Buying Existing Loans

 

Last week, I shared information about hard-money loans, which are loans that often work when conventional loans won’t. This week, I’ll talk about buying and selling notes secured by real estate, a close cousin to real estate-backed, hard-money loans.

If you sold a property and carried the financing, you are now the proud owner of a note secured by a deed of trust. The note outlines the terms of the obligation, including length, monthly payments, interest rate, and when any associated balloon payment(s) will come due, among other things. (A balloon payment is a payment that amounts to more than double the value of a regular payment, and is usually planned as the final payoff at the end of the loan.)

The main job of the deed of trust is to tie the specific loan to the real estate that secures it. In a seller carry-back situation, the real estate is normally the property you sold. When you sold the property and carried the financing, there may have been good reasons to do so: a higher sales price, a faster sale, a better return on investment than was available from other investment sources; or maybe the sale could not have happened at all without seller financing. Now, however, things have changed. Your princess may be about to graduate from high school and hoping to go to college, or perhaps you want to remodel your home or take advantage of an exciting investment opportunity.

Whatever the reason, you’re currently in a position of needing cash. Happily for you, that note secured by a deed of trust is a negotiable instrument. That means you can sell it.

Depending on a number of factors, you will usually get something less than the outstanding balance owed. If the financing you provided was at a low rate or had an especially long term, the note’s sales price will almost certainly be less than the outstanding balance. If the loan-to-value (LTV) ratio is high—calculated by dividing the total loan amount by the value of the property—you can also expect to sell the note for less than the outstanding balance. Still, cash in your hands may be worth more than the value of the note.

If you choose to sell the note, these transactions are typically handled by a licensed broker who charges a commission for arranging the sale. Like a real estate transaction, it should be handled in a professional manner, making sure all escrow instructions are carefully drafted and followed, and title insurance is secured.

As a buyer of this note, you should have your broker verify that the value of the property supports the loan, and that fire insurance and property taxes are accounted for. And most importantly, confirm that the seller does, in fact, own the note—and that there are no liens that might encumber the note. Your broker can also provide a financial analysis to let you know what the rate of return will yield if all the payments are made in a timely manner (including any balloon payments).

When the dust settles, the sale of an existing loan can be a reasonable source of cash for the seller and an attractive investment option for the note’s buyer.

If you have questions about real estate investment, sales or property management, please contact me at rselzer@selzerrealty.com or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com.

Dick Selzer is a real estate broker who has been in the business for more than 40 years.

 

 

Real Estate Investing in Your 20’s and 30’s

Each week I ask for recommendations for column topics, and this week I received an excellent suggestion from Realty World agent and Ukiah’s rookie agent of the year Tanya Gilmore, who wants to help people of her generation think ahead and make wise investments. She rightly pointed out that many people are waiting until their mid-30’s to have children. This means hard-working people in their 20’s and early 30’s have an opportunity to save some money and invest. Depending on their financial goals, real estate could be a great option.

Before I go any further, I need to point out that all investing comes with a tradeoff between risk and return: the higher the potential return, the more risky the investment (“return” refers to the money you make). Also, real estate investing is a long-term endeavor. It can lead to significant financial benefits, but it is by no means the get-rich-quick option. A word of advice: be suspicious of anyone who offers you a get-rich-quick option.

For a first-time investor who is young and willing to live in a multi-unit housing situation, I’d recommend buying a duplex, triplex or four-plex. Loans for owner-occupied residences generally come with better terms (lower down payments and interest rates, for example), and a four-plex is more likely to provide positive cash flow than a single-family home.

Investing in real estate provides several benefits. Virtually all the money you spend repairing an investment property is tax deductible. That means the IRS reduces your overall income by the amount you spend repairing your investment property, then calculates the taxes you owe on that number. Translation? You pay less in taxes. In addition, depreciation is deducted from your earnings, which means even more money in your pocket.

If you’ve chosen the right investment property, you are also building equity (ownership) over time, and your tenants are helping you do that because their rent payments help you cover upkeep, management, and mortgage payments.

