REITs

One of the oldest modern forms is a REIT — Real Estate Investment Trust. REITs are mutual funds that invest in real estate, actual property as well as mortgage portfolios. Like other securities opportunities, they sell on the major exchanges and are professionally managed, receive special tax considerations, and often have higher yields and greater liquidity than straight property investment.

There are Equity REITS which invest in and own properties. Revenues come primarily from rents. Mortgage REITs deal in investment and ownership of mortgages rather than property with revenue coming mainly from interest on the loans. Hybrid REITs do both.

Keep in mind, however, that REITs are closed-end mutual funds that have a specific number of shares for sale and once sold can’t be redeemed through the fund. They have to be bought and sold to other investors as you would corporate stock, through a broker.

REITs are required to pay out at least 90% of their taxable profits as dividends to shareholders, so they can be relatively high yield. In terms of total return- dividends plus price appreciation - they’re similar to small-cap stocks, with on average two-thirds of the return coming from dividends. They’re therefore sensitive to interest rate changes. As interest rates increase REIT prices tend to decline.

MBS

MBS (Mortgage-Backed Securities) are a type of bond in which the paper is backed by a pool of mortgage loans. In the U.S. lenders make about $2.8 trillion in such loans annually with about 80% being covered by mortgage-backed securities.

Investors in mortgage securities earn a coupon rate of interest, like other kinds of bonds. But in contrast to other bonds, they receive repayments of the principle in increments over the life of the security, as the underlying mortgage loans are paid off, rather than on one large payment at maturity.

One of the advantages, one which lends the security some stability, is the statistical effect of pooling loans. No single or small number of loans that pre-pay or default wipes out the investor’s entire investment.

But pre-payment of mortgages does occur for a certain percentage and that introduces some risk. The investor isn’t aware of or interested in which loans pre-pay, but the fact that some do causes them to be sensitive to interest rate changes, one of the major influences in pre-pay rate. If borrowers took mortgages at 8% and rates drop to 5% a certain number are going to re-finance, causing the original to pay off early.

So, if interest rates are likely to fall, it’s best to avoid pre-payable MBS. Closed MBS are, in that scenario, a better alternative.

There are specialized instruments like CMOs - collateralized mortgage obligations - and REMICs -Real Estate Mortgage Investment Conduits with similar behavior and risks. ETFs - Fixed Income Exchange-Traded Funds, too, sometimes are supported by underlying mortgage-backed securities and trade on the major stock exchanges. They’re designed to track the performance of specific bond indexes, which track performance of an underlying bond market, such as MBS.

SELF-DIRECTED IRAs

You can even set up an individual IRA (Individual Retirement Account) that allows you to add assets in the form of raw land, single-family homes, apartments and other commercial buildings, rather than straight cash inputs. This allows you to take advantage of your knowledge of real estate, while avoiding some of the downside of actual property management.

Whichever instrument you choose, and there are many others, be sure to do your homework and get the advice of a financial professional before investing large amounts. The sharks can always smell fresh blood in the water.

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Real estate, unlike stocks or other investments, is always local — property is always somewhere, somewhere specific. The investor may be far away, but the property has a location that forms part of its local market.

That affects how it’s appraised, bought, used and sold. Unlike residential property — even though one in four homes are bought by investors — commercial property is usually intended to be used for a business purpose.

It may be a multi-dwelling apartment complex used as residences by others, but to the investor it’s a commercial enterprise. As often, the commercial property is a multi-tenant commercial building on land zoned for that purpose. That introduces different considerations for valuing, financing, leasing, maintaining and a host of other tasks.

The commercial investor has, usually, to invest a larger amount — requiring superior credit and incurring greater risk — and to estimate capitalization rate (cap rate) and Gross Rent Multiplier (GRM).

The cap rate is calculated by dividing a property’s annual net operating income by its purchase price. Historically, good investments had a 10% cap rate, but the last few years has seen that decline to 8% corresponding to a greater risk and lower expected return. The GRM is arrived at by dividing the purchase price by the property’s monthly gross operating income. These, along with consideration of assessed vs appraised value, and comparables, total income and replacement costs form the hard-fact base for estimating the worth of a deal.

Commercial properties are at greater risk of unpredictable changes in general economic conditions. A building that enjoyed a 100% occupancy rate can quickly become only half full because of factors far outside the local market. Events in Asia or elsewhere around the globe can turn business conditions for some upside down overnight, whether the tenants are located in California or Barcelona.

Commercial property investment requires increased knowledge of law, maintenance and finance. Zoning, leasing regulations, and other legal issues are more complex than for residential property. Where properties are rented, rather than just bought and sold — often the case with CREI — owners usually have to consider large electrical, air-conditioning and security systems, along with fire suppression, telephone and Internet facilities. Even plumbing is more complicated in commercial structures. Mortgages are more complicated and insurance is more costly.

The exception is the triple-net lease. In this arrangement the tenant is responsible for all the expense and arrangements for maintenance and repair as well as insurance.

