Acquisition Strategy: Dollar Cost Averaging

What is so interesting about real estate investing is that you can take techniques from other forms of investing and apply them, usually more profitably, to acquiring investment real estate. With that being said, dollar cost averaging is generally applied to the stock market, as defined below:

Dollar Cost Averaging: is an investing technique intended to reduce exposure to risk associated with making a single large purchase. The idea is simple: spend a fixed dollar amount at regular intervals (e.g., monthly) on a particular investment or portfolio/part of a portfolio, regardless of the share price. The premise of dollar cost averaging is that the investor wants to guard against the risk that the market may lose value shortly after making his investment.

Putting it into simpler terms, when you are buying stock in a company, if it doesn’t increase(suppose it decreases in value), then you average the cost of your dollars by purchasing more stock at the lower price. The theory is, if you have done your research on the company’s fundamentals, then you should have no problem buying at lower price, and should actually see it as bargain shopping. You get more of the stock you wanted, and paid a lower price.

Of course, that works if the stock price then proceeds to go back up. But, what if it goes down? Then, you feel like you made a bad mistake. “I never should have bought that stupid stock”, you say. “Now I have lost my money.”

So you sell. Then, 2 years later, the stock quadruples.

Fantasy? An extreme example, you say?

Perhaps. But take this scenario, and apply it to residential real estate. What if you could buy bargains, but they paid you valuable monthly dividends, giving you massive returns on your investment, and realizing 3x – 5x what you paid for them, over time, through historical appreciation?

This scenario is happening, right now, in Memphis. The house prices are actually falling a little. Yet, investors all over the country are running scared and hoarding cash. “Things are too scary”, they say. “Let’s hang on to cash”. And, credit seems to be getting a little tighter(can you say credit crisis?) So, why would an investor even consider, in this volatile environment, purchasing investment property?

Dollar cost averaging.

The prices in Memphis are dropping right now. Why? Is it because the properties are no longer sustaining their values? Not at all. Prices are falling in Memphis because the amount of foreclosures negatively skew the comparables and make it look like no houses are retaining their value. Often, when you discard the foreclosures, what you find is that recent normal sales are still strong – and that is very positive news.

Now, some readers of this will say “well, it doesn’t matter, appraisers can’t necessarily just ignore foreclosure comparables,” and that of course is true. But, it is also true that appraisers offer an opinion of what a property is worth, but the insurance professional has to furnish a number that is much more important: replacement cost.

Replacement cost is the total cost of reconstructing a home that has been destroyed. All insurance policies have to include the replacement cost, at least in their estimate – homeowners ultimately decide what they will insure a home for, but one thing is for certain: the replacement cost dictates what the actual cost is to furnish a replica of the home, including labor, and especially, materials.

With the skyrockerting cost of commodity prices today, real estate investors are given a pretty good tip about the fact that home prices in areas such as Memphis cannot realistically stay this low forever. The falling/depreciating dollar, coupled with rising commodity prices, clearly point to home values increasing in value, even if we see a short term decrease in prices. Naturally, at The Feol – Hinricher Companies, we advise investors to consider residential real investments for the long term. But, with that being said, even the intermediate term holds great promise if you do the following things:

1) Buy your properties correctly, with careful attention being paid to location, appraised value, amount of work needed.

2) Focus on purchasing properties as cheaply as possible. Often, you can buy two properties today for what you could have bought one for 2 years ago, and contrary to popular belief that is actually a good thing.

3) Look to construct a viable portfolio – don’t try and ‘dabble’ in the Memphis market by purchasing a single investment home and then letting it ‘work out.’

4) Use a team that is reliable and that you can trust. There are merits to using a company that offers a host of ’in – house’ services, such as overseeing renovations and providing property management. While this can, depending on the integrity of the vendor, be a workable solution, at The Feol – Hinricher Companies we believe that a jack of all trades is, generally, a master of none. We try to leave all of these things to experts in their respective fields. Either way you go, make sure you have the relationships in place to make a purchase and have peace of mind and an action plan if something goes awry.

Dollar cost averaging is an interesting concept, but the concept of timing is perhaps even more critical. For example, everywhere in the world right now(at the time of this writing), gold supplies are dwindling, to the point where Mints around the world are no longer making certain types of gold coins, yet the prices of gold keep falling. From a free market perspective, this makes no sense, but we know that the value of gold relative to the number of dollars in circulation(essentially, an undisclosed number since the discontinuation of the M3 report, reporting newly printed US Dollars in circulation) would be in the thousands of dollars per ounce – yet gold’s price today is about to drop below $800/oz. So, nobody really cares and points to the crazy markets, but bargain hunters who understand that, at some point, there has to be a correction in the market to commodity prices, are snatching up available gold(hard to come by), knowing that free market economic laws, while suppressed and manipulated by various financial/government institutions, will come calling some day. Memphis homes are identical in this way – there exists an incredible and robust opportunity for people who are willing to look, beyond the crowd, and take advantage of investment opportunities that make sense. The timing of the market and the price points make purchasing and constructing a portfolio in Memphis a logical and sound decision, nothing more, and nothing less.

The next time that you are considering making some investments, stretch the purchasing power of your dollar further – look to acquire assets as cheaply as possible, and capitalize on a robust rental pool to make some substantial gains.

Tags: appraised value, dollar cost averaging, investing with a team, replacement cost