Investors make money either by increasing revenues or decreasing expenses.  The expense side of the ledger is very tricky.  At times, it will be important to spend money on regular maintenance items in order to avoid a much larger issue in the future.  Investors should keep this simple concept in mind as they tackle the due diligence of expenses.

When beginning the due diligence process, it is important to verify exactly what was spent.  Most property owners should have a list of major and minor repairs since they purchased the property or at least over the last five years.  Match these expenses with cancelled checks or bank withdrawals.  These should also be given to the property inspector so that they can verify that the work was done as well.  This should also be done with monthly expenses like utilities, taxes and standard repairs/maintenance items.

The next step in this process is to determine what work should have been done vs. what work was actually done.  Deferred Maintenance is a real estate term that describes necessary maintenance items that have been pushed out to save property owners cash today, typically at the expense of significantly more cash tomorrow.  Remember, the value of the property is equal to the net operating income divided by the capitalization rate.  If owners know they will sell their property this year or the next year, expect them to delay expenses to inflate their net operating income to increase the overall property value.

A traditional property inspector can spot deferred maintenance right away.  Small leaks that were never fixed can turn into significant water damage or worse, create conditions for mold to thrive.  Tour the property with the property inspector and ask them to point out any areas where deferred maintenance could exist.  This helps an investor in two ways.  First, it gives the ammunition to renegotiate the selling price.  Second, it helps the investor understand what kinds of items need regular preventative maintenance to avoid major headaches down the road.

The expense side of the equation also represents a hidden value in the property.  Hands off managers could be running expenses too high by paying outside property managers, who have no vested interest in keeping expenses in line.  Appraisals offer an easy check for expenses.  Most appraisals have a section that outlines market expenses.  Check these against the subject property’s expenses.  If the potential investment properties expenses seem too high, ask questions of the owner or the management company.  Older properties typically require more maintenance and have higher yearly expense costs.  Consider installing newer equipment to save money.  Refer back to the renovation section to figure out how to determine if an upgrade is really worth the money.

Expense should be monitored carefully and check against bills and cancelled check or bank statements.  Getting a handle around the expense side of the property could present an opportunity to significantly increase the value of the property.

Investor should be able to make money both buying and selling real estate.  Perfecting the due diligence process is a great way to save money when purchasing a property.  The first step in the due diligence process is to verify the revenue stream.  In order to verify the revenues an investor should request the following documents: Rent Roll, Operating Statement, Rent Receipts, Bank Statement to verify deposits and either the owner’s tax record (past 3-5 years) or the LLC’s tax records if the property is incorporated.

All of these documents work in conjunction with each other.  The rent roll represents the highest possible collected rent.  Assuming every tenant pays on time every month, the operating revenues should match the rent rolls exactly.  This is rarely the case.  Some times tenants receive rent concessions, they pay late, move out mid-month, etc.  The closer the total rent roll and the operating rent are, the better the collections and the higher quality the tenants.  It is a sign of a good operator.  On the other hand, huge disparities could mean an opportunity to increase value significantly through sound operational excellence.  The further the gap, the more important it is to verify all of the items listed above.

Rent receipts and bank statements should be used to verify the rent collected in the operating statement.  It’s very easy to falsify receipts.  While landlords typically will not do this to inflate the NOI, they will do this to give the perception that their tenants pay in a timely fashion, when in reality they do not.  Comparing monthly deposits is a way to ferret out this issue.  In this case, monthly deposits should match the operating statement exactly.

Tax records should be used as an additional check.  Some can be hard to navigate depending on how they were prepared and whether the entity is a stand alone LLC or tie to other properties, but sellers should be willing to provide this information to potential investors.

Remember, all sellers are not created equal.  Some sellers will be able to produce all of these items with no problem, while other sellers may not even have a current rent roll.  Be firm and adjust the offer price according to the data provided.  If there is no way to verify the last 12 months of Net Operating Income, the offer should be extremely conservative.  If bank records cannot be provided to prove when rent was collected, assume a higher than average bad debt collection and reduce the price accordingly.

The due diligence process is designed to mitigate risk.  Even if an investor chooses to purchase a property after receiving very little information, the investor knows the risk of that decision.  Failing to do proper due diligence leaves money on the table.

A major difference between purchasing an investment property and personal property is the due diligence process.  Typically, when buying personal property due diligence consists of hiring an appraiser and a home inspector.  Personal home buyers depend upon other general experts to ensure their purchase matches its general description.  An investor’s due diligence process should go much further.

Investors must verify cash flow.  Remember investment properties are valued based on Net Operating Income, which is essentially income available after all property related expenses have been paid, and the Capitalization Rate (cap rate).  The cap rate represents the risk adjusted expected growth rate over time.  Older properties in secondary neighborhood would command higher cap rates because they have more risk and lower expected growth rates.

With that in mind, verification of Net Operating Income will directly affect the price that should be paid for the asset.  In this vein, investors should look to understand and check every line item in detail.

Revenues

Rent receipts should be compared against actually bank deposits.  Any unscrupulous landlord can produce receipts, but it is important to verify that the cash was collected and specifically when the cash was collected.  This should then be compared to the in-place leases to understand if tenants are paying rent on time.  These record should be easy to produce and easy to check.  If you have problems at this stage, be very suspicious of the seller.

Don’t forget to verify ancillary income as well.  Any cash collected from washer/dryers on site or use of specific facilities like a weight room or pool should also be verified against bank deposits.

Expenses

Like revenues, expenses should be verified with bank statements or cancelled checks.  Unlike revenues, there is no rent roll to check expenses against.  The only way to verify that all property expenses have been accounted for is to check against tax filings.  For larger properties, investors will probably incorporate each building, making it easy to verify tax records.  Smaller properties will require looking at the owner’s tax records.  Some make balk at this request, but be firm.  This is the best way to verify the income on the property.

Landlord must figure out a way to keep a tenant full invested in the property.  The perfect tenant treats the landlord’s investment property like it’s their own personal home.  Even if tenants pays the rent on time every month, how they treat the property can still make them very bad tenants.

The standard way to mitigate tenant damage to the property is to collect a security deposit upfront, typically one month additional rent.  This deposit serves as insurance against property damage when the tenant leaves.  Unfortunately, with this method, how much rent landlords collect directly correlates with how much insurance they can secure.  Furthermore, the less a tenant pays in rent, the less invested a tenant will feel.

Landlords can turn regular paying tenants into perfect tenants with some create leasing agreements and good maintenance habits.  As a caveat, always consult a lawyer before adding non-standard provisions into lease agreements.  Assuming a state or city allows the landlord to put in minimum maintenance provisions, these can be extremely helpful. 

Some landlords have even charged a below market rental rate, but required tenants to do all maintenance on the property.  This strategy works well with established, responsible tenants.  Be careful using these provisions with first time tenants because this gives tenants much greater incentive to simply defer maintenance.  Landlords are often surprised by the conditions tenants can live in when they have to maintain the property themselves. 

In the absence of any maintenance provisions, it helps to show an interest in the property.  Being responsive to maintenance calls and checking in on a monthly basis to perform standard preventative maintenance shows tenants that a landlord is very invested in the property.  Most tenants will value this and help maintain the property.  Landlords should be eager to provide tenants paint and other light working equipment, if a tenant expresses interest in doing some upgrades to the property.

