Over the past few years, Nashville has been teeming with new construction. Jokes have abounded about how the crane is the city’s official bird, and how new cranes are nesting outside of loft windows. Indeed, Nashville has experienced new developments at a previously unprecedented rate. The Metro fiscal year that ended on June 30, 2016 had approved a record of over $3.6 billion in building permits. This was a 50% increase over the previous year, which had set a record of $2.4 billion. The past three fiscal years have all set new records for the amount of development dollars pouring into the county. In other words, this city is on fire.
After watching others make good money in the new construction business, I had been watching and waiting for the right opportunity to get into the game myself. In May of 2016, that moment presented itself.
I came across a property in emerging Buena Vista, a neighborhood in North Nashville that has experienced new revitalization, largely due to its close proximity to downtown. The property I looked at included an old house in terrible condition. It had been vacant for years and the yard was overgrown. As much as I like to see the restoration of historic homes, this particular house had virtually no vintage charm remaining and was in too poor of condition for a renovation to make sense financially. The intelligent decision was to tear it down.
While writing Part 1 of this discussion, I quickly realized how lengthy it could become. The problem is that there are so many details and variables to consider in this debate. From monthly cashflow, to opportunity cost, to tax implications, the analysis gets complicated. I read through a very thorough article about a similar debate to “Pay Off Mortgage Early Or Invest” on the Financial Mentor site. Many of the points raised in that article are relevant to this discussion, although that debate is about paying off the primary residence mortgage early or investing that extra money into a low-cost index portfolio. The debate I am having here is whether it is better to leverage investment properties and borrow as much as possible, or have no debt. Of course there is a very large range of options in between the two extremes, but if one extreme is indeed better, then wouldn’t it make sense to maximize it to the fullest?
There is no shortage of real estate investing advice that discusses the power of leverage in purchasing properties. Experts talk about how to buy houses with “low down payments,” or even “no money down.” It seems these strategies are sometimes touted because there is a larger market of people who will buy a book about how to get started investing with little money. After all, there are more Americans who barely have any money saved than the number of Americans who would buy a book about how to buy houses with, “cash savings over $200,000.” However, if an investor can borrow money at 4% and get a return of 14%, why wouldn’t that investor capitalize on using other people’s money and maximize profits?
Meanwhile, there is another group of financial experts (Dave Ramsey being one of the leaders) who advise against having any debt at all, including real estate. The thinking from this group is, “Why lose 4-5% by paying interest to a lender when saving the cost to borrow can directly increase profits?” I find myself thoroughly understanding both sides of the argument, but unable to decide which approach is better.
I remember having a conversation about nine years ago with a very wealthy individual about what neighborhoods would have the best future appreciation in the local real estate market. She replied, “That’s easy, the same neighborhoods that have always had the best appreciation.” I nodded my head in agreement. It seemed like the perfect answer. But there was something in me that didn’t totally buy in. If neighborhoods appreciate at the same rate they always do, then how are gentrifying neighborhoods with rapid increases of home values explained? What causes the exceptional upward momentum of rising prices?
By the time I had that conversation, I had witnessed several neighborhoods in Nashville, TN experience rising property values that did not line up with their historic appreciation rates. They were beating their previous track record. Those neighborhoods had been undervalued, but began over-performing to compensate. Renovations were being completed by homeowners and investors alike. As more dollars poured into the improving neighborhoods, others took note and wanted to buy in as well. Activity furthered more activity, and successful flips led to more investment projects. I watched with a desire to understand what market forces were at work. And I began to anticipate what neighborhoods might be next. I knew that being able to identify undervalued parts of town would be key to future investment success.
I recently read a book titled, “The Great Depression – A Diary” by Benjamin Roth. It is the first-person account of a 38 year-old lawyer living in Youngstown, Ohio during The Great Depression. The book’s summary says, “After (Benjamin) began to grasp the magnitude of what had happened to American economic life, he decided to set down his impressions in his diary. This collection of those entries reveals another side of The Great Depression—one lived through by ordinary, middle-class Americans, who on a daily basis grappled with a swiftly changing economy coupled with anxiety about the unknown future.”
Much of the book’s content deals with the local and national economy, stock market, and politics, but Roth kept an eye on general investing and real estate as well. The following entry was dated September 24, 1936:
“To build an estate it is necessary first of all to get money by saving it and secondly it is most important to invest these savings so that they will increase and work for you without losing the principal. Most people learn the first rule and succeed in saving various amounts out of their earnings but very few learn the second rule – how to invest it so it earns a profit and yet not lose the principal. It follows then that it is most important to learn how to invest money and make it work for you.
