Are you "CLEAR"
on What is a
Good Deal?
by Attorney
William
Bronchick
So often
beginning
investors focus
on real estate
investing
techniques
that they lose
sight of the
important issue
- is this a good
deal? Learning
to recognize a
good deal takes
research,
education and,
above all,
experience.
Here's a good
formula to
determine
whether a
potential real
estate purchase
is a deal. It's
a simple acronym
called "C.L.E.A.R."
CASH FLOW
Ask yourself,
will this
property cash
flow? Well,
that depends on
a lot of
factors, such as
the strength of
the local rental
market, the
interest rate on
the financing
and how much of
a down payment
you make. Also,
it depends on
whether it is a
single family or
multi-family
dwelling. All
of these factors
considered, ask
yourself, "will
this provide
income for me?"
Also, ask the
question, "how
will this
property cash
flow compared to
other potential
properties?"
For example, a
$150,000 house
that rents for
$1,000/month has
a better income
potential than a
$300,000 house
that rents for
$1,600/month. A
four-unit
building that
costs $400,000
may bring in
$3,000/month in
the same
neighborhood.
Now, of course,
whether the
property will
provide income
to you begs the
question of
whether income
is important to
you. Is it? Do
you earn other
income? Do you
need more income
now, or is
future equity
growth more
important?
There's no right
answer to these
questions, but
are all factors
to consider when
looking at a
potential
purchase.
LEVERAGE
Leverage is
important in
investing because
the less cash you
put down on each
property, the more
properties you can
buy. If the
properties go up in
value, your rate of
return goes up
exponentially.
However, if the
properties go down
in value and you
have a lot of debt
on the property,
this can result in
negative cash flow
(see above). Since
real estate is
generally cyclical,
negative cash flow
is only a short term
problem and can be
handled if you have
other income or a
cash reserve to
handle the
negative. "Nothing
down" investing is
very attractive for
the high-leverage
investor, but should
be approached with
caution.
If you are a
long-term player,
leverage will
generally work in
your favor if the
markets in which you
invest appreciate in
the long run and
your income from the
properties can pay
for most of the
monthly debt
service.
EQUITY
Does the property
you are purchasing
have equity? Equity
can take a number of
forms, such as:
There are many ways
to create equity,
but buying INTO
EQUITY is your best
bet. Find a
motivated seller
that wants out of
his property and is
willing to give up
his or equity for
less than full
value. Or, buy a
property that needs
work that can be
done for 50 cents on
the dollar or less.
In other words, if
the property needs
$10,000 in work,
make sure you get a
$20,000 discount on
the price or better.
APPRECIATION
Buying in the right
neighborhoods and in
the right stage of a
real estate cycle
will result in
appreciation and
profit. However,
timing a real estate
cycle is difficult
and can be very
speculative. If you
buy properties
without equity or
cash flow solely for
short-term
appreciation, you
are engaging in a
very risky
investment.
Buying for moderate
long-term (10 to 20
years) appreciation
is safer and
easier. Look at
long-term
neighborhood and
city-wide trends to
pick areas that will
hold their values
and grow at an
average 5 to 7%
pace. Combine this
tactic with
reasonable cash flow
and buying into
equity and you will
be a smart investor.
RISK
Risk is a
consideration that
too few investors
consider. Ask
yourself, "what if
my assumptions are
wrong?" In other
words, do you have a
"plan B"? If you
bought for
appreciation and the
property did not
appreciate in value,
can you rent for
positive cash flow?
If you buy with an
adjustable rate loan
and the rates go up,
will this put you
out of business? If
you have a few
vacancies, can you
handle the negative
cash flow, or will
it break the bank
for you? Expect the
best, but prepare
for the worst.
Remember, whenever
you look at a
property to
purchase, think
"CLEAR".
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