Saturday, June 5, 2021

The E-Z Make Money In Real Estate System!

It is possible to make money with investment real estate - but it ain't easy, and your timing has to be just right.  Now may not be the time.

A reader writes asking me what I think of a guy who does a podcast and YouTube videos about the "BRRRR" system, which stands for "Buy, Rehab, Rent, and Repeat" or something along those lines.  We had a name for this "system" back in the day, it was called Real Estate.  For some reason, people act like buying and selling real estate involves some great State Secret and that you have to pay someone money to learn the "insider secret tips 'n tricks" to making money. You don't.  And often, these companies charge a lot of money - money that would make a good down payment on an investment property.  There is more money to be made putting on seminars!

By the way, one of the "R's" they talk about is refinance to take money out a property.  This reminds me of a "make money in real estate!" scam from a few years back that basically promoted the idea of buying a property for $100,000 and then somehow mysteriously mortgaging it for $150,000 and then pocketing $50,000 as a "Profit".   You still owe the money.  Borrowed money is not income.  Seems like a simple proposition, but it escapes most!

Be skeptical of anything sold as a "system."  Life is not a "system."  Making money isn't a "system" - it is hard work, period.

Yes, you can make money in real estate by buying low, fixing up, renting out, and then selling out, eventually.  I did, but the timing has to be right.  How do you know the time is right?  I'll cut to the chase and you don't have to read the rest of this:  If you can buy a property and rent it out for a positive cash-flow, maybe the time is right.  If not, ask yourself why you would want to lose money to subsidize the lifestyle of your tenants.

You don't need to attend a "seminar" or a "webinar"or pay fees or buy a program to do this.  In fact, the people who are trying to sell "systems" are usually just con artists.  Keep your money in your pocket - you'll need it when the right property comes along - and you have to wait for that.

We bought our properties after the meltdown of 1989, which some say never happened.  Some are now saying the meltdown of 2008 never happened, but was merely a "market correction."  I have had readers try to convince me that the Tulip bubble never happened, the railroad bubble never happened, and the various silver and gold bubbles throughout history never happened.  Oh, and the South Sea Company Bubble - never happened!  It was just a market correction, is all.

It seems right now that things are smelling bubble-like.  Why do I say this?  Well, back in 1988 and 2007, before the real estate bubbles burst - excuse me, the market re-evaluated itself - people were bidding houses through the roof.  Mark could list a house on Friday, do an open house on Sunday, and have multiple offers over asking price with escalation clauses and close the deal on Monday, for tens of thousands of dollars over asking price.

Sounds familiar?

Throw in some pretty aggressive inflation which is reducing the spending power of most Americans and the question I have to ask is, who can afford to pay these staggering prices for houses?

Buying things and then re-selling them for a profit isn't easy to do.  Another reader sends me a link to a video about buying and flipping cars.  Again, the guy in the video is selling a "system" with a fancy name.  Back in the day, we had a system like that - still do, in fact.  We call it "used car dealer".  You go to auto auctions and buy low, fix up, and sell high.  Simple as that.

The big problem is buying low.  And right now there is a "car shortage" which is making it hard to buy low.  My King Ranch, if I sold it today, would garner more money than I paid for it two years ago, as there is a shortage of cars.  Hoovie, of Hoovie's Garage, noted that the Range Rover he bought pre-pandemic, is now wholesaling for more than he paid for it, just a year ago.  The world has gone insane!

Shortages don't last forever.  Thanks to capitalism, companies rush to fill in vacuums in our markets, if the markets are left alone.  The chip shortage, the car shortage, the house shortage - they will all eventually equalize themselves, and in fact, over-shoot their goals until there is a glut of chips, and cars, and houses.  Why do I say this with confidence?  Because I have seen this happen in my lifetime, many times, over the last 61 years.

I was told we would "run out of gas" by the year 2000 - by my professors at General Motors Institute, no less.  Not Cornell University in far-out far-left Ithaca, New York!   But 2000 came and went and we discovered fracking and, well, we are (at least one of) the world's largest oil producer, an exporter, and the king of natural gas.

Don't try this at home, or anywhere, for that matter!

