t have to read a bunch of data to know that the real estate market is very different this year compared to previous years since the 2008 recession.

Phenomena that had been all but forgotten since 2005 or so are coming back. Multiple buyers competing for the same properties causing bidding wars and driving up prices are becoming commonplace. Where listings would stay on the market six months to a year with no activity just a short time ago, now sales are happening in weeks not months. And this isn’t just an isolated local situation either: Real estate agents all across the country are gleefully reporting the same turn of the tide in their markets. Inventories keep shrinking: There used to be 7-10 months of inventory available on the market and now all of a sudden there’s 3-6.

Now, let’s be clear about one thing. During the recession in Houston, there were declining sales for over two years! Nine months of recovering numbers is a good start but that’s where it stops. We need to see if there will be continued strength in the market through the busy spring and summer seasons before we can call this a bona fide recovery. But at this point, at least in the Houston real estate market, it’s a matter of when versus if. It may take longer to reach a full bloom recovery than the numbers show at the moment but we will get there soon.

So what are the implications of a real estate market recovery on real estate investors? What do they need to look out for as they adapt from a stagnant market to a competitive one? How does the duration of low interest rates play into their overall strategy in the next 24-36 months?

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More competition from owner occupants will make it harder to locate properties

If you are an investor that’s been actively pursuing properties in the first quarter of 2012, you have seen this implication with your own eyes. As more owner occupants get off the fence and start competing with investors for the same foreclosures, short sales and distressed properties, it will become even harder to be the winning bidder. Many distressed properties are government owned or administered and as such carry exclusive “first look” periods for owner occupants that eliminate a real estate investor from even competing for a set time. Besides that, owner occupants are looking for great deals as well – meaning homes priced below fair market value – but a good deal to an owner occupant doesn’t have to have as much built in equity as you need when you’re an equity investor. For example, if a home is worth $120,000 and priced at $90,000, the asking price is probably the highest price that would make sense to an investor whereas the owner occupant might be happy even at $100,000 or $105,000. So, competing under those conditions will be very difficult for real estate investors.

Cash investors seeking yield are entering the market in thousands

Not only do investors face stiff competition from more confident owner occupants, but also from fellow investors that are cash buyers and seeking strong returns on that investment. The banks and institutions that hold these properties largely prefer cash offers because they’re guaranteed to close and close quickly. There are no financing contingencies, no loans falling through, no complications. In the event that you have two equal offers – a cash and a financed one – the cash offer will always win the bidding. And cash buyers have an edge in this fight: Generally equity takes a secondary role since what they are looking for is primarily, yield.

Interest rates are only here for a limited time

Competition and the fight to acquire properties has always been a part of the game for real estate investors to some degree. Therefore the prospect of missing out on the acquisition of properties isn’t new either. Except that it’s more complicated that when you throw interest rates into the mix. A few weeks back, one of our clients locked a 4.25% interest rate on an investment property. Your rate may vary somewhat but that doesn’t obscure the fact that interest rates are a major factor in changing the fundamental numbers and the investing landscape. The problem is they’re only here to stay for a limited time. Bernanke said the FED will probably keep the rates at the same level through 2014. But that’s assuming that there won’t be an acceleration in recovery and a rise in inflation. Predicting the future isn’t part of my skills set, but I can tell you this much: The damage caused to your real estate portfolio’s returns by your inability to add quality assets to it in a favorable interest rate landscape will be much higher than the equity dollars you’re supposedly leaving on the table.

Continued strength in rental market and rising rents

While there is justified skepticism about the presence and strength of a recovery in home sales, the rental market has been bullish for the better part of three years. In the latest report from HAR, rental properties were up 21% over the same period in 2011. Meanwhile, from the trenches we can report that the average days on market in quality locations are usually under 30 with Landlords typically getting 100% of asking. In addition, properties that would rent for $1000-1100 in 2006 are renting for over $1350 every day of the week. This matters because you can choose to look at this from two different perspectives. The shortsighted view that looks at the short term metric of initial equity and nothing else. Or the birds eye view that sees increasing rents as a counterbalance that overcomes the former strategy’s returns over the long run.

Smart real estate investors have to think strategically and adapt to the coming change. Why would you choose to compete in an impossible landscape and settle for inferior left overs on purpose? It may take you 5-10 bids and the tens of hours wasted before what I’m telling you truly sinks in. And you’re more than welcome to go down that ride to see for yourself. But if you want to get about your business and add some crucial pieces to your portfolio in a favorable interest rate and rental market environment, instead of fighting the usual suspects for overpriced properties, listen up. Don’t participate and refuse to fish in the same river as everyone. Initial equity does not matter in a solid long term strategy despite what you may have been told. Quality does. Call my cell at 713-922-2702 and I will show you a different way to invest, to build wealth and retire. A way that’s based on a well thought out Blueprint and doesn’t involve fighting with newbies for overpriced inferior properties.

