Want to Make Money in Real Estate? Understand Returns

Most people purchase real estate in hopes of earning wealth from their purchase, just as they would with any other investment asset.

However, real estate is unique in that it has four distinct components of investment return.

Essentially, here are the four ways you can make money as a result of real estate ownership:

  • appreciation in value
  • cash flows
  • income tax benefits
  • mortgage principal pay down

make-money-in-real-estateIt’s important to note that just because there are several components of returns, that does not mean you will earn money on real estate investments.

Many people lose money due to insufficient research and analysis, as well as through unmitigated risk issues. Do your homework before investing in real estate.

Appreciation in value

Most people buy investment properties with the thought that “it will appreciate in value and I’ll get rich.”

If the past six years have taught us anything, it is that real estate doesn’t always go up on value.

However, over long periods of time, say 15 to 25 years, real estate seems to perform well and has earned much wealth for many long-term holders.

Be aware, though, that appreciation does not pay the bills. It is better to invest based on cash flows, the next noted component of returns.

Cash flow positive

Most real estate investors do not understand how to pencil out their real estate deal. What this means is putting conservative estimates of rents and expenses down on paper and making sure that the rents, less all the expenses, leave the owner some cash in the bank. We call these “cash flow positive” properties.

Buying properties with true positive cash flow is the best way to ensure that your investment will add to your wealth. Far too many buyers purchase negative cash flow real estate and take additional monies out of their bank accounts each month, for years, to cover the deficit. That is no way to invest your hard-earned capital.

Income tax benefits

There are potential income tax benefits from owning rental properties. “Benefits” means that as a result of your ownership, you pay less in taxes than you would have if you did not own the property. Unfortunately, few investors really understand how this works.

If you are self-employed and pay little in taxes or you have income greater than $150,000, you probably have little tax benefit from your real estate ownership. Before you start banking on the tax benefits you’re going to get from a real estate investment, consult with a tax pro who can tell you whether or not you will actually save a dime.

Mortgage principal pay down

If you have an amortizing mortgage – which most are these days — you may realize some return. Each monthly mortgage payment pays the accrued interest, plus a little bit of the outstanding principal of the mortgage. That principal is pure investment return and it can really super-size your returns.

However, principal pay down does not provide cash flow, so it can’t help pay the bills if you need money for a plumber, electrician or handyman.

While all the investment returns may help your long-term wealth, the cash flow component is the most important. Cash feels nice in your hands, it pays the bills and, most importantly, it accumulates in your bank account and earns interest.

If your investment doesn’t generate cash, you won’t be able to pay the mortgage, you’ll likely lose the property and you’ll never realize the returns you’d hoped for.

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Rent It Out or Sell It? Options for a Home You No Longer Love

You might be one of the countless homeowners who’ve fallen out of love with your current home.

Maybe it’s the general area, the neighbors or the house itself.

3D red glass houseOr maybe the “dream” of homeownership has become a nightmare for some reason.

Regardless of your situation, push has come to shove, and it’s time to make a decision on where to go from here.

Your choices are to keep the house as a rental property for investment purposes or sell it and maybe buy elsewhere. Answering the questions below should help you decide which route is best for you.

Do I have the money to purchase another property if I hold this one?

When you purchase a home you need to have enough cash for a down payment and closing costs, plus funds for moving expenses and associated costs. A 20percent down payment is ideal because you’ll avoid paying private mortgage insurance (PMI). 

Therefore, take a look at your savings.

Do you see enough cash to be able to put down a hefty chunk of change on a new property? If you don’t, it’s probably best to sell your current property, and hopefully that will generate the cash needed to put down a large down payment on your new home.

Do I want to be a landlord?

Yes, all the TV shows make it look like owning property is fun and doesn’t take up too much of your time, energy and effort. Unfortunately reality TV isn’t reality rental property investing.

