The best way to own Real Estate is to own it free and clear. In that way, and only in that way, is it an asset. A property you own free and clear is salable at any time no matter what the market conditions. It is rentable for cash flow.

The idea of leveraging is to own and control as many properties as possible. The strategy is to be able to have cash flow from multiple properties that can pay down principle balances in other properties. Throwing money at the principle is the only way to pay the property off. It’s best to pay the property down in the first fifteen years of the thirty year mortgage cycle.

There are four types of mortgages, thirty or fifteen year, FHA or conventional. Exotic loans are for turning a property for a profit. The strategy is however to own all of your properties free and clear to live off of the rental income while maintaining the property.

The theory is to own five properties free and clear to retire. One you live in, the second for food, third for living expenses, fourth for essentials, and the fifth for fun. Real Estate and rental income are tied to the Consumer Price Index. They then become a hedge against inflation or deflation. Free and Clear properties are recession proof.

Now back to leveraging. If you own twenty properties it’s easier to pay off the five you need to retire. First and foremost is that every property you own should cash flow or have that potential in the first year. Many people start in more rural or out lying areas for cheap properties. A fourplex in a rural community can cash flow out of the gate. Some sellers may just want the income without the hassle of owning the property any longer. If that sounds strange some owners have moved on. You will move on some day also.

That cash flow can be dedicated to a negative or as a portion of a payment on another property. The only reason to risk owning properties with mortgages is to pay the mortgage off.

An acquaintance of mine began buying properties in low economic areas. He bought mobile homes, with the land, run down houses, duplexes, fourplexes, pretty much anything that showed a positive cash flow.

I should mention that he had a good job when he began buying the properties. He made a profit and loss statement of what he was buying, a cash flow chart, an estimate of appreciation based on 4%, then updated it over the five years it took him to accumulate the properties.

After he quit his job it was possible to live a meager existence while improving these properties. He spent a couple of years in the area living in one place to the next while he fixed up and rented the properties out.

He came back to Seattle, got a job in a warehouse, and had his rental income augment his pay check. On paper this guy looked golden. After seven years of sacrifice he was ready to start owning in city properties by the same principles. He bought a house a year for five years. He’s into the game now twelve years.

He sold off a problem property in his rural portfolio, paid the capital gains, and applied the profit to the principle balance on his first house. That house began to amortize quicker. It became a game of paying off properties to increase his cash flow. Once a property was owned free and clear it was all income. That income was applied to other principle balances. in his over all fifteen years as a Real estate investor he was on his way to being retired.

It became kind of easy to allocate money to living, and maintaining assets. Of course in those fifteen years his net worth was huge. By simple appreciation of what was now twelve properties with high equity positions he looked really good on paper. Income plus equity put him into the category of being rich. Fifteen year to being called rich is pretty quick.

Let’s get back to some basics of fixing houses. One of the things that always put me off was the amount of money contractors charge to redo a kitchen or bathroom.

This started years ago when my buddy Dan and I looked at the kitchen remodel of some friends of mine. It was beautiful. This was back in the days when granite was a new thing, cabinets were still wood, and the price was $80K. Yes, it was extremely expensive.

In all fairness the price included a half bath with pocket door, and it opened two rooms into one. My original thought for this post was how to move or get rid of a wall, but it got too technical. The point of the original post was how cheap and easy it is to get rid of or move a wall. Let me just say that on two occasions with kitchen remodels I’ve looked at the contractor added $10K for removing the wall and putting in a beam.

In both the kitchen and bathroom it’s all about plumb and level. The space, the box, the walls, ceiling, and floor have to be square. That’s the trick and what people pay the big bucks for. People pay thousands of dollars for the contractor to make the box, the space, a set of right angles, or variations there of.

I’m going to spare you the stories of how I got to this conclusion. Let’s just start with the floor. You want the floor to be perfectly level. If you need to take out the sub floor do that rather than shim the floor that is there. If you are keeping the cabinets you need to cut under the toe kick and level the floor to the level of the cabinet bases that you are keeping. That’s why most contractors want to sell you new cabinets, or take out the ones you have to reuse.

