We don’t know much but we do know a few things about investing during and after COVID-19. It’s not pretty right now and it’s almost certain to get uglier for at least the next several months. This might not be one of your core principles but one of Warren Buffett’s most famous quotes is that investors “should be fearful when others are greedy and greedy when others are fearful.” If you can take a medium to long term view of the residential real estate market, Buffett’s investing philosophy could serve you well.
The Medium Term Outlook
Real estate investors with a medium to long term view are likely to soon find a powerful combination in distressed prices along with the lowest loan interest rates of a lifetime. But there are some important caveats to be aware of. One is that the origins of this recession are very different from the Great Recession. There was a huge demand for housing when this bottom fell out a month or so ago. Some investors are expecting the demand curve to have a sharp “V” shape that returns with a roar sometime this summer when it’s assumed the coronavirus will be under control. But will it?
It’s relatively safe to assume that the Federal Reserve Board’s fiscal stimulus policies will continue into the foreseeable future. On the other hand, until there is a vaccine for coronavirus, it’s reasonable to assume that social distancing may have to be practiced off and on for the next 18 months. That will continue to disrupt the supply chain and economic recovery. Currently, those appear to be two of the major factors for investors to think about in the risk/reward equation.
Of course, there are also a thousand other factors. For instance, will the new work from home routine become permanent or will it mostly end when the stay at home orders are permanently lifted? If work from home remains permanent, it will mean a shift in housing preferences to more space for home offices and maybe for homeschooling. The bottom line is that now is a time to review and revamp your due diligence checklist. Or if you are taking this opportunity to get started with real estate investing, you still need to begin with the basics…
Real Estate Investing Isn’t Rocket Science
There are many more books, seminars, and college courses on the subject of real estate investing than there are about rocket science. That can make you think that basic real estate investing is a vastly complex subject. Closer to the truth is that there is so much material available because there are so many opportunities to succeed with real estate investing.
Some estimates are that up to 60% of all assets in this world are tied to real estate. The total value of real estate exceeds the value of all the fleets of jet aircraft and all the computer code combined with all the other assets that exist. It’s little wonder that so many people have become very wealthy by investing in real estate. Or that so many people want to invest in real estate.
The almost infinite opportunities also create enormous confusion about where to begin. Just the list of opportunities would cover more space than a single article. A very short list includes commercial properties and residential homes. That itself stretches from a single-wide mobile home to a skyscraper in Manhattan. There is also private mortgage financing, tax lien investing, and a whole lot more in the mix.
However, basic real estate investing can be boiled down to two fundamentals. The first is “positive cash flow”. These properties generate more cash each month than they cost to own. The owner can depend on putting some cash in his or her pocket each month. The other fundamental philosophy is “buy and hold”. These properties don’t always have a positive cash flow. What they need to have is an upside that will be profitable over time. Often this is simply an appreciation in market value. In many scenarios it’s improving the property to create positive cash flow. Of course, it can involve both appreciated market value and improving cash flow.
Every investing strategy is based on one of these two basic fundamentals. For example, “turnkey rentals” deliver positive cash flow from day 1. “Flipping properties” is a version of buy and hold. You cannot flip the property for a profit until the market value is greater than your investment. This often means making improvements.
Investing always comes down to money. It might not be your money but there is going to be money in the deal. It could be as little as a fee for the “option to purchase” or it could be an “all-cash deal”. Outside of inheriting property (which is a gift, not investing), I don’t know of any way to own or control real estate without having some money in the deal. There are hundreds of variations that can involve bartering, contingencies, or sweat equity but you’re going to have skin in the game.
Understanding the basic fundamentals is not enough to get started investing. But it is the foundation to begin an analysis of any investment opportunity you are considering. With answers to just a couple of questions, you should be able to determine if it is a “cash flow” or “buy and hold” opportunity. But it has to be based on your situation. For instance, you can ask a current landlord how much the monthly positive cash flow is but even a review of his/her books doesn’t assure the property will be positive cash flow for you. He might own the property free and clear and you might need to take out a mortgage.
When you become serious about investing, you need to perform a thorough due diligence and financial analysis. An experienced house flipper can do a rough financial analysis by walking through a house in a half-hour or less. He or she can quickly estimate how much it will cost for new carpet, remodel the kitchen, and even put on a new roof. However, a more thorough due diligence is still needed to determine if the house is on a flood plain, has liens against the title, or has hidden defects.
Even an investor in a turnkey rental needs to do his homework. The property may be generating a positive cash flow based on rental income minus taxes, insurance, and general maintenance. However, that doesn’t mean it will have positive cash flow when he factors in a mortgage and a property manager. An investor should also have an emergency reserve for things like paying the insurance deductible in the event a storm blows half the roof away.
Real estate investing is a great way to build wealth and/or generate income. As long as you understand and follow the fundamentals. You don’t need to know everything there is to know about real estate. But you do need to do some research. There are thousands of books on the subject and if you are near a major metropolitan area, there is likely a free seminar this weekend covering at least one investing strategy. Your best approach is becoming familiar with several strategies before deciding on a specific strategy. Once you decide on a strategy, make sure it has a foundation based on one of the two basic investing fundamentals. When you are considering a specific investment property, always conduct a thorough due diligence and financial analysis based on your situation.
Certainly, you have something you can add to real estate investing 101? Please leave your comment.
Also, our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions, inquiries, or article ideas to [email protected].