You do have the good fortune that your current home is probably already in good shape, so at least there won’t be a lot of money out of pocket to make it rental-ready. But you will still have to educate yourself, obtain leasing documents, advertise and show the property and screen prospective tenants.

It really can take a fair amount of time, so is that within your interest? Alternatively you could have a property management company handle it, but that would wipe out a lot of your potential wealth generation from the property.

Would this property even be a good investment?

Good real estate investments are cash-flow positive and provide a fair rate of return on the equity you hold in the property.

Will the rents less all the expenses and mortgage be positive? If the answer is no — and this is often the case — that particular property probably isn’t a good investment.

Talk to your financial adviser or accountant and ask for help penciling out your real estate deal based on the cash flows and current equity in the property. Once you figure out your current investment returns — free cash flow divided by your equity — you can compare those returns to other investments.

Maybe it’s better to invest elsewhere

If you could sell and generate a large chuck of change, like $100,000 or $300,000, you could invest that money elsewhere. Considering the risk factors for real estate, a well-diversified large capitalization stock mutual fund, with long-term returns of 7-9 percent per year probably is a better deal than owning real estate.

Note: As an added bonus on financial assets, no mutual fund has ever had a clogged toilet that flooded the house.

Those are some items to consider just to get into the landlord game. If none of those look appetizing related to your current home, sell it! Then you can decide whether to take a step back and rent for a while or try to find a new home and not repeat the home buying mistakes of your past. Good luck!

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The Ins and Outs of Homeowners Associations

The Ins and Outs of Homeowners Associations-Professor-BaronAbout 20 to 30 percent of home buyers purchase properties within common-interest developments, commonly referred to as homeowners associations (HOAs).

Before weighing the pros and cons of owning a property in an HOA community it’s important to understand what HOAs are, how they are governed and how they affect a homeowner’s bottom line.

Here are some basic facts home buyers should know.

What is a common-interest development?

In a common-interest development individual owners typically share some parcel and the buildings on that parcel as co-owners. A common-interest development would generally be a condominium building, a town home community or lofts, or could be a single-family home community, private neighborhood or other similar arrangement. Buyers in the development or building agree to live by the community rules and regulations.

These regulations mean that as an owner you have certain rights and restrictions as outlined by development documents commonly called CC&Rs (covenants, conditions and restrictions). The CC&Rs govern your allowed ownership, use and behavior at the property — everything from use of your unit to parking restrictions, insurance, architectural rules, paint colors, storage of RVs or boats, pets, allowed inhabitants and more. These rules and regulations can be changed, subject to approval by a majority of the owners.

How are HOAs governed?

To interpret and enforce the rules and regulations, most HOAs elect a board of directors who follow the regulations of the community and make prudent financial and operational decisions. As an owner, you get to vote for the board members (this process is usually outlined in the community bylaws).

However, most owners in a typical community don’t go to board meetings and don’t get involved in the operations of the community. And that’s fine, as there’s no requirement for an owner to vote or otherwise be involved. Most owners only show up to meetings when HOA fees are raised or if they are affected by a particular issue. Keep in mind though, if you have an issue or disagree with a restriction in your community, you should attend the board meetings and work with the HOA toward finding a solution that the majority of owners can agree with.

Are there financial risks with HOAs?

HOAs are nonprofit organizations, but their complex financial and legal operations can sometimes cause owners significant financial pain in the form of unexpected dues increases and special assessments. Unfortunately, few buyers know how to evaluate HOA documents ahead of time, which could help mitigate the considerable risks.

Many people don’t like having to follow rules and decide to avoid living in an HOA-governed community altogether. But don’t forget, the HOA makes sure your neighbors don’t park cars in their front yards and/or that a neighbor doesn’t paint a house pink or carry out other nuisance behaviors — any of which could easily occur in an area not governed by an HOA.

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6 Renovation Tips for New Landlords

If you’re new to investing in real estate, you’ll probably be really excited when you close escrow on your first purchase.

