Building a Real Estate Investment Portfolio in a Down Market!


Published on - I made this presentation in November 2007 (before the Great Recession) in Colorado Springs during an Investors Roundtable Seminar. Surprisingly, many of the ideas presented then still hold up today. If I had to do the presentation today, I would obviously make some changes.

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  • Author: Matthew Chan, Investors Roundtable Seminar (
  • Author: Matthew Chan, Investors Roundtable Seminar (
  • Author: Matthew Chan, Investors Roundtable Seminar (
  • Building a Real Estate Investment Portfolio in a Down Market!

    1. 1. “ Building a Real Estate Investment Portfolio in a Down Market” by Matthew S. Chan, MBA
    2. 2. Building a Portfolio in a “Down” Market? <ul><li>“ Are you nuts? Have you read the news?” </li></ul><ul><li>Did it in Columbus, GA & Phenix City, AL </li></ul><ul><li>My family did it in the early 1980’s </li></ul><ul><li>Requires a different mindset & perspective </li></ul><ul><li>Requires a different set of skills & expertise </li></ul><ul><li>Requires working with a different group of people. </li></ul>
    3. 3. Credentials & Achievements - I <ul><li>Real Estate Investor – ATL, COLS (1999) </li></ul><ul><li>ISBN Publisher (2003) </li></ul><ul><li> Author (2003) </li></ul><ul><li>National Assoc. of Realtors Author (2005) </li></ul><ul><li>1 st book on Lease-Options from Mgmt Perspective (2004) </li></ul><ul><li>1 st book on “subject to” mtg financing (2005) </li></ul>
    4. 4. Credentials & Achievements - II <ul><li>#1 Providers of OFH in our local area </li></ul><ul><li>Most Established “Takeover” Homebuyers in our local area </li></ul><ul><li>1 st in our area to truly use website presence to market properties </li></ul><ul><li>1 st in our area to legitimize ‘subject to’ mortgage transactions. </li></ul><ul><li>Raised in family real estate </li></ul><ul><li>Ownership interest in 30 Properties. Assist in Management of 60 properties worth +$5.5 million </li></ul>
    5. 5. Formal Education <ul><li>Bachelor of Science – Business Admin. </li></ul><ul><li>Masters of Business Administration </li></ul>
    6. 6. Corporate World (1984-1995)
    7. 7. I.T. Self-Employed Business (1995-2000) <ul><li>Adjunct Professor – 1 Year </li></ul><ul><li>Independent Consultant / Contract Trainer </li></ul>
    8. 8. Why Do We Invest? <ul><li>Make more money </li></ul><ul><li>Quicker than saving money </li></ul><ul><li>Create equity & wealth </li></ul><ul><li>Create cash flow </li></ul><ul><li>Retirement & Security </li></ul><ul><li>Most people don’t have a vision or goals in their investments. That is why so few have a meaningful portfolio. Having LOTS of cash alone is not an investment portfolio! </li></ul>
    10. 10. Everyone knows Money is necessary to live but everyone has different ideas on “the rules of money”.
