What They Didn’t Teach You in Those Expensive Classes: Investing is a Business
Have you read, studied, completed worksheets, and watched videos, but have not yet invested in your first property? Have you attended weekend seminars with well-known gurus in real estate investing, but think there’s still a piece missing from the puzzle? Have you been to classes, workshops, and weekend retreats and still don’t know where to begin?
To know where to begin, you have to know what you want, and you can figure out what you want by writing your business plan. To be a successful investor, you have to treat your investing like a business. Every successful business owner knows that the first step to creating a business is writing out your plan. What are your goals? What are your strengths? What are your weaknesses? At the end of the day, what do you really want?
Let’s begin writing your plan by reviewing your options. You have several, in each of four categories: strategy, property type, situation, and money. Now let’s review your options in each category.
Your strategy is your approach to how you will make your money. Will you buy properties and keep them for the income from rent money and appreciation? Will you buy properties, fix them up, and sell them at a profit? Will you act as a middleman and never actually own the property, just make money from the transaction? How do you decide which strategy to pick? Not every strategy is appropriate for every investor. Let’s look at the pros and cons of each to decide which is right for you. This will be your strategy for your business plan.
How do you want your income to be, slow and steady or inconsistent in frequency and amount? If you prefer slow, steady profits over time with the potential for a large payoff when you eventually sell the property, then buying and holding property is the right strategy for you. If you prefer a higher income and are comfortable with making inconsistent amounts of money and at uneven intervals, then flipping or acting as a middleman is right for you.
There are two ways you can act as a middleman. You can be a real estate agent or real estate facilitator. To be a real estate agent, you need to attend a sixty-hour class and take a multiple-choice test on several areas of real estate. The exam is divided into two major sections: general/national real estate topics and Connecticut-specific content. Your class and the exam will cover topics such as real property ownership and transfer, contracts and agent relationships with clients, and federal laws, as well as state-specific duties and powers, licensing requirements, and commissions. As real estate agent, you have access to the Multiple Listing Service (MLS) system. As a beginning agent, you work for a broker. A broker is an agent who has been in the business at least two years, has taken additional coursework, and has passed an additional licensing exam. The benefit to you as a newbie in the industry is that when you join a brokerage, you get the advertising, support, knowledge, and reputation of that company. You don’t have to start a business from scratch, in contrast to all of the other methods we are going to discuss.
The process to become a real estate facilitator is a little less defined. At the highest level, a facilitator is merely a real estate investor who makes money by matching buyers with sellers. A real estate investor can act as a facilitator in many types of deals, including the following:
1. Finding leads on potential properties and selling those leads to other investors (sometimes referred to as "birddogging" or "wholesaling")
2. Formally signing a Purchase & Sale Contract with a seller and then assigning that contract to another investor or end-buyer
3. Executing an option contract with a seller and then selling the option to purchase real estate to another investor. For example, many investors who use the "We Buy Houses" signs (sometimes referred to as "bandit signs") employ a form of wholesaling or option contracts.
To keep things simple, we will treat all of these methods as merely acting as a facilitator, even though the way the investor facilitated the deal varies among approaches.
The upside to becoming a facilitator is that there are no formal or licensing requirements. Additionally, most facilitating approaches require very little upfront cash. You will not actually be acquiring properties, so you do not need to have large amounts of cash or financing. The downside of deciding to work as a facilitator is that because this approach is so broad, it is often difficult to decide how you will facilitate a deal. How will you find your sellers? To whom will you sell your deals? This information can often be overwhelming for a first-time investor.
Most facilitators learn their techniques through a mix of approaches, all of which require self-teaching, including books, workshops, seminars, and coaching. Courses can be either online or in person. Your local real estate investing association (REIA) should have a regular stream of monthly speakers and workshops. In Connecticut, the two biggest REIAs are Connecticut REIA (www.ctreia.com/) and Northeast REIA (www.northeastreia.com). Community colleges and libraries also sometimes sponsor workshops on beginning real estate investing techniques. An Internet search will yield many online courses available to you without leaving your home.
Be careful when selecting a course, because the courses vary greatly in quality. Www.realestateinvestor.com, founded by my clients Colin Andrews Egbert and Matt Leitz, is a great resource for free information for beginning investors. It is a great place to turn if you are researching a course you are considering. On that site investors freely share their experiences, tips, and techniques that have worked for them.
Property Type
The options of property types are probably obvious to you: single-family homes and condos, multifamily housing, apartment buildings, and office buildings. The ones that are probably less obvious are mixed-use buildings, vacation homes, and timeshares.
