John D. Rockefeller, considered the wealthiest man in modern history (with an estimated wealth equal to $318 billion in 2007 U.S. dollars, according to Forbes), once said, “Buy straw hats in winter.”
The point Rockefeller was making is simple—buy when others are selling, and sell when others are buying. But that’s a whole lot easier said than done, right? Only the confident and courageous move against the herd.
Figuring out what to buy, and how much to pay, is where the work starts. As I explain in my recent book, Successful Real Estate Investing in a Boom or Bust Market, savvy real estate investors make money in all markets. They just do it in different ways. When prices are high, interest rates are often low. When prices are low, rates are often high. When mortgage interest rates have been absurd, as they were during the fall of 1981 when they reached more than 18 percent, buyers simply forced sellers to finance their properties at reasonable rates. When prices are low and rates are low, it’s time to buy. But how do we know if prices really are low?
Determining Value
The first task of every investor is to value the asset. As Warren Buffett says, “Price is what you pay, but value is what you get.” For residential multifamily properties (2-4 units), the measuring stick is the GRM (gross rents multiplier), which is the price divided by the annual gross rents. For commercial properties, the cap rate (net operating income divided by the purchase price) is the guide. For multifamily properties, your target should be buying at a GRM of 8 or below. For other commercial properties, your target should be a cap rate of 8.5 or higher.*
“Only the confident and courageous move against the herd.”
Naturally, factors such as location, quality of property, occupancy, age of roofs, and deferred maintenance should all be considered. A very clean property might be a good buy at a cap rate of 8, while a property with some issues might only be considered at a cap rate of 10 or higher.
The bottom-line goal is cash flow. With residential mortgage rates dropping to 5 percent and below, these properties can generate more income. In addition, multi-family properties of five units or more that can use some rehab can now be financed with some lenders over a term of 40 years, with a 90 percent loan-to-value (i.e., 10 percent down), on a non-recourse basis. Real estate prices are down almost everywhere. And with this kind of financing, getting properties to cash flow (at least multi-family) has not been easier.
Straw hats, anyone?
* If you want the detailed numbers on this analysis, take a look at my book, Investing in Duplexes, Triplexes and Quads (Kaplan, 2006).
Larry Loftis is an AV-rated Florida attorney, real estate investor, adjunct law professor, and best-selling author. His latest book, Successful Real Estate Investing in a Boom or Bust Market (Kaplan, 2007), can be found at www.larryloftis.com, Amazon, or your local bookstore.
Tags: interest rates, Larry Loftis, mortgage, REAL ESTATE