    11. 11. Scarcity Minded <ul><li>Crosses all socio-economic circles </li></ul><ul><li>Tend to hoard money </li></ul><ul><li>Believe that money is scarce </li></ul><ul><li>Have frugal habits </li></ul><ul><li>Give themselves “just enough” </li></ul><ul><li>High financial discipline & savings </li></ul>
    12. 12. Poor <ul><li>Value brand names & status objects </li></ul><ul><li>Their idea of wealth is what is visible & material, so they buy small symbols of wealth (shoes, clothes, jewelry, car) </li></ul><ul><li>Live paycheck to paycheck </li></ul><ul><li>Will only save when they need something </li></ul><ul><li>Don’t understand credit & have little or bad credit </li></ul><ul><li>Have little ability to withstand financial hits </li></ul><ul><li>Low value on traditional education </li></ul>
    13. 13. Middle-class <ul><li>Understand credit & have good credit </li></ul><ul><li>Value home and car ownership </li></ul><ul><li>Aggressively finance all aspects of their lifestyle </li></ul><ul><li>Have the ability to save money </li></ul><ul><li>Most income from W-2 jobs. Pay most taxes. </li></ul><ul><li>Dependency on 401k’s & IRAs for retirement </li></ul><ul><li>Dependency on home equity for future wealth </li></ul><ul><li>High value on academic education </li></ul>
    14. 14. Wealth-class <ul><li>Income from business or investments </li></ul><ul><li>Use leveraged financial tools to amplify their results (Corp, credit, EE’s, investors) </li></ul><ul><li>“ Long-term value” focus on business & investment decisions </li></ul><ul><li>Pay less proportional taxes through business or investment deductions </li></ul><ul><li>Dependency on business, real estate, & dividends (cash flows) for retirement </li></ul><ul><li>High value on financial education </li></ul>
    15. 15. Common Ideas About Money <ul><li>Money is scarce & hard to get </li></ul><ul><li>The more money I have, the more problems I will have </li></ul><ul><li>I have to work hard to make money </li></ul><ul><li>Money is the root of all evil </li></ul><ul><li>No one will ever trust me enough to give me money </li></ul><ul><li>If I have bad credit, I cannot invest in real estate </li></ul><ul><li>I cannot afford to lose money </li></ul><ul><li>People will sue or come after me if I have money </li></ul><ul><li>I will lose friends & family if I have more money </li></ul><ul><li>I have to have a degree to make good money </li></ul>
    16. 16. You Came to Get Another Perspective! But also realize that everyone has a bias.
    17. 17. Alternative Ideas of Money <ul><li>Money is Abundant (but you must think beyond yourself) </li></ul><ul><li>Everyone has Money Problems (You get to choose the problems you have.) </li></ul><ul><li>Investing is About Risk (Manage & control risk, not eliminate it) </li></ul><ul><li>Debt is an essential & valuable financial tool </li></ul><ul><li>Successful Investing is a learned skill that requires introspection. (Emotions & bias) </li></ul>
    19. 19. “ Reasonable” Returns <ul><li>Checking (0%-2%) </li></ul><ul><li>Savings (2%-4%) </li></ul><ul><li>Money market (4%-5%) </li></ul><ul><li>Certificate of Deposit (5%-7%) </li></ul><ul><li>Mutual funds (0%-10%) </li></ul><ul><li>Stocks (0%-20%) </li></ul>
    20. 20. “ Unreasonable” & “Risky” Rates of Return <ul><li>25%-50% “Extremely” risky </li></ul><ul><li>50%-1,000% “Impossible!”, “Scam!” </li></ul><ul><li>∞ What is this? Never heard of it. No one has ever taught me. </li></ul>
    21. 21. Once you make money, then what? Most people spend more time planning their vacation or buying a new car than thinking and learning about investments.
    22. 22. Asset Classes <ul><li>Paper (Stocks, mutual funds, foreign currency) </li></ul><ul><li>Precious Metals (gold, silver) </li></ul><ul><li>Business (non self-employed) </li></ul><ul><li>Intellectual property (brands, franchise & products, publishing) </li></ul><ul><li>Real estate (SFH, commercial, land) </li></ul>
    23. 23. Ask a banker how much they will loan you to buy <ul><li>Paper assets (Up to 50%, if at all) </li></ul><ul><li>Precious metals (none) </li></ul><ul><li>Business (Up to 65%) </li></ul><ul><li>Intellectual property (falls under business loan) </li></ul><ul><li>Real estate (Up to 90%) </li></ul>
    24. 24. Benefits of Real Estate <ul><li>High leverage investment requiring a very small percentage of cash </li></ul><ul><li>Favorable tax treatment </li></ul><ul><li>Hedge against inflation & decreasing dollar </li></ul><ul><li>High demand for use </li></ul><ul><li>Able to get “unreasonable” rates of return </li></ul><ul><li>Market Value can be influenced by individuals </li></ul><ul><li>Can be managed by non-investors </li></ul><ul><li>Market changes move slower </li></ul>
    25. 25. Downsides of Real Estate <ul><li>Requires greater management than paper assets </li></ul><ul><li>Not as liquid as paper assets </li></ul><ul><li>More room for fraud & manipulation </li></ul><ul><li>Can destroy credit and personal financial situation </li></ul><ul><li>More “moving parts” to consider </li></ul>
    26. 26. Management is The Single Most Important Factor That Determines Investment Success!
