LilBob's  Instablog

I've been conversing with some friends of mine who are involved in real estate, along with my brother who works in construction and from those conversations I've created this investment strategy for those interested in picking up real estate on the cheap and cashing in on pending appreciation of urban properties. 

The American dollar is weak, and there is discussion of the possibility of the creation of a new international reserve currency to facilitate commodities trading, if this does happen the price of oil will almost certainly go up and stay up.  If this happens then homes in urban neighborhoods will appreciate in value as suburbanites try to trim their cost of living by moving closer to work.  With proper planning and reconnaissance, a bit of study of the basics of real estate and neighborhoods, and some sweat equity, one can build a nice segment of one's retirement portfolio from rental properties. 

This is something that is best done locally.  You can begin by getting a map of the area where you live and/or intend to invest in property.  Look at the areas that have the following characteristics: 

1.  Good access to major traffic arteries, grocery stores, bus-lines. 

2.  Homes that are not dilapidated or condemned.

3.  Little or no problems with crime, especially drug use, prostitution and squatters. 

4.  Significant potential to appreciate as a return to $3.50-$4.00/gallon gas prompts many to move closer to the cities. 

Take your highlighter and outline on your map those residential arteries that you think are most likely to appreciate.  Never assume that a neighborhood will appreciate as a whole.  It is not uncommon in urban areas to go from very nice neighborhoods to slums in the space of less than six blocks.
Once you've selected your potential neighborhoods go out and actually walk those neighborhoods, keeping an eye out for "For Sale" signs and deciding-literally on a street by street basis-where your best investment opportunities are.  

Find friends who are involved in construction who can look at the properties with you and give you a realistic estimate of what it will cost to maintain those properties.  Remember that you'll have to invest at least time, sweat, paint and buckets of cleaning fluids on any property.  Make sure that you inspect every properly thoroughly enough so that you don't end up with a money pit.  The ideal property is one that is mechanically sound and up to code but that you can pick up cheaply because it needs basic cosmetic work-paint, plaster, cleaning, landscaping.  Any property will eventually need a new roof, furnace and water heater.  Try to avoid especially large homes with steeply pitched roofs and complex heating and plumbing systems that can drastically increase the cost of maintenance and upgrades.

Look at apartments held by commercial management companies in your area to get an idea what prevailing rental rates are.  Ideally your probably going to want to get at least $15/sf/yr for your rental units.  Invest wisely and progressively, improving properties in those areas that seem to be appreciating-so you can eventually increase your $/sf revenues-but remaining mindful and realistic regarding property revenues so you can balance what you put in with what you are likely to get out of a property.

One of the primary problems of the current US economy is the destruction of the cash-cycle, by which I mean the process by which capital moves through the economy from producers, to employees, who then become consumers whose patronage supports producers, and so on.  This cash cycle bears some resemblance to the nitrogen cycle that we all remember from high school biology.  In short, we have ended up in a situation where we have too much investment capital floating around to fund ventures that have no hope of surviving, because consumers-due to stagnation of wages-do not possess sufficient capital to support  new ventures via regular patronage.  The capital that was built up in the savings accounts and investments of the WWII generation is now largely spent, and the elimination of good paying jobs in favor of "minimum wage plus a dollar" service sector jobs has resulted in a growing number of working poor whose lives are lived on the brink of homelessness.  More Americans are suffering through financial outcomes approximating those of late 19th century immigrants.  The only potential solution to this problem is an abandonment of currently predominating service and retail sector business models in favor of approaches that stress the importance of maximizing return on investment/man hour of labor. 

This author is a strong believer in the power of entrepreneurship, and a growth in new businesses and greater market competition is just about the only legitimate hope left to revive the US economy.  The typical counter-argument to this is that entrepreneurship, if it dissipates potential revenues and distributes consumer spending over too many firms eliminates economies of scale and reduces innovation.  That argument is bogus.  Economies of scale destroy jobs, and oligopoly has always proven a far greater destructive force towards innovation than free market competition.  It should come as no surprise that the current scramble for new drug products to patent in the pharmaceutical industry follows a period of rapid mergers when blockbuster drugs facilitated massive industry profits. .

With so many Americans suffering through days of mindless low-paying retail and service sector work one would think entrepreneurship in this country would be overwhelming.  The opportunity cost of an $8 or $9 an hour job is so low that one could do better with even a moderately successful single person venture.  Unfortunately, Americans have been conditioned to accept a herd mentality and be the "company man".  Many do not have the courage to believe in themselves and are socialized to believe that "You can't compete with the big boys anyway".  What this all points to is that our current economic crisis really has-at its center-a social component.  This nation will never have a vibrant entrepreneur based economy with numerous small firms engaging in aggressive free market competition that keeps industry sharp, benefits consumers, and reduces lobbying for government subsidies until we all-collectively-get over our fear of trying to compete with "The big boys".

I'm generally a pessimist, but I still think that with entrepreneurship-especially entrepreneurship which focuses on some key fundamentals of good business plan design, the current economic crisis can be overcome.  One of the drawbacks of service industries is that on a $ sales/employee hour basis returns tend to be dismally low.  Manufacturing can provide a much higher return.  Much of the out-sourcing that was enacted over the course of the last few years was not done because plants were not profitable, it was done to bust the last remaining labor unions and to pursue the opportunity to sell to developed world consumers without having to pay developed world wage rates.  Ironically, a weak dollar and high oil prices could reverse this trend, making overseas production comparatively more costly and leading to a realignment of US trade balances. 

The business planning fundamentals which must be focused on are:

1.  Making sure that goods have a market, and that market will provide a reliable return on capital.  The flaky Web 2.0 "We'll figure out how to make money later," idea has to be abandoned.

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During financial panics in the latter half of the 19th and early part of the 20th century, famed banker J.P. Morgan repeatedly stepped in with his own financial capital to quell economic disturbances.  With the current recession ongoing-or recently passed, depending on which talking head you listen to-America needs a modern version of Morgan to help foment spending and increase dollar velocity in the economy. 

Although many bristle at the thought of non-profit organizations leading the for-profit sector into prosperity, right now the only way we are likely to see significant improvements in the economic situation of this country is if recent gains in the stock market translate into increased hiring by endowment backed non-profits.  Universities, foundations, think tanks and hospitals collectively represent a total of over 2000 institutions with over a trillion dollars of capital nationwide.  These are organizations whose very existence is based on the generosity of financial contributors.  If these organizations would be willing to "put their endowments on the line," and increase their spending as much as possible-the increase in employment and dollar velocity, and the takeup of economic slack could yield significant benefits for the economy at large. 

Obviously, the liquidation of assets to fund this effort at a private version of economic stimulus could result in a significant periodic hit to financial markets.  Unfortunately, failure to act in a timely manner, so as to improve economic prospects  could result in an implosion of gains in the recent bull market (a market which many on this same website admit appears to lack any underlying growth fundamentals) and result in even greater losses as the result of inaction.