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First, some context. For most of the last half of the 20th century, real estate was a safe and prudent investment. Your returns, especially here in Silicon Valley, were almost guaranteed, unless you bought at the top of the occasional frenzy.

The last frenzy was probably the worst, and certainly wasn’t limited to California. When the tech boom went bust (and even before), a lot of money that traditionally would have gone into stocks went into real estate, something solid and presumably immovable. The idea of “irrational exuberance” shifted to real estate, and we saw the results in the form of 120% loans and relaxed verification of income. There was a lot of greed on the part of both buyers and lenders, and lest I forget to mention, sellers were happy to walk away with a lot of easy money.

What comprises this new mindset? For one thing, greed can no longer be a component of your investment goals. The new investor still wants a return on his or her money, but self-centered, me-driven greed won’t have a place anymore. Returns won’t justify it. Real estate will grow at a steady pace, but not a spectacular one.

I’m actually seeing a trend toward more altruism. With this new program Diving Into the Pool of Real Estate I’m working on, the investors are actually doing something for the common good. The program involves buying distressed properties in bulk, essentially, and then selling or writing them off as appropriate. The profits come in a variety of ways Six Ways to Profit From Distressed Properties, and the altruism comes from the fact that investors are helping lenders get back to some semblance of normal sooner.

Lenders like the fact that these “pool purchases” clean out the pipeline of properties they’ve already written off and have no other way of dealing with. They’re hamstrung by regulations that limit what they can do with the properties. But when the altruistic investor takes 100 properties out of lenders’ portfolios, they’ve created an enormous space for that lender to focus on the others. It’s a tremendous relief.

That’s not all there is to it. Because the cost of the houses is so low, investors can still get a profit selling to buyers who may not have been able to afford homes at the height of the boom. In some cases, buyers can offer mortgage payments that approximate their rental payments. They’re getting equity, but the investor can still benefit by holding the note if they wish.

It’s a win-win situation all around, something we haven’t had in real estate for quite a while.

In last week’s blog, we talked about diving into the pool of distressed real estate. I’ve been working with an investment firm that buys distressed properties in huge lots and resells them in groups of 15 to 20. You don’t get to pick which properties you get, but chances are that, even if some are worthless, the potential profit from the others would more than cover the clinkers.

If you’re practical, though, you probably wondered just where the potential profit comes from, especially when we’re talking about properties that could be anywhere in the U.S. So this week, we’ll talk about six ways to profit from your package of homes, while preserving your opportunity for a big upside.

Sell to a local investor. Distressed or not, there’s still profit left in many of these properties. Whether through a classified ad or by contracting with a local real estate office, you can sell them almost immediately to local investors. Look for local investors who already know the neighborhood and who can pay cash so there’s no mortgage paperwork involved. We’re not talking about a lot of money. In some severely depressed areas, such as Detroit or Newark, it’s not uncommon to buy individual properties for $500 to $1000. Because they’re local, these investors are willing to fix the properties up and flip them themselves.

Sell to renters looking to buy. In some parts of the country, there are renters who are looking to take advantage of this down market to get into real estate and have monthly payments for less than the local rents. These are people who have the resources and skills to do repairs on properties, and are willing to get sweat equity. You can handle these transactions with what’s known as a contract of sale, which is different than a deed of trust, the traditional method of buying a home. The contract itself holds the value, not the property itself, and it’s basically an agreement that the buyer gets the property once they’ve paid the debt on it.

Hire a local contractor. If the property is in fairly good condition, you can hire someone to do any basic repairs, and then sell it through traditional channels. Out of a portfolio of 20 properties, this isn’t likely to be the case for more than one or two of the properties.

Hire a local agent. I’ve encountered another national company that, for $250, will go onto a property, take pictures, deliver an inspection report, detail what’s missing from the house, put a lockbox on it for local access, hoist a “for sale” sign where it can’t be stolen.

Take the loss. Even if the property is worthless, you can turn around and sell or transfer the title to companies that specialize in junk properties. It gets the liability away from your name, and you get a deduction.

