Leveraging Equity vs. Paying Off Mortgage

I had a good conversation yesterday about which strategy works best, leveraging the equity in your property to buy other properties or to pay down the principal to be free of the mortgage.

The example we were debating was whether it was better to own 5 properties free and clear or to own 10 properties that were still being financed.  If these properties are cash flowing at $1,000 a month then the difference is $10,000 a month versus $7,000 (your profit margin is higher than $1k a month if you've paid off your mortgage).  

I would tend to want more profit because you can use the cash to pay down the principals faster.  With that said the big issue is managing risk.  There will definitely be vacancies to account for and other expenses like maintenance and owning 10 properties leaves you exposed to a lot more variables.  

That being said I think a combination of strategies is the best approach.  I think the leveraging equity is ideal for beginning investors who do not have enough capital to buy properties with cash.  When you build your cash reserves and have several properties then it is probably more ideal to pay off your mortgages and then buy another property free and clear.

Real Estate versus the Stock Market

I was recently in a debate about which investment vehicle is the best one to invest in.  More specifically I made the comment that real estate is the "fastest" way for people to become wealthy.  I said this because no bank will ever give you a loan to buy stocks, however they will gladly give you a loan to buy a property.  This key difference is why you are able to make money faster through real estate, you are leveraging the bank's money to get more valuable assets.  Buying stocks overtime will make you wealthy but buying a valuable property at a low price gives you instant equity. 

There are ways of building your wealth through dollar cost averaging and buying stocks over time, but real estate in my opinion is the fastest way to wealth.  There is one caveat here, buying stock options might be a faster way to gaining wealth.  I however don't recommend everyone buy options and try to build wealth that way.  There is more risk in buying options because you are not buying the underlying asset.  You are buying an opportunity to buy something.  You can however leverage your money in a greater way through options trading which will generate larger amounts faster.  That said I do not think the everyone should use this as a vehicle.  I think if you are dedicated to learning about it and doing the research then by all means see if you can master it, but it takes skill and a lot of research.

In essence buying properties at a discount, fixing them up to gain equity and renting them out, is a great way to build wealth quickly, and if you supplement it with buying dividend paying stocks using dollar cost averaging then you are well on your way to financial freedom.

My Early Real Estate Transactions: Contracts for Contractors

Back in 2005 I saw a building for sale on a main road near my parent’s property in North Carolina.  The road is a well-traveled and busy thoroughfare so I thought it would be a great investment for a commercial property.  Aside from the location the asking price was around $25,000.  That, I thought, was a steal.  I contacted the owner went through the negotiation process and bought the property at $22,000.  

Now the property needed some renovation so I asked some of the people my dad knew in the area about renovations and they recommended a guy to me who wasn’t licensed but did great work.  I contracted the job out to him and he started work.  I told him that my payments to him in the beginning would be small but that I would have more money to give him in a month or so.  This was my first mistake.  I should have drawn up a contract and clarified everything in writing.  

They contractor complained a few weeks in about getting payment and I told him that I had a large payment that was coming in a couple weeks.  When I did pay him, I gave him extra to pay for future work so he wouldn’t feel neglected.  To my dismay, he took the money and ran.  I never heard from him again, neither did the guys who recommended him ever hear from him either.  It was a dramatic and painful first lesson to rehabbing.

Because the work was still incomplete I asked a buddy of mine who owned several properties what she knew about renovations (because I was totally clueless as a newbie).  She actually had a guy working for her who had family in NC and said that he could come down and work on the project.  He wasn’t licensed either but I trusted my friend.  This time around I drafted a contract for the work.

This new contractor actually worked his tail off and did a lot of the work the other guy didn’t complete.  Unfortunately his work was nowhere near the quality of the previous contractor.  After he was done I had to hire another contractor to come and correct some of the issues that were unresolved.

All in all I spent about $7,000 to get the place renovated and was able to appreciate the value at the time to around $50,000.  Although it could have been better, it was a good first investment and I learned a lot.   

The Best Strategy For Private Money: Buy and Hold or Fix and Flip

By tungphoto, published on 10 March 2011
Stock Photo - image ID: 10033486

Deciding on a lender can make or break a deal because the profit margin depends on your interest rate, points and loan term.  Having a low interest rate can keep your costs low and for buy and hold investors this is crucial in determining if a deal is profitable.  For fix and flip properties the interest rate is not as important just so long as you can turn the property around and sell it in a short period of time.  The key for fix and flip deals is to keep the points low and to also have a buffer of time in case the renovation is taking longer than expected.  However the longer you have a loan for renovation the more money you’re spending which can eat into your profits in the long run.

