Hope to Prosper » Real Estate

Real Estate 101 – Investment Property

Bret — Mon, 06 Jun 2011 17:41:16 +0000

Whenever an investment is universally despised, it’s often a good time to consider investing. And, no investment is as unpopular as real estate right now. If I had a nickel for every article I’ve read lately that says, “A house is not an investment”, I could probably pay off my house. The truth is that a house or other property IS an investment. It’s a very large investment. But, that doesn’t necessarily make it a good one.

This is the last in a series of four posts on real estate.

Real Estate 101 – Renting vs. Owning
Real Estate 101 – Market Dynamics
Real Estate 101 – Purchase and Finance
Real Estate 101 – Investment Property

Disclaimer: I’m not a licensed broker or a real estate professional and laws change and vary by state. Before making any decision about buying a house, you should be aware of the laws or consult with a licensed professional.

The Economics of Investment Property

If a property is rented at a profit, or the mortgage is paid off, it’s an asset.
If a property is occupied with a mortgage, or rented at a loss, it’s a liability.

Image by Alan Cleaver

Notice this has nothing to do with the property values, appreciation or home equity? What it has everything to do with is cash flow. Real estate investment professionals look for properties that will provide a positive return on their investment. The equity and appreciation are secondary. A property that doesn’t return a positive cash flow is a poor investment and professionals will avoid it. If it doesn’t “pencil out” they will look for another property.

Someone who buys a house to live in (retail customer) has very different needs and motives than someone who buys a property to make a profit (professional investor). A retail customer should be much more concerned if this is a house they are going to enjoy living in for many years to come. Is the neighborhood safe? Are the schools good? Are the neighbors friendly? Is the structure sound? Are there employment opportunities in the area? If not, it’s probably a bad investment, no matter how much it costs or changes in value.

Finding Properties to Invest In

One of the most difficult things for a novice real estate investor to do is to find potential investment properties. The network of real estate agents, brokers and mortgage lenders are geared primarily to serve retail customers. And, they generally aren’t interested in looking through thousands of properties to find one that could provide a positive cash flow. If they do find a house that is priced way under market and is suitable as a rental, it usually yields a pretty small commission. And, it often comes with transfer hassles, such as a foreclosure or a short sale. This doesn’t mean a real estate agent won’t help you find a good rental property. But, they may be less than enthusiastic. Or, they may try to convince you that retail-priced properties are a good investment. Most of the retail properties will be money-losers.

Be prepared to a do a lot of the legwork yourself. Look for FSBOs and talk to distressed sellers. Check on Craigslist and look in your local newspaper. Talk to banks and ask about their REO properties. Ask around about agents who work as “bird dogs”. These agents will look for specific types of properties for a finder’s fee. Since, they are looking at properties all day anyway; they may spot something that meets your needs. And, if sales are slow, they may be pretty aggressive in finding what you need. Don’t get discouraged because you are going to have to look through a lot of properties to find a few suitable ones. Then, you will discover the reason they are priced under market. Patience and persistence are going to be the keys.

Money is Made or Lost in the Purchase

It may seem ridiculous to go through such a frustrating process to find a rental property. But, the profitability is determined in the purchase. If you buy an overpriced or unsuitable property, it could become a terrible investment that loses money every month. This is known as an “alligator” because it will eat you alive. If you don’t have the patience and the fortitude to find a suitable rental property, you should keep your money in the bank or a good mutual fund. You probably aren’t cut out to be a landlord.

Here are the things you must know, before you buy a property:

Does it pencil out to a profit?
Is it a sound and suitable structure?
Is it the right size for a rental?
Is it in a rent-able neighborhood?
Is it within a short driving distance?

What Makes a Property Suitable?

Profit Potential – No matter how much you like a rental property, it must be profitable. This means the rent must be high enough to cover the mortgage, taxes, insurance, and some vacancy. Other costs such as routine maintenance, appliance repair, HVAC servicing, etc. should also be factored into the rent or be the tenant’s responsibility by contract. A good rule of thumb is that a property should rent for about 20% more than the mortgage, taxes and insurance. Every landlord should also carry a liability policy to cover unforeseen expenses. Finally, before you buy a rental, you should know the comparable rents in the area or you risk extended periods of vacancy.

Location, Location, Location- There are two big issues with location and rental properties. First, is it in a rent-able area? The area should be safe and close to a large source of jobs. There shouldn’t be a lot of vacant properties. The area should have something that attracts tenants, such as a nice location, a college or a military base. Second, is it within a reasonable driving distance. The book Nothing Down recommends properties within the “Golden Hour”. That way, you can easily maintain the property and collect the rent if necessary. Unless you are going to pay a property manager, you shouldn’t buy properties too far away from where you live.

Size and Type- Obviously, you want a property that will rent easily. These are 2-3 bedroom condos, 3-4 bedroom houses or duplexes and triplexes. It is best to stay away from small or large rental properties. The rental market mostly consists of young couples, small families or sets of roommates. There is a demand for studio and single bedroom units, but these people will usually rent in an apartment complex a duplex/triplex. Single bedroom condos are rarely profitable after the association costs. And, the resale value on a 2 bedroom house is deplorable. Large houses attract multi-family tenants or lots of roommates. This leads to high maintenance costs and problems collecting the rent. Vacation or luxury homes can difficult to keep occupied.

