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REAL ESTATE INVESTING 101 If you are interesting in investing in real estate as an alternative to investing in the stock market and other financial markets, read this primer and anything else you can get your hands on. First, you will want to decide what type of investor you want to be with regard to the level of risk, the amount of time that you have available and the money you have available. We classify investing in these categories: 1. Investing in a REIT (Real Estate Investment Trust)--This is similar to investing in the stock market and is done through a financial expert, not a Realtor. You invest your money and the trust handles the details. You are sort of a 'silent partner'. Not much risk and no liability, not much time involved, smaller potential profits. 2. Investing in rental property--This is, obviously, the category where you find, purchase, fix up property for the purpose of renting it. This may be foreclosed property, distressed property or just a good deal. You may hold on to that property until retirement or when you feel it is the right time to sell. A good bit of risk, a good bit of time involved, and larger potential profits. 3. Flipping property--This is the category where you purchase property with the sole intent of fixing it up and reselling it quickly at a higher price. This can be foreclosed property, distressed property or just a good deal. A lot of risk, a lot of time involved, and the potential for big profits. We will only discuss categories 2. and 3. in this primer. INVESTING IN RENTAL PROPERTY: Your first investment needs to be a success story or you will give up quickly. We know many would-be investors who jump into this unprepared only to bail out when things didn't go as planned. Start slowly. Be prepared. Educate yourself. If you work Monday through Friday, 8:00 to 5:00, this is going to be tough unless you have a partner or a spouse to rely on. These are some good rules of thumb for your first investment: 1. The best way to get started is to make your current home your first rental property. In other words, pull out your equity (refinance) and buy yourself another home, keep the one you have and use it as a rental property. That way, you have "owner occupied" financing rather than "investor" financing on the property. More later on financing. Get used to the fact that your renters will not take care of the property the way that you have. 2. The best rentals are priced less than $150,000. Check out what apartments are renting for in your area and use that as a guide to establish what the market will bear as far as monthly rent. There is not one central database for rental homes, although the multiple listing service has some homes for rent. Remember that people who want to rent houses as opposed to apartments do so for several reasons: they have a pet, they have a large family, they need a yard, they have bad credit and apartments won't take them, etc. 3. Buy close to home. You will be at the property all the time while you are fixing up the property and you will need to be able to drive by periodically. If it is too far, you won't go. We'd say within a 30 minute commute from your home is best. 4. Don't buy on a busy street. Yes, you will have more drive-by traffic to find renters, but you will find that the home will not appreciate in value as much as one tucked away in a nice subdivision. Unless, of course, you think the property will turn into commercial zoning. 5. Your first investment should probably be in a home that needs only cosmetics: paint, wallpaper removal, carpet, vinyl flooring, light fixtures, landscaping. Leave the big remodeling for when you have more expertise. You WILL overdo it on your first property--you will make want to make the home into a place that you could live in yourself. Always remember, this is rental property--it doesn't have to be perfect to be a good rental. 6. Line up your team: A Realtor (that would be us, Joli Tripp, Jennifer Prange and Gay Locke @ RE/MAX Around Atlanta 678-819-9251), a lender, an inspector, a handyman/contractor, a real estate attorney, and a property management company (optional). 7. The lender is critical--you must know what type of loans are available before you start, what your cash outlay will be and how much payments will be in various scenarios. Typically, 25% down is required, but there are other plans available. The interest rates on investor loans (non-owner occupied) are higher as well. Get preapproved with a lender so that you will be ready when you find the first property. You will need to allow for vacancy (typically 2 months of each year). 8. Find an inspector that you can trust. You will spend lots of money on inspections ($300-$500 each) on properties that you DON'T buy. Your inspector will uncover things that would have been potentially expensive to repair or replace. Remember that the utilities (gas, power and water) need to be on to do a proper inspection. 9. Find a contractor that can do the hard stuff. We all can paint, strip wallpaper and landscape, but when it comes to putting in flooring, repairing plumbing, electrical, replacing windows, siding and roofs, it's best to rely on an expert. When you are inspecting and assessing a property, you will want that contractor to tell you how much it will cost to replace the siding or the broken windows, etc. 10. Find a real estate attorney (not just any attorney) that you can call on to review documents, give you legal advice and keep you out of trouble. 11. Find a property management company for two important reasons: to check the potential tenant's credit and to find you a tenant. Management companies typically charge the first month's rent as their fee for finding you a tenant and checking their credit. Credit laws have changed and it is now very difficult for an individual to check someone else's credit. Of course, you must have the tenant's permission in writing. Try "Qualified Renter" at 678-762-0040 for credit checks. You may be able to talk your lender into pulling a credit report for you for a fee or perhaps a property management company will oblige as well. Management companies will also manage the property for you if you desire. They will collect the rent, send it to you every month, get estimates on repairs, etc. typically for 8% to 10% of the monthly rent. 12. Avoid condos, townhouses, duplexes, triplexes, mobile homes, etc. (unless you are Intown inside I-285). Those markets are very cyclical and you may find that you cannot get rid of your property when you need to. Remember the reasons why people want to rent a home in the first place. They typically want a yard and some space between themselves and the neighbors. 