    28. 28. Real Estate Roles <ul><li>Job (Appraiser, inspector, sales agent, mtg broker) </li></ul><ul><li>Business Owner (Sales or Mtg Brokerage, Property Mgmt, job-driven) </li></ul><ul><li>Investor (Asset owner or shareholder) </li></ul><ul><li>Active Investors (Developers, landlord-owners) </li></ul><ul><li>Semi-active Investors (Staff, partnerships) </li></ul><ul><li>Passive Investors (Partner with active/semi-active investors or property managers.) </li></ul>
    29. 29. Investors or Not? <ul><li>IRS Guideline: Capital gain tax treatment after 12 months </li></ul><ul><li>Flippers & Wholesalers? </li></ul><ul><li>Rehabbers & Renovators? </li></ul><ul><li>Builders & Developers? </li></ul><ul><li>Short-sellers & Foreclosure resales? </li></ul><ul><li>Landlords & Long-term Holders? </li></ul>
    30. 30. “ Most rehabbers, sales agents, and property managers make terrible real estate investors because they want to make every property retail-ready!”
    31. 31. Benefits of a Portfolio <ul><li>Very simple rules to follow </li></ul><ul><li>Building a portfolio requires only a finite number of transactions </li></ul><ul><li>The financial rules for managing a portfolio differs from those of a single deal </li></ul><ul><li>3 properties gives you a starting portfolio </li></ul><ul><li>Cost of management per property decreases as you portfolio grows </li></ul><ul><li>A few “bad” investments does not collapse the entire portfolio </li></ul>
    32. 32. Who is More Highly Regarded? <ul><li>A person who has flipped or rehabbed 10 properties? </li></ul><ul><li>A person who holds and maintains 10 properties in a portfolio? </li></ul><ul><li>Who will have more after 10 years once the transactions stop? </li></ul>
    33. 33. “ A True Investor is Focused on Building & Maintaining Their Portfolio in Good Times or Bad, not just flipping or turning deals.”
    34. 34. Who can stop after 5 years? <ul><li>Job holders – No </li></ul><ul><li>Business owners – Maybe but subject to strength & stability of job holders </li></ul><ul><li>Investors – Yes, they choose when they can stop </li></ul>
    35. 35. Did You Know? <ul><li>It takes only a small portfolio of 4-5 properties to create a $1 million equity position after 20 years. </li></ul><ul><li>What is staggering is that your cash contribution could be less than $50,000. </li></ul><ul><li>Tenants pay the rest. </li></ul>
    37. 37. Real Estate Purchase <ul><li>Financed with: Equities + Debt </li></ul><ul><li>Equities = Savings from Personal labor </li></ul><ul><li>Debt = OPM (lenders/investors) & (if structured correctly), paid by users (tenants) </li></ul><ul><li>Accessing Debt = Financial Leverage </li></ul>
    38. 38. “ Cash positions in itself will not get you into great wealth positions.” However, wealth positions can almost always get you into great cash positions!
