In my previous article, I talked about the importance of surrounding yourself with the right people when it comes to your non-family and business pursuits. In this article, I want to remind you of a couple of fundamental rules that real estate investors often forget.
First, real estate can go down in value, and rents can drop. If you doubt me, look at the pricing of commercial office space and the cost to rent that space or one similar. Prices are down, and it’s because of the second fundamental rule, which is that interest rates can go up, and the Fed is not your friend.
From 2011 through early 2023, we were in an environment where interest rates were kept low for far too long. Low interest rates are like pouring an accelerant on a bonfire. Interest rates are the fulcrum on which the tool of leverage pivots. They can be up or down, and you must be risk aware to determine what will happen if the leverage swings the other way.
A third fundamental has to do with a topic about which I am very passionate, and that is subject-to residential real estate transactions. For those of you who want to know more about what I think about subject-to transactions, you can visit SeriousSubTo.com.
Subject-to deals make good sense when you recognize that you must have a safety margin or profit margin built into at least two of the three potential deltas in the deal. Just because the interest rate is low, it isn’t necessarily a good subject-to deal. If the interest rate is low, and you are able to resell on a wrap, all-inclusive transaction which is properly and fully documented, and you can create a spread between the underlying interest rate and the resale rate, that’s good, but you also need to have a spread between the purchase price and the resale price, as well as a spread between the monthly payment and the term on the loan.
Right now, I’m seeing an increasing number of investors who thought they got into a good subject-to deal based solely on the interest rate without verifying that there was a sizable profit in the difference between the purchase price and resale price or the possibility of a good, monthly spread if it were run as a rental property. Those investors who took over a property subject-to with no equity and no monthly cash flow thinking that an elixir of time and inflation would make them rich are in for a big surprise.
Remember, I’m a huge fan of subject-to transactions if they are done correctly with the right paperwork and disclosures. It’s important to have these fundamentals nailed down before you complete a subject-to transaction.
