That’s right, Invest in real estate and get free condos. Lets clear up a few qustions:
“How is this possible? Isn’t the real estate market awful? What about all these people I see on TV losing their homes? You’re crazy!!”

Fine–bury your head in the sand and repeat the party line. The truth is, it is actually still possible to make money in real estate. Before you go reaching for the mouse to close out this article in anger and disgust read on (even if the bank is carrying your fancy new furniture out the door as you read)

The Way Things Were

This is NOT the get rich quick method of the early 2000s where you could simply buy anything and watch it appreciate by 100% within 6 months and flip it for a fortune. You may be riding high for awhile but that kind of leveraged gambling will often end in ruins as so many would be real estate tycoons have quickly found out. This is the old school method.

Real Estate Investment for Grown-ups

It’s simple really, buy something that is cheap and rent it out for more money then your carrying costs. The key to this method is accurately forecasting your carrying costs and giving yourself enough of a cushion if rental rates fluctuate a bit. The nice thing about rental rates is that when they do fluctuate it tends to be in the upward direction. Have you ever gotten a call from your landlord informing you that your rent will be decreasing? Neither have I. The whole idea of cash flowing on a rental property is based on this. If you can cash flow from day one then you’ll be sitting pretty as rental rates go up with inflation.

The most important thing in real estate is the price you pay for the property. It doesn’t matter what kind of fancy financing you do with down payments, points, and interest only loans, it all comes down to the final sale price. This will ultimately determine how much money you make. For us simpletons I say it’s best to always use a standard 30 year fixed loan with a 20% down payment at current market rates. This will make it easier to forecast your carrying costs.

What are these carrying costs I keep bringing up anyway? Carrying costs are expenses associated with owning a piece of property. This includes the mortgage, maintenance, management fees, taxes, etc. If you can figure out how much it’s going to cost you per month to own a piece of property you can figure out how much you can potentially make based on current rental rates.

Case Study: “Flipping” Someone Else’s Bad Investment

Here’s a property located in San Diego in the popular “college area”. The former owner apparently thought they were some sort of real estate “tycoon” and they were certain the market was going higher and they could cover their monthly losses with the equity in the property. That type of investing should be left to the pros. As a matter of fact, when you start seeing hair stylists and warehouse workers “investing” in real estate that’s the first sign that the trend is over. The pros are selling to the amateurs who will be left holding the bag. We’ll use this example and break down all the costs associated with owning this condo.

4860 Rolando Ct #10

Current List Price: (8/2008) $99,000
1bed/1 bath
Complex Features: Bbq,clubhouse/rec Room,exercise Room,laundry Facilities,pet Restrictions,pool,recreation Area,spa/hot Tub
Association Fee: $190/mo
Located about 1 mile from San Diego State University
Previous Sale: (11/2005) $215,000 (oops!)

Sounds like a pretty sweet place to me, college pool parties are the best. Let’s see where the seller went wrong here. We’ll be making some assumptions regarding rental rates, vacancy losses, and repairs based on generally accepted standards.

Total Monthly Rental Income - $1000 (based on current comps)

  • Previous Owner’s Monthly Expenses (@$215,000)
  • Mortgage (assuming 30 year fixed with 20% down at 6.5%) - $1087.16
  • Property Taxes - $215
  • HOA fees - $190
  • Management - $70 (7% of monthly gross rent)
  • Vacancy Losses - $83 (count on the place being empty one month out of the year)
  • Repairs - $30 (3%)
  • Supplemental Insurance - $25

Total Monthly Operating Expenses - $1700.16
Net Operating Income - ($700.16)

My finance professor once said anything that loses $700 a month isn’t such a good investment (or something like that). Now that this loser has been flushed out, let’s pick up the pieces of his mess and make some money off of it. Let’s assume you’ve got some killer negotiating skills, you should be able to get this condo for $85,000 in foreclosure.

Total Monthly Rental Income - $1000

Monthly Expenses at $85,000 (negotiated from $99,000 in foreclosure)

  • Mortgage (assuming 30 year fixed with 20% down at 6.5%) - $429.81
  • Property Taxes (1.2%)- $85
  • HOA fees - $190
  • Management - $70
  • Vacancy Losses - $83
  • Repairs - $30
  • Supplemental Insurance - $25

Total Monthly Operating Expenses - $912.81
Net Operating Income - $87.19

My Take

OK, $87/mo isn’t a lot of money and it’s certainly not a viable strategy for producing immediate income that you could live off of. However, keep in mind that this is cash flow from month one. You’ve got inflation on your side and as the years go on, monthly operating income will increase. By year 10 you should be making about $5000/year off of this property taking into account increases in both rent and expenses indexed to inflation. Of course there are other things to consider such as your return on equity and the tax benefits associated with a rental property but in its simplest form this investment will make you money and in thirty years you’ll have a free condo that will be generating around $2400/mo in gross income. Not as glamarous as flipping in 6-months during the boom years, but that’s how you invest in real estate and get free condos.