WITH PRICES JUMPING SHOULD YOU SELL NOW
OR HOLD ON AND RAISE YOUR RENTS?

EXPANDING YOUR HORIZONS

I recently followed my own advice and got out of town. If, like me, you work basically by yourself, it is easy to get into a routine (rut). Getting out of town exposes you to new ideas. The plane ride gives you quiet time to analyze your progress and make plans to change your strategy for the better. It's a good investment.

I visited areas where the housing market is different than mine. Yogi Berra said, "You can observe a lot by watching." I did that and more. In addition to looking at property and studying the ads, I talked to subscribers who are active investors in Alaska and the Seattle area.

These markets are about as far from Florida as you can get. But, houses are houses, tenants are tenants, and buyers and sellers are buyers and sellers. They are amazingly predictable. Both Anchorage and Seattle have strong housing markets with a lot of upside potential. Alaska and Washington have a lot of undeveloped land, and environmentalists who want to keep it that way. The entire state of Alaska has fewer people than my two-county market (about 500,000 people). Both Alaska and Seattle are must see places.

LOCATION X 3

Most people want to live near jobs and services. They settle in cities like Anchorage and Seattle. These cities were built where they are because of geography. Both have the best weather in the area and other amenities that make living there good. Sure, you can buy a lot of property cheap in either state if you get away from town. But, it's the property near the cities that is experiencing the greatest increase in values and rents. 

Buy the best quality house in the best neighborhood you can afford and you will increase your chances of higher appreciation. Higher quality houses command higher rents and higher quality tenants. Rents in Seattle's best neighborhoods have jumped as much as 40% this year.


TRACKING RENTS AND PRICES

Rents and prices leapfrog each other in these strong markets. First, rents increase. Then renters (the ones with a down payment and good credit, that isn't everybody) discover that they can buy a house and have payments lower than their rent. As they buy, they compete for the limited number of houses on the market. That drives up prices. Unfortunately for the remaining renters, it also takes many houses off the rental market, because many owners would rather sell than rent when they have that option. So eventually, rents start up again.

Chart houses in neighborhoods that you like. You can get historical data from your property recorder's office, telling you what houses have sold for. Every time a house sells in a neighborhood you like, go look at it. Other landlords may be able to give you a history of rents, or you can start now tracking rents. Just call the ads in the "houses for rent" column. Keep track of how many houses in your price range are for rent, what they are asking for rent and security deposits, and how long they have been on the market.

MAKING THE DECISION TO SELL OR HOLD

While meeting with subscribers in Seattle, we discussed a dilemma facing one investor that may be one you face one day soon. She owned a house that had appreciated significantly. She had several buyers interested in buying the house for $195,000; approximately ten times her basis in the house. If she sold, she would have a large capital gain if she did not complete a tax-free exchange.

She was ready to sell as the house was empty, and the prospect of a ton of cash was not totally unappealing. I asked a couple of questions that you should ask before selling in a hot market.

1. Do you really know what the property is worth?

2. What will you do with the money after the sale?

AVOIDING THE BUY LOW, SELL LOW STRATEGY

I have sold several properties at prices that I now know were too low. You work hard to make a good purchase, get it financed on good terms and then manage the property. Don't make a quick decision to sell, without knowing that you are getting top dollar.

I have warned before that buyers will typically want to buy your best houses. If you have a long-term game plan to accumulate a portfolio of rental houses, don't sell, just because you can. If your plan is to own ten houses free and clear to replace the income you work for today, identify the ten houses you want to own to produce that income and don't sell them!

Part of your plan may be selling other houses to pay off the debt on your ten keepers. Ideally, you want to wait until you can sell those houses in a strong market so that you can net the most for them.

BUYING FRENZIES

While in Alaska we watched people fishing for salmon. There were a lot of salmon and they were aggressive. The fish would compete to bite about any lure put in their way. 

In a housing market that is appreciating rapidly, buyers, like those salmon, will compete to buy a house. In fact, the subscriber who was considering selling her house in Seattle had four parties interested in buying her house, and fifty more calls on the ad, the first day it ran.

