Friend's Mentor: Visionary Or Crazy?
I have two friends who have been REI for two years in the Sacramento,Ca area. They took several courses from a well known guru and hit the ground running. They have been very successful buying and flipping properties in this very hot market. Approx two weeks ago their "mentor" came to town for several days to complete their training. Their mentor told them to gather data on their market and follow what their market is doing. He showed them a new way to evaluate deals also. He showed them how to evaluate deals using appreciation as part of the equation. He then proceeded to show them how much more money that they would have made if they had held all of the properties that they had flipped. He said that they should have kept all of the properties and refinanced to get all of their money out tax free. Due to the rampant appreciation they would have made more money and still owned the properties with break even or slightly negative cash flow (interest only loans). Now they have decided to hold onto everything that they buy and refinance to get their money out leaving very little equity in the properties.
What does everyone think of this idea? Does anyone else take appreciation into their buying equation or is this something that people do right before the bubble bursts? I don't want to see my friends get burned if/when the appreciation ride stops. I have limited experience having only done a few deals but this doesn't seem like a sane way of investing to me. I was unfortunate enough to buy my first house in Southern Ca in 1989 right before the last bubble burst and was upside down for many years before the market came back. It was not much fun!!!!!
Am I being Chicken Little or will the sky really fall???
Ernie
are they renting the props. to cover the monthly interest on the refin. not enough info.[ Edited by kenmax on Date 04/16/2004 ]
I am in the same market and see the possibility IF things stay the same...the market has been steadily climbing but what goes up eventually goes down....I buy and hold and have enjoyed the appreciation BUT I am only buying properties that I can get a positive cash flow out of with a fixed rate loan...this usually requires 10-20% down and a lot of searching....thy will do ok and probably see a bigger gain than me if the market stays hot, but their risk is much greater..........
Ernie,I agree with you your friends are taking a big risk holding all their acquisitions and taking out most of the equity. The real estate market is due for another correction it has been about 15 years since the last big one. I do not believe it will be as severe as the stock market correction 3 years ago. I have been an investor/builder/developer for 28 years and have seen 3 major corrections and many minor ones. Remember what goes up will come down!
Why didn't he tell them that 2 years ago when they were starting? It's easy to come up with a brilliant plan for what you should of, could of done.
Whatever the masses are feeling, it's generally a good idea to go the other way. The internet hype in the stock market... newbies who had never read a financial statement were throwing their money into the market blindly because that was the place to be. I was selling, a friend did me one better and shorted a couple of the fiber companies all the way to 0. A little over a year ago, i'm getting on a plane for Iraq, the market was pretty much DOA, others are hollering over their shoulders at their families that they loved them, I'm hollering move money from cash into the Qs.
Now the masses are on the REI bandwagon. At what point we are in the bubble I wish I was visionary enough to say.
Advice given after the event is like looking back at time and correcting all of your mistakes in present www.time.It is not a proper application.
I have watched many a bubble break and I have watched the overly extended drop properties like crazy as the cycle spun down. But I have also watched the game played where you do finance out and if the market turns down, you John Doe deed out and pretend you had nothing to do with it.
I always rode the middle path. I tried to get my properties to the point that I could keep rents about 10% under market and the maintenance levels so high that everybody wanted to be a tenant.
When the shake came, I always tried to buy out my high leveraged properties by offering to buy seconds at discount. You would be amazed how many times I did that.
Example: I buy a property value about $500,000 rents adjusted to the norm of the area. About 25% of the average family income. But I bought it with an existing lst TD payed down to $200,000. The rest was in a very large Purchase Money Trust Deed taken back by the prior owner who wanted just to hold paper. That note was for $250,000 int at 6% running for 10 years. Interest payable monthly. The market dumped and I bought the second for 10 cents on the dollar. The holder really needed money. Now my unpaid balance is for $275,000 and the value had dropped from $500,000 to $400,000. Still a good deal, loyal tenants happy at their slightly under market rents. Still a good equity. I gave it to my son.
Of course the value today is sky high now on the spike, but the rents are still where they belong up slightly but slightly because while real estate has gone up. The wages of the employed person are still pretty much where they have been all along. Thus the Spike is now out of proportion to the rental income. This of course tells you that the Spike is not firm. If you check you will see a little wavering on the high prices at this time. My bet is eight months or so. Unless of course Alan plays with the interest rate and then it might accellerate
a bit.
I hope this is helpful. I am very good at looking backward. My problem lies in the next eight months. Of course some idiot just might really stir the market with the introduction of really cheap housing made from steel ISO Containers. Now that would cause some interesting adjustments. I hope to find out.
Lucius the Container man. 8-)
I thank all of you for your great advice and for sharing your experiences...
Ernie
Ernie,
Holding in and of itself is not bad. Most of us that have made large amounts of money have done so by holding.
As was pointed out you want to have stable costs and good coverage from the rents. Hence you only hold properties that easily cash flow. Sometimes that means flipping some to reinvest the cash in others.
You can refinance but you should not assume an always upward market. Hence you refinance when you can pull out equity and continue to have a cash flow positive investment.
The mentor's idea as you relate it is a problem but it is not far from something that works well.
John
Started in San Jose CA some time ago with a Nothing Down deal. Likely 1 or more corrections since then in Northern CA.
[addsig]