Buying a House vs. a Home: Being an Investor vs. a Personal Home Buyer

January 20, 2007

A lot of people have asked me recently how to start their own real estate business.  Over the last few entries I have tried to give a good overview of how I got into the business.  Today I want to share some key differences between real estate investing and personal home buying.  It is very important that anyone approaching one or the other understand how they are different.  

Personal home buying represents turning a house into a home.  In this situation you are looking through a very personal lens.  If you like finished basements or large kitchens, you need to look for a house that either can be completely redone or that comes close to meeting your needs.  You go in expecting to put in several years (or more) worth of work to get things just the way you like it.  Have you ever wondered why some houses have more bathrooms than bedrooms or why the walls are pink under that wallpaper?  The answer is simple; everyone who moves into a house makes it a home.

The goal of real estate investment buying is almost the opposite.  In this situation you are taking a home and turning it into a blank canvas for future renters or buyers.  Those flower window dressings you like so much, might not appeal to perspective tenants.  Additionally, while you might be able to live with that hole in the door, future buyers might see that as a sign of disrepair.  Most importantly, the properties you look for will be diamonds in the rough.  Properties with broken doors and windows, but fairly new appliances, a good foundation, and an intact furnace make excellent investments.

Good investors have great vision.  They know how to separate buying a home from buying a house.  These investors know how to change little things to make a big impact.  New door knobs, a new address sign, freshly cut grass, and a few shrubs in the front can turn a house completely around.

New investors need to keep this in mind as they approach an opportunity.  The quickest way to kill a return is with expensive upgrades that you fall in love with.  A keen understanding of personal home buyers is important.  Home buyers expect to purchase or rent a house and make changes to fit their lifestyle (not yours).  Save money by providing them a blank canvas and let them create the vision.


Cook Squared Enterprises: The Beginning

January 19, 2007

I have decided to start a blog chronicling the rebirth of Cook Squared Enterprises, the real estate business my wife and I started several years ago with our first investment in Detroit.  The ups and downs, tears of joy and pain, will hopefully serve others well as they pursue similar endeavors.  Friends and family alike seem to enjoy our tales of woe and comical misfortune as we battled the Detroit Water Company, an organization comparable to the relentless Borg for Star Trek fans, (for others, just substitute the most evil thing you can think of and that would be the Detroit Water Company).


Other more comical mishaps we hope to avoid this time around involved the surly contractors who drink on the job.  The adage you get what you pay for really applies here.  Projects filled with cost overruns, surely due to the high beer tax in
Detroit, along with an old house that seemed to be a death trap lying in wait for its next victim combined for some long penniless nights.  For those of you who have ever tried negotiating with a contractor with nothing to lose (not even his teeth), you will know that my Cornell degree add very little value to this situation.


But for the grace of God and some great tenants, all is well that ends well.  After taking a two year hiatus, Cook Squared Enterprises is back in business.  Armed with a new Cornell MBA in Real Estate, we are pursuing our first apartment building in Greensboro, North Carolina, a great southern town experiencing moderate growth.  Again, we are starting with a small budget, so the readers of this blog can expect plenty of hilarity as we try to save money using family, friends, and others to get off the ground.

Cook Squared Enterprises’ First Investment

January 19, 2007

After a tenuous start in the real estate business in California, we took our success on the road.  A job promotion forced us to pack up our things in sunny California and move to the not so sunny Detroit, MI.  A lot of people have a lot of bad things to say about Detroit, but not I.  I think the city gets a bad rap.  The people were great and there were a lot of things to do beside visit the casinos. 

Despite the rocky start in California, the wife and I were eager to get back on the saddle.  This time around we had real money and were much smarter.  The real estate agent interviews were a huge surprise.  Due to our age many agents didn’t take us seriously.  A lot of them were unwilling to talk about what they had done in the past or even sit down for the interviews.  Additionally, very few agents had good experience working with investors.  Of course there were a few good agents out there.  We selected a great one, Tamara Smith, who had great experience working with investors and strictly worked with buyers (very important). 