HOW YOU CAN GET THE TOP DOLLAR IN A HOT MARKET?

What should you do when more than one person wants to buy your house? First, get a grip on what the house is worth. Don't set a hard number, set a range. You should be able to say that the house is worth at least X dollars, and may be worth as much as Y dollars.

I recently sold a property through a broker. I always sell houses myself, but this was an apartment building. I asked him what the property was worth. Using the income it produced he came up with a number between $175,000 and $200,000. I asked him what the highest price he might conceive we could get, and he guessed $225,000. Being unsure of the exact value of the property, I guessed even higher, and listed it for $300,000. It sold in a few months for $250,000.

In a hot market establish a price range and then increase your highest price by 10%-20% to allow room for negotiation. If there are many buyers and few sellers, you will get offers, and may get a higher price than you imagined. The worst that can happen is that you don't sell it. That's far better than selling $20,000 below the market. It's going up in value every day!

If two or more buyers are interested, encourage them to bid against one another. This has to be done with some finesse so that they don't get mad and quit. Perhaps a statement like, "I'd rather sell to you, but the other buyers are offering more", will encourage them to bid higher.

People bid against each other openly at auctions all of the time. They do this because they know that eventually one of them will prevail. To get people to bid up a price, they must be convinced that they have a good chance of getting the property and are not just being used to get another buyer to pay more.

More bidders produce more competition. Avoid Realtors when selling. There is no reason to pay a commission in a hot market if you know how to sell. Use Realtors to buy. I am still buying bank foreclosures listed through brokers.

WHAT WILL YOU DO WITH THE MONEY IF YOU GET IT?

Spend it? There is a time to spend it. The reason to invest is to be able to enjoy spending the money. Don't wait so long to spend it, that you can't enjoy spending it. I just took my family on a three-week trip to Alaska and Seattle. It was expensive, but it was a trip we will never forget. It was a good way to spend some money.
On the other hand, you should have the financial discipline not to spend your investment capital until you meet certain goals. I never took an expensive vacation or bought a new car, or even bought a house to live in until I reached specific financial goals. Setting these goals, and then rewarding yourself by buying a new car, or taking a great vacation when you reach that goal, motivates you to work harder.

My friend Jimmy Napier used to kid me about how much money I was giving away when I bought a new car. If instead of spending the $35,000 I spent on a new car, I invested that money at 12% for 30 years I could have $1,048,597. Once you get your net worth growing steadily, you can drive a new car and have all the money you need.

Every dollar you save and invest will be worth at least $30 (at 12%) if you keep it invested for 30 years. If you learn to use leverage wisely, your returns will be much higher than 12%. Look at what a $1,000 investment grows to over 30 years at different rates of returns compounded annually.

$1000 today grows to $29,960 in 30 years at 12% 
$1000 today grows to $143,370 in 30 years at 18%
$1000 today grows to $634,819 in 30 years at 24%
$1000 today grows to $10,143,019 in 30 years at 36%

Returns of 36% and higher are available when you buy income property and wisely use leverage. In my seminar I call this using positive leverage. Positive leverage is borrowing part of the purchase price on terms that increases your return on your investment. Many borrowers pay a higher interest rate than the property can support. I call that negative leverage.

HOW TO EARN 36% AND MORE

Here is a quick example of how positive leverage can dramatically increase your rate of return. You purchase a house from an out-of-town (or other anxious) seller. The house has been vacant for several months. He owes $60,000 and the monthly loan payments, including taxes and insurance, are $600. 

You offer him $90,000 for his house. It is worth between $110,000 and $125,000 in your estimation. Your offer solves his most pressing problems as you agree to immediately take over ALL responsibility for the house, including all maintenance, and pay him $5,000 (subject to him delivering good title), and then immediately begin making his loan payments of $600. He will never have to worry about this house again. 

You agree to pay him the $25,000 balance that you owe him as soon as you sell the house. If you do not resell it within 24 months, then you agree to begin making payments of $100 a month until the $25,000 is repaid in full without interest. Whenever you sell the house, you will pay off the remaining balance.

