Fredericksburg Texas

Thanks for the calls and comments from the previous post titled “Business For Sale”.  I know I’ve been neglectful in my follow-up posting on the subject.  Many have called and asked questions about the basic nuts and bolts of ZERTZ (the business for sale in Fredericksburg, TX, see www.zertz.com ), while surprisingly few have asked any detailed questions about the numbers behind the business.

 

When I look for places to invest my “spare cash”, the first thing I want to know about is the return I can expect on the dollars that come out of my pocket (generally referred to as return on equity, or ROE).  If I can achieve a 15%-20% return on every dollar invested by purchasing, say, ZERTZ, compared to earning 1%-2% from money market accounts, 10%-15% from real estate and 12%-15% from stocks, common sense tells me I should take a closer look.

 

What do I get if I buy ZERTZ: inventory, furniture/fixtures, trade name/website, mailing lists, increasing sales and (as of YE 2004) $60,000 in net cash.  This return must be considered in the context of risk; however, purchasing a newer/growing concern is often more profitable than purchasing a mature concern.

 

The numbers:

 

Sale for YE 2004         $344,617

Net Income-2004         $  59,509

YE 2004 Inventory       $134,701

Fixed Assets                 $  13,750

 

Figures for ytd 2005 are available for those agreeing to sign a confidentiality agreement.

 

Using a simple formula shows that investing $225,000 into ZERTZ (the asking price) would produce a whopping 26.5% return on equity.  If you can find a better return than that…take it.  Let’s say you pay only ½ down and finance the balance of $112,500 at a market rate of 7%, the laws of leverage boost that return on equity at nearly 45%!!  Finally, using a more traditional debit to equity ratio of 80/20 (you pay out only $45,000 and finance the balance of $180,000) your ROE jumps to an astonishing 100%.

 

WHY ARE YOU NOT BUYING THIS STORE????????????

2005 is certainly outpacing same-period figures from 2004. For the months of Jan. through June 29, 2005 overall total sales volume was +59.88%. Components of this are: Residential +25.58%, Residential/ wAcreage +115.16%, City Lots +230.88%, Acreage Farm/Ranch +94.37%, Rural Subdivision +8.14% and Commercial -8.34%.

These figures reflect the transition of our market from a traditional Spring/Summer peak to a more healthy year-round market. The bright spots in the residential sector continue to be the hot-selling Stone Ridge neighborhood as well as the areas immediately north of Main Street.

We’ve all heard that famous song by the great Aretha Franklin (as well as others) and it’s made me consider the respect, or lack thereof, that the public holds for real estate agents.

 

To most, we are a necessary evil, a group of individual who want nothing more than to garner a fat commission for our own selfish reasons.  To others we provide the valuable service of bringing together a buyer and a seller and facilitating a result that leaves everyone happy.  Obviously, I’d prefer that more people fall into the latter category and, to that end, I’ll post a recent survey listing 200 reasons why Realtors are critical to a real estate transaction.

 

On the former, why some hold us such low esteem, I submit that as a professional community, we have discounted our services and negotiated our fees to an extent that we’ve created an air of desperation about how we make a living.  Like a bully on the playground, the public smells that “weakness” and treats us accordingly.

 

How does this happen?  The vast majority of us are educated, well-spoken and experienced professionals.  We’re licensed by the state and required to take continuing education classes to stay up on the evolution of our industry.  Most of us also seek non-statutory continuing education to earn coveted designations such as the GRI, ABR, e-PRO and CPM.  Most of all, most of us do it because we love it.  In my opinion, the gradual decline in the public’s regard for our work is due to three primary factors: 1) too many agents are unqualified and/or do this as a sideline; 2) we give too much away and don’t demand the respect our experience deserves, and; 3) we don’t make the public aware of the value of our services and experience.

 

Our little community has over 200 active agents working an average of 800 listings at any given time.  Of those 200, roughly half could be considered part-time or people who having their licenses but are not actively working with buyers or sellers.  The others furiously compete for a share of the $90,000,000 or so of transactions that take place every year.  After considering office overhead, advertising, commission splits and other business expenses, that’s a lot of people chasing not very much net income.  In reality, there are probably only 20 agents in our market that can truly say they make a living doing what they are doing.  If I’m a buyer or seller, do I want a full-time, successful agent, or do I want someone who does this as a “hobby”?