Your floor has to match the level of your working surface. You can shim counter tops, but that adds work and makes things funky. I’m mentioning this to give you an idea of what makes a good project great.

Once again, if in doubt, gut it, and gut it to the studs. You also want to be mindful of the rooms adjacent and how they match up. You’ll notice a little step up, ramp up, from other rooms into kitchens and baths. I also used to think this was for tile or sub floor below vinyl. This was also a factor, but have also learned that it gives the contractor a better transition into a level floor.

OK, enough about the floor, it needs to be level, straight and sturdy. A good second point is that whatever you have to do there should be no spring to the floor. You can add support, or blocking, but I have found that two layers of criss cross plywood, screwed, and glued can add a lot. I like keeping ship lap cross angle sub floors, three quarter inch is good. If the floor will be vinyl we sheath with plywood, if tile we hardi board.

Another thing is about tiling under the cabinets. I have grown to prefer tiling the entire floor. Butting tile into cabinets makes things weird. With vinyl it’s OK, you’re going to replace it anyway.

Once the floor is level we plumb the walls to it and set the angles of the corners. You want a perfect box or set of angles. When the cabinets, and appliances come they are going to be at set angles. You want the fit to be perfect. That perfect fit is what people pay for. Tight is the word, a tight fit. Keep in mind about the drywall, and where the joints are. A drywall joint can add almost a quarter inch if it is on both sides of a cabinet install. We’ll get to the cabinets in a minute.

Now the ceiling is a stupid thing that many people leave alone, when they shouldn’t. Ceilings sag, can be unlevel, you may level the floor in a house that has settled ever so slightly, and you want it all to be new. The ceiling should be level with the floor and not just level. The box needs to be a complete picture. While you are up there figure where the lights, and vent should be.

You’ll notice I haven’t addressed design yet. Another part of my charm is the fact I like to see what’s going on behind the walls before I make a plan. I’ve talked about it before as a way to get cheaper bids by having the contractor see a gutted room. With the whole room exposed it’s easier to see where wires, and plumbing can run in harmony. I also started my career as a painter and rot was always the thing that drove my costs way up.

Now about the cabinets. They come in groupings even if you have them custom made. This is the time to get measurements and start shopping. I would prefer to have the drywall up, but it takes time to get good, high quality cabinets made. You’ll be surprised how cheap a cabinet company is. Look them up, or even go to an outlet store. The cabinets are all anyone is going to see. A lot of talk lately focuses on the counter tops, but as granite falls out of favor, or becomes worn, the cabinets should be able to get a second life. Buy wood if you can.

The design we can keep for another time. Counter tops, sink, stove, and refrigerator should match the lighting. Window placement is important for kitchens, not so much for the bath. In both it’s important to keep the structure level, plumb, and square.

There are three elements to the sale of a property: Location, Price, and Condition.

Lately, and over the past few years, Real Estate agents have made the statement that price is everything in the sale of a property. It is for sure a sales gimmick that allows some agents with absolutely no skill to have a marketing plan. Some of those agents are very successful.

If you read through my articles you know that our companies work on properties. In this past year when the market has been soft we have had the opportunity to work on some homes that were headed to market. A couple of agents are marketing homes that are selling for a higher price than I would have thought. They spend a few weeks before the house goes on the market to get the condition to match the price and location.

The location is set in stone. There are elements to a location such as it’s proximity to amenities. A great cocktail lounge or restaurant can add value. In our city a popular spot is Green Lake. It’s an in city park that features walking, biking, and roller skating paths. In that neighborhood there are pockets of homes near shopping or entertainment. A bakery was a draw for people around the city for many years and it actually attracted buyers who had to live within walking distance.

Location close to job centers, or now public transportation, shopping malls, or medical facilities are common draws. Location is king in terms of value.

Price is a subjective thing. Some properties command a higher price by having expensive features, view, or convenience. Price can over come objections such as location or condition. Traffic is a great objection commonly over come by a lower price.

