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.

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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.

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.

Is Buying A Home Still Worth It Today?

You know the picture–rose-covered cottage, while picket fence, yard for frolicking dog and kids. Is this still what we want? More and more polls and surveys are saying-No, we’d rather rent.   Does that mean for now or permanently? This is the question for which not only the public, but every segment of the real estate industry craves an answer.

Let’s take a look. Is it still worthwhile to own a home today? What are some of the advantages  of home ownership?

    • Having a home is a great tax deduction. Yeah, sure, but that’s a pretty boring reason to go to all the trouble of buying a house unless you’re an accountant. Next.
    • Having a home saves money.  This is what we were all led to believe. All the money spent on the mortgage, repairs, lawn care would all translate into increased equity. Not lately. Do you believe that in the long run home values will go up again? If so, then this could still be true. I, for one, do believe that, eventually, values will go up, but I don’t know when or by how much. This one is kind of shaky.
    • Having a home is a creative outlet.  Well, this one is definitely true. Need to remodel your kitchen or bathroom, do an addition or just paint a bedroom? If you own the home, you get to do it your way even if that includes purple ceilings and green and orange striped walls or no walls at all. Your way is the right way if you own the home. This can be really fun.
    • Having a home is a learning experience. You got that one right, for sure. You will learn all about interesting things like unstopping a  toilet, repairing a leaky roof, getting the doorbell to work, putting up ceiling fans, and installing drywall. This will make you a better, more well-rounded person to boot.
    • Having a home confers prestige. Ever give your address in a store and the clerk asks you: is that an apartment of a house? How proud you will be to say-It’s a house! And, it’s yours.
    • Having a home gives you freedom.  Oh, I know you’re going to quibble and whine how you’re  tied to a giant monkey on your back. But, really, now you can turn the TV or stereo up as loud as you want. You can cook kippers and not worry about the smell. You can smoke if you want. [I hope you don’t want.]

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  • Having a home is good for animals. So many times when you were renting, you couldn’t have a dog or even a cat, sometimes even Iggy the Iguana was persona non grata. Now, you can have a dog or even two dogs, plus a cat(s), rabbits,chickens, snakes, lizards and a whole menagerie as long as you care for them properly. It’s all up to you.
  • Having a home  allows  vegetable and flower gardens. For many, this is a huge plus. If you don’t have your own yard, you have to pay through the nose for organic produce which you can raise at home for peanuts. Plus, roses are beautiful.

Notice how this one is  a double-edged sword, of course, just like many of the reasons for owning a home. Raising flowers or vegetables is a lot of back-breaking work. You have to try it to find out how satisfying it is. Training a dog takes time and attention. Caring for animals costs money and takes time. Most of us find the rewards are worth it kind of like raising kids. Often, the work involved in owning a home is as back-breaking as gardening. You have to want it. Apparently, we still do as 7 out of 10 renters say they are looking forward to buying a house someday.

Loan Modifications: Obama’s Plan

Called the Home Ownership Stability Initiative the heart of Obama’s plan really is the loan modification. As we have all heard, some homeowners are facing payments jumping thousands of dollars a month as adjustable loans readjust. Many homeowners are paying 50% or 60% or more of their income in mortgage payments while the value of their proerties is tumbling.

This plan aims to modify loans for those who qualify at 31% of income. Notice, that just like refinances, modifications require income. That’s the first qualification: income sufficient to pay the modified mortgage.

Until now, banks have been reluctant to offer loan modifications to homeowners who, whatever struggles they were having, remained current on their mortgages. Most banks refused outright to help such borrowers. This plan changes that and makes loan mods available to those who are current in their home loans as well as those who are behind in their payments.

This is important because it allows those who have not missed a payment to maintain their credit. As we all know, often a few dings on the credit and a missed mortgage payment is a major ding, have a cascade effect. Credit card companies find out and jump up rates on credit card debt. It becomes much harder to get any credit at a decent rate, etc.

Let’s say, for instance, that the borrower is paying 43% of his income for his mortgage. He applies for a loan mod and the lender brings the payment down to 38% of his income. Then, the government [Freddie and Fannie] and the lender bring the loan down by equal contributions [3.5% and 3.5%] to 31% of the borrower’s income. That mod stays in place for 5 years. At the end of that time, the rate would be gradually increased to the rate at the time of the loan mod.