13. Join the Georgia Real Estate Investors Association (GAREIA). This is a large group of investors ranging from the first time investor to the fulltime veteran investor. They have monthly meetings and you can join one of their subgroups (based on geography or type of investment) for more interactive discussion. Visit them at www.gareia.org for membership information. 14. Get on John Adam's (a local Atlanta real estate guru) mailing list. It's only $12 per year for a subscription or go to his website each month for a free copy. Visit his website at www.money99.com. Almost everything good that we've ever learned about real estate investing we've learned from John Adams. 15. You will need to maintain homeowner's insurance (the landlord variety) on the property at all times. Your lease will require your tenant to maintain renter's insurance, but there is no guarantee that the tenant will keep it in force. 16. Buy one property and see how it goes for a while before jumping into the next one. 17. We've all heard the seminar gurus promising that "You can buy property with no money down" on TV and the radio. And, yes, there are certainly ways (some legal, some not) to buy a home without a down payment. But unless you can negotiate with the seller to finance 100% of the price, you will need to have some money when investing in real estate. Most traditional lenders require 20% down for investment property (unless it is resort property or a "vacation" home). The amount of down payment you will need depends on your income, assets and credit. In the buyer's market that we find ourselves in, you likely will be able to negotiate with the seller to pay your closing costs. But you will need to have cash reserves on hand to allow for repairs, maintenance, vacancies, etc. 18. The goal is to use as little of your own money as possible. Use the OPM principle (Other People's Money). Borrow as much as you can and then let the tenants pay off your mortgage for you. 19. Avoid buying the largest home in a neighborhood. Avoid homes that are adjacent to undesirable objects such as: County Dumps or Landfills, Power Lines, Train Tracks, Busy Roads, Commercial property (there are exceptions), Trailer Parks, etc. 20. As a general rule, if your adjusted
gross income (AGI) is less than $100,000, you can deduct up to $25,000 of rental
losses against your other sources of income. If your AGI exceeds $100,000 you lose 50 cents of your deductible
losses for each dollar of income over $100,000. Once you reach an AGI of
$150,000, you receive no rental loss deduction. You must be actively
participating in management decisions, at least a 10% owner and not a limited
partner. Essentially, you must be actively
managing the property yourself. If you hire a management company to find new
tenants, effect repairs, deal with all the tenant and property issues – your
deductions will be limited to your rental income. Unused deductions are carried
forward until one of two things happen – you have rental income, or you sell the
property. There is one exception to this rule. If you are a "real estate professional", you are entitled to claim unlimited rental losses. A real estate professional is defined as one whose primary business is one of the following: a) developer, b) builder, c) landlord, d) property manager, e) property purchaser f) marketer and seller of property, or g) property converters. You must spend more than 50% of your work time in real estate related activities and you must spend at least 750 hours during the year working on your real estate activities. In other words, just getting your real estate license or buying a property or two won't qualify you for the exception. Typical rental property tax deductions include mortgage
interest, property taxes, homeowners association dues, insurance, utilities,
gardener/landscaper, routine repairs and maintenance. When it comes to
appliances, improvements and major repairs, you may have to depreciate those
costs.
INVESTING IN RESORT RENTAL PROPERTY If you have ever considered buying a home or condo in a resort setting such as at the beach or a ski resort, now is the time to do it. Remember that you can purchase a second home at owner-occupied interest rates and deduct all the mortgage interest and taxes just like you do on your current home. However, if you decide to make it a rental property, different rules apply. If the property is deemed to be "rental" property, you can only use it yourself no more than 14 days per year (referred to as the Augusta Rule for tax purposes). However, any time that you use your property for purposes of repairs, maintenance, homeowners association meetings, cleaning, etc., that time doesn't count towards the 14 days. Also, the travel days to and from the property for property management related reasons don't count either. As rental property, you can deduct nearly all your expenses on the property from the rent you receive. When you allow friends and family to use your resort rental property for free--that counts towards your 14 day limit. Unless you live very near the resort rental property you own, it is a wise idea to use the services of a local property management company to market and rent your property. SOME ADVICE ABOUT BEACHFRONT PROPERTY Through the school of hard knocks, we've learned a good bit about investing in beach property, specifically condos. If your goal is to capture the vacation rental market, then you will find that you will have more income, but more wear and tear. If your goal is to capture the "snowbird" (retirement age people escaping the cold for the winter months), then your property will be better maintained, but there is less income. The information below is targeted toward the vacation rental market, my area of expertise. 1. Off the beach and on the beach are TWO entirely different animals. Ask any beach property manager and they will tell you that ON the beach is the only way to ensure rentals. Property off the beach does not rent as well. 2. The property management community in Florida, at least, have a funny notion about what is "high season" and what is "low season". They tell us that high season is the winter. We have found nothing "high" about it at all. The elusive "snowbird" that we have all heard about is scarce. A snowbird is, of course, the retired person fleeing the cold winters up north and willing to rent your place for several months of the year. The rent that they negotiate is much lower than the "low season" rate, presumably because they rent for longer and typically do less damage. Most of our rentals have been from March (Spring Break) through Labor Day. 3. When shopping for a beach condo, be aware that there are many communities that have condo docs (covenants and restrictions) that only allow for long term rentals which can be defined as: 1 month, 3 months, 6 months etc. So the 1 week vacationer would not be allowed. Ask that question first before even looking at a property. 