What Is The Best Investment Property? Part 2

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.

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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.

cash-flow

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.

Is The Housing Crisis Over and Out?

Housing Is On The Upswing

The Good News

The worst of housing times may be slowly working its way into a dim memory as home buyers are returning to the marketplace. The national housing stats are suggesting that the terrible pain of the last six years may, at last, be coming to an end.  According to the National Association of Realtors [NAR], national home sales rose 3.4% in April for a total of 4.6 million homes sold  and the median home price for the nation rose to $177,400, a full 10% over last year. Of course, the  NAR has a vested interest in the health of the housing sector and its stats may be on the rosy side, as many commentators have pointed out. Still, 10% increase in value, even 5%, is terrific news.

house arrow up

For more good news,  purchases of new homes rose almost 10% over last year. At the same time the purchase price of these new homes rose almost 5% to a national median of $235,700. Housing starts are up over 50% from their 2009 low.  So, it does seem as if there is some ground for optimism. Finally, the combination of  incredibly low mortgage rates and low home prices has begun to attract the public, still stunned from the worst economic downturn in decades.

Why Is This Happening?

For the millions still underwater and behind in outrageous payments, even thinking that the housing crisis may be on its way out is a cruel joke. Nevertheless, there are some solid reasons for an eventual and actual end to the housing crisis of the last few years.  Our U.S, labor market has been improving over the last two years ever so gradually, diminishing the ranks of the unemployed slightly month by month. Add to that enticing mortgage rates which remain at historic lows and it makes sense that home buyers with the wherewithal would begin to have enough confidence in their future prospects to make that big home purchase.

Rent vs. Buy

Rental rates have been rising throughout the country and renting has many advantages over owning a home. Nevertheless, rental rates are still much higher than the cost of owning a home in great swaths of the country. This is based on purchasing a home with 20% down and owning the same home for at least 5 years  Additionally,these stats take into consideration only the purchase price of the home,  not the ongoing costs of maintaining it.

Though for the most part  in Southern California rental rates are still cheaper than owning a home, the allure of home ownership is still a strong pull both for the younger, first-time buyers as well as older, more experienced ones. The many young people who have returned to live with Mom and Dad or those who have rented with roommates for several years are now yearning to live free–in their own homes.

Is The Crisis Finally Over?

Millions of homes are still underwater. Millions of homeowners are still faced with foreclosure or the prospect of short sale. With that in mind,  the housing crisis is certainly not over.  Despite the modest recovery in the U.S., now our global trading partners are starting to slow down or even crash themselves, especially the EU and the BRIC countries [Brazil, Russia, India, China], which had been keeping the economic engine stoked.  This country is recovering and we may manage to keep up the trend going mainly by satisfying pent-up internal demand, especially in housing.

 

Should I Buy Or Sell Now?

smiley-face-house

It seems clear that now and for the rest of this year, it’s a good time to buy a home. Prices are still very low and mortgage rates are very low. Both of these factors are likely to extend through the end of the year and into 2013.

For those thinking of selling, it’s a more mixed picture. For those deeply underwater, home prices are unlikely to spike in the next few years, so better to bite the bullet and sell now.  For those who want to move up, this  seems to be the ideal time to make the move. And, of course, many have little choice in the matter: whether it’s through marriage, divorce, new babies or new jobs, selling is really the only option.

 

 

Is Your Real Estate Investment A Good Deal?

Mortgage rates are the lowest since World War II.  Property values have hit bottom in most locales. Many now see the stock market as corrupt and manipulated.  Besides gold, silver and precious metals, all already hitting record values, real estate has emerged as the best place for an investor to place money.  Investors in mutual funds are passive participants in the process. Real estate investment is usually active. How does the novice investor recognize a good deal?

For rent

How To Value Real Estate

Traditionally, real estate investments generate value in two ways-through cash-flow and appreciation.  Simply put, cash flow is the amount flowing to the owner on a monthly basis after payment of the mortgage and all expenses. This calculation can and should be made before purchase. The second way to generate value, appreciation, is more tenuous as it refers to the future value of the property. No matter how good the deal, how wonderful the neighborhood or how solid the local economy, the future is always unknown, so appreciation cannot really be calculated, only assumed.  Never rely on appreciation alone in making a real estate investment. 

Calculating The Cash

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Cash Flow Calculation

That leaves cash flow. The serious buyer must always calculate the cash flow before jumping into any investment.  From my observation, though, it seems this crucial step is often skipped.  For simple cash flow, here’s what you need to consider.   The owner will also have to pay whatever is stipulated in the leases, such as water, trash, electricity, gas,  gardening, pool maintenance, snow removal, pest control and, possibly, property management and whatever other monthly expenses might accrue.  Subtract this from the rental income and that is Net Operating Income [NOI].

The purchase price minus the down payment equals the amount financed which, in turn, tells us the monthly mortgage payment.  For instance, on a $200,000 investment, the down payment might be 25% or $50,000, leaving a mortgage of $150,000 and a payment of  $1000, including taxes and insurance.   The NOI minus the mortgage payment is the monthly cash flow.

Cash On Cash Calculation

Another way to calculate a real estate investment is called the cash on cash return method. This time, the investor considers all the money invested in the property, including the down payment, to figure out exactly what is the return for every dollar invested.  the purchase price is still important, but more vital is the amount generated from the cash put out.

On a $200,000 investment, the down payments is typically 25% to 30% or $50,000 plus an additional  5% in closing costs, loan fees and rehab costs, another $10,000.  The total cash outlay is now $60,000 with a mortgage of $150,000.  Now, estimate that the rents generate $2000 monthly and the ongoing costs amount to about $500 [utilities, maintenance] leaving $1500 a month. This is the Net Operating Income. From that subtract the monthly mortgage cost of $1000 and that leave $500 a month, producing a cash flow of $6000 per year.

Divide that $6000 by $60,000 to get the cash on cash return. In this case, it is 10%. Considering that leaving money in a CD will generate less than 1% these days and even the stock market less than 5%, that’s an excellent return on money invested. But, real estate investment is an inherently risky investment, so the returns should be decent.

Tax Benefits of Real Estate Investment

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.

Save Money: Don’t Pay the Mortgage

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.

New Rules: Short Sales on Steroids

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

NAR on HAFA

Buyers’ Tax Credit Now For All Buyers

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!

Who’s Eligible?

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.

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