Friday, August 9, 2013

33 Guidelines to investing in real estate........................

Guideline #24:  Pay attention to your financing.

A few examples are in order:

In the late 1970's a group of local investors were buying small apartment complexes with the assistance of "owner financing."  They would make a small down payment, borrow some from the bank, and then borrow the rest from the seller on a five year note.  Their plan was to have built up some equity by the end of the fifth year, which would allow them to refinance with a bank to pay off their loan to the Seller in a timely fashion.  They thought of "five years" as being a long time.  Add five years to 1978 and your end up in 1983.  The history majors amongst us will remember that interest rates spiked in the early 1980s.  In 1983, rates for commercial loans were in the 15% range.  It is hard to make real estate investments profitable paying 15% interest.  It made for some interesting times and real scrambling for those investors.

In 2002 a local investment group refinanced a 250 unit apartment complex.  Times were good, values were appreciating, they had significant equity, lenders were eager, interest rates seemed reasonable, and  the appraisers were all optimistic.  Our investor friends decided to free up as much equity as possible by borrowing as much as they could, which was a lot.   Flash forward nine years.  The note is coming due in January of 2013.  It had to be either paid off or refinanced.  Paying it off was not an option.  Times were difficult, values had fallen, their equity had disappeared, lenders were scarce, interest rates were very low, and the appraisers were all pessimistic.  Failure to secure new financing would have had catastrophic implications for the partners.  While the mortgage was non-recourse, the tax consequences of a forced sale was in the seven figure range.   It was a bit tense for them for awhile, but this story has a happy ending.  Because the investors were paying attention, they consulted early on with a trusted mortgage broker, on his advice they took the necessary steps of spending many hundreds of thousands of dollars to upgrade units.  It did not hurt that the market for commercial loans also improved quite a bit in 2012,  As a result, the partners were able to secure new financing for another ten years, at a very interest rate.

Just as the economy runs in cycles, so does financing.  Between 2002-2006 you could borrow money if you could "fog a mirror."   Between 2008-2009, heaven help you if you needed to borrow money.  It should be noted that in the 30 some odd years we have been doing this investment real estate thing, financing has only been problematic in four or five of those years.  The other 25 or 26 years , borrowing money varied between a reasonable business proposition and way too easy.  The important thing is to be prepared for the problematic years.

It should be noted that, if you invest with a plan similar to these guidelines, most business cycles will not be an issue for you.  You just weather the storm, and maybe even take advantage of it.  A lot of money gets made when markets are in turmoil.  This last-go round was no different.

Every investment is different.  There are no hard and fast rules, other than "pay attention."

1 comment:

  1. okay as you say we will follow your guideline before investing in real estate but can you tell some guidelines for builders also we are Om builders

    builder in Bhopal