I get a large number of news feeds related to real estate and investing, and this week a couple of articles caught my attention. One was at Nasdaq.com and the other at USNews.com. The Nasdaq piece addressed the pros and cons of “turnkey real estate investing.” At USNews, the article discussed growing interest in using IRAs for real estate.
These presented an opportunity to tie them together, as there are many retirement account holders out there not that happy with their returns in the stock market or the ups and downs that come with stock investing. Bonds are safer, but the returns are barely beating inflation, even though it is low right now. I wanted to discuss the points in these articles as they relate to an investor who wants to move into real estate, but they want to do it in a low-involvement way with experts to help.
The Turnkey Approach to Rental Property Investment
There are a great many companies and consultants offering turnkey rental properties to investors. Basically, these companies buy a property, rehab it, and then sell it to an investor who rents it out as a long term investment. Some also place a tenant before the sale with rent that will generate a positive cash flow, even with a mortgage. These companies also manage the property. The investor who wants to invest in rental property without searching out homes, doing rehab, finding tenants and handling management find this an attractive option. There are advantages to this approach:
• Simplicity – Whether the property is local or across the country, this approach allows you to invest simply, without the hassles of management or marketing.
• Professional management and staff – Few people are good landlords and property managers. There’s a lot of legal stuff, as well as touchy tenant problems and ongoing maintenance.
There are some things you’ll need to be careful about however. First, you’ll need to trust the company you’re dealing with, as they’ll be taking over everything, and possibly far away from where you live. Also, you need to run the numbers and know something about that area’s rental market. They’re going to be selling you a property, and even if there is a tenant in it already, the numbers and return on investment need to work for you. You also want to gather evidence that the rental market is at least stable or growing in the area. A vacancy your first year can wipe out much or all of that year’s ROI.
These companies make money in several ways. First, they do extensive marketing and can locate deep discount purchases they can rehab and flip to you at a nice profit. They also are paid for their management services. Even though they’re marking up the property, you may still be able to get a good deal simply because they have a system to locate and buy at bargain prices. You need to thoroughly understand all of your costs and cash flow projections.
Self-directed Retirement Accounts for Real Estate
There is an option for 401k and IRA accounts to be set up as “self-directed.” Doing so allows the owner to invest in assets other than the normal stocks, bonds, mutual funds, etc. You’ll probably have to move your account, as the extra level of management required of the custodian means most of the major firms like Fidelity, Merrill Lynch and others do not offer these.
There are strict rules, and the IRS is quick to remove your retirement tax breaks if you break them, so do your research. Select a strong firm with provable experience and happy investor clients holding rental properties. Since your income is tax deferred in these accounts, you’re not doing the normal tax deduction things available to rental investors. However, many investors with large retirement accounts earning tiny returns have found real estate to be a good alternative, sometimes with double-digit returns.
Combining the Two
Consult an accountant and a reliable investment advisor you trust. You may be able to combine the turnkey and retirement account approaches to get into rental property investment without a lot of time and extra risk from your inexperience. You may want to stick close to home at first so you can drive by your properties for that great “I own that” feeling. Dean Graziosi
A report issued by Clear Capital early in February begins with a pretty strongly bullish comment about housing: “Fifteen years into the new millennium, we are finally seeing real potential that the market can support full buyer momentum.” It goes on to say that 2015 has the potential to be a transitional year when buyer momentum in the low and mid pricing tiers can reinforce a strong housing recovery.
Several data points are cited to support this bullish housing outlook:
• There has been sustained growth in the low tier price segment, which should encourage first time buyers to put a toe into the water. In the past, investors have driven this upward price movement, but more consumer buyers are expected to move it forward.
• Potential move-up buyers are being freed from their underwater mortgage positions by these price increases at an increasing rate.
