How To Articles
How to Spot the Profitable Opportunities in Real Estate Investments
By
Jan 7, 2006, 10:28

LARGE EQUITY POSITION

The third key ingredient to profitable realty investing is for the seller to have a large equity position in the property. A large amount of equity presents a two fold profit opportunity for the smart investor. The opportunity is two fold because if the seller is willing to carry back a note for a portion of the equity in the property, the buyer has created financing that is usually at below market cost. 

When the buyer later resells the property, he or she can use this low-cost financing to generate additional profits through a loan assumption or wraparound mortgage.

For now, here's basically how it works. Let's say you purchase a house for $75,000 with a $5,000 down payment. You assume (take over payment of) the existing 8 percent loan of $40,000, and the seller lets you pay for his $30,000 equity in the property in installments at 9 percent interest. Now you have built-in financing that another buyer can assume, or even better, you can lend the balance to your buyer at a higher rate of interest and make a profit in the spread in interest rates.

Additionally, a large equity position in the property often can lead to a bargain price. Let's say that you locate a property you feel is worth $90,000, which happens to be the price it is listed at. The seller owes $40,000, which means she has a $50,000 equity position. The seller bought this property eight years ago for $50,000, and because of appreciation and paying down the loan, she now has a sizable gain in the property. Therefore, it is likely the seller will accept an offer of $80,000 on the property because she will earn a $30,000 gain.

On the other hand, if the property doesn't have a sizable amount of equity, there is little room for price negotiation. Take, for example, a situation where the owners have a $40,000 first loan and a $40,000 second loan on the property. Thus, they owe $80,000. The owners have to sell for at least $86,000 just to cover the cost of the loans and the selling costs. Without a large equity position, they have no room to make price concessions.

MOTIVATED SELLER

The fourth ingredient of a good buy is to purchase from a motivated seller. 

A motivated seller (sometimes referred to as a "don't-wanter") is someone who, because of certain circumstances, is prepared to sell at below market value. Such circumstances might include divorce, death in the family, job relocation, vacant rental and associated landlord headaches, lack of money, or another property bought and ready to move to. If you have any combination of these factors, the seller will be extremely motivated and prepared to look at just about any offer.

SIZABLE PIECE OF LAND (THE MORE, THE BETTER)

Improvements on the land have value, but these improvements eventually wear down and become obsolete. It's the land, by itself, that endures and appreciates. And as time passes, it emerges as the most valuable asset for the investor.

Before there was anything else.., there was land. It has, and always has had, certain characteristics of unique value. Land has supreme worth because, unlike anything else, it cannot be increased in quantity. Land is required for the production of food and commodities and provides the location to shelter its landlords and tenants. 

Land provides natural resources, which in turn are valuable in themselves as oil and mineral products. Each plot of land is absolutely different from every other plot of land. Each plot has its own soil quality and underlying composition, its own water supply and drainage ability, its own vegetation and terrain, and its own view. 

From feudal kings and landlords of the past to the homeowners and developers of today, a measure of one's wealth has been described primarily in the amount of land one owns. Therefore, holding title to land is something precious indeed.

I discovered a few years ago that the best bargains were to be found investing in homes on large parcels of land. In particular, I began specializing in the purchase of middle cross homes on half-acre lots. The reason for this specialization was that I could get more for my money, particularly more land. 

Also, the sellers of these so-called half-acre mini-estates never really had an accurate appraisal of the land value. In other words, frequently I could buy a 1,600-square_foot home on a half-acre for about the price of a similar tract home on one-fourth the amount of land.

It's often difficult to find a bargain among tract homes and condominiums because they are all so much alike. Therefore, these properties are easy to appraise and arrive at relative values. Everyone within the tract knows what they're worth because all the properties are about the same. 

On the other hand, half-acre mini-estates are more diverse. Most uninformed owners of these properties tend to give insufficient value to the land, and therein lies the opportunity for the wise investor who knows the value of the land.

Lack of sufficient land also inhibits the growth of a property. Many potential homeowners want more land so they can later add on to the house. Obviously, if there isn't enough land, expansion of the home will be limited; but, more importantly, the more land you have, the better off you'll be when it comes time to convert the home to another higher use. For instance, if the home you own can eventually be converted to commercial usage and the land area isn't big enough, the amount of new office space you develop, not to mention the required parking area, will be limited to the small area you have available.

To make a long story short, try to get as much land as you can. Over the long term, the primary value of the entire property will eventually be in the land itself. This is most certainly true when buying a home for yourself, but is not always the case when purchasing investment property.

Bear in mind your objective when purchasing investment property - you want a money maker, a property that appreciates, one that offers tax shelter benefits and a better than average return on invested capital. 

The subject property you're interested in may not be in the best part of town, but if it's a money maker, don't let the location stop you from making a sound investment. In other words, just because you wouldn't live there yourself, don't let the location detract from what would otherwise be a good investment.

Instead of knowing what to look for in a location, sometimes it's better to be aware of what to avoid in a location. 

Be careful of buying property in a neighborhood that has certain nuisances that may detract from the value. Before purchasing residential property, ask the following questions:

* Is it located next to commercial buildings, such as a warehouse or factory?
* Is it adjacent to a cemetery or an undertaker?
* Is it next to a school playground, where noisy children may interfere with the quiet enjoyment of the premises?
* Is it near an airport, or under the flight path of incoming or departing aircraft?
* Is the property subject to floods'?
* Does an unusual volume of traffic pass nearby that may prove to be a nuisance?

These characteristics of a location detract from the value of residential property. You can avoid these nuisances by carefully checking out the surrounding neighborhood before committing yourself to a long-term investment such as real estate.

Good location in a thriving market

Finally, you have to be sure you're investing in a thriving real estate market. Generally speaking, a thriving market is anything that is not declining in population, employment, and property values. For instance, a non-thriving market, or declining area, could be the city of Houston, Texas, during the late 1980s. During this time, Houston experienced what economists call a "rolling recession." A glut of petroleum supplies on the world market caused oil prices to fall drastically. This resulted in oil companies cutting back on employment, with many related businesses failing. Also, many banks failed during this time, partially owing to real estate loans that many unemployed people living in Houston could no longer make payments on. The result was an oversupply of new housing and foreclosures, which most people couldn't afford to buy. Eventually, the value of housing in Houston dropped dramatically because of this rolling recession.

Caution should also be taken when investing in smaller urban areas that depend primarily on one type of industry. This is because if that particular employer experiences bad economic times or has to close, the surrounding area will probably become depressed. On the other hand, areas that have diverse industries, such as Los Angeles or Boston, do not depend on one industry. These urban areas will economically thrive even if one major industry fails.

After you have a grasp of investment objectives and the key ingredients of profitable opportunities, you should look at some profitable investment strategies next.