Buying investment property

In today’s real estate market there are dozens upon dozens of people who will present themselves as leading experts on how to succeed in the investment property market.  These considered experts will gladly present their “easy-to-use”, fail- safe techniques to you, for a moderate price.  You know who I am talking about here.  You have probably seen the infomercial on TV where a well-spoken young man talks about the millions he has made in just a few short years by applying his proven techniques, which (lucky for you) he now wants to share with others.  The infomercial starts off by showing you pictures of unbelievable homes, cars, jewelry, beautiful people partying and having a good time.  Just as it catches your attention a spokesman appears wearing nothing but a bathing suit walking poolside at his home somewhere in Beverly Hills.  He looks to the camera and says; “You too can have these things and much, much more. Over the next ½ hour I will show you how easy it is.”  The spokesman attempts to entice you by addressing a few key points to his strategy.  He will follow this up by presenting testimonial after testimonial from ordinary people who have made millions by applying his techniques when buying investment Real Estate.  With such lavish and extravagant enticements, it would be hard for anyone to doubt the validity of these infomercials, particularly when you see infomercials inundated with testimonials of seemingly average, everyday people making it big in this market.  But what you don’t see in those infomercials are the other 99.9% of the people who did not make it big in this industry.  I am not here today to tell you what is the right way to succeed in the investment property market, because honestly, there is not just one “right way.”  You simply need to do your homework and educate yourself enough to handle the issues as they arise.  I want to provide you a realistic overview of some basic concepts you need to know before buying investment property. 

There are many things you should know before going out and buying investment property.  I will not be able to give you everything you need to know here today, so it is important for you to do as much research as possible before betting your livelihood on a piece of Real Estate.  Purchasing investment property is not for everyone, which is why so few people actually do it today.  In fact, most people who own investment properties do so because they were forced into it.  These investment property owners found it difficult to sell their existing homes before purchasing their current homes.  Because the market at the time was not strong enough for them to sell their old properties, they were forced to rent the property out until the market improved.  Most of these people will not own investment properties in the future and will do whatever they can to break free from the properties they have today.  Essentially, most investment property owners presently own investment property due to misfortune, not due to opportunistic ambition.

I receive at least one call ever week from someone who is interested in buying an investment property.  Their goal, like everyone else, is to buy it far below value and sell it for far more, yielding them a substantial profit.  Well, let me tell you a little secret:  “EVERYONE WISHES THEY COULD DO THAT.” What amazes me is that these same individuals think that the only requirement to buy investment property is for them to want to do it.  They will also want us to finance the entire purchase price so that they can enter into the transaction with no money out of their own pockets. 

Let’s think about this for a moment.  We have a client who calls in because they think they have found a home with real equity in it, and they are looking for someone to provide the funds so that they can buy it.  The home is a real find and yet, for some reason, no one else has had a chance to put in a bid; and even though the home has been on the market for 60 days, no red flags have appeared.  Now let’s go back to the request for financing: you discover that they do not want to use any of their own funds (often because they have no funds), but instead they want the bank to take on all of the risk and finance the entire transaction.  If, by chance, they get the financing they need their next step is to turn around and sell it at a higher price so that they can make a return.  Wow, if it were only that easy.  I will tell you one thing: I certainly would not be sitting around writing articles while other people are make money by doing this.  I would be right in it with you.  Heck, everyone would want a piece of the action.  The reason that so few people actually succeed in this is because buying and selling investment property is just not that easy.  Again, there is not a person on this planet who does not have a desire to buy property and then sell it for a profit, especially if there are no requirements for them to use any of their own funds.  This is a common misconception that people have, and to be honest, you would be amazed at how many people actually think that they can do just that.  Because of the misconception I believe that the first thing we need to cover is what types of buyers qualify to purchase investment property, as well as what types of financing are available for them.

