Choose Your Method of Profit
 

12/08/2006 12:30 AM

DEC 08, 2006
Realty Times
 

To hear many reports from my media colleagues, there's no reason to buy real estate today because the "bottom's fallen out," the "balloon burst," etc. With the real estate market down (number of sales AND dollar volume), you might as well put your money somewhere else -- how about the stock market or in bonds?

Following this philosophy, then whenever any investment tool drops in value -- dump it. Stocks, bonds, real estate, mutual funds -- it doesn't matter which vehicle, park it, get out and hitch a ride on the fastest moving investment possible … right? Actually, for the real estate investor who does his homework, money can be made in any market. You just have to decide on your profit methodology: cash flow or asset growth. Both are available in today's market, and the savvy investor must be sure to conduct due diligence on the bottom line.

For those who want to get in on the ground floor -- this is the best market in which to buy to plan for future asset growth. Equity growth comes in more than just buy low and sell high.

In the last few years, short-term, play investors lucked out with the market and bought houses/condos/pre-construction at high prices and were able to sell at higher prices in just a few weeks or months. This buy now, profit later can still be experienced, it just takes more patience.

Most real estate assets grow consistently year after year. What the last few years created in the short-term, however, is what it usually takes years to create -- thousands of dollars in equity growth. The usual way this growth occurs is by using other people's money (OPM) to grow your equity along with the usual appreciation.

OPM is one of the most powerful investment tools out there. Most people use OPM to purchase real estate (the mortgage) with a little bit of their own money (down payment). Each month after you buy a house, there's the monthly mortgage payment. Thus, your second use of OPM is the rental payments you receive from your tenants. Now, you're growing that equity month by month, plus paying the interest, fees, etc., with the funds provided to you from the tenants.

The second way your equity grows is through appreciation. This figure is not as controllable by you. What's really exciting about this part of the profit growth plan is that since you took control of this large asset with a little down payment, the cash on cash growth is astronomical.

For instance, let's say a rental property is purchased for $200,000 with a 10 percent down payment - $20,000. As time moves forward, you're going to make money two different ways. If the property moves up in value 6 percent on average through the next few years -- remember looking at it long term, not just in the last year -- then the house will be worth $212,000 in the next year. However, that 6 percent growth converts into a 60 percent growth of your cash investment (the $20,000) in the first year.

Secondly, if the house rents at $1,500 per month, then you have income of $18,000 per year. If you have a 6 percent mortgage, then you'll carry about a $2,500 annual profit after expenses. So your gross income is nearly 100 percent of your down payment, resulting in a nearly 10 percent net profit based on the investment of your down payment.

Your next profit choice is the stand-by fixer upper. With a slow market, many sellers are willing to sell their house as-is for a stiff discount just so they don't have to fix up the property and compete with homes that have upgrades throughout. Many investors are marketing for this type property with the "We Buy Houses" signs you've seen throughout the community. Some of the sellers are people who are behind on the mortgage and have no resources to fix up the house to sell it at a market rate. The key here is having the money already lined up through a lender to acquire the house, fix it up and market it quickly to pull in profit on the sale.

Finally, there's the method of positive cash flow. This is my method of choice, where you're creating profit with a renter who is paying for your mortgage payment and expenses, leaving profit in your bank account at the end of each month.