Dealing with properties that have a permanent functional obsolescence can be purchased at a discount, but usually need to be sold at a discount as well.
In this episode, Charles discusses buying permanently discounted properties correctly, without treating them like normal neighborhood comparables.
Charles:
Buying at a discount doesn’t always mean you’re making money, and what if buying a property at a discount is actually a bad deal? Welcome to Strategy Saturday! I’m Charles Carillo, and today we’re breaking down the truth about buying at a discount… and why selling at a discount might already be built into your deal.
New Speaker:
Let’s get started. I was speaking with a new real estate investor recently, and they were telling me about a three-unit property they were looking at buying. The property was selling at a discount and had been on the market for a few months. They couldn’t tell me why they thought the property hadn’t already been sold, given that it was listed at a discount compared to other recent sales nearby in the city. They sent me the financials and the address, and after a few minutes on Google Maps, I realized what I might have thought the reason might have been.
Charles:
It was surrounded by several industrial buildings, almost in the middle of an industrial park. And when you looked at the broker’s comps, they were somewhat nearby, but this was really one of only a few residential properties within a half mile to a mile. Yes, the property was listed at a discount, but that is because the property has a permanent valuation penalty. As a previous mentor of mine would say, it will be hard to rent that property at market rents, and it was also apparent that selling it, even at a discount, would be even harder.
Charles:
There is an entry discount as you buy the property below market value because of the defect, and then there are operational impacts. These are gonna be lower rents versus comparable properties, reduced tenant demand, and long vacancies. Usually higher concessions are required to get people into the property. When you sell, the new buyer receives the same discount, if not greater. The end result, the discount often is canceled out unless you can create additional value. Number one is external obsolescence, which is unfixable. Overhead, high voltage power lines, noisy, nearby highways, railways are located on an extremely busy street, property surrounded by an industrial park or next to a gas station, next to a public utility, a power plant, or sewage treatment plant. Number two is functional obsolescence. It’s a design issue. Design flaws are internal and might be fixable, but are usually extremely expensive and cost prohibitive to do so.
Charles:
So poor floor plans, walking through another bedroom to get to a bathroom, low ceilings, no parking, no room to add a parking lot.
Charles:
The biggest is that you do not notice it. If you cannot recognize the issue before purchasing, you will find yourself in a tough situation, non-liquid. You cannot sell the property in a bad market since buyers usually have many options. In good markets, you might find a buyer willing to settle. The yield is higher. You can purchase a property at a 25% discount and rent it at a 10% discount. You’ve achieved a higher ROI. The unfixable issue is being fixed and few people know about it. So the overhead, high voltage power lines are being buried. A new road is being planned to divert a large amount of traffic from the busy road. The vacant industrial properties are being converted to offices and residential units. Some of the vacant properties are being leveled for a new supermarket and strip center. You don’t care. You don’t plan on selling the property for decades and the exit discount doesn’t matter to you.
Charles:
In many of these situations, you cannot control anything. And you are kind of gambling because of a development can be green lit by the government, the administration changes, and the whole project is stopped cold. Properties with unfixable issues may present an opportunity. However, investors cannot renovate their way out of a poor location. If you purchase a property with a permanent issue, your profit must come from the cashflow. And you must be aware that you most likely cannot sell the property in a down or stagnant parts of the market cycles since it will probably be one of the last properties to sell in a recession unless you offer an even bigger discount than what you purchased it for. Hope you enjoyed. Please remember to rate reviews, subscribe, submit comments and potential show topics at globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our mentoring programs at syndicationsuperstars.com.
Charles:
That is syndicationsuperstars.com. Look forward to another episode next week. See you then.
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