Where is the Profit in Your Deal?
When we see Donald Trump on TV, we see a guy who is living the high life. Money, women and fame - all thanks to real estate. By media standards "The Donald" is a rich, successful real estate mogul. But, even he would have to admit that sometimes, he makes more money doing television than in real estate.
Whether you want a nice positive cash flow each month, ora cash profit on a quick resale, the only honest and ethical way to get there is EQUITY. Equity is the property value over and abovethe total amount owed on the property.
You may think that an investor who owns say, 50 houses, is probably very well set financially. He he might be...butif this investor has refinanced his properties to take all thecash out, or he paid too much to begin with, he may find himself on the brink of foreclosure or bankruptcy if vacancy rates climb.
One the biggest dangers I see today is the incredible paceat which home owners and investors are pulling equityout of their properties. (or worse, buying properties that havelittle equity to begin with)
Many investors are buying properties without even understanding how crucial equity is to their profitability.And homeowners who get 125% loans on their homesare asking for a foreclosure.
Regular readers know that I harp on the idea of keepinga minimum of 20% equity in every property you own. And the best reason to take lots of cash out of a property isfor the purpose of paying down debt on other real property.
Every week I get calls from investors who are desperate toget a fix on why they are losing money on a deal. The numberone reason I see over and over, is a definite tendency to take too much cash out of a property, which can kill yourpositive cash flow.
It's not flashy, it doesn't sell as well as telling someone theycan make $10,000 by next week, but buying, holdingand accumulating equity is the absolute bottom line rule forsuccess if you are a small investor. I don't want to burstany guru bubbles, but the facts are the facts.
Let's take my mom for example, who happens to be one of my favorite investors and also by far, the most conservative oneI know. She owns 5 houses all paid for free and clear. All are rented for an average of $525 per month. (Her location is Cedartown, GA., relatively low cost compared toAtlanta)Her personal residence is paid for too.
Mom is bringing in $2,625 per month in rent. Taxes and Insurance will get about $600 of it, leaving $2025. Over 12 months thatis $24,300. Not too bad. Added to other income and investmentsthis makes for comfortable, reliable retirement income.
On top of that, her passive income will increase over time as her rentgoes up. And, she is earning a solid 5% per year appreciation in thevalue of each property. Some of her houses have doubled in valueover the past 12 years. In terms of equity, mom is worth a prettygood chunk. In a good market, I'd guess about $800,000 justfor those 5 houses and her residence.
She took about 15 years to do it. Nothing fancy, just classic real estate investing. Anyone could do the same thing easily in10 years or less. But Mom knows that even when a property isowned free and clear, there are still unexpected events and coststhat will eat into your cash flow.
She represents the vast majority of the conservative, "never-been-toa-seminar-in-my-life", types who make up the bulk of the real investors out there. Some have 5 houses, and some have 75. I once workedfor a guy who had about 150 income properties. He was debtfree and had untold wealth in his equity. He had spent 30 yearsbuilding this portfolio, buying good deals as he came across them.
Like Mom, he also is careful to save money, avoid wasteful spending, andkeeps his equity in tact, so that his cash flow is in a safer range.
Equity gives you breathing room when the unexpected strikes. You might have a tenant that skips out on you, or a tree falls on the roof andyour deductible is $1000. Practical real estate investing requiresequity for long term safety and security.
In contrast, many of the best known real estate gurus have been broke and even filed bankruptcy. They could have used more equity.
Many people don't know that real estate guru Robert Allen, the author of "Nothing Down" and "Creating Wealth", which ignited the investing boom in the early 1990's, went bankrupt in July of 1996.
It appears that his no money down deals loaded him with too much debt. When interest rates went down and the rental market gotsoft, there was not enough real equity there to pay the bills.
Remember investing guru Robert Huff? Well known in the 1980's, he wound up in bankruptcy too.
There are many gurus and investors who like to argue that equitysitting in a property is money that is not being used. I understand their point, but I respectfully disagree. Taking equity out of a property also creates a situation in which that property requires more cash flow to sustain the costs. Then, when unexpected vacancies, higher taxes, or bad tenants come along, the investor is left with too much debtand not enough income to support that debt. The result can be catastrophic for the over-leveraged investor,some gurus have discovered.
Even "The Donald" has been broke. His restructuring of massive debt on his New York City properties during the late 1980's was the basis for his "comeback" to real estate glory. He got into a hole about 100 feet deep and then managed to get himself out. The book he wrote about the experience was a best seller that made him famous.
Mom probably won't be writing any books, but if she did, she would caution Mr. Trump not to be over leveraged. She will probably never be as famous as "The Donald" but what 'cha wanna bet she has more equity...
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