Yet a pipeline goes down for a week, and people in DC are hoarding gas.  Check out this guy, trying to fill the back of his pickup truck with gasoline - with predictable results.  Remember the toilet-paper "shortage"? People stocked up like Georgia Pacific would never fell another tree.

So, these shortages of 2021 will go away.  The "Labor Shortage" will disappear once unemployment benefits are cut off and bonuses are cut, which some sources say will be at the end of June.  Not long now...

There is no shortage of people trying to buy and flip real estate right now, which also gives me pause.  I recounted before, that in the early 2000's, a friend of mine, seeing that Mark and I were making money on real estate, decided to jump in.  We bought our duplex for $95,000.  We bought the condo for $30,000.  We bought my office building for $210,000.  That was back in 1994-1998, when foreclosures and short sales from 1989 were still going on.

My friend bought a condo in the same development that we were in, in 2004, for nearly $100,000.  He was hemorrhaging cash from the get-go, and never even bothered to rent it out.  Worse yet, he was hiring people to make repairs and improvements to the place.  It was just about everything you could do wrong with buying investment real estate, starting with paying too much for the place.  Even if rented out, he would have had a negative cash flow for a decade or more, perhaps even today.  And today, he would be seeing only a paltry $60,000 gain on his investment - after over 15 years.  But of course, that never happened - he lost the place to foreclosure and declared bankruptcy in 2009.

(That is key, by the way - being able to do repairs yourself.  The "flipper" shows all show the property twins or whoever, hiring people to do repairs and upgrades (some of them nonsensical).  The cost of hiring people, particularly today (timing, again) is staggering.  If you can't sheetrock a wall, paint a room, wire an outlet, install a toilet, and so on and so forth, forgetaboutit!  You'll lose your shirt trying to "rehab" a property for rental or resale.)

Every day, I get a text, e-mail, or phone call (and Mark does as well) from people asking us if we want to sell our condo.  Some are people who paid money to go to a "Make Money In Real Estate!!" seminar.  Others are cold-callers for buy-and-flip people.  Still others are from overseas, hoping to sell us as a "lead" to someone who went to one of these seminars.

The deal is, we voted to abolish the condominium and demolition begins later this year.  We may still have the place for years, as the 22-acre site is being developed in stages. They have offered us $160,000 for the condo, and in the meantime, it is rented out to a long-term tenant with a small profit of about $5000 a year.  Nice work if you can get it.  The worst problem about it (oh, weep for me!) is that we will have to pay capital gains tax on $160,000, unless we can roll it over into another investment property in a Starker deferred exchange.

By the way, if you didn't understand that last sentence or understand what the depreciation deduction is, you should not be investing in real estate - yet.

So I went along with one of these yahoos, who texted me each day, asking about the property condition and how much I wanted for it.  I explained that due to a pipe leak, the condo association paid for a whole new kitchen, and the standing offer from the Condo association was $160,000.  He replied back and said they were looking for "distressed" properties but maybe I would want to list it with an agent?

Each text was a day apart - in a chain of about eight texts.  It was like pulling teeth with this guy.  I suspect he was from a call center in India, and they were fishing for "leads" and wanted to sell my lead either as a potential "distressed property" to a buy-and-flip guy, or as a listing lead to a real estate agent.  No thanks to either.

That is the problem with this market.  It is so heated up right now, and once again, we are treated to one television show after another about buying-and-flipping real estate or making money in real estate and everyone wants in on the deal.  It is like gold or stocks or bitcoin - the media does a "story" about it, and after the price has already shot up, people want in on the deal, after it is too late.

Once again, I made money on real estate by buying during a lull - the post-1989 bear market.  I missed the 2009 lull and kick myself for not jumping on some deals.  A duplex near the beach was on the market for $210,000 for both sides.  I could have re-habbed this, and rented it out with a huge positive cash-flow, particularly as a weekly rental to tourists.  And today?  Well, I could sell each side for $210,000 and have offers over-asking.  But at the time, I had a vacation home (dumb!) and was "too busy" to invest in that opportunity.

Which brings up a point.  To make money in investment real estate, you have to be feet on the ground in the area you want to invest in.  This shit is hard to do, remotely.  We have a "manager" for our condo, and we are hanging on to it only because of the buy-out.   The management fees and repair fees (having to pay someone) really cut into the profits.  In fact, in some years, they wipe them out, particularly if there is vacancy for a few months.

