Two Divergant Real Estate Strategies: Buying New Construction vs. Buying for Value
3 August 2006For those of you who think blogs are the end-all be-all of useful information on the Internet, here’s a reminder that forums can often be an even better source (hey, why not join ours and add some advice of your own?).
Over in a thread in a real estate forum on the Rich Dad site, a spirited discussion has been taking place between two different kinds of real estate investors over which approach is better.
Iggyigette opened the discussion by analyzing several geographic areas and issuing some recommendations for prospective buyers:
Locate a Phase I area with good fundamentals, buy for cash flow, and ride it up. - nice areas to get cash flow
It’s OK to buy in Phase 2 or 3 - you get very good appreciation, but less cash flow or slightly neg cash flow due the price vs rent differential - you need $$ reserves in these areas.
Top of the Market - phase 4 - Orange County, LA, San Diego - sell sell sell
Phase 5 - downturn - Certain areas of Michigan, Ohio, etc - nice areas to get cash flow and do preforeclosures, HUDs, REOs
Local Indicators to sell in CA: foreclosure rates have reach the bottom…and is inching up. Longer time on MLS - Victorville area approx 1-2 months. Increase inventory on MLS. Increase NOD rate. Declining appreciation rate (but not zero or negative) on NAR stats.
He then began fielding questions about his strategy, which turned out to be to buy new construction homes in areas he’d never seen:
You may notice that the 98K 4/2/2 homes are not listed anymore, That’s because my family and I bought up all available inventory under 100K earlier this year (in 2 days).
Builder pays closing costs up to 2% of loan amount - that means for a 98K home, 5% down - it costs me around 6-7K acquire a property if you include what’s left of closing costs.
Once I get adequate appreciation for 80 LTV, I refi and lower my payments (typically one year).
I could put down 20% and get great cash flow on one property, but IF I can still cash flow or break even with 5% I prefer to leverage myself and buy 4 props with 5% rather than one with 20%. The key determining factor is whether you can cash flow or not with 5% down.
Here’s my reasoning: One Home 20% down - gook cash flow…that’s nice….
4 homes at 5% down with break even or slight positive cash flow : 4 mortgage payment interest write-offs, 4 property tax payment write-offs, 4 properties depreciation including component depreciation at accelerated time frames write offs, 4 appreciating properties….plus 4 rent increases when its time…
If you add this up..you’ll see why I buy new props with 5% down…
His response to criticism that this was risky speculation?
I don’t see ALL pre-constructions as Speculative. They’re just new homes. You need to determine your cash flow based on rental range, vacancy factors, and WORSE CASE loan payment scenarios based on expected rates by the time your property is constructed. The properties I already own in NM and El Paso rent between $975-1K.
The preconstructions that I’ve bought for cash flow - they cash flow.
The ones I buy for speculation - they’re for speculation!
The benefits of preconstructions are this:
- you get higher rents on new homes
- no repairs/fix-ups/ plugged toilets
- builder’s warrantee and home owner’s warrantee
- lower cost property management
- and the MOST IMPORTANT REASON : YOUR TENANT WILL LOOK LIKE YOUR HOME. YOUR HOME WILL LOOK LIKE YOUR TENANT. Those of you renting in poor neighborhoods know what I mean.
Soon, the discussion got even more interesting, as a poster named SeriouslyStubborn jumped in to advocate a different strategy: bargain hunting in an area you know well, buying for below market value, fixing up the property, and holding it as a rental. His main point was that this strategy would perform far better than buying homes over the phone without ever seeing them, because you have an instant gain - you make money even if the market goes South:
If you REALLY want to make money, why not go into those markets you really like and try to pick up some properties below market there. Imagine if you will, if you can get a property for 70% in a market that goes up 45%, then your return on investment(assuming your same 5%) would be more than double, and at least this way you’re protected.
You might make money on these deals, and the next deals. But, I’ve yet to see any long term investors who bet on appreciation who are still in the game 10 years later. I suppose you could be the first.
The problem is, you’re taking this $300k in equity/profit and diluting it into speculation by spreading the money around(in gambling terms, you’re letting it ride). If you buy a property for $200k, and you put $20k into it. Your property would have to go up about $20k just to get your money back out. Versus the way I would do it. I would buy the $200k property for $140k, $20k down, where I only owe $120k, and the property doesn’t have to go up for me to get my money back. I could sell it tomorrow, and get my money back and more, and I have a lot of room to wiggle with. You’re at risk until the property goes up $20-30k or more. Why not take the money you’ve made speculating so far, and rather than diversifying into 15 properties with no equity, instead try to take that $300k in equity and make it into $600k in equity NOW. You’ve done well so far, perhaps it’s time to think about a more aggressive yet effective means of investment.
The discussion got even more interesting from there, with both sides offering spirited defenses of two polar opposite real estate investing strategies: Iggy’s macro strategy of ignoring the house itself, focusing on the real estate market in general in that area, and relying on the far fewer problems you usually encounter with new construction homes and the tenants they attract, vs. SeriouslyStubborn’s approach of buying for value in the home itself. If you’re seriously considering buying properties as investments, this is a must read, as both sides offer good insights into the pros and cons of each strategy.
And as always, we’d love to have you as a member of the Free the Drones forum - interacting with others directly, asking about your own financial situation, and offering advice where you have it is a great way to educate yourself about financial matters actively instead of passively.
One Response to “Two Divergant Real Estate Strategies: Buying New Construction vs. Buying for Value”
November 17th, 2006 at 9:34 pm
nice Fair and Balanced Presentation