Also, and this is important, the government would reinburse the lenders who agree to bring down the principal. Bringing down the principal: all underwater borrowers’ dream and their lenders’ nightmare. Until now, it’s been the rare lender who would touch that principal.

Now, lenders have incentives. If they modify a current loan,servicers receive $500 and lenders [investors] $1500. Borrowers have incentives, too. Every year a borrower stays current in the new mod, he receives $1,000 for up to 5 years. This is clear incentive to help those “good” borrowers who have made tremendous efforts to pay their mortgages during this current crisis and by dint of great sacrifice maintain their credit. Obama’s plan clearly tries to help these people while at least partially answering the persistent critique that responsible homeowners received no help while the irresponsible were being bailed out. Obama’s plan specifically says speculators or flippers cannot particpate.

This, of course, brings up another issue: small investors who own rental properties, especially single family homes or condos, are suffering, too, but seem to be eliminated from this program. Apparently, that is the case except for rental property that was originally a principal residence. So, if you are renting out the condo or 2-bedroom house you bought as your first home before you bought your current residence, then you may be able to participate.

Final details of this plan are supposed to be released this week. The Treasury Department says it will issue clear guidelines for all lenders to follow in doing loan modifications. That would be a relief. At the moment, it’s a free-for-all out there. Some lenders are very cooperative; others refuse to do anything. There’s no doubt we need to do something even if it means helping those who have not, shall we say, been the most prudent in their financial choices. If we don’t the fallout is just too terrible to contemplate.

How To Buy a Rental Property

Sometimes it’s best to cut to the chase. Buying a rental property is not brain surgery, but it does require preparation, called in real estate due diligence. I f you want to make money with your rental, you must do your due diligence.

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Bottom line: Research the area, the demand, the renters, and the zoning. And listen to your gut instinct.
Buying a rental property is different from buying for yourself. Banks know this as well.  Banks often require a larger down payment and charge higher interest rates for rental property than they do for owner-occupied homes. Today, for the best buyers, that is, those with those excellent FICO scores of 750+,  lenders are offering 4.5% on 30-year conventional fixed loans for owner-occupied properties.  For non-owner occupied, add 1%, so the rate for the same loan would be 5.5%. If your FICO is not quite as good, never mind, you’ll just pay a slightly higher rate. But, these are the best rates in 50 years!!

And never forget: Real estate is not a liquid asset. If you need to sell quickly, especially in a down market, you could have trouble getting the price you want or finding a buyer at all.

In addition, if you’re without a tenant for a period of time, the investment goes from cash cow to cash drain. For that reason,the typical advice for landlords is set aside about six months of monthly expenses. It’s good advice, but easier said than done. If you wait until you’re completely safe, you may never take the plunge.

Do the Math


Besides doing your due diligence  on the area and the property,  take some time to  sit down with a calculator and run the numbers.

First, you need a good idea of what rental prices for  comparable properties in the area fetch. How to find out? You could ask your friendly Realtor or these days check out the local Craigslist and figure it out for yourself.

Then total what you’d pay each month for the mortgage, insurance, and 1/12 of the annual property taxes. Include any expenses that you’re paying, like water, maintenance or community dues. If you’re not managing the property yourself, include the management fees. This is your monthly cost.

What you want to see on that balance sheet is a positive cash flow of at least 6 percent.

In addition to income, you can get a break on your income taxes. The Internal Revenue Service lets you depreciate the building portion of your property (minus the value of the land) over 27.5 years, which means much of your cash flow will be tax-deferred.  If  you ever sell the property, you’ll have to pay taxes on that depreciation, but if you don’t sell it, your heirs will never have to pay it.

And realize that this is not a short-term investment, you have to be in it for the long haul. The longer you hold the property, the greater your gain.

Before you consider buying a rental property, get an inspection from a certified professional home inspector. That way, you know exactly what you’re getting and what, if any maintenance issues you may have. Also, especially in the current financial climate, be prepared for “all those negative emotions” from people on the sidelines telling you not to buy.  The people who are telling you this, I guarantee they are not investors.

