Expert: Russel Ray - 6/9/2008

Question
Hello Russel. I am looking to get into commercial real estate as a private investor in the chicago area. I lack the money at the moment so I believe my best start would be residential investment homes of "flipping." I also lack knowledge so im having a hard time finding the path to my success. I also have less than perfect credit, It might or might not pose an extra wrinkle to iron out. I can find properties  but I would like to know the pros analiyze properties they intend to flip and how do beginners finance a project like this. Thank you for your time.

Answer
Hey, Earl.

First, for commercial real estate, it's far easier, with fewer headaches, to start in residential real estate.

Right now, though, the best way to get into property investing and flipping is not to. Instead, read everything you can for the next couple of years about property investing and flipping. There are several reasons why I say this:

First, and property investors used to take advantage of this: One of the standard, 30-year loan, low interest requirements is that one would live in the property. Of course, every property investor in the world said, "Oh, yeah. I'm going to live there." Well, that's loan fraud, and as the banks and mortgage companies discovered what we were doing, they clamped down by inserting a "pre-payment penalty" into the fine print. All of a sudden, we found out that when we sent to sell two months later, we had a "pre-payment penalty" of 10% of the loan amount, not the outstanding loan amount, the original, full loan amount. Ouch! That wiped away a significant part of one's profit.

Well, next, we found out that if we had virtually perfect credit, we could negotiate the removal of the "pre-payment penalty," but to do that, they inserted a penalty if the loan was re-financed or paid off, or the house was sold, within two years. Ouch again! No one wanted to hold on to a property for two years.

Then, all of a sudden, things became real easy. This is in the late 1980s to late 1990s, depending on which state you were in. People were financing their closing costs, or get cash back at closing, by agreeing with the seller to finance the house for a higher amount than what it was actually selling for. So the seller and buyer would agree that instead of a $100,000 loan for a $100,000 house, the buyer would get a $110,000 loan for a $110,000 house, all money paid to the seller, and then the seller would write the buyer a check for $10,000. That, of course, is also loan fraud.

However, no one cares about loan fraud when home prices are rising. No one cares about ability to repay the loan when home prices are rising. No one cares about documentation of buyer income when home prices are rising. No one cares about anything when home prices are rising. And therein lays the problem.

Now that home prices are plummeting, it's a totally different ballgame. Even the Feds are getting involved for Fannie May, Freddie Mac, and Vet loans because those are federal loans, so they involve federal loan fraud.

Banks and mortgage companies are back to making loans only to those with perfect credit, back to inserting all sorts of penalties into the loan documents, back to requiring income documentation and verification, back to not making loans to people buying in a complex where more than 50% of the owners are tenants, back to not making loans to people who own more than three properties already, etc.

For some strange reason, they are blaming everything on property investors and flippers rather than themselves for making such ridiculous loan terms. But this is America where no one wants to take responsibilities for their own actions; always try to blame someone else.

Nonetheless, I've been involved in real estate for 43 years. It cycles. Always has, always will. It will recover, but I don't know how long it will be.

Meanwhile, read, read, read.

Next, find yourself a property investing group in your neighborhood. Go to their monthly meetings, meet people, talk with people, etc. You might be able to find someone who's willing to take you on as a partner. In some cases, he'll put up the money, you put up the sweat equity and get some experience doing things yourself, and when he goes to sell, he splits the profits with you. That's probably the best way to get experience, see how it's done, etc.

If you need help finding a property investing group, email me directly at russelraypc@aol.com and I can find them for you.