The Structure - The structure must be sound and the layout practical. Unless you work in the construction trades, I recommend hiring an inspector prior to buying a property. There could be huge liabilities from things like a cracked foundation, leaky roof, mold in the walls or substandard plumbing and electrical. Properties that have been modified or converted into a duplex, should have layouts that make sense and all of the proper permitting.

Market Conditions

The last thing I want to talk about is market conditions for rental properties. In some areas of the country, it’s easy to buy houses and rent them out. The housing prices are low and the rents are high enough to make a profit, even on retail properties. Where I live at the beach, a modest house costs $500K and would rent for about $2,500 per month. It makes no sense to put down $100K and take out a $400K mortgage to lose $1,000 per month. My uncle lives out in the desert and he just bought a nice 3 bedroom foreclosure for $60K cash and rented it out for $950 per month. You could do really well finding three or four deals like this. But, that’s not typical of the market in Southern California. It’s important to understand the market conditions where you live, so you don’t get stuck with an alligator property.

The Bottom Line

The bottom line is that short-term thinking doesn’t work for a long-term investment, like real estate. The payoff from rental property comes after many years, as the rents rise and the mortgage gets paid down. If you are looking to get rich quickly, I wouldn’t recommend becoming a landlord. If you are looking for cash flow from investments, real estate makes a lot of sense.

“Landlords grow rich in their sleep.”

John Stuart Mill – British Philosopher

Real Estate 101 – Purchase and Finance

Bret — Sat, 21 May 2011 21:25:58 +0000

It’s time to cover the nuts and bolts of real estate, the purchase and finance. I could write a whole book on this subject. But, I suspect most readers would get bored after a couple of thousand words. So, here is the summary version of the important things everyone should know before they purchase a house.

This is the third in a series of four posts on real estate.

Real Estate 101 – Renting vs. Owning
Real Estate 101 – Market Dynamics
Real Estate 101 – Purchase and Finance
Real Estate 101 – Investment Property

Real Estate Agents

: Image by Mark Knobil

The first decision is whether you should engage an agent or go it alone. For most first time home buyers, the safe and practical route is to find a buyer’s agent. This will ensure the paperwork is completed correctly and you don’t get taken advantage of by the seller or the seller’s agent. And, a good agent will be very helpful in locating and showing suitable properties. If the seller has a listing agent, a commission will have to be paid either way. So, there are no potential savings from doing it yourself.

I purchased my house without using an agent in what is called a FSBO (fiz·bow), meaning For Sale By Owner. There were two important benefits to buying the house directly from the owner. First, I had a lot more control of the process and was able to negotiate directly with the owner. Second, I definitely got a better deal on the house, because the seller didn’t have to pay the agent’s commissions. An agent will tell you the seller pays the agent’s commissions. But, the reality is that these costs are usually figured into the selling price of the house, which is paid for by the buyer.

The paperwork in California to sell a house is pretty straight-forward and the forms can be found everywhere. But, it’s definitely not something you would want to mess up. There is a lot of money at stake and you could wind up in a nasty lawsuit. I took the California Real Estate course in college, which gave me the confidence to do it on my own. And, the owner of the property was very honest and straight-forward. So, the sale went well and we were both happy with the deal.

Getting a Mortgage

In my experience, getting the home loan is the riskiest part of the deal for the home buyer. There’s no easy way to sugar coat this so I’m just going to come right out and say it, the mortgage business is pretty slimy. I’ve known a lot of people in the business, going all the way back to the ’80s, including one who went to jail for fraud. Mortgage brokers often receive incentives from banks to fund borrowers with the worst loans, in order to make the highest possible commissions. This is called Yield Spread Premium and I believe it is finally illegal. The YSP is the reason so many people were stuck with subprime loans, even though they should have qualified for Alt-A or A loans.

Here is how the game works. First, the mortgage broker shows you some incredibly low interest rates and says you are pre-qualified for one of these loans. Because the interest rate is so low, you will qualify for a surprisingly high loan amount. This makes the seller happy, because you can afford to pay a lot for the house. It makes the real estate agents and mortgage broker happy, because their commissions go up. But, when you study the details of the loan, you discover the interest rate will shoot up over the next couple of years and so will your payments. If you point this out to the mortgage broker he or she will say, “don’t worry about it, we have some great first-time home buyer programs you qualify for.” Then, it will take forever to get funded. As your closing date approaches, the delay will be blamed on the processor, the underwriter or some other circumstance. Finally, at the last minute, you will be told that you don’t qualify for the first-time home buyer’s loan and you will be presented with a subprime, 40 year or balloon loan.

I had this experience with a mortgage broker, which caused me to walk away from my first house and lose my escrow deposit. So, when I found our current house, I marched right into Home Savings and got my own loan, directly from the bank. The bank’s broker was very honest with what I could or couldn’t do. And, she was very clear and helpful in explaining my debt ratios and how much I was qualified to borrow. Although I didn’t qualify for the fixed loan I really wanted, I did get a great indexed ARM that I still have today.

