THE NAME OF THE GAME IS PROFIT, NOT PROPERTIES By David A. Chodack You've seen the ads: "Buy real estate with no money down!" "Buy with no cash or credit!" and they work, too. Many people have built their fortunes starting with little or nothing, pyramiding one property into the next. The problem is, that some times you get exactly what you pay for or even less and so many others wind up broke and frustrated, buried under negative cash flows and convinced that real estate investing doesn't work. The key is understanding the difference between owning properties and owning equity. The key to getting rich in real estate is not how many properties you own, but how much equity and cash flow you have. Equity and cash flow mean cash in your pocket and dollars added to your net worth. Owning a lot of properties means a lot of responsibility, but not necessarily a lot of profit, even if you buy them with no money down. A famous author once proved the truth of this statement, however unintentionally, when he set the challenge to buy real estate with no money down. "Take away my money, my identification and my credit" this famous author said, "leave me anywhere in the United States and I will still buy real estate with no money down." When a newspaper took him up on the challenge, he simply called a real estate broker who had taken his course and asked the broker to help him find properties to buy with no money down. He did not specify that the properties had to have any equity, or be good deals. They just had to be available for purchase with no money down. As a result, the author had no trouble winning the bet. He was able to locate and purchase several properties with no cash out of pocket. The problem was that all these properties were purchased at or above market value. This is why the Sellers were willing and even anxious to sell with no money down. The famous author didn't care. He had no need to hold on to the properties once he purchased them. The terms of the bet only specified that he would buy properties with no money down. He never claimed that he was making money with these properties. Therefore, as soon as the bet was over, the famous author let most of the properties go. In most cases, he never even closed escrow. There was no reason to. He had accomplished his purpose just by buying the properties. Since they offered neither equity, nor positive cash flow, there was nothing to be gained by closing escrow and taking possession of the properties. Unfortunately, not all investors are this sophisticated. Too many investors still believe they will get rich automatically just by buying real estate, especially if they can buy with little or no money down. For example, a friend of mine once purchased a condo for no money down. She could not afford to live there, so she decided to rent it out. Between the mortgage payment, taxes, insurance and condo maintenance fees, she knew she would be facing a negative cash flow of about $100 a month, a significant sum for her at the time, when she was employed only part-time and could barely meet her own rent and expenses. However, she was so thrilled to own a piece of real estate, particularly one that she had purchased with no money down, that she convinced herself that it was worth the sacrifice. Then reality hit her in the face, like a brick wall. Her $100 a month projected negative cash flow, was based on everything going right, i.e., finding a stable tenant who would pay the rent each month without fail and not getting hit for any unscheduled maintenance and repairs. Unfortunately, things did not work out quite the way she planned. Almost immediately, she ran into tenant problems. First, the place did not rent as easily as she had hoped and when she finally got a tenant in there after almost a month with no rent, it turned out to be the mistake of her life. The tenant was a racial minority and visually handicapped as well. He knew that this made him practically eviction-proof and he took full advantage of the situation. By the second month, was demanding unnecessary and unreasonable repairs and improvements and when he didn't get what he wanted, he stopped paying rent. My friend was devastated and did not know what to do. I advised her to sign the place over to the bank and walk away before she lost even more money. It was a no-win situation and with no equity, she had nothing to gain by hanging on to the property. This is an extreme case, but a true story. It took my friend a while to realize the difference between owning properties and owning equity, but today, she is a self-made millionaire. She doesn't own a lot of property, but she has millions in equity and a positive cash flow of several thousand dollars a month. She is set for life. Beware of Sellers who are too willing to sell you property with no money down. You can get many excellent deals this way, but you can also get many bad deals. The key is to look at the numbers carefully, to be sure what you are really getting. For example, let's say that someone is willing to sell you property that is worth exactly $200,000 for $200,000, with no money down. If you want the property to live in, this can be a great deal, but if you're buying for investment purposes, you have a lot of research to do. First of all, how much will the property rent for? How much will it cost you each month, including taxes, insurance and maintenance? How fast are properties in the area appreciating? How much tax write-off will you get and how badly do you need it? If properties in