6 Renovation Tips for New Landlords-Professor-BaronThat’s great because real estate investing can be a very good way to improve your long-term wealth picture. However, if you are an average real estate investor — as 99 percent of us are — that excitement will turn quickly to the realization that a lot of hard work is coming to your plate, especially when it comes to renovating your new investment property.

Here are some items you should be aware of so you can better prepare for your future as a real estate mogul.

Budget money and time wisely

As your closing come close, you are probably putting together a starry-eyed list of all the improvements you’re going to make on a shoestring of a budget. Of course the repairs will also be completed in 30 days so you can rent the property out and start earning some income. Not going to happen! Once you get going and realize improvements cost much more than you thought and take longer to complete, you’ll be doing some major revisions to your estimates. Be cautious when estimating a low-priced and quick-turnaround renovation, as that rarely ends up being the case.

Expect to invest your sweat equity

To better educate yourself and minimize budget overruns, plan on spending a lot of time at the property from the day you close escrow until about one month after it is occupied by renters. Why? Because it’s a lot of hard work — getting bids, waiting for deliveries, reviewing work, doing work, shopping for supplies (and more supplies), advertising your property, reviewing rental applications. You’ll be doing it all at your new property. It may start out fun but will not end that way; however, you are in this for long-term wealth building, and that’s why you are willing to invest your time and energy in hopes of a better retirement.

Don’t take the first bid

You must get several bids to ensure that you’re getting a fair price for any contracting work. The more expensive the job, the more bids you should get. This is going to be exhausting and time consuming. However, doing your legwork can lead to better and/or less expensive bids in the long run.

Focus on paint and flooring

If the paint and flooring in your property don’t look nice — and they usually don’t — fix them! It’s going to cost some money, but hopefully you’ll get a little more rent when you make these improvements.

Use a bright and neutral color, and paint all the walls the same color and sheen. When you have to do touch-ups down the road, it’s nice to just have one color in the property, and you can always have a can of that color on hand.

Your flooring options include carpet, tile, wood laminate and vinyl. Tile is best for kitchens and bathrooms due to water and moisture issues. Wood laminate is best for elsewhere due to its durability and easy cleaning. Carpet is not good for rentals as it stains easily, and every new tenant wants new carpet. Shop around: You can find some good laminate deals, and it’s relatively easy and inexpensive to install.

Check for plumbing and electrical issues

Properties that are more than 20 years old usually should have the water valves and electrical outlets replaced. So round up a few plumbers and electricians and get some bids. Do this while the property is empty. Water valves, supply line hoses, washing machine and dishwasher hoses and drains pose the biggest leak and flood risk. Change them all out. Electrical outlets and covers are not as big a risk, but usually look really bad with many coats of different color paint on them. An electrician can change out a whole house of outlets and on/off switches in half a day or less.

Don’t go for the lowest-priced supplies

When you get bids and are reviewing costs at a home improvement store, don’t just pick the least expensive supplies. Those items will never stick when you are actually making the decisions on what to contract for and purchase for your rental. You’ll end up buying the more expensive stuff, creating a budget headache that could have been avoided.

These basic tips should be supplemented with your investigation and seeking guidance from experienced real estate investors in your area. They’ll have other good advice, too. Just don’t think being a real estate investor is an easy walk in the park. It’s more like a marathon in the hot sun with a lot of hard work. But this hard work and determination will make your eventual success even more rewarding!

Have questions? Just leave me a comment below and I’m happy to help you!

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Are You Wasting Money Renting?

are-you-wasting-money-rentingPeople generally buy property in hopes that they will be better off financially down the road than if they did not buy property. However, for many people, it’s better to skip property ownership and stay a renter – at least for a while.

If you find yourself in any of the following scenarios, you may be someone who is better off as a renter than a homeowner.

Scenario 1:

Whether you buy or sell a home, real estate has significant transaction costs. If you want to come out ahead financially, the value increase of the property you buy has to be more than the total transaction cost of the deal.

