As an investor in commercial and residential real estate for the past thirty years, I’ve learned a thing or two about the real estate market, about mortgages and about interest rates. There’s an old saying in the business world: “When a man with money meets a man with experience, the man with the experience will get the money and the man with money will get the experience.” Like anybody learning the ropes, I’ve gained some high-priced experience in my lifetime, but all of us learn from our mistakes. Compared to the big guys in the real estate business, I’m just a chump. But, if you’re new to real estate, perhaps my advice in this short column will save you some headaches. You might even make some money!
Start Early: If you have a desire to invest in real estate, start as soon as possible. Like all investments, the earlier you start the greater will be the appreciation of your property. Don’t try to be a tycoon. Start small with something you can just barely afford. Then move on to bigger deals.
Location: You’ve heard it said before, but it cannot be overemphasized. The location of a property is the most important determinant of its value and there are no exceptions! Never scrimp on location. Never purchase a property in a neighborhood that has a possibility of declining property values. If possible invest in a good, safe, neighborhood where property values are rising. If you can only afford properties in declining or “dicey” neighborhoods, you’ll be in for a nightmare. Save some more money until you can purchase a property in a good neighborhood.
Finance with a fixed interest rate: Over the past five years many lenders attracted potential homebuyers with Adjustable Rate Mortgages (ARM’s) or other types of variable interest rate loans. While the initial rates are low and the monthly payments are cheap, the homebuyer is taking the risk associated with rising interest rates and higher monthly payments in the future. If you want to get your payment down, go ahead and get a 30-year fixed payment mortgage, but don’t be attracted by low “teaser” rates on home mortgages. Right now the mortgage default rate in the United States is very high, largely because those who financed with variable rate mortgages can no longer afford their rising monthly house payments. Ironically, the mortgage companies that convinced these buyers to accept variable interest mortgages are now running ads offering to “get you out of your ARM and into a fixed rate mortgage!” Mortgage companies will now earn new fees and closing costs getting buyers out of the same ARMS they got them into four years ago! They get you coming and they get you going; there’s a sucker born every minute!
Make sure it’s solid: Make sure your purchase agreement has a contingency for a home inspection, including a radon test. Hire a good inspector to go over the property from foundation to roof. If you’re not paying at least $400 for an inspector, you’re probably not getting your money’s worth. Get a radon test. It costs less than $25 and if the house has high levels of radon, negotiate with the home seller to reduce the price about $2,500, which is the cost to have the radon problem permanently solved. Remember, all properties have some defects. Your inspector’s job is to notify you of structural or other potentially irreparable defects. If the house has a structural problem, walk away, period. If other problems exist that are fixable but expensive, try to negotiate a reduced price from the seller to compensate you for these extraordinary costs.
Advice about Realtors: Anybody with reasonable intelligence and a modicum of drive and ambition can become a licensed realtor. When real estate is selling quickly and it is a seller’s market, a lot of “newbies” enter into the real estate profession. Some of them are good and some of them aren’t so good, but they all lack the experience of someone who has been selling real estate for several years. Over time, as the market for real estate “cycles” from good to bad, most of the “newbie realtors” end up pursuing careers other than real estate. Whether you’re buying or selling, I recommend that you deal with a realtor that has been in the business for at least five years. Personally, I like the one’s who’ve been in for at least 20 years, and I seldom deal with “newbies”.
If possible deal with the “Lister”: When a house is sold, the commission is split three ways. About a third of the commission goes to the “Broker,” the person who owns the real estate office. Another third goes to the “Lister,” the person who got the seller to sign the listing agreement. The last third of the commission goes to the “Selling Agent,” who shows the buyer the property gets the buyer’s signature on the purchase agreement. For example, if Rachael “lists” the property and she works for Bob Brown Realty, Rachel is the Lister and Bob is the Broker. If Tammy, a real estate sales agent working for another broker, shows the home and convinces a buyer to sign the purchase agreement, at closing the commission is split between the broker, the lister, and the selling agent. In this example, if the total commission is 6 percent, Bob Brown would get 2%, Rachael would get 2% and Tammy would get 2%.
Here’s the point. If you can get Rachael (the “Lister”) to show you the home instead of Tammy, Rachael stands to get 4% if she sells the house. This gives her much more incentive to get the deal done, including convincing the seller that it would be wise to reduce the price of the property for a sure sale. When you see the sign out front of a property, look to see if the lister’s name is on the sign. If not, call the broker’s number and ask them who “listed” the property. The person on the phone will likely volunteer to show you the house, but tell them you want to deal with the “Lister.” If you are insistent, they will comply and give you the name of the lister.
There is one important exception to my “Deal with the Lister” advice. If you are entering an entirely new geographic area and are not familiar with the real estate market, you may be better off to work with one agent and let him or her show you homes until you make your purchase. A couple of years ago I worked with an agent in Chicago who was very proficient. She showed me properties in Chicago for almost 18 months before I made a purchase. With her valued assistance, I “learned” the Chicago real estate market. She was absolutely instrumental in assisting me to make what turned out to be a wonderful purchase. For the closing paperwork she also referred me to an extremely competent Chicago attorney. She is a credit to the real estate profession, and believe it or not, she was fairly new to the business.
Investing In Rental Property: There are a lot of late night “infomercials” featuring people who “made it rich” in real estate by “flipping” (quick purchase and resale) properties or by purchasing investment real estate. Listening to them, you get the idea that owning property is as easy as pie. Forget it. They are making money selling their courses and CD’s. They’ve found out a long time ago that infomercials are a lot more profitable than real estate! Remember that ownership of real estate entails receiving rent money, but it also includes tenants that don’t pay, unforeseen damages, and toilets and roofs that leak! If you want to own rental property, you have to MANAGE it! Someone has to do the repairs and deal with impossible tenants. There are a lot of “headaches” involved in owning real estate, like the midnight phone call in January informing you that the furnace isn’t working. Believe me, real estate is work!
Conclusion: I’ve sometimes referred to real estate as “the poor man’s investment.” It is the only asset I know of that you can purchase with someone else’s money and it will supply monthly income to pay off the loan; all with very little downside risk! The banker provides most of the money. The tenants make the mortgage payments by generating rental income. If you purchase quality real estate (in a good location) and manage it competently for twenty or thirty years, believe me, your real estate will take real good care of you.
Owning real estate isn’t a get rich quick scheme, it’s a long-run investment that (if done right) will add substantially to your net worth and provide some nice retirement income. I remember the day I bought my first rental property from Mrs. Ruth Markle in Winona, Minnesota. She was eighty-seven years old at the time. I paid her $48,000 for a house that she had paid $3,000 for in 1938. I didn’t have two nickels to rub together. At the time $48,000 was so much money for me that I could hardly imagine even borrowing it. I can still remember her advice as I pondered my decision. She said, “Don, over the years this house has been like a gold mine for me. Buy it and it will be a gold mine for you.” I stand here thirty years later to testify that Mrs. Markle, God rest her wonderful soul, was absolutely right!