Why you make money in real estate (Part 2)

Back in Part One I wrote about what money was. My conclusion there was that money was the way we measure value. The amount of money we are willing to spend displays how valuable something is to us.

So how does that pertain to real estate? If you want to make money in real estate, you need to figure out a way to provide value to someone. Our customers tend to come from two places, tenants and buyers, so everything you do should be adding value to one of those two groups.

Let's take a hypothetical example of John Doe who just bought a book that taught him how to buy a home for No Money Down. He gets a 100% mortgage and let's assume that his mortgage payments are about $1500 a month. He sets his rent to $1600 a month (because he's heard about the importance of cash flow). Now what are the odds that he's going to rent? If his potential tenant could pay $1600 a month in rent, why wouldn't they just go out and buy their own home for $1500 a month like he did? John Doe has failed to add value.

So how can we, as real estate investors, add value for our customers? There are a variety of methods, some common and others not so. Let's look at some of the commoner methods that a investor can add value for his customers.

Fix the home up. Buying a fixer-upper and then fixing it is possibly the most obvious method of adding value to a home.

Offer life beyond their means. This is something that every investor does, but rarely thinks about the mechanics behind it. Imagine that John Doe instead sets his rent at $1200 a month. He'll have to either eat a negative cash flow for a while or put more money down at closing, but he has immediately added value. Tenants can now afford to live in a nicer house than they could afford to buy. For example Jane might only be able to allocate $1300 a month to housing, but wants to live in the nice school district for her children. John Doe is allowing her to enjoy a home that she couldn't afford.

Offer hassle-free living. This strategy mostly deals with transient populations who won't sit down long enough to making purchasing a home reasonable. Military bases, college towns, downtown city areas are all places where large numbers of people move, stay for a few short years, and then leave. Very few of them can afford the hassle of buying a house, and even fewer would be profitable in the transaction given the short amount of time involved. You add value by giving them an alternative to purchasing a home.

In these areas you can sometimes start making money immediately. Biff and I bought out first house with only 10% down, yet we were making a $25 a month profit when our first tenant moved in (after all regular monthly costs including insurance, HOA dues and PMI). The reason we were able to do this is because our tenant was a military contractor and wasn't expecting to be in the area for more than 2 years, hardly enough time to buy (we also bought the house at reasonable discount).

Buy properties at a discount. The value added when you buy properties at a discount is the difference between your purchase price and the price that others are willing to pay for the home. You add this value through your knowledge and expertise. With so many investors out there it is very difficult to spot these sorts of bargains, so your value is hard earned.


What are some less common methods that real estate investors use?

Offer to buy out distressed buyers. Find people in difficult situations and offer to buy them out, though at a discount. The value added here is the difference between what you paid for the house and what the market value is. You add this value through time, you are offering money quicker than more traditional methods.

Rezone a property. Some investors have the knowledge and expertise to get areas rezoned or re-lotted. For example an investor might buy a house on a large plot of land and then subdivide it and sell the lots. Since most buyers wouldn't be able to do that on their own (they lack either knowledge or the time to get the knowledge), you've added value through your expertise.

Make the property a landmark. It's also possible to increase value by adding a bit of celebrity to the property. If you buy a very old home, for example, you may be able to petition to have it recognized as a historical landmark. If you really wanted to be a little creative, you could also try tracking down a property that housed some celebrity before they had made it (Eminem's home on eBay leaps to mind) . This could add value to both buyers AND tenants.

An important note to close on is that every method of increasing value requires either money (to fix a house or make a larger down payment) or legwork and expertise (to find bargains or get a property recognized as a landmark). There is no free money in real estate; to get it requires either cash or hard work, and usually both. But if you are willing to get your hands a little dirty and be a little imaginative, then you'll often be surprised how many different ways you can add some value to your customers.