 

When you go visit a lawyer for advice on your will or visit your doctor because you have the flu, do they charge you for their time?  Of course.  When you visit a realtor for information about the market, do you pay for that?  Not unless you buy or sell a property.  The pet peeve of any agent are a “buyer” that will never buy and a seller that “over lists” their property.  Both are tremendous time wasters and present huge opportunity costs for agents.  We want to be paid for our experience and expertise, just like everyone else. Please respect that.

 

Much to our disservice, we allow these things to perpetuate. We are forced to allow anyone with a license to join our boards (whether they live in our community or in Timbuktu), marginal agents still get listings from uncle Bob or sister Rose and give us all a bad name when they mess things up, desperate agents negotiate away well-deserved earnings in a misguided attempt to get “market share”.

 

I, for one, have taken pains to not go down this path.  My experience, education and track record are worth something.  I do this for a living, it’s all I’ve ever done and I have never lost money (for myself or a client) doing it.  That deserves R-E-S-P-E-C-T.

For buyers today, the biggest obstacle to successful real estate investing isn’t a meltdown in property values or tenants who wreck an apartment or don’t pay their rent. It’s overconfidence. If you’re expecting to cash in on the 21st century’s first gold rush without breaking a sweat, it would be wise to take this to heart. The margin of error for making money in real estate is closing fast.

It’s not surprising that real estate tempts so many Americans today. Over the past five years, home prices have soared and rags-to-riches tales abound. But so much real estate has become so expensive that Real Estate Research Corp. in Chicago reports that many real estate pros say now is a better time to sell than buy.
Of course, that doesn’t mean that all deals are doomed to fail. But it does mean that it’s time for would-be investors to pay more attention to the perils of owning property, not just the potential profits.

Watch your cash flow

The most common entree into real estate investing is the single-family house. Investors bought almost one-fourth of all homes sold in 2004, according to the National Association of Realtors. If you’re one of those buyers and your income from that property (after taxes) exceeds your expenses by $100 or $200 a month, you’re in good shape.

But because prices and property taxes are so high in many areas, and there’s so much competition for attractive rental properties, it’s increasingly difficult to find deals that generate enough income to more than cover your expenses -- what’s called positive cash flow. In areas of Fredericksburg, where a modest three-bedroom house can easily cost $350,000, there’s no way you can collect enough rent to cover the steep property taxes and payments on a $280,000 mortgage. Figure monthly out-of-pocket expenses of more than $2,500, if not $3,000. The pool of renters who will pay that much is small.

So be ready to set your sights lower and get your hands dirty. Instead of a well-located home in pristine condition, look for a fixer-upper off the beaten track for maybe $120,000 that you can rent for $750 a month. The numbers work if you’re willing to spend weekends, say, painting the walls and, if you’re capable, making repairs that would otherwise require professional help. The hidden profit from home improvements is why ugly real estate often makes more money than the nice stuff.

Mind the cap

You can quickly figure out whether a house is likely to generate positive cash flow. For more complex properties, such as a small office building or retail space, check the cap rate, a single number that can tell you if you’re overpaying.

The cap rate -- cap is short for capitalization -- is a property’s net operating income as a percentage of its price. The figure is real estate’s version of a bond yield. If a property sells for $500,000 and generates net income of $50,000 (rents minus expenses), the cap rate is 50,000 divided by 500,000, or 10%. The lower the cap rate, the more you pay for each dollar of annual income.

In 2000, the average cap rate on commercial property in the U.S. was 10%. Since then, because of relentless price appreciation, the average cap rate has sunk to 8%. That alone suggests that wringing further gains out of commercial property is unlikely.

If you want to invest in a commercial property, aim for a purchase price that results in a 10% cap rate. But remember that the cap rate also depends on how much you collect in rent. Ask the broker for details about the tenants’ leases, including how rents compare with those of other nearby properties and when the leases are up for renewal. The property should come with an information packet that is more like a stock prospectus than a real estate agent’s fact sheet on a single-family house. If necessary, hire a property inspector. Then take all the information to a lawyer who specializes in real estate. If you have any doubts about the property, walk away.

