Real Estate Investing

November 24, 2009 by Peter Maclennan 1 Comment

Investing in Real Estate Notes

A note is a signed document between two parties acknowledging a debt and promising repayment. Simply put it is a promise to pay.

Bob borrows $10,000 from Paul to buy a house and signs a note for $10,000 agreeing to repay the debt in one year with 6% interest.

A note can be secured by real estate. This allows the lender to sell the property if the borrower does not faithfully repay the debt as agreed in the note.

In many states a mortgage is used to secure a note with real estate. In California the most popular means of securing a note with real estate is a trust deed or deed of trust.

Many notes are originated when a piece of real estate is sold. If the buyer is unable to procure financing to buy the property outright, the seller may “carry back” a note secured by a deed of trust.

For instance, Bob is buying a house from Paul for $100,000. Bob has $15,000 cash and is able to get a bank loan for $75,000. This leaves him short of the purchase price by $10,000. Paul can take a note from Bob promising to pay $10,000 if Bob is willing to pay interest on the $10,000 and repay the balance in 5 years. Both parties win. Paul is able to sell the house and Bob is able to buy the house.

Notes as Investments

A note is similar in concept to annuity. The investor makes an initial investment, the loan. If all goes according to plan, the investor receives steady payments from the borrower until the debt is repaid.

Notes are generally good investments for those that have reached their retirement years. Notes offer income to the investor that can be used to fund monthly expenses.

Real Estate Note Variety

Real estate notes come in all sizes and shapes. Notes can be secured by homes, office buildings, shopping centers, apartments, vacant land, or warehouses. Notes can range in value from a few thousand dollars to millions of dollars.

Buying Notes

Notes are often sold when the original lender needs a lump sum, rather than income.

For instance, Paul needs to pay his daughter’s college tuition of $7,500. The $50 of monthly interest is not sufficient to pay the tuition and he requires a lump sum.

Paul could sell his note to an investor. If the investor pays the face value on the note, $10,000, the investor will receive a 6% return on their money until the note is repaid.

Discounting Notes

If an note holder is willing to accept less than the face value of the note, this note is said to be discounted. The note buyer will be able to realize a return greater than the stated rate.

For instance, Paul loans Bob $10,000 for one year at 6% interest due at the end of the year. That same day Paul sells the note to Jim for $9,500. Jim will earn a return of 11.58% on his investment of $9,500.

For the savvy investor, buying notes at a discount can be a great means of earning above average returns.

August 27, 2009 by Peter Maclennan Leave a Comment

The Mrs.’ Question #3: How often will I get money or interest from my real estate investment?

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 # 3: How often do I get money from my real estate investment?

Their are many different types of real estate investments. They range from bare land and developed lots, to office buildings and houses.

Most of the investments that we assist our clients with are income-producing investments. This means that the properties have a tenant (renter), of some kind, that pays rent.

Typically, an agreement is made between a landlord and tenant through a written lease. The lease will spell out the details of how much the rent is and how often it will be paid.

The majority of leases are written to receive monthly rent. Some leases are over longer periods of time. For instance, agricultural land is generally leased on an annual basis. But the majority of leases are written with monthly rent.

Generally, Monthly Income

Most investors when they start out will invest in multi-family investments. Rent is usually collected on a monthly basis. Therefore, you can expect to get monthly income.

The amount of income can vary from month to month. Buildings need repairs, tenants move out, and taxes need to be paid all affecting net income.

August 27, 2009 by Peter Maclennan Leave a Comment

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?

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.
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.
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.
Credit markets are still stuck. Financing for buyers is difficult to obtain without a significant down-payment. Probably not the bottom.
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…

Invest now if, you do not need appreciation to achieve an acceptable return on your investment.
Invest now if, you have enough liquidity (cash) to cover potential vacancies or repairs after acquiring your property.
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?

August 26, 2009 by Peter Maclennan Leave a Comment

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.

August 13, 2009 by Peter Maclennan Leave a Comment

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

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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