Last, and the point of my bog, is condition. The holy grail of condition is a well cared for home that has had the same owner for decades who took really good care of the property. Some places who have never had anything done to them in fifty years create the most desire. Many remodels devalue properties.

For a short while there was a saying in Real Estate that the value was tied to terms. Terms such as mortgage terms in my opinion are what drove up the price of properties. The only reason to mention this now is to prepare you for the response that property values are a function of price and terms. It’s a misconception that diverts attention away from the basic principles of Real Estate.

If you are selling you should sell and take your cash to invest elsewhere. Things like owner finance or lease options are great for a stable or appreciation market, but in a time of doubt cash is king.

The best time to sell is in January. People need to pick a school before February 15th. The most corporate transfers happen in the first of the year. It used to be that bonuses were also paid at the end of the year, but now, not so much. There is also the fact your competition is lower. We can address Spring time in a minute.

To get the most exposure putting your home on the market during the holidays gives people a chance to see it on line or in the news paper. To me the 15th of December is a great time to get a home on the market while most people prefer the 27th of December.

The Spring is when most people think of selling a home. If you put your house on the market right after tax time, or before the first of May, the house can sell and close about the end of the school year. You then have the time when the kids are out of school to settle into your new home. For some this is the time of the most selection so many homes trade hands at this time of year.

The elements of a sale are to create desire while calming fears. In preparing a property for sale we routinely address scary stuff. Lose wires, unsecured siding, rusted pipes, a worn roof, bad paint, or broken windows give the impression that you just don’t care or worse, that you don’t have the money for repairs. Either way it opens a negotiating position.

Many people concentrate on the creating desire portion of presentation by staging. Bringing in furniture or decoration is a great idea. The holidays are a good time to decorate and give a festive impression. As long as the staging fits the home it’s a very good thing. What some people have tried to do is mask the homes draw backs by staging. I worked with one stager who routinely brought in three quarter, condo, furniture to make places look bigger.

I’m more in favor of having places vacant with the ability to imagine yourself in the home, with your own stuff. There used to be a saying in real estate that when people began measuring to see if their couch would fit you had a sale. In that regard I recommend spending the staging budget on getting a place as clean as possible.

I never recommend capital expenditures to sell a place. Things like refinishing floors I deduct for. A bad kitchen or bath remodel can really screw with a sale. Everything needs to flow and fit together. Homogeneous is what most buyers look for. Having the perfect kitchen, bath, floors, or even windows in a lack luster place can be jarring.

Take a whole house approach. get everything to look in proportion to everything else. I do recommend cleaning, everything. As an agent told me one time anything will sell if it’s clean enough.

In the first few weeks of November 2008 there have been lower priced properties on the market. One was listed for below $200K, in city, with a small house. There was one photo of the lot, but the house was on a foundation.

What has happened is people who were holding properties while prices were going up are now selling them to get into something better. There are hundreds of properties owned free and clear or have small first position loans with deferred maintenance. You see these houses in nice neighborhoods that have never changed in years. In some cases there isn’t even a renter, the houses are just sitting there.

Whatever hope of future appreciation is fading and these sellers may even be looking for income. A tactic for controlling those properties could be to make an offer dedicating the rental income to the seller. You could be a property manager to do that, or just a buyer with the promise to cash out within three years.

One of the things I’ll post about later is lending standards. As lenders look at borrowers they will also be looking at the asset, property, they are lending on. In the 1980s I saw deals fall apart over peeling paint. Lenders in the next few years may care more about the condition than they do today, or in the past five years.

If you can present a plan to a seller of bringing a property back into reasonable condition, or improve it, they may consider that a down payment. I have done exactly that on two occasions, and probably should have done more. In the first case the seller started building the house on his lot next door, got old, and never finished. The second house was from an investor who bought side by side properties, rehabbed one, got tired, and out of money, then sold me the second triplex, on contract, no money down.