Now you have $5,000 cash invested in a house that rents for $950 a month. After operating expenses it will net about $665 a month. Here are your expenses on the house.
(these are estimates based on actual figures in my town - yours will be different)
First mortgage interest $60,000 at 8.5 % $425 monthly
Taxes 100 monthly
Insurance 30 monthly
Maintenance, advertising, etc. 150 monthly
Total expenses 705 monthly 

Monthly profit when rented $959 - $705 = $245
$245 x12 = $2940 annual return

This income combined with the appreciation, (both negotiated when you bought it below $20K-$35K below the market, and earned as it appreciates), will give you an annual return of far more than 36% on your original investment. Your rate of return will drop a little each year as you invest more in the property. Each year buy one more house to keep your average return above 36%.

REINVEST IT?

In order to accumulate a lot of net worth, you have to keep your capital continually invested at high rates of return. Real estate is criticized as being illiquid. Actually, that feature has made more people millionaires than Bill Gates. Because it is hard to sell property, you tend to hold it for a long time. The longer you hold it, the longer your money grows at compound rates. 

Using IRC Section 1031, you can reinvest your money tax free. Study my course Taking the Mystery Out of Tax Free Exchanging to learn how to plan and complete a profitable exchange (paperwork included). The part that trips up many investors is the provision that says, you have 45 days from your first closing to identify your replacement property.

The 45 days will fly by. Many investors pay retail for their next property because they did not find a good deal below retail, or even worse, let the 45 days go by without identifying a replacement property. Now you have to pay the taxes.

I suggest that you plan ahead by finding the next property you want to buy and even getting it under contract before you sell your old property. This is especially important in a hot market where it is easier to sell than to buy. 

SHOULD YOU SELL OR KEEP THE HOUSE AND RAISE THE RENT

There are only a couple reasons why you should ever sell a house. One would be a high cost of operating or maintaining the property. Some houses are poorly built and cost too much to keep in good repair. Sell them. Others are poorly designed or in a bad location. Both of these problems are impossible to fix and prevent you from attracting and keeping good tenants. Sell them.

Finally, some houses are poorly financed. If you have mastered the skills of negotiating and understand how to borrow money from sellers, you can borrow at far cheaper rates than the banks charge. Selling a house with a bad loan and buying another with good financing is a profit making move. The alternative is refinancing the bad loan. This will increase your long term profit, but cost you money today. If the house is a great house in a great neighborhood, refinance it. If it is marginal, sell it and buy another with better financing.

Finally, sometimes you are tempted to sell a house because it's not producing much cash flow. The simple solution may be to raise your rent. It is a common mistake to let a good tenant stay in a property at far below market rent.. Raising your rents a little each year, even with your best tenants, both increases your profits each year, and keeps them from falling too far below market. Being a little below market is good strategy.

If you are going to jump the rent significantly on a good tenant, personalize your letter with a handwritten note asking them to call you (they will anyway). Over the phone you can soften the impact by telling them about how other houses are renting for even more than they will be paying with the increase. You can also compromise a little. Rather than raising the rent $200 a month, you may agree to a $125 increase the first year, $160 the second year, and then $200 in the third. By keeping a good tenant three more years, you save the cost of a turnover, and can buy another property with the confidence that this one will stay full and profitable.

GETTING A RESPONSE FROM JOHN

Every day I receive phone calls and letters from students and subscribers. I want to be of help and respond ASAP. However, due to other demands on my time, it often takes a while. If you are on-line, you will get the quickest response by using e-mail. Contact me at Makinitbig @AOL. If you write, please keep it as brief as possible. The long letters take the longest to answer. If you call, please leave a number on which I can call you collect. I return all of my calls, but often get answering machines which will not accept a collect call. If you don't hear back from me, chances are I called and missed you, so give me another call. The best time to catch me in the office is 10-12 AM.

Note: The information offered in this letter is part of an ongoing series. This issue builds on the information given in previous issues. The author and publisher are not engaged in offering tax or legal advice. Laws are constantly changing and advice of a competent accountant and attorney should be obtained before implementing strategies suggested in this letter. 

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