Worth - Dangers for New Real Estate Investors
Many believe that having millionaire status is a great place to be, and indeed it can be. But there is a BIG difference between having a million dollars of equity in real estate that is 90% leveraged and having cash in the bank or even a million dollars in equity in real estate that is only financially leveraged say 50% or 60%. The difference is "liquidity". If you have cash you can pay the bills. If you have a million in real estate equity, but the property is so heavily leveraged that you cannot readily sell it, or sell it at all, with a net cash profit, then you may end up in a situation where you cannot pay the bills. Indeed, many real estate investors have gone bankrupt with a legitimate million dollar balance sheet.
I've seen many articles on the net encouraging investors to buy properties using a technique known as "Subject To" whereby they take over the seller's house, informally assuming the underlying non-assumable loan. Some of these explain to the investor that its okay to buy with no equity provided the rents on the property will provide a positive cash flow. Some talk about how the underlying loan being owner occupied will result in lower rates thus allowing the property to cash flow where it might not on an investor loan. This is in itself somewhat misleading as typically those with poor credit, which constitutes a good part of those you find in default and thus willing to sell to you Subject To, tend to have higher interest rates. Also, once a loan goes into default the lender may very well kick in a default interest rate higher than the normal rate. Buying a property in such a manner, with little or no equity, is a dangerous play, especially if the investor buying using a Subject To acquisition has poor credit, which is often why the buyer chose to buy in this manner to begin with.
Many of the courses you'll find that encourage you to buy with little equity in such a manner as explained above are very professionally packaged and taught by trainers that are not only good speakers but also excellent salespersons. Many attendees who are new to investing, and especially those with little assets, little financial or business knowledge, and often with poor credit, get pulled into the "get rich quick" dream and buy an expensive course or boot camp on credit and then feel compelled to go and buy, buy, buy to get that elusive millionaire status.
To come full circle, the buying of real estate with little or no equity, and focusing too much on building your net worth using equity without careful attention to the liquidity of that equity, and especially your available cash reserves, is very dangerous and in many cases could lead to financial suicide. Step into real estate investing with your eyes wide open, get good advice and know the numbers well before jumping in, and learn all you can about liquidity and having proper financial reserves BEFORE you buy that first property.
See the following article for more insights: No
Equity, No Problem.
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Copyright © 2006 by Ron D. Pate. All rights reserved.