    39. 39. Investment Criteria Professionals Use <ul><li>Cash-on-cash Returns </li></ul><ul><li>Fair Market Value (Appraisal & comps) </li></ul><ul><li>“ True” Market vs. “Fire Sale” Value </li></ul><ul><li>Holding Costs (# mos. vacant x Mtg pymt x Mktg costs) </li></ul>
    40. 40. Cash-on-cash Returns <ul><li>Assume $150/mo CF = Get $1,800/year </li></ul><ul><li>Invest $10K Down Pymt = 18% CCR </li></ul><ul><li>Invest $5K Down Pymt = 36% CCR </li></ul><ul><li>Invest $2K Down Pymt = 111.1% CCR </li></ul><ul><li>Invest $0 = ∞ “Infinite Returns” </li></ul>
    41. 41. Determining “Value” <ul><li>Fair Market Value (Comps & appraisals) </li></ul><ul><li>“ Fire” Sale (Immediate) </li></ul><ul><li>True Market Value (Within time frame) </li></ul><ul><li>“ Value” can be subjective and improved with salesmanship and terms of sale. </li></ul>
    42. 42. “ Successful real estate investors do not always rely on hard formulas. They also have a great sense of intuition & ‘instinct’.”
    43. 43. Deadly Equity Moves Amateurs Make <ul><li>Look for capital growth only (appreciation). No regard for “fire sale” values, cash flow, holding costs, mgmt, etc. Without continued appreciation, the asset cannot be sustained. </li></ul><ul><li>Simplistic understanding of Equity and Cash. </li></ul><ul><li>Convert “perceived & soft” value of equity into “hard-core” debt. (Overleveraging) </li></ul><ul><li>Covert unsecured debt to secured debt (and pay huge for the opportunity to do so!) </li></ul><ul><li>Use equity for non-investment purposes. </li></ul>
    44. 44. “ For amateurs, pulling cash from a property will almost always turn a good investment into a bad one.”
    45. 45. Where Wealth Goes During Times of Drastic Change <ul><li>Wealth is created by amateurs during up-cycles and transferred to “pros” during down-cycles! </li></ul><ul><li>“ Amateurs” buy asset </li></ul><ul><li>Equity (wealth) is “created” from asset </li></ul><ul><li>Amateur loses asset to market (underlying fundamentals unable to support it) </li></ul><ul><li>Investor buys asset (only if fundamentals support it) </li></ul><ul><li>Investors keep (or resell) the asset and reap the rewards. </li></ul><ul><li>Resellers get cash. Holders get equity (wealth) + ongoing cash flow (that keeps up with inflation & decreasing currency values). </li></ul>
    46. 46. Deadly Sins of Real Estate Investing <ul><li>Lack of vision </li></ul><ul><li>Over-leveraging </li></ul><ul><li>Having only 1 exit plan (rent or resell) </li></ul><ul><li>Ignoring the Fundamentals (Rents, cash flow, holding costs) </li></ul><ul><li>Listening to the wrong people </li></ul><ul><li>Poor Internal Compass (self-sabotage, inability to make good decisions) </li></ul>
    47. 47. “ Single family real estate is the only REI niche where ‘investors’ routinely ignore the fundamentals!”
    49. 49. Lease-Option Benefits <ul><li>Higher upfront money </li></ul><ul><li>Higher rents </li></ul><ul><li>Higher Purchase Option price </li></ul><ul><li>Less competition / niche product </li></ul><ul><li>Taps into “homeowner” mindset </li></ul><ul><li>Eviction for defaults under Landlord-Tenant laws </li></ul>