Why investing in condominiums does not work in the Houston market

March 19, 2012 By Erion Shehaj 10 Comments

In most real estate markets across the US, condominiums are the poster child investment property of choice. The reasons are obvious: They are small, easy to rent, usually well located and priced lower than their single family counterparts. So when our out of town clients come to Houston to view investment properties, the question never fails to arise: What about condos? What follows are three strong reasons why investing in condos in the Houston market does not make sense.

Higher operating costs hurt or eliminate cashflow

The primary reason why investing in condos does not make sense in the Houston market is their higher operating costs relative to the income they produce. Here’s what I mean in a simple example. Let’s compare two properties: The first is a single family home in a suburb of Houston and the second a Galleria condominium both priced at $135k. Let’s assume that they both rent out for $1200/mo to level the playing field. The single family home will have operating costs of about 40% of the incoming rent or $480/mo which covers property taxes, insurance, annual HOA dues etc. In comparison, the condo will have operating costs of about 60% or $720/mo. The reason: Houston condos typically have $300 per month in maintenance fees. Put a different way, a condo that costs $135k has similar costs to a $160-170k single family home. What does this mean? If you were to invest in the condo by putting 20% down, your positive cashflow would be wiped out by those higher costs and you would have a break even property at best. In contrast, if you invested in the single family home, there would be $3600-4000 annual positive cashflow – a 10-12% cash on cash return on your invested capital.

When you take cashflow off the picture, appreciation is all that’s left

So if your investment property isn’t producing positive cashflow then where will that return you hope for come from? All that’s left is appreciation. In other words, you would purchase an investment property that pays it’s own bills while waiting for its value to go up as your tenant pays your mortgage. Small problem with that plan: Houston has never been a high appreciation market. Even in the peak of the market, we were barely scraping 5% annual price growth. And besides, have you seen what happened to markets that did have that steroidal appreciation? I’ll take Florida condos for a third of the price, Alex. An investment plan that relies solely on your property appreciating in value in Houston Texas is two rungs above buying a Texas Two Step lotto ticket on the sound investment scale.

But what about location, location, location?

Condos have proven to be sound investments when they allow the real estate investor to acquire property in a sought after location and the tide of popularity of that location has made values across the board rise. Example: If you want to live in the city, chances are you can’t afford a single family home but a condo will get you all the benefits of that location at a much lower price tag. The Houston market is different in that it’s very de-centralized. Houstonians don’t mind commuting for 35-45 minutes each way if that means they can have all the space and amenities that a great home can offer. Certainly there’s a subculture of people that would never live outside of the Inner Loop, but that’s not the majority. Most people would rather live in the suburbs where schools and amenities are better and work Downtown or in the Galleria. This commuter culture results in a lack of land shortage that is a necessary ingredient for value appreciation. For instance, if you want to live in Manhattan, you have to pay the price as they’ve run out of land long ago. In contrast, in Houston you could get twice or three times the size of home if you just go out 15-20 miles. And if you don’t mind the drive, it’s a no brainer. And it’s bad news for condos as investment properties.

Bonus Reasons: Age and control issues

Some additional concerns with condo investments are the age and the lack of control in certain circumstances. Let’s tackle them one at a time. For the most part, condos priced low enough to break even on the incoming rent tend to be built in the 1980s. Age may do great things to wine but all it does to investment properties is cause the operating costs to creep upward which makes rent increases a necessity. Besides, if you are a long term investor think about the age of the property 10-15 years from now. Is it smart to own a property that when you want to sell it will be hitting the half century mark? I know some out of towner’s eyebrows might be raised right now, but you should know that in Houston, 50 year old properties are considered “historic”! Last but not least, condos present some unique control issues. What happens when a hurricane damages a condominium’s roof? Well you might be hit with an unexpected “special assessment” bill from the homeowner’s association that’s trying to offset the large deductible on their master insurance policy. Oh, and what happens to your tenant when the roof is leaking profusely but the Landlord can’t fix it right away because she has to wait for the homeowner’s association to reach an agreement with the insurance adjuster? Like the title said: pretty much out of control.

I’m a firm believer in taking what the market gives you when investing in real estate. And in Houston Texas the market gives you new (or 5 years old or less) single family homes in good neighborhoods with great schools between $125-$150k. Anything else, you’re sacrificing something you shouldn’t.

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Side note: This analysis addresses condominiums as pure investments. If you’re looking into purchasing a condo as a residence, it may make sense as an investment because you have to consider the fact that you have a cost of living to contend with everywhere you go.