Multifamily housing, apartment buildings, commercial properties, and mixed-use building are best suited for buy-and-hold strategies. If you are interested in buying distressed properties, fixing them up, and selling them (sometimes referred to as “flipping” properties), single-family homes and condominiums typically work best. Some investors have been successful in renting out vacation homes and timeshares. To do this, the investor needs to be comfortable with very sporadic income–high income during the peak season for that vacation spot and little income during the off-season. This type of investing works best for an investor who can afford to pay for ongoing expenses of the property without the income from the rental, such as an investor who owns the property free and clear or an investor who has significant income from other sources.
To decide which kind of property is right for you, you need to align the type of property with your strategy. Look at your strengths and weaknesses. Have you been a landlord before? Are you good with people? Will you be able to evict people when they don’t pay rent? Some investors are simply not good at dealing with the tenants. If this is the case for you, don’t be a landlord.
If you are hoping to flip properties, do you have the skills necessary to rehab the property yourself? If not, do you have access to a team of people who have these skills? Do you have a network of home improvement contractors? What is your skill set, and how does it match up to the types of properties you will be acquiring?
Situation
When you buy a property for investment purposes, you should look for situations that cause the existing homeowner to sell to you at a bargain. This fact is often overlooked by real estate investors, but remember, you make your money on the front end. If you overpay for a property when acquiring it, you won’t be able to sell it at a profit. To make a profit, you need to buy properties from sellers who are motivated to sell at a discount. How will you find those properties? The first step is recognizing which situations create the need for a homeowner to sell quickly and cheaply.
The hottest topic in real estate investing today is pre-foreclosures. As we all know, the real estate market in the last two years has shifted significantly, resulting in an increased number of homeowners facing foreclosure. Investors see this situation as an opportunity, because the homeowners are strongly motivated to sell and to sell quickly.
Other situations also cause homeowners to sell quickly and at discounted prices, including probate and divorce. Some of these situations are available on the MLS, while others require additional research from you to locate. Divorcing couples frequently list their properties with real estate agents. Probate information is public information, but it requires homework on your part. Decide which types of situations you are looking for and then develop an approach for finding those situations.
Money
The last category is money. The more expensive the property is, the more access you will need to have to financing, to make the project happen. As you create your plan, keep in mind how will you access the money you need to make your project a success. You need to be able to finance your transactions, including closing costs, acquisition costs, and improvement costs. Ways to finance the transactions include using any or all of the following: institutional lending (such as borrowing from a bank), cash, hard-money lending or private financing, and seller financing.
Institutional lending includes purchase money mortgages for the properties you are acquiring as well as home equity loans against property you currently own. Your two options for institutional lending are direct lenders and brokers. Brokers have access to a wider range of loans, but you need to pay the broker for the service. You will pay the broker at the closing in the form of financing charges. Direct lenders typically have better rates than brokers because you are not paying the middleman, but direct lenders might have tougher requirements to obtain the loan. If your credit is not very good or you are self-employed, a broker can help you shop around for a loan that works for you. If you have good credit, a stable work history, and a good debt-to-income ratio, try local lenders such as Liberty Bank, Webster Bank, and local credit unions.
Hard-money lending or private financing is when a third-party, not an institution like a bank, lends you money for your project. These types of loans are typically shorter term (for example, six months to a year) and at a higher interest rate. Hard money is most appropriate for improvement costs, as institutional lenders typically will not lend you this money. Keep in mind that you need to have a plan for how you will pay the hard money lender back, because the due date of the loan will approach quickly. What is your backup plan in the event that you are flipping the property and can’t find a buyer, but the hard money is due? How will you pay the lender back? Be sure you have a plan.
Seller financing is also a possibility. Through seller financing, the seller agrees to sell a property to you and take the money from you over time. You own the property at the closing, but the seller has a mortgage against the property, in the same way an institutional lender secures its loan against the property with a mortgage. The key is to find a seller who is willing to take a promissory note and accept payments over time. Some sellers would rather have the income from the property than a lump sum payment at closing.
To decide the best approach for acquiring money, look at your strengths and weaknesses from a lender’s perspective. How is your credit? How is your income from employment? Are you self-employed? (You are a higher risk to lenders if you are self-employed, so you will be better off with a broker than a direct lender.) How is your debt-to-income ratio? Have you owned other properties in the past? Can you borrow against the equity in your home? Do you have access to hard money lenders or private lenders? What do you have in savings?
Summary: Treat your investing like a business
If you want to be a successful real estate investor, you need a plan. Your plan should identify your strategy for investing, the types of properties in which you invest, your method for finding the properties, and your plan for financing the deals. Once you have an approach for each of the categories, you have the outline of a plan for your business. Stay focused and refer to your plan often. Professionals are more likely to help you in your project if you have clear goals and an approach to attaining those goals.
For more information, see the following resources:
Diana L. Bartolotta is an attorney with the Bartolotta Law Office in Middletown, Connecticut and may be reached by e-mail at diana@bartolottalawoffice.com.