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No. of Recommendations: 3
Fools,

I learned one great lesson from the last thread(among many smaller ones). As I mentioned previously, I have just begun looking for my first REI deal. I don't know if you all were like me when you started, but I am almost overly anxious to get the first notch in my belt, so to speak. As soon as I saw an opportunity for positive cash flow I was ready to jump all over it before I missed the opportunity and somebody else scooped it up!

I now realize that I don't have to buy everything that has a positive cash flow, and that I can screen a little harded to find the right opportunity for me. I am now more particular in what I am looking for in a good REI, and know that I may have to look at a hundred or more before I find something that is going to make me some good money. I probably won't be investing in more than one property every couple of years, so I should expect that it may take this long to find the one that is suitable for me.

When I had first begun my search, I would have been happy with a 15% ROI on my first investment, but no longer. I am going to look hard and evaluate almost every opportunity that comes on the maket to find a GREAT investment rather than one that I beleive will provide only an 'average' return.

Patience is a virtue! You think that I would have already learned this lesson from investing in the stock market, but apparently I am a slow learner.

Good luck Fools and have a great weekend.

ThePup
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No. of Recommendations: 8
The problem with a 15% ROI is this. Much of it is non-cash, and there is a serious downside risk to real estate, which is exacerbated when most of your return is non-cash.

Vacancies. You have in the recent past heard Trick complain about them, and if you read back through this board to the beginning, you will find me complaining of them also. In fact, my vacancies very nearly sank me in early 2000 - and I am still recovering, even though on paper I am worth several millions.

Vacancies may occur for many reasons. For me, in the last few years there have been two reasons. First, the strong economy has caused many of the better tenants to buy houses. This has impacted me in several neighborhoods.

Second, I have been working to reposition a major property, and in order to do it I first had to throw out a lot of people. Then I had to struggle for a long time with the reputation the property had. This was a hard one; convincing people that "it is different now" takes a long time. It took me a lot longer than I expected and cost a lot more than I expected. When I began, I expected it to cost about $60K in lost income to turn the place. In fact it has cost over $200K.

Now, I could have withstood EITHER the loss of tenants due to a historically powerful economy OR the cost of repositioning the complex. But both together have been brutal.

I have survived on my reserves and on my nerve. My reserves are nearly depleted, and my nerve is shot. But my system wide occupancy is now at 86% and rising, and this major property has turned and is now filling so quickly that I literally cannot keep up.

We have entered another stage of the cycle, and I do not fear the loss of tenants due to house buying binges for the next several years. I now am seeing a lot of people who are (a) splitting up and one of them is coming to me or (b) they mortgaged to 125%, are upside down, one of them has lost a job, and they are giving the keys to the bank and coming to me. These people won't be purchasing again for a long time, if ever.

The moral is this. A 15% total ROI looks very attractive when you see the infomercials or due your financial statement, but when much or most of it is not cash, in your hands every month, then it is a paper gain that can vanish in a short time and, under any circumstances, won't do you any good if you hit circumstances where you need cash quickly.

Realistically, you want to see 10 or 15% cash return, at a minimum and based on conservative assumptions. Let me emphasize: conservative assumptions. If you can achieve that, then your total ROI will run 50% or better, and you will find yourself with a cushion when (not IF, but WHEN) things go south. If you have enough cushion, then you will have the time you need to do whatever it is that you need to do to straighten things out. Just remember that real estate is NOT a liquid asset, and being forced to liquidate just hands your profit to someone else.
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I'll also say that it's important to know there are properties out there that will turn a good cash flow. ThePup describes the problem well, when at first, it seems like any positive cash flow is good. You want to jump, but that's because you don't really believe there are better deals out there. It's inexperience. Beyond that, it takes more work to find a good deal. Usually, lots more work. Lots of dead ends.

I have a loose goal of buying a property each year, sometimes more, sometimes nothing. I have a little extra time in the summer, and that is when I get serious about shopping. I pretty much look at everything that is available. EVERYTHING. I have to find something positioned differently or that others are missing. Here is what I have right now.