The Purchase Offer

First, I don’t recommend shopping for houses until you are prequalified for a loan. The only thing worse than falling in love with a house you can’t afford is making an offer on a house and finding out you can’t get funded. I recommend finding a house you can easily afford and offer less than you are qualified for. That way, you have some wiggle room if the seller counter offers or something changes in your credit profile.

When you make an offer in California, you will fill out a Residential Purchase Agreement and attach a check as a good faith deposit. If the seller accepts your offer, your deposit is placed in an escrow account. If the seller rejects your offer or accepts another buyer’s offer, they will return your deposit and you can start looking for another house. Often, the seller will reply with a counter-offer, asking for a higher amount. The important thing to understand about a counter-offer is that it constitutes a rejection of the original offer. So, you can accept the counter-offer, counter back or ask for your deposit back.

If a seller takes a long time to respond to your offer or they come back with multiple counters, they are likely trying to draw you into a bidding war with other buyers. The important thing to understand about this is you need to put an expiration date on your offer, preferably for two days or less. This lets the seller know you won’t be held hostage in the negotiation. And, it frees up your deposit, in case you find another house that you like better. Your agent will often encourage you to increase your offer up to the full amount you are qualified for. This may save the sale and increase their commission. The danger in doing this is that you may offer more than the house will appraise for. If that happens, you may have to come up with a larger down-payment. I would avoid high counter-offers and bidding wars, because they work in everyone’s favor but yours.

Escrow Account

One of the most confusing aspects of buying a home is the escrow and closing process. This is where you officially lose control of your money and everyone starts telling you what to do. If you understand the process, it’s not so bad. If you don’t understand, it can become pretty frustrating. When I took the real estate course in college, many of the students had already purchased a home and they were taking the class to figure out what happened. Here is a simple breakdown of what happens and why.

The escrow account is created to hold and disperse all of the money in a real estate transaction. Incoming sources of money are the buyer’s good faith deposit, down payment and funding from the bank loan. Outgoing money goes to the seller, agents, brokers, appraiser, pest inspector, taxes, escrow fees, closing costs and to pay off any existing mortgages. The escrow officer’s duty is to make sure that the proper amount of money is collected and disbursed and the property title is legally transferred, before the deal can close. This ensures everyone gets paid and no one gets cheated.

Title Search & Insurance

The title of a property assigns and records ownership. The title search is the process of looking through the county records to make sure the title is clear. This means that it doesn’t have any outstanding loans, taxes, liens, easements or legal actions that weren’t identified by the seller. It also ensures the seller has the rights to the title and can legally sell the property. This way, no one can try to sell you the Brooklyn Bridge.

The Title Insurance is a policy that covers anything that may have been overlooked in the title search. If you buy the house and find out there is a mechanic’s lien on the property for some construction that wasn’t paid for, the title insurance company has to pay off the lien. The lender will require title insurance to cover their investment. So, there are usually two title policies, one to cover the buyer and one to cover the lender.

Closing Costs

The buyer’s closing costs are usually around 3-5% of the price of the house. The seller’s costs can be much higher, because they also include the real estate broker’s commission. You will receive a good faith estimate that will list the closing costs, so you will know about how much you have to pay.

At the closing, you will need to bring a certified check for the down payment and closing costs, minus your deposit. The important thing to remember is that closing costs are negotiable and a motivated seller may be willing to pay some of your costs. But, they may expect a higher price for the house. If you are short on money for closing costs, this may help.

Buyer’s Closing Costs

Loan Origination Fees (points)
Loan Application Fee
Home Appraisal
Credit Report
PMI – Private Mortgage Insurance (if less than 20% down)
Escrow Fees (1/2 each)
Title Insurance (buyer, seller or 1/2 each)
Prepaid Interest & Insurance
Home Inspection (Optional, but recommended)

Seller’s Closing Costs

Real Estate Broker’s Fees
Title Insurance (buyer, seller or 1/2 each)
Recording Fee
Transfer Taxes
Escrow Fees (1/2 each)
Prorated Property Taxes
Pest Control Inspection & Remediation
Home Owner’s Association Transfer Fees
Home Warranty Plan (Optional, but recommended)

Note: Closing costs and who is responsible for paying them vary. Not only are these costs different in every state, they often vary by county.

Creative Transactions

There are many kinds of creative property transactions, including short-sales, wrap-around, seller financing and property auctions. I generally don’t recommend these types of creative transactions to novice buyers, unless you are assisted by a professional. Many of the properties selling right now are foreclosures and short-sales. And, a buyer can definitely get a good deal. But, they can also get tied up into a mess, since many of the recent foreclosures may have been processed illegally. My advice is buyer beware.

The Bottom Line

The bottom line is that buying a home is a complex and perilous journey. The difference between getting a good deal and getting taken to the cleaners is in knowing how the process works, before you start looking.

“Don’t stretch yourself too much with a mortgage. Buy within your means.. it’s not worth the sleepless nights.”