the area are appreciating quickly and/or you need the tax write-off badly, then it might be worth it to you to put up with some negative cash flow for a while and then sell the property for a profit. On the other hand, if properties are appreciating slowly or not at all and/or you have to put up with a heavy negative cash flow, then you'll probably better off passing up the property. Nothing down can wind up costing you big money if you buy wrong. For example, you buy the property for $200,000. It needs $10,000 worth of work. It's costing you $1500 a month, but you can only get $1000 a month in rent. You turn around and sell the property for $200,000, exactly what you paid for it. You lose $10,000, plus $500 for each month you own it, $1000 more for each month that it is vacant. But, that is not the end of your loss. You also have expenses when you bought the property and now you have expenses again when you sell it. The real estate agents commission alone will be $12,000. Even if you sell the property yourself, without an agent, you still have to pay some closing costs and all together, you can usually lose $20,000 or more, by the time you get rid of the property. So how do you avoid this? You look at the Sellers motivation. Every seller has a problem. Otherwise, they would not be selling. Sometimes the problems are minor. For example, the seller is leaving town and doesn't really want to rent the property. However, the seller does not get the price he wants, he does not have to sell. This is not the type of seller you want to deal with. You want to deal with the seller who is forced to sell because of serious problems, but even then, you want to narrow it down a little further. You want to identify the type of serious problems the seller is having, and how they might affect you, before you make an offer. The serious problems that can force a property owner to sell, fall into two categories, those that stay with the property and those that go with the Seller. Guess which ones you want to look for? For example, let's say that the seller is anxious to sell, because he has found a job somewhere out of the state. He has already bought a new house in the location where he will be moving and so he is anxious to sell the existing house as quickly as possible. This is a no-brainer. There is no way the seller's problem, will affect you. His problem has nothing to do with the property itself, so this is an ideal situation. On the other hand, let's say the seller is having problems with the property. Before you make an offer, you want to decide whether the property itself really is a problem, or if the seller is just a poor manager. For example, maybe it is a four unit building, but only two units pay their rent consistently and on time. Obviously you need to replace two tenants, but will this really solve the problem? How easy will it be to replace those tenants? Are those two tenants just deadbeats, or is there a problem with the building, and/or the neighborhood? Is the seller just a poor landlord, or with those the best tenants that he could get under the circumstances? What if it turns out that the tenants who pay their rent on time are the exception, rather than the rule? All your skills at managing property and people may not do any good, if you're taking over a building that is in bad condition and/or in a bad area, where tenant problems are than the norm. Maybe the seller gave special breaks to those good tenants, in order to induce them to stay in the building and keep paying their rent on time. He might be glad to sell you the building with no money down, because he knows something that you do not. Don't be discouraged and decide that no money down deals don't work. Just be aware that you have to do your homework and make sure what you're buying. Remember the seller will always have a reason for selling, particularly for selling with no money down. Make sure that you understand that reason and what effect, if any, it will have on you as a new owner. In general, you'll probably find that you get better deals when you can structure your no money down transactions so that the seller does get some cash. If the seller gets some cash, but it doesn't come out of your pocket, then everybody wins and the seller has more incentive to give you a genuinely good deal. If he or she is getting some cash, then he or she has reason to sell, beyond just wanting to be rid of the property. Your challenge as a creative buyer, is to give the seller what they want, so that they will be motivated to give you the good deal that you want. You can do this with new first loans and/or with junior (2nd, third, fourth, etc.) loans, or with wraparound loans, where the seller retains responsibility for any existing loans and then agrees to carry a new loan for you, usually at a higher interest rate, which allows them to make money off the point spread. Just remember, when you negotiate your deals, is the seller's equity that you want, not just the property. The more you can offer the seller in terms of cash and/or other incentives, the more likely the seller is to give up at least a piece of that equity. In other words, if the property is worth $200,000, then you don't want to pay more than $170,000, or $180,000 at the most. If you do, then in most cases, even if you do get the property for no money down, at best, you'll be paying nothing and getting nothing in return. BACK TO THE REAL ESTATE ARTICLES PAGE CONTRACT WIZARD HOME PAGE TAX SALE RICHES HOME PAGE MORTGAGE MAGIC HOME PAGE |