No money down I have addressed in the past and will again in the future. No money down usually means an investment. It could mean your time, but usually it’s your money, you just allocate it to the property instead of the seller. Back taxes are a good example, or mortgage payments. There is a guy who sells a program of paying back taxes to get a property free and clear for hundreds of dollars. One of those properties had a bright sunny picture but in the winter the entire house is covered with snow for a month or two.

We will address contracts for purchase at a later time. The important thing is that you look at problem properties as an opportunity for both you and the seller. If the seller has seen rampant appreciation in prices they want to capitalize on that. At the same time if they have let the property go in the mean time it’s not fair that some one should come in and pay retail for taking over the problems.

While other people are waiting for the “bottom” of the real estate market my contention has been we hit bottom in August of 2008. As September and October drug on it became clear that the market had changed, maybe forever.

My focus has been on the stock market. In my opinion stocks have been over priced since 1998. between 1998 to 2001 the market became unsustainable. My feeling is that large corporations began shifting cash into Real Estate. They did it in kind of a neat way by building, lending, then being able to keep the properties at a discount. It may be a conspiracy theory, but it seems to make sense that huge multi national corporations never meant to “lose” anything.

Crash or bubble makes no difference here. The only thing to keep in mind is to control a Real Estate to own free and clear. The only thing you have direct ownership of is the property you can hold on to.

With all the talk about property prices falling we just aren’t seeing it. Like the stock market the housing market will take years to adjust. There are people today who are dumping properties with good location, and condition. A whole bunch of people converted stock profits to Real Estate in the boom years and have profits now beyond equity.

There are deals to be made, as there always have been, but today people are beat up and weary. This is a window of opportunity. My preference would be to get in a high equity cash position on properties with future upside potential. I have been talking a lot about wrapping first position loans with a large down payment, or having a seller carry back a second that can be bought down over a five year period. 

What that looks like is a seller owes $300K on a property they want to sell for $425K. You can put down $125K or have the seller carry back a second position loan for the $125K at say 6% or 7% interest. You can have the payments be based on an amortization of 30 down to five years or 30 years with a five year balloon payment.

If you opt for the payment based on a 30 year amortization schedule with a 5 year balloon you should throw money at the principle balance early on to amortize the loan down quicker. A better idea is, depending on where the first position loan is in the amortization process, to throw money at the first position principle balance to get that to amortize quicker.

The entire idea I have is to keep the first position loan in place to pay it down quicker over the life of the loan. If you can manage to pay off the second or make it smaller so you can more easily pay it off when due that is better.

Keeping a high cash position in the property will help the seller feel more comfortable letting you handle his mortgage. The mortgage will still be in the seller’s name and they are going to want out of the loan. It’s best to have the loan administered by an escrow account. The goal is to get the property in a free and clear position.

This is being written in 2008. In 2010 the United States will be in the midst of the Census which is the largest mobilization of man power outside of war time. People will be employed, a new president will be in office, and things will look great on paper. You can sell or hold to pay down or pay off in the better times. If you have to refi that would also be an opportune time to do that, or maybe 2011. 

Now is the time to position yourself.

George Bush said we need to address the root cause of the financial crisis by pumping money into the mortgage market. Home loans, irresponsible lending, and irresponsible borrowing were to blame for today’s economic woes according to the administration.

What does that mean?

What it means to me is that the financial markets have run a natural course of lending money until the ability to collect on those loans became a problem. You’ll remember we changed the bankruptcy laws to make it harder to get rid of debt. We made the FICO scores the corner stone of the insurance industry. There have been many fixes in the works in the past year with each one promising more tax payer dollars.

What should happen is that these huge multinational corporations should go back to the consumers they made loans to and restructure those loans. They made bad loans on over priced assets and now want tax dollars to subsidize those bad business decisions. If it were in fact only Real Estate that was over priced that might be OK.

I paid $30K for a Prius this year that has a retail value, at the time of purchase, of $23K. I was told they were hard to come by, supply and demand. In fact there is a glut of 2008 Priuses in the United States, most people refused to pay the excessive fees.