• Top tier prices actually softened a bit, down 0.3% in the fourth quarter of 2014. January data seems to indicate that the lower price tier is holding on to a double-digit annual price growth trend. In January, that rate was 10.2% higher year-over-year for the low tier market. The article implies a “trickle-down” or tiered staircase:
• The upper price tier has softening prices, encouraging mid-tier buyers to sell and move up.
• This upward movement out of the mid-tier will create opportunity for move-up of low-tier owners/buyers.
• This in turn creates confidence in first time buyers to enter the market, as their fear of buying and going backwards in equity are lessened.
The report goes on to break out data over regions, but all show positive movement. From my perspective the question remains as to whether all of the price encouragement will draw first time buyers into the market in significant numbers. They’ve been conspicuously absent since the crash. I’m not as excited as many about a surge in first time buying.
Home prices are just one leg of a three-legged table. The other two are jobs/wages and the economy as a whole. Job and wage gains are being reported as improving, which encourages consumers. However, they’re nominal, and consumers are expected to continue a trend toward demanding significant discounting before they’ll pull the trigger on larger purchases.
As long as discounting is the tool to build sales, businesses will not be showing the profit levels that fund growth and more job and wage improvement. The younger generations are by and large grouping up for renting or staying at home with parents. They’re trying to reach comfort in their job and wage prospects, and they need to build up down payment money before buying. That’s made more difficult with high student loan payments.
The Retail and First Time Buyer
In general, I think that move-up buying is going to see some healthy gains. I’m not as convinced about first time buyers. This is aggravated by the long term erosion of bilateral loyalty between employees and employers. When data shows you need to hold a home five to eight years to recoup your investment and before profit, you really want to feel comfortable in your current location and employment situation.
The Rental Home Investor
Here we have an interesting situation. While prices are higher, appreciation is better, so it could encourage some investors to buy and rent with lower rental cash flows than in the past. Calculating the overall return on investment with a nice profit at sale can help. Rising home prices are also often accompanied by rising rents, so the cash flow situation can be improved gradually.
It will be interesting next January or February in looking back at all of these early predictions versus actual housing market performance in 2015.
Trulia.com recently released a report questioning if flipping houses is a declining activity because home prices aren’t appreciating fast enough to provide enough profit in flips. A quote or two early in the article give us a better picture of what I think they really are measuring, which is more amateur flipping than professional activity.
Selling houses at a premium generally requires price growth. The more prices are rising, the more profitable it is to flip. Thus, when prices are rising faster, flippers have greater opportunity to come out ahead.
To tease out how price increases affect flipping activity, we focus exclusively on non-distressed sales–transactions not involving foreclosures or short sales–of homes that had last sold within the previous 12 months.
Sure, professional repeat flippers buy homes with the goal of fast price appreciation for a quick profitable resale. But, the article is right in that the strategy doesn’t yield enough reward for the risk unless prices are rising at a double-digit annual pace. When they are, a lot of first time flippers enter the markets as well.
They focus on two sales of the same property within the previous twelve months. They also rule out foreclosures or short sales, areas in which the more experienced flippers concentrate their efforts. Without significant rehab, significant profits are not possible without rising prices.
With these factors in mind, it’s no problem to accept their basic premise. They grouped some average flips between 2000 and 2014 by level of year-over-year price changes when the same home sold. They found that the “flipping point,” when flipping activity picks up, was when prices were rising by 10% or more year-over-year. Areas with this double-digit price increase activity tended to have flipping activity between 4% and 7% of market activity. Areas with single-digit price increases had rates of between 1% and 2% of the market.
I think that it’s a valuable study, and it should be a caution to investors or would-be investors who want to make money flipping homes almost totally from rising prices. Every day you wait for the price to rise to a profitable level is another day of risk. There is also added holding cost, which is working against you, especially if you have short term financing involved.
The Pros are Still Very Active and Profitable
The most active flippers are those who do rehab, and they normally buy distressed properties, not included in this Trulia study. They shop for short sales, foreclosures, and even estate sales to locate discounts below current value. The less rehab that’s needed, the greater the necessary discount. They don’t want to sit around holding the home hoping for price increases to bail them out.
