Following is an article by Justin Ford that is quite informative.
Take It Easy: Why Making Good Money in Real Estate Shouldn't Be That Hard
"Business is easy," according to Sam Zell. "If you've got a low downside and a big upside, you do it. If you've got a big downside and a small upside, you run away." That philosophy has stood Zell in good stead. He started out buying and renting out small properties to college students while he was an undergrad himself at the University of Michigan in the early '60s. More recently, he sold one of his flagship Real Estate Investment Trusts to a leading hedge fund for $36 billion.
In real estate, the best way to keep your investment decisions "easy" - with low risk and a high potential for profits - is to act on values others can't see. Often, that means going against the herd, especially against dominant ideas in the mainstream media.
Zell grew his portfolio rapidly from the '60s through the '80s. But he only leapfrogged into the league of billionaires in the early '90s. He bought aggressively during the real estate recession of those years, while the headlines and public sentiment about real estate were at their worst.
I've tried to help my readers see beyond the mainstream hysteria. I've been warning about bubble markets for about four years now. I advised not to get caught up in the hype. Instead, I recommended to be sure to buy below market value; buy cash-flow properties only; fix your interest rates; have a margin of safety in the form of ample cash reserves, cash flow, or both. And always have a Plan B. (If, for instance, you were planning to flip, to be prepared to rent, sell on terms, or do a lease option that would keep you in the black if the flip didn't work out.)
That advice ran contrary to the headlines. It also cut against the advice of real estate gurus who figured the easiest way for them to make money was to sell you on the idea that real estate is a can't-miss proposition. The height of the "can't-miss" mania was marked by the publication of Are You Missing the Real Estate Boom? It was written by David Lereah, former shill... er, "chief economist" of the National Association of Realtors. It came out in February 2005, just months before some of the hottest markets in the country peaked. For timing, it ranks right up there with James Glassman's Dow 36,000, published in 1999, shortly before the second-worst stock market crash of the last century.
Different Headlines, Same Story
Today, the real estate headlines are all about doom and gloom. But, once again, there are tremendous opportunities out there. You just have to tune out the herd, focus on the facts, try to understand the true, larger trends, and look for values others can't see. For instance, I live in South Florida, one of the worst markets in the country. Prices are down. Volume is down. (The number of transactions is off 50-60 percent in many areas.) Insurance and real estate taxes have soared, and foreclosures are setting new records. Yet, I've continued to make good money in real estate. That's basically because I've followed my own advice. Over the last two years, I've been writing about exceptional values outside the bubble markets. And I've gone into these markets in search of undervalued properties.
In one western state, the first property I bought was a four-plex in an area where college students live. We bought it for $180,000 on a street where comparable properties were selling for $220,000. It produced just over $25,000 a year in gross revenue. So we bought it under value and it cash-flowed comfortably. We also fixed the interest rate.
Even though this was a market that offered great values and strong growth... and where sales volume remained (and remains) high... we followed the deep-value, low-risk/high-potential-reward formula I've always recommended. And it's continued to work well.
Within six months, we got an unsolicited offer for $60,000 more than we paid. Since then, we've received two more offers for as much as $80,000 more than our purchase price. Not long after we bought this property, we bought another four-unit property not too far away. We ended up selling it for $129,000 more than we paid in just under 14 months.
In another market in another state, I closed on a 14-unit apartment building five months ago. The seller was asking $565,000 for this mostly vacant building. We ended up buying it for $397,500. Today, after about $68,000 in rehab, the property is fully leased (with a waiting list) and generates just over $7,000 a month in gross revenue. It also generates about $4,100 in net operating income (NOI - revenue minus expenses).
A conservative eight percent cap rate puts the current value of the building at about $615,000. That's about $145,000 more than the roughly $470,000 we have into it, including purchase price, closing costs and repairs. (A cap rate is basically the yield you would get on an income-producing property if you bought it for all cash. It is arrived at by dividing the NOI by the purchase price.)
Even an ultra-conservative 8.5 percent cap rate would put the value of this property at about $579,000. That means we've been able to create - at a minimum - an additional $109,000 in equity on a cash-flow property in five months. And yet, the prospects going forward are even better.
It Pays to Invest in Value & Growth Cities
Right now, I'm looking at properties in one of the most affordable cities in America. It's a major city that not only offers value, but strong growth as well. It's the fastest growing city in its state. In fact, its population growth has been 75 percent greater than the national average over the last 15 years. Jobs have grown at nearly twice the national rate over the last two years.
The fact is, value cities like these are actually benefiting from the mayhem going on in the bubble cities. There is a huge flow of money moving from the bubble areas to the value areas - from homeowners, individual investors, institutional investors, and operating companies.
This will continue for years to come - even while the national headlines shout "sub-prime crisis" and "real estate meltdown."
Here is a quick overview of how to look beyond the headlines that everyone sees... so you can find the true opportunities that few can see.
Tune out the noise: Get facts and figures from media outlets, professional associations, and government outlets. But draw your own conclusions. Look for the emergence of "value gaps" and the flow of money from overvalued to undervalued areas.
Always buy cash flow: If you do this, you dramatically reduce your chances of seriously being hurt in any market. Even if you don't want to be a landlord and you prefer to "flip" houses, why not flip them at prices where you could rent them out on a cash-flow-positive basis if you had to? If you like million-dollar deals, why should you deal with luxury homes when you can do million-dollar cash-flow apartment houses or offices or warehouses instead? If cash is king... cash-flow is the Holy Roman Emperor.
Buy at or below market value: Know your target-market values cold, on a dollar-per-square-foot basis and on a price/rent basis. If you're in a good value market that also has strong growth and where real estate sales are brisk, it may make sense to buy cash-flow properties close to, or even at, market value. But the more overvalued your market, the more undervalued a purchase should be. The greater the discount at which you buy, the more of a cash and equity cushion you'll have if and when the market corrects.
Fix your interest rates: This alone would have prevented half the foreclosures going on in the country right now. If you have to do some negative-amortization, adjustable, time-bomb mortgage to make a deal work... chances are it's not a deal after all.
Focus on value and growth cities: Remember, real estate is local, yet all markets are connected. Extreme overvalue in certain markets can create extremely attractive undervalued investment opportunities in other markets.
When you combine these criteria and buy undervalued properties in undervalued, growing markets... consistently making money in real estate almost becomes "easy," as Sam Zell says.
According to the U.S. Census, Arizona is now the fastest growing state in the U.S. It is projected to continue to be the fastest growing state through 2030. There is only so much real estate to satisfy this huge demand. Therefore, Arizona real estate values are expected to continue to rise. Professionally managed, leveraged real estate will continue to be a top tax-advantaged wealth builder.