The chart below shows a two-year ownership scenario with the property going up in value 3.5% per year – a healthy projected increase in value – and then taking out typical costs on the buy and sell. Notice how the owner put in $35,000 to buy and is left with only $25,440 in the bank after two years. Look at all those transaction costs, $5,000 + $8,560 is $13,560 or 13.5% of the $100,000 purchase price.

It is clear to see that this person would be better off financially after a couple of years if they stayed a renter.

This doesn’t even account for all the money this owner may have paid for upgrades such as new flooring, landscaping, and appliances — things that will not add much value to the property. The current owner will never get to enjoy them, but the next owner certainly will.

Who should avoid ownership? A few groups that should really think hard before they buy are military people and professional athletes. Both of these groups move often and in general would most likely be much better off to stay renters until they are settled in a city where they are sure they will be staying for a long period of time. Additionally, parents considering buying properties for their college students to live in during school will be probably end up being a short-term ownership situation – skip the hassle!

Five years is typically the break-even point where it probably is better to own over renting, but again depends on the difference between the cost of renting and the cost of owning.

Scenario 2:

On a monthly basis, it is almost always more expensive to own, but let’s just talk about when it’s expensive to own on yearly basis, which is most often the case in areas where there is plenty of nearby land to build upon. This is common in revitalizing downtown areas where cities construct  luxury condominium projects, and there are still many lots available for building additional properties, as well as a glut of vacant or rental properties.

It probably makes sense to consider staying a renter in those areas, because rentals are widely available and most likely more affordable. You might be paying an extra $750 per month or $9,000 per year for the “pride of ownership.” Year two as an owner may still have $8,750 more in costs than if you rented, year three could cost $8,500 more to be an owner – and these costs add up each year! You could be in the “red” for ten years, adding up to $60,000 to $70,000 or more to your costs. Your hope would be that the appreciation in value would compensate for these huge cumulative annual negative amounts – but the odds are against you.

Staying a renter is the best choice for many people, and for many, renting does not equate to throwing money away. If you want to purchase real estate, consider the surrounding area and rentals, and make sure you own the property for at least five years or more to recoup costs.

Your best chance of increasing your wealth through real estate ownership is buying property that suits your wants and needs and to hold it for a long, long time — the longer the better!

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Do You Understand Income Tax Considerations of Rental Properties?

A rental property can generate “taxable losses” that can be used to reduce your normal salary income, hence the federal income taxes you pay.

Do-You-Understand-Income-Tax-Considerations-of-Rental-PropertiesIt’s difficult for most people to understand how taxes work, and even more confusing once we get into the realm of rental properties and taxes. Note that understanding how taxes impact personal residences are a completely different topic, as those are governed by totally separate tax codes and go elsewhere on your 1040 form.

Below are some of the basics to understanding rental properties and federal income taxes.

Often I hear people saying that they want to buy some real estate to save money on income taxes. However, depending on your tax situation, owning real estate might not save you a dime on taxes. It wholly depends on your specific tax picture and the IRS rules about Passive Activity Loss Limitations.

First and foremost you should never make real estate investment decisions based solely on tax considerations. The first order of business is do your due diligence and determine if an investment makes sense based on cash flows, cash on cash returns, renovation costs, rental income, financing, and the risk of any particular property. Once you believe it makes sense in every other sense, then you can contemplate the tax effects.

Important note: Always have a CPA, attorney or licensed tax professional guide you through your individual tax picture — this article is an illustration of one scenario but your scenario can be very different based on your financial picture.

To better understand, let’s first quickly discuss the IRS 1040 form.

