Not every real estate investor increases their wealth at the same speed. There are faster ways, and there are slower ways.
When it comes to increasing our wealth, we would all prefer fast growth over slow growth, so long as it doesn’t involve any extra risk. The faster the growth, the faster our equity increases, which means the sooner we can buy that next property, which in turn builds our wealth even faster.
If you just want average growth, you can buy at market price, and wait. Your property value will move with the market, and over time, you’ll (usually) see an increase. If you are lucky or smart and you buy in a better market, you’ll get faster growth, but you’re still fundamentally limited by that market.
For truly extraordinary growth, you need a property which increases in value faster than the market grows. There are two ways to do this:
1. Take action which increases the value of the property
For example, renovating a ‘fixer-upper’, subdividing a block, refurbishing, re-zoning, re-leasing, or redeveloping a property. These things can make the property more valuable than it was when you bought it, without relying on any shift in the market itself. If you increase the value by more than you spend doing it, you increase your equity.
2. Buy a property below market value
This creates instant equity the moment you purchase it.
Of course, there is no reason you can’t do both! But in this article, I want to concentrate on the second method: buying below market value. Buying property below market value is an extremely effective way to build rapid equity.
OK, so far, so obvious. Everyone knows that it is good to get stuff below market value. Even the guy who breaks into your house for your high-definition plasma TV knows this.
If you have any skeptical bone in your body (and if you’re investing in real estate, I hope you do), you’ll be saying: “of course buying below market value is desirable, but it’s easier said than done.”
That’s very true. So the question is, ‘how do I buy real estate below market value?’
A second question, which I think is important, but the guy who breaks into your house does not, is ‘how do I do it ethically?’
Don’t be alarmed, I’m not about to spend time talking about ethics. You’ve got your own standards, and I’m not going to preach mine to you.
But I will point out that I see a lot of stories in the media presenting real estate investors as ’sharks’, interested only in their own profit than at the expense of other people. And you might think this is the only way to buy real estate below market value. You’re probably thinking of things like:
- buying foreclosures
- making lowball offers to flush out the desperate seller, or the seller who is grossly out-of-touch with current market value.
- finding senile old ladies and tricking them,
- and so on.
Before you call the station to lodge a complaint, I know, I know - if you buy from a desperate seller, you’re actually helping them out of a tight spot. Furthermore, I’m definitely not saying that buying a foreclosure is the same as tricking a senile person.
I list these scenarios together because for you to make a rapid gain, someone else has to lose (or has already lost) in some way. If you look for this type of property, good luck to you. I’m saying that personally, I do not look for these types of property, and I know that there are other investors who do not want to deal with this segment of the market, but who are still interested in buying below market value.
What I look for is a piece of real estate where the asking price is well below market value. I don’t need to make a lowball offer if the price is very good already - the seller is delighted because they’ve got what they were asking for, and everyone ends up happy. To me, that is a great deal. Sounds too much like a Disney cartoon? Well, it happens!
I’m not just talking about 5% below market value, either. I’m talking 20% or more below market value. And I repeat, I’m not insulting anyone with lowball offers - I’m paying full asking price!
But why, you ask, would anyone be happy to sell below market value? How would you find such a property?
Well, my advice is to stop looking at residential real estate, and turn your eyes to commercial real estate. I’ve found deals like this on multiple occasions. Once is a fluke, twice is a pattern. In other words, these deals are out there, and will continue to be out there. It takes finding them.
Example 1
I’ve written elsewhere about the first commercial property I purchased, so I won’t go into great detail here. To summarize: the sale had fallen through, and the seller was disappointed, wanting to sell it quickly. They were set to retire to their dream house on the coast. They had already sold their businesses for a good price. Now they were just selling the building which housed those businesses. They already had enough money. What they needed was a quick sale, so they could start their retirement. Speed was more important than getting top dollar. The agent told me “They previously contracted to sell it for $400,000. They’ll sell it to you for the same price. It’s worth more than that.” Yes, he didn’t serve the seller very well by telling us that. Sure enough, straight after we bought it, we had it officially (and conservatively) valued at $500,000. That’s $100,000 of equity on day one.