Private Money lenders are more suitable for fix and flip properties than they are for buy and hold but you can make it work for a buy and hold property if it’s your last option.  For people who have bad credit, private money is usually the only option and that means you have to have really high profit potential from a property to make it worthwhile for a buy and hold property.  

One way to make private money work for a buy and hold scenario is to buy the property and then use it for collateral for a bank loan.  Banks are more likely to give you a loan if you have real estate as collateral.  This way you can pay off your private money loan faster, get a lower rate from a bank and save money on your rentals.  Community banks and credit unions are the best option for rates and more lenient terms than larger banks.  

Just remember that private money is for short term solutions and make sure you create a relationship with your private money lender so they will be more willing to loan to you again. 

What Kind of Investor Are You?

When getting started in real estate investing it is important to choose which kind of investor you will be.  This does not mean that you won't do other types of investing, but it is important to focus and learn one type thoroughly.

Wholesaler
A wholesaler finds deals and sells them to other investors.  This type of investing requires a lot of marketing, networking and talking frequently with sellers and buyers.  The key to being a good wholesaler is to have many buyer and seller contacts and being good about connecting them together.  You are in effect the middle man.

Fix and Flip
Many people know about this type of investing through watching shows on television.  The key with being a flipper is to rehab the property and sell it to a buyer in a short amount of time to reduce the amount of interest that has to be paid for the private money loan. Private money loans are typical in these types of investments.  They are a great resource to obtain much needed funding to close a deal but they have to be paid back fast because the interest rate is much higher than a bank loan. 

Flippers usually make large lump sums of money from selling properties after they have increased the property's equity after renovating it.

Buy and Hold
This type of investing is probably the most common and is great for a retirement strategy.  By buying several properties where you're monthly mortgage payment is less than the rental income, you are creating passive, residual income that comes in every month.  This type of investing creates real wealth and can help get you out of the proverbial "rat race" as outlined very eloquently by Robert Kiyosaki.

It is also the type of investing that many complain about because you have to deal with "tenants, toilets, and termites." Dealing with unruly tenants, repairs and maintenance does not have to be difficult if you hire a property management company and have insurance.  Any issues that arise can be mitigated via the property manager and your insurance will cover any damages.

The issues with owning a property don't happen that frequently and the reward is definitely higher than any risk especially if you have a great property that is bringing in revenue.

Buying Notes
One of the least understood types of investing is buying notes.  Buying notes is actually an easier process than all of the above types of investing.  You are basically buying other people's loans from the bank and becoming the bank yourself.  The point of owning the note is to get residual passive income from the homeowner paying back the loan.

By buying the note you actually have control of the property and if the homeowner goes into default you can actually foreclose on the property.  This is not a glamorous prospect and what you can also do is renegotiate with the homeowner for better terms and help them out.  If you really have to then you can foreclose and gain possession of the property.

Buying notes is easier because you are basically calling a bank to get a list of properties and then searching the notes you want to buy.  Then you make an offer to the bank and negotiate for less than what it's worth so you can make a profit.

You can also wholesale notes just like deals.  To do this you have to have the same resources as before: a huge list of buyers and sellers.

Real estate investing is one of the major sources of wealth creation and is something that many people mistakenly think is difficult.  With some effort and due diligence you can build your portfolio and be on your way to financial freedom.

Getting Started Investing in Real Estate

Investing in real estate can seem daunting if you've never bought a property before.  Even if you have bought a property going through the traditional home buying process, it can be one of the most stressful experiences you'll ever go through.  Getting qualified for a loan, finding the house, making offers, negotiating prices, going through inspections and appraisals and waiting to close can be draining to say the least.

Well I have good news...investing in real estate is not as stressful.  First off, you are buying a home that you will not be staying in yourself.  Believe it or not that is one of the most stressful aspects of home buying.  When you know that you don't have to live in the home you are buying your requirement list goes down and your emotional attachment decreases.

That's not all...if you use a hard money lender you don't have the stringent credit and loan requirements and you can close a whole lot faster.  True, the interest rate is higher but when you refinance your loan with a bank 60-90 days later to get a lower interest rate, it's a whole lot easier refinancing a property you already own then trying to get a new loan for a new property.

You can also do what's called wholesaling properties by securing a deal and then selling it to someone else for a fee.  This is the easiest way to invest in real estate.  You can act as a head hunter for deals and not have to deal with what they describe as "tenants, toilets and termites."

There are many ways to get involved in real estate investing and all of them have their challenges, but they all can be very rewarding and lucrative ventures if you practice due diligence and be creative when looking for opportunities.