The more rehab needed, particularly with foreclosures needing a lot of work, the greater the potential for short term profit. The goal is normally to have a buyer locked in even before the project rehab is completed. And, they’re normally not requiring a rise in prices for their desire margin, though it certainly helps.
The successful rehab flipper has these major profit contributors on their radar for every deal:
• A purchase well below market value, even lower than it’s current value in current rough condition. Lock in a profit even with a short flip without the necessary work. This is a negotiation skill factor. • A project system that’s well-refined and the right material sources and contractors who consistently perform on time and on budget. • If funding is necessary, its cost is factored into the project and profit markup applied. • Rehab work that can be performed at wholesale level with a markup that adds profit to the project. • A buyer ready to buy at a price the flipper has factored for the desired profit margin.
This whole process is not at all considered in the Trulia study, as it is focused on flipping for price appreciation. Good information, but those who are experienced at fix & flip, or those who want to be, should move right past it. There isn’t a correlation. There is still plenty of opportunity out there for the fix & flip investor. Of course, it doesn’t hurt if a project takes a planned six months and the home’s ARV (After Repair Value), is a couple of percent higher than when the project began. Dean Graziosi
More reports, studies and surveys are telling us that demand for rental properties is rising. It’s to be expected when:
• Millennials are beginning to move out of their parents homes, but most can’t buy due to credit or down payment situations. • Though jobs reports are showing improvement, much of it is due to people dropping out and no longer looking, so renting is still more available to many than buying. • College graduates aren’t finding the high paying jobs they were expecting in many industries, though some are doing well, such as technology. • The Boomer generation isn’t always downsizing into another purchased home. Many are choosing to rent and stay more mobile in their retirement. • There is overall a lack of confidence in home prices and near term appreciation.
The law of supply and demand is always in charge, and rental demand is rising while supply is struggling to keep up. For this reason there is a definite “boom” in multi-family property construction. Investors have noticed and are fueling the boom with their money. CBRE, a global real estate company, issued their U.S. Multi-family MarketView Report recently. It predicts a rosy near term future for investors in the multi-family market.
Multi-family investment is definitely leading the commercial real estate sector in funds infusion. Brian McAuliffe, a senior managing director at CBRE, cites three trends that represent recent investment activity:
1. Total investment activity is now seeing a rise in private non-institutional buyers. 2. More foreign capital is moving into the multi-family market. 3. REITs are less active in multi-family than in the recent past.
A verifying factor is the average price of an apartment unit. It has risen 5.9 percent year over year. According to Jed Kolko, chief economist at Trulia, “Nearly all of new household formation right now is renters. Young people are starting to move out of their parents’ homes, and both young and older adults are having a hard time buying houses.”
Multi-family properties can be a good expansion of a real estate portfolio. They attract investors with economy of scale, lower purchase and maintenance costs per unit. In the third quarter of 2014, multi-family sales volume rose 28 percent over the same period the previous year. More investor and tenant demand is spurring more construction, and that is increasing demand for funding.
Lenders are responding with some attractive terms and rates because they see the strong demand and cash flows. They’re not getting careless however, continuing with conservative valuations and loan structure. This has led to an increase in interest for crowdfunding. This is where some small investors can get their foot in the door.
You don’t have to buy one or more full units with crowdfunding. You simply invest your funds in the project and participate in the profits according to your share of ownership. It’s a way for small investors with limited funds, sometimes just a few thousand dollars, to own a share of income-producing multi-family properties.
If you can fund a larger purchase, smaller multi-family properties like duplexes to four-plex properties are a great way to break into the market. You get the economy of scale that multiple units under one roof generate. This increases ROI and cash flow due to lower per-unit expenses. You can even expand your funding resources if you live in one of the units. VA and FHA loans may be available if you live in one of the units.
As the supply of foreclosure units continues to shrink, it may be time to look for opportunities in the multi-family market.