Why was it undervalued? We had a keen seller who already had enough money, and a slack agent who wanted a quick commission.
Example 2
Then there was the oil company who were offloading all their ’second-tier’ service stations. Mine was the last of their inventory, and by the time I came along, they just wanted it gone. They had already reached their sales target. Paid $400,000 and immediately had it valued at $480,000.
Why was it undervalued? The company wanted a quick, easy sale more than it wanted to achieve a top price.
Example 3
Then there was the government department which was selling one of its offices for less than $100,000. I passed up the deal, because there was some uncertainty about the lease. When the extra information came through, I realised the property was worth more than $200,000, but by then, some bolder soul had already bought it.
Why was it undervalued? A policy change meant that a government department suddenly sold all its offices, preferring to rent in future. I suspect that because the department was selling so many properties simultaneously, it did not have its full attention on this particular (and minor) office. I also suspect the government department lacked the in-house expertise to price the property correctly.
Example 4
Another example: my latest commercial property purchase was a floor in a nine-story city office building. Several years ago, a company had bought the entire building for $8 million. They had then fully refurbished the building, were now selling it at a healthy profit. I bought my floor for $1.4 million. Overall, they sold the entire building for around $16 million.
Less than an hour after I bought the property, the agent who sold it to me said “$1.4 was a good price. If you like, I could sell it for you immediately for $1.6 million.” That was two months ago. I’ve since spoken to a valuer who believes it is more likely worth around 2.0 million, but that’s also because I’ve since re-tenanted my floor.
Why was it undervalued? The seller had contracted to buy a much larger office building for over $30 million, which would be very profitable for it. But they needed to sell this current building fast, to ensure they had finance for the next deal. By the time I came along, they were very keen to offload this floor to me. I suspect we had a secondary factor of a minor real estate company who were out of their depth, and who underestimated market value.
I could list more examples than this, but you take my point. It’s as though people are giving me hundreds of thousands of dollars. Yet they’re happy to sell. There are two main factors at work here:
1. Sellers require a quick, easy sale.
These sellers are not financially distressed, desperate, sad, or mentally unsound. For their own reasons, they place more importance on a quick, easy sale, than on maximizing their sale price.
2. Bad Selling Agents.
They may be agents who, to secure their commission, are deliberately, willfully bad. Alternatively, they may be well-intentioned agents who, for whatever reason, have set a price which I believe is under market value. It takes good knowledge of a market to spot an incorrectly priced property. Incidentally, it also takes a lot of courage to proceed to purchase an undervalued property, without talking yourself out of the deal.
Maybe I’m not looking in the right places, but I don’t find deals anywhere near this good in residential real estate. There’s a different selling mindset. I’ve found that the residential seller will haggle over every dollar. Their house is a big asset, and they’re sure going to make damn sure they achieve top dollar. See the grumpy old man who has been so carefully manicuring his lawn and pruning his roses for the last 60 years. If I offer him 75% of his asking price, he’ll stab me in the chest with his secateurs, and rightly so; this is his retirement nest-egg!
However, I’ve seen these bargains a number of times in commercial real estate, and I hear again and again from other commercial investors who find exactly the same thing. This is one of the many things I like about commercial real estate. So bear in mind if you’re looking to build equity quickly: there are bargains out there in commercial real estate.
Finally, some comments, which I need to add for completeness, and to hose you down if you’ve become too excited.
I don’t want to leave you with the impression that every commercial property is a bargain, with every seller throwing away money. It still takes something to find these properties. I spent months looking for that last property, and made at least twenty enquiries, after dismissing hundreds of properties through browsing the internet.
Secondly, I’m saying nothing about the long-term prospects for the property. After ten or twenty years, the top-quality property in the great location will have done much better than the shabby mediocre one in a run-down area. It won’t matter which one you purchased below market value.
The reason I look for under-valued properties at this early stage of my career is that they give me fast equity, so I can grow my portfolio relatively quickly, without waiting for market growth. At the moment I place more emphasis on this than on long-term growth prospects.
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