Deaton Investment Real Estate & The Wake County Apartment Association

Friday, September 28, 2007

Okay, so yeah. It's been a while. No excuses, just lazy blogging. Anyway, on with the show:

A couple weeks ago Raleigh hosted an investor bus tour of CA and OR investors seeking property in the Triangle. They were organized by a real estate mentoring/consultant/conference organizer out of San Diego. This was the group's second or third visit to the area and this time, we were asked to be their agent on the ground.

Our job was to research and organize the properties to be seen on the tour and provide market insight along the way. It was our initial understanding that it would be a mix of multi-family and single-family rentals. As it turned out, we mainly viewed vacant foreclosures in more often than not, questionable neighborhoods. By questionable I mean, you were always asking, "From what direction will the bullets come?" Okay, I'm kidding. A little.

To backtrack a bit, our expectations were that we'd be spending an entire weekend (did I mention it was on a weekend?) with financially established and motivated real estate investors. Then, when the organizer told us they were looking for 10 caps, we had to re-adjust our expectations. And in that, comes our lesson: There are no 10 caps here. Well, no 10 caps that won't be 20 caps on the headache return scale, that is.

You see, once you factor in management headaches, repairs, rent loss and low appreciation, you simply won't see a 10% return. Which brings us to cap rates.

Long considered the de-facto way to measure an investment property's return, the truth is cap rates only offer a one year "snapshot" of actual financial performance. Actually, a cap rate really only offers a "day-one" snapshot, assuming the property will operate exactly how it is the day you decide to buy it. And often does that happen?

We found that the people on the tour were essentially creating "false cap rates" by starting with that 10% and working backwards to find a price point at which the property would return 10%/year. Guess what happened? The prices configured -- some actually became offers -- landed somewhere in the 45-70% below list price range. Ouch.

Now, is someone wrong to take a lowball shot at a property? Not at all. Especially given the locations and types of properties in question. Most of the properties looked at could function well in the long-term if held on to, even at list price. Even at 10% down, after a year the property would be cash-flowing and in some cases, possibly appreciating. Once a steady rental history is established and management issues worked out, many of the properties we looked at could work. But the strategy being employed was more or less, flipping. Although, as opposed to major renovations, the investors aimed at quick, affordable cosmetic fixes. New carpet, paint, shutters, landscaping. Again, spit and polish can work, but the market has to be right. And right now, it's not. In fact, it might not be at that place again.

A local investor with whom we work often tells us that real estate investing is not about timing, it's about time. As in, how long you hold on to a property. The real estate market is always up and down but in the long run, it's still always going up.

So I guess my point is to understand how your investing strategy dictates the type of property you buy. Don't try to fit a square peg in a round hole, especially when it comes to real estate investing.