Sarah Beeny – Host of the TV Show Property Ladder

Real Estate 101 – Market Dynamics

Bret — Sun, 08 May 2011 18:33:55 +0000

Real estate can be a positive lifelong investment or it can be a financial nightmare, depending on who you talk to. Often, the difference comes down to a couple of market factors that must be evaluated carefully, before the decision is made to buy. Thankfully, this is pretty simple stuff, even for first-timers.

This is the second in a series of four posts on real estate.

Real Estate 101 – Renting vs. Owning
Real Estate 101 – Market Dynamics
Real Estate 101 – Purchase and Finance
Real Estate 101 – Investment Property

Timing is Everything

Image by Woodley Wonderworks

Here in California, there are three things you can always count on, sunshine, earthquakes and the real estate market crashing. It seems to happen about once every decade. The only difference between this crash and others in the past is the mania spread all over the country. Some of the markets are even worse off than ours. People who bought recently in Phoenix and Las Vegas are completely upside-down and their local market probably won’t recover for a decade. Many have chosen to walk away and rent for a while.

Everyone I know who says real estate is a bad investment bought their house within the past couple of years. Anyone who bought a house 15 years ago probably thinks it’s the smartest thing they have ever done. Timing can be one of the biggest factors that determine whether any investment pays off. And, real estate is an awfully big investment. So, when it comes to buying a house, you want to be more like Warren Buffet than Nicolas Cage.

What is a House Worth?

So, how do you know if you are getting a good value in a house or you are buying at the top of the market just before the collapse? It’s really no different that stocks, gold or any other commodity. There is a fundamental value of housing and that doesn’t change. Speculation, interest rates, access to credit and many other factors can make housing prices rise and fall. But, in the long-term, they always return to the mean.

Housing prices are based on income and the ability to qualify for a loan. Whenever housing prices rise and real incomes don’t there will be a correction. This is measured by the Median Home Price to Median Family Income Ratio. Historically, this ratio has been around 2.7. So, if the median family income in an area is $100K, the median price of a house should be around $270K. At the peak of the real estate bubble, this ratio had risen to around 4.6, which wasn’t sustainable. Since the crash, it has settled in around 3.5, which is reasonable, considering the very low interest rates.

Location, Location, Location

Any good real estate agent will tell you location is one of the biggest factors in determining the value of a house. There are many reasons for this including the crime rate, quality of schools and proximity to jobs, shopping and other resources. There are desirability factors, such as natural surroundings and the weather. That is why some areas such as LA, San Diego and Honolulu are consistently low on the affordability index.

Here is another huge factor in a property’s location that agents rarely discuss; the value of properties sold recently affects the value of all properties in the area. A couple of foreclosures or short sales on a block can devastate the property values and make it very difficult to qualify for a loan. So, a buyer may have to come up with a bigger down-payment and they would be buying a house for more than its appraised value. This leads to the common advice, “buy the cheapest house in the best neighborhood you can afford.”

Every Market is Different

Different regions of the country each have their own unique market conditions. Popular locations in the Sun Belt, such as California, Nevada, Arizona, Texas and Florida have seen very rapid growth. Unfortunately, this caused the housing prices to skyrocket, which led to more foreclosures and much sharper declines in the prices. But, they will likely boom again, in the future. Areas that are losing population, such as some agricultural areas of the Midwest, have seen slow but steady declines in property values. These markets may never recover, unless new residents move there to create a demand for the housing. In fact, some municipalities are giving away houses for free, just to keep the schools open.

The biggest regional factor has to do with jobs and opportunity. Rust Belt cities that once provided hundreds of thousands of jobs during the industrial revolution are now areas of economic stagnation. States such as Michigan, Ohio, Pennsylvania, West Virginia and Upstate New York are losing population and their median income is dropping. High crime and urban blight chase away the middle class couples that create a future demand for properties. If you have a solid job and live in one of these areas, you may be able to get a great deal on a house. Just don’t expect it to appreciate in value.

The Bottom Line

The bottom line is that buying a house is no longer a sure thing. Market conditions dictate the future prospects for a property. So, it’s critical for everyone to understand these factors before they buy.

“Don’t buy the house; buy the neighborhood.”

Russian Proverb

Real Estate 101 – Renting vs. Owning

Bret — Wed, 13 Apr 2011 04:06:09 +0000

One of the common themes that get kicked around the financial blogosphere is the debate between buying and renting a place to live. Recently, there has been a rash of posts depicting the horrors of home ownership, warning others to avoid it like the plague. But, is this seasoned advice from people who understand the housing market? Or, is it bitter criticism from people who made an untimely investment? The truth is probably a little of both.

This is the first in a series of four posts on real estate.

Real Estate 101 – Renting vs. Owning
Real Estate 101 – Market Dynamics
Real Estate 101 – Purchase and Finance
Real Estate 101 – Investment Property

How you Live is a Personal Choice

Image by National Acrobat

The decision to rent or buy is often based on personal reasons that favor one approach over the other. I never make blanket recommendations that people should rent or buy, because everyone’s situation is different. In life, most important decisions are made with the heart, not the wallet.

