Professional athletes regularly refer to the difference between art and science in their skillset. The science refers to all the fundamentals that everyone in their sport must know the includes the rules, techniques, disciplines, etc. The art is what cannot be taught. Art is when sheer talent takes over, and the athlete does what no coach ever could accomplish. Why did Tiger put with a driver when he was off the green? How was Cleveland Cavilers able to convert FIVE 3-pointers in the closing minutes of the NBA Championship including Kyrie Irving’s 3-pointer with less than a 60 seconds left?
I can’t say you have the talent to build a multi-billion-dollar real estate portfolio, but just doing the basics and understanding the fundamentals especially in good markets you can build a multi-million-dollar portfolio. However, it is very exciting (and rewarding) if you happen to start your pursuit of acquiring real estate when market conditions are excellent, and conditions for owning residential property now are about the best in over 60 years.
Why? First is a lack of supply. If you own an asset that people NEED and are in short supply prices go up. Forbes wrote an article on the severe shortage of residential property stating:
America is suffering from the severest undersupply of housing since the end of the Second World War. Although population growth has slowed significantly since the 1950’s and 1960’s, production has slowed down even more so. It’s not surprising that home building declined after the housing bubble burst in 2008, but from 2011 to 2015 it continued to fall, dropping almost a full 25%.”
Second is the cost of leverage has not been this low since the 1960’s. The 10-Year Treasury yield that influences mortgage rates have NEVER been this low in history – ever. At the writing of this article, the 10-Treasury yield has dropped from 2.5% in 2015 to recent low of 1.3%. Typically the 30-year fixed mortgage rates for residential properties correlates with the 10- Treasury yield and not surprising it has dropped to new low around 3.5%. In comparison, my first house bought in the late 1970’s my variable mortgage rate was 13.5% and fixed rates were 16%. The house still doubled in value over the next five years even with extraordinarily high rates. How much easier will it be for you now with mortgage payments below the cost of renting the same home?
So trust me, market conditions are good. This blog is the first of several posts we will write on building and managing real estate properties. Buying, selling, and managing real estate is a never-ending process, and we are learning something new every day. Jake Harris, my partner in Harris Bay, LLC our real estate private equity firm, is completing a Master’s degree in domestic and international real estate that takes his knowledge of real estate to another level after 15 years in the business. We buy and sell over 50 houses a month and currently have over $130M in new development projects. This blog along with our podcasts will be regular contributions on the subject. This first one is laying down the fundamentals and starting our conversation.
Now let’s get into the steps of building a real estate portfolio.
STEP 1: RESEARCH
I can’t emphasize the importance of research enough. Real estate is a slow moving giant, and it can take months or years to unwind a poor purchase. We will invest 50 hours of research on 100’s of homes, to buy just ten properties. The result is we rarely lose money. The internet offers a significant resource for research to learn critical information on your designated region. Critical data you need to obtain include:
- Past prices and trends. Research home sales for the past 12 and 24 months to determine a trend in prices. One source we use is Redfin (redfin.com) which offers free subscribers the ability to type in a zip code or address and pull up every house sold, listed, and pending in the area.
- Demand for properties in the area. You can monitor the duration of listings to determine how much demand there is for properties. Also, look at the listing price versus sale price. If sale prices are below or trending below then demand and appreciation potential may be softening.
- School district ratings. One key element to high demand areas is schools. Good schools draw wealthier families who want the best education for their kids. You can research school ratings by district. Some sites for this information include greatschools.com, www.schooldigger.com, and www.school-ratings.com.
STEP 2: WHAT TO BUY
Based on your budget, you need to determine the following:
- Square footage of the property. Your budget will dictate how large of a house you can afford, however, key factors that influence the value of the house is not as much the total square footage but how the square footage is allocated. Large master bedroom with all other bedrooms small along with tiny kitchen and living room will challenge its value. My opinion is the key areas of a house are in order; kitchen, master bedroom, bathrooms, breakfast area (not formal dining), living room or great room, and bedrooms.
- One level houses have 20% – 40% higher per square foot valuations over two level homes. I have no preference to the number of levels of the house so long as it is appropriately priced based on similar properties in the immediate area with an excellent floor plan.
- Probably the most important aspect of one level vs. two levels are the houses in the immediate area and on the same street. Is your prospective house the only one level or two level? Could be an advantage and looking at past activities of the house and in areas around can determine if buyers want that type of home. Secondly is the backyard. You don’t want a backyard surrounded by two level homes that all look easily into your space.
STEP 3: PREPARING TO BUY
If you don’t own property, the following applies to you:
- Regardless the state of your financial affairs, meet with a mortgage broker and go through the process of applying for a loan. If you are not qualified, they will give you a checklist of the criteria you need to meet before becoming qualified for a loan. Many times I find on my credit report information that is either inaccurate or outdated that will impact my credit score and the ability to qualify for a loan. Going to the process of applying for a loan will flush out all the issues that may prevent you from qualifying for a loan. You want to do this as soon as possible and even when you know you are not ready. This is only a trial process and giving you the game plan of what you need to do to get qualified.
The following applies if you currently own your home:
- As mentioned, mortgage rates are the lowest in 50 years. The last time the 10-year treasury yield was close to current rates was in the 1960’s. The rule of thumb is if you can reduce your mortgage rate by 0.75% (75 basis points) or more it typically is worth refinancing. In obtaining mortgage rate quotes ask for the net par pricing (no discounts or lender credits) along with total closing costs (the amount of money you need to bring to the title to close the loan). Then, ask how much the rate will increase to have enough lender credit to cover some or all of your closing costs. I like to have all the closing costs included, which typically increases the rate by 0.25%.
- If you have equity in your property(ies), at the writing of this Blog is possibly the absolute best time to refinance (of course I said this two years ago when rates dropped to 4.25%!). If you are in a growing/building stage of your finances then leveraging assets with tax deductible loans at 3.5% interest is ideal. Then with the cashout, refinance the proceeds and prepare to acquire your next property.
- Also, evaluate the rental income and your own income to determine the amount of debt you want to incur. The challenge during the 2005-2010 real estate crash did not impact those property leveraged with balanced financial budgets of rental income to debt. I crushed those over-leveraged without sustainable income to support their debt. We owned many properties during the crash that did decline in value. However, the rent was paid and so was the mortgage. Those same properties have since fully recovered in value and now worth more than pre-2005 values. It was a long bumpy ride but none the less the final result was sufficient.
STEP 4: WHEN TO BUY
As stated earlier, market conditions in macro terms are excellent. However, in every cycle, there are ebbs and flows of rapid appreciation and consolidation. Property prices finally bottomed in late 2010 with declines of 50% or more to pre-2005 prices. In the subsequent three years, property values in many areas bounced back increasing over 100%. By 2014 prices were near pre-2005 prices and started to level off. Prices booming and then consolidating as investors/buyers assimilate to new costs is a typical market cycle. After a period of stability and consolidation demand, starts to exceed supply and the next wave of appreciation begins. In our opinion, we are in the middle trend of the consolidation stage and as a result, you may be able to negotiate better price points. During the growth stage, it is even a challenge to get an offer accepted let alone negotiate. So we would consider this time a good opportunity to be actively pursuing to acquire property now.
If you have any questions or comments, let us hear from you in the section below! Happy hunting!