Besides the considerations of Part 1 in the previous post, price , tenants and condition, the investor has to investigate thoroughly before purchasing anything. In fact, the main job of the investor is not getting the money together, which, admittedly, can be very tough, or running around looking at various deals, which does takes time and shoe leather. No, the most important job for the investor is doing the due diligence.
We often hear that expression, “You’ve got to do your homework” or do the due diligence. For real estate, what does due diligence entail exactly? As might be expected with such a vague term, it’s complicated. To me, though, it can be simplified by dividing your due diligence into pre-purchase and during-purchase due diligence. Whatever happens, you don’t want your due diligence to happen post-purchase.
Location, Location, Location
Of course, that’s the most basic mantra of real estate and it certainly should be part of any investor’s pre-purchase due diligence. The location of the property will determine the rents and the quality of the tenants, so it is of utmost importance.
What is a desirable rental location?
Many would-be investors think that a newer building in their own suburb is an ideal investment. This may or may not be true. If the suburb is filled with homeowners, it’s likely that it’s not an ideal place for renters. Here are few questions to ask when considering location?
- where do most residents work?
- is public transportation handy?
- is there adequate parking?
- what is the area vacancy rate?
If most locals commute to the city, then renters will, too. That means most renters will seek housing closer to their work. Many renters do not have cars, so proximity to public transportation is a must. Whether tenants have cars or not, for most areas the building must have adequate parking. This means at least one space and preferably two per unit plus one or two extra for guests. Failing that, overnight street parking must be available. Make sure the vacancy rate is not above 5% as nothing costs a landlord more than vacancies, especially multiple vacancies.
Sometimes areas near a military base or adjacent to colleges and universities offer wonderful rental opportunities which are, nevertheless, different from “normal” rentals. Frequently, in such areas rentals are for six months or two semesters or a summer and then over and out. This might entail more work prepping the units more often, but the rents are actually higher. Usually, too, students and soldiers are not particularly fussy about their short-term digs.
Often, would-be investors start out looking for the “best” properties. That is usually a mistake. The best rental properties are usually in moderate to low-moderate areas which are not only more likely to attract renters, but which also offer what every investor should be seeking-immediate cash flow. Cash flow is the name of the game and more expensive properties in the best areas rarely offer it. Also, those moderate renters are more likely to stay put than the higher-paying renters with plenty of options. Remember: vacancies are a landlord’s bane.
Rental Property: Amazing Tax Benefits
These days we hear a lot about the tax havens and tax loopholes available to high-income taxpayers and corporations, but most ordinary people do not understand the amazing tax benefits offered by owning rental property. In most cases, a “taxable loss” accrues from the rental which can offset ordinary income and thus the federal income tax bite. Of course, most people’s eyes glaze over at this point, so I’m going to make this as painless as possible!
Tax Savings For Middle-Income Earners
Not everyone is going to save tax money on real estate investments. Most middle-income wage-earners, though, will. First, let’s be clear. It takes a certain type of person to be a landlord as indicated in a previous post. So, looking at owning property to save money on taxes is, how do you say, bass-ackwards.
First and foremost, purchase a rental property with the idea of making money. Look for a property which will give you income after all the expenses are eliminated. This is cash-flow. Assuming you have such a property, how does it happen that even cash-flow properties can save you money on your taxes?
Rental properties generally show a “taxable loss” for many years after the purchase. This is true because, as in any business, you have the income from the rents, but then you can deduct all your expenses to come up with your net operating income. Your expenses include repairs, utilities paid, labor costs, property management or any of a vast variety of other expenses. Once you have your net operating income, then you can deduct any mortgage interest paid to arrive at the net income.
Rental Tax Saver: Depreciation
Now, here comes the good part for rental property--depreciation. You also get to deduct 1/27.5 of the building’s cost from your net income. This figure becomes your taxable income or, in many cases, loss. This is how even a good, cash flowing property can manage to be a loss for tax purposes. It is also how an investment property can help reduce ordinary income because this “loss” is deducted from the owner’s wage income and can often substantially reduce income tax owed.
