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Is It Time to Get Back Into Real Estate?

Are we there yet? Have we reached the bottom of the market?

Dave Kansas for the WSJ.com writes: Is It Time to Get Back Into Real Estate?

What I find especially interesting is where most of my risk-taking friends are headed. It isn’t the stock market; in fact, the only folks I know who have waded back into the stock market are the gunslinger types who never really left it.

Instead, they seem to be heading for real estate. At first I found this puzzling, given the brutal battering real estate has taken. But that’s the point: An increasing number of my friends see this as the perfect opportunity to find something at a bargain-basement price.

…

The people doing this are employed, feel confident that they’re not going to lose their jobs, and believe that while housing prices may fall a bit more the bottom is not too far away. Moreover, financing remains relatively cheap and, according to one lawyer I know in house-hunting mode, banks aren’t as tight with mortgage lending as headlines indicate.

As I wrote a couple of months ago, it’s always dangerous to hypothesize a global trend based on the all-too-limited view from your own backyard. But it’s also sometimes an insightful way to get a jump on what’s coming. And for me, what’s most intriguing is that, for now, most of this risk talk is prospective. There’s no sense of rushing, no desire to “stretch” too far in making a purchase. It’s like these people are permitting themselves to dream a little bit and get closer to pulling the trigger. But they want to be doubly sure before making a move.

What’s more, all of these people have a similar, cautious, mind-set. They don’t believe real estate will rebound or make a great investment. But they also don’t think real estate will lose a lot of value. Instead, they are focused on real estate as something they can use: a solid place to live or play that should also be, at worst, an OK investment.

Start Thinking About Investing

I can’t say that I agree with certainty that now is the best time to invest in real estate. However, I would definitely start to think about it.

Why start thinking about investing in real estate?

  1. In some areas prices have fallen 30% or more from peak market values. This is a huge drop and brings prices more in line with historical averages and growth rates. We are closer to the bottom.
  2. The foreclosure epidemic has not quelled. In fact by many standards there is still a wave of foreclosures coming. We are probably not at the bottom yet.
  3. If unemployment continues to rise, more foreclosures could occur. Unemployment is likely to cause higher vacancies in multi-family properties. The bottom could be a ways away.
  4. Credit markets are still stuck. Financing for buyers is difficult to obtain without a significant down-payment. Probably not the bottom.
  5. Banks continue to be closed by the FDIC. Meredith Whitney warned that 300 banks may fail before the end of the financial crisis.

Invest Now If…

  1. Invest now if, you do not need appreciation to achieve an acceptable return on your investment.
  2. Invest now if, you have enough liquidity (cash) to cover potential vacancies or repairs after acquiring your property.
  3. Invest now if, you have included 10% rent decreases and at least 10% vacancy factor in the near term.

What do you think? Are we at the bottom?

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Real Estate Investors of Tomorrow

Enoch Lawrence, Senior Vice President at CBRE Capital Markets, has written an article Deconstructing the Downturn in the Commercial Real Estate Capital Markets. While the title led me to believe it would be an analysis of how we got here, I was surprised to find a commentary on where commercial real estate investing is headed.

The new world order in commercial real estate will be governed by patient, well-capitalized investors. Many new names and faces will appear and many old ones will re-surface again to cherry pick the market for quality assets ―the players are changing daily. The acquisition decision process is driven by equity, not debt, in this alternate universe. Investors must match their equity profile with the appropriate mode of lending, while at the same time monitoring the state of flux of the commercial real estate capital markets where respective sources of capital become more or less available. Government supported programs will significantly impact the availability of capital in the short run, but investor confidence must return to the market to help stabilize the lending environment. For this to happen, all market participants must realize that capital is available. The world has changed, and to access this capital, a healthier balance between risk and return must be achieved.

The market will be characterized by investors that have capital and are willing to earn a reasonable return equal to their risk. Mr. Lawrence questions whether 20% Internal Rates of Return (IRR) are realistic in the model going forward:

One may inquire about the vast sums of money raised to deploy into opportunistic investment strategies.  In an environment where valuation remains challenging, you may ask how a 20% Internal Rate of Return over a 3-5 year holding period is being modeled and presented as a sustainable investment model en masse.  This may be possible with small pools of capital deployed in niche markets, but the large scale deployment of this capital in search of distressed opportunistic returns has not materialized and is further exacerbated by more conservative underwriting from available debt sources.

Prior to the Lehman Brothers collapse in September of 2008 real estate markets were awash with inexpensive leverage. The market for debt that existed allowed real estate investors to leverage deals over 90%, in some cases, at historically low rates. The leverage boosted returns and allowed investors to have Internal Rates of Return of 20% or greater on paper.

Going forward investors must adjust their expectations to a lesser return. The important factors are going to cash on cash return and a stable long-term investment.

