Confessions of an Entrepreneur: Real Estate Investing 101
July 29, 2020 | By Mark Zweig
I get a lot of questions from students and other people in the community about real estate investing.
We never had a huge operation compared to some, but for most of each of the last 10 years or so we probably sold $5-10 million worth of properties annually through our design/build/development/property management company, Mark Zweig, Inc., and were pretty well-known in the area for doing high quality projects.
I started out doing this stuff as many people do – working on my own house. I built my first house in 1981-1982, and after that (bad) experience, started buying older houses and redoing them as we lived in them.
That strategy allowed us to crawl up the property ladder over the next 20 years or so to where we had a 5200-square-foot house with an enormous swimming pool on six acres on the Charles River in the affluent Boston-area bedroom community of Dover, Massachusetts.
When we bought our first house on E. Prospect Street in Fayetteville in 2004, we did the same thing. We bought A. L. Trent’s house (he was the founder of Wilson Park, formerly known as “Trent’s Pond”), a rock house built in 1935 and did a major makeover with multiple additions, art studio, guest house and more.
We spent more than twice as much on improvements as we did buying the house.
That was a particularly fun and rewarding project. Afterward, I decided to turn my passion for redoing houses into a legitimate business. We incorporated in 2005 and started buying other old houses in the downtown, Washington-Willow, Mt. Sequoyah and Wilson Park areas for cash, one at a time, and redoing them.
We sold them for what was at the time record high prices for a house in Fayetteville. When we started getting over $300 a square foot for houses we bought for $50-80 a square foot or less in some cases, people were amazed. And this was during a real estate recession.
Over time, our business grew. One of the ways we sold houses was by taking trade-ins of suburban houses our downtown house buyers wanted out of but couldn’t sell. We got into rental properties through these trade-ins.
Then, we started carving lots off houses and building new houses next to the older ones we redid. We got into a new bank-owned subdivision and built some brand-new houses. We bought apartments and condos and redid them. We got into commercial properties, including office and retail. We built new apartments and new condos. We got on the Inc. 5000 list of fastest-growing privately-held companies in 2014. At our peak in 2018, we owned somewhere north of $22 million worth of heavily leveraged commercial and residential properties. We also did a certain amount of work as a general contractor for clients and had an unlimited commercial and residential contractor’s license.
We had our own in-house architectural designer, carpenters, laborers, a construction manager, a bookkeeper/property manager, a general manager, two outside accounting firms, an outside property management company, an office, a warehouse, company cars, trucks, trailers, and tools, along with a bond to be licensed, and some very expensive workers’ comp, general liability and health insurance.
We had lots of overhead, especially when paired with all of the interest on speculative projects under construction. To support all that overhead, we had to take on even more projects.
It was then that we decided we had gone too far. Prices to buy had been bid up too high to make a profit. It was hard to get the work done. Everything took longer than it should have which cost us more interest. Property management was a hassle, and we had a tenant destroy one of our houses. Our working capital was being eaten up at a ferocious pace.
Today, we are winding down. We gave up our contractor’s license, shed most all of our business overhead and have sold off about 70% of the properties with more to go. My wife and I are both feeling very good about our decision to get out of the business.
Here are some of the lessons I’ve learned about this business, in no particular order of importance:
- I wish I had known what I know now 40 years ago and gotten into the business sooner.
Rental properties can be a great wealth builder over time and the depreciation is a fantastic tax shelter. Real estate is an appreciating/depreciating asset and it should be part of your wealth-building plan.
- As an investor, you want to be out of synch with the market.
All markets are cyclical and there are many sub markets in the real estate business. That means you want to be buying when no one else wants to buy (whatever type of properties those are), because that is when everything is the cheapest.
It is also the time when banks will have properties they have foreclosed on which means you can get better-than-normal financing. Conversely, you want to be selling when everyone is clamoring to buy. That is when you will get the quickest sale at the highest price. On short, do the opposite of what everyone else is doing.
- The business is not as easy as it looks.
HGTV has made the whole process look simpler and more profitable than it is. They never talk about the time value of money or interest carrying costs. They also seem to always leave out any discussion of real estate commissions. They beat down their subcontractors mercilessly. Everything gets done in record time.
The fact is, it’s a difficult business and not an easy one to make money in. Sometimes you make money and sometimes you lose money. We have done plenty of both over the years.
- You need to study the market carefully so you can recognize a good deal when you see
There are so many great online resources today that make this easier than ever to do. I look at Zillow every morning to see the new residential listings and try to find out what is selling for how much in Fayetteville. You have to focus on a specific community or area. I wouldn’t know a good deal in Bentonville or Springdale or Rogers if it hit me on the head, but Fayetteville is another matter. Even in Fayetteville, I know nothing about west Fayetteville.