There is a hitch, naturally. If losses are over $25,000 and ordinary income is over $100,000, then the taxpayer may not be able to deduct the whole amount due to Passive Activity Loss Limitations. Still, the taxpayer does get all other ordinary deductions and may well substantially reduce the amount of tax owed. Owning real estate is one of the best tax strategies allowed by the current tax code. Anyone earning any kind of money really should consider investing in rental property, whether residential, multi-family or commercial.
Today’s real estate market offers amazing opportunities for anyone thinking about investing in real estate. Mortgage rates are incredibly low, values are lower than they have been in many years and rents have not dipped. Want to discuss rental property? Call me anytime.
Sounds awful, doesn’t it? Contrary to the frugal rules your parents taught you or maybe your grandparents. Well, the Great Depression was a long time ago and we’ve come a long way, baby. No more do trivial items like mortgage contracts bother us because, well, the other partner in the contract, the banks, are showing how little they care for us.
I’ve discussed loan mods ad nauseam in this blog. The fact is for most borrowers either the bank refuses to offer one for a variety of reasons [too much income, not enough income, current in payments] or the loan mod proffered after months of paper-pushing is too draconian for the homeowners who soon fall into arrears again.
What’s the solution?
As mentioned in a recent NY Times article, in practice passive resistance rules . Homeowners simply stop paying on their underwater mortgages. Now, living “rent-free”, they take whatever money they have and pay down bills, eke out an existence, put it away for the post- foreclosure rent deposit or do whatever they have to do to make ends meet.
What about the foreclosure?
Don’t the banks swoop down and grab the house throwing its occupants into the streets? That’s what most of us think of when we think foreclosure, but the simple fact is the banks are swamped. In fact, today, the average borrower in foreclosure has been delinquent for 438 days before actually being evicted, up from 251 days in January 2008, according to LPS Applied Analytics.
In my travels I’ve met plenty of homeowners who manage to stay in their homes rent free for months, even years. Not so long ago I talked to a man whose home in the Hollywood Hills had been in foreclosure for 24 months before the bank even threatened to evict him. He also had a guest house and had been collecting rent for the entire time. By law, his tenant was allowed to stay for another 60 to 90 days, though not rent-free.
More than 650,000 households had not paid in 18 months, LPS calculated earlier this year. With 19 percent of those homes, the lender had not even begun to take action to repossess the property — double the rate of a year earlier. In California, a non-judicial foreclosure state, the process can be fairly rapid, 3 months and 21 days from start to finish. That’s theoretically and legally possible, except, again, it rarely happens. In California, the average is now 415 days and lengthening every month. The reason is the overwhelming number of defaulting mortgages.
Even in short sales, the banks seem to be in no rush to consummate the transaction as borrowers forced to wait for 3 to 6 months have discovered. In the meantime, the homeowner lives rent free or collects rent from tenants Everyone lives in a kind of limbo knowing the ax will fall sometime and some would much rather just move out and get on with their lives and reconstructing their credit reports. For many, it may not be much, but it is some small revenge again the behemoth banks who took all that bailout money and turned a tidy profit while the nation’s homeowners bore the brunt. Yes, a small but satisfying revenge.
The new federal guidelines for short sales, called HAFA [Home Affordable Mortgage Alternative] came into being November, 2009 and just recently became operational. Most loan servicers and banks are now using HAFA.
What’s So Great About HAFA?
Really, what’s the big deal? Everybody knows short sales are tedious, take forever and are a last resort for the homeowner, right? Not exactly–HAFA does streamline the process, shorten the time periods and provide significant incentive s for both short sellers and their banks. In short, it’s a win-win for all parties.
If you’re a homeowner considering a short sale, then, it’s a fairly big deal, assuming that it works out as envisaged by the federal government. Home sellers can get up to $3000 in relocation money from the transaction. That’s very helpful to distressed homeowners who may want to rent and need to pay a deposit. And, another very big deal is that homeowners would be guaranteed from their banks to have no deficiency judgments. Coupled with the 2007 law foregoing any tax on defaulted income, that leaves short sellers really free and clear once they close escrow on their underwater properties.
What Do the Banks Get Out of HAFA?
We have to ask why would the banks want to do this? What’s in it for them? Here, too, are some very positive reasons. Banks prefer short sales over foreclosures because banks save about 20% on average by doing the short sale. This program simplifies the process, streamlines it, and allows the mortgage servicers $1500 to cover administrative costs with an additional $2000 to the investor who actually owns the loan. Banks do better with this program. Altogether, sellers, servicers and investors are collecting $6000 on each HAFA transaction. Not too shabby.
