Hello Mr. F.
My wife and I have been doing some diligence on commercial real estate investment and found one site online that suggested that most investors buy net leased properties with short term financing and then “flip” those assets as the loan matures. We have really enjoyed reading your stories and blog and see no reference to that sort of investing. Is there a reason you haven’t written about this sort of investment strategy? I hope you can answer our question … we are getting very excited about venturing into real estate investing.
Mr. and Mrs. Robert S – Biloxi, Miss.
Dear Mr. and Mrs. S,
Your question is one that has been coming across my desk very recently and I appreciate your writing me.
There are persons who make money in a great many ways and there certainly are those persons who can “time a market” … buying low and selling high, but for every success we believe there is a less spoken story of failure. That is not to suggest that buying an investment with a relatively short term mortgage is a bad practice, but we avoid doing so because there are too many variables that would concern us in a relatively short “hold” of an investment.
First there is the obvious … the concern that the property that pretty much needs to be sold could hit the market at the wrong time. In the past ten years we have seen some dramatic shifts in the economy in general and in some cases to an even greater extent in the commercial real estate pricing. If you are lucky, or perhaps really prescient, you might buy a property at its nadir and sell at the height of the market. But if you time it incorrectly, you could face a severe economic loss – forced to sell a few months or years before the market fully rebounds.
The second is a tad less obvious, but of equal concern. With lenders currently required to pay out almost nothing on savings deposits, they are currently motivated to lend at remarkably low rates. But if the economy continues to rebound and the Fed starts to tighten money supply, the rate to refinance a new mortgage can rise sharply and whether it is you, or your potential buyer, that will need financing, the full cost to own your investment will be substantially higher. The net return you [or the acquirer] is often net of mortgage costs, so if rates move higher, the net income will be reduced [or disappear entirely].
In short, we believe in a strategy of acquiring solid properties with longer term leases and finance our holdings for long term appreciation, not for sale within a shorter timeframe. It does work well for some, but we feel it to be higher risk than we would want to suggest for the new investor.
Hope this helps.