Being "on the ground" means you understand local property values.  Mr. See loves to scrutinize real estate listings in his spare time, and as a result, we had a good handle on Northern Virginia property values.  So when we had the opportunity to buy our investment properties, we realized they were real bargains.

We also could add up a column of numbers and "do the math" and figure out that the rental income would exceed the cost of insurance, taxes, mortgage, and other expenses, and thus generate a positive cash-flow right away.  And by renting slightly below market value, we had long-term tenants who never left, and as a result, weren't sandbagged by vacancy.  One month's vacancy can kill your profits for the year, easily.  This is a business of thin margins.  And it is a business, too!

It is also helpful to make connections and contacts.  We had a friend who was a real estate agent who was selling foreclosure properties for Ford Motor Company finance (they have since wisely gotten out of the home loan business!).  We tried to buy one house through him, but the deal fell through.  But that contact resulted in a phone call later on when the duplex hit the market.  He also sponsored Mark at Weichert, where he got his real estate license, later on.

Knowing some bankers is helpful, too.  I was able to make connection with Taylor Burke, who wrote the first note on my office building (hand-typed on an IBM selectric - Taylor was old school!).  I made friends with another banker, and he and his friends started their own bank, which they sold me stock in.  Nice to be able to speed-dial the vice-president of a bank and have them answer on the first ring.

I'm not saying you need connections like that - but it helps.  But you should have your financial house in order - reduce debt, have a good credit score, a verifiable income, and a balance in your bank account.   Investment real estate can be risky, so you have to be a good prospect.

Now, some folks cut corners here.  Loans for investment properties are riskier than home loans, and thus interest rates are higher - and often the notes are "callable" which kept me up at night.  We knew a lot of people who would buy an investment property and claim it was a personal residence, and thus get a lower down payment and lower interest rate.   And so long as they made their mortgage payments, I guess the bank didn't care.  But technically, if they found out the place was a commerical rental, they could call the note and foreclose.

In the Northern Virginia area, sometimes people would just fall into this situation.  They would buy a condo and finance it as their principal residence.  After a few years, they would buy a townhouse and rent out the condo, not telling the bank that it was now a rental property.  A few years after that, they would buy a house and rent out the townhouse - and now have two rental properties - and not tell the two banks about that, either.  I guess it helps to have your loans through separate banks.  In other situations, particularly with unmarried couples, one spouse would claim one house as their residence, and the other as theirs.  With different names on the deeds, I guess the bank didn't notice.  But it is a form of fraud, even if you don't get caught.  We never did it, and paid higher interest rates on commercial notes as a result.

Right now, I doubt there are many "bargains" in the real estate market.  But again, you have to know your own market like the back of your hand - housing prices, neighborhoods, and rental rates.  It helps to know which neighborhoods are on the way up, and which are on the way out.  Northern Virginia was pretty easy for us, as the area keeps expanding (Federal Government) and a lot of places that were kind of run-down became upscale.  My Office building was in the 900 block of Duke Street.  The next block had undeveloped land on it.  They put the Patent Office (and Federal Courthouse, and condos and townhomes and whatnot) not a few blocks from me, later on.  The empty land became upscale townhomes.  My old office building is now a home again, and no doubt sells for a million dollars.  I  sold out at $680,000.

The duplex?  They re-paved the street and put in curbing and new sidewalks and offered to put in driveways for home owners at a cut-rate price.  I said "yes" to that deal, as did many other owners.  Overnight, the street crowded with parked cars became a nice neighborhood with off-street parking.  Changed the entire head of the place and being across the street from the Metro, made it very desirable.  We sold it for nearly $300,000 and I am sure they are a half-mil today.

And the condo?  They are tearing it down to put up luxury mid-rises.  The land is worth so much more than the buildings.

On the other hand, places in the rustbelt or other depressed areas might sell for cheap, but there might not be much growth to be had down the road.  You might be able to rent out such places for a positive cash-flow, but you might also become a slumlord, renting to the worst sort of people who you have to evict on a regular basis.  It is a hard way to make money.