I’m a middle-aged guy, with a family and a stable career. I love where I live and have no intention of moving. So, buying a house was an easy choice for me. My brother owns a house down the street and the rest of our family lives within a short drive. My wife has pets, chickens, tropical plants and a vegetable garden. I have motorcycles, trailers, a truck and I want a motor home. We love our property and could never go back to renting.

On the other hand, I have friends who are happy renters. One is single and he often relocates for work. He is close to retirement age and most of his money is tied up in retirement accounts. It would be foolish to raise his cost of living and undertake a mortgage at this point in his life. Others I know have recently lost their houses and they no longer want the crushing pressure of debt.

Common Myths & Misconceptions

“I save a lot of money by renting.”

Unfortunately, it’s not that simple. The cost of a fixed mortgage stays the same, while the cost of rent continuously goes up. When I bought my house 15 years ago, my neighbors thought we were nuts to pay $500 more per month to buy, instead of renting. Now, they pay more to rent their apartment than the mortgage payment on our house. After our house is paid off, they will be paying a lot more than us. We are headed into an inflationary environment, which heavily favors owners over renters.

“When you rent, you are throwing money away.”

Shelter is a commodity, just like copper, oil or soybeans. Whether you rent or buy, you have to pay for shelter. For some people, it’s much more practical and efficient to rent. For others, buying is the only way to go. I don’t regret all of the money I paid out for the 13 years I rented. I was young and lived right on the beach. I wasn’t ready for the responsibility of a mortgage. My income wasn’t high enough to afford a house. So, I saved up money for when the time was right to buy. And, I never looked back with remorse.

“You should buy a house for the tax deduction”.

The mortgage interest deduction is a terrible reason to buy a house. In my opinion, it’s more of a scam than a benefit. This tax break is widely publicized by the mortgage and real estate industries. But, unless you pay a lot of interest, it doesn’t add up. The standard deduction is so high now it’s harder to itemize taxes. Even if someone can write off part of the interest, it’s like giving the bank a dollar to get a dime back in taxes.

Disclaimer: I’m not a tax professional and the tax laws change and vary by state. Before making any financial decision for tax purposes, you should consult with a licensed tax professional.

Who is a Candidate to Buy or Rent?

There are dozens of complex issues surrounding the decision to rent or buy. But, the decision can be simplified by using a few basic criteria that make the choice seem obvious. Which of these conditions apply to you?

Better Off Renting

Have limited or sporadic income or employment
Desire the freedom to move, travel or relocate
Don’t want the expense or hassle of maintenance
Don’t have many pets or need a lot of storage space
Don’t have or want to invest a down payment
Want to live in an area where you can’t afford to own

Potential Owners

Plan to live in one place for many years
Have a stable income and predictable expenses
Have money put aside for a down payment
Want the freedom to customize their surroundings
Can absorb the cost of taxes and maintenance
Want more control over their lifestyle decisions

Looking into the Future

In the short-term, renting has a lot of financial advantages over buying.

Lower initial cost per month
No down-payment required
No property taxes or maintenance costs
It’s cheaper to move, without selling a house
Never owe more than a house is worth

In the long-term, the financial advantages shift toward ownership.

The payment on a fixed mortgage never goes up
It’s very cheap to live, after the mortgages is paid off
Housing values usually rise with wages and inflation
Owners can sell or downsize with tax advantages
A property can be rented or mortgaged for income
Owners can retire with predictable housing costs

The Bottom Line

The bottom line is that life is a series of trade-offs. Renting and owning both have their fair share. The decision to rent or buy has a lot more to do with a person’s goals and desires than with the math involved.

“The most critical factor subduing the demand for housing is that home ownership is no longer seen as the great, long-term buildup in equity value it once was.”

Mort Zuckerman – Real Estate Billionaire

Over a Million Homes are in Foreclosure

Bret — Sat, 14 Jun 2008 17:59:34 +0000

“Once again this quarter, the rate of foreclosure starts and the percent of loans in the process of foreclosure are the highest recorded since 1979.”
Mortgage Bankers Association

Here are the Grim Statistics

The delinquency rate on residential properties was 6.35%.
The percentage of loans in the foreclosure process was 2.47%.
Loans with foreclosure actions started this quarter were 0.99%.
The number of homes in foreclosure is around 1.1 Million

The Vicious Cycle of Foreclosure

Unfortunately, the foreclosures contribute to a breakdown in property values, as the market is flooded with vacant properties that must be sold. This drop in property values then causes more foreclosures as delinquent homeowners realize that they owe significantly more than their houses are worth. The temptation to just walk away increases as it becomes obvious that it is impossible to sell a house at market value in this environment. Soon, desperate For Sale signs plague the neighborhood and continue the cycle.

The Haves and Have-Nots

Surprisingly, even in this disastrous environment, most homeowners are just doing fine. Those with good jobs and good loans aren’t in much danger of defaulting. Unfortunately, for people in the mortgage, real estate, housing or construction industries, it’s going to be a bumpy ride. And, for people with adjustable-rate mortgages, the situation is getting desperate. Subprime ARMs represent only 6% of outstanding loans, but 39% of the foreclosures.

