In times of great appreciation, the phrase that comes to mind is, “All boats rise on an incoming tide.” For the past few years it has been hard to make a mistake when buying investment real estate. The success formula was easy… buy something… buy anything. Every property went up in value; it was just a matter of how fast and how far.

Boom markets make everyone look like financial Einsteins. Now that we are no longer experiencing a boom market, however, is it axiomatic that we can no longer profit from investing in real estate? It’s certain that we definitely cannot play spin-the-bottle investing any more, but we can make profits – strong profits in fact – profits as sizable as ever. We just have to think a little harder, be a little more patient, understand the market a little better, and appreciate our capacities, intentions, and idiosyncrasies a little better. Now that there is less room for error, experience can be a critical assist, too.

The question is, “How”? The following is not intended to be an exhaustive study of the subject, but perhaps we can stir-up some creative investment juices because now is certainly the time to buy. There are two basic reasons to leap into a sound investment, NOW. The first is that some sellers are nervous and overextended, either financially or psychologically. Lost is the brazen cockiness all owners had just a short time ago. It is certainly not universally true, but many owners are ready to deal for the first time in a decade. The second reason to buy now is financing. Who would have thought that adjustable loans are readily available with interest in the low fives? Serious cash flows can once again be developed.

If you’re considering a strategy of investing for retirement, the low interest rates are an opportunity not to be missed. Locking in a low interest rate mortgage will make you look like genius a few years from now. Not only will you appear to be of high intellect, you’ll have an abundance of extra cash to help you celebrate your timely decision. For instance, on a 30 year amortized, fixed-rate mortgage for $500,000, the difference between 6% and 8.5% interest over a five-year holding period is $50,809!

Let’s forget the premise that the way to make money in real estate is by “stealing” the property from a seller – buying an investment that is dramatically under its market value. Can this be done? Of course, it is, obviously, a possibility. But come now, how often in your lifetime have you gotten something for nothing?

Let’s make the realistic assumption that it is going to be up to us to develop a sound, profitable transaction. There is one basic method at our disposal: increasing the Net Operating Income (NOI). This is true because the value of a real estate investment is directly proportional to the income that the property generates. Investors buy return. The NOI is the residual income that a property produces after all expenses are paid. There are, fortunately, an infinite number of ways this may be accomplished. Let’s look at some possibilities.

As income and expenses are the two components of NOI, the NOI may be increased by either increasing the income or by decreasing the expenses. Simple. Not easy, but simple. The question then becomes two-fold: “How can I drive up the income and/or drive down expenses.”

Controlling expenses is the dry side of the equation. That’s why it is commonly overlooked. In fact, in good times it is routinely ignored. For most of us, it is just more fun to concentrate on creative ways to increase income. A wise practitioner, however, regularly examines each expense and searches for less expensive alternatives: Insurance? Get bids. Management? Research your opportunities. Utilities? Check your options. Taxes? Appeal your assessment.

Don’t be too quick to casually dismiss your options, either. For instance, one of my clients is researching geo-thermal heat and air conditioning for his retail building. If it proves to be cost effective not only will his costs go down but he will also be able to “sell” heat and air-conditioning to his tenants, thereby decreasing expenses while increasing income.

This brings us to the fun stuff, increasing income. The most common technique is to increase rents. Nothing wrong here, but after you have moved rents to their economic maximum, that is, to a point where even with increased vacancy costs you still attain a higher NOI, then what?

The principle is to give your tenants more and thereby create demand. The higher the perceived benefits, the more tenants are willing to pay. This is an area of boundless opportunities in itself. Physical improvements to their building may be made, vending machines may be installed, parking may be expanded, garages may be rented separately to others, space planning may be developed to create additional bedrooms. The beat goes on …

In early 2002, I sold an apartment building to a client who was able to increase the rentable space 33% with a modest capital expense. By increasing the building’s tenant capacity, he increased the income. By increasing the income, he increased the NOI. By increasing the NOI, he increased the building’s value. Now, eight months later, the building is under contract for a price that is 27% higher than the purchase price and, when it closes, will produce a net return of 105% on the capital invested!

Another way to make your property more valuable is to shift its use. I also sold a large boarding house to which the new owner will make some obvious improvements and lease the property to a single national user at a handsome increase in income and a dramatic decrease in management expense. Up goes the income, down go the expenses, up goes the NOI, and up goes the value.

A cousin strategy is more common -- change the use entirely. Often zoning changes can bring this about. As a general rule, the more dense the zoning, the higher is the value of the property. A common example would be the conversion of an old home on a major arterial into a property for retail or office use.

“No can do,” you say. “The regulators in our town are just too Boulderized. They won’t budge an inch if the project smacks of development (the dreaded “D” word).” Times change. When the dog days and dog nights of an economic downturn emerge, sacred government jobs are threatened. Surprise, cooperation! A common benefit of having a wolf at the door.

Another opportunity for profit not found in “good” times comes from a greatly increased number of sellers who are willing to carry financing to facilitate the sale of their property. Seller financing can increase leverage and by so doing, increase your return. By way of illustration, a recent client purchased a multi-family building with a 60% first loan at 6.25% and a 25% owner-carry second at 3%. This enabled them to acquire the investment with a blended rate of 5.35% and to only have a 15% capital investment. Lower interest payments translate, of course, to a higher cash flow.

In one way or another, good investment opportunities are most often the result of negligent management. It seems that top quality, attentive management exists in only 20%? of the market while 50% or so are various shades of mediocre and a good 30% are from careless to downright slipshod. In good times, the sheer force of the market often overcomes the problems of poor management practices, not so when the tenant population thins or for some other reason we dip into difficult financial times.

Not every poorly run property is an opportunity; some are over priced, some are too costly or too time consuming to tackle, some are just too far gone to resurrect. However, in the tangled thicket of investment properties suffering from management practices gone awry, there are some treasures. This can be a fertile field for the astute investor. More good news: These properties come in every size and shape, in every town and in every part of town, in every price range and in every condition, in every category and every market type.

The moral is to be a contrarian. Now that the media is filled with dire predictions, now that winter’s winds have stripped the landscape of its blossoms, now that people are retreating from financial exposure, now is the time to slide some money out from under your mattress and be a buyer. As Goethe said, “Whatever you can do, or dream you can, begin it. Boldness has genius, power and magic in it.” - MH