Investing in Real Estate Today: An Investor’s Story
If you’re investing in real estate or planning to, this story provides some valuable lessons. This is not someone just starting their foray into real estate investing or someone jumping on the foreclosure bandwagon. This comes from my own personal experience. As a real estate investor for 30 years, I’ve seen my share of real estate cycles, but nothing compares to what we’re experiencing today.
I recently had an exchange on an investment property that I need to do to continue tax deferral. With a standard 1031 exchange, you have 45 days to find a replacement property and 180 days to close.
However, my exchange is not a typical 1031 exchange. It’s from an insurance payment on a property that was part of a previous exchange. This property had a sinkhole and because of this the insurance company no longer wanted to insure the property so they paid me at the fair market value of the property which was higher at the time than it is today.
I paid off my loan with the proceeds and then resold the property “as is”, fully disclosing to a nice couple who probably never could have had the luxury of living in the community where the property was located. We did the closing at a local lawyer’s office, as I did not want any mistakes in the sale of this property. For those of you who are not familiar with the exchanges, because it is a secure payment, it gives you more time to roll over.
If I don’t reinvest the earnings dollars and my basis from this insurance exchange, I have to pay taxes. Trades are tax deferred until you stop making them. You then owe the tax that goes back to your basis in the original exchange. In other words, I would have to invest more money than I received from this insurance payment.
Normally, it would not be that difficult to obtain another property. However, due to current market conditions, it’s not just about finding the right property, it’s about getting the financing. Financing in today’s climate is quite challenging with lenders not lending and high borrowing rates from investors.
Even if you can get a loan, the sheer number of foreclosures and short-sale properties is overwhelming not only for lenders (who are at least two months late) but for us investors as well.
Not to get discouraged, I decided to see how things really stood in a market I know and understand, but haven’t invested in lately. I also thought that I could find the money from other “financial friends” if necessary. I’ve been a real estate investor for a few years and have known a lot of resources in the industry, so I wasn’t worried. With my strategy in place, I headed out to buy real estate in Florida. I know, some people go for the sun, but since Florida is on sale and I love to shop, I headed south.
Before I went to Florida, I reviewed dozens of foreclosure sites, did cost-of-living studies; I researched education, the arts, crime, and other statistics I felt were necessary to identify communities where I might be interested in investing in real estate before moving to Florida.
I had 3 goals for my real estate tour.
Must have cash flow
The property must generate a positive cash flow. If I make a 10% down payment, how much will I earn each month to cover the 10% down payment? How fast will I get my money back? Is there enough positive cash flow to offset emergencies, vacancies, or other surprises? I expect a positive cash flow on my investment.
reinvest the profit
He needed to be able to reinvest the profits from the trade.
newer communities
My investment practice is to be able to invest in newer family communities where people want to live. Is there a pride of ownership in the community? Are there services such as shops and schools nearby? Is the interstate close but not right in the backyard?
I read with interest that Florida is on sale. Now I needed to see for myself if the sale is like a promotional sale where the retailer advertises a sale but there really isn’t a huge sale, or are we talking SALE!
Once I arrived in Florida and began my journey, I quickly learned one thing that every real estate investor, experienced or not, should know. If you think you can buy property over the internet from these fancy websites that have instant quotes among other bells and whistles, FORGET IT! There is no way for you to try to buy anything on the site without being seen. Even if you have a trusted person in an area you want to invest in, trust but check. Get on the plane, in the car, on the bus and see for yourself what you are buying or stay out of this market.
I found that in communities that are overbuilt, tons of homes are empty and property values in the communities are well below 50% of the 2007 high. I visited three communities on my trip; One area was so bad that he was convinced that empty houses outnumbered occupied ones!
I also learned a few things about Florida real estate that I didn’t know before.
drywall problems
Everyone was talking about homeowners’ lawsuits against builders and previous owners of poorly built homes with drywall problems. Apparently some of the neighborhoods in the developments I was visiting are experiencing environmental hazards as a result of drywall that didn’t cure properly. So not only do I need house inspections for the structure itself, but I also need an additional inspection for a new problem on homes built from 2004 to present.
on speculation
There is more than one reason why properties are for sale in Florida. Many areas I visited had properties that investors bought on speculation. Once turned upside down, these investors walked away from the property. There are entire communities vacant as a result of poor decisions by investors in the recent past and now the communities are in various stages of completion. For my part, I am not interested in acquiring property in areas where no one wants to live.
HOA Fees
Many new communities have HOA (homeowners association fees) agreements and fees that are outrageous. In a community I would have to pay almost $200 per month to just one community association, which would impact my cash flow. Also, if there are enough foreclosures, short sales, or other distressed properties, who pays the HOA owed on all these troubled properties, and can the community keep up with the maintenance these fees pay?
I must have looked at 3 dozen short sales or foreclosures before I found one I was ready to make an offer on. It turned out to be a property that the borrower had no taxes and insurance on in an escrow account paid for by the lender, so he was behind on his taxes and insurance… 3 years ago.
The tax lien was sold as certificates to an investor and now time was running out. The property needed to be sold and the deal closed in early June or else the investor holding the tax lien certificates could sue over the deed.
The chances of the lender allowing approximately $15,000 in back taxes to get in the way of their position were slim to none. The lender wanted and needed a sale and a closing. Period.
The sale price of this house was $249,000 in December 2008. The lender lowered the price to $199,000 in March 2009. I decided to make an offer. With the short time available to close, it had to be an all-cash offer to get the bank excited.
The property was a 4 bed 2 bath in a nice area where people want to live. I did a cash flow analysis, did some research, and determined that I would make $1200-$1500 a month in rent.
I ended up making a $130K cash offer. He would find out how he would get the cash later, but at least he had an offer with a deposit that the bank could review. In the past, that would be enough for the bank.
In today’s market, my cash offer and deposit were not enough for the bank. They wanted verification that the funds would be immediately available before accepting the offer.
No verification. No acceptance.
Another lesson learned. This is not the financing experienced investors are used to. You better have the cash or financing in place before you go shopping. With the economy the way it is, the banking industry in crisis, all markets tightening, and the average credit score falling to 651 (according to Trans Union, one of the top three credit reporting companies), banks want cash. They just don’t want to be the one to give it to you!
In the end I did not get my offer for the house nor did the bank accept it. I decided to go home and look locally, develop relationships with those investors who have something to sell at the right price, make connections with local lenders. Focus on other strategies besides short sales where it may be easier for my offers to be accepted and not compromise my investment strategy, which is to buy single-family homes in neighborhoods where people want to live.
The real takeaway for me in all of this and a lesson I learned was not to think that the market I’m targeting is on sale; that I can just go to an area on a one-time trip and buy what I want for the price I expect to pay and in the end… nothing is as easy as it seems.