Some landlords offer bonuses to tenants that add additional value to their property.  If a tenant consistently keeps the property in great condition or upgrades appliances, carpets or fixtures, that tenant has added significant value to the property at no cost to the investor.  Encouraging this behavior with a gift card to Home Depot or Lowe’s makes the tenant feel great and further enhances the value of the property.

Regardless of the method, moving a consistently paying tenant to a true property asset pays significant dividends.  With a very small monetary investment and a lot of thoughtfulness, landlords can improve their investment tremendously.

Investors that focus on long-term hold periods must become experts in tenant selections.  Great tenants add tremendous value to a property, while poor tenants not only detract from the property valuation, but will also take years off of your life.  Every investor that has been in the real estate business for a while can share a tenant nightmare story.  Tenant selection is a mixture of art and science, so here are a few quick ways to stack the odds in your favor.

1.         Standardize the Process: Start with a basic tenant questionnaire.  Focus on questions like employment history and rental history.  Before conducting any tenant interviews, familiarize yourself with the tenanting laws of your state.  A variety of questions are illegal to ask and could potentially open you up to litigation from rejected tenants.  Additionally, familiarizing yourself with landlord tenant laws of your state will make you a better landlord.  Regardless of the area, always assume tenants know their rights.  Many lawyers specialize in finding tenants with the sole purpose of suing landlords.

2.         Credit Checks: Always run credit checks on your tenants.  If you have a mortgage broker, they can traditional run credit checks for you for a nominal fee ($15-$30), which should be passed on to the applying tenant.  Credit checks should not be solely used to approve or deny a perspective tenant, but they should add to the overall tenant story.

3.         Rental History: Be careful when verifying rental history.  Bad tenants will often get excellent reviews from their current landlords.  Think about it.  If you have a nightmare tenant that is looking to move to another location, would you do anything to prevent them from getting out of your property?  Get around this by asking for their past three landlords or more. 

4.         Employment History: Look for patterns in employment or any major gaps.  Great tenants keep jobs for long periods of time, have no employment gaps, and work for strong industries.  Be wary of tenants in bad industries (e.g., autos) or in commission-based jobs.  These types of jobs layoff often and traditionally these people have fewer savings.

5.         Financial Statements: Secure monthly income and expenses.  The most important items to note are the credit card bills.  Watch out for tenants with significant revolving debt, even if they pay it off regularly.  Factor in what rents you will be charging and the expenses that will be passed through to the tenant.

Tenants should not be approved or denied on any one factor.  Perfect tenants are tenants that value your property as they would their own.  The best tenants not only have strong scores in the factors above, but also have strong character.

For novice investors, a No Money Down strategy will look very different than it will for an experienced investor.  The risks of a true No Money Down strategy are too high for investors just getting into real estate investing.  While many novice investors started with this strategy in 2003 – 2006, 2009/2010 will not be a great time to secure these mortgages.  Additionally, the high costs and high risks of this financing strategy make it a poor fit for the novice investor.

So what is a novice investor to do when they are short on capital?  Take the traditional fundraising approach: Family, Friends, Investment Clubs and well wishers.  Fundraising in this manner not only gets a novice investor much needed capital, but it forces him/her to critically analyze their investment opportunity because they have to present it in a compelling manner to their future investors.

There are critical rules to working with friends, family, investment clubs, etc.  First, an investor should prepare clear terms and spell out exactly what will be done with any funding received.  For example, if an investment property will be purchased for $100,000 and the money received will go towards the down payment that should be clearly stated. 

Next, an investor should create a simple return structure.  It’s easy for non-real estate people to understand a monthly cash flow and it’s easy for an investor to manage.  Returning to the $100,000 example, if friends or family members commit $20,000 for the down payment, an investor should promise a fair return.  Assuming a 10% return on $20,000 ($2,000/year), an investor should commit to paying $167/month and returning the full principal upon the sell of the property.

These agreements should always be in writing.  This is a best practice for any investor and should be no different with friends, family, etc.  The more structure and professionalism an investor brings to the deal, the more credibility he/she will have when pitching their investment.  Be detailed about the role of the general manager and the role of the silent investment partner.  It might be worth having a lawyer draw up a very basic boilerplate contract to use for future deals.

Investors should also try to under-promise and over-deliver.  Never promise unrealistic returns or understate the risk of an investment to secure funding.  This only serves to ruin your credibility and cut off future funding sources when the road gets rough.  Real estate investments carry inherent risk that is only compounded by limited experience in real estate investing.  Being honest and regularly providing information to financial backers helps the novice investor stay abreast of the market and their investment.

Friends, family, investment clubs, etc. offer great opportunities to connect with other real estate investors and secure additional investment funds.  This No Money Down strategy provides capital and important relationships to help grow a successful real estate investment business.

“No Money Down…”  A phrase widely used in infomercials and by many proponents of real estate investing.  Does it exist; certainly.  Is it a good idea; sometimes.  Will it work for you; almost certainly not. 

After 2007, many zero down financing programs dried up, making the possibility of purchasing an investment property with no money down challenging.  Traditionally, no money down financing was reserved for investors who planned significant renovations to their property.  For example, if an investor wanted to buy a $50,000 home, and then perform $20,000 of renovations, it would be possible to get a loan for $55,000 or more.  The interest rate on these loans was usually significantly higher than a traditional investment loan, but it provided many buyers the advantage of securing property with no upfront equity.

Hard money lenders also filled the cash void for many investors before 2007.  If an investor identified a good investment opportunity, they could secure a traditional investment loan (80% Loan to Value) and then get a hard money lender to supply the 20% down payment.  Hard money lender traditionally charge rates above 10%, but again, they provide a way for an investor to secure an investment property for little or no cash equity.

While this strategy is high risk, it has significant advantages.  First, none of these loans are recourse.  This means that the only recourse the banks and the hard money lender have is the underlying property.  This will certainly do a number on an investor’s credit rating, but their home, other investment properties and personal possessions will remain secure.  As a quick aside, every investor should read every page of every document they sign.  Never sign up for recourse debt, ever.  Second, this strategy allows an investor to expand quickly.  Depending on the investment strategy, this can be a great means of securing multiple properties fast.

Numerous risks exist with this financing strategy as well.  Investors traditionally have to hit a homerun with a property to make this financing worthwhile.  At a 12-15% interest rate and a short term maturity with stiff penalties, any hiccups in the project could totally derail the investment.  In a rising market, this risk might be very manageable, but in a falling or even a steady market, this risk can overwhelm even the most experienced investor very quickly.

Like all financing, a No Money Down financing strategy is a tool.  This tool is very dangerous, even in the most capable hands.  Before an investor jumps into the No Money Down market with both feet, he/she should be well aware of the risks and expect to hit a homerun on their project.

For Sale by Owner (FSBO), a concept few sellers attempt, holds many potential rewards for the savvy seller.  Unfortunately it also holds many perils for the seller solely attempting to cut out a perceived middleman.  With the tactics any investor can learn from this very website, it should be easy to find a realtor worth their 6% fee.  Before an investor decides whether or not this method of selling would work best for them, they should consider the following analysis.Strongly consider the value of your time and the expected cost savings of not using a realtor.  On a $100,000 home, an investor will avoid costs of approximately $6,000 or 6% by not hiring a realtor.  However, the investor will incur numerous additional costs that would be traditionally born by the realtor.  Marketing fees can be substantial.  After printing signs, flyers and putting ads in the paper a seller could be down $500 - $1,000. 

