Is There a Low Risk Way to Invest in Residential Real Estate? (Second in a Series)

I first got interested in real estate investing when I was a commodity futures broker on the east coast of Florida twenty years ago. I did what everyone did. I went to a seminar. The promoter of the seminar soon went to jail and I joined the huge crowd of people that knew you could not invest in real estate. I was lucky enough to have a disaster in my conventional real estate dealing show me the big picture.

Maryan and I had bought a home in Boca Raton and when we decided to move back to Pinellas County (Tampa Bay area) we had become aware that the home we bought was a mile away from where a garbage burning incinerator was to be built. The person who sold us the house may have known about the plans, but we did not. When we were ready to sell everyone knew and we could not sell the house.

We left the house with a Realtor and moved to Palm Harbor to start a new business. Not real estate. Months later the Realtor called to say a “nice young couple” wanted to buy our house and wanted us to finance it. We were terrified because we had learned the conventional wisdom that banks make mortgage loans and people get the loans. But it was sell that way or not sell for a long time, so we did the financing.

It eventually worked out, the people, who really were a nice young couple, refinanced a couple of years later and I was fascinated with creative real estate. We bought a couple of foreclosures, which were pretty big in the late 80’s as they are now, that needed very little work and sold with owner financing, since we had learned that financing moved houses fast and finally bought a really ugly house to do our first real rehab.

The house cost about $17,000 and we paid about $12,000 to fix it up and quickly leased it with an option to buy at $50,000. The tenant buyer was paying us $550 a month. I thought this was terrific. I had never seen anything like this in the stock market or commodities market.

We thought this was pretty good until a mortgage broker we know, let’s call her “Mary,” mostly because that is her real name, approached us and said.

“Forget taxes, repairs and insurance for simplicity and tell me what your rate of return is?”

“And would you be interested if I could show you how to make a LOT more, and if I do will it is okay if I make a profit too?”

“Sure,” we said. “If it is really rented all year (and it may not be) we will have $6,600 in rent and since we have about $30,000 of our own money in it, the return is 22 per cent a year and we will make some more off the backend when the tenants refinance and cash us out.”

“So, if I were to loan you the $30,000 that you have in it at 8%, you would pay me $2,400 a year, a whole lot more than what I can make off of CDs, you would have an income of $4,200 and you would have all of your money back so you could buy and renovate another house and your return of $4,200 on a zero investment would be better than 22 per cent.”

We thought that was pretty convincing logic. We took the loan and everything went well until the tenants refinanced and cashed us out. WE had to take another check of a little under $20,000, on what was now a zero investment. But we decided we could get used to it.

Mary suggested we should “walk the mortgage.” That means we shifted the mortgage to another property so Mary could continue to received the8 per cent interest and we did not have to come up with the $30,000 to pay her off. So the check we got was really closer to $50,000 than $20,000.

I always think of this early experience when people tell me that real estate is risky. It is and thousands and thousands of people who considered themselves to be real estate investors have gone through terrible stress, foreclosure and bankruptcy. But as we said at the beginning of the first article in this series. “there are real estate investments and then there are real estate investments.

Many of those recently departed investors bought at full price when the market was high and hoped the market would go up so they could re sell and make a profit. That only worked when the market is going up. When it stopped, they lost substantial amounts of money.

Being a partner of a person rehabbing a property bought below the market may have less risk than outright speculation, but it still has risk. There are always a variety of things that can go wrong.

Even the strategy that Mary showed us has its risk, but it seems to me it is less than most of the vehicles available for investment of any kind. You cannot buy IBM below the market price because the stock certificates are torn and get paid for taping them back together. You stand a pretty good chance of getting paid for fixing houses that need repair and are selling below market because most other people think it will cost a lot more to fix than we have found to be the case.