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Gathering Your Real Estate Investment Team

Every real estate investor should have a team of trusted professionals that advise them on real estate investments. It is best to have an attorney and a tax professional on your team. As well, you should have a real estate broker and a real estate finance expert on your team of advisors.

Jeffrey Hare, an attorney in the Silicon Valley, demonstrates why gathering your team is important before you invest in his article, Get Legal Advice BEFORE You Invest.

Why should you seek legal assistance as part of your due diligence when considering an investment opportunity?  For starters, it might be a lot less expensive than seeking legal assistance after something goes wrong.  To be perfectly honest, I would really prefer not to hear a client tell me “I wish I’d talked to you sooner.”  Actually, there are several ways an attorney can be a valuable member of your real estate investment team.  Here are a few points to consider when making the decision how to maximize the return on your legal dollar.

For starters, you need to focus on your goals.  Most successful real estate investors have a clear focus on their financial objectives.  If you have a plan and are focused on clearly defined and realistic objectives, you’ll be able to communicate these objectives to your investment team.  By staying focused, you can avoid distractions and concentrate on your goals.  How can you expect your advisors to help you get where you’re going if you don’t know where you want to end up?

The next step is to make sure you consult with an attorney familiar with real estate issues.  Not all attorneys are equally knowledgeable in all areas of the law.  You wouldn’t hire a plumber to do your electrical work, or consult with a foot doctor for a head injury.  For the same reason, a brilliant patent lawyer may not be the best choice for evaluating a real estate investment opportunity.   If you are not sure — ask.  It will save both you and the attorney time — and money.

Next, heed the age-old maxim:  “You get what you pay for.”  Don’t start the conversation “Do you give free advice?”  The right attorney is going to provide you with valuable advice that will be worth the cost.  The attorney – client relationship is not only privileged, and over a period of time your attorney can become a very valuable and trusted member of your investment team.  Work on developing a long-term professional relationship with your attorney, and you will realize a good return on your investment.

Spend wisely.  Let the attorney know your budget.  Most attorneys will work with you, so long as you have realistic expectations and take a reasonable approach.  At the same time, recognize that the true measure of value of professional advice is avoiding the loss of your investment.  If you are investing $50,000 in a project that promises to yield a 10% return, you need to measure your legal costs against the risk of losing the entire $50,000, not as a percentage of your profit.  Remember, you will hopefully be able to apply good legal advice over and over — thus maximizing your return on your legal investment.

Avoid litigation.  One of the reasons to do your due diligence is to avoid situations that will result in litigation.  Unfortunately, there are many:  poorly drafted investment contracts; easement disputes; zoning violations; and overzealous promises, to name a few.  No one benefits from litigation except trial attorneys.  Aside from the costs, there are the inevitable delays, fractured relationships, and lost opportunities.  Again:  Avoid litigation.

Follow the advice.  You paid for it — so use it!  Of course, it’s your choice.  But you should at least give the legal advice some consideration before you take action.  Many times, an attorney cannot unequivocally state that a particular real estate investment complies 100% with all applicable state and federal laws, tax codes, SEC regulations, etc.  Each investor should recognize that there is no such thing as 100% certainty, and adjust their risk tolerance accordingly.

Ultimately, the decision whether to proceed with an investment is up to the individual investor.  Seeking advice from financial planners, tax advisors, real estate professionals and attorneys, as well as from experienced investors, is all part your due diligence.  Getting legal advice before you invest is often a smart investment strategy.

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The Mrs.’ Question #2: Is there a chance I would lose my money?

This post is one in a series of posts featuring my wife, The Mrs. I asked her to pretend that she was a wealthy woman with $2,000,000 (million) to invest. This money was needed to provide her for the rest of her life. She is to ask questions that might come up in the course of investigating a new investment advisor. Please check back for more questions.

Question #2: Is there a chance I would lose my money by investing in real estate?

The short answer is yes. Real estate is an investment and there is a chance that money can be lost.

However, nothing is a guaranteed investment. There is some risk, though it may be incredibly small, no matter where you put your money.

Did you hear the story about the Israeli woman that faithfully stuffed her life savings into her mattress? Over the years she accumulated well over $1,000,000 in cash in her mattress. This was all well and good until her daughter bought a replacement mattress and threw the old one out with the garbage. Who would have thought that a mattress wouldn’t be a safe place to keep your cash?

Strategy and Planning Can Reduce Risk

There are ways to lower the amount of risk you take on any investment.

Diversification

Just as keeping all of your money in one mattress is probably a bad idea, so is placing all of your money in one asset.

Give a portion to seven, or even to eight,
for you know not what disaster may happen on earth.

– King Solomon (Ecc. 11:2)

Spreading your investment capital into different assets protects you from the risk of losing all of your money in one fell swoop.

If you had invested all of your money in New Orleans prior to Katrina, there is a good chance you would have lost a good deal of your savings. Many investors and homeowners learned the hard way that insurance companies are very particular about the difference between rain damage and flood damage.

