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There are three broad categories of investment
strategy that I advocate:
-
bargain purchase
-
increase value
-
double-digit cap rate.
Bargain purchase is the purchase of
real estate for at least 20% below current market value.
In the increase-value strategy, you buy a
property for its current market value, but you select only properties with some
unrealized potential. Then, immediately after purchase, you make whatever
changes are necessary to increase the value of the property. In general, you
must increase the value by at least 20% within six months in order for the
strategy to be worthwhile.
Double-digit cap rate means that you
buy the building on terms that it has a capitalization rate of 10% or more. The
capitalization rate is the net operating income (rent minus operating expenses
but before debt service) divided by the purchase price. In other words, it is
the cash-on-cash rate of return you would get if you owned the property free and
clear. In the absence of a bargain purchase, double-digit cap rates are very
hard to find. They generally only occur temporarily in depressed markets or in
small market niches.
The most common real estate investment
strategy, however, is one which I condemn: buying properties which the investor
believes will soon increase in value due to market-wide appreciation. This is,
in fact, pure speculation. No one knows which areas will appreciate. Many
billions have been made by investors pursuing this strategy, but they were
simply lucky.
Another common strategy which is advocated by most
real estate gurus are various forms of finding unsophisticated sellers and using
some convoluted real estate transaction to take advantage of their lack of
sophistication. These strategies are unethical, immoral, and often illegal. I do
not advocate them.
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