So how much do you need? Let’s say a four-plex sells for $500,000. With an FHA loan, you could qualify for a low down payment if you live in one of the units. Your down payment would be approximately $17,500 for a 30-year, fixed-rate loan. You’ll need a good credit rating (a FICO score of 680 or higher) and proof of income, so the bank knows you can cover the mortgage and other costs. Your monthly payments will be under $3,000.

If we’re talking about 2-bedroom, 1.5-bath units, you can charge $1050 per month for each of the three units you’re not living in: that’s $3150 per month in income. When calculating expenses, I add 40 percent of the income to the monthly payment figure because, having owned investment properties for decades, I know I will need that much to cover management fees, as well as expected (and unexpected) maintenance and repairs. So you’ll need approximately $4500 per month including expenses, which means your monthly “rent” would be $1400.

If you have cash for the down payment and a 3-month cushion for mortgage payments, insurance and expenses, you have enough to buy this property. As rents increase over time, your payments will decrease. And you don’t have to occupy the unit forever. If you live there for a few years and then move, you will have met the owner-occupied terms of most loans.

Because transaction costs are high, you typically want to buy a property and keep it for at least 3-5 years, depending on the housing market. Do not buy a property if you need its value to rise quickly. Instead, build equity in the property you buy, and then down the road consider refinancing and pulling some of your equity out to put a down payment on another investment property.

If you have questions, please contact me at rselzer@selzerrealty.com or visit www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 40 years.

Maximize Your Investing With a Line of Credit

Whether you’re investing in real estate, the stock market, mutual funds or loans backed by real estate, you want your money working for you, maximizing your overall financial health. If you’re an investor, at the very least your goal is to find an investment with a rate of return higher than the bank would pay on a Certificate of Deposit (CD) or the U.S. government would pay on a Treasury bill—not too hard considering that the going rate for a CD is less than one percent and T-bills pay about two percent.

In their defense, both CDs and T-bills are extremely safe—a haven for the risk-averse. However, both require you to tie up your money for long periods of time, and at the rates noted above, you won’t even keep up with inflation (which is running at about three percent). Just to be clear, this means you are actually losing money, especially when you factor in paying taxes on those interest “earnings” because inflation is not tax-deductible.

So you want to make sure your hard-earned savings are working as hard as you do. Having said that, you also want to make sure that if an emergency arose, you’d have access to your cash to cover the unexpected. Fortunately, there’s a way to have your cake and eat it, too. By establishing a line of credit, you can tie up virtually all of your savings in profitable ventures and still have access to cash should the unexpected befall you.

Let’s say you have $50,000 in a bank account paying less than one percent. By having a line of credit, even one that charges six or seven percent, you can invest the $50,000 and—even if your investment only pays five percent—still come out ahead because you haven’t tapped the line of credit.

The line of credit acts solely as a security blanket in the unlikely event that you need funds on very short notice. This allows you to keep all of your assets working for you all of the time. And if you need to tap into the line of credit, you can use liquidation proceeds or cash flow to pay down or pay off the line of credit in a timely and orderly fashion.

Depending on your overall financial picture, the rate on your line of credit will vary from three-and-a-half percent on up. The things that influence the cost are what security you put up, your credit rating and your ability to make timely payments on your debts. By the way, even credit cards at an exorbitant rate could provide backup if you need quick cash, but you need to investigate because some are affordable; others are outrageous. Many will offer “teaser” rates as low as zero percent for a short term, so as always, read the fine print.

On the topic of credit cards, shop for them! Virtually all credit card companies today want your business and are literally willing to pay you for it. Most credit cards give you a one-percent rebate, and many provide other perks. For example, some credit cards offer a five-percent rebate that you accumulate over time and can apply to the purchase of a new General Motors vehicle. Others allow you to accumulate miles to travel around the world. Still others have a particular focus like hotels and/or restaurants, giving you a five-percent rebate on those purchases and a one-percent rebate on other purchases. Look at your spending patterns and shop around. Between Visa, MasterCard, American Express, and Discover, you’re sure to find one that rewards your spending habits.