Food is extremely expensive, oil ridiculous, and products from China were supposed to be cheap, in fact we pay the same for those as Made in America. The list of items requiring more money is long. Plasma TVs were $800 last year and $700 this year. That’s the sign of the times, fewer consumers lower prices. If we have to pay cash for things the prices will really drop.

Everything became expensive by consumers buying on credit with easy credit terms. The question I have kept asking is what lower interest had to do with increased cost. Just because you pay a lower interest rate, your payment should be less. Paying more for the product using lower interest rates for lower payments seems to me to be a wash.  The value, core value, remains the same, we are simply paying more with lower payments due to lower interest rates.

As the lenders began taking back assets the problems began. Housing is the most notable. Houses being foreclosed on were being sold for a twenty per cent discount. That wiped out the twenty per cent second that comprised the 0 down financing options. That began the run. As more housing units went into the system fewer buyers were willing to pay the 80% of value. In California and Florida some builders were selling for fifty cents on the dollar. The flood gates opened.

As builders went out of the building business people lost jobs. Construction, building materials, washers, dryers, refrigerators, home decorating items, and furniture all lost jobs. As people lost their homes they lost hope and stopped paying credit card bills. As lender debt became consolidated the securities that were backed by this consumer income became questionable. It snow balled into the financial markets losing jobs, losing income, losing the ability to tap into the consumer credit cash cow.

Now we have consumer confidence declining which in turn causes a panic. If the consumer stops buying the entire economy stops expanding. As a matter of fact consumers may just turn in what they have and stop paying. That would mean huge losses.

There is a bright side from my perspective. I think if the government does nothing lenders will be forced to reorganize debt. If the government interferes lenders will become more bold and hold out for stronger payments on already bad loans. Either way the result is the same. Lenders will have to focus on what is done rather than what the future may bring. Core values will settle in, prices will go down, and the commodities market will stabilize. As a result inflation will be held at bay for a while.

Whether you are in a cash or debt situation I think the opportunities are the same as long as you focus on the basics. If you have cash invest cash for an immediate return. Invest profits into long term, of course I like real estate. If you are in debt, you may have the opportunity in the next three to five years to pay it off. Work more for whatever you can get and pay debt.

Either way I think this is good news. The madness needed to end.

As you read this blog you know that in the past year I have not bought or worked on a project property. In a declining Real Estate market it’s harder to make a deal as prices are going down. You would have to buy at a discount then convince the seller that you need to discount that much more to compensate for the declining market. It’s difficult to make that leap.

In the world of don’t wanter properties the the vast majority have financed thier way out of the problems they faced. Drive by appraisals with a twenty per cent equity position pretty much ensured any one could get a fair market value for doing nothing. Now that the lending bubble has burst people are going to have to come to grips with the fact a property has to have a certain look or quality in order to sell.

We’re looking today more for commercial properties than residential. The run up in prices of commercial has only started in the last few years. I think investors were trading up into commercial or that builders were looking for multi use situations so people started converting or exchanging Real Estate dollars into larger apartments or commercial retail. The trend is still going on but that was a short lived dream more than an actual value added purchase. I think what stymies more people is what to do with the apartments or commercial space in order to cash flow it while waiting for the over all market to turn.

A true fixer or rehabber can spiff a place up to increase rents, but I have been talking with people who are a little more creative in what they do. Making multiple office spaces with a shared reception is one, or just making smaller more efficient office space is more to the point. Some people are short term renting for executive housing, or hitting high end user tenants. What I like best is converting commercial spaces into smaller retail spaces that compliment each other.

A computer store with an office supply, with a cell phone outlet, with a coffee shop, or copy center, printing, or equipment leasing. What is happening more is smaller La Tiendas with meat, produce, cigarettes, dollar store, cakes, bakery, cafe, DVD rental, or clothing. The list goes on, but small business is getting smaller. The more traffic you can bring the better. Location is important, but access is critical. Parking, with the ability to pull in and out easily is what drives rents.