The 1040 form you fill out each year does two things:

  1. Calculates the amount of federal income taxes you owe for the year based on how much you earned in salary, income, wages, profits and distributions — LESS all the deductions (tax “shields”/subtractions) to those totals in the form of losses, deductions and exemptions to get to your Taxable income on Line 43. Then, look at the IRS Tax Tables and determine how much you owe in taxes based on your tax filing status (Single, Married Filing Jointly, etc.) and your Taxable Income.
  2. Second, it reconciles the amount you owe from #1 above against the amount you have already paid during the year. This is commonly called “withholdings” from your salary, or if you are self-employed, you probably paid quarterly estimated income tax amounts to the IRS during the year.
  • If you paid more in #2 than you owe in #1, you get a tax refund!
  • If you paid less in #2 than you owe in #1, you write the IRS an additional check!

Tax Considerations of Rental Properties

Rental properties generally show taxable losses for the first many years. That taxable loss is essentially another “deduction” that lowers your taxable income — noted in #1 above — and hence lowers your income taxes.

This chart below shows an example of how a loss would be calculated. For example, this property might show a ($7,500) loss. That loss would filter through your IRS 1040 form, reducing your taxable income, and hence reducing your taxes.

This is how you might save money on taxes by owning rental properties — using losses on your rental real estate to reduce your taxable income, which allows you to pay less in federal income taxes.

How much it reduces your taxes depends on your income and filing status. It is a little complicated and can get very complicated depending on your situation.

There are also limits on how much of a loss on rental property any particular taxpayer can use to “shield” their income. These limits are called Passive Activity Loss Limitations. If your losses are over $25,000 and/or your Adjusted Gross Income is over $100,000, you may not be able to use all of the losses. You may have losses, but you are not allowed to reduce your income with them based on the IRS rules. Consult a professional.

Have questions? Just leave me a comment below and I’m happy to help you!

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Should You Buy a House with Seller Financing?

So, you want to buy a home with the seller financing the deal.

Generally, this is not a good idea for many reasons. Mainly, if there is anything we have learned in this ongoing recession, it is that contrary to the thinking of past years, people do often lose money in real estate. To avoid that, people should buy the RIGHT property that fits all the RIGHT reasons that they want to own real estate and a particular property.

Why It’s Not a Good Idea to Buy a Seller-Financed Home:

Should-You-Buy-a-House-with-Seller-Financing1. Not credit-worthy — Buyers who are interested in seller financing are often people who cannot get traditional long-term, low-interest financing because they have some credit issues. For these people, the bank is telling them that they are not currently creditworthy. These people should generally avoid making large, risky purchases like real estate where they may get in over their head. They should instead work hard over the next few years to get into a creditworthy position where traditional financing is available.

2. Not the right property — To add to issues for buyers, seller-financed houses make up a very very small percentage of the overall real estate market. There might be 1-3 seller-financed houses for every 100 for sale. With those odds, the chances of a seller-financed house being the RIGHT property for a particular buyer for all the RIGHT reasons is very low. So don’t buy, just to buy!

3. Not a good deal — In addition, many seller-financed deals are properties bought for cash by investors who are selling them to inexperienced and non-creditworthy buyers at either above-market prices, or above-market financing rates on short-term loans, or both. And that is a recipe for getting the buyer into deeper financial problems and losing the property just a few years down the road.

When You Add Up 1 + 2 + 3 You Have a Buyer Who:

  1. Isn’t really in the financial position to buy real estate,
  2. Is going to buy a house that probably doesn’t really match what they want and need
  3. Is possibly paying an above-market price and above-market interest rate on short-term financing.

Even a first grader can add up those numbers and realize it’s simply not a good idea.

Traditional Sellers/Owners with Mortgages

There are also seller-financed deals called “all-inclusive trust deeds” and “wrap-around financing.” Both of these are basically sales where the existing mortgage stays in place and the seller offers some additional financing behind the first trust mortgage deed. In almost all cases, this violates the existing mortgage agreement’s “due on sale” clause. While many people have done this, it just isn’t a good idea for a buyer to get involved in one of these situations. The buyer is taking on a lot of additional risk and potential problems down the road.

What If You Are the Seller?