    50. 50. Rental vs. L/O Comparison <ul><li>Conventional Rental </li></ul><ul><li>$100K house FMV </li></ul><ul><li>Rent for $900/mo. </li></ul><ul><li>Security Deposit: $900 </li></ul><ul><li>Sales Price: None </li></ul><ul><li>Owner pays maint. </li></ul><ul><li>Renter mentality </li></ul><ul><li>Many competitors </li></ul><ul><li>Lease-Option </li></ul><ul><li>$100K house FMV </li></ul><ul><li>Rent for $1,000/mo. </li></ul><ul><li>Upfront Money: $2,500 </li></ul><ul><li>Option Price: $120K </li></ul><ul><li>Tenant pays maint. </li></ul><ul><li>Buyer mentality </li></ul><ul><li>Few competitors </li></ul>
    51. 51. Invest with Lease-Options ($100K house) <ul><li>Buy with bank financing </li></ul><ul><li>$95K (5% discount) </li></ul><ul><li>- $9.5K down (10% down) </li></ul><ul><li>--------------------------------- </li></ul><ul><li>$85,500 Loan @ 7%, 30-yrs. = $569/month (Prin. & Interest) </li></ul><ul><li>+ $200/month (Taxes & Insur.) </li></ul><ul><li>= $769/month (PITI) </li></ul><ul><li>---------------------------------- </li></ul><ul><li>$2,400 = 3 mos. hold cost </li></ul><ul><li>$9,500 down + hold cost </li></ul><ul><li>= Cash Invested = $11,900 </li></ul><ul><li>“ Sell” with Lease-Option </li></ul><ul><li>$120K (equity with a pen) </li></ul><ul><li>$11,900 Cash Invested </li></ul><ul><li>- $2,500 upfront money </li></ul><ul><li>= $9,400 Net cash Invested </li></ul><ul><li>---------------------------------- </li></ul><ul><li>Rent = $1,000, $231 Mo. CF </li></ul><ul><li>$231 x 12 mos. = $2,772/yr CF </li></ul><ul><li>----------------------------------- </li></ul><ul><li>$2,772 CF/$9,400 Cash Invest = 29% CCR 1 st year!!! </li></ul>
    52. 52. Lease-Option Exit Scenarios <ul><li>Cash Out within 2 yrs </li></ul><ul><li>$120K - $1,500 credits </li></ul><ul><li>= $118.5K tenant payoff </li></ul><ul><li>- $85K loan payoff </li></ul><ul><li>---------------------------- </li></ul><ul><li>= $33.5K Payout </li></ul><ul><li>- $9.4K Cash Invest </li></ul><ul><li>= $24,100 net profits </li></ul><ul><li>------------------------------ </li></ul><ul><li>$24.1K profit / $9.4K cash </li></ul><ul><li>=256% / 2-yrs = 128% CCR!! </li></ul><ul><li>Tenant Leaves </li></ul><ul><li>Tenant paid down loan </li></ul><ul><li>Property appreciates 5%/yr </li></ul><ul><li>FMV Yr 2= $105K, 81% LTV </li></ul><ul><li>FMV Yr 3 = $110K, 76% LTV </li></ul><ul><li>--------------------------------- </li></ul><ul><li>Rent increases over time </li></ul><ul><li>Upfront money covers most of holding costs of turnover </li></ul><ul><li>Wealth effect compounds quickly which is why we don’t want cash outs!!! </li></ul>
    53. 53. “ We are in a business where the customer is ALMOST never right!”
    54. 54. Essential Areas to Great Management <ul><li>Tenant Screening (No $ & no income, no keys) </li></ul><ul><li>Asset Management & Maintenance </li></ul><ul><li>Quick Non-Payment Response (Eviction) </li></ul><ul><li>Ongoing Tenant Management </li></ul><ul><li>Quick vacancy turnarounds (Property prep. & Marketing) </li></ul>
    55. 55. Traits of Good Managers <ul><li>Understands Investor Issues </li></ul><ul><li>Firm but Courteous with Tenants </li></ul><ul><li>Good with Collections </li></ul><ul><li>Should not have socialistic tendencies </li></ul><ul><li>Good Internal Compass </li></ul>
    56. 56. “ If you (or your manager) cannot evict a single mother with 3 small kids on Christmas Eve, you have the wrong person for the job!”