The Bottom Line

The bottom line is that opportunity is knocking for those who are thinking of buying a house or a rental property. These conditions are ideal for buyers and they won’t last forever. Even if you think you can’t buy a house right now, you may be able to buy a foreclosure property. Just don’t be like the previous owners and get in over your head. And, for god’s sakes, get a fixed loan if at all possible. Inflation is on the rise and interest rates are definitely going to have to be raised. They may need to be raised a couple of percent.

Top 10 Reasons to Buy a House

Bret — Wed, 26 Mar 2008 00:09:29 +0000

Everyone is down on real estate as an investment right now. But, this dismal real estate market is exactly what investors have been waiting for. And, it’s exactly what home buyers should be hoping for. Here is an affordable chance to purchase what could be the best investment you will ever make.

Some people will disagree with me. They may have woeful tales of broken dreams and lost properties. Others may declare that houses are a money-pit and recount every painful expense. They may suggest you don’t have to pay these expenses as a renter, but that simply isn’t true. All costs are factored into rent and passed on. If your landlord pays a large maintenance expense, count on the rent going up.

Basic Premise

This Top 10 list is based on the purchase of a house to live in versus renting. I won’t get into rental properties or commercial real estate, which have their own risks and benefits. It also compares an investment in a house with other common investments.

Recommendations

I believe in getting one good mortgage and paying it off. I don’t believe in refinancing, unless interest rates drop two percent or you shorten the loan by five years. I recommend against lease-options, flipping, wrap-arounds, property auctions or any other risky ventures, unless you are an experienced investor. You can get hurt in creative transactions of any kind and real estate is no exception.

So, without further delay, here is the list:

1. Leverage: Leverage is a double-edged sword. You can control a large financial asset for a small down payment. When the real estate market goes up by a few percentage points you can quickly double your equity. When the market goes down a few points, you can be completely upside-down. Since the long-term trend of real estate is positive, leverage is your friend.

2. Stability: Historically, real estate is a very stable long-term investment. There are low-demand areas that won’t appreciate much and high-demand areas that rise and fall dramatically. But over all, the real estate market is a steady long-term gainer. If you don’t think so, compare it to the stock market for the past 100 years. There are decades when stocks gained very little. I’m not just talking about the Great Depression. If you had bought stocks during the ’70s, you would have wished you kept your money in the bank.

3. Practical Use: You get to live in your investment. You can’t do that with precious metals, collectibles or financial assets. You may assume this just offsets the cost of rent. But when you own a home, you can do things renters only dream about. You can get a satellite dish, add a bedroom, remodel the kitchen or landscape the yard. Basically, you are the king of your castle, as long as you obey the laws and regulations. Here is another thought, no one can terminate your lease, keep your deposit or charge you for having a pet.

4. Fixed Costs: If you get a fixed loan and you don’t refinance, you can count on paying the same mortgage until your house is paid off. Your taxes and insurance may go up, but that won’t even dent your budget. Twenty years from now, your mortgage will be really cheap compared to everyone else’s.

5. Inflation Hedge: Inflation causes the cost of most items to go up every year. It also causes housing costs and property values to rise. So, you can rent and watch your housing costs go up. Or, you can buy and watch your property values go up, while your housing costs stay the same. Although, this was a bad year for property values, they will go back up in the next few years.

6. Real Assets: This is often overlooked, but very important. Real estate has real value, based on the land and the usefulness of the dwelling. Take it from someone who owns 2,000 shares of worthless stock. The prices of houses will rise and fall, but they will always have value as long as people need places to live. Paper assets, including our currency, have dubious future value.

7. Tax Advantages: Writing off your mortgage interest is huge. For most homeowners, you can pay more on your mortgage than you would for rent and still come out ahead, after taxes. And, you can usually write off your property taxes. Finally, you can do equity swaps or sell a property and keep some proceeds tax-free. No other investment offers you all of these tax advantages. You may have to pay an accountant to figure it out, but the tax benefits are worth the effort.

8. Collateral Value: Say you need a lot of money quickly for any reason. Let’s say you have the business opportunity of a lifetime. Maybe you are less fortunate and get sick or injured. The reason doesn’t really matter. If you have equity in real estate, you can borrow against it. And you can do it without cashing in your investment, moving out of your house or taking a hit on taxes. You can even borrow from one property to invest in another. You still have to pay the loan back. But, it’s nice to have options.

9. Forced Savings: Modern Americans are terrible savers and our personal savings rate is -1%. I’m not saying that a house is the best way to save money, but it definitely forces you to save. You have to pay the mortgage, if you want to stay in the house. And, when you make the payment, some portion goes right into your equity.

10. Live Frugally: This is my favorite point and that’s why I saved it for last. Once your mortgage is paid off, you only have to pay taxes, maintenance and insurance. I’m still about 10 years away from paying off my house, but I am literally counting down the months. Once my house is paid off, I could live comfortably on a fraction of my current income. Then, I can think about travel, mini-retirements and everything else I want but can’t afford.

