Identifying Undervalued Neighborhoods

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. ubanAs 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.

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Lessons Learned From The Great Depression

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.”

rothMuch 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.

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When the Numbers Don’t Work

As a real estate investor, I tell people in the business that I am always buying. What I mean is that I will consider any property that is available for purchase, and if it seems like a good deal, I will make an offer. If it is a great deal, I won’t hesitate. Some sellers want too high of a price based on the location, size, and condition. I don’t waste time making an offer when their price and my valuation are too far apart, but I still think through the possibility. I like to contemplate lots of deals, because essentially nearly every property is worth buying at the right price. I know I can’t buy everything, nor do I want to. But analyzing hundreds of deals and thinking through the numbers is something I have practiced so much it is almost automatic. When a property comes along that is priced well below the market value, I can spot it quickly and it is a simple decision to buy. It’s easy to point to the great deals that I have purchased over the years and think they are the reason my investing career has succeeded. However, another factor is just as important: being able to turn down a deal when the numbers don’t work.

I usually have a real estate transaction every few months. I get used to the rhythm of buying and selling. Sometimes, like in the fall of 2012, I bought two houses in a five week span, and three in three months. But other times a few months goes by without any

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The Difference Between Speculation and Proven Value


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?

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Why I Invest Near the City Center

I received a phone call a few weeks ago from a wholesaler who had “the deal of the century.” She talked about how it was a can’t miss opportunity because the house only needed a few updates to be an easy flip. She had my full attention. As she was beginning to embark on a rapid-fire detailed list of all the attributes of this moneymaker, I tried to interrupt. Finally I was able to get my question in. “Where is it at?” She told me it was in a nondescript suburban area of town about fifteen miles southeast of the urban core of Nashville, TN. For some major cities, that proximity would still be considered close to town. At this point in time in Nashville, it is farther away than the zip codes where I want to put my money. In fact, that is how I answered the wholesaler. “I don’t buy houses in that zip code.” She didn’t seem to understand my reply and countered, “You could make $50,000 on this deal!” Maybe I could, but I have targeted specific areas of Nashville where I will buy properties, and I don’t stray from that strategy. I told her good luck, and if the deal was as sweet as she was describing it, I was pretty sure she could find an investor who would take it, but it wasn’t going to be me.

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The Similarity of Real Estate Investing and Fantasy Football

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.

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Purchase Profile: Acquiring a Craigslist House

In August, 2014, I purchased an investment house in Nashville, TN that I found advertised on Craigslist. It was a rented single family house for sale by owner, due to a relocation out of state. I responded to the ad by email and requested the address of the property since it wasn’t stated. The address is required to move forward with any analysis, and to see if the deal is worth pursuing further. If I don’t like the location, I forget about it.

Next, I proceeded to do my usual information collection about a property. I look it up on the county tax assessor’s website to find out the lot size, square footage of the house, year it was built, zoning classification, past sales history, and appraised value. This data gives me an introduction to the property and lets me figure out the price per square foot. However, the square footage stated on the tax records is not always accurate, so it is wise to verify the actual area of the physical structure. In fact, the tax records were 600 square feet off from the actual area of my first primary residence.

The house on Craigslist had the two most important  features that I am looking for in an investment property: location near a red hot neighborhood, and a cheap price tag. This house was just a couple of blocks from the historic Germantown neighborhood, and priced at only $72,000.

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