4 Ways To Avoid The Housing Bubble

If there are two things that everyone knows about real estate investing, they are: "I don't have the money to get started" and "It's too risky". These people never end up investing. The risk argument usually has to do with the uncertainty of the market, or "the bubble". True investors do deals that are successful no matter what the market's mood. Those with money can buy and hold to ride out the inevitable swings; the rest of us can work quickly enough to ignore the bubble entirely.

The transaction costs of real estate exchanges are prohibitively expensive for most people to play real estate like they do the stock market. Instead, real estate investors make money by providing a service that is inherently valuable. There are four main ways to provide a valuable service and get out quickly enough to circumvent any market losses:

1. Buy and sell concurrently - by profiting from the spread between two long-term contracts - usually selling at an increased rate to someone who couldn't otherwise buy - as part of a terms deal. By including appropriate contingency clauses and keeping a buyers list, you can structure both contracts to begin at the same time, creating a steady flow of profit.
   
2. Sell a better product than you buy - rehab and "flip" an unattractive property. Aim to be out of the deal within 3 months, and if you do things right, it should never take more than 6 months from beginning to end. Build in a fairly large profit margin, and have a comfortable "hedge" margin for any disasters.
3. Help others avoid greater losses - by working around foreclosures. Get to know the people at foreclosure auctions and buy from lenders who want to get the properties off their books. Better yet, work with the defaulting homeowner before the lender even forecloses. Either way, you can get the property at a deep discount and resell it, with a profit margin that negates even the most catastrophic market.
4. Don't buy in the first place - negotiate and analyze as you would with any other deal, including the necessary contingency and assignment clauses in the contract, and then assign the purchase contract to another investor who will buy the property and carry out the deal by him/herself.
   

Rehabbing 101: Don't Be Fancy

Perhaps the biggest mistake that plagues rookie rehab investors is the tendency to aim too high. In the spirit of improvement, it can be very tempting to put in marble floors or an exotic granite slab countertop. Don't do it! While these improvements can add luxury and a sense of status to a house, investors who aim to rebuild Neuschwanstein are losing sight of the goal of rehabbing: to bring a property back to liveable condition.

There are very few investors who make a living by turning perfectly-usable houses into cutting-edge design spaces. It's certainly true that the latter will often command a higher price on the market than the former, but for 98% of real estate investors, there are far too many drawbacks to the golden egg approach.

1) Cost - These high-level improvements are, by definition, more expensive to implement. They may entail advanced planning, custom-built parts and pricey construction fees. Even if they don't, the price of the materials will not increase property value by as much (percentage-wise) as the standard "take it out, put it in" approach. Most homebuyers will pay a lot of extra money to move into a good house, because they don't have (or don't think they have) the time or expertise to rehab their own house, and want to be able to use the property immediately. When it comes to bells and whistles, they are no longer paying for convenience, but for luxuries, which brings me to the second drawback.

2) Inappropriate for the Marketplace - As is evident from the sheer number of foreclosure proceedings, it's already tough enough to keep up with mortgage payments for many people, and there is only a very small segment of the buyer marketplace that can afford to pay extra money for frills. Although many people can pay a few thousand extra for a pristinely-renovated house, only a small fraction of these buyers can (or will) pay much more than that. This fraction is also difficult for investors to access because these buyers are often interested in custom-renovating a property just the way they want it, and some may even want to have a custom house built for them. Every shiny, unnecessary addition reduces the size of the resale market at the end of the deal.

Another problem is the fact that few neighborhoods are suitable for the really elegant houses. As a general rule, make houses blend in with their surroundings.

3) Time - Auren Hoffman has said that, for young people, time is more important than money. I think that for all real estate investors - young and old - time should be a principal consideration. There are a lot of potential deals in the marketplace, and you would be well-served to aim for many effective and profitable deals than a few big ones. Standard materials are so useful for that very reason: they are almost universally-usable, and the construction industry is best suited to work with them. Anyone who's seen Flip This House can attest that simple changes can become complicated in a hurry, and it'll do your mind and your calendar a lot of good to stick with what works. One of my favorite bloggers, Ramit Sethi (who's also one of the founders of PBwiki), likes to ask "do you want to be sexy or do you want to be rich?", and with the potential complications and slower resale (because of the smaller buyer's market) that come with ambitious renovations, it's wise to let your business make you rich, and to be sexy and stress-free during your other life.

Tools of the Trade: Tickler File

In other posts I discuss setting up your business from a legal perspective, which is a must-read topic for anyone going into business for the first time, especially in a big-money industry like real estate investing. Reading that post can save your financial life. Today's post focuses on how to be ready for action when the gears start turning, by setting up a fully functional office space.

