Sitting across the table from our friend and real estate investing partner of nearly a decade I nearly choked on the won ton I was eating when he said “I’m going to buy a property in California to use as a vacation property and hope it goes up in value.”
This guy is smart and it won’t be his first property. He’s bought several with us, a couple on his own and at least one with his relatives. And he’s been successful with his investments – especially the ones he made with us. 😉
So I was absolutely shocked when he told me that hope was in fact his strategy for his next investment. And not to worry, I gave him a good lecture over lunch about why it wasn’t the way to go about making a real estate purchase.
I told him: HOPE IS NOT A STRATEGY.
Yes, I think properties in many markets in the US are undervalued. And I definitely believe there are opportunities for the smart buyer to make some big profits in real estate in just about every market if they buy in good areas and can hold on for at least 5 years.
The last I heard the place he was trying to buy sounded gorgeous, undervalued and likely to rebound quickly. And for him, I think this property is more of a lifestyle choice than an investment – he wants a fun vacation home and a place he can potentially retire to.
I think our friend is going to do ok in the long term with his purchase in California. As long as he can afford to hold onto that property for awhile, his hopes and dreams of making a great profit on that property are pretty darn likely to come true. And I know he’ll have a lot of fun owning it in the meantime. And as long as he remembers that this purchase is a lifestyle choice, and with that choice will come greater costs, then that’s okay. But it should never be considered just an investment – especially based on hope!
And most of us can’t afford to use HOPE as a strategy.
Buying undervalued properties and waiting for them to rebound in price, or appreciate to new highs is a scary and high risk strategy. I think it was in the book Rich Dad Poor Dad where the question was asked “How many houses can you afford to buy if they are all costing you $100 per month?”.
The answer for some is probably quite a few … as long as you have your job!
But we have structured our entire lives around creating freedom. And freedom for us means that we don’t want to buy investments that enslave us to our jobs or put us in dire need to make money. We want our investments to free us not trap us.
For that reason alone we’re not VALUE investors. We’re CASHFLOW investors.
Buying properties in anticipation of value increases is how so many people got burned in the past 5 years. They bought properties with little regard for their cashflow … believing that the value increase would happen so swiftly their monthly revenue losses would be more than made up for. And besides, losing money every month is ok because it’s a tax write off, right?!
I can’t tell you how many times I have heard that piece of flawed logic. And you know why it’s flawed? Because your mortgage principal pay down expense each month … the biggest expense you have as a real estate investor … is NOT A TAX WRITE OFF. Only the interest you pay on that mortgage is. So… sadly … even though you are paying $300 a month out of your pocket to subsidize that property filled with hope … the government actually thinks you’re making money so you’ll get to pay tax on the income you generated even if it never hit your own jeans!!
Sucks doesn’t it?! So wouldn’t it be better to actually BE making money from that property while you ‘hope’ it goes up in value?
That way, if something happens and the market shifts downwards, you are still making money from that property and you can afford to hang onto it for years and years to come. And you’ll be making money from it even if it’s worth less because you have positive cash flow AND your mortgage is being paid down by your tenant therefore building your wealth.
For that reason we don’t buy properties with the anticipation that the value will increase. We buy properties that:
- Are in areas that will attract agood pool of quality tenants,
- Put money in our pockets each and every month,
- Have more than one exit strategy,
- Are in market areas that have really strong fundamentals for growth and stability,
- Primarily have risks we can control.
This is more work. It takes market research, it takes patience and it takes a lot of effort to find the properties that will actually generate a positive cash flow. But it’s also the only strategy we’d advise any real estate investor use.
If you’re not sure how to figure out if a property will generate a positive cashflow here’s a few resources and tools you can use:
- Article: How to Evaluate a Property in 60 seconds
- Video: How to Calculate Cashflow
- Free Trial of a Real Estate Analysis Software: Call them for your free 30 day trial. If you buy use the code: revnyou10 for a 10% discount.
Published on April 12th, 2010
Image Credit ©Gerald Bernard |Dreamstime.com