The $40,000 property that at this point has more questions than answers.
Last week I looked at an investment property in Nashville, TN that is about as cheap as it gets right now, priced at $40,000. I had previously driven by the property and given it a bit of thought, but I needed to see the inside before I knew what investment options were in play. After meeting the owners and viewing the inside, it turns out that there are a few different strategies for this property. But it seems the most profitable options are all reliant on a higher future value. Guessing that the value will rise is speculation, where the expected profit comes from the future value, not the present value. Regardless of if the guessing turns out to be correct or not, the investor is still taking a leap of faith.
I don’t buy on speculation, but typically only buy properties at a discounted price of their current market value. Of course I try to buy in areas where there will be significant appreciation, but I’m not basing my whole purchase on a future value that may never come. I choose to buy proven value, where my purchase price is 65-70% of market value. But with such a cheap price of $40k, and new construction infill creeping closer and closer to this location, should I take a gamble? Should I bet on future value and speculate?
Whether you have heard stories from a distant uncle, watched dramatic renovations on HGTV, or read dozens of books about real estate investing, there is a lot of misinformation floating around. It can be hard to know what to believe. The Urban Investor is here to divide fact from fiction and unveil The Top Six Myths About Real Estate Investing:
6. You need to have a business name, logo, contractor, accountant, attorney, etc. before buying an investment property. This idea of having everything lined up perfectly before buying a property is a chapter out of a generic “tips for successful business” book and simply not true. Don’t spend time and money on all of these things before you know if you even LIKE investing in real estate. One of the best parts of investing is that you can do as little or as much of it that you like. Start out small and stay small, or grow incrementally if you desire. If you get to the point of pursue investing as a career, you will naturally make connections with people that you need to know and be able to get referrals when you need to. Don’t worry about if you need to be an LLC or an S-Corp if you are just starting out. Focus on knowing the values of property in the market that you want to invest in. Be patient and get a good deal. It doesn’t have to be a home run, but start out with a winner.
Many aspiring real estate investors want to have a plan for how to succeed and build a strong portfolio. They want to build wealth and have heard stories about other investors making lots of money through flips or rentals. But what is the best first step? There can be so many “voices of wisdom” and so much “advice” that it can become paralyzing. New investors want to know how to get started on solid footing and make a strong first purchase. I know I did. So what is the best way to begin on the real estate road to riches? Is there a strategy or formula to follow? How do you start with a winner?
My real estate story started pretty simply, and I think that my approach is the easiest way to begin to build wealth through property. I believe that buying a well-appreciating primary residence is the best first investment. In 2002, when I was buying my first home in Nashville, TN, I took time to understand the real estate market. I learned how to look at every property with an eye toward its potential profit. I was searching for a good deal, for a property that already had some equity in it and one in which I could also increase its value through improvements. The more I looked at properties on the computer and in person, the more I started to grasp the characteristics of the different neighborhoods around town. I learned which neighborhoods were out of my price range, which ones were stagnant or declining, and which ones were improving. I soon narrowed my searching to two zip codes, with my focus being about 80% on the zip code that I thought had the most upside.
In the fall of 2010, I was looking for a house to flip. I viewed several different options and settled on a cottage in East Nashville. It was a bank owned foreclosure that needed cosmetic updates on every surface and a re-imagined floor plan. But it had a lot of profit potential, so I closed the purchase in November, 2010 for $67,500. I was optimistic while preparing to embark on a four month renovation. Even though the real estate market was struggling all across the country, I liked the location of the property a lot and thought it would have sufficient demand that would result in above average appreciation. Little did I know, the house would sell for nearly five times that amount three and a half years later.
S. 11th Street. Nashville, TN 37206
I wouldn’t consider myself to be a huge sports fan. I liked playing baseball and basketball as a kid, and the Cincinnati Reds and Indiana Hoosiers were my favorite teams. Pretty typical. After college I moved to Nashville, TN, and started rooting for the Tennessee Titans. I watched most of their games and followed the team news. The NFL became the only sport I really paid attention to. Three years ago a friend invited me to play in his fantasy football league, and I was hooked. Last year I played in two leagues, and this season I started my own. It turns out that the reasons I like fantasy football are the same reasons I like real estate investing.
The fantasy football season starts with the draft. Each of the ten teams take turns picking NFL players. When it is my turn to pick I analyze the available players. Who is consistently productive? Who is more injury-prone, and thus a higher risk? Who is a young guy ready for a breakout performance? This analysis is remarkably similar to the reasoning I use when examining potential real estate investment deals.