 

Don’t be in a rush

With so many people hungry to invest, you may think that real estate is a race to the swift.  Generally speaking, if the seller is trying to get you to hurry and close, someone is hiding an ugly truth.

The details are often complicated but one problem often leads to another. There are zoning roadblocks, construction delays and cost overruns to watch for.  Don’t be rash and fall in love with an “idea”, do your homework before you close.

Know who’s paying

You could snag a property at what appears to be a giveaway price and still fail to make money because you can’t keep tenants, or you have tenants who aren’t worth keeping.

You need a system for finding reliable renters. At the very least, pay for credit checks on potential tenants and see if they have any outstanding judgments in the local courts for unpaid rent. If you just put up a sign expecting the perfect tenant to walk through the door, you’re dreaming.

Have an exit strategy

Flipping is yesterday’s news. If you fantasize about buying something -- anything -- and quickly unloading for a fortune, keep in mind that the pros predict that values may be peaking. Better to think long term. How long? Some experts say a minimum of three to five years, which should be long enough to ride out a possible downturn.

The ideal exit strategy is to be free to wait for as long as it takes to get the price you want. Be content because you not the short-term fluctuations of the markets (real estate or stock), determined the ultimate outcome of the investment.

Make sure it’s for you

Even if you’re new to real-estate investing, you probably sense the financial issues involved -- property-value trends, the interest-rate picture and whether you can make a deal work so that your income exceeds outlays. But a direct investment in real estate also requires specialized business skills. If you plan to stay personally involved -- and many investors want to because they like to fix up and show off their places -- you’ll have regular dealings with tenants, contractors and local officials. That may end up costing more money and requiring more time than you anticipated. You could hire a property manager, but that could clip 8% to 10% of your income, and you’re still not assured full occupancy, satisfied tenants and an absence of structural problems.

Rob Hill, a Nashville real estate lawyer and investor, says the best property investors master both the finances and the nuts and bolts. To get a feel for what it’s like to be a hands-on real estate investor, we recommend Hill’s book, "What No One Ever Tells You About Investing in Real Estate: Real Life Advice From 101 Successful Investors" (Dearborn Trade Publishing).

It isn’t about getting rich quickly by leveraging yourself to the hilt or turning yourself into a slumlord. Rather, the book is a collection of practical real-life occurrences. After reading it, you may conclude that investing directly in property is not for you, at least not now when the margin of error is so slim. Don’t sweat it. You can always turn to real-estate stocks and mutual funds.

There are a growing number of reasons why anyone contemplating investing in real estate or buying a home should consider the current environment as a rare opportunity to “get into the game”.

 

An unusual array of “financial experts” seems to agree that world financial markets are awash in capital.  Notable examples of this liquidity wave include the huge sums available to middle eastern governments and individuals benefiting from the recent spike in crude oil prices as well as the flood of funds leaving the European markets in wake recent setbacks regarding the European Union.

 

What does this mean to someone looking to buy property in Fredericksburg, TX?  It means that despite the fact that the economy is showing healthy gains (and therefore inflationary risks have increased) and the Federal Reserve have increased short-term rates, mortgage rates remain at historic lows.  Simply put, investors (who set mortgage rates) are confident that real estate is not overvalued, there is no bubble and investing in real property continues to be one of the safest ways to increase personal wealth.

 

On the local front, evidence exists that prices may be on the verge of softening a bit.  As sellers enter the summer doldrums and day-on-market stretch past normal averages, anyone looking to sell and move on to other opportunities will (wisely) consider the time value of money and accept less than they might have two to three months ago. 

 

Remember, cheap money is attractive to both buyers and sellers.  Buyers can qualify for “more home” or enjoy lower payments and sellers (who then become buyers) are anxious not to miss out on the low rates for their next purchase.  Very much a win-win situation.

 

Adding fuel to this is the very real prospect that local real estate will continue to out-perform other investment opportunities.  We are beginning to see money coming to real property from “non-traditional” sources such as IRA’s and 401(k)’s. (to learn more about this, visit www.THEePRO.com).  Throw in the tax advantages to owning real estate that are not available to other investment options and you have a “perfect storm” of opportunity for wealth creation!