While investing in real estate, beware rules of thumb

Dale Beede
Dale Beede

“I’m looking for a solid single-tenant, NNN investment property at a 10 cap.”  “You know what they say, location, location, location.”  “Buy and hold.  There’s never a good reason to sell.”  “I buy only in the foreclosure market. That’s where the deals are.”  “If you don’t have 35 percent down, don’t buy investment real estate.”

Perhaps you’ve heard these statements, maybe repeatedly. Real estate investing comes with many
so-called rules of thumb — what some have come to believe as absolute truths. But have you thoroughly investigated any of these rules?

Let’s look at the buyer who only wants to invest in 10 percent caps or better. A cap refers to an the capitalization rate of an investment, or the expected net income divided by the desired rate of return before taxes and debt service. If we limit our searches to only 10 percent returns, we’re probably limiting ourselves to the riskiest of investments. There’s a reason a property is selling at a 10 cap. It might be functionally obsolescent or have a lot of deferred maintenance. The tenant could be financially weak or the tenant’s lease soon expires and there’s no guarantee of renewal. The strongest national tenants — including Starbucks and Walgreens — occupy properties that sell at cap rates between 4 percent and 6.5 percent, meaning you’ll typically pay more for properties that house a strong tenant on a cap rate basis.

How about focusing only on properties in “A” locations? How many long-term leased properties with credit tenants — those publicly listed or Dunn & Bradstreet rated — do we overlook because they’re not on the optimum corner with traffic signals? Too often we overlook a diamond investment in favor of a pearl that sits on an intersection.

Should you ever sell a real estate investment held for income? Conversely, we could ask, have you ever regretted selling an income property?

I’ve worked for many individuals over the years who seldom sold any real estate because, in their minds, the only entity that makes money when you sell an investment is Uncle Sam. Although the government allows us to sell and repurchase using the tax-deferred exchange mechanism, one argument the buy and holders usually make is that because of the short time frame allowed in naming a replacement property, many investors are pushed into buying mediocre properties at higher than average prices just to avoid the tax man. The other side of the argument could be found by those who realize that on properties they’ve owned many years, they no longer enjoy the tax advantage of taking depreciation on that property. Perhaps the property is functionally obsolescent or located in a neighborhood that’s no longer desirable There could be very good reasons to sell a property, but get your accountant’s input prior to making the decision.

Buying only foreclosure properties limits your research to those properties that someone has previously lost money on or might not be rentable in their present state. There’s usually more than one reason that property went into foreclosure.

As for having 35 percent down or more before investing, ask this question: How does one get started in real estate investment? For me it was purchasing fixer houses 38 years ago with $2,500 to $5,000 down and getting owner-carry terms. Is that kind of investment still possible?  Absolutely.

Happy investing. And don’t focus too much on the rules of thumb.