Now the Big One: Who is Eligible?
If your principal residence qualified for a loan mod under HAMP [Home Affordable Modification Program] and you can’t pay or have fallen behind you are eligible. If this is an investment property or rental, you are not eligible. If your loan is FHA or VA, you are not eligible. Both FHA and VA have their own short sale programs with different rules.
Having applied for the HAMP program is crucial. If you applied and were rejected, you are eligible. If you entered a trial period and fell by the wayside, you are eligible. If you received a permanent loan mod under HAMP and have missed at least two payments, you are eligible.
Let’s say, you discover you probably are not eligible for HAMP or HAFA, what should you do? Don’t worry. The servicer will still do a short sale; it will simply not be using the HAFA guidelines. We’ve been doing what seems like zillions of short sales for the past three years, so the process there has become more streamlined as well. If you need help or want to do a short sale, make sure to call me at 626-641-0346. I can even help if you are outside of California.
Oh-one last thing-if you are an investor who would like to purchase a HAFA short sale then flip it, you must wait for 90 days.
Here’s the National Association of Realtors’ video on the topic
Announced in November, 2009, new tax credits not only offer first-time buyers incentives to purchase a new home [up to $8,000], but all buyers, even those who already own homes. If you’re seeking to change your house and take advantage of low home prices and interest rates, now’s the time!
If you’ve owned your principal residence for 5 consecutive years of the last 8, you’re in. If you’re planning to live in your new home as your principal residence, you’re in. If you’re single, you can earn up to $125,000 adjusted gross income and still receive the full credit of $6500. For married folks, that’s $225,000 adjusted gross income. Singles earning $125,000 to $145,000 and marrieds $225,000 to $245,000 can still get incrementals of the tax credit.
What’s the Deal?
Your new home cannot cost more than $800,000. Beyond that, I guess the feds’ feeling is you can handle the costs yourself. And the credit is actually 10% of the purchase price up to a limit of $6500. Your purchase contract must be dated between November 7, 2009 and April 30, 2010. And, you must close on your deal no later than June 30th.
Notice: Your new home’s price has no relation to your previous home’s value. This tax credit is for move-up buyers, downsizing buyers and relocating buyers. The legislation has no provision regarding the price of the new home.
In case you were wondering, you are not required to sell your previous home. A detail announced by the IRS, however, states you are not eligible if you convert your previous home into a rental. It does seem, though, you could short sale your previous home and still purchase a new home with the federal tax credit using the special loan mentioned in a previous post. Another detail is that you must live in your new home for which you received the tax credit for 36 months or you might have to repay it.
What’s the Catch?
Really, there’s no catch. The federal government is trying to send some “stimulus” to the average taxpayer and to the moribund housing industry. As we know, the buyers’ tax credit was extended and this one for move-up buyers added, so there’s little likelihood that this will be extended again…
The main catch to this program is the same for any government program. It requires proper paperwork. Especially this time around, after many proven cases of out-and-out fraud in the buyers’ program, the IRS is determined to make sure all claims are valid.
So, here’s what you need: a copy of the HUD-1 settlement sheet from your new property. This gives the sales price and date of closing. You will need some evidence of the 5 consecutive years at the previous property–property tax, homeowners’ insurance or the like. And revised Form 5405 available at www.irs.gov.
That’s it. You’re in business. Now go get that property.
Southern California has become a kind of barometer for troubled home values. Unlike Nevada and Florida’s transient and part-time populations, in Southern California it’s actual home- and condo-owners who live on their properties full-time who are in trouble. Or, we have local investors who find their rental properties are no longer worth the trouble of keeping they are so far underwater. As mentioned in an earlier post, statewide, about 27% of homeowners are now underwater. With the unemployment rate at over 12% and rising, with even the state laying off workers, that percentage is most likely going to get worse.
Six counties make up Southern California. Here are the stories of the two extremes of the spectrum. On the one end is Orange County, richest of all the counties, full of gorgeous new homes and award-winning planned communities. On the other end is San Bernardino, the New Appalachia, where poverty is grinding and the marginal population is being pushed from the other, richer, surrounding counties. The contrast is stark.