A brief aside on buyers’ agents.  Buyers’ agents only work with home buyers and investors, who are on the buying side of transactions.  Their plus is the fact that they have a lot of great experience negotiating from the buyers’ side.  They also build a relationship with a lot of buyers and can typically be counted on to find a buyer for almost any property; great people to know if you buy a lot of properties. If you recall from yesterday we decided to start the business with $30,000.  For those of you who many not know the Detroit real estate market probably falls in the lowest 5% of all real estate markets in the US.  This being the case we found it imperative to choose very wisely in the properties we selected.  After some market research we found a great arbitrage opportunity.  The average price of investment homes ranged from $20,000-$50,000.  In addition, many of the homes were owned by the City, State, or local banks.  This meant they could easily be purchased for $10,000-$30,000 below market value.  With the average rental price of these units being $650-$800, there was a great opportunity to get mortgages of $200-$300 with these rents. 

The opportunities for good investment were everywhere; unfortunately there was also a lot of opportunity for failure.  Many buildings were actually worth less than $0 (that is not a misprint).  Some houses were literally falling over or had so much internal work that needed to be done it just wasn’t worth it.  When looking at houses with a finished value of at most $50,000, we could only accept houses that were in need of cosmetic repairs.  After looking at over 1000 houses in person and on line, we settled on our first investment; a great house that appraised for almost double what we purchased it for.  After several hundred dollars of cosmetic repairs we were up and running.  Amazingly, the rental market was so hot, in one day of working on the house six people came by asking if they could rent the house.  After some credit and reference checks we settled on our first tenant.  Thus began Cook Squared Enterprises.  Key Learnings…

  • Great opportunities are everywhere
  • Be selective.  Even good opportunities may not be the right opportunities to start with
  • Go where no else wants to go, there is less competition and often a lot of money to be had

Strategies for Selling Real Estate

January 19, 2007

Nothing new on the Cook Squared Enterprises front, so yet another rant from me.  As I have been looking at pricing in real estate it struck me that a lot of people do not really have a pricing strategy.  Most people seem to just price their properties high and expect to drop it as offers come in.  While this strategy tends to work well in very hot real estate market, I have found that it really does not work well in other situations. 

Let’s look at a quick example.  During our renovations of a house in Gross Pointe Woods, Michigan we experience a rehabbers nightmare.  In a matter of months the market literally tanked.  Much of this was due to layoffs in the Big Three Automakers and the exodus of Kmart to Chicago.  Unfortunately for us, what we expected to be a sale of maybe $250,000 turned into a far flung hope for $205,000 (eventually sold for $197,000).  Lucky for us we bought the house really cheap.  Our neighbors were not so fortunate.  They had recently refinanced their home for $250,000 and used the money for very nice renovation.  In a stroke of very bad luck he was being forced to relocate and had to list his property right away.  Due to all the renovations and the refinancing, he really needed to get $250,000 to break even on his home, so he listed it as such.  He placed his property on the market about six months before we sold ours.  Eventually, he sold his house for about $220,000 after it had been on the market for almost 2 years.  This was one of many cases in that area of people chasing the market with their pricing. 