The place I'm offering on right now is a fantastic little house. The location isn't perfect but it isn't bad either, but the charm factor is through the roof, which means it will rent easy. Excellent wood floors with wood built-ins, plaster walls with rounded corners and arched doors, a fire place, and a huge living room and dining room with lots of sun. It will be the largest two bedroom in town. The houses in this section of town are selling for about $95K-105K, this one was listed at $79K. If that were the whole story, the first person who looked at it would have bought it.

This place has a gutted basement, with a 1.5 foot trench along two exterior walls empyting into a sump pump basin. I can imagine anyone thinking of buying this place a home would be charmed until they went downstairs, where even if they see the way the water problem was mismanaged, they also see a lot of work. People want to move into a home, they don't want to repair it from day one. That rules out homeowners as buyers.

I brought my contractor in and we went over the place carefully. I was sure the owner simply didn't know what he was doing and this added to the bad appearance and made the water problem seem worse than it is. The contractor agreed, and was kind enough to write out and defend a $14K bid that would bring this house to a point where water will not be a problem for another thirty years. I got a second to come in, and he bid at $13.3K. (Both are way too high, including hand digging the trenches and billing $33/hour for ditch diggers. Yeah, uh-huh. I've got a guy who will charge me real prices.) I know another $5K will be needed for sheetrock (the walls are framed) and flooring and carpet (because I did a similar job last summer) and I have another 2 bdrm apartment ready for $500. Upstairs will go easy for $650.

By this time, the house has been shown to at least fifty people without an offer. The owners are divorcing, and they just dropped the price to $69K. That still doesn't work for me, because the basement is a bit of a crapshoot, and I have to offer a price that makes the house work upstairs only, in case I am wrong about the basement (I'm not.)

I offer $55K and I ask for all the appliances and that the owner fill the ditch and paint the house. I'm pretty sure I'll get it for $57K and no work done, but with all appliances. (I would have had to go higher, I'm sure, without the divorce. I love divorce, because I can't go higher and make this work for me.) The key is offering the low price. You can't lowball as a rule and succeed. This property has many things working against it.

So what do we have: I'll take the $12K down out of another building and finance the rest, all at 7.75%. Banks are doing home equity type loans now even on non-owner occupieds, so the fees will be low, I might be paying about $1000, which I might ask the seller to cover. Anyway, my payment is $410, plus about $125 for insurance, sewer, water and garbage. Figuring $100 per month maintenance (too much) gives me a slightly positive cash flow on monthly rent for upstairs only. I'm getting the downstairs (and its water problem) basically for free. I spend the approximately $16K to put in another 2 bdrm over the next six months, and I get the $500/month from that, minus $190 equity loan, plus another say $40 for increased water and garbage, gives me $270/month, or somewhere around $300 month on a house I basically paid nothing for.

I did use up $12K worth of equity in another building, so you can factor return on that if you wish. Where I also benefit, as a working man with a salary, is the added tax benefit of the depreciation. I get another $100/month because of it. I'll have the remodeling loan paid off in 7 years, so that will add money then, plus, as houses increase in cost faster and faster around here, the rents will appreciate faster than an apartment building.

If, on the other hand, this isn't working out like it should, my cosmetic improvement alone and the added value of the apartment downstairs makes this immediately sellable at about $95K, minimum $90K, giving me a $16-19K return in a year. I consider this a good use of my $12K equity just sitting in another building. It might not be a deal Jim would do, but it works for me this year.

Rick

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If, on the other hand, this isn't working out like it should, my cosmetic improvement alone and the added value of the apartment downstairs makes this immediately sellable at about $95K, minimum $90K, giving
me a $16-19K return in a year. I consider this a good use of my $12K equity just sitting in another building. It might not be a deal Jim would do, but it works for me this year.


Once upon a time I would have done that deal. These days though I seldom fool with single houses (although I still have several of them). I tend to prefer much larger properties, which give me the economies (and costs) of scale.
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