The River and the Fish

February 22, 2012 By Erion Shehaj 2 Comments

Today I want to tell you a story.

Once upon a time, there was a beautiful river nestled in the middle of a peaceful forest just a few miles away from the village. Only a select few weathered and experienced village fishermen knew that this river was chock full of fish: trout, bass, you name it. It was their secret – and they preferred to keep it that way. They could drive up there in the weekends knowing that they would come home with a great haul. One day, a news reporter from the city nearby did a story about the wonderful bounty in this river. “If you like fishing – she said – this is a “must try” place”. Soon after the story aired, the village fishermen that had been coming to the spot for years, were surprised to find hundreds of people fishing at the same spot. They soon came to the realization that their fishing trips would never be the same again. Eager folks started fighting over spots and arguing with each other. Instead of going home with the best fish this river had to offer, they started settling for what was left. Everyone went home unhappy. The End.

Almost every real estate investor out there, long term or not, starts their investment property search by looking at bank owned foreclosures. The reasons are obvious. You are taught that to make an investment work you have to find a good deal – one that is priced well below the current market value. And if you want a great deal like that, foreclosures are the place to be. I understand that line of thinking and those motivations. But let me fill you in on what the reality of the bank foreclosure submarket is:

EVERYONE is fishing in the foreclosure river. The “news story” on this has been out awhile and the demand has already skyrocketed. So what happens when demand is high and supply stays the same? Price goes up. Basic economics. If you don’t believe me, try to make an offer on 10 bank foreclosures in any city. I am willing to bet that 9 out of 10 properties will have multiple offers. This results in sales prices that are often higher than asking by as much as 10%. So that great deal you thought you were getting, is looking less and less shiny.
Over 90% of foreclosure inventory is not investment grade. This may come as a shock to many, but the overwhelming majority of foreclosure properties aren’t good deals. They might be selling at market value even if they still need work to be in market condition, or discounted just enough to account for the rehab. Why would you pay market value and get a rehab project to boot.
Investors’ selection is limited to leftovers. A large percentage (over 50%) of foreclosure properties in the market today are FannieMae/Freddie Mac or HUD owned. Because the government wants to promote home ownership, they usually have a “first look” or owner occupied exclusive period. That means, for the first 14-30 days these properties are on the market, only buyers that are planning on living in the homes are allowed to bid. Investors don’t even get a shot during this period. So really, the inventory you can go after is what the homeowners didn’t buy – or what’s left over.
Banks aren’t known for their flexibility. Most banks (the eight that are left anyway 🙂 ) strictly refuse to contribute in ways that would help an investors rate of return tremendously. For instance, they will agree to lower the price by $2,000 but won’t agree to pay $2,000 in closing costs at the asking price. Same thing with home warranty costs. Pointless I know. This matters in the context of a portfolio made of several properties. The money you save on closing costs on your portfolio may give you the capital to purchase an additional property that increases the return and the cashflow you will enjoy once the strategy has been executed.

So what’s my recommendation? Fish upstream. Remove the blinders that are arbitrarily making you pick a long term investment using a short term metric like built in equity. Open up your selection of properties to include new construction homes, retail sales as well as well taken care of foreclosures. Then make a selection based on which property you would rather hold in 10+ years.

The next three years

February 2, 2012 By Erion Shehaj 1 Comment

Last week, Fed Chairman Ben Bernanke announced that the central bank will likely keep the fed funds rate near zero until late 2014. This piece of news is likely to be greeted by a standing ovation in the real estate investing community as a whole. So far, Fed’s downward pressure on the fed funds rate has resulted in never before seen 4.75% interest rates on 30 Year fixed investment property mortgages! This latest announcement means rates will probably stay put through 2014.

As a long term investor you are now presented with a choice: You can choose to interpret this as evidence that the best environment to invest in decades isn’t going anywhere and procrastinate. Or, you can look at this as a gift. An opportunity to get a glimpse of what’s around the corner and use the timeframe to build an incredible portfolio. Allow me to present you with three pieces of data that should hopefully make that choice a no-brainer:

Increasing the interest rate on your investment property’s mortgage by 1% results in positive cashflow that’s 27.5% lower.
A portfolio consisting of three $100k properties would be debt free in 12.25 years at 4.75%. The same portfolio would be debt free in 14.67 years at 5.75%.
That 2.42 years translates to $64,514 of lost cashflow!

Assembling a great portfolio doesn’t happen overnight and it doesn’t happen automatically. You have to take action.

Not doing so, could cost you $64, 514.

Do you have a Blueprint yet? Call me at 713.922.2702 and we’ll craft one together over coffee.