If you have questions about real estate or property management, feel free to contact me at rselzer@selzerrealty.com or visit our website at www.realtyworldselzer.com. If I use your suggestion in a column, I’ll send you’re a $5.00 gift card to Schat’s Bakery. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.

Why Invest in Real Estate?

If you are in the fortunate position of having a little money to invest, or if you are just curious about investing, here’s a bit on real estate as an investment. Before I get started, I’ll remind you that I am neither a financial advisor nor a tax professional. I am not advising any action; rather I am sharing my opinion and my rationale when I invest. This should not be your only education on investing before you go out to buy that 67-unit apartment complex. Take the time to learn about the pros and cons in more detail before you put up Junior’s college fund or your retirement.

Compared to other investment options with similar risk, real estate offers some excellent advantages. Real estate provides cash flow based on rent, and a tax shelter from depreciation. (A quick definition of depreciation is a measure of how much of an asset’s value has aged or has been used up.)

If you are the type to do your own improvements, maintenance, and repairs, you can spend relatively little to increase the market value of your investment property and/or the amount you can charge for rent. Even if you don’t do your own repairs, as long as you keep the investment property in good condition, real estate generally increases in value over time.

When I evaluate an investment property, I expect rents and market value to go up at about the same rate as inflation over the long term; bear in mind that real estate isn’t like trading stocks. Real estate comes with high transactions costs: you won’t find a broker willing to handle a real estate transaction for $39.95 and it also doesn’t happen this afternoon.

When I’m on the purchasing side of a transaction, I generally assume the transactions costs will be about two percent of the purchase price (i.e., loan fees, escrow fees, title insurance, and closing costs). If I’m on the selling side of the transaction, I expect to pay closer to seven percent of the sales price (i.e., brokerage fees and closing costs).

However, even with high transaction costs, I think real estate is a great investment. Once I own a property, I can leverage it (borrow a large percent of the purchase price). Rental income should be sufficient to cover the loan payments and other expenses including taxes, insurance, maintenance, utilities, and management fees. Depending on the property type, with a 20-30 percent down payment, you should be able to at least break even with cash flow.

Then, since depreciation is based on the   purchase price of “improvements” (a real estate term that refers to everything except the land for a given property, so I’m talking about any structures, paving, etc.), you should have a tax loss of about two percent of the purchase price. That taxable loss creates a tax savings that will probably provide at least a four percent after-tax positive cash flow. To put that another way: usually you have to spend money to reduce your taxable income, right? So, with real estate, you don’t have to spend money to reduce your taxable income because depreciation does it for you. No cash outlay, but reduced tax burden. Win/Win.

If you went to the bank and purchased a Certificate of Deposit (CD), your return would likely be a tiny percent of the same money invested for the same period in real estate. However, unlike the CD, the real estate investment provides you with no guarantees. We’re talking about the risk/return tradeoff: the higher the risk, the greater the potential return. There’s also a risk to not investing: the opportunity cost of giving up the potential income.

When it comes to investing, you have to think about lots of factors. Is this a short-term or long-term investment? If you need this money for Junior’s college fund next year, I wouldn’t invest in real estate. Real estate is not a “liquid” investment (you can’t turn it into cash easily).

If you are interested in a long-term investment and real estate appeals to you, talk to your financial advisor and/or tax professional. Every property is unique. Every transaction is unique, and every person’s financial situation is unique. Two investment opportunities that appear similar may have different financial structures, tax structures, maintenance requirements, risk factors, and more. Be a careful shopper.

If you’re interested in acquiring a list of potential investment properties, call your realtor. Trust me, your realtor will be happy to help you.

Next time I’ll write about 1031 Exchanges. If there’s something you would like me to write about or if you have questions about real estate or property management, feel free to contact me at rselzer@selzerrealty.com or visit our website at www.realtyworldselzer.com. If you’d like to read previous articles, visit my blog at www.richardselzer.com. Dick Selzer is a real estate broker who has been in the business for more than 35 years.

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