The real estate market moves in cycles, like most businesses. Now that we’re in a particular down cycle, we need to rethink our strategies. (By the way, don’t believe the media that the sky is falling everywhere; there are pockets where the market is holding and even appreciating. One school of thought that I’ve heard, “Live where you want to live, but invest where it makes sense”)
The new strategy should ensure one thing first and foremost – CA$H FLOW. This is the key to survival. You can’t eat equity for dinner and can’t use equity to pay bills. Lack of cash flow is the underlying reason why so many investors cannot survive and go back to their regular job.
How many ways can you generate cash in your business? When things are tough and the market has shifted, do you know where to go to create new profit centers?
Everything you do during the current slow market should be aimed at creating an influx of cash that you can ride through the slow times. You may have properties that are good properties to hold on to, but they don’t make positive cash flow, and you’re not quite ready to sell them either. So you’ll have to come up with new ways to generate cash flow and perhaps even create new profit centers that you didn’t explore before.
How can you generate cash from your business?
Let’s explore all the possibilities and how they stack up in the current market condition:
Wholesale
This is the fastest way to generate a chunk of cash in this business without using your own cash or credit, by simply assigning your contract. There are lots of deals out there due to the foreclosure epidemic and the general slowing of the market. But here’s the problem--if you don’t have a buyer ready, this strategy may not work. Besides, the competition is also high as lots of investors are going after those deals.
Rehab & Retail
This strategy worked very well in the last few years, and is the best way to maximize the profit from a deal. But due to the sub-prime mortgage meltdown and the general tightening of loan criteria, it’s getting harder and harder to get buyers to qualify for a loan. Those 100% financing loans and no doc loans are drying up pretty fast. So, if you’re relying on this strategy to create cash, you may be heading for a crash.
Lease Option Deposits
This is my favorite exit strategy, but it’s not a good one if you need all the cash right now. Typically, lease option buyers are not in a position to negotiate (but that’s changing rapidly as the inventory of homes increases), so you can get the full market value of your property if not 10 to 20% higher. The problem is, you get the cash if and when they exercise their option. First, that’s a big ‘if,’ and, second, they may still have a problem qualifying for the institutional loan. So the only money you’ll get upfront is the option deposits which are typically 2 to 5% of the price. You’d need a sizable inventory to generate large sums of cash, and after your expenses, you’ll probably not have much cash left (if any). The monthly cash flow from lease payments are pretty much a break-even or negative proposition and are usually not a great way to generate cash either, so I don’t count on them.
Rental Income
This is similar to the above, only worse because you don’t get a large chunk of cash up front other than an extra month of rent (last month rent plus security deposit which is not your money). Rental income typically starts generating some positive cash flow after you’ve had the property for 4 to 6 years and, hopefully, have experienced some appreciation (and a bit of mortgage reduction). If you put a lot of money (20% or more) down, then you can get cash flow, but you have your own money tied up and your cash-on-cash return is going to be lower. Since the market is slowing down and many markets are going through corrections, it’s not wise to count on appreciation for the next couple of years, and this is not a viable method of generating a chunk of cash. This is the way to hold on to the properties until the market turns, so you’d have to depend on other ways to generate some cash to live.
Refinance
This is certainly a viable way to infuse cash into your company, but there are a couple of key assumptions here. First, you need plenty of equity (at least 30 to 40%). Second, you must have good credit to get a decent non-owner occupied loan. Because of the current market conditions, this strategy is also getting tight for two reasons – lenders are lowering the LTV (loan to value) for cash out refinancing, and appraisals are being chopped down. Typical non-owner occupied cashout refinancings are limited to 70% for stated and 80% for full doc (which most investors can’t do). I prefer this strategy over selling out completely to access your equity to ride the slow market (and still own the property to enjoy all the other tax benefits and appreciation.)
That’s probably it. I’ve polled participants during my seminars all around the country and asked people to come up with any other ways to generate cash from the real estate business, and they said, “There are no other ways. Houses are our inventory in this business and we can make money by selling them, renting them or refinancing them.” Again, that’s it.
The New Currency
The focus of our real estate business has always been to find motivated sellers and everything stems from that premise. None of the techniques of buying distressed properties work unless the seller is motivated. All the strategies employed are typically geared for generating motivated sellers.
However, smart investors are realizing that there are plenty of motivated sellers out there due to the foreclosure epidemic, REOs and the general slowdown of the market. The new currency for making money in this down market is not necessarily finding a motivated seller; it’s having a motivated and qualified buyer in your hand. Did you get that? The new currency is having a motivated and qualified buyer.
So, your marketing needs to shift to find qualified and motivated buyers. You’ll need to build a herd of buyers, whether they are investors, rehabbers, landlords or retail buyers. If you want to maximize and increase your options, you probably should create a separate list of all of the categories.
Today’s Key Skill
I told you earlier that money is the reward for solving problems. Where is the market having the most problems? Selling houses. In my market, the greater Tampa Bay area, the absorption rate was less than 5% this year when it was 50% two years ago (absorption rate is the number of homes sold divided by the number of homes available).
So, if you know how to sell houses fast when others can’t sell them, you’ll be handsomely rewarded. With the glut of homes that need to be sold, there’s no shortage of prospects either.
The last few years of rapid growth and easy credit made selling skills and marketing for buyers almost obsolete. The FSBO (For Sale by Owner) industry enjoyed a rapid growth during that period. You didn’t need a realtor to sell your house who you’d have to pay a 6% commission. In some cases, all you did was stick a sign in the yard. By the time you returned home, you had three offers on your answering machine. Why would you want to spend a dime on marketing your home or need any selling skills? Some California builders were holding lotteries as they were breaking ground because there were so many buyers applying to purchase. I saw people line up the night before, as if for concert tickets, when a Clearwater, FL waterfront apartment owner announced that he was going to do a condo conversion. I’d bet that you could tell me similar stories from your town.
I love the saying, “Tough times never last, but tough people do.” Don’t wish it was easier; wish you were better and then do something to get better. When you get better, it always gets easier. There’s one skill that will pay you the most dividends in life – that is learning how to sell. When I worked for Tony Robbins speaking and traveling 48 weeks out of the year, that’s what I was teaching – selling, persuasion & influencing skills. I’d speak to an entire company and would ask a trick question to start my talk, “How many of you are in sales?” Invariably, the support and admin staff would not raise their hands.
The truth is we’re all in sales. A mother trying to “sell” her child on choosing vegetables over ice cream may be even tougher than selling to a corporate boardroom. In a group of friends deciding which movie to see, the better persuader will succeed in convincing the rest to go to his or her choice. The principles of sales and persuasion and influence are the same. If you learn them, you can apply them in any situation – personal or professional.
I was listening to CNN this morning and they were saying that there may be a silver lining to a higher oil price (as the barrel of oil reached a new high and is predicted to go higher for various reasons, the continuing Middle East crisis being the main one.) Whenever there is a serious spike in the oil price, we get more serious about focusing our energy on alternative resources and reducing our addiction to oil. Whenever there is a spike in oil price, we think of cooperating more (e.g. carpooling), paying attention to global warming, etc.
Similarly, if there is a silver lining to the market change, it may force you to develop skills that you would not have otherwise tried. This will cause you to be less dependent on the market condition for your livelihood. Out of this crisis, you’ll develop systems and processes and resources that’ll catapult you to the top of this industry.
Be sure to check back next month, as we'll cover the next part of this article —
"Maintaining Cash Flow During These Rough Times"