Next, the seller must put an hourly wage on their time.  As an investor, a generous number of $50 per hour is appropriate.  Doing some very simple math, after marketing a seller can afford to spend about 100 hours of their time on the sells process.  While that seems like a lot, its about 12 eight hour work days.  The most basic property will require a minimum of two to four weekends of showings.  After four days (2 weekends) of showings at six hours a day (2hrs. prep time, 4hrs. show time), an investor only has about 76 hours left.  Add 5 -10 off hour showings and the time really starts to add up.  This is before the buyer’s realtor begins requesting documents from you and the banks start calling.  It’s very easy to spend 12.5 eight hour days selling your home.  Most realtors spend the equivalent of that amount of time or more on a transaction.  And remember, they do it for a living so they are much faster and generally better at it than you.

Consider the market you are selling into.  FSBO properties work very well in strong markets when the seller has the upper hand.  Conversely in a buyers market, the negative perception of an FSBO property alone could cost an investor 2-3% of the property value.  Think about it from the prospect of a buyer.  Owners typically know much less about the real estate market, have very little access to current market comparables and have completed far fewer transactions than an experienced realtor.  That’s worth a 2-3% discount in most buyers’ opinions.  Additionally, so many FSBO properties are poorly managed.  Many realtors farm FSBO markets for this very reason. 

Investors should also understand the scope and the value of their network before attempting a FSBO transaction.  Realtors know buyers, sellers, other realtors, investors and other interested parties.  They employ their entire network with the goal of selling this particular property.  If an investor can’t think of at least 10 people to pitch their investment property to it might be time to call a realtor.  Smaller networks mean it will take longer to sell the property.  During this time an investor could be missing numerous investment opportunities. 

FSBO transactions can work, but investors need to understand the risk and rewards.

Real estate can be an excellent buy and hold investment.  Provided rent covers a substantial portion of the mortgage payments and operating costs, investors can simply hold a property and wait for leveraged appreciation to make them wealthy.  While this seems like a deceptively easy strategy, buy and hold investors need to have a good understanding of finance and the market to maximize their investment.

Buy and hold investors make money on the buy.  Since these investors are much less sensitive to short term market movements, these investors should try to locate up and coming neighborhoods.  Neighborhoods with significant construction represent great opportunities to get in on the ground floor and wait.  These investors should absolutely avoid the flavor of the month or locations that have experienced unexplainable appreciation.

Investors with a little more experience should consider major markets in a down cycle.  Many major market experienced 40%+ declines in real estate valuations, with very little change in the economic fundamentals.  Areas like Las Vegas and Florida in 2007, 2008 and 2009 could be prime targets for smart buy and hold investors.  Investors that understand where the fundamental value in these areas is could purchase new homes at deep discounts with a great deal of seller concessions.  These opportunities may help investors minimize the upfront costs and provide them with properties that pay for themselves.  Again, buy and hold investors in major markets need an in-depth understanding on the historical market rent trends, economic/job growth trends and real estate pricing trends. 

Another area that traps buy and hold investors is the holding period.  Typically, these investors are overly concerned with selling at the height of the market.  This presents two problems.  First, many times investors wait too long and miss great buying and selling opportunities.  Second, investors do not remember to maximize their interest and tax deductions. 

Sellers should not try to time the market.  Buy and hold investors should look to maximize the value of their property and then locate their next investment.  As the market trend higher, sellers should begin to look for great buying opportunities.  When an opportunity is located, the investor should considering selling or refinancing their original buy and hold investment.  Buy and hold investors should be very familiar with 1031 Exchanges.  Remember, buy and hold investors can cash out of their investment with a refinance or with a sell.  Refinancing allows investors to maintain control of the property, increases their tax deductions and frees up cash to make additional investments.

Buy and hold investing should not be a passive pursuit of wealth.  Actively managing a buy and hold portfolio yields more investment opportunities and the potential for much higher returns on investments.

Many buyers solely rely on their real estate agents to negotiate their real estate deals.  Regardless of how well a real estate agent performs their job; their financial interest does not align with the buyer.  Real estate agents often argue that they have a fiduciary duty to the buyer and that their reputation is too valuable to sacrifice by not representing their clients properly.  If this were truly the case, they would change the compensation system.  The system has been designed to keep real estate prices high and all parties benefit financially, except the buyer writing the check, from higher pricing.

With that understanding in mind, the buyer should drive the negotiations.  Start by arming yourself with market data.  Many of these items should be provided by the real estate agent, but be sure to do your own research on/in the neighborhood.  Potential investment buyers need to know what comparable properties sell and rent for.  Next, they need to understand the current inventory and the average days on the market.  Then, they need to figure out the trend of the neighborhood (new retails, more jobs, new developments, etc.).  Finally, buyers need to try to understand the motivation of the seller.  This is the hardest piece of the equation because many buyers never meet the seller or never get straight answers from the seller’s agent.

The information above should be used to determine a fair price for the property.  Once an investor gets the value of comparable properties, these valuations should be adjusted for positive and negative trends in the neighborhood.  If market rents seem to be declining or retail sectors seem to be trending down, comparable values might be too rosy.  Additionally, if inventory in the market is high and days on the market have been increasing, potential buyers should take this as a sign that they have the upper hand in the negotiation.

Once a buyer develops comfortable around a potential offer price, they should verify their potential return on this investment.  Investors looking to purchase stable properties should be looking for a return of 5-10% annually.  If you buy a $100,000 home today, assuming no positive or negative cash flow, and sell the home in a year, you should be able to sell it for $105,000 to $110,000 (in two years, $110,250 - $121,000, etc.).

Buyers should also be generous with earnest money deposits.  Sellers equate the size of the earnest money deposit with the seriousness of the buyers.  Be sure before you send a check for the deposit, the contract contains the appropriate contingencies. 

Finally, buyers need to consider what additional terms and contingencies they need in order to secure a painless (and costless) exit if they decide not to buy the property or to maximize their investment.  Buyers should consider asking for seller financing, a 30-day due diligence period where they verify the financials of the property and the soundness of the physical structure, financing contingencies and anything else they can think of to address potential concerns.  Even if these needs are not presented, they can serve as an alternative to price, should the seller prove unwilling to accept the initial offer.

Consumers have a variety of misconceptions around appraisals.  The most important misconception is that appraisals represent a factual value of the worth of your home.  Your home is worth what someone is willing to pay for it, period.  Appraisals remain an important tool in the world of real estate because banks rely on that valuation to determine how much they will lend against the property.  Following a few simple steps will ensure that you get the maximum value for you home.

Appraisers are certified to value properties.  They go through fairly arduous training to understand how to ferret out the nuances that make each house unique, and therefore adding or subtracting from the home’s value.  Despite all of this training, appraisers will not be able to see every piece of value you have added to your home.  The first rule of dealing with appraisers is to be present during the walkthrough.  You will be pleasantly surprised at how many questions they ask you and how helpful you can be in describing the cost of additions and upgrades that may not be apparent to the naked eye. 

Before the appraiser gets to your property, prepare a simple list of any recent (past five years) upgrades or modifications you may have done to your home to add value.  This can either be given directly to the appraiser or used as a guide when you walk through your property with the appraiser.  Be sure to have accurate cost information because that does make a difference.  A bathroom renovation that costs $5,000 will be more valuable than one that may have costs only $2,000. 