During this same market we were able to sell our house in a little less than two months because we priced our house with the market.  First, we took weekly tours of the market.  My wife and I enjoy attending open houses.  Kind of a weird hobby, but we really have a passion for real estate.  We knew what our competition was offering as far as upgrades and we knew their pricing.  Additionally, we tried to emotionally detach ourselves from the pricing.  This was the hardest thing to do.  Thinking about how much time and money we put into the property, we really wanted to get a good return.  Fortunately, we priced smart.  We chose to price our property just under houses with similar upgrades.  Since we had the same school system and the exact same neighborhood we felt like we had an edge.  We got good traffic and eventually were able to get a good price. People often don’t figure carrying cost into their pricing strategy.  Consider the average mortgage on a $200,000 house.  Let’s say that it is a $1,200 monthly payment.  If you hold a property for an additional 6 months, which amounts to roughly $6,000 in interest payments that you would not have to pay if your property was sold.  Additionally, the longer the property is on the market, the more concessions the buyer will ask for and the more desperate you will get.  The stress of this situation is certainly an additional price you have to be willing to pay.  Consider the situation above where the person made $30,000 of concessions and held the property for two years.  Adding in interest payments, that is almost $50,000 off the purchase price.  That would be the same price we sold our house for and it had fewer big upgrades. 

To investors and first time sellers I recommend discussing a strategy with your agent.  First, go out and look at all of the properties in your 3 mile radius that are for sale.  Don’t just get the MLS report because it won’t show you what the upgrades look like and how the property truly compares to yours.  Once you get that information, think about your timing and what is happening in your market.  If the market seems to be strong, consider pricing right at or slightly above houses that currently have the same or few upgrades.  Make sure you are honest with yourself about your property.  Do not consider the amount of money you put into the house.  As economist say, that is a SUNK cost and should never be factored into your decision.  Finally, be proactive.  If you see houses are sitting on the market for a long time, lower your price slightly.  It brings people back to your property and gives you an advantage.  Always remember, money is made on the purchase of the property, not the sale.   

No Money Down, Think Again

January 19, 2007

During this hiatus I want to talk about a few pet peeves I have in the real estate business.  This entry is dedicated to the many real estate schemes and scams that you see on television.  Before I rant, I want to say that many of them certainly have the potential to work.  Additionally, many of these products do work, but not the way they claim.  For those of you hoping to be the next Donald Trump for three easy payments of $49.99, think again.  There are much cheaper alternatives to getting started in real estate. 

I want to first give you my credentials so you know how much experience I have and where my perspective comes from.  I am 26 years old with an undergraduate degree in business from Cornell University and am currently one semester away from having an MBA in Real Estate from Cornell as well.  I bought my first house at 21 and have owned about five houses since them turning a solid profit on all of them.  I only say this so that you know I am a reasonably intelligent person with a bit of real estate knowledge. 

I first came into contact with these get rich quick real estate “systems” through my brother.  After I had bought several houses, he mentioned that he had purchased a famous system on EBay.  I thought I might be able to gain some value from it, so I borrowed it for two weeks and read it cover to cover.  Now at this point I had bought two houses and read tons of books.  The lies from this book astounded me.  My most favorite of them is that you can start a real estate business with no money down.  They mention borrowing from relatives, creative financing, mortgaging your current home and other off the wall schemes.  Let me tell you that there are about .00001% of people in this business that started with no money.  And many of them go bankrupt very quickly. 

Let me take a minute to explain the no money down scheme.  First, you have to have impeccable credit and a great property.  Next, you have to submit to what amounts to usury from an interest rate standpoint (10-15% over normal rates).  If you manage to get past all of that you still have to make sure that you meet all the financial hurdles banks set for these kinds of loans or they will foreclose on the property.  Many people who have good credit can lose their home and send their credit scores in the tank from one misstep with no money down loans.  Additionally, if the market takes a turn you often end up with a property worthless than you bought it for with a loan you cannot get rid of. 

The only exceptions to this are the people in ultra hot real estate markets like California or New York City.  Here there will be a lot more competition, but if you can find a good property you make a fortunate regardless of the financing.  Good luck finding that homerun though; there will be at least 100 people (no exaggeration) right there with you. The people that make no money down loans work typically have experience in the real estate business.  If you have good connections and a great property you can make it work.  The rub, of course, is that you will make a much higher return using a conventional loan or even a commercial loan and by the time you get to this point you don’t need a no money down loan.   

