By Jonathan Yates
While campaigning for office last year, Anne Arundel County Executive Steven R. Schuh would often point out that the county is incredibly important due to the presence of the state capitol in Annapolis, along with important federal facilities such as Fort George S. Meade, the National Security Agency, and the United States Naval Academy, among many other compelling features.
These and other factors result in a unique set of advantages for local real estate investors in the Chesapeake Bay region. Due to the concentration of civil servants in the public sector and those such as lawyers, lobbyists, high tech firms, and others, who receive a secure, steady income from deriving their business from the government, it’s difficult to imagine a more financially stable region.
This does not make it a fool proof market by any stretch of the imagination, though. And despite all of the shows on reality television touting “flip this, flip that,” as with all investing, it is wiser to buy real estate and hold it for the long term, rather than sell the property quickly.
There are many reasons for a “buy and hold” approach. The first is the substantial expenses that go along with buying and selling real estate. Capital gains taxes can be almost 40 percent for some sellers, if the asset is held less than a year. Then there are closing costs, which are quite substantial. Selling real estate is a challenging process, in which it is even possible to sell a property for 50 percent more than the original purchase price and still lose money due to taxes and transaction costs. That makes a buy-and-hold approach much more rewarding for real estate, as with all investing; from 1978–2004, real estate had an average return on investment of 8.6 percent. Advice here to remember for all investing, not just real estate: transaction costs, while important, should not be the predominant factor for a deal, which should rather be based on the future income stream to be produced by the asset.
It is rarely advisable to try to time the market for any asset class, especially real estate. Few, if any, anticipated the housing collapse that led to The Great Recession. Flipping houses or other real estate is simply trying to sell a piece of property before the market cools. And if it cools before a deal is made, flippers are stuck with real estate that is not only difficult to sell, but most likely carries with it burdensome mortgage payments, along with the associated expenses for upkeep, repair, and basic maintenance.
Which ings up another fundamental tenet for investing: buy an asset that pays you to own it. For real estate, that means the purchase of properties that provide a reliable stream of rental income. Real estate that can be rented for an amount that covers the mortgage payment provides protection against a cooling market, if it cannot be sold at a profitable price. An appealing feature is that when fewer pieces of property are being sold, rents will generally rise. This results from there being a greater demand for rental housing as fewer want to buy in times of adverse economic conditions.
Like any investment, real estate requires a plan. One local experienced real estate agent advises, “Real estate investing is a business.” That means that the investor should, “Have a plan and work it like a business. The three keys to success are: buy right, manage expenses, and good tenants.” Like any financial professional who understands the process, our agent concludes with sound advice, “Real estate investing can be one of the best tools to provide for your own financial future. But it is about making good decisions to get rich slow—not get rich quick. For that, you need have a good business model that must maximize return and minimize risks.”
As with entering any business or investment, thorough due diligence is critical before buying any piece of real estate. Return-on-equity is how much an investor earns for all of the resources put into an asset. For stocks, investment mogul Warren Buffett looks for a return-on-equity of at least 20 percent for three consecutive years. In real estate, this is challenging as it requires the owner to place a value on their time. Real estate investing entails a great deal of this, as properties must be found and thoroughly inspected, along with other time-consuming efforts, such as obtaining a mortgage. A stock already has that factored into the price of the share as a component of its operating expenses.
Free cash flow is the most important feature due to the relative illiquidity of a piece of real estate. Free cash flow is the amount of cash that is left over from funding all other operations, including capital investments. It is the money that is left over and can be utilized for needs that, many times, are not related to that asset. The amount of free cash flow available for use in real estate can be enhanced through opening a line-of-credit to tap into the equity of the property. Buffett utilizes free cash flow to buy other companies. For real estate, the free cash flow can be deployed in the same manner, through the purchase of additional properties.
That is why the level of debt for real estate investing should be minimized as much as possible. Excessive leverage, the piling on of too much debt, for any investment absorbs a disproportionate amount from all resources. Examples: Management is constantly dealing with the many aspects of debt; Capital must be dedicated to servicing the borrowing costs; or a mortgage can also be called in, forcing the owners to scramble for other funding.
Those precious, finite resources could be going to acquiring other properties rather than dealing with a high amount of leverage. For matters of debt, Buffett believes that an appealing asset should generate enough capital from basic business operations so that it does not have to borrow heavily.
So, where to begin in acquiring real estate to make money? As with all investing, it’s advisable to buy the assets of what you know. Look for real estate opportunities close to home. The time expenditure is greatly reduced, making the return-on-investment even more robust. Properties nearby are also much easier to maintain and repair. All aspects of tenant relations are much, much better when the landlord is close.
Fortunately “close to home” is the Chesapeake Bay region in Maryland; close to Washington, D.C., Baltimore, Annapolis, and points throughout the Eastern Shore. It offers the diversity and the demographics that any real estate investor would seek. There are three distinct urban areas that reach into Anne Arundel County alone. Student housing needs in the region are also defined markets that can be very rewarding for investors. The needs of the military are another alluring sector of investment housing. As an affluent region, there are many experienced real estate professionals to assist in every step of the buying, renting, or selling process for all types of properties.
Any asset carries with it risk and opportunity cost, but the reward of buying real estate in our region has been proven for investors who are willing to conduct the needed due diligence, buy when there are financial features that would appeal to an experienced investor like Buffett, and then hold the property for the long term to maximize the gains.
Jonathan Yates has bought, rented out, and sold real estate for profit in Anne Arundel County, the Eastern Shore, Montgomery County, Maine, California, Virginia, New Hampshire, and Washington, DC. Every piece of property he had went under contract or sold for a profit, even during The Great Recession.