During the walk though, politely point out areas that make your property unique.  Only note items of significant value, as the appraiser will not be interested in the fact that your property has ceilings that are 1 inch higher than your neighbors.  Note items like original hardwood floors that have been refurbished or new windows throughout the property.  These items add real value and should not be missed in the appraisal. 

Don’t forget to ask the appraiser questions as well.  Appraisers are an excellent source of market information because they typically work around a few neighborhoods.  Ask how your property compares to the average properties he sees and ask if there is anything you can do to add a significant amount of value to the home.  For example, the appraiser may ding your home for having a roof that is 20+ years old and he may suggest a cheap alternative to a full tear down that could add significant value.  This can be used later to bargain with potential buyers as they consider purchasing the property. 

Think of the appraiser as a free resource or a guide to help you maximize your properties value.  Not only should you be eager to help them maximize the value of your home, but you should seek information from them as well.  Appraisers can be a true value added resource and cost you only a few hours of your time.

Sellers will make a lot of decisions when it comes to selling their home.  The pricing of a home is probably the most important decision.  Pricing is rarely as simple as looking at comparable properties and pricing your home accordingly.  Pricing should factor in the sellers motivation, the market trends and potential buyer’s highest and best use of the property.

First, pricing should be considered in the context of why the seller is actually selling the home.  Sellers looking to cash out of an investment to move to a new investment area with better growth potential have the option of refinancing.  Rather then price a home on the lower end of the market; it would be an excellent opportunity to test the higher end because of the refinance alternative.  On the other hand, if an investor plans to move across country and would like to liquidate their portfolio locally, it would be smarter to price the property more conservatively.  This places a higher value on a quick, sure-fire sale and hopefully ensures you a worry-free move.  By understanding your alternative to selling your property, you can make a smarter pricing decision.

Second, pricing should factor in market trends.  Many times realtors will show you comparable properties currently on the market and suggest you price your property at the midpoint.  Pricing is far more art than science.  Before considering comparables, you should have a view on the market pricing trend.  If the market is strong, shoot for a price on the higher end of the neighborhood and let the market catch up to you.  Aggressive pricing is a good strategy in a strong market.  Conversely, a declining market is the seller’s enemy.  In this market it is often wise to price your home 2-5% below the comparable average.  Many times sellers will begin lowering their prices in a race to attract buyers, often times well after the market has passed them by.  Avoid this problem altogether by sacrificing a small profit for a quick sale.  Chasing the market will ultimately result in you getting far less than the original perceived discount you are offering.

Last, consider the best use for your property.  If you have been using your property as a rental home, but you notice a mix of new home buyers and investors coming to your neighborhood, cater to the buyer group that will pay the most money.  While this seems obvious, it is often not an easy task.  Investors traditionally want a blank canvas to work with, while new home buyers are drawn to homes with a bit of character.  If you notice investors paying 5-10% more, remove all the furniture, paint the walls white and provide pertinent information on the rental market in your area.  If new home buyers seem to be paying a premium, consider a simply staged home with a few local touches.  Every little detail adds that much more to the offer price you receive.

Pricing is far more than looking at comparables.  Realtors are out to close a transaction, so consider your motivation and drive the pricing process.  Ultimately, it’s your bottom line.

Real estate transactions slant in the favor of the seller.  The seller pays both agents commissions and both agents are rewarded for transacting at the highest price possible.  Given these incentives many sellers select the agent that offers to list their home for the highest price, and then simply waits for the offers to come rolling in.  Sellers employing this tactic are making a big mistake, particularly investors looking to sell their investment property. 

Sellers should first understand that time is money.  Even the best realtor will only dedicate two or three months to actively selling your home.  Furthermore, realtors want to get paid.  Commission based employees love to see a big check.  From a realtors perspective, selling a $100,000 for 6%, nets them a commission of $6,000.  Increasing the price by $10,000 only nets them an increase of $600.  Given the challenges of getting to the closing table, most realtors value a quick closing more than they value getting the extra $10,000 for their seller that could take months to materialize.  What means a lot to you, really only means a little to your real estate agent. 

Always remember that you as the investor should drive the process.  Hire great professionals and let them work for you.  After selecting the best realtor a seller must prepare for the negotiation.  Start by understanding your potential pool of buyers.  Is your neighborhood an active investor community or should you position your property for new families?  By understanding your potential buyer, you can shape your property into a blank slate, with subtle hints of character that might appeal to your audience.  If you expect to have a lot of investors coming by, it might be helpful to do some research on rental rates and neighborhood occupancy details.  Young families might enjoy a list of local parks and recreation activities gear towards family.

Sophisticated buyers will be armed with facts about the neighborhood and property values.  You should know your property and know your competition as well as or better than the buyers.  Shop your competition.  It’s always helpful if you are able to comparatively list off details that make your investment property unique.  These unique items should increase the value proposition of your property.  While your house may be the only one on the block with a bird feeder, that will not drive traffic or stop a buyer in his/her tracks.  On the other hand, if you can say my house is the only one in the area with newly refurbished hardwood floors, buyers might certainly take notice.

Check your emotions at the door.  Creating a value proposition for the buyer means offering a superior product at a competitive price.  Don’t be offended by low offers.  Even low offers tell you something about the market and potential buyers mind sets.  Getting more than one might suggest you are in a buyers market.  Take every opportunity to seek to understand the value of your asset.

 A strong return on investment starts with achieving the lowest purchase price with the best terms.  Novice investors spend too much time solely focusing on price, at times to the determent of an excellent real estate investment.  Real estate negotiations tend to be a zero sum game when the two parties solely focus on price.  However, when consider items like seller financing, capital improvements, tenant removal, and others, both parties can come away from the deal better off.

Before thinking about negotiations from a buyer’s perspective, it is important to understand the motivations of the seller.  A majority of sellers would like to get the best price from a buyer that can close quickly and without any major issues.  Veteran real estate buyers can do their due diligence, secure their financing and close on a simple real estate transaction within 30-60 days.  Sellers also prefer no contingencies, clauses in the offer contract that allow buyers to walk away from the transaction with their earnest money.

On the other hand, buyers want the lowest price and the ability to have the property under contract for as long as possible before closing.  Additionally, buyers would like to be able to walk away from the transaction and receive their earnest money back if there is anything wrong with the property, their financing falls through or they simply find a better deal.  This additional time also allows the buyer to shop the property.  In extremely hot markets, it is not out of the ordinary for a buyer to put a property under contract, find another buyer at a higher price and flip the property before they even purchase it.

Buyers need more than the right price.  Seller financing can be an excellent way to increase the return on your investment and conserve much needed capital for future investments.  Seller financing is a deferred payment to the seller with interest.  Since 2008, seller financing has been on the rise and should be a potential negotiating point for any real estate transaction. 

Negotiations should always be fact based and unemotional.  Buyers should enter negotiations with the seller armed with market data and a clear understanding of neighborhood fact patterns that justify their bid price.  If all the comparables from the past six months show decline property values, then it is fair to say based on the trend in this neighborhood, your property appears to be worth x, not y.  During the due diligence process, a buyer discover the tenant has been late with multiple payments or worse, the seller can not produce an accurate payment history, it is perfectly fair to say, due to concerns about the current tenant on the property, your property is worth x and not y.

Over prepare for the negotiation process.  Do not solely rely on a real estate agent, whose interest is not aligned with yours.  Remember, they are compensated as a percentage of the selling price.  The higher the price, the more they get paid.  Remember, the buyers perspective is more than just a low price. 

