Miami Beach Real Estate, South Beach Real Estate, Miami Real Estate, Marc Manfredi

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May 1, 2012

I was recently asked to come up with a list of some of the basic aspects of investing in real estate that ought to be considered by any potential real estate investor. All of these aspects should be studied prior to actually making any investment in real estate. I have separated these various aspects of real estate investing into topic, or subject headings below.

  Topics will usually contain a bit of commentary explaining basic ideas relating to the topic. Also discussed are some of the benefits of adopting one strategy vs another. There will also be questions posed that will need to be answered by the individual investor that should coincide with the investor's particular needs and goals. Once an investor has answered the questions that relate to the various topics they should then be able to compose a competent and coherent investment strategy. These observations and questions are based on my experience as a Realtor and investor in the Miami Beach and greater Miami real estate market. There may be regional variations in the real estate market that will require the investor to make adjustments to their strategies in order to conform to the local conditions in their part of the country.

I have also discussed some of the benefits of investing in real estate and why I think that this is a good time to consider investing. Please note that I am not licenced to provide investment advice and that I am not trying to act in that capacity. I am just sharing my personal opinions on the subject. Please see the full disclaimer at the bottom of the article.

The list that follows is not all inclusive. There are many other aspects of real estate investing that are not listed here. I just wanted to provide a list of some of the basic things that an investor might want to consider before going forward.

BUDGET AND PRICE POINTS. What is the real estate investor's overall budget and what price points do they prefer or require? Have they set aside enough cash to cover emergency repairs or other unexpected contingencies once the purchase price and closing costs have been deducted from their budget? Have they made reasonable allowances for vacancies and collection losses when making their cash flow analysis?

If a renovation of the property is planned does the investor have adequate reserves to cover the cost of all of the renovations? What if the process of pulling permits, renovating and inspecting takes longer than expected? (It always does) What if the final cost of renovation exceeds the initial estimates (It always will) What if one of the contractors or subcontractors disappears or goes out of business when the job is only half finished? What if a contractor or subcontractor collects a fat deposit to start the job and then immediately runs off to Costa Rica with his girlfriend? The point I'm trying to make is that the real estate investor can always expect the unexpected. I think that it's always wise to plan on having a significant cushion of extra cash available to cover unexpected contingencies. The overhead and holding costs of a building can get an investor into trouble fast if their units are empty and they're not collecting rent, especially if they have taken out a mortgage. One who invests in real estate should always keep a little in reserve to protect their investment.

CASH OR FINANCE. Will the real estate investor be paying cash or financing the deal? If the investor will be paying cash they can negotiate from a position of strength because the seller will know that the buyer can actually follow through with any offer that is presented. The seller may also need or desire a quick deal which won't face the possible delays or outright collapse of a deal that depends on financing. "Cash on the barrelhead" as they used to say can motivate a seller to make a quick deal, often at a significant discount to a "might go through some day" financed offer. In a quick cash deal the seller can almost smell the money and they are highly motivated to accept the offer. They don't say "Cash is King" for nothing!

The cash investor should have a proof of funds letter from the institution where the money is held, printed on the institution's letterhead and dated within 30 days of the time that they will be making their offer. If the investor is going to rely on financing then if possible they should have their financing approved by the lending institution ahead of time. They should also have a pre-approval letter from the lender printed on the lender's letterhead that is dated within 30 days of the time that they makes their offer. Proof of funds or pre-approval letters are often expected when making a serious offer for a property. Time is of the essence when trying to beat another real estate investor to the punch to secure a deal. The investor should make sure that they have these documents in hand before they start looking for property as an investment.

Getting banks to finance anything today is a lot tougher than it used to be. Having solid financing arranged ahead of time isn't as good as cash but the more solid the financing arrangement, the better the investor's negotiating position will be when dealing with a seller. An upside of financing is that interest rates are at historic lows right now so the cost of money is very cheap. One other benefit of financing is the ability of the investor to leverage their cash down payment to control a much more expensive investment than they would ever be able to purchase if they were just relying on cash alone. Suppose they purchased a $1,000,000 property and the value goes up to $1,500,000. If they had purchased the property for cash then they would have made a 50% return on their money. If the investor had put up a 25% down payment ($250,000) then they would have made a 200% return on their money! This of course does not take into account the cost of money which would vary depending on the interest rate that they were able to obtain on the loan and the length and other terms of the loan.

