Building a Portfolio versus Building Equity

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“My portfolio is growing!  I just closed on my fourth house and I just got a promotion at work – things couldn’t be better!”  On the outset this sounds great.  Until you ask, “do you have any debt on those properties?”  The eager up-and-comer quickly responds “well, yes, but I have renters, so I’m building equity!”  As the onion peels away we start understanding the situation much better.  “I took advantage of a low down payment loan program to buy the houses so my renters (as they pay their monthly rent) are paying down my mortgage for me.  These houses will be my retirement portfolio one day.”  If this sounds familiar, then I agree with you.  I am learning about more and more “investors” who are buying homes at or near market price, adding some fresh paint and carpet, replace a few kitchen cabinets and toilets and then rent their properties out.  This strategy is only one paycheck (of the renter) away from becoming a disaster for the owner.  Simply put, the only viable reason to rent out a single family house is because either (a) you are using your own money, and (b) the rental rate is so far above your holding costs that your net profit is better than any other investment alternative on a return-on-cash basis.  Otherwise, if you are buying a house near or at market price, one missed rental payment (and usually will at the wrong time) can spell disaster for the owner.  The cost of eviction and missed payments will eat up any “discount” you bought the property for.  So now you have to ask yourself, DID YOU GET INTO REAL ESTATE TO BUILD A PORTFOLIO OR TO BUILD EQUITY?  The purchase of a rental home should made at a steep enough discount that lost rents, non-paying tenants, and expensive repairs do no cut significantly into PROFITS.  Remember profits are why you got into real estate investing to begin with!  Four home purchases made at or near market price with a low to zero down payment is speculation.  The buyer is speculating that the renter will not default, that the house will not need repairs, that economic circumstances won’t change, that a host of factors will not cut into profits.  Homes in several hot markets during 2007-2012 including Las Vegas, Phoenix and Tucson went through a boom/bust cycle that wiped out half the value of the residential market.  Short sale properties were so common few people wanted to buy them and so many more couldn’t because the banks were barely lending to even the top tier borrowers in the country!  Build a portfolio Yes, if you bought equity on the day of closing.  But, depending on a series of factors that are not under your control No.  Equity is bought on day one.  Having a strategy to cash in on that equity will be in my next article!  To your prosperity!

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