So, to my reader, my take is this:  get your ducks in a row.  Understand the tax situation with investment real estate - the capital gains issues and the depreciation deduction (which can cut your taxes for now and convert them into capital gains later on!).   Get to know the neighborhoods, the property values and the rental rates.  Get to know the bankers and real estate agents, mortgage brokers and other hangers-on in the industry.  Their knowledge and leads are invaluable.

Mark's Dad used to buy and flip properties - often taking back mortgages (in rural Maine) to do so.  The local banker had his name and phone number in his Rolodex (remember those?) and when a property was foreclosed upon, he would call Mark's Dad (and maybe a few others who actually had bank balances) and offer to sell him the property for cheap.   Maybe those sort of back-scratching deals are gone - at least in more urban areas - but it pays to know people in the business and know the tax code and know the values.

Because, when you know all that, you'll know when the right deal comes along, and you can pounce.

Right now, though, I am skeptical it is the right time.  Maybe this bubble will continue to inflate for some time now.  Maybe my home will shoot up to a million dollars in value.  Maybe, but I doubt it.  I think a lot of the panic buying going on right now, due to the pandemic, may taper off just as quickly.  We saw this in 1989, we saw this in 2009.  It went from Bull market to Bear market in a matter of months.  Houses and condos that were sold for over-asking with escalation clauses one month, were languishing on the market the next - with many contracts being cancelled.

We also had two investment condos in Pompano Beach, which brings us to another point - knowing when to get out.   We saw the bubble really froth there - far moreso than even in Northern Virginia.  When we started getting unsolicited offers for the condos for twice what we paid for them two years earlier we sold out.  Ditto for our home in Virginia, which was sold to a developer who drove a bulldozer through it (again, land worth more than the building!).

Right now, we are seeing the same kind of froth right here on the island.  Nothing on the market, houses selling for over-asking in a matter of days or hours, people moving in and spending almost half what they paid for the place (sometimes more!) gutting and remodeling the homes.  New condos here are selling for a half-million each.  It makes the homes seem cheap in comparison.  It could be that someone comes knocking at our door with a wheelbarrow full of money - and we know what to do when that happens, right?

Good time to sell, crappy time to buy.  I am not sure what the market is like where our reader lives, but that is the point - he is the "boots on the ground" there and knows, or should know, the market where he lives and wants to invest.

But nationwide, the general trend is toward high prices and shortage of homes. It doesn't strike me as a good time to buy investment real estate, if you get into a bidding war with other investors.   You want to buy when you are the only guy looking.

And this idea of over-mortgaging a property and taking out cash as "profit" is utter bullshit in case I am not being clear.  Borrowed money is NEVER, EVER profit, but a loan that has to be paid back.  As a result, I have to say the third "R" in "BRRR" is utter nonsense and a con-job and you should stay away from people who promote the idea that loan is profit.  It never is, never was, and never will be.  If you want to profit from a property, either have a positive cash-flow, or cash-out by selling it.  Borrowing against it is just increasing your debt load and decreasing your net worth, not "profiting" at all.

So, what's my "system?"

L - Learn the law and tax code.  You need to understand how deductions work, particularly the depreciation deduction, to understand if you are really making money on a property.

B - Boots on the ground.  Know the property values and rental rates in your area, the neighborhoods, which are going up and going out and the overall market in your area in general.

C - Connections.  Make friends and connections with real estate agents, bankers, mortgage brokers, and others in the business.  They can provide you leads, lend you money, and make deals happen (they get paid when deals happen, too!).

D - Do the Math.  Add up the costs of ownership and the potential rental income. Figure in one month's vacancy a year, as a contingency.  If you have a positive cash-flow, good.  If not, walk away.

S - Skills.  Know how to sheetrock a wall, paint a room, wire an outlet, and do other mundane repairs.  Otherwise, you'll lose your shirt.

W - Wait for the right deal to come along.  Buying during a bubble is hard to do.  Wait for the crash.  There always is one.  If not, well, maybe investing in real estate isn't a good idea.  You don't have to invest in every damn thing that comes down the pike.

S - Sell out when the market goes berserk again.  Property isn't forever, and when the market bubbles, it is time to get out.

But hey, LBCDSWS - that doesn't spell anything catchy, right?  Life isn't about catchy slogans or acronyms!