For a traditional owner trying to sell a property, or a less experienced investor, you are selling a property to someone who the bank has deemed not financially able to buy real estate. Remember the term “subprime mortgage?”  We do not hear that term any longer because banks were burned badly on subprime loans and they are no longer issued. A seller needs to understand that there might be a little additional risk in trying this strategy.

Final Word:

This is not to say all seller-financed deals will fail. It just means chances are slim that it is going to be a fair deal for the buyer and a safe deal for the seller. In most cases, there are better courses of action for all parties.

If you are going to do one of these, make sure to get adequate legal advice. The rules, laws and disclosures on financing are extensive and if you do not properly dot your I’s and cross your T’s it could become major trouble down the road.

As always, spend your time finding the RIGHT property that works for you for ALL the reasons you want to own property and that particular property. And for the long term.

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Homeowner’s Insurance: Do You Have the Right Type and Amount of Coverage?

With all the hurricanes, forest fires, even an earthquake on the East Coast in the recent past, now is a good time to start paying a little more attention to the homeowner’s insurance coverage you carry on your property.

Most people select their homeowner’s insurance policy when they buy property and just pay the bill each year, giving little thought to keeping the proper coverage in place. Rarely do they understand, or even look at, their coverage in following years. And as long as they don’t have a loss, they don’t even notice. The problem is once you have a loss, it’s too late!

do-you-have-the-right-type-and-amount-of-coverageConsidering that your residence is probably your largest and riskiest investment, it really makes sense to better understand how insurance works to ensure you have the right type and enough coverage in place for your specific situation.

The objective of insurance coverage is to try to assist policy holders in avoiding major financial issues and disruptions to their lives if they have a loss. Insurance companies know that losses are generally predictable in total relative to a population of properties, but they are not foreseeable as to which specific property will incur the loss. You have insurance so that when that specific loss happens to you, the coverage will help ease the financial burden.

That loss could be a variety of different issues: a tree falls through your roof, a broken water line could cause a flood, or your playful golden retriever mistakenly bites a neighbor’s child.

Reviewing your homeowners policy, or renter’s insurance, is something you should do each year  to make sure you are adequately and properly covered.

How Much and What is Covered by Your Policy?

A standard policy has a single page noted as “Coverage Limits” with the maximum amount an insurer will pay out on each category of risk you have in being a property owner. Here are the more important ones:

Dwelling/Structure – This covers the main building structure, walls, roof, doors, windows, kitchen, etc. My house of 1,250 square feet is valued at $560,000 but I only have $205/per square footage worth of coverage, or $256,250 maximum loss payout. That is because the rest of the value in my property relates to land (about $264,000), which typically doesn’t need insurance. Rule of thumb: If you have a big fancy house, you need more coverage.

It’s important to talk to your insurance professional each year and make sure that the current coverage maximum dollar limit for your dwelling is enough to pay to rebuild your house in case it is destroyed. Other dwelling coverages to discuss are “Extended Replacement” and “Building Ordinance” coverage — so as to make sure you are fully protected.

Personal Property – Your insurance also covers your personal items (i.e., clothing, computers, couches, flatware, etc.). Make sure you have enough coverage as personal property costs more than you think. Special expensive items like jewelry, and artwork should be discussed with your agent for the proper separate insurance.

Liability and Lawsuit Protection – Homeowners insurance also typically covers you if you get sued. Some examples would be if your child hits a baseball that hurts another child, or a slip and fall accident occurs on your property. Typical liability coverage is $300,000 and you need to discuss your net worth with your insurance agent to see if that is sufficient. If your net worth is high, it is smart to consider an “Umbrella” policy to increase liability coverage to $1 million+. Talk to your insurance agent to determine the premium cost increase.

Want a lower premium? Raise your deductible! When a loss occurs, you are required to pay for the first few hundred or thousand dollars of a claim out of pocket. This is called your deductible amount and you can select the amount. The reason to have a higher deductible is to get a lower premium.