LONG OR SHORT TIME FRAME. The duration that the investment will be held is important if the investor in real estate is hoping for appreciation of their investment. This is especially true if they are trying to time the market. Being right at the wrong time is the same as being wrong when it comes to the bottom line. Let's say a property doubles in value "just like they thought it would" after 7 years. This is worthless to them if all of the increase came in the last two years and they had sold out at the 5 year mark because that was the time they had allotted for the increase to occur. Timing can literally be everything. Beyond that of course are tax considerations that depend on whether any increase in the value of the property will be counted as short term or long term capital gains.

CAP RATE VS APPRECIATION POTENTIAL. Is the real estate investor mostly interested in a cap rate/rate of return or are they more interested in appreciation potential? As a rule the more appreciation potential the lower the rate of return. Higher rates of return are often found in less desirable neighborhoods so there is that trade off to consider. Investors that see little appreciation potential in a property or neighborhood are always going to demand a higher rate of return to compensate for this lack of potential appreciation. Properties that have decent appreciation potential along with pretty good returns represent a good balance to many investors.

In an upscale neighborhood with strong potential for appreciation an investor in real estate might expect to negotiate a 5%-7% cap rate. In a less desirable neighborhood they might hope for a 7%-9% cap rate. In a rough neighborhood they may be able to find 9%, 10%, 11% or even higher cap rates. In the go-go days during the renaissance of South Beach (especially when the market was hot) investors were happy to purchase a building with a negative rate of return. We didn't even bother quoting cap rates...there were none! Investors were hoping to enjoy 10%, 20% or an even higher rate of appreciation every year on their investment. Many buildings were flipped over a 20 year period with each new owner making a nice profit on appreciation before selling to the next guy. That worked fine of course until it didn't...around 2007.

A fun example is a large multi-story building at 846 Lincoln Road on South Beach. It was built in 1924 at a cost as I recall (no I wasn't there personally!) of around $232,000. I think it sold in around 1987 for only about $275,000-not much more than it cost to build 63 years earlier! It sold again three years later in 1990 for $900,000. It dipped down a bit to $870,000 in a 1992 sale, then finally sold for $15,500,000 in 2007 at the height of the real estate market! It's now valued for tax purposes at $10,400,000. I guess the lesson going forward here is not as much about appreciation potential versus current rate of return. It's more about...

MARKET TIMING. As they say, "In life, timing is everything!" I personally think it helps to be a bit of a contrarian when considering investments. Named in the 1966 Guinness Book of World Records as the world's richest private citizen, J. Paul Getty was quoted as saying "Buy when everyone else is selling and hold when everyone else is buying. This is not merely a catchy slogan. It is the very essence of successful investments." I don't know if we're at the absolute bottom of the real estate market yet. I do believe that anytime you can buy a valuable, essential asset like investment real estate at a 50%-90% reduction from the recent high prices you "just do it." People are always going to need a place to live.

GLOBAL MARKETS. As developing markets in China, India and many other countries strive to archive a first world standard of living they are going to continue to put upward competitive price pressure on basic building materials like concrete, steel and copper. With these increases in basic commodity prices along with inevitable wage cost inflation I think that the distressed prices today are but a fraction of what building costs are going to be in the future. I don't think you'll ever be able to build most of these properties for anywhere near the low prices that many of these distressed properties are selling for now. Additionally, the other aspect of the global marketplace is that many of the citizens of formerly underdeveloped countries now have the means to invest in real estate...here! This is already very apparent in resort real estate markets like Miami and Miami Beach. Much of the current real estate activity in this market is coming from foreign nationals. Quite often these deals are made for cash. In the case of Miami this has helped to alleviate excess inventory left over from the last real estate boom. It has also no doubt helped to stabilize prices. I expect these global influences to continue to put upward price pressure on real estate prices here in the U.S.

LOCATION, LOCATION, LOCATION. Earlier when discussing the cap rate vs appreciation potential we discussed the inverse relationship between appreciation potential and expected rates of return. At that time we started to delve into the differences in neighborhoods and how that relates to expected rates of return and expected appreciation potential. This brings us to the Location, location, location topic of discussion. Real estate investors expect a property located in a poor neighborhood to offer a greater rate of return than a similar property in a more upscale neighborhood. One reason is the lack of expected appreciation potential as discussed. Another reason is because there is a perception among investors that the vacancy and collection losses are likely to be higher in a poor neighborhood. An investor in real estate may also need to consider the cost that vandalism, graffiti and possibly other crime may have upon their investment. The investor may find that it's difficult or expensive to obtain insurance in such an environment. However, a property in a poor neighborhood will often be able to be purchased for significantly less than a similar property in an upscale neighborhood. This is because of the lack of appreciation, as well as some of the other issues just discussed. This combination of lower starting price points for similar properties along with higher than average returns appeals to some real estate investors.