Orange County shows that in some ways things are getting better for us. In Orange County, for instance, last month [June 2009] home values dropped only 8% over last year. That’s the slowest drop in a long time. The median price in Orange County is now $485,000. Some cities have held steady or even improved: Aliso Viejo held last year’s median value of $600,000; Anaheim Hills increased about 10% across its two ZIP codes to a median of $498,000  and $640,000 ; Fullerton in 92833 decreased less than 2% from last year to a median of $378,000; Fountain Valley also decreased 2% to a median $570,000. Two areas of Irvine increased in median value in 92303 up 5% to $690,000 and in 92616 up 4% to $662,000. Its other areas decreased around 15% to over $600,000 with pricey 92603 down 34% to a median of $920,000.
Laguna Hills rose 1% to a median of $629,000 while Laguna Beach lost 21% over last year to a median $1,265,000. Must be tough. This, of course, makes us wonder what is happening in the highest priced areas, Newport Beach and Newport Coast? Well, there were really too few sales to decide. What sales did take place were unmistakably downward in price, but it would be hard to get too much higher…Corona del Mar had 12 sales in the month showing a 40% slide from last year to $1,180,000. Seal Beach is now a median of $710,000 while Huntington Beach now has two areas with many sales bring its median to $587,000 [92646 down 5%], $522,000 [92647 down 3%], $695,000 [92649 down 21%] and $822,000 [92649 down 17%].
Orange County does have a few working class areas, such as Santa Ana which shows three areas actually down to a median of less than $300,000 [92701 to an incredible $213000, 92704 to $288,000, 92707 to $255,000]. Orange 92868 is down 10% to $318,000, though its other ZIPs are all closer to $500,000 and holding fairly firm. One area of Garden Grove and one area of Anaheim have medians of less than $300,000 [92844 to$298000 and 92805 to $272,000].
What does this mean? Orange County is the most affluent county in Southern California and its citizens have the most in reserves. Unemployment is less here, but the pain is being felt. As the recession grinds on and the unemployment rate rises, biting deeper into the ranks of middle- and upper-income workers, even here values tumble. In California the recession shows no signs of abating.
Other area counties are suffering terribly, especially San Bernardino, the hardest hit of all. Despite record losses in home values there from 2007 to 2008, home values countywide dropped another 40% in June 2009 over June 2008. The median home value in San Bernardino in now $135,000, almost unbelievable…
Outlying areas have been very hard hit. Twentynine Palms in down 45% to a median $80,000.Yucaipa and Yucca Valley are down 24 and 26% respectively to $215,000 and $100,000 median. The High Desert is a disaster area: Apple Valley is down over 50% to a median of around $88,000; Victorville is down 40% to a median of about $95,000. The good news there? Hundreds of homes are being sold…Sales are very brisk at these prices, so maybe the bottom is near. It must be. These prices are below replacement value, meaning we can’t build homes for these prices.
The City of San Bernardino itself has only one ZIP with a median value of over $100,000 and that is 92407 at $140,000, a drop of 31% over last year. The rest of the city has plunged in value nearly 50% to closer to $58,000 and, while some homes are being sold, sales are by no means brisk. This is the New Appalachia where SoCal poverty is concentrated and food stamps are common currency. This is where our charity dollars should be going.
More affluent areas, as always, are doing better, but still dropping. Upland has dropped 6% in 91784 to $471,000 median and to $259,000 in 91786, down 13%. Rancho Cucamonga has dropped over 25% in all areas to a median now of around $300,000 and in 91739 almost $400,000. But, the housing stock here is mainly new and high quality. This is a tremendous dip. Rialto is down 32% to $198,000. Colton is down 42% to $110,000. Chino Hills, also with newer housing stock, has dropped only 6% to a median $298,000, again undeard of… Ontario’s hightest median value is $235,000, down almost 30% over last year. Fontana is down around 35% to $122,000 in 92335, to $185000 in 92337 and down 18% to $260,000 in 92336. Again, in Fontana hundreds of homes are being sold, many below replacement value.
Really, there’s no good news in San Bernardino County.
The program rolled out amidst much fanfare in March from the Obama administration, Home Affordable Refinance Program [HARP], was a major dud as far as California was concerned…The reason? As explained in this post at the time, instead of the typical 80% loan to value [LTV] for a refi, it offered government help for up to 105% LTV. Some places, even many places in the country, that’s a big help, but not here. We are too far underwater.
