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The Benefits of Real Estate Investing

A few years back, I wrote some columns on real estate investing. Since then, I’ve been asked about the tax benefits and other upsides of owning income properties, so here’s a bit more information.

If you are a business owner interested in owning your own office building, a property manager who wants to own your own apartment building, or simply an investor interested in commercial property, one of the ways to maximize tax benefits in real estate during the first few years you own the property is to have a cost segregation study done.

Without a cost segregation study, improvements to your property depreciate over a fixed amount of time. (“Improvements” include things like buildings and other structures that add value to the raw land.) Each year a little bit of the value is considered an expense or a “write-off” for tax purposes. At the end of 27.5 years, residential property is considered fully depreciated. At the end of 39 years, commercial property is considered fully depreciated.

If you have a segregation study done, however, you’ll get an itemized list of how long various parts of your investment will last, and therefore, how quickly you can depreciate them. The segregation study will consider the value and longevity of things like HVAC systems, interior and exterior paint, carpet and other flooring, asphalt and paving, roofing, and more.

I’ve yet to find an air conditioning unit that lasts 39 years, and still meets quality and safety standards. And unless you require employees to take off their shoes when they enter the building, carpet probably won’t last that long, either.

The segregation study allows you to front-load depreciation, increasing the tax benefits of your real estate investment in the early years. The studies can cost several thousand dollars, but if you can pay for them in the first year with tax savings, they’re worth it. Generally, this is only the case for four-plexes and apartment buildings on the residential side. The savings on single-family homes and duplexes are generally too small to justify the cost of the study.

However, if you’re just getting started with real estate investing and you want to start with a single-family home, there are still plenty of tax benefits and financial upsides.

Lower priced properties typically have a better rent-to-price ratio. A $200,000 home will probably rent for $1,200 per month, while a $750,000 home will likely rent for $3000 per month. In addition to a better rent (income)-to-price ratio, you’ll probably have shorter vacancies with a less expensive property. More people are in the market for a $1200 per month property than for a $3,000 per month property.

A $200,000 rental property in good condition shouldn’t be too burdensome to manage or maintain, and with $150-200 per month in depreciation, has about a break-even cash flow. You invested $45,000 (a 20 percent down payment plus $5,000 in closing costs), and your benefit is the potential appreciation in the value of this property. If values rise at three percent a year, that equates to $6,000 per year on a $200,000 house—that means you made $6,000 on a $45,000 investment or a 15 percent return. This is called leverage. Compared to other investment options, real estate looks pretty darn good!

In addition to the increased property value, over time rents will also increase. And while expenses go up with inflation, mortgage payment (your biggest expense) won’t go up over time. The bottom line is, if you can afford to buy a $200,000 rental today, by the time junior heads to college in 10-15 years, you should have an asset capable of paying for much of his education.

If you have questions about real estate or property management, contact me at rselzer@selzerrealty.com or visit 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 40 years.

 

 

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.

Wells and Water

Believe it or not, when you turn on the tap at home, water doesn’t just magically appear. It depends on a well somewhere, whether it’s a well on your property, a private water district, or at a municipal site. Almost all the water we use comes from wells.

For this article, I’m going to talk about wells on your property. The first thing to know is where to drill, and there are two basic schools of thought on this: either use a geologist and experienced well driller or find a water witch (also called a dowser). A geologist and well driller will review soil types, terrain, history of successful wells in the area, and plant life. And while no single one of these (or set combination) will guarantee you won’t find a dusty hole, their input is incredibly valuable. A dowser, on the other hand, will inspect a property while holding a branch or copper rods to divine the most likely spot for water. (I’d put my money on option one, but that’s just me.)

As you think about where to sink a well, consider where your septic system is (and its leach field—you don’t want to be nearby, especially on the downhill side). You should also consider the ease of getting well-drilling equipment in and water back to your house. Ideally, you want a location uphill from your home with sufficient quantity to allow gravity feeding, eliminating the need for a pressure tank.

Once your realtor has recommended a good well driller, it’s time for the expensive part. The well driller will haul his equipment to your property and put a hole in the ground starting with about a four-inch diameter. Once he’s past the surface water (at about 30 feet), you’ll want to him to find water quickly. The sooner he finds water, the less expensive this will be because he’ll have less drilling and casing to do. To create the well, the well driller will drop a pipe into the ground called a casing. The pipe is full of holes and is surrounded by gravel, and that’s how the water gets in. Then you will have to seal the well to prevent surface water from contaminating your well water.

Next, the well driller will install a pump and measure how much water the well can deliver. While everyone would love 15-20 gallons per minute, people usually hear, “Well, you’ve got about a half-a-gallon a minute.” While that might not be enough for a household with six kids, half-a-gallon a minute is fine for a typical family of four for regular domestic use. You may not have an impressive vegetable garden and lush lawn, but you’ll be able to make coffee in the morning and brush your teeth at night.

Depending on the productivity of the well, you will want a holding tank to give you a little cushion. The well will pump water into the holding tank automatically on a 24-hour cycle—pulling water out of the well, waiting for the water to recover, and pulling it out again until the holding tank is full. When it comes to water, you want both quantity and quality (water must be potable). The two types of contamination are bacterial and chemical. Bacteria can be removed with chemicals, ozone treatment, or ultraviolet treatment. Chemical contamination can be addressed with filters and sometimes a chemical treatment. High iron content leaves nasty orange stains on sinks and toilets, and boron—while not harmful to people—is a death sentence to plants (and extremely hard to get rid of).  So, before you spend a bunch of money sinking a well and building the infrastructure it requires, be sure you have sufficient quantity and quality.

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.