Editor’s note: This is the second of a two-part series. Read Part 1.
Steve Chader, Jennice Doty, and Linda and Jim McKissack have a new book out called "Hold: How to Find, Buy, and Rent Houses for Wealth." While property flipping was all the rage a few years ago, the tried and true strategy of buying a property and holding it is still as effective today as it was 50 years ago.
President Franklin D. Roosevelt is said to have observed, "Real estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world."
"Hold" sets out to show investors exactly how to succeed in achieving this goal.
The authors of "Hold" summarize their "Ultimate Wealth-Building Strategy" in five steps:
1. Find the right property at the right terms and the right price.
In order to identify the right property at the right price, "Hold" suggests that you follow the "Rule of 72," which allows you to see how long it will take various types of investments to double in value. To apply the rule, simply take the rate of return and divide it by 72.
For example, if you have a stock investment that yields a 6 percent rate of return and you divide that number by 72, the predicted time for your stock investment to double in value will be 12 years. (The actual time is 11.9 years.) This is a simple way to evaluate return without using complex mathematical formulas. "Hold" recommends that investors target a 17-20 percent rate of return. This means that you double you money almost every four years.
The authors also recommend that you purchase two- to four-unit properties either on the edge of good neighborhoods or in transitional neighborhoods where there are essential public services nearby. While single-family residences may have greater rental demand, multifamily units generate better cash flow.
2. Analyze a property to make sure the numbers and the terms make sense.
A primary premise of "Hold" is that "cash flow is king." This means the amount that you keep each month after you pay all expenses, including the mortgage, taxes, any utilities, vacancy, etc. The beauty of the "Hold" model is that your tenants give you "leverage" by making your mortgage payments for you. Furthermore, you also build equity through appreciation.
No matter what you purchase, it must create cash flow. Carefully evaluate the holding costs, the current rental market, as well as putting aside money for repairs and vacancy. You must also constantly keep your eye on the rental market because it can literally change overnight.
3. Buy an investment property where you make money going in.
"The biggest reason investors don’t make money is that they pay too much for the property." To make money going in, you must purchase a property for less than fair market value. The authors recommend finding a property that is listed at least 10 percent under market value. If you’re in an area with high average price points, aim for at least $15,000 as the discount amount.
As you evaluate the property, also check the average rate of appreciation for the area. The national average is 4.4 percent, but this varies due to market conditions.
You must also identify which neighborhoods generate the best returns. Be sure to include which rental price ranges are the easiest and the hardest to rent, which neighborhoods have the greatest rental demand, and what features renters in that area most want. Also, pay special attention to the condition of the property. Properties in poor condition can eat through cash flow quickly.
4. Manage your tenants and properties like a pro.
An important aspect of investing is to carefully screen your tenants. This process begins by identifying a specific target market and tailoring your ads and other marketing to attract those renters. Marketing must include a yard sign as well as print and social media. The more exposure your property has, the greater the probability of attracting the right tenant.
The best time to conduct showings is between 5:30 p.m. and 6 p.m. during the week. Also note that unlike residential sales, when someone becomes your tenant, you are establishing a long-term relationship. How you interact with the tenant initially sets the tone for your future relationship.
If you don’t want to handle this process personally you can list the property with a real estate agent or with a property management company that also does rentals. These companies will screen the tenants for you as well as collecting the deposits and finalizing the rental agreement.
"Hold" also recommends that you create a trusted vendor list. You can attend investment groups or use companies such as Angie’s List or ListedBy that aggregate vendors to help you manage your rental property.
5. Grow your way to wealth and financial freedom.
There’s no magic bullet when it comes to real estate investment. It’s a matter of knowing the models and repeatedly applying them as you purchase more property.
Even if you don’t decide to invest yourself, working with investors and being familiar with the models in "Hold" can help you dramatically increase your sales for many years to come. Part of the reason is that the typical homeowner purchases a new home once every seven years. In contrast, the typical investor purchases two properties per year or 14 properties over the course of seven years. The formula is one investor equals 14 residential clients. It’s something to consider as you make your business plan for 2013.