Realize. however, that you will pay more out of pocket when a loss occurs. It’s wise to discuss this with your insurance professional.

What Isn’t Covered and What to Consider Adding

You also need to understand that a typical homeowners policy does NOT cover many perils like earthquakes, floods, business activities and other specialty occurrences. Other policies may cover these and your insurance professional can help.

HO-6 Policy for Condos: For townhouse and condominium owners, it’s wise to have an HO-6 policy in place. HO-6 refers to the form used for a condominium/townhouse insurance policy. An HO-6 policy typically covers the interior of the unit, personal property and personal liability from the “studs in.” Many people are under the impression that the condo association’s master policy protects interior unit coverage, but most times it does not.

Policy Binder – Your insurance company will mail you a policy binder that has all the coverage items, maximum limits, terms and conditions outlining your coverage with the insurance company. While this document is lengthy, it is your money at risk if you have a loss and are not covered.

To lower your risk and potential financial disruptions in life, make sure you have the right type and amount of insurance in place. Any loss will most likely be devastating, but by properly preparing yourself with sufficient insurance the loss should be a lot less painful!

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Is Now a Good Time to Buy Real Estate?

People always ask, “Is it a good time to buy real estate?” The answer is always, “Yes, but it depends.” In order to make that determination for you, we first must understand the three most important words in real estate:

Long-Term Ownership

is-now-a-good-time-to-buy-real-estateWe buy property, whether a personal residence or for investment, in hopes that we are financially better off down the road than we are today. The chance of that occurring is very low if one does not own real estate for at least five or more years. The reason is that transaction costs, repairs, monthly ownership costs higher than comparable rent, and ownership hassles dictate that it is better to invest your money elsewhere and stay as a renter if you are not sure you will own long term.

Therefore, since you are going to be a long-term holder (the longer the better) you really should not be that concerned with short-term current market price fluctuations because ten years from now the home’s value will be more than it is today.

What you should be concerned about is finding a house that you “love”— one that fits all the right reasons you want to own that particular property for a long time!

That could almost be the end of this article…but there are a few more issues to consider to make sure it is a good time for you to buy property. If you fail any of the below tests, you should think through the issue(s) and whether or not it really is a good time for you personally to buy.

1. You are planning to be a long term holder, 5+ years of course

2. For owner occupants – payments are affordable and you have a steady job

3. It isn’t significantly more expensive to own over renting – this very important.

4. For investors – It makes cash flow sense, 4-5 percent-plus cash on cash. The higher the better but watch out for returns that appear too good to be true.

5. It is the RIGHT property for you for all the right reasons; you “love” it!

6. It is fairly priced relative to the recent comparable market sales in the immediate area for similar properties

7. You plan to own it for a long long long time!

8. Vacancy isn’t too high in the area. This is very important whether an owner occupant or investor. Empty unstable neighborhoods or communities have a higher risk of vandalism and risk downward price spirals.

9. It is in decent shape and doesn’t need much fixing-up. Skip the junkers, the ones with foundation issues, or anything labeled as “needs a little TLC” in the listing, as that means it is a wreck. Leave the fixers for the contractors. And doing it yourself doesn’t usually save you much money.

10. It is not near a big vacant parcel, non-residential zoned parcel, empty or retail/industrial/religious site where you are not 100 percent sure what is going to be built or in use there. A new use of that land could impact your “quiet enjoyment” of your residential unit.

11. You complete the proper due diligence steps to reduce your risk as much as possible. Mind your contract terms and contingencies, pencil out your deal, get a couple of bids on financing and dissect your GFE, review the HOA condition, review the property condition, make sure you have the right type and amount of property insurance in place, make sure you adequately review the title abstract and title policy and everything else you need to do to lower your risk.

12. And you plan to own it a long long time!

Those Three Important Words? I laughed when someone once said “location, location, location” were the three most important words in real estate. Not only is that actually only one word but we pay a handsome premium for “location” and is that premium worth it? It may or may not be, but “long-term ownership” are by far and away the three most important words in real estate.