While owning rental property can be challenging at times, financially and even emotionally the rewards of a well-bought and well-managed property are  really worthwhile. You are providing housing to families, you are making money for yourself, and you are running your own operation. What could be better?

Investors: Avoid Over-Improving!

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The market today is great for investors who can buy low and then resell for a profit. That’s especially true here in Southern California where, until recently, astronomical home prices had made reselling for a profit a very dicey deal.

In today’s SoCal market investors who get one of those fabulous low, low deals need to rethink their strategy. Gone are the days when they needed to add those granite counters and cherry cabinets,  mahogany doors and paver driveways. It’s true buyers love those amenities still, but today’s buyer is focused laser-like on one thing: PRICE.

Investors hoping to make a few bucks must compete in today’s market of repos and short sales. That means getting in and out fast. Clean up the property, provide basic kitchens and baths, make sure the lawn is in and the driveway looks presentable. Then, put it back on the market at a competitive price. Investors hoping to compete must think at least 10% to 15% BELOW the other properties on the market if they  want to sell fast, even though they might be bank-owned properties. The buyers are there, but they are increasingly guarding their wallets as never before.

To accomplish that, investors not only have to buy low to start, but be highly cost-efficient in the types of rehab improvements they make, the contractors, and their turnaround time. It’s essential that investors not become prisoners of “reproduction cost” formulas that used to work, but amount to over-improvements today.

Although reproduction costs are often cited by appraisers and builders, smart investors now have to ask a very different question: “Would you reproduce this building in today’s (tougher) market?”

When you look at house, ask yourself: Is it OVER-improved for the area? based on what’s selling or being built now? If a builder today can build a brand new house for $100 a square foot, a house built years ago for $150 a foot (even though it has a fancy kitchen and bathroom) is now worth closer to $100 a foot– at least until buyers are willing to pay a premium again.

It’s a Great Time To Invest!

Every action has an equal and opposite reaction. We all learned that in science class. It’s true not only in nature, but also in real estate. Times are tough for sellers who formerly ruled supreme. We all know it’s a buyer’s market. But, have we figured out yet that it’s also an investor’s market?

 

Think about this if you have been considering the money-making possibilities of real estate.

 

The selection today is phenomenal. It’s the best time for buyers in any price in years. Just last year and certainly in 2006, the inventory even in vast L.A. County was minute. Today, homes are languishing on the market for months, despite price cut after price cut. Oh, happy day!

 

Back in the sellers’ market, buyers inevitably got involved in bidding wars. Every “good” listing immediately had multiple offers. Sellers had the pick of the crop. Very often, the “winning” offer was above list price. The trick then for buyers was how high above list to go in order to beat out the other offers. Good for the sellers, bad for the buyers. Today, no bidding wars.

 

Now if you make any offer, especially on property which has been on the market for awhile, as most have, sellers carefully consider your offer,  even if it’s far from what is desired.  Selling a home has a psychological dimension. If the home has received no offers for a significant time period, sellers lower their expectations.

 

Sellers today are willing to make concessions. Do you have a repair request? Last year or the year before, forget it. In this market, though, sellers are more willing to make repairs or lower the price. Do you want a long or short escrow? Need to sell yours first?

 

Sellers today are making special deals we haven’t seen in years. Looking for seller financing? You may find it. Looking for lease option? That’s more likely, too. How about VA? Sellers will consider any offer these days.

 

Do you hate to rush? Buyers in the sellers’ market had to make instant decisions. No more. Since property is on the market longer, buyers have a chance to think through their choices, always a good idea when making a major decision.

 

As mentioned last month, now jumbo loans and FHA loans are available up to a loan amount of $729,000. This is a huge benefit for buyers. Yes, the crazy loans of the past are history, but teachers, police officers and first-time buyers, buyers in specially designated areas will get special deals. Many new home builders are offering special financing.

 

And last, but very important—few investors are out there today. If you want to invest, you have far less competition than in previous years. The selection is great.  Sellers’ motivation is great. The only missing element is available money. You may have more than you suspect. Check out the next post for an unheralded way to invest in real estate.