THIS IS MY SIXTH POST ON UNDERSTANDING MONEY TOOLS
Money! Money! Money!
Let’s talk real estate.
This is a broad topic. We will cover it in several pieces and only the
basics, hopefully make some sense
guiding you to better investment decisions.
I’ve been in the real estate arena in almost all aspects and
I can tell you the industry “ain’t” rocket science, but it does have
fundamentals that if followed can cut risk. In my opinion two of these is money
and it’s availability at a low interest rate, and market….location, demographic
changes, etc.
RESIDENTIAL REAL ESTATE: Most people think of their home when it comes to this type
of real estate. It will be, to
most people, the most expensive decision you make. Residential real estate means living within the improvement
so can encompass single family, duplexes/flats, and multi-family such as
apartment buildings and conversions of large homes to serve more than one
family under the same roof. Land or lot costs can vary greatly depending on
area, location, desirability, demographics, etc. Construction costs can vary greatly, too from well under
$100/sq. ft. to over $1,000 sq. ft. for top luxury.
Single Family residences are either new homes, including
custom build, or resale homes. After the “go, go” real estate years of
2003-2006 we fortunately have for the most part better quality companies
remaining who stand behind their new home builds. You might pay a bit more for
a new home, but you have new home warranties, a contractor who can go over
things as the home is being built, have selection of interior and exterior
custom changes you want and higher energy efficiency.
New home builders many times offer buying incentives for
using their mortgage lending company and for options within the home. During
the past 6 years there have been so many acreage/lot bankruptcies that new home
prices are not much higher than foreclosed upon homes owned by banks without
any warranties. Part of this is
because the builders remaining in business today are buying foreclosed lots
from banks at about $.20 on the dollar and passing that savings on to you, thus
you are paying mainly for the construction of the home (referred to as the
improvement on the land) and not the land development costs.
If buying from a bank and the property was a foreclosure or
short sale, there are no warranties, and don’t be surprised if you need to put
money into the property after you take ownership. Definitely get a real estate lawyer involved early on in the
transaction. As far as all real
estate transactions go they must be in writing and it is highly recommended to
be advised by legal counsel. Also, have the property thoroughly inspected by a
reputable company that has been in business for a good period of time.
Many areas have Home Owners Associations, and there are pros
and cons to being in one. When the
property was developed unless very old, the developer most likely needed to
file with the county a “Public Report”.
Best to review that instrument.
If a condominium or townhouse purchase review the “CC&R’s” and
“Declarations” for the association.
Trends:
Residential real estate has changed the past 6 years. As you are aware
we started the decline in real estate in about 2006. Prior to that we had large builders wanting tracks of land
to develop in California, Arizona, and Florida of 1,000 acres and more. The demand from baby boomers wanting to
retire in warm climates created this demand along with easy financing. “Let’s get in before things go up more”
theory, and commodity prices were rising.
Those days are gone. Now,
even the large companies want small developed lot projects and are scouring the
banks for bankrupt land, especially developed lots. They want to get in and out, and limit risk. When commodity
prices were rising, and home values appreciating quickly, people wanted large
homes, in some places 6,000 to 15,000 sq. ft.
Now days, baby boomers are concerned about having enough
money to retire and there is deflation/devaluation in home prices so I don’t
see the desire or want in the future for large homes. Large, expensive homes have high real estate taxes, a great
deal of maintenance hassle and related costs. You will always have a small
segment where the expensive home is in want, but right now that is mostly
confined to New York City with many foreign buyers, some in Washington D. C.
and California where you have pockets of great wealth.
Also, the next generation down is struggling for employment
and with interest rates expected to be low until 2015 and a poor economy that generation
wants a more practical home. Families are smaller today. Adding to this is mortgage
financing. We went from easy
financing to very difficult financing and tons of paper work to support each
loan. The Federal Reserve printed
money for QE 1, QE 2 and now QE 3.
This significant amount of money was to assist the real estate industry,
the largest industry in the country, however the money has gone to the largest
of banks and they have invested the money to make profits for themselves and
their stockholders, and not given proportional aid to US homeowners, nor
allocated a large amount to the real estate industry. In addition, American wages are currently at a 50 year low
as a percentage of our Gross Domestic Product. Inflation is running at a higher
rate than our increase in wages, therefore people have less money to spend on
housing. Thus, with all this printed money very little is in circulation
helping our gross domestic product and our middle class and small companies and
businesses.
Duplexes/Flats are two residential units within one
structure. They can be side by side or many times in the Midwest referred to as
flats stacked one on top of the other, each with a separate entrance. Many people buy these for investments
either to rent both sides or live in one side and rent out the other side,
producing income and helping on a mortgage.
Anytime you rent out real estate you must depreciate the
property from an accounting tax standpoint. There are different depreciation schedules and this is where
you need to be advised by an accountant.
With depreciation you take a tax deduction from income on a Schedule E
Form for that year, however the case with all real estate you then need to
“recapture” that deduction when you sell the property hopefully for a gain and
pay taxes on that increased amount.
For instance, if you bought a $100,000 property and you rent 1/2 of it
($50,000) must be depreciated. If you select a 30 year straight line amortized
depreciation schedule that would be $1666.66/year, ($50,000 divided by 30). At
the end of a 5 year period your cost basis in the duplex after depreciation is
$41,667 for the portion you rent ($1,666,66 X 5 equals $8333. subtracted from
$50,000) plus the side you live in, $50,000 or $91,667 adjusted cost basis.
You may want to run a business out of your house or home
office and expensive that square footage as a percentage of the entire square
footage. Keep good tax records of these deductions as that amount lowers the
cost basis in your home and you will need to recapture that when you sell the
house and pay taxes on it. A benefit here is that long-term capital gains tax
for holding assets in excess of one year is 15%, versus perhaps a higher
ordinary income tax.
One drawback from renting a duplex and relying on the income
is that one or two months of vacancy really hurts cash flow. You are only
spreading the loss of rental risk to one unit.
Some counties and municipalities have a tax on rental income
separate from income taxes. Best
to check, or have your lawyer or accountant advise you before purchasing.
Multi-Family Residential has been a strong industry through
our recession years. As people
have been foreclosed upon, done short sales and walked from homes their credit
has been hurt and yet they need a place to live, thus renting. For buying this
type of investment property like all real estate, location, location, location
is all important. Buying around
hospitals and schools can be good. Risk/reward for student type housing. The students you rent to may be harder
on the property, but incomes are normally higher. Purchasing near hospitals is usually good as you have a
solid employment base of administrators, nurses, doctors, etc.
One last comment:
There is no “free lunch”!
Buying real estate is easy, but maintaining the property, placating to
tenants wants and needs, the maintenance costs all can be wearing. With economy
of scale you can have a management company manage your properties, but that
also lowers your return on investment.
Real estate is not very liquid in most cases, like stocks, and hitting a
bad market may place you in a position where you need to hold the real estate
for several years before you can sell.
I have found that on a “cash on cash basis” and properly
maintaining a good property returns are about the same as most conservative
investments, or perhaps slightly higher.
No comments:
Post a Comment