Investors will normally be individuals who have the ability to disburse large amounts of money—from their own funds—into an investment property transaction.  They will also have superior credit and a proven track record for purchasing property in the past.  An investor will not be a first time homebuyer, nor will they be constrained by income or any other financial restrictions tied to a real estate transaction.  In fact, most experienced investors will not have a need for financing at all; they will simply purchase the home outright, using their own funds.  If you happen to find yourself in a situation where buying an investment property makes sense (but don’t have the resources to buy the property outright) you will need to understand your financing options.  Note: financing an investment property will be a high risk transaction; therefore, investors will demand a premium for any loans underwritten within these circumstances.  Interest rates offered on investment properties will range about 1 to 1.5% higher than what is normally offered on primary residences.  Investment property loans will also have a higher down payment requirement.  Due to the recent increases in default risk for these types of transactions, lenders have begun to require as much as 20% of your own funds to be used as a down payment.  The next time you see an infomercial that claims that there is no out of pocket money required, they are LYING!

Another factor to consider when buying an investment property is the perceived value of the property.  Unless you are buying property from someone you know, or have some type of insider information about the property not yet disclosed to the market, you will most likely buy the property near its actual value.  For those of you who might think that you have found property that is unexpectedly undervalued, I will warn you to use extreme caution.  Keep in mind, people trying to sell their property will attempt to get the highest price possible from the buying market; therefore, there will be a good reason for that home to be on the market at its current asking price.  If the bank or the sellers thought that they could get more for that home they would price it in such a way. 

Here is something to think about: do you really think no one else has seen the property before you? And if so, why would they walk away from such a great value without putting in an offer to buy the home themselves?  Investors make a great deal of money by knowing things before you and they succeed at this because they pay well for this information. Odds are that by the time you begin to look for a property, any properties having any significant value to be gained will already be under contract.  These homes do not stay on the market long and are normally snatched up by those who have insider information about the home, before it reaches the market.  The fair market value for most homes will fall right in line with the asking price listed on the home.  So, the sooner you understand that there are no deals that happen to be considerably below the fair market value, the sooner you will be able to make a good buying decision. 

If you are not a risk taker then I will recommend that you avoid buying investment properties altogether.  Buying investment properties can be a very risky investment.  However, you can help reduce some of that risk by knowing when it is the right time to buy.  The right time to buy investment properties is when no one else is buying them.  A buyer’s market will ensure that you are getting the best possible price available on a specific property. 

You should also motivate yourself to buy an investment property during the winter season.  Most people will attempt to sell their homes during the summer, and those that are in little or no hurry, who don’t have an immediate need to sell will take their home off the market during the winter months.  For this reason, the winter months will typically have far more highly motivated sellers than any other time of the year.  Obviously, having more motivated sellers increases your likelihood of getting the best price possible for your investment. 

As an investor you should always attempt to purchase homes that are in the lower price range for a given area.  The appreciation potential on these homes will be greater than the higher valued homes in that area.  These homes will also be easier to rent out, because they are located in better neighborhoods than similarly priced homes in other areas.  Renters will typically settle on the actual home versus the location of the home when making a rental decision.

You should avoid investment properties that require extensive work.  These homes will be priced well below their potential, but you will also be required to invest large amounts of money to bring the home up to acceptable standards.  This is how you can get yourself into a bit of trouble.  Most people do not properly budget for what is actually needed to bring the home back up to standard.  Not budgeting properly will cause you to lose some of the profit potential you thought you had.  You may also find yourself faced with many unknown issues, and as a result you might be required to invest even more.  The more you need to put into a home for repairs, the more you lose in profit.  Some homes become such a strain that the investor will actually lose money when they later decide to sell the property.  You will be far better off leaving that inevitable headache behind.  There are a lot of people who lose money when attempting to buy investment property, so my recommendation is to limit the risk as much as possible by avoiding what could be a potential disaster.

Finally, do not buy investment properties unless you have the financial means to do so.  Buying investment property will be a gamble, and although most of these gambles (if done right) will pay off, you still run the risk of losing money.  If you have to make a withdrawal from your child’s college funds, or you have to borrow money from other resources, then you are not in a financial position to gamble.  Don’t invest unless you are prepared to lose.