A Smart Purchase Will Eventually Result in the Best Sale

“You make your profit when you buy your house” is one of the many maxims in real estate and one of the smartest. Here are five ways to make money when you buy:

1. Buy the best house you can afford in the best location.

A few months ago, while attending a Realtors’ convention, I got into a conversation with a man who lives in the Minneapolis area, where I grew up and still own property.

When I named what I think is its best, affordable suburb, Edina, he told me that’s where he and his wife should have bought their home. Instead, they bought a less expensive house in a community with less desirable schools and a long commute.

Now he’s stuck because he figures that selling and buying a house in a better community would be too expensive. He added that, after about five years of homeownership, he would be lucky to sell his house for as much as he paid. Obviously, he bought in the wrong area.

Based on similar personal experiences, I’ve concluded it’s smart to buy a sound well-located house where most people want to live, even if it costs a little more than those in less expensive areas.

Top-quality school districts are usually the key indicator. Avoid areas with bad schools because they won’t attract families who value education, thus depressing home values. The higher the demand for homes in a community, the greater their potential for market value appreciation.

2. Avoid condos and townhouses.

These can be great places to live. I’ve owned several and still own one as a second home. But most condos and townhouses do not appreciate as rapidly in market value as comparable single-family houses.

The market demand for condos and townhouses is limited because most people want to own a house.

Also, when demand for condos and townhouses rises, builders can usually quickly supply that demand. When a local market for condos and townhouses becomes glutted, market values stagnate or fall.

3. Don’t buy a near-perfect house.

Most home buyers want to purchase a house in near-perfect condition so all they have to do is turn the key in the front door and move in. That’s the way to sell houses, but it’s not the way to buy houses if you want to make a profit.

If you buy a house in excellent condition, you will pay top price. However, if the local real estate market doesn’t continue to appreciate, you’ll lose on that house because of selling expenses if you have to sell within a few years.

Similarly, avoid buying the best house in the neighborhood because its marketability will be pulled down by less expensive nearby homes.

Instead, buy the worst house in a good neighborhood and fix it up. With the new $250,000 or $500,000 principal residence tax exemption of Internal Revenue Code 121, all you need to do is own and live in your home two of the five years before sale to claim up to $250,000 per owner resale tax exemption.

This tax law has created a new tax-free industry in “serial home sales.” Owners can buy fixer-uppers, upgrade them and sell them tax-free after two years of ownership and occupancy. Then they can buy and do it all again.

4. Buy wholesale, sell retail.

Another way to earn a real estate profit is to “buy wholesale, sell retail.” That means buying below market value, often because the property has a defect that most potential buyers don’t want to tackle. Then you can add value, such as by painting, cleaning, fixing and landscaping, to resell at a profit.

For example, I’ve bought foreclosure properties, both at foreclosure sales and from foreclosing lenders. A major advantage of buying from the foreclosing lender is excellent mortgage financing with a low down payment usually offered by the lender.

5. Buy with a low down payment.

Just in case you make a mistake and buy the wrong house or investment property, make as small a down payment as possible. (Don’t tell anyone, but I once bought a house with 20% down.) I much prefer buying with no money down, or 3%, 5% or 10% down because it creates leverage.

To illustrate, suppose you buy a $100,000 house with a $10,000 down payment and a $90,000 mortgage. If that house appreciates in market value just 5% (the current national average) in the next 12 months, that $5,000 increased value is a 50% “profit” on your $10,000 investment.

However, if you paid $100,000 cash for the same house, the $5,000 increased value is only a 5% return on your investment.

Robert J. Bruss is a syndicated columnist as well as a real estate investor, lawyer, broker and educator in the Bay Area.