Investing for appreciation carries higher risks and higher rewards.  Investors should focus on selecting the right market and the right property to execute this strategy.  While this strategy usually yields very little cash flow during the life of the investment, investors profit when they sell their investment property for a gain.

Appreciation focuses expected future rent growth.  Traditionally, markets with high appreciation experience strong job growth and have a significant retail presence.  Real estate markets experience a life cycle.  Appreciation ebbs and flows as prices increase and decline.  As major metro areas price homeowners and investors out of the market, they begin to move to less populated areas, which in turn begin to see a price increase.  As these areas become more populated, pricing pressures ease in major markets and the migration ceases.  Understanding this cycle helps investors better understand when and where to invest to capture the highest amount of appreciation.

Selecting the right market is paramount to execute this strategy.  Young markets with significant upside potential represent the best chance to minimize downside risk.  Additionally, small to mid-size markets with easy access to major metro areas, jobs and retail aid in future rent growth.  Be careful of markets that appear to be too strong or experience unreasonable appreciation levels.  As markets appreciate, affordability declines.  At some point all markets reach a tipping point where appreciation slows, stops or declines because they become unaffordable. 

Investors can also create value by choosing the right property to invest in.  In these markets renovations can make sense.  It’s usually best to choose the properties with the most upside potential, but it is equally important to choose the properties that suit the investor.  Large renovations take time, effort and capital.  Investors with limited capital resources investing in these markets should choose projects that need cosmetic renovations or upgrades. 

Remember, the goal is not to have the best house in the neighborhood, but rather to achieve the highest rent with the lowest capital spend.  Map out investment items and compare each item to an expected rental increase to ensure the upgrade or renovation makes sense.  Even if every home has newly remodeled bathroom, it could more sense to charge a below market rent then to actually remodel all the bathrooms in a home.

Appreciation and buy and hold usually go hand and hand.  Properties that appreciate 5% per year return about 25% per year to an investor, who put 20% down to purchase the property.  Let the appreciation and leverage work together.  Investors should watch the market closely for opportunities to exit or upgrade their investment.  As markets mature and appreciation slows, investors should be prepared to cash out and move to another growing market.

Investment strategy starts with choose the right market.  Markets drive strategy.  In markets with rapid appreciation or escalating rents, buy and hold strategies or renovation strategies might be appropriate.  In more stagnant markets it might be less attractive to renovate, but investors might be able to generate value by placing quality tenants in quality properties.

Remember, current rents and expectation of future rent growth drive the value of real estate.  An investment strategy is the way in which an investor will affect one or both of these metrics to improve the valuation of the property.  Simply taking an empty property and putting in a tenant increases the current rent and potentially increases the future growth potential; therefore, the property valuation will increase.  Additionally, renovating allows investors to charge higher rents, in turn increasing the current rent and the future growth potential.

In considering the first investment, an investor needs to develop a clear understanding of the market and formulate a strategy that will be successful based on those market factors.  Once an investor selects a strategy, the investor must implement the strategy in a cost effective way to increase value by more than his/her costs.  While this seems obvious, novice investors often underestimate their costs and overestimate the value they should receive from their investment.

Consider an investor, who has chosen to renovate a small foreclosed home in a less than stellar neighborhood.  In this situation, the most important investment strategy should be tenant selection.  Renovations will return very little on their investment because of the general neighborhood conditions and the expectations that the neighborhood will not improve.  If an investor performs cosmetic renovations (~$1,000 – $2,000) and selects a quality tenant that will pay rent on time and take good care of the property, that investor has just created a very attractive, easy to manage cash flow stream.  This investor now has the option of selling the property at a gain and potentially reinvesting the profits into another investment or simply farming the cash flow of the property.

It should be noted in this situation that the investor should not expect any additional appreciation beyond the value created from placing the tenant; therefore, should not plan to hold this type of a property for a long period of time, unless their goal is to invest in stable cash flowing properties.

Investors should look at each investment with a clear plan of action.  Understanding the market and formulating a clear strategy will increase the likelihood of an investments success.

Finding a good real estate market should never be an excuse not to invest.  Almost every market presents a unique opportunity for a creative investor.  Markets with low appreciation and few investors present excellent opportunities to buy cheap, renovate, rent and sell for a profit.  Markets with strong appreciation will require larger capital outlays, but allow the investor to spend less time per dollar invested.

Novice investors should maximize their competitive advantages.  Typically, people know a lot about the neighborhoods in which they live and the surrounding areas.  Little details about what block tends to be worth more than another or new plans for retail development present hyper local investors the opportunity to invest smarter and earlier then outsiders.  Do not give this advantage away by trying to invest in the “next hot market.”

Understanding where the market trends lead should help an investor formulate their investment strategy.  In some areas, renovating and leasing make sense.  In other areas, it might make sense to buy new construction at deep discounts, leases and hold for profits.  Regardless of the area, the more knowledgeable investors can be the better investment decision investors can make. 

Local investors have a valuation advantage as well.  Tracking real estate values in an area for 5+ years provides a good idea of good times to buy and sell.  Additionally, identifying long term trends can often signal market shifts and investment opportunities.  As the new mall becomes the old mall or the north side becomes younger and more desirable, it may be time to cash out of one investment and upgrade to a new area. 

Do not forget that relationship building also takes a tremendous amount of time and effort.  Getting connected to the real estate community is much easier when it’s a 10 minute trip to see an agent, accountant or lawyer. 

Regardless of where you decide to invest, you should be familiar with your local markets.  Investors should never miss opportunities close to home and should be constantly farming their local neighborhoods for like-minded investors.  Maximize your competitive advantage by knowing your neighborhood better than anyone else.

Major and minor developers and investors fill markets like Los Angeles, New York City and Chicago looking to capitalize on the growth associated with these markets.  Novice investors typically take the “me too” approach by trying to enter these markets on a smaller scale or drifting to the outskirts or city limits.  Conversely, smart investors know that by establishing a superior value proposition in an area with little competition yields the biggest return on investment.

Consider my own interesting start in the real estate business.  Living in Detroit, Michigan, I decided to start my real estate practice in the worst real estate city in the United States.  Luckily, I had two things going for me: 1) A tremendous passion for people and real estate and 2) An excellent eye for out of the box investment strategies.  After speaking with real estate agents and mortgage brokers, I discovered that most tenants would pay about $700-$800 to rent a two-bedroom home.  I also discovered that a two-bedroom house sold for $25,000 - $60,000.  The lowest end of the range represented fixer uppers without tenants, while the upper end represented nice structures usually owned by a family or rented to a family.  There would be no natural appreciation because jobs were leaving and the city continued to experience terrible urban decay.

Next, I got on the ground and spoke with the market.  After interviewing tenants, landlords and more agents, I found that most landlords treated tenants poorly and most tenants were only tenants because of their glaring credit score issues.  It turns out that it is very hard to live in Detroit without being laid off at least one time. 

By now I had established a need, an opportunity and a plan.  Everyone in the city needed a decent place to live where they could be treated with respect.  At $25,000 - $40,000, I had the opportunity to provide this at a cost to me of approximately $250-$300/month, while charging a rent of $700 - $800.  Finally, I put together a plan to buy two houses to start the business and test my theory.