The Bottom Line

If you are still renting, you may finally have an opportunity to buy a house for a cost that is close to rent. That just wasn’t possible in California or any other hot market a couple of years ago. Don’t let anyone discourage you from living “The American Dream” because you deserve it. Clean up your credit, save that down payment and take advantage of the market collapse. This opportunity is going to disappear in a couple of years. Then, you will have to pay a lot more to buy your dream home.

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Worst Financial Advice Ever

Bret — Mon, 03 Mar 2008 03:56:43 +0000

Here is the worst financial advice I have ever heard:

“It’s better to rent instead of buying a house and then you can invest the difference in the stock market.”

Logic Behind the Advice

Often, this advice comes from someone who has “Run the Numbers” and determined mathematically that you will be ahead if you invest the difference between renting and owning in the stock market, instead of investing in real estate. This advice is even more popular in a dropping real estate market, like we have right now. On the surface, this argument may sound convincing. If the historic returns of the stock market exceed the historic return of real estate in your area, then why wouldn’t you be ahead?

Errors & Omissions

Invariably, this bad advice is based on a number of important factors, which have been naively or conveniently omitted. Factors such as leverage, taxation, inflation, appreciation and local market conditions all play a huge factor in long-term investments and they usually benefit the investment in real assets over financial assets.

Special Circumstances

It’s easy to point out housing markets like Detroit or Philadelphia and argue that real estate is a bad long-term investment. The same could be said for the people who recently bought in market bubble areas, such as Florida, California and Nevada. But, if you look beyond these special circumstances and consider the overall market from a long-term perspective, real estate has consistently outpaced inflation and will likely continue to do so well into the future. Barring some spectacular catastrophe in the economy or the population, there will definitely be a future demand for prime American property.

Death by Taxes

Everyone’s tax situation is different and the interest deduction from a house will vary greatly, based on your income and deductions. One thing is fairly certain; your tax benefit from purchasing a property will greatly exceed your renter’s credits. And, since you pay for housing in post-tax dollars, you will have to earn $1.30-$1.50 of income for every dollar of housing costs. So, why pay extra taxes to the Government, when you can invest it in your house or some other worthy goal.

Interest & Inflation

Interest and inflation may seem like a small percentage, which doesn’t add up to much. But, over the course of an adult lifetime, they can compound into a significant factor. It’s been my experience that rent and housing costs seem to double every 10-15 years.

Soon after you buy a house, a couple of magical things start to happen. First, your mortgage payment stays roughly the same, while everybody else’s rent keeps going up. Second, your interest expense keeps going down, and more of your mortgage payment goes back into the principal. This assumes that you get a good fixed mortgage and you don’t keep refinancing your house. As time goes by, inflation and interest start to work in your favor, because your house is gaining value at the same time your loan is shrinking.

Retiring in Style

Nothing in the financial realm terrifies me as much as paying rent or a mortgage from a fixed income, when I retire. The real goal of buying a house should be to pay it off completely before you reach retirement age. Then, you can retire in style and spend your housing money for recreation. You may still have to worry about your property taxes and insurance going up, but that’s nothing compared to the future price of rent.

I can almost guarantee you that anyone who has supposedly “Run the Numbers” hasn’t calculated how big of a nest egg it will take to pay rent fifty years from now after getting taxed on the proceeds from their IRA account or 401K plan. And if they have, I would be very curious how they calculated the future cost of rent.

I’ll make it easy and “Run the Numbers” for you. I’m 43 years old and live in California. My retirement age is 67, which happens in the year 2032. Estimating that rents will almost double twice in the next 24 years, rent will cost around $6000 per month for a small apartment. That means rent will cost $72,000 per year after taxes, so it will take $100K in income, just to pay the rent. And then, the cost will almost quadruple again, during my life expectancy. If you are younger than me, then it will cost you even more.

The Bottom Line

The bottom line is that bad financial advice is everywhere. Many people weren’t taught sound financial principles nor do they have the discipline to stick with a financial plan that makes sense. People working in the mortgage, real estate or financial services industries, may have an incentive to recommend products or investments that benefit themselves and their employers, instead of you.

Any financial advice that is based on convenience, risk or gratification probably isn’t going to work out too well. Stick to the proven methods of building wealth and you will be rewarded in the future.

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Avoiding Foreclosure

Bret — Sun, 23 Dec 2007 19:34:06 +0000

Are you Struggling to Pay your Mortgage ?

It is estimated by the Center for Responsible Lending, that 2.2 million homes with subprime loans may be lost to foreclosure in the next few years. That’s 1 in 5 subprime mortgages that are projected to end in foreclosure. And, if the economy falters, it could get worse.

If you are one of those in trouble with your mortgage, it may seem overwhelming. But, don’t give up hope just yet. Unbelievably, banks, mortgage servicers and the Government are all working together to help keep people in their homes.

New Sources of Help

Banks are quickly figuring out that it’s cheaper and easier to relax their hostile standards, then to take on a bunch of foreclosures in a dropping housing market. So, if you are willing and able to keep making your payments, your bank may suddenly seem very eager to work with you. Give them a call and explain your situation.

