Chapter 17: Real Estate Investing Summary

Investors in Real Estate could be interested in supplementing income, reducing taxes, enjoying a property for personal reasons or creating an estate for the family.

• An investor must have the financial abilityto handle the costs of the investment and not place himself or herself in financial jeopardy.
• An investor must carefully examine the economic soundness of the investment - doing "due diligence" on the property.

Benefits to Investing

• Tax Shelter- investors in high tax brackets could benefit from sheltering part of their income by investing in real estate.
• Other Tax Benefits- capital gains could be deferred through a 1031 exchange or an installment sale.
• Appreciation - the value of land and property tends to grow over time.
• Hedge Against Inflation - typically, real estate outpaces the inflation rate. Prices tend to bounce back relatively quickly.
• Income- the goal of many investment properties is to provide the investor with a good cash flow.
• Interim Use- some investors purchase properties to generate some small income while waiting for some later, more profitable use.
• Stability - some properties have a history of producing a stable income for investors.
• Control and Use- analyzing a property's current use could lead to finding ways to enhance its "highest and best use."
• Refinancing- An investor could choose to refinance one property to free up funds to purchase another income property.

Investment Risks

• Capital Outlay- An investor typically needs a large amount of money for a real estate investment.
• Liquidity- Investment property is not considered to be a very liquid asset.
• Property Management- Most investors will need to hire a property manager who has the skill and expertise to make the investment a profitable one.
• Financing- Loans and terms available when the investor is ready to make a purchase may not be favorable.
• Other Negatives- Property restrictions could have negative effects on the usefulness of a property. Obsolescence and/or poor management could also negatively affect a property.

Financing Investment Properties

• Savings Banks - Most savings banks deal only in housing loans for single-family residences. They do not currently give loans for commercial buildings.
• Commercial Banks give high-interest, short-term loans and specialize in interim financing, which is typically a construction loan. They do not like apartment projects because they tie up funds for too long.
• Life insurance companiesdo not have a restricted geographical lending area; so they have no problem lending on projects that are distant from their home offices.
• Sellersoften become a good source of financing for land and special purpose projects. A "Seller Carry Back Purchase Money Trust Deed" and a "Contract for Sale" are the instruments used in these financing arrangements.
• A syndicateis a group of two or more people who combine their financial resources to achieve certain investment objectives. A syndicate is able to acquire real estate that could not be purchased by an individual alone.
  • Limited Partnership are made up of two or more people. One general partner has unlimited liability for the debts and obligations of the group's projects. All other partners have liability that is limited to their capital investment in the project.
  • General Partnership are also comprised of two or more people. All partners have unlimited personal liability for the debts and obligations of the partnership.
  • Corporation is a business entity which is separate and apart from its owners (stockholders). It has a Board of Directors, and the stockholders have liability that is limited to their capital investment.
  • Real Estate Investment Trust (REIT) sells ownership shares. REITs receive special tax considerations and offer high yields to investors.

An investment property should be professionally managed to protect the investment, minimize expenses and maximize profits.

Purchasing Income Property

Analyzing the particular property

Detailed analysis of the property's income and expenses with the focus on the future operating income of the building, with the help of an appraiser:

• Potential gross income- The total income the property would produce at full occupancy with no deductions for expenses.
• Vacancy factor- An allowance for vacancies and uncollectible rents.
• Effective gross income- Potential gross income adjusted for vacancy.
• Net operating income- Effective gross income minus operating expenses. 

Analyzing the rental market

It is important to look at the property in light of its actual physical location.

A disadvantage today may actually become an advantage a few years down the road.

Studying characteristics of the area

• Population- Has the population in the area of the property increased or decreased, and will this trend continue?
• Rental Trends- Are families looking for rental units in this area, and how many apartments are available to satisfy that need?
• Projected Demands- What is the projected demand for multiple rental units in the proposed area?  

Understanding characteristics of the rental market. 

• Income characteristics- What is the income range of the types of persons and families that are attracted to the area?
• Current rental ranges- What are people actually paying for rental units in the area?
• Current vacancy rates- How many of the existing units in the area are vacant?
• Rent control- Does the community impose rent control in the area?
• Distribution of units- How does the type of unit available compare to the types and sizes of families that move into the area?