Offer It As A Rental. One investor who worked with the company that creates the pools of distressed properties found himself with a condo in California that was not only in pretty good shape, but was probably worth $45,000; he’d paid $9100 for it as part of the pool. He rented it out for $650 per month for about six months, until the renter offered him $38,000 for it.

For a long time, I’ve been looking for a savvy financial group applying the pool approach to the thousands of distressed real estate investment properties on the market. That is, putting together clusters of properties into a group of 15 to 20 properties for purchase by investors.

Investors would get the same kind of benefits venture capitalists get, only more so. As those of us here in Silicon Valley know, venture capitalists calculate ten companies on the premise that two will hit the jackpot, three will break even, and the investment in the other five will be more than covered by the two winners. With a cluster of properties from different locations across the country, as opposed to all in one locale, investors’ chances of reaping a profit on the deal as a whole increase mightily.

Doing so would not only help investors, but be a boon for lenders as well. These distressed properties are the so-called “pig in the python” — a huge bottleneck that’s making it hard for lenders to handle all their transactions.

Now that the real estate investment market has returned, I’ve finally found a company that’s putting this plan into action. They’ve been in business since 1986, and have used the relationships they’ve built up over that time to buy properties at 10 to 15 cents on the dollar. They’re asking for anywhere between $1100 and $1500 per property as their commission, increasing the cost to the investor to about 30 cents, but they’ve also set up a turnkey program that will help investors through the process of essentially flipping using a pooling system.

Investors with a minimum of $100,000 have the opportunity to buy in bulk and even sell in bulk. While they give up the ability to pick and choose from a portfolio of distressed properties, there’s still a strong upside. This company has purchased the properties all over the country at such distressed prices that the short-term profit potential is impressive.

The waters’ fine, get in. . .

It has been my practice for the last 5+ years to do my best to advise and counsel real estate investors.  As market conditions have changed several times in that span, of course my advice has shifted as well.  My basic philosophy is Buy what you can afford while prices and rates are low, and this continues to be good advice.  After all:

• The number of people who need homes to live in is increasing
• The available supply of homes is finite and not expanding
• According to a US Census Bureau survey, home ownership is down nationwide (see details below)
• People who want to own remains constant
• The majority of buyers are first timers
• Affordability has drastically improved, while financing availability has deteriorated

If this is you, it is the perfect storm:

• You have at least $100,000 or as much as $2.5 million you want invested in real estate immediately
• You have a high tolerance for the risk of buying property across the country you have not and will never see
• You may or may not want to become a landlord, but a looking for fast turn-around and high ROI’s
• Owning 20 - 30 properties short term while they are sold does not frighten you
• You are an active investor who would hire a trusted adviser to oversee a 3-6 month project
• Recycling distressed property to return it to homeowners appeals to you
• Avoiding all complications by not securing financing appeals to you
• A portion of your investment capital can be at work for 3-5 years or longer

US Census Bureau Survey results:

“The homeownership rate declined in 2008 for the fourth straight year according to the Housing Vacancy Survey, conducted by the US Census Bureau in conjunction with the Current Population Survey.

The home ownership rate for 2008 was 67.8%, down from 68.1% in 2007.

By region, home ownership in 2008 was highest in the Midwest at 71.7%, followed by the South (69.9%), the Northeast (64.6%) and the West (63.0%).” - Home Ownership Rates

The major problem with these types of investments has not been investors who meet the milestones listed above, but the companies who secure the property have had 3 major drawbacks:

1. They could not acquire bulk REO or distress property below 60% of current value leaving insufficient margins for wholesalers or investors to implement a profitable exit strategy
2. They have not had a reliable or tested turn-key process that worked to dispose of the purchased property by their investors
3. They have not had a dependable relationship with suppliers to be able to acquire property on an ongoing basis at low discount prices.

Since the buyers are back in force and multiple offers on the lowest priced property is again common, there are now several companies with programs that have solved the 3 performance issues above.  But you won’t find them advertising or taking a high profile in any way.  They prefer to remain connected and committed to their long term, private referral sources, who seem to be able to supply them with all the business they need.

This is the best example “It’s not what you know but who”, and my strong advice is to protect those relationships that give you access to high ROI’s.