After a dismal failure in effective regulation, the Government is stepping up it’s game. Senator Christopher Dodd has introduced S.2452, the Home Ownership Preservation and Protection Act of 2007. This may be of little help to current borrowers, but it may help a lot in the future. Effective consumer protection in mortgage lending is way overdue.

Many of the States are way ahead of the Federal Government in providing relief. There are hot-lines, websites, task forces and new legislation designed to curb foreclosures. The States are starting to understand that they are going to be big losers in this housing crisis. As foreclosures rise and property values drop, the States are projected to lose billions in property taxes. And, raising other taxes on strapped constituents, won’t be very popular.

Foreclosure Help Resources

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The Subprime Meltdown

Bret — Wed, 05 Sep 2007 07:07:24 +0000

Ok, so I’m late to the party.

Every blogger, pundit and reporter has already been waiving their arms around for weeks now, trying to get their 15 minutes of fame from the subprime fiasco. Never mind that most of these hacks never saw it coming. It’s big news right now and everyone is chiming in, with thoughtful analysis.

So what could I possibly have to add?

The biggest issue if there ever was one, is the Opportunity. Yes, that’s right. This is a golden opportunity, carefully disguised as a total disaster. For two or three years now, I have been telling everyone who would listen to save money and they would have a great opportunity to buy property. Unfortunately, sound financial advice isn’t always popular. Especially, if it requires cutting back on spending in order to save money. But, here it is. The opportunity to pick up a house for prices not seen in years. And, it’s getting better daily.

The Dynamics of the Meltdown

So, how did I predict three years ago that real estate would crash?

Personal consumer debt had tripled since the ‘90s
Housing prices rose by double-digits, while real income was flat
Interest rates were historically very low and bound to go up
An unusually high number of houses were non-owner occupied
Mortgage regulation and underwriting standards were abandoned

Look, anyone paying attention could have seen this coming. When flippers are on TV with their own infomercials and your neighbor takes out a second to buy an H2, its last call at the party. It’s only a matter of time before the pros cash out and the amateurs get hurt. Doesn’t anyone remember the ‘80s?

The Victims

Unfortunately, in the cold hard world of finance, one person’s misfortune is often another person’s opportunity. Now, don’t get me wrong, I feel absolutely terrible for anyone who is losing a home. This has to be devastating to the affected people and their families. But, there is an immutable law of borrowing; that you have to pay money back. I truly feel sorry for anyone who got stuck with a rotten loan. But, keep your chin up. It’s not the end of the world. You may be able to rebound in a few years, with an affordable house and a stress-reduced mortgage.

The Scoundrels

Public enemy number one has to be the Mortgage Brokers. These smooth talking, bait and switching, commission-mongers are currently the poster child for all that is evil in the world. Are all mortgage brokers bad? No, of course not. But there are certainly enough bad brokers to give the industry a black eye.

Public enemy number two has to be our Government. You may have noticed that Congress and the President are suddenly “concerned” that people are losing their homes. And, regulators are pointing fingers faster than a downtown traffic cop. It’s amazing how poorly our Government serves the public interest.

Rounding out the top-four are Investment Banks and Hedge Funds. They seem to have invented a new way to profit, called a CDO, or a Collateralized Debt Obligation. This is just a nifty new way of packaging up non-conforming loans and selling them to Hedge Funds who speculate with your money. If you didn’t get stuck with an exploding mortgage, you may have seen your savings disappear.

The Bottom Line

No matter what anyone tells you, the cost of housing is based on the consumer’s ability to pay the loan. A young couple just starting out most likely can’t afford the mortgage on a $600K house. So, even if they qualify with a “liar loan” or a teaser rate, they probably won’t be in the house for long. That’s why houses aren’t selling and they won’t start selling until the prices come way down.

Hope to Prosper » Real Estate

Real Estate 101 – Investment Property

The Economics of Investment Property

Finding Properties to Invest In

Money is Made or Lost in the Purchase

What Makes a Property Suitable?

Market Conditions

The Bottom Line

Recommended Reading

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Real Estate 101 – Purchase and Finance

Real Estate Agents

Getting a Mortgage

The Purchase Offer

Escrow Account

Title Search & Insurance

Closing Costs

Creative Transactions

The Bottom Line

Recommended Reading

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Real Estate 101 – Market Dynamics

Timing is Everything

What is a House Worth?

Location, Location, Location

Every Market is Different

The Bottom Line

Recommended Reading

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Real Estate 101 – Renting vs. Owning

How you Live is a Personal Choice

Common Myths & Misconceptions

Who is a Candidate to Buy or Rent?

Looking into the Future

The Bottom Line

Recommended Reading

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Over a Million Homes are in Foreclosure

Here are the Grim Statistics

The Vicious Cycle of Foreclosure

The Haves and Have-Nots

The Bottom Line

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Top 10 Reasons to Buy a House

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Worst Financial Advice Ever

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Avoiding Foreclosure

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The Subprime Meltdown

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