Most people investing in a college town will try and get a home, condo, or duplex that they get rent to students. This is an excellent way to set yourself up for retirement, especially when it gets paid off. But for various reasons, there is always someone selling an income property that they have held on to for a while.
One litmus test that people often apply when buying an income property is whether they can break even on the rents or have a positive cash flow. In most cases this is the smart thing to do, because if you ever were out of a job for a while it would be comforting to know that you were making money and not losing money on your property. One person thought contrary to this, however. Over the course of 20 years, they slowly purchased every home on the city block. Some of these were cash flow positive properties, some of them were not. But the power that the owner yielded at the end of those 20 years enabled him to tear down all the houses and build a mega-plex of student housing and in that moment ensuring significant, stable wealth the rest of their days.
At the core of this person's investment strategy is what I call contrarian thinking. In other words, 99% of people are doing one thing and so you do another. If you are thoughtful enough, you too can find a way to do the opposite that everyone else is doing and have little competition.
As I write this in the year 2003, I look back over the last 3 years and reflect on the rapid rise in the price of residential income properties (duplexes, triplexes, fourplexes, apartments). It is amazing to see how people have really missed a great opportunity. Average home prices have gone up 3% or so per year while income properties have increased 5-15% per year. At the very least, a humble investor with a duplex made about $30,000.
What produced the rise in income property prices? A couple factors jump out:
- Money being drained from the stock market
- A surge in real estate investment books (Dolf DeRoos, Robert Kiyosaki, etc.)
- Proliferation of investor groups
A lot of people said over the last few years "Call me when there is a property that is 30K under value." And then they never have bought anything. In the mean time, even the worst investors made that much just for being in the market. One problem you run into currently with this mentality is that an opportunity comes up like that once a year, and it goes in 24-48 hours to a guy who can pay all cash. At the same time, the person asking for the 30K deal is planning on buying their bargain property with a loan and don't stand much of a chance of getting it.
Will the cycle fade? Definitely. You can probably expect about a 10 year cycle. Things will go up for a few years, things will soften (but not bottom out for a few years), things will stabilize for a few years, and things will go up again. Over the last 70 years or so, the only thing in this country that has performed consistently is appreciation of real estate values. A short drop in California values is the only drop of note and that was handsomely compensated for within 10 years. Truth be told, there isn't much financial stability in anything in this world, but real estate value is definitely at the top of the list for things you can count on.
One common request I hear is "show me a property with a good cash flow and I'll buy it" or "Call me when there is a rental property that is 30K under value". I said these exact same things when I got started in investing. But, for today's market that is like saying you want to go skiing on lots of snow in the middle of the summer. I already discussed the price issue, and in short it is a seller's market right now. In terms a good cash flow, that brings up another problem. I could tell you stories at length such as people getting shot and killed in my great "cash flow" property, but let me just summarize by saying that there are three ways which you can get a property with a good cash flow, none of which are very likely
at this moment.
- Bad neighborhood. Your property gets beat to heck and wipes out your cash flow and you can't ever collect your rent and you can't keep a renter in there but if you could then you'd have a great cash flow at market rents.
- The seller has owned the property for so long that he simply doesn't want fair market value for it and he feels bad about getting so much for it and he hasn't raised his rents enough to make it worth more
- The property is so old that you are going to lose your shirt on your first $40,000 repair bill.
I am not negative about any specific investment strategy, but I think there are seasons for investment strategies. And based on current circumstances, I would recommend buying and holding an income property. Here is why. Let's say you have $10,000 and you put it in the bank or a money market account or stocks. If it earns 2% that year, you've made $200. Now let's say you buy a $200,000 duplex with 5% down. It goes up in value 5% that year and you've made $10,000. Or let's be conservative and say it goes up 3% a year (like homes which aren't appreciating as fast) and that happens three years in a row. Year 1 you make 6,000, year two you make 6,180, year three you make 6,365, so you've made close to $18,000. For a $10,000 investment, that isn't bad.
The question that most people have been asking over the last few years is to show them a property with positive rents and they'll buy it. They pass on the opportunity to buy properties while values skyrocket. If you understand the market, you can be making monumental gains. One local investor applied this strategy and started with a house they made about $3,000 on their first year. Then about 5 years later they own property worth $30 million dollars.
Wise investors say you make money when you buy, not when you sell, which implies you buy a property for under value. In spite of this good counsel, I have watched every single residential home that has hit the market this year and pursued the ones with equity in them on behalf of investors, only to see a few of them make reasonable returns. At the same time, I have seen the majority of investors who got into the income property market without applying a whole lot of intelligence to the matter and do extremely well. In short, I would summarize by saying: Don't be afraid to buy an income property right now, they may not get you a killer cash flow but their value is on the rise.