4. You must have a pool on the property. A heated pool is better. Also, the location of the pool can be important too. The pool should be on the beachside, not the streetside. Check to see if any large structures shade the pool too much as well. Check the beach out as well. At high tide, is the beach under water? Is the beach public or private? Is there a service (city or county) that cleans the beach, not just the trash, but uses tractors to clean up the seaweed and whatever else washes ashore. 5. A lanai or porch is also very important. Of course, a beachfront unit will be the most expensive, a beach view unit is next, bay view (if there is a bay) is next, garden view and street view is last. 6. An elevator is critical for a multistory complex. A trash chute is nice too. You probably don't want your unit too near either of these things because of the noise factor. People are very noisy when they get on and off an elevator. 7. Parking is usually critical at the beach. Covered parking is wonderful, but usually hard to find. Does the unit have an assigned parking space? Can one be purchased? What about guest parking? 8. How are the units rented? Is there property management on site? Do you have to find your own property manager? Try to select a large property management company that has a lot of resources, does lots of advertising, has a website, and is involved with a major travel website such as: Travelocity, Expedia, etc. If the unit is a resale, ask for the rental history if there is one. Ask for the homeowner's association financial records. Is there enough money in reserve for future repairs and renovations? 9. When asking questions about the property management company, get the whole picture. Some companies charge a low percentage of the rental income (15%) but then charge you for everything under the sun (credit card fees, cleaning fees, etc.). Others charge higher fees (35%) and include more. 10. You will find a variety of types of condos: the traditional condo, the condo/hotel and the hotel conversion (that's my name for it). The condo/hotel is relatively new and describes a condominium that is approved for hotel usage. In other words, they can usually rent short term, some nightly, others have a 3 night minimum, etc. The hotel conversion, in my opinion, should be avoided. This is when a former hotel remodels its rooms and calls them condos. Typically, it still looks like a hotel room except a kitchenette is tucked inside. They can be very nicely appointed, but it's still a hotel room. No privacy whatsoever. They are usually much more affordable than a condo or condo/hotel unit. My guess is that we won't see as much appreciation in value in the hotel conversion units. FLIPPING PROPERTY First of all, let me clarify that "flipping" is NOT illegal. You may have read or heard lately something to that effect, but the flipping that you have heard about involves corrupt appraisers, lenders and investors. This is not the type of flipping that we are talking about. Flipping requires lots of expertise and time. This is not a good avenue for those with a Monday through Friday, 8:00 to 5:00 job. All of the rules of thumb recommended in rental property apply here and then some. 1. You must be much faster in assessing, inspecting and making offers on property when you are a flipper. You really need to be good with financial analyses to succeed. Most homes you encounter will not be good candidates because the profit is not there. Your Realtor needs to help you determine what a reasonable selling price will be once the property is fixed up. Your inspector needs to determine what is wrong (at some point you will probably do your own inspections, but definitely not at first). Your contractor needs to determine the costs of fixing it up and estimating the time it will take (it always takes longer than you expect). YOU need to determine how much it is going to cost to purchase it, fix it up, the holding costs, and the marketing costs to establish if there is profit in it for you. 2. You will find that most of the homes that meet your profit criteria will be distressed properties (properties in need of LOTS of work and/or in danger of foreclosure) or foreclosed properties (which typically need LOTS of work also). It is rare indeed to find a desperate seller who just wants to "get rid of it" for a below market price. Oddly enough, many people will let their homes go into foreclosure and file bankruptcy believing that the bank won't really foreclose. In many cases, the former owner of the property has obtained 2nd and 3rd mortgages on the property making it worth less than they owe. More on foreclosures in another article. 3. You need to make lots of offers before you can land a good one. Everybody and their brother is now investing in the real estate market since the stock market took a nose dive. Your Realtor (that's us) will help you to negotiate a safety net in your offer to allow you to bail out of the deal before it closes if things go awry. 4. Loans on flipper property are more difficult to obtain. Most lenders want a loan to "season" 6 months to a year before it is paid off making investor loans (permanent financing for non-owner occupied properties) difficult to obtain for a flipper. "Hard Money" which is a commercial loan is one avenue to pursue. It is loaned on a short term basis and at a much higher interest rate. See John Adam's newsletter for more lender information. It is CRITICAL that you pursue your financing FIRST. This is the absolute first step. 5. In our opinion, now is not the time for flipping. It is the time to buy and hold. Homes prices are lower than they have been in years and foreclosures abound. Interest rates are great. But just wait until the market improves before you sell your investment property.
Consult with a CPA for tax information concerning flipping or rental property. Your profession, level of income and number of properties owned may affect your tax deductions. For more information contact: Joli Tripp, Jennifer Prange, Gay Locke
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