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YEAR July 1988 February 1990 September 1991 April 1993 November 1994 June 1996 January 1998 August 1999 March 2001 October 2002 May 2004 December 2005 July 2007 February 2009 September 2010
STRATEGIC SHIFT
When values fall below the long term trend line, we always see the return of the real estate investor. From 2007 through the early portion of 2011, the common strategy was The Flip. This model is featured prominently on Cable shows like Flipping Out, Flip This House, Flip That House and Flip Men. There are even plans at Bravo Network to air a Houston based show hosted by a former Survivor star. While it may look simple on TV, this is no business for the first time investor. A distressed property, typically a foreclosure, is acquired on the Courthouse steps. The acquirer has very limited information about the home; usually what they are able to learn from viewing the exterior of the home and peeking in the windows. While they are likely able to buy the property at a discount, there could be tens of thousands of dollars in needed repair before they can resell. Once in possession of the property, time becomes the enemy. The investor assesses what is needed to return the property to market- ready condition and acts as the General Contractor to complete the repairs and updates. When complete, the property is then remarketed at the new , higher value; hopefully allowing the investor to earn a profit. As an investor profile, these are the Day Traders of real estate. Flipping is a high risk, high reward strategy. Since no pre-purchase inspection rights are available, there are often latent defects which become costly repairs. Purchasers have to pay cash for these properties and fund all improvement from their own pocketbook. When you consider the necessary risk tolerance, capital requirements, legal and title expertise, general contracting experience and valuation competency, successful investors in this category are few and far between. As our market continues to improve, flip opportunities are becoming more limited. Without an oversupply of poorly conditioned foreclosed inventory, the steep discounts needed to make this strategy valid are not available. We are now experiencing the transition of these investors toward a Buy and Hold strategy. If Flipping is like day trading, then Buy and Hold is akin to buying Blue Chips for a newborn grandchild to fund their college education. The two strategies are at opposite ends of the risk curve. Unlike Flipping, the buy and hold strategy is a realistic opportunity for working families. It can even be accomplished inside a qualified retirement plan.
COST OF ACQUISITION
Purchase Price: Down Payment: Closing Costs: Mortgage Amount: Mortgage Rate: Appreciation Rate: $141,000 $28,000 $4,230 $112,800 4.75% 5%
We will make the assumption this investor purchased this property on the day their first child was born with the intent to fund their childs college education by selling the property when the child turns eighteen. Investor sales require a twenty percent down payment, in this case $26,200. Closing costs are typically around three percent of the purchase price. Their total initial investment was $30,430 and they obtained a thirty year fixed rate loan (at the incredibly attractive rate of 4.75%) of $112,800 to make up the balance of the purchase price. This investor felt as if this property would have a higher value eighteen years from now than it does today. In order to forecast a future value, they had to become comfortable with an appreciation assumption. After considerable debate, they concluded that an annual appreciation rate of five percent per year was a reasonable expectation over the long term perspective.
CASH FLOW
After expenses and debt service, this property provides a positive cash flow of $7,296 annually, or a little more than $600 per month. Using historical data as our guide, we assume prevailing rental rates will continue to increase by five percent a year. That means that each year, your rental income will increase, while expenses remain relatively flat. This investor can expect positive cash flow of about $10,000 annually in 2016, $20,000 annually in 2026 and $26,000 when the child turns 18 in 2030. 3
SUMMARY
Sincerely,
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