A tickler file is a system that gives you reminders every once in a while to keep up-to-date with potential leads that haven't quite developed into true leads.

Oftentimes, you'll find that sellers - particularly those facing foreclosure or who have become motivated because of rapid changes in their personal lives - may be reluctant to work with you at first. A soon-to-be motivated homeowner may not yet be ready to part with her house, or may be trying to avoid some of the hard decisions associated with foreclosure or difficult life events.

A tickler file allows an investor to follow up periodically to be able to quickly seize an opportunity when it arises. A universally-identifiable quality of a tickler file is its system of "entries" or reminders tied to a particular date.

The best tickler files are straightforward and easy to use and update. The more complicated and intricate a system is, the less likely an investor will rigidly adhere to it, thereby undermining the dependability of having such a system.

Perhaps the simplest and most common form of tickler system is the "43 folders" system. Advocated by productivity trainer David Allen in his perennial bestseller Getting Things Done (quick summary here), it involves a straightforward setup of 31 folders numbered 1-31 (for each day of the month), and 12 folders representing the months of the year.

The 31 folders are placed in front of the folder representing the current month. For items to be "tickled" within the next 31 days, the investor simply sticks a reminder (usually a piece of paper) in that day's folder. For items to be reviewed more than one month in the future, the reminder is placed in the folder for that particular month. Then, each day, the investor can simply open that day's folder, look at the items, and take the appropriate actions. At the end of the day, you move that day's numbered folder to the spot directly in front of the next month's folder. This graphic shows a tickler system as it would appear on the 6th of November (or October, depending on whether you want the day folders before or after the month folder). Folders 6-31 represent the remaining days of November (the "31" folder wouldn't be used this month), Folders numbered 1-5 have been moved to represent the corresponding day in December. At the end of November, the investor should look through the "December" folder and move those items to an appropriate day for follow-up.

For real estate investors working primarily from the office, this is probably the best system to start with; it's easy to use and requires only 43 file folders and half a filing cabinet drawer. Investors who are constantly out of the office may find a software or notebook-based solution preferable. Online tools such as MyTicklerFile and Jott can be useful for keeping things in a centralized location, and if you don't plan on having internet access, there are many "Getting Things Done" software programs out there (although a simple Word document may be just as effective and easier to maintain). Many popular calendar programs can also handle task lists and to-do items, including:
(book synopsis

• Microsoft Outlook
• Mozilla Sunbird (free, open source software for Windows from the makers of Firefox)
• iCal (for Macs)
  

However, many productivity experts warn against combining "calendar" items (which are time-specific) with "tickler/maybe" items (which may only need to be reviewed and aren't set in stone) in the same system.

If you are going to use a "non-file folder" system, there are many options available, and it can be confusing. Aim for a simple solution that you can trust, so that you can put your mental energy toward more important tasks than remembering follow-up items.

Books I've Read Lately

Brian Tracy, in his "21 Secrets of Self-Made Millionaires", suggests reading or listening to audiobooks for 1 hour every day, and remarkable success stories like that of Ben Casnocha are a testament to the importance of reading, even in our multimedia-heavy society. After reading Ben's blog for a while, I was inspired to start reading again, and it has expanded my worldview and changed the way I think about life and business. Over the last 6 months, I've been averaging about two books a month. Not bad, but there's still room for improvement.

Made to Stick - Chip Heath & Dan Heath
The Tipping Point - Malcolm Gladwell
Dreams from my Father - Barack Obama
Getting Things Done - David Allen
Freakonomics - Steven D. Levitt & Stephen J. Dubner
The Anatomy of Buzz - Emanuel Rosen
The Power of Full Engagement - Jim Loehr and Tony Schwartz
The Audacity of Hope - Barack Obama
How to Talk to Anyone - Leil Lowndes
Death of a Salesman - Arthur Miller
Positioning - Al Ries & Jack Trout
Ender's Game - Orson Scott Card
Wishcraft - Barbara Sher and Annie Gottlieb
Think - Simon Blackburn
The 22 Immutable Laws of Branding - Al Ries and Laura Ries
King Warrior Magician Lover - Robert Moore & Douglas Gillette
At Last There Is Nothing Left to Say - Matthew Good

In Progress: My Start-Up Life - Ben Casnocha
The Likeability Factor (audiobook) - Tim Sanders

Up Next:
Never Eat Alone - Keith Ferrazzi
True North - Bill George, Peter Sims, and David Gergen