Bottom line, steer clear of the many “systems” that you see on television.  If you want to get started in the real estate game, head to Borders or what ever local bookstore is near you and browse the real estate section.  I recommend the following books: Real Estate from A to Z, Rehabbing for Dummies, Profiting from Real Estate Rehab, [Buy it, Fit it, Sell it], and any other basic book on real estate investing.  Steer clear of books that promise you will be a millionaire in a month or that suggest starting the business with no money down.  Read at least two or three books, then start small with an easy property to rehab and rent.  After that, go at your own pace.  If you want to do it full time set goals of say 10 houses this year and 20 the next.  The most important piece of this process is to make the first investment.  Don’t read yourself out of investing.  The sooner you invest the better.  Real estate is not a hard business, but you have to be educated. 

One last thought.  When you see people on television talking about how they made millions in the real estate market, ask yourself why they are now on television selling a “system” and not out making more millions?  If I could make a million dollars a year, I certainly would not waste my time selling junk on television.   

How to Buy Real Estate

January 19, 2007

Yesterday I spoke about real estate pricing strategies.  Today I would like to talk about the other side of the game, real estate buying strategies.  I have read many good books on this subject, but have found that personal experience (i.e. trial and much error) has been the best teacher.  To sum up briefly yesterday, I stated that sellers do not often use a specific pricing strategy, typically they look at the MLS prices in their area and price near the top and expect the buyer to low ball them.  With this in mind what is the best strategy for a buyer?  Well, despite the seller’s strategy it is often not best to simply suggest the lowest price, hoping to avoid hurting their feelings. 

In my experience the best strategy has been to get as much information about the seller and the property as you can.  For example, many people meet the sellers for the first time at the closing table (if even then).  This is a hard step, but I suggest trying to meet briefly with the seller and their agent to discuss the property and their listing.  This can be hard to arrange, but net very valuable information.  This is a must for any person buying an investment property, but strongly suggest for personal home buyers as well.  This initial step has several benefits.  First, you become a real person to the seller.  This makes it much harder for them to dismiss your offer.  Next, it gives you a chance to ask questions about the property.  People love talking about all the things they have done (and even something they haven’t).  Watch out for any items the seller may mention having problems with or that he/she mentions will not be included.  One of the worst things about buying a property is coming in and realizing all the appliances and window treatments are gone, when you thought they were staying. 

Finally, ask a few probing questions.  Framing is key here.  Say things like, I just visited a property down the street that was selling for x with the following upgrades.  How do you think your property compares?  It seems like you have put a lot of work in the house and it looks great, is there anything else you would do if you had more time?  I am considering remodeling the basement, who did you use for your remodeling?  All of these questions give you valuable insight into what work they actually had done, if it was done by reputable people, and if they have looked at other properties when pricing their. 

Based on this initial assessment, your bid should be based on the following.  First, your bid should allow you to get a reasonable return on the property.  If you are an investor, this is obvious because you can consider the NOI and the cap rate.  If you are a personal home buyer this is a little more challenging, but should still be considered.  Consider a bundle of properties.  Think about what you want.  For example, if you want a new kitchen consider the price of a kitchen remodel.  What is the price difference between that house with a beautiful kitchen vs. the one that needs the remodel?  If they are the same (when you add the cost of remodeling), go with the beautiful kitchen because it saves you a lot of headache.  If they are significantly different consider buying the cheaper house and take on the remodel.  Assign a value to each house based on your needs.  Bathrooms are fairly easy to remodel, while kitchens and basements can be tougher.

Houses are unique investments.  No two houses are the same, so listing the most important aspects is critical.  Keep that investment mentality.  Additionally, it is always better to buy the worst house in the best neighborhood vs. buying the best house in the worst neighborhood (or even an average neighborhood).  When you buy the worst home in the best neighborhood you can make additional investments at your leisure, the way you want, and get maximum value for your improvements.  Nicer properties in average markets tend to stay on the market longer and tend to recover less per dollar invested.