7 April 2008 182 views 4 Comments Print This Post  Email This Post

Whether or not real estate is the path to wealth is a tough question to answer. In her recent article about real estate, Thursday mentioned that the idea of building wealth through one’s primary residence has become a little tarnished. I agree because homeownership is not the best option in a lot of major metropolitan areas. In a past article, I showed why renting is smarter in the San Francisco bay area. However, homeownership and real estate investment are two completely different things. In areas with high rent and job growth, it may be wise to purchase a rental property during this soft market. Additionally, we are experiencing some of the highest foreclosure numbers in recent years. For savvy investors, now is the time to strike.

Where Are the Deals?

While foreclosures are everywhere, not all of them in all areas are good candidates for an investment property. I look primarily in areas that are undervalued, very much like a stock. I look for low real estate costs compared to income levels. I look at high rent amounts compared to real estate costs, much like a P/E ratio in the stock market. Lastly, I look for places with signs of growth. While there are many cities throughout the nation with my criteria, I’ve narrowed down my search to the Houston, TX area. On specific properties I look for homes built after 2000 in areas with good school districts. This shows me there is a stable rental market and maintenance is minimal. The property must also be in foreclosure or otherwise be significantly under market value. Take this property for instance. It’s something I would buy. It’s a foreclosed property listed at $107,000 and it is a prime candidate for anyone looking to get into real estate investing. Here’s a quick breakdown of the conservative numbers I used when evaluating it.

Results

This undervalued piece of real estate would rent for $1200 according to my property manager. I used a figure of $1150 to be conservative, and it gives us a 6% cash on cash return on investment annually even with a 10% vacancy rate. 6% is not bad, certainly better than index funds at the moment as well as CDs, but that’s just the beginning. If I bought this property I would hold it for 10 years and increase the rent by 2% annually. I also estimated a very conservative 3% annual appreciation rate. With those conservative numbers and the power of leverage, we get an approximately 22% internal rate of return. You would earn an average return of 22% annually. Keep in mind I didn’t take into account selling costs because I estimate that by purchasing a foreclosure, the “built-in” equity will cover those expenses. Now, anyone who knows me know that I love stocks and mutual funds for the sake of diversification, but a 22% ROI kicks mutual fund ass. Even the most successful investors say that we won’t see the spectacular ROI that we’ve seen in the past from stocks. That being said, this property is an example of a pretty good investment and it’s just sitting on the market waiting to be snatched up.

Don’t Limit Yourself

The deals are out there, but you don’t have to limit yourself to certain areas. Don’t be afraid to go beyond a 50 mile radius. You know, Donald Trump doesn’t own real estate in NYC alone. He has great people around him, property managers in our case, making sure his properties are performing well throughout the world. I was born and raised in San Francisco and I’ve lived here all my life but I’ve traveled to upstate New York, Texas, and Vegas to research potential investment properties. When I was 21, I remember driving 8 hours to and from the central valley in California with my friend when we were looking to buy our first investment properties. Now, along with many investors, I’m looking at Texas, which is a great place to look for foreclosed deals. These deals are everywhere. You just have to look and do your homework. With the government pushing to bail out banks and people near foreclosure, they won’t be around for long. The time is now.