In terms of appreciation potential though, the old adage still applies: Location, location location! For those investors who lean more towards the appreciation potential side of the equation I will leave them with one final maxim that is one of the cornerstones of investing in real estate. "Always try to purchase the worst house in the best neighborhood."

PROPERTY TYPE. Does the real estate investor have a preference for a certain type or types of property? Do they have experience managing retail or restaurant property? Perhaps they are only familiar with industrial or warehouse space. Are they only interested in residential multi-family projects? All of these different types of properties may be in different phases of their market cycles. Which type looks most attractive to an investor right now? Which type is still headed down in price? Which type is likely to rebound soon? Once again, we have to consider market timing. Are condos overbuilt? Is retail space still a drug on the market because of the larger economic climate right now? Is the global marketplace likely to have an effect on the market the investor is considering?

Is the real estate investor interested in purchasing several small or even individual condos or small warehouses that can often be purchased "distressed" in a short sale or foreclosure? These can often be purchased at a greater discount than the larger projects. Greater discounts usually translate into greater returns when they are rented out. They're also much easier to find. On the other hand if the investor has 10 units scattered around town instead of one 10 unit apartment building how much more time and travel will managing the 10 separate units require? How much is their time worth? Will they now be required to hire someone to manage the 10 units for them and thus squander the higher returns they were planning on receiving? Does the investor want to have to worry about the monthly maintenance fees and possible special assessments that come with owning individual condo units? Are they OK with that loss of control over their expenses? Would they prefer to purchase only one or two large projects that are located in only one or two locations so that they are easier to keep track of and manage? Lot's of things to consider before making the leap!

RENOVATED VS FIXER UPPER. Does the investor in real estate want to get a property that has had a recent renovation so that they can budget the next several years confident that maintenance costs will be low and fairly predictable? Are they able to pick up the renovated property for about the same price as similar unrenovated properties in the same neighborhood? This would allow them to essentially get the expensive renovation work that was done on the property for free. Maybe they'd prefer to pick up a building at a big discount that needs a lot of work. They might have good contacts for having renovation work done and realize that they can add value to the property beyond the cost of renovation which makes it worth the time and expense. Plus they know that they will be able to raise the rents which will increase the immediate cash flow plus allow for a higher sale price when a buyer sees the larger income stream.

INSURANCE. Every real estate investor should schedule an appointment to sit down with an insurance agent to discuss the cost and availability of various types of insurance coverage. They should try and determine the probable cost of insurance coverage if possible before making an offer on a property. The considerable cost may change the amount that they are willing to offer for the property. Liability, windstorm, flood and fire are some of the types of coverage that should be considered.  The types of coverage and the limits of the coverage will depend on a variety of issues. These will include the investors particular circumstances, the type and condition of the building and area where the building is situated. It will also depend on whether or not they plan to finance the sale. If the sale is to be financed the investor will need to know what kind of insurance and what limits of insurance the lender will require. Try to find an agent who has experience in writing insurance for commercial property. The insurance should be set up and ready to take effect no later than the day of the closing.

COMPETING INVESTMENT OPTIONS. Today many investors are afraid of volatility in the stock market or of another potential stock market crash like the one in 2008-2009. A stock price can go to zero. It is almost certain that a good real estate investment will always retain some value. It is a real entity. An investor can always live in it or rent it out. It's not going away and as they say, "They're not making any more of it!" Interest rates are at historic lows so it is very difficult for an investor to make money on their money. If you consider the inflation rate then their cash is probably going to have less purchasing power every year even after including their miserable interest income. Just saving their money or parking it where it will obtain a minimal interest rate is not really a good option. I would say that at best it's still going to be a losing proposition in the long run in this low interest rate, moderate inflation environment. As inflation rates go up, (and they most certainly will at some point) then their purchasing power will shrink even faster. If they consider the probable real inflation rate which they can check on sites like www.shadowstats.com then they are losing money right now at an even faster rate than they realize.

Many fortunes have been made in real estate over the years. I can't guarantee that every investor that invests in real estate is going to make a fortune. I do think that every investor owes it to themselves and their family to at least consider the benefits of real estate when deciding where to invest today. Good luck!

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Please note that I am not licenced to provide investment advice and that I am not trying to act in that capacity. NO MATERIAL ON THIS SITE CONSTITUTES "INVESTMENT ADVICE" AND NOTHING HEREIN CONSTITUTES A RECOMMENDATION TO BUY OR SELL ANYTHING. All of the content on this site is provided without any warranty, express or implied. All of the opinions expressed on this site are the personal opinions of the author and may contain errors or omissions. Any actions you may undertake as a consequence of any analysis or opinion that you have been exposed to on this site are your sole responsibility.

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