My plan ended up being wildly successful.  Not only were both properties providing ~$300/month in cash flow after expenses and debt service, but the properties were appreciating.  They were not appreciating because of the neighborhood, but rather, they were appreciating because I was able to provide any future buyer with tenants, who did not miss a payment in 12 months, and who were locked into a lease at $750/month.  Properties purchased for $30,000 - $40,000 were now worth $50,000 - $60,000. 

This is one example of a unique plan tailored to a local real estate market.  With few investors interested in this market, I had all the investment opportunities I could buy.  Once I established my reputation as one of the best landlords in Detroit, I also had all the tenants I could house.  While this turned out not to be scalable because of its intensive management requirements, I could not have asked for a better first time investment experience.

Novice investors rarely understand the value of a great accountant until after they need one.  Real Estate accountants specialize in tax planning to help investors better understand the tax consequences of their investments.  Numerous laws govern taxes around profits and losses in real estate and a good accountant can help an investor navigate these laws to maximize their return on investment.

Before considering any real estate investment, an investor should speak with their accountant.  Many accountants provide free consultations and typically want to build a relationship in expectation of future services.  Like all real estate professionals, accountants should be vetted with a focus on their real estate experience.  Most accounts will have a cursory knowledge of the real estate tax code; however, an accountant that specializes in real estate taxes provides a much broader knowledge base and stays up to date on all of the latest tax changes.  While investors will certainly pay more for these professionals, the long run value will far outweigh the short term cost.

Investors should familiarize themselves with the following real estate tax terminology: Depreciation, Depreciation Recapture, 1031 exchange, and capital gains and losses.  Accountants also provide guidance around corporate structure.  Many investors don’t understand the value and simplicity of a Limited Liability Company or other forms of partnerships.  Accountants can recommend structures that supply protection against personal liability, while minimizing incremental tax burdens. 

Investors should utilize accountants year-round.  Paying too much in taxes is the same as giving money away.  Additionally, holding a property an extra month or year might not make a difference from a market price perspective, but that simple decision might represents thousands of dollars in tax savings. 

Finally, real estate accountants know real estate investors.  In real estate, access and relationships add value.  Accountants know investors that need to sell or buy properties right away for tax purposes, as well as investors looking for partners.  Their needs should be your gain.

Mortgage brokers provide financial solutions for investment properties.  They provide investors unparalleled access to a number a banking institutions and products, saving them time and money.  Like all real estate professionals, the great mortgage brokers create additional value for investors, while poor mortgage brokers simply take a commission and supply very few useful services.

Every mortgage broker can access the cheapest lending solution for your investment property.  Obtaining the lowest interest rate covers the origination fee mortgage brokers charge, but excellent mortgage brokers have the ability to do so much more.

Great mortgage brokers understand the interest rate environment extremely well.  While it may be impossible to predict future interest rates, having the knowledge of any regulations or economic impacts on rates will help investors make better financing decisions.  When considering whether to secure a fixed or adjustable rate mortgage, helpful advice from a good mortgage professional can assist you in choosing the best financial option. 

Excellent mortgage brokers also provide broader financial solutions.  Many mortgage brokers have familiarized themselves with hard money lenders, other real estate investors, mortgage lenders and other alternative sources of financing.  As a side note, many of these financial solutions should not be chosen by novice investors; however, as investors become more sophisticated it will be extremely useful to have a mortgage broker with access to additional financing sources.

Lastly, good mortgage brokers have great relationships.  Real Estate investors make up a very small world of professionals focused on a single asset type.  Mortgage brokers, who work with investors regularly, can supply potential investment partners and investment ideas as you develop your investment business.  Additionally, mortgage brokers know very detailed financial information about their clients, so their partner recommendations come pre-vetted. 

Great mortgage brokers provide low cost financing, fair pricing and connections to other investors around the real estate investment landscape.  The costs of a good mortgage broker and a poor mortgage broker vary slightly, but the value provided differs greatly.  Maximize your investment in a mortgage broker by choosing an excellent mortgage professional. 

Investors make money when they buy smart and when they sell smart.  Finding the right real estate agent to market and sell your property can help secure substantial profits; however, their services come at a steep cost, usually ranging from 4-6% of the selling price. 

Remember, time is money.  Getting your investment property sold quickly for an above market price should always be the number one objective.  A great real estate agent can help achieve this goal for a savvy investor. 

As with all real estate professionals, an investor should conduct a rigorous screening process before settling on one real estate agent.  Investors should interview at least three agents and focus specifically on each agent’s marketing plan, valuation assessment, personal fit and commission.  For more information on questions to consider when interviewing real estate agents, please see the download section of the site. 

Many sellers do not negotiate commissions.  Everything in real estate is negotiable and every dollar saved on fees and commissions goes directly to the bottom line.  Maximizing value means getting the best services for the lowest costs.  Note, this does not mean sacrificing excellent service to simply save a few dollars.  When choosing a professional it means choosing the person that can achieve your goal at a fair price.   

Real estate marketing should go beyond putting up a website and an MLS entry.  Excellent real estate agents have a stable of potential investors they have worked with in the past and connections with other agents that represent active real estate investors.  They should also be able to do a walkthrough of your investment property and provide helpful suggestions to maximize value.  Putting in as little as $500 worth of finishes could increase the value of a home by $5,000 simply based on presentation. 

Always remember the goal is to get the property sold quickly and for the highest possible value.  Investors should communicate this goal with their agent during the interview process.  Additionally, any real estate agent should be able to provide an investor with time on the market data, comparable properties currently in the market and recent sales comparables.  A great agent will also know more detailed information about the recent sales and the comparable properties in the market currently.  They should be able to comment on the finishes in comparison to your property and provide a comprehensive analysis for their pricing suggestion.   

After choosing a real estate agent, trust their instincts and be responsive.  An investor should not expect quick and timely performance from their real estate agent if they are not quick and timely in their responses back to the real estate agent.  Furthermore, a great real estate agent should know the market at least as well and hopefully better then you.  Be vigilant, but trust their pricing, marketing and negotiating guidance.

  All real estate agents are not created equal. In fact, a vast majority of them provide no value, I repeat, no value in a transaction. Real estate buyers suffer from the false belief that they get a free ride since the seller pays both real estate agents in the transactions. This could not be further from the truth.

In truth, the real estate system stacks the deck against the buyer. Think about two key points:

1. Both agents compensation is based on the selling price. The higher the price the seller achieves, the higher the compensation to BOTH agents.  

2. If a seller did not have to pay an agent 6%, they would be able to lower the price by some amount up to 6% and still come out ahead. Both the buyer and the seller would be better off.

    

Considering the incentive alignment, buyers should naturally be on their guard when dealing with real estate agents. Every buyer and seller should interview at least three real estate agents. If the agents get uncomfortable with this in anyway, they should not even be considered. Great agents know their greatness and can prove it.  For a list of potential interview questions see the download section of the site.

Buyers should consider working with a buyers’ agent. These agents only work with buyers and tend to be more familiar with buyers issues and negotiations from a buyer perspective. Although these agents still receive their compensation from the seller, the additional experience working with buyers can be helpful.

Real estate agents should also be chosen based on their past experience with INVESTORS. Even when buying single family homes, a real estate agent, who is familiar with investors needs, will be able to answer questions about market rents, comparable rental properties, tenant/landlord laws, etc. better than agents that work with primary home buyers. Additionally, these agents should be able to source investment properties much better than other agents.

Novice investors should take their time with this process. The interviewing process should be a great time to learn about the market, the neighborhood and any other quirky real estate news happening around town. The agent should be chosen based on experience, knowledge of the market and personal fit.   

