With the size of the real estate market in the trillions of dollars, there are a multitude of strategies being used to tap into its potential. From a small single-family fix and flip to a large scale commercial development project, we believe there are three common elements to every successful real estate investment:
- Buying Right
- Aligned Capital
- Business Plan Execution
In today’s blog post, we examine the first of these critical elements – Buying Right.
There is an old adage in the real estate business – You make money on real estate when you buy, not when you sell. There isn’t a better principle to guide you in your investing activities. If you spend the time to understand the key drivers of value and only engage opportunities that meet the right criteria, you will set yourself up for success in real estate.
A lot of things can go wrong in any investment, and this is certainly true with real estate. Construction or renovation costs can end up higher than anticipated, interest rates can rise, and market conditions can deteriorate. Creating equity with the right purchase price is your best protection against these risks.
So, how do you acquire under-valued real estate? The keys lie in where you look and in how you go about acquiring property. Here are some time-tested strategies that have proven to be effective for successful real estate entrepreneurs:
- Become an expert
Being an expert on the neighborhood or sub-market gives you great power in the acquisition process. It allows you to identify opportunities more readily and execute on them with confidence. While your competitors are spending time to understand a property’s value and potential, you could be negotiating with the seller to get control of the property with a purchase contract.
Becoming an expert on a particular market takes time. Do your research, understand the market, and determine what is driving values. Proximity to quality schools and shopping are key issues for many home buyers and renters. Household income is also a key metric to understand, particularly for residential and retail investments. Most importantly, get to know what properties have traded for and the trend in values. Once you know the market and understand the variances in prices for comparable properties, you will be well prepared to identify attractive acquisition opportunities.
- Hunt for off market properties
Finding off market opportunities represents your best chance of success in acquiring under-valued real estate. The following are some of the most effective strategies for locating these opportunities:
- Direct mail – Learning how to obtain relevant data and parse it so that you can effectively market directly to your target market is the most effective way of finding off market properties. Even if your response rate is only a small percentage, any responder is generally a very qualified lead and highly motivated to sell.
- Brokers – Find out who the most active real estate broker or agent is in your target market and develop a relationship with them. Make it known that you are a serious buyer and will perform (and make sure you do when given the chance). You want to become the first call they make when they have a unique or off market deal.
- Non-local ownership – Targeting out of town, out of state and foreign owners can be a lucrative strategy. The further the ownership is from the property the less they generally know about the local market. Nurturing these relationships until they are ready to sell is often an effective method for getting an acctractive price.
- Distressed properties – Often the easiest way to find opportunities is by driving the market and identifying properties that are in disrepair. Owners of these assets could be highly motivated to sell and avoid future capital expenses associated with the property.
- “Value-add” opportunities – Properties with rents lower than other similar quality properties in the market could be perfect candidates for repositioning through upgrades, capital improvements, and rent increases.
- Be diligent
There isn’t anything more important in the buying process than thorough due diligence. Mistakes made in the inspection period prior to closing can impair your returns dramatically. Poor due diligence causes more losses than any other element in the real estate investment process. Many of the common mistakes made by investors can be avoided by thorough research and commitment to a carefully crafted pre-closing process.
So how can you avoid the pitfalls associated with poor due diligence? First of all, start with a comprehensive checklist. The type of due diligence you perform will vary depending on the property type and condition but any list should at least cover these items:
- Title and survey review – A thorough title review will expose whether the seller actually has title to the property, whether there are any encumbrances attached to the property, such as a mortgage or tax lien, and whether there is any litigation pending that might threaten the title to the property. A survey identifies what property you are actually buying and it should match the title commitment. Read together, the title commitment and survey provide a comprehensive view of what you are buying and all easements, encroachments and other recorded issues that may exist.
- Physical inspection – Whether the project is a single family fix and flip or a multifamily or commercial property, having a thorough understanding of the physical condition of the property and what is needed to put the property into the condition required to meet your revenue objectives is critical. Any red flags that come up in this process, such as foundation, roof or mechanical/plumbing issues should be evaluated by licensed professionals. The original building plans can be valuable to this process and should be requested from the seller. Your capital improvement budget should be supported by bids from qualified contractors. Getting the rehab or construction numbers right is a time consuming process, so it is important to get started on this as early as possible (preferably prior to contract).
- Value – Your disposition price should be well supported by comparable sales. Spend the time to understand any key differences between the comparable properties and the subject property in order to properly set expectations, as well as identify value-add improvement possibilities.
- Rents – For an income-producing property, it is equally important to know what comparable properties are renting for and make adjustments for any key differences.
- Historical data – For income-producing properties, it is important to review a certified rent roll, historical operating statements for a minimum of the prior two years, and all of the actual leases currently in place.
- Property tax and insurance assumptions – Be sure to review the currently assessed tax values and charges, and understand the impact your purchase and deed transfer could have on those assessments. Taxing authorities are always looking for opportunities to increase revenue, so make sure to take into account the likelihood of a re-appraisal. Get quotes for hazard and liability insurance for your property early on to make sure there are no surprises.
Your list might also include a number of other items depending on the property type and characteristics, such as an environmental assessment or a land use review of zoning, deed and other use restrictions.
A diligent review of the critical elements to your purchase and business plan during your inspection period can save you from the pain of a poor investment that could have been avoided. Time spent in this area on the front end will pay off throughout the process, allowing you to bring capital to your purchase and execute your plan with confidence.
Next Blog post: Aligned Capital – Learn the importance of having your investment capital aligned with you and your objectives.