You can’t do this in many places simultaneously. Focus your efforts, especially early on, in a small enough area that you can really get to know it.
- You make money when you are buying, and you make money when you are selling.
That means that you need to buy properties at the best possible price. For us, that meant we made a lot of offers on properties the day they hit the market. We also made a lot of offers on properties that had been languishing on the market for months or even years. I learned that making offers with no inspection or financing contingencies made our offers more attractive than those coming from many other buyers. We could close quickly and there wouldn’t be any post-inspection renegotiation.
We made a lot of offers. I remember one week where we made four or five offers. We found that about one in four or five low offers we made got accepted. At some point sellers get fed up with not selling and they want to unload. That is the ideal time to buy.
- Only buy in the best locations.
No amount of time or money spent will overcome a bad location. Fayetteville is very unique in that properties on individual streets could have significantly more value than others that could be as close as just around the corner.
We focused initially on downtown, the Square, Washington-Willow, Wilson Park and other walk-to-town and campus locations. Eventually we spread out to locations that were a short drive from town or in desirable areas of East Fayetteville or close-in on North College.
- Don’t buy raw land unless you plan on building on it immediately.
I have explained this repeatedly to people. If you have a million dollars to invest (or can borrow a million dollars), buying apartments that are leased or commercial space with tenants is so much better than buying non-income-producing land – and those leased properties still have the same opportunity to appreciate that the land does.
The apartments could easily generate $150K a year or more in rental income. After three years, you are $450K ahead of where you would be if you bought the land. That will be hard to make up with appreciation.
- Build your banking relationships.
For a number of years, we worked exclusively with one bank. They handled all of our needs, and the financing got easier and more convenient over time. Eventually, our borrowing needs exceeded their capacity and we started working with a few other banks.
We like local banks where we can have a personal relationship with the top people. I’m not a fan of large, impersonal, formula-driven banks. Smaller, local banks can be a little more creative (though none of them are in a position where they can take on any inordinate risks), and when you are a bigger customer for them they seem to treat you better.
It’s good to have a real banking relationship if you ever run into trouble or need to know you can get money fast to not lose out on a deal.
- Appraisals are beyond crucial.
Residential property appraisals are based on comparable sales (“comps”). If there are no comps at the price per square foot you are selling your property, unless you find a cash buyer (rare outside of a very few areas here), your buyer won’t be able to get the financing to buy from you.
Know the market and realize that whatever the top price per square foot is in that area is probably the most you will be able to get. Use that as a ceiling and work backwards to figure out what you can afford to buy it, improve it, pay the carrying costs and pay the real estate commissions and other fees you will have to when you sell it. Appraisals for commercial and multi-family properties are strictly based on the rental income they currently generate or what they can generate post-improvement. Comps mean nothing there.
- Construction loans are a great financing tool.
One of the reasons I learned to love dilapidated properties is because you can get construction loans to buy and improve them. For example, if you can buy a house for $250K – one that based on the improvements you plan to make could be worth $500K when done – you can probably borrow as much as 80% or more of the post-improvement value. That means you can borrow $400K (interest only loan) on the house, use part of that to pay for it ($250K), and still have $150K left over for improvements and carrying costs during construction. If you can get everything done you told your lender that you would do for that $150K, when completed you have a $500K appraised value house that you can either sell (hopefully for a profit) or lease out. When done, the bank’s appraiser would certify that the improvements were, in fact, done, and the construction loan could be rewritten as an amortizing loan. The $100K equity you now have in theory would be called “sweat equity.”
- Pick one realtor.
Choose an already proven high producer – not just a friend who is selling real estate – and do all of your business with them. Be loyal and they will show loyalty to you. That loyalty translates to you hearing about every good buy they learn about first – potentially very valuable information.
Never cut them out of the deal. Even when someone approached me or another member of our firm directly about interest in a property, we always sent the buyers to our realtor. He earned his fee by being a fantastic negotiator and by making sure the other realtor and everyone else involved did their jobs so the deal closed.
When you don’t have a realtor and go FSBO (for sale by owner), the buyer automatically deducts the real estate commissions from what they will be willing to pay you. And then you have no one representing your interests and assuming all of the transaction-related liability. And our realtor always helped us buy FSBO properties and would negotiate and paper the whole deal because he knew we wouldn’t cut him out of the eventual sale of the property.
- If you own your own businesses, consider buying a building to house it.
Set it up in a different company and pay yourself rent. Your rent won’t be wasted. And you can finance it based on the income projections from your own lease to yourself. That lease will justify a certain appraisal value for the property.
That’s all for now. Perhaps in a future post I will get into what I have learned about construction over the years. There have been some costly lessons I would like someone else to benefit from!