Real estate investing 2009 and beyond – Part 3 of 4

The two main concerns of new investors I have helped in the past are: 1 – How do I ensure that the tenant doesn’t trash my property? 2 – How do I determine the right exit price for me? We covered a terrific strategy for protecting your equity from tenant abuse in part 2 of this 4 part series, so I will focus on exit strategy in this part of the series. The first thing to remember is that it is very difficult to loose money on real estate, unless you do one of two things; buy a property with a higher mortgage payment than can be covered by rent, or sell for less than you paid. The only exceptions to these rules are generally created by unwise choices. Failing to keep property adequately insured, deferred maintenance, and failure to maintain a warranty on the major appliances are good examples. Entering with known exit price – I will start this paragraph with the appropriate disclaimer, “Past performance is no indication of future results, and I don’t know if we will ever reach the highs of 2005 again”. That said, if I didn’t believe that we would see those prices again, I am sufficiently educated around the real estate transaction to make navigate myself out of the multiple residential properties which I currently own in Sterling Virginia. However, I have no intention of doing so, because historically I know that there has been a trend in Loudoun and Fairfax Counties that has repeated at least 3 times in my own lifetime – Residential property values have doubled from their previous highs ever 23 years or less without fail. So while I don’t “know” that this will happen again, I have a fairly high level of confidence concerning this anomaly. As an example, I will use the little house featured in the Cool Real Estate Story video which I released recently. The original price on the property in 1973, when it was built, was approximately $70,000. After price increases in the late ’70s, there was a cooling in the market and prices dropped again. Then a few years later in the late ’80s, similar properties briefly sold for over $150,000. I purchased the property in the depressed market of 1993 for $134,900. By 2005 the property was valued at $425,000 plus. Today in the cooler market it has dropped to a low between $180,000 and $210,000. Notice two important things; the property never returned to the previous low and, the property low today is approximately 3 times its price 36 years ago. Quick projection here, “In the next 10 years the property will return to above $280,000″. Why? Because that will be the completion of the second 23 year cycle – 70k to 140k to 280k. When we get into trouble is when we are looking for greater returns than the doubling of values every 23 years. It isn’t that we don’t see this, it is just that when we do there is a high likelihood that we are moving ahead of income with home prices. What is key to remember here is that even though this is only slightly better than 3% increase per year on the price, because most people only invest 5-10% of the price in cash, the actual return on you investment is more like 30%-60%. That by far out-paces any other investment vehicle you are likely to find anywhere. So how does this help us? Well, if you buy only properties that return a positive cash flow, at less than 80% of the high in the last 23 years, you positioning yourself to be more secure than most of the rest of the market. Right now, most areas in Northern Virginia are experiencing that scenario in pricing. If you also know your most distant exit date you can make some fairly good assumptions about the highest likely value of the properties you are buying between now and then.

Here is an example: Let’s say you were interested in buying some properties in Sterling, VA today and you are 35 years old. You have determined that you will get out of the market in no more than 23 years, and want to sell your personal home and have enough to pay cash for a retirement home when you do. Currently you owe $500,000 on your personal home, but you will have paid that down to $143,000 in 23 years. You find several properties which meet the profile you are interested in purchasing. Of these 7 properties are listed below 80% of the previous high – $425,000, but three need too much work. The remaining four are listed between $225,000 and $250,000 and need only cosmetic work. You write on the least expensive property and pay a 5% down payment and 5% in closing costs. Using the system described in part 2 of 4 in this series, you place a long term tenant in the property. You agent or broker ensures the correct lease provision is included to ensure that the tenant will both maintain the property and will benefit from equity only if he/she remains in the property until you are ready to sell. For once economists are right and price return to previous highs of $425,000 in 2025, well in advance of the 23 year limit you set. While you could wait and see if prices go even higher, you realize that you are way ahead and are beginning to buck the 23 year trend. You sell the property for a net gain, after tenant share and closing costs, of $157,000. Wait! What about taxes? Your real estate professional saw that one coming and helped you to initiate a 1031 tax free exchange. You wisely invest the proceeds of the investment property sale into another investment property. This one looks just like a home you in which you want to live in the future. Having purchased the perfect home for your own retirement, you insist on double the monthly going rent in the neighborhood. Surprisingly, no one will pay that much and the property remains vacant all year. Fortunately, you decided to sell your primary residence, when you sold your rental property, and to become a tenant for a year. Because your primary residence had experienced the same value increase as the other properties in the area, you were able to net an additional $350,000 on that more expensive sale. This allowed you to pay-off the remainder of the mortgage on the new property, so you didn’t really care that it was vacant, and decided to use the time, and money you used to spend on the mortgage, to add all those special personal touches you want to enjoy when you move in to the property. A year later, your smart attorney and CPA explain that there is no longer a tax liability from you moving into the new home as a primary residence, and you move into your new paid-off, home at age 52. With no more mortgage payment, you realize that you have considerable amounts of disposable income – which is nice.
Okay, sure there are no guarantees on this but, if you think it through, I bet you will decide the downside is fairly limited and the upside could be pretty significant.