Lastly, be upfront with the agents. Let them know exactly what the process entails. If you plan on interviewing three agents and then buying a single family property in the $150,000 to $200,000 that can rent for $1,000, let them know the plan. Importantly, do what you say you will do and get back to them right away. If you choose one agent, let the other two agents know that they were not chosen and why. This professional courtesy keeps the lines of communication open and provides avenues for future deal sourcing.

In the land of the illiquid investment, cash is king. After 2008 lending institutions severely tighten their underwriting standards, requiring 20%+ down payments for investment properties. 20% down makes even the smallest investment a capital intensive endeavor. Buying a $100,000 property now takes $20,000 in cash. Not a small sum for many first time investors. What makes real estate even more challenging is the fact that the $20,000 investment will be tied up for the next two years (minimum) and cannot be used for any other down payments.

For many novice investors, this proves to be a significant barrier to entry and puts a hefty premium on success. However, even by putting 20% into an investment, real estate still remains one of the highest leveraged investments many individuals will make. This leverage provides the power behind investment returns in real estate. Let’s demonstrate this with an example.

Assume an investor puts $20,000 down on a property worth $100,000. Next, let’s assume the property appreciates 5% in the first year and the investor sells the property. For ease of explanation, let’s assume no selling costs. Upon selling the property, which is now worth $105,000 after the 5% appreciation, the investor pays off the $80,000 and receives $25,000. In one year, the investor turned $20,000 into $25,000, a 25% return, based on an appreciation rate of only 5%.

This is the lure of leverage. A great way to work with friends and family, who want to invest in real estate, is to promise a fixed return plus some return of principal. Consider a stable property selling for $100,000 with a market rent of $700. Rather than putting $20,000 down to secure the property, an investor might consider raising $10,000 from friends and family by promising them a yearly return of 10%, much better than a return they might get in a saving account. Again, let’s assume in the first year the investment appreciates 5% and the investor sells the property. Now the investor pays of the mortgage of $80,000, plus the friends and family loan of $10,000 and keeps the remaining $15,000. After subtracting the $1,000 additional interest payment, the investor is left with $14,000 or a return of 40%.

Importantly, leverage works both ways. While it magnifies gains, it also magnifies losses. Using the same examples above, if the property lost 5% of its value the returns would be highly negative. Leverage provides an excellent tool to stretch investable income and to boost returns, but it also adds to the risk of the investment and costs money in the form of high interest rates. All investors should take care to understand the cost of any financing they employ in their real estate investments. 

 An underestimated, but extremely important, source of real estate profits, financing can drastically changes the success of an investment. While an investment should not be made solely on the fact that a borrower can obtain favorable financing, financing options should play a very important role in analyzing an investment opportunity.

Consider the interest rate an investor will pay on a mortgage. Lets take a $125,000 investment property as an example. An investor puts 20% down and obtains a standard 30-year amortizing mortgage for $100,000. At an interest rate of 5% the investor pays approximately $535/month, at 6% its $600 and at 7% its $665. At 5%, the investor pays $130/month or $1,560/year less than he/she would have paid at 7%.

Taking this a step further, lets say an investor has to choose between buying today or waiting six months in hopes that the home will sell for less. If the home decreases in value by 5% after six months, but the interest rate increases by 1%, was it worth the wait for the investor? Lets take a look. Now the investor pays $118,750 for the house or 5% less than $125,000, but has to pay an interest rate of 6% instead of 5%.

Interestingly, the investor saves $1,250 on the initial down payment. Now, instead of putting $25,000 down or 20% of $125,000, the investor only puts down $23,750 or 20% of $118,750. The monthly payments show a different story. The $125,000 pays $535/month, while the $118,750 investor pays $570/month or a difference of $420/year. In less than three years, the $125,000 investor will be better off. Again, we assume that this is the same property, so there will be no difference in future appreciation. In this example, the owner of the $125,000 house would see their value depreciate 5% in the first six months and would then experience the exact same upside or downside as the owner in the second scenario who buys in at $118,750.

This analysis shows the importance of locking in low, fixed-rate financing for long term investments. Periods of historically low mortgage rates represent excellent buying opportunities in down markets. Low fixed rate financing allows long term investors to weather moderate deprecation, while locking in a low interest expense when the market turns around.

Novice investors often worry too much about buying before the bottom. When considering investing, it is better to consider the entire investment landscape. Historically low interest rates and deep discounts in real estate values provide excellent investment opportunities. 

Appreciation always wins. Novice investors can fall in this trap unknowingly as they search for the perfect first investment. Consider two potential investments: 1) Single family home with a purchase price of $100,000 and a market rent of $1,000. 2) Single family home with a purchase price of $200,000 and a market rent of $1,000. The novice investor will always pick the first investment. It represents a way to stretch investable income and it is intuitively less risky because the rent will more than cover the cost of ownership. So who would ever choose the second investment?

A better question to ask is why the second investment is worth an additional $100,000? There are two ways to answer this question. The simplest way is to say that investors expect the $1,000 generated by the $200,000 property to grow at a much faster rate then the $100,000 property.

Here is an example. The $100,000 property might have rental growth rates of 5%, while the $200,000 might have a rental growth rate of 10%. After 5 years, the $100,000 property will have rents of about $1,275, while the $200,000 property will have rents of about $1,600. What about after 30 years? The $100,000 property will have rents of about $4,300, while the $200,000 will have rents of about $17,500. Over a 30 year period, the owner of the $200,000 will secure about $1.3 million of additional cash based on the higher rental growth rates.

This analysis gets more pronounced when additional renovations that further add to the property are consider because the higher rent also grows at a higher rate. Conversely, it becomes harder to generate appreciation through renovation in lower income, slower growth properties. Typically, the cost of an improvement are fixed (i.e., a washer and dryer costs ~$500 regardless of what neighborhood it is purchased in) but the potential rental increases are highly variable. In some neighborhoods the inclusion of a washer and dryer will bring rents up $10/month, while in other it could be as high as $100. At $10/month, it could take up to 50 months to recover the initial investment, while in the other example, it could take as few as five months. 

Remember the risk/reward trade off in these scenarios. Expected future growth is always riskier than steady consistent cash flow. While the $200,000 property has the ability to appreciate at a much faster rate, it also has the ability to depreciate at a much faster rate. Until 2008 many real estate investors had no concept of deprecation. When expected growth rates adjust downward rapidly, prices follow. Smart investors navigate these ups and downs by buying smart. Great neighborhoods will always be great neighborhoods. Great tenants will always be great tenants. Investors should mitigate the risk they can control, watch the markets diligently and look for potential for area and property specific appreciation. 

 Many first time real estate investors choose single family homes because of their low cost and familiarity. The similarities to purchasing your first home enable the buyer to better understand the risk and offer the buyer an inherent familiarity with the product type. This can be a double edge sword; however, when a buyer becomes so enamored with what he/she wants and forgets about the main focus, the tenant.

Single family investments increase in value based on two factors: asset appreciation and rental increases. Consider two homes in the same neighborhood. One home has a tenant paying $600 per month, while the other has a tenant paying $700 per month. Assuming the market rent is $600 per month and the houses are identical, the $700 per month home will be more valuable because of its higher cash flow. Furthermore, as neighborhoods improve, investors may be willing to pay a higher price for any house in that neighborhood. Perhaps the neighborhood has more jobs, retail, better schools, etc. This increase in value represents appreciation or the thought that the market rent growth rate for a neighborhood should be greater. 

