Currently, almost every media comment concerning real estate refers to the word bubble. By inference, this indicates a collapse of real estate value that is out of the buyer’s control. Well, the facts are that most collapses of real estate value are the fault of the buyer. Avoiding loss of real estate value is what this Blog’s first article is all about.

“Three strikes and you’re out” is a popular phrase that has been applied to criminal activity. It means enough! No more! It’s over! There’s no future in this type of behavior!

The phrase “three strikes and you’re out” has a similar meaning for some aspects of real estate investing and lending. When this phrase is applied to ending a criminal’s career, it refers to a criminal who is convicted of breaking the law three times. The three strikes in real estate investing and lending are (1) negative spread, (2) negative debt service coverage, and (3) negative cash flow.
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There are two certainties with lenders: They incur a cost to the money that they lend, and they are in the business of making a profit. Their offset to lending at below market rates could be in the fees, penalties or new rates that they charge. Most of the time below market rates translate into negative amortization. That is when the difference between the below market rate and the market rate is added to your principle. The result is the amount of money you owe goes up, not down. The lender will also probably increase your rate in the future. If you think you can refinance out before the lender increases the rate, be prepared for a hefty prepayment penalty. In other words, there are no free lunches.

Managed correctly, a variable rate can be a useful tool. However, the lower monthly cost of debt service should not be the sole criteria for choosing a variable rate. Buying income property comes with expectations and demands: Investing in capital improvements, reducing expenses, raising rents and selling the property. These expectations should not conflict with the index used to determine interest rate increases, or the terms of rate adjustments.