To summarize: Subject to the above issues, it is always a great time to buy real estate but:

  • Not for everyone,
  • Not at any price, and
  • Not just any property.

Find a house you love or rental property that makes sense, that you will own for a long time, is in decent shape, lock in a long-term mortgage and sleep well.

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Risks of Buying into an HOA Community – Buyer Beware!

Zillow blogger Brendon DeSimone wrote an article called “Three Ways an HOA Can Screw Up the Sale of a Condo” which discussed some of the red flags a seller should learn and items they should clear to help get their property ready for sale. In addition, it’s necessary for a buyer to do an in-depth analysis of the HOA to better protect themselves when purchasing a property.

Researching an HOA is a time consuming process and very few buyers have any idea what they should be looking into when purchasing. Yet your time and effort is worth it as it is your money at risk!

risks-of-buying-into-an-hoa-communityEach one of these items is a significant risk issue and should be reviewed and understood, no matter how difficult it is to get the proper documentation. Some states are not helpful with requiring things like reserve studies, and some communities don’t even have or prepare what is needed. But if you understand the issues, that will help you reduce your real estate risk.

While you may be familiar with basic due diligence for HOAs, there are additional risks a buyer needs to understand to protect themselves when purchasing a home for sale in a common interest development community:

Unfunded or seriously underfunded reserve and replacement accounts: In this case, there are long-term repairs and replacements that will be needed in the future, like roofs, private streets, mechanical equipment, but the HOA has not saved anywhere near enough money to pay for these.

HOA in litigation: The HOA could spend a lot of money filing or fighting litigation and most lenders will not lend money on a project that is in litigation. This also means that you may have trouble selling your unit until the litigation is ended – which could be years – and possibly beyond that date.

Water and mold issues: Potential large dollar uninsured repairs that were not anticipated – so potential regular or emergency special assessments in large amounts.

Too many rental units: You many have trouble obtaining a mortgage or it may be more expensive (i.e. a higher interest rate) and the project may not be as well taken care of, thus making it harder to sell.

New project, few owners:  Less than a majority percentage of the units are sold and the developer is in financial trouble. You need to determine who will be paying the HOA fees on the unsold units to cover the property expenses to keep the lights on, elevators working, maintenance, etc.

Insurance: This involves not being properly insured for the inherent risks you potentially incur on the interior part of the unit you own, or the exterior. Cash buyers be especially aware here.

Is the building on a ground lease? Or does the HOA own the pool, parking lots, clubhouse, streets? This may seem extreme but in some rare instances the HOA may be leasing common areas because the original developer made them separate and kept ownership. You better know for sure before you invest.

One owner controls multiple units: If the original developer or a subsequent owner has control over more than 10.0% of the units this may be an issue with financing and other issues.

CC&Rs (Covenants, Conditions and Restrictions): CC&Rs are the governing documents or rules that the HOA’s abide by. It is necessary to read them, and the bylaws, as well as the Board of Directors meetings minutes and notes. If you don’t, you run the risk of being in the dark about a possible special assessment and could be charged the week after you close escrow. I know one incidence in which a woman closed three days before a $7,500 special assessment that had been noted in the BOD minutes that she got via escrow but did not read.

Lender Condo Certification (Condo Cert) – Did your lender do one? Did you ask for it and get a copy? Did you read it and made sure you understood the items on it? If you are paying cash, you don’t have the lender watching out for you, how are you going to mitigate that risk?

Banks will not finance it, just pay cash! If a bank will not finance a unit, they are telling you something! I often hear investors say, “well, I’ll just pay cash.” What you must consider however, is that the bank, with decades of experience losing money on loans in these communities, is signifying a problem by not approving the loan. Don’t just pay cash because you have it; I suggest that you listen to the banker.

Those are the issues, and if you plan to buy into an HOA-governed community, you need to fully understand these items and how to mitigate these risks.

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