Novice investors have no problem understanding the first concept of rental increases lifting market values; however, the more challenging aspect to understand is appreciation. Appreciation can certainly be property specific.   As an investor installs new kitchens, bathroom, etc. their home increases in value based on these additions. Again, the value increase is because investors expect that they will be able to secure higher rent rates based on the nicer amenities of the property. As in the neighborhood improvement above, investors are willing to pay more today to secure a property where rents will grow at a more rapid pace.

Consider two identical properties today, both rented for $100. An investor buys one of these properties and installs a washer and dryer for $500 and raise the rent $25. Now one property rents for $100 and the other rents for $125. In this example, the fact that one property nets an additional $25 per month in cash flow will add value. Additionally, if market rents increase 10% a year, in the second year the rent for the unit without the washer/dryer will increase by $10, but the unit with the washer and dryer will increase by $12.50.

Based on this simple understanding of appreciation, investors should understand how to create value and how to spot a potentially successful real estate investment. First, look for neighborhoods with strong appreciation. Avoid areas where prices appear to be abnormally high or falling rapidly, even if you think it’s a good deal. Second, look for properties with potential for appreciation. It is rarely a good investment to buy a newly renovated home as a rental because you will have to pay the price for the expected higher rental growth. It is much better to buy a home with no renovation, put in the items that will yield the highest returns and then let the appreciation work for you. It’s always better to buy the worst home in the best neighborhood, than to buy the best home in the worst neighborhood. 

 Everyone possesses different strengths and weaknesses. Successful investors maximize their strengths and surround themselves with professionals that compensate for their weaknesses. Real estate investing requires skills with people, relationships, organizations and finances.

Regardless of where your personal strengths lie, investors should understand the importance of comparative advantage. Comparative advantage describes a situation in which an individual should focus their time on activities that they are best at. Even if a person is an expert at everything involved in real estate investing, time limits how effective that person can be at each skill. 

Early in my real estate investing career I quickly found that the numbers aspect of real estate drew me to the investments. While I am certainly good with people, relationships and organization, my passion and training fall on the side of finance. In order to maximize my effectiveness in real estate investing, I spend more of my time underwriting investments and sourcing deal. Furthermore, I surround myself with partners and professionals that work well with people and have great organization skills.

While comparative advantage is extremely important, investors should not neglect their weakest skills. Solely relying on people skills or finance skills opens investors up to missing opportunities or being taken advantage of by professionals who are well rounded. An investor must be responsible for their own investment decisions, must be able to keep their business organized and must be able to source tenants, investments and other real estate professionals. Real estate investing requires a basic level of understanding in all of these areas despite what an investor may inherently be better at. 

Novice investors must constantly be learning every aspect of real estate investing; while more advanced investors should ensure that they deploy their efforts to the activities that will yield the biggest return on the time investment. 

 Before considering real estate investing, investors should take stock of the amount of resources they have to invest. This analysis should go beyond the current bank statement. Real estate investors raise money from a variety of sources: Friends, Family, Co-workers, Investment Clubs, Angel Investors, etc. Additionally, investors overlook an extremely valuable commodity, time.

Once you decide to invest in real estate and decide how much you can comfortably afford to dedicate to the activity, you must figure out a way to best deploy your limited capital. If your capital limits constrain your investment opportunities, it might be worth considering adding to your capital base through additional resources. Having a good assessment of who can be relied upon to provide additional investment support should the right invest turn up will be invaluable as you start seeking investment opportunities.

In addition to having a good grasp on financial resources, investor must understand their time. Real estate investing requires hands on, up close and personal, hard work. If you work a 9 to 5, appreciate the fact that real estate investing could be a second job that requires long evening hours.

Investors, who stretch their resources by doing work themselves, should appreciate that they are trading money for their time. Spending a weekend painting a house means that weekend will not be spent with family or friends or looking for additional investment opportunities. Smart investors value that time. When considering doing something yourself always think about how much time you will spend not doing something else. This applies to managing properties, renovating units, sourcing investment opportunities, completing real estate taxes, etc. Hired professionals trade their time for your money.

A good foundational knowledge of your resources provides an excellent investment base; however, this assessment should not end after making the first investment. As you build relationships and grow your investments, remaining vigilant around resource optimization will help you maximize your investment potential.

 Before making their first real estate investment, investors must understand their basic needs. Beyond food, clothes and shelter, what is important to investors and their family should play a large part in how investments are made. Real estate entrepreneurs must be prepared to endure sacrifices as they start their real estate investment business, but a good understanding at the beginning of the investment process smooth the transition for all parties involved.

Everyone needs a cash safety net. Depending on responsibilities, some investors need three to six months of their primary home mortgage in the bank, while others may need three to six months of their primary mortgage, a vacation fund, a college fund, a new baby fund, etc. Remember, when investing in real estate investors risk losing their entire principal and then some at worse. Investors also forfeit the use of that cash for long periods of time while invested. Even investing too much in successful investments could leave an investor in dire straits if an immediate cash need arises and the investor happens to be unable to liquidate their investments.

Real estate investments are not like stock. They can not be liquidated at a moments notice and they cannot always be refinanced despite what a mortgage professional might say. Even refinancing a good property with significant equity requires the borrower to have strong credit and a good source of income. First time investors serve themselves well by investing their funds in multiple properties over time if they have the capital to do so. 

Wants provide the reason for investing. Investors want to move from their current financial standings to higher financials stands in order to secure their wants in life. Understanding the end goal of investing should also shape investment strategy. A 50 year old looking for a little extra income during his/her retirement should approach real estate differently than a 25 year old single person looking to make real estate investing their primary career. 

First time real estate investor often become too enamored with getting rich quickly to realize what they truly want out of real estate investing. Sacrifices must be made to achieve goals in real estate investing, so investors must properly understand where they want to go. 

 Investments by definition require some level of risk. Before deciding the type of real estate investor you want to be you must understand the amount of risk you can tolerate. No matter how successful of an investor you become, there will be ups and downs. Traditionally, a lot of these hiccups come at the beginning as a result of novice mistakes, but investors always risk issues from general market conditions and unforeseen circumstances.

Many investors do not understand the risk they face in real estate. It is easy to feel secure exchanging money for a solid, tangible building. Until 2008, many real estate investors felt that real estate at the bare minimum would always retain its value. Unfortunately, investors and homeowners alike realized too late that it was possible to not only lose their entire equity investment, but also be forced to add additional equity to support a mortgage worth more than their property value. Even in the stock market, the most an investor can lose is their original investment. Furthermore that would require the underlying company to go bankrupt, which is a rare occurrence.

Too often investors underestimate the risk in real estate. Part time investors, for example, that have day time jobs and invest in real estate should have enough saving to cover the mortgage of their investment property(s) and their primary residence. Investors should factor in at least three to six months vacancy at any time based on their geography. Real estate is a people business and people are often very unpredictable. Some times they move out in the middle of night or get laid off or simply stop paying rent. In most states the foreclosure process is very tenant friendly and very costly to the landlord.

When it rains, it pours, so accurately forecasting how much rain you can sustain is vitally important. Over investing or investing too quickly can often allow small shocks to create undue hardships. This site will go into specific details around the risk of each investment, but it is important to understand the real estate itself is a risky asset class.