Are You Clear On What is a Good Deal
by Bill Bronchick
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?" 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
Is the property you are purchasing have equity? Equity can take a number of
forms, such as:
- A discounted price
- A potential fixer upper
- A rezoning opportunity
- A poorly managed property
- A foreclosure
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 a 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".
Bio:
William Bronchick, CEO of Legalwiz Publications, is a Nationally-known attorney,
author, entrepreneur and speaker. Mr. Bronchick has been practicing law and real
estate since 1990, having been involved in over 600 transactions. He has
appeared as a guest on numerous radio and television talk shows including CNBC
Power Lunch. He has been featured in Who's Who in American Business, Money
Magazine, the Los Angeles Times and the Denver Business Journal. William
Bronchick has served as President of the Colorado Association of Real Estate
Investors since 1996.