It may not be for you but apartment buildings should be a big item in the next few years. Many places have become run down while land lords collect more rent as people now have an exodus from home ownership to renter. This last year some land lords have raised rents 25% with people paying it just to have some place decent to live. As pricing for houses goes down more people will be making choices. Renting will become more competitive. More home owners will rent out an investment property and pay the short between income and mortgage. There is always hope the market is coming back. The nicer places will be chosen and some of those overly optimistic Net Operating Incomes will go way down.

My hope is that some of the newer land lords, and some of the older ones, who have a property manager eating up all the profits will just want to get rid of it. A side note about Property Management companies is that there are very few good ones. Most Property Management companies who started with the housing boom who are now hitting a stride with rising rents. That will collapse. Hands on attention will become more of a focus. The best part about multi unit rental properties is that they can be done over the course of time. A little here a little there. In a couple of years you can go through all the units while maintaining a cash flow.

The bottom line will be that as more and more people come to grips with the fact Real Estate requires work and attention they will leave the market place for safer investment strategies. If you truly want to build a portfolio now will be the best time to do that. We’ll talk about taking over properties with financing in place a little later.

Last night I attended a great presentation of a foreclosure auction service here in the Seattle/Bellevue area.

The web site is www.foreclosuresolutionsnw.com

They lend hard money with an easy conversion to a fixed rate mortgage for 15% down you can own a property. The hard money costs you 4% loan origination, plus 12% interest. If you cash out the loan in three months they will rebate 2% of the loan fee. All in all it was avery good deal.

They charge a 3% commission for anything you buy at auction through them and they have a great resource for tracking the properties. They also drive by the properties before the auction date. They are actually taking most of the usual difficulties of buying at auction out of the equation.

Now there is a reason why we haven’t addressed auctions here, but the time is right. There are too many foreclosed properties to ignore.

First, the bank determines the auction price. They take what they are owed, plus fees, then set a price for auction. If there was equity most times some one would buy the property before the auction as a ”short sale.” That’s where the bank accepts less than what is owed. Higher equities are bought for the value. Most distressed seller with equity can get out.

The per centage the foreclosure group was quoting was 73% of fair market value. Given a discount of 25% for the amount of work a foreclosure is that doesn’t seem like a very good return. Now with this computer, web site system in place it makes it a lot more cost effective. The other thing today is that there are so many foreclosures the banks need to make the properties more attractive to cash strapped investors. Banks are much more willing to let go of fees, or even sell for a discount when so many properties are going to auction.

What I have traded in is REO or Real Estate Owned properties. These are properties the bank couldn’t sell at auction and returned them to regular inventory with a Real Estate agent. Did I mention you have to pay cash at auction?  You do have to have all cash or cahiers checks at the auction. That is where the 15% down payment for hard money makes more sense. REOs are eligible for bank financing.

In the past there were some bank owned properties that would get discounted until they sold. Now we see hundreds that sit on the market. Price reductions for what was a distressed property are competing with properties that are owner cared for. With all the properties thrown together even the very cheap below market government owned houses that used to get bid up are taking longer to sell and in some cases require price reductions.

Just to recap, there are plenty of properties to chose from today. More are added daily. Real Estate agents, banks, and Investor groups are dumping properties on the market. Many people aren’t getting the value of the properties. As I’ve pointed out before there is a wholesale price for every property you see. People want to have hope that the market will turn around, but it’s like an ocean liner. Just because we had a quick run up in pricing doesn’t make that a standard.   

This type of market is where I got my start turning properties. In a depreciating market place every day you are losing money if a property does not sell. You want to turn it and burn it, quickly. You buy and sell for cheap. You need to sell below market value. Your costs have to be very tight and you need to get the place done quickly. You can’t do it all yourself, you have to let other people help you. You need volume to make the numbers work.

When you buy a builder’s product you pay retail.

Every body has a system from horse, to stocks, to roulette, but it doesn’t have to be a gamble.