    58. 58. Seller-Financing Techniques <ul><li>Seller First Mtg (Free & clear only) </li></ul><ul><li>“ Subject To” Mortgage </li></ul><ul><li>Wrap-around mortgage </li></ul><ul><li>Contract for Deed / Land Contract </li></ul><ul><li>Lease-Option </li></ul>
    59. 59. “ Subject To” Mortgage <ul><li>“ Assuming” a non-assumable loan </li></ul><ul><li>Deed is conveyed </li></ul><ul><li>Mortgage is left in seller’s name </li></ul><ul><li>Required doc: Limited POA </li></ul><ul><li>Mtg payments directly to lender </li></ul>
    60. 60. Wrap-Around Mortgage <ul><li>Deed is conveyed </li></ul><ul><li>Provides seller additional protection against buyer default </li></ul><ul><li>New mortgage encompasses the original one </li></ul><ul><li>Conventional wrap vs. Mirror” wrap </li></ul>
    61. 61. Contract for Deed / Land Contract <ul><li>Provides seller strong protection </li></ul><ul><li>Deed is not conveyed until payoff. Receive Equitable title, not formal title in the interim. </li></ul><ul><li>Conventional vs. “Mirror” terms </li></ul>
    62. 62. Lease-Options <ul><li>Weak way to finance a property </li></ul><ul><li>Easy for the buyer to exit relationship </li></ul><ul><li>Record the option to protect the buyer </li></ul><ul><li>Seller retains most of responsibilities while letting buyer easily use the property </li></ul>
    63. 63. THE NEAR FUTURE
    64. 64. First-tier & Second-tier Cities <ul><li>First-tier cities: Major metro area / airport hub </li></ul><ul><li>Second-tier cities: Smaller metro area 1-3 hours from first-tier city </li></ul><ul><li>Atlanta – Columbus, Macon, Augusta </li></ul><ul><li>Denver – Colorado Springs & Ft. Collins </li></ul><ul><li>Orlando – Ocala, Daytona Beach, Lakeland </li></ul><ul><li>Phoenix – Tucson, Flagstaff </li></ul><ul><li>Salt Lake City – Provo </li></ul>
    65. 65. Colorado Springs <ul><li>Population - City: 380K, Metro: 550K </li></ul><ul><li>Market Velocity </li></ul><ul><li>Sales DOM: 90 days, Rental DOM: 60 days </li></ul><ul><li>60% own, 40% rent, </li></ul><ul><li>150K housing units, 5% vacancy (2000 census) </li></ul>
    67. 67. Investment Team <ul><li>Real estate agent – Investor mindset </li></ul><ul><li>Title company </li></ul><ul><li>Inspector </li></ul><ul><li>Insurance Agent </li></ul><ul><li>Lender / mortgage broker </li></ul><ul><li>Property Manager </li></ul><ul><li>Investment partners </li></ul>
    68. 68. Investment Partners <ul><li>Flat Interest Rate (12%) </li></ul><ul><li>Equity Share (Share up & downsides) </li></ul><ul><li>Financial and Mgmt Partners </li></ul><ul><li>Joint Venture & Alliances </li></ul><ul><li>Partnerships </li></ul><ul><li>Land Trust Beneficiaries </li></ul>
    69. 69. Guidelines for Buying Investment Property <ul><li>Research local trends & tastes </li></ul><ul><li>3-BR / 2-BA houses are the best </li></ul><ul><li>No war/drug zones, or high-crime areas </li></ul><ul><li>Avoid HOA & historic areas </li></ul><ul><li>Never buy a house that does not positive cash flow! </li></ul>
    70. 70. “ Amateurs tend to look for houses they would want to live in and not the houses their customers would live in.”
    71. 71. Strategies to Overcome Limitations <ul><li>Limited Cash – Cash partner </li></ul><ul><li>Limited Credit – Credit partner </li></ul><ul><li>Limited cash & credit – Become mgmt partner with a financial partner </li></ul><ul><li>Limited time/expertise – Partner financially with experienced mgmt partner </li></ul>
    72. 72. “ The reason so many ‘investors’ get out is they do not think of liquidity until it is too late!” “ Always Get Money When You Don’t Need It!”
    73. 73. “ Amateurs focus on what they don’t have instead of what they do have!” “ Whether you believe you can do something or can’t, either way you are absolutely right!”
    74. 74. Matthew Chan - Contact Information <ul><li> – Personal site/Blog </li></ul><ul><li> – Publishing </li></ul><ul><li> – Real Estate Investor Education Materials </li></ul><ul><li> – Lease-Options </li></ul>