By Rick Sharga, Vice President of Marketing for RealtyTrac
With real estate outperforming most other investment vehicles, it's not surprising that an increasing number of buyers are pursuing investment properties.
With the rapid appreciation in many real estate markets, investors can realize a quick profit in the short term by reselling a property. Even if a particular real estate market is not red-hot, investors can profit over the long term by initially using the property as a revenue generator-leasing the property while allowing equity to build.
That doesn't mean it's always easy to find investment properties. But with the right strategy for pinpointing investment opportunities, investors can realize sizeable profits even in an overheated real estate market, according to T.J. Marrs, a real estate investment trainer and author based in Vancouver, Wash.
"In general, if you can trade a 20 to 30 percent spread between your costs and your resale price, you can be fairly safe that you're going to make a profit no matter what, even in a bubble market," he said, adding that costs include not just the purchase price but other fees and expenses involved in buying a property.
Locating investment properties
The ideal investment purchase involves a motivated seller who has built a solid amount of property equity but doesn't have the time, money or other resources to sell the property at its full market value.
"There are literally dozens of ways to find properties. But the key is to find a property where there is a motivated seller involved," Marrs said, noting that one of the best ways to find motivated sellers is to search pre-foreclosure properties.
Although the hidden market of foreclosures and pre-foreclosures has previously been available only to industry insiders willing to sift through public records at the local county courthouse, services like RealtyTrac have made this information easily available online. Visit RealtyTrac to search pre-foreclosure, auction and bank-owned properties nationwide.
A property enters the foreclosure process when an owner defaults on monthly loan payments, and the property is scheduled for public auction. The owner can stop the auction during a pre-foreclosure period by paying off the amount in default or by selling the property for a price that covers the balance of the loan.
Many real estate investors contact the owner during pre-foreclosure and offer to buy the property at a bargain price. If a deal is worked out, the owner avoids having a foreclosure on his or her credit history and usually walks away with some cash in his pocket.
"The reason they're willing to sell is that they are very motivated sellers. And they're going to lose the property if they don't sell," said Marrs.
When contacting the owner, investors need to be aggressive marketers because they are often contacting the owner before the owner has made the final decision to sell the property.
"With any kind of marketing campaign, you need to get a penetration beyond first impact," Marrs said. "One letter is pretty much useless. Three letters is about five times more effective than one letter to the same lead."
If the owner doesn't sell or pay off the amount owed during pre-foreclosure, investors can bid for the property at the public auction. Auctions often represent great bargain-buying opportunities, but they also represent more risk and more competition from other bidders, according to Marrs, who usually buys before the auction.
The foreclosing bank sometimes bids on the property at the public auction. If the bank is the winning bidder, it takes ownership of the property. Banks are usually motivated sellers since they consider foreclosed properties nonperforming assets and often want to unload them quickly. Many banks are willing to sell foreclosed property below market price as long as they break even.
Judging profit potential
A good investment property is bought below market price and appreciates in value after the purchase. This requires a motivated seller, but it also requires the numbers to work for both the buyer and the seller. A real estate investor should crunch the numbers on any potential investment property to determine if it meets the criteria of a good investment while still meeting the needs of the seller.
The total amount of any debts secured by the property should be significantly below the property's market value. Investors can research all the debts owed at the county recorder's office or online using RealtyTrac's Legal and Vesting Report or Transaction History Report.
RealtyTrac provides estimated market value information for each pre-foreclosure and foreclosure property posted in its database, and investors can order a Comparable Sales Report for a detailed list of comparable sales. If the total amount of debts owed is 20-30 percent below the market value, the investor should continue to pursue the property. If not, the investor should probably move on to another property.
The amount of bargain an investor is happy with can vary depending on the structuring of the purchase agreement. If he can take over the current loan on a property, Marrs is willing to buy it for up to 90 percent of its market value. But if he has to secure a new loan to buy the property, he wants his purchase costs to be at most 75 percent of the market value.
"If I can avoid using my credit or my money, then I'm gaining leverage. The more leverage I can use, the lower risk it is for me," he said.
In addition to evaluating the potential bargain, investors should consider how to generate a profit after buying the property. Investors should weigh whether reselling or leasing provides a better return on their investment.
If interest rates are low and property values are increasing rapidly, it may be better to resell the property after making any needed repairs and improvements. The cash profit can then be re-invested in more real estate.
Leasing may be a better option if rental property is in high demand. Marrs uses lease options or installment land contracts to sell the property on an installment basis. This allows him to obtain a higher purchase for the property in the long run and maintain a monthly cash flow in the process.
"I look at my exit strategy and entrance strategy at the same time to determine what makes up a good deal," he said. "It's not just about the price of the property. It's about how I can structure financing to make the most amount of profit with the least amount of risk."