Real estate investing by its very nature is rampant with peril. As a child I experienced this firsthand with the occupation of my father, who, as a young man at the age of twenty-six, got his brokerage license in California and started selling homes. Eventually, and successfully, he sold industrial and storefront retail properties in South Central Los Angeles. As a child, I remember helping Dad hang up signs. The signs read "Quik Realty, Malcolm Potter, Broker." Having migrated from Ohio just a few years earlier, starting in real estate at such a young age, with three young kids intact and my kid sister on the way, one can understand the motivation to succeed quickly. Apparently this worked, since by the early 1970s, Dad was awash in cash; so much so, that we had two homes, one in Los Angeles, the other 80 miles away in the resort ski town of Lake Arrowhead, with a couple of cars to boot. Real estate was booming, and times were good. The flip side of this nirvana was something called a recession. Unless you were bullet proof, it hit a lot of real estate professionals hard, including Dad. It's hard to make a living when nobody's buying, especially when you make your living selling-and when nobody's buying, nobody's selling. Long story short, Dad had some major highs and lows through his career, but it was those early years when I was a child that were most indelible to me.
One of the two major lessons I learned was never, and I repeat never, leverage yourself too deeply into any piece of real estate. If things go south, you don't want to be catastrophically and economically destroyed. When applied correctly, leverage is the eighth wonder of the world, and when in the world of real estate investing, use it to your advantage, meaning use other people's money, also known as OPM. Using OPM obviously means going to lenders, banks, and mortgage brokers to do all the heavy lifting. And as for lesson two, refer back to lesson one.
Real estate investing should in fact be called "real estate leveraging" instead. Thought of in this way, real estate investing should be about the proper allocation of leverage and its use. More particularly, real estate investing in new tract housing is one of the few areas of real estate investing where the investor proactively reduces the risk of financial loss to an absolute minimum. To illustrate, the following are just a few reasons why the risk is minimized: first, most earnest money deposits are in the $2,000 to $8,000 range, with many builders at the industry standard of $5,000. Second, and unlike REOs where acquisitions usually occur quickly and mortgage debt servicing begins immediately, this doesn't happen on new tract homes. The first loan payment doesn't occur until the home is completed, and that's typically nine or twelve months away when the home has been finished. Third, what I consider the unrequited beauty of flipping new tract homes, is the free build-up of appreciation without having to pay for it-although notwithstanding the risk of losing your nominal earnest money deposit, this is like buying options or futures, with little or no money down while maximizing the upside.
If after the property is built and the buyer is asked to close on it, the investor may, however unethical as it may seem, choose not to close on the property and walk away. As an equation, the latter methodology might be formulated as follows: low deposit + walk away option = low risk / high upside2
As crude as that may sound, the prospect of losing one's nominal security deposit, where a $5,000 down payment may result in a $40,000 gain, which is an 800 percent cash on cash return, the loss of the $5,000 pales in comparison to the uncharted territory of buying an REO or pre-owned home. At any rate, despite the pros and cons of pre-owned homes (a.k.a. "resell homes"), the purchase of that type of housing product could result in an infinite number of structural defects in the property, not to mention title defects-which may be indicative of outstanding lien positions or other unknown obligations that are not apparent at the time of acquisition. In short, that type of title defect, otherwise known as a "clouded title", could seriously encumber the investor in reselling the property. Furthermore, with the myriad of potential problems that can arise when buying pre-owned homes, it can only add to the cost of ownership and to the reduction of profit when compared to the acquisition of a brand-spanking new tract home that is defect free.
(The latter passage was an excerpt from the recently released book, The Flip: The True Life Story of How a Successful New Tract Home Investor Went from Zero to Hero, Back to Zero. To learn about Mr. Potter's expertise, go to http://www.theflip.tv/ and discover why New York Times bestsellers, PhD's, and HGTV hosts have raved about The Flip, a real estate docu-fiction which chronicles the real estate crisis before, after, and now. The book was also an Amazon Kindle reader bestseller).
As a member of the National Association of Realtors and the National Association of Home Builders, D. Sidney Potter began his real estate career in 1992 as a mortgage operations consultant for Synergy Consultancy Group, and proceeded to work for Marcus & Millichap and Sperry Van Ness as a commercial real estate broker selling shopping centers and storefront retail.
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