So, it was good to hear the other day that Obamanites have figured this out finally–the program has been pretty much a bust–and changed the rules so that now the government will help for up to 125% LTV. This means you can refinance if say your home is worth $300,000 right now, but you owe $375,000 and you’re paying 8% on an adjustable If you’re eligible, you could get that refi at the new, lower rates, maybe in 5.5% on a 30-year fixed.
Who is eligible? First, your loan must be owned by Fannie Mae or Freddie Mac. To find out if your is, check the Fannie Loan Look-up or the Freddie Loan Look-Up. Good so far? Well, now it comes to you and your house. You must have a job or at least income sufficient to take on such a loan. This is becoming more difficult when L.A. County’s unemployment rate is 12.6% as of May. And, then, your home must be worth that $375,000 you think it is. Talk to a reputable lender and s/he can figure all this out for you in minutes over the phone.Call me at 626-641-0346 for a referral.
Don’t delay. Property values are still sinking. Next month might be too late.
Some will question whether this applies to rental property as well…I believe it does, as the previous loan limit of 105% LTV did. Small investors need help right now. Rents are not covering costs and the big initial down payment that many investors made to get their loans have disappeared as the value of the homes has sunk.
And, last, of course, you still owe $375,000 and you’re paying on $75,000 that isn’t there. If you have a financial turn of mind, you will see that doesn’t make a lot of sense. So far, we haven’t seen too much relief for that problem. Maybe down the road…
It’s no secret that plunging home prices still make home-buying out of reach for many. The reason? Lenders have become tough and tougher. It’s the old shutting the barn door after the horse has run out gambit. Lenders were so profligate with their money before that now in reaction they’ve become regular Scrooges. Today, many of the best deals, the REOs and properly-priced properties, go to those with 20%, 30% or more down payments and A+ credit. Gone are the no-money-down loans, the no-PMI second mortgages and the no documented income loans…Gone, gone, gone.
So, what to do if your credit isn’t quite good enough right now? Or, you want to buy now, but haven’t yet gotten that down payment together? One possible scenario is to bring back the lease-option contract, fallen out of favor lo these many years of booming home prices.
What, exactly, is a lease-option? A lease-option is a legal contract between buyer and seller in which the buyer agrees to rent for a specified period of time at a specific rent and has the option to purchase the home at a specified time in the future at a pre-determined price. The details can vary wildly…
Often, the buyer/renter pays an “option fee” up-front, sometimes pays more than market rent for the property, both predicated on the seller agreeing to apply part or all of the option fee and the extra rent to an eventual down-payment on the property. So, if I want to purchase a $300,000 home, I might pay $5000 in option fee to the seller and $2500 a month in rent, instead of $2000, applying the extra rent and half, say, of the option fee to the down-payment. At the end of a year, I’d have $8500 or a good chunk of my down-payment. If, at the end of that year, I wanted to exercise the contract, I’d buy the house. If not, then I’d forfeit the option money and the extra rent.
Bear in mind that the details of the agreement are totally up to the buyer/renter and seller/landlord. The contract could say the buyer gets to apply the whole $5000 or the rent is $2300 with $500 applied or the period is 18 months or the purchase price is $320,000 or whatever the two parties can negotiate between themselves.
The good part about this is that sellers get up-front money for their rental properties with a good chance at selling in the future at a fair price to a qualified buyer. They also get a renter who is more likely to take good care of his property. Renters get to become buyers over time instead of all at once. They get to know the property intimately before buying it outright. As always, renters get to walk if the deal no longer appeals to them. And, sellers get to keep their option money or part of it, depending on the agreement, if they do.
But, there are a few downsides. Buyers must beware as sellers still control the property and may take out more loans or have liens placed as a consequence of court judgments, or, may have already done so. Potential renter/buyers should protect themselves by checking with a title company or a real estate lawyer. Buyer/renters should also make their interest in the property public by recording their legal contract with the County Recorder. That way, everyone is aware of the contract.
This type of agreement is potentially a great deal, especially for the buyer/renter. The seller is locked in for the duration, but the buyer/renter can continue to look at other properties and can always decide to buy another property when the time comes.