Leverage

Leverage is the ability to control a large asset with a smaller amount of investor funds. With real estate investing this comes by using a loan. The loan may take the form of a mortgage or a note and deed of trust in California.

With leverage an investor can buy multiple properties, reaping the benefits of diversification. For example, imagine an investor plans to buy his properties with 30% down and a mortgage of 70% of the purchase price.

With $100,000 this investor can purchase three (3) properties valued at $100,000 a piece and have $10,000 in hand for reserves. A purchase price of $100,000 x 30% down payment = $30,000.

Purchasing multiple properties spreads the risk of a loss of income over multiple locations. A tree falling on one property will not cause the investor to lose all of their money.

Caveat: Leverage can cut both ways. If a property were to go down in value, the first thing to decrease is the investor’s equity. This is a risk that each individual will have to determine they are comfortable with.

You Can Lose Money, but You Can Minimize the Risk

Yes you can lose money by investing in real estate. You can also lose money while stuffing into your mattress.

We have identified two ways to minimize risk, diversification and leverage. We didn’t even mention buying multiple unit properties, buying below market properties, and other strategies that can minimize the risk of owning real estate.

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The Mrs.’ Question #1: How much do I have to invest?

This post is one in a series of posts featuring my wife, The Mrs. I asked her to pretend that she was a wealthy woman with $2,000,000 (million) to invest. This money was needed to provide her for the rest of her life. She is to ask questions that might come up in the course of investigating a new investment advisor. Please check back for more questions.

Question: How much do I have to invest with Maclennan Investment Group?

You can invest as little or as much as you want with Maclennan Investment Group. However, you will probably need at least $50,000  to invest in a single property.

We offer investment solutions tailored to the individual needs of each investor. We can provide solutions for people with $50,000 to over $10,000,000 to invest.

Why a $50,000 minimum?

Our investments are not like stocks where you can buy a few shares for $100.

With Maclennan Investment Group you will be investing in the ownership of real estate. You will be buying a house, a duplex, a triplex, or an apartment house with your money. These investments require more capital to begin.

In most regions the average minimum cost of investment quality real estate is around $200,000. A twenty percent (20%) down payment is equal to $40,000, leaving about $10,000 for closing costs. An investor would need $50,000 to invest in this type of real estate.

Are there exceptions to the minimum?

Yes. It is possible to invest in real estate with less than $50,000. However, this solution often requires that you have a partner or partners to make up the difference. Having a partner is not something that everyone is comfortable with.

If you have $50,000 to invest, we can start you on a Course to Retirement Freedom.

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Accumulation and Income

As an investor makes plans for Retirement Freedom, they should keep in mind where they are in the wealth building process.

Investors, generally, can be put into one of two phases depending upon their financial needs and their employment status. I will call these the Accumulation and Income Phases.

Accumulation Phase

During the Accumulation Phase an investor is not trying to live off of their investments. Usually, the investor has a source of employment that generates their investing capital and supports their daily needs.

At this point it vital that the investor attempt to gather and grow assets. These assets need to be as large as possible to create as large an income as possible.

Appreciation is a key ingredient in a successful Accumulation Phase. Appreciation is the growth in value of real estate.

Imagine that you will earn a return of 7% on your assets once you retire. Would you rather retire with assets worth $500,000 or $5,000,000 ?

Income Phase

Once you have quit your day job, retirees need their investments to support their lifestyle. Consequently, income is more important than growth during this phase.

A transition to properties that will generate regular cash flow should be executed prior to your transition from 9-5 to retirement. Hopefully, much of this income is sheltered from the IRS through depreciation.

Why Accumulation and Income Matter

So what? Why should you care?

Your investing phase will determine the types of real estate investments you should consider.

An apartment building that will appreciate slowly over the next 5-10 years and throws off tons of cash flow may not be the best investment if you need to accumulate wealth. It may be the perfect investment for someone in the income phase of their wealth planning.

A four-plex that is break even on cash flow, but will appreciate by 15% in the next 5-10 years isn’t a great fit for someone who needs to survive off of their investment income. It may fit well into the accumulation plans of someone starting out on their journey to Retirement Freedom.

Do you need help evaluating which phase you are in? Do you need assistance making the transition from one phase of investing to the next? If so click the link below to give us a call, we would love to chat with you.

Company Profile

Welcome to Maclennan Investment Group, Inc., your East Bay Area real estate investment advisors. Maclennan Investment Group assists buyers and sellers of real estate maximize the investment potential of their real estate assets.

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Offering real estate services in the communities of: Walnut Creek, Concord, Pleasant Hill, Martinez, Alamo, Lafayette, and surrounding cities.

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925.385.8798

Maclennan Investment Group, Inc.
3380 Vincent Rd, Ste HUB
Pleasant Hill, CA 94523
p. (925) 385-8798
Licensed Broker in the State of California, DRE#01871809
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