But not to be gloomy, there are great potential rewards from CREI. The risks are greater, but often the return is as well — especially during good economic times. And the satisfaction of being part of sustaining and helping grow the dreams of other entrepreneurs is a great bonus for the commercial real estate investor.

And, after all, sometimes, more complicated means more interesting.

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There are now a dozen or more ways to finance a property purchase, whether for pure investment or primary residence. One common method is to have more than one loan, usually in the form of a second mortgage. The buyer puts 5 percent in, and effectively borrows the other 15 percent on a separate loan, usually at a much higher interest rate.

While it’s nice to invest less for the same property, the downside is not limited to the higher interest rate on the second mortgage loan. Since the buyer doesn’t meet the standard 20 percent minimum, lenders almost always require PMI (private mortgage insurance). Fees are usually hefty.

Though it’s theoretically possible to have the lender remove the PMI requirement after enough payments have been made it rarely happens. In theory, once the loan(s) have been paid down so that the LTV (loan-to-value ratio) is at 80 percent — usually by a combination of paying down the second mortgage and appreciation of the value of the property — the lender will be willing to consider removing the PMI cost from monthly payments. Most often, before that happens, the loan is refinanced or the property sold.

The ambitious can find other sources of financing. When considering property in a new development, such as a planned community or new housing tract, manufacturers will often be willing to fund a home loan for early buyers. Such loans are frequently available at only 5 percent of the purchase price.

For the really daring it’s possible to ‘buy’ a property, then sell it, without ever owning it — at least not for long. It’s possible to buy a property, establish a contract, and then sell the contract for anywhere from $500-$5,000 without ever taking possession or even being on the title. Profits are usually smaller, but obtained quicker, though deals require excellent credit.

‘Sub2′ deals are another form of creative financing. The typical ’subject-to’ deal involves having a seller deed you the property while leaving the existing mortgage in place. You never legally assume the loan, but simply start making the payments. There are lots of variations on this new way of buying property. Not recommended for the beginner.

You can finance a property investment by forming a limited partnership. Arrangements cover the spectrum. In some, each partner puts up some percentage of the cost, usually half and half, but sometimes profit is apportioned according the original percent invested. In some cases, it’s possible for one partner to invest money, while the other(s) performs services —— such as repairs on a ‘fixer-upper’. The deals are as varied as people.

For those with low incomes, or military service, or other special circumstances various government loan programs are available — though they’re usually limited to individuals intending to occupy the property.

It’s even possible to fund a property purchase with credit cards, but there are several obvious downsides to this method. Apart from the substantially higher interest rates, lenders look at all outstanding debt when judging whether to grant a loan on the remaining balance. Taking out a cash advance to cover a shortfall between the needed 5-20 percent down will usually get you turned down.

Friends, family, and other sources of money are usually viewed the same way, unless you can prove to the bank that the money is a gift and not just a loan.

Mortgage lenders have seen it all! Don’t try to fool them.

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Foreclosure is a legal procedure in which a mortgage holder reclaims a property due to default on a loan. Some states in the U.S. allow ’strict’ foreclosure — the borrower has a certain period to make the debt current, after which the title reverts to the lender.

Needless to say, you don’t want to get in the middle of someone’s legal process. Any thought of holding out a promise of ‘rescue’ to the current owner in exchange for part or whole ownership is suicidal. Look elsewhere for that great deal.

Also keep in mind that, in some foreclosure proceedings, borrowers have the ‘right of redemption’. This allows them a certain period in which to ‘cure the loan’ — make back payments, shore up credit, etc — and reclaim title to and possession of the property. Stay clear.

Once the foreclosure process is complete, or at least inevitable, you can put in action a plan to acquire the property. Look for deals in which, at minimum, a Notice of Default has been issued.

Auctions on foreclosed property are common but tricky. Never bid blind on a property. There’s no substitute for first hand knowledge of the physical condition and legal status of a property.

Keep in mind that foreclosures are sold ‘as is’. Unlike other property sales, no warranties are provided and no title insurance granted.

At minimum, you’ll need to have a professional inspection performed, even if you are a knowledgeable investor. Some investors are, of course, professional inspectors themselves — along with wearing many other hats. The property needn’t be free of every tiny defect, but you’ll want to know that the roof doesn’t need to be replaced, that the plumbing is sound, there are no serious foundation cracks, or potential for flooding, etc. If any of those are present, they can be acceptable if you’re looking for a ‘fixer-upper’ and have the time and funds. Discount your offer accordingly.

Eventually you’ll hear about someone entering a ’short sale’ deal. This occurs when a lender is willing to accept less money for a property than is outstanding on the loan.

Another type of foreclosure opportunity is the REO — real estate owned (by the lender). These are properties auctioned but not bought. It’s possible to get some very good deals, but exercise extreme caution.

Remember to do your research. Get a thorough inspection and perform adequate title research. Any major defects or encumbrances in the form of tax or other liens has to factor large in your plans.

Remember, arsenic just tastes like sugar, it’s still poison. Learn to tell the difference.
 

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One of the largest expenses involved in selling a property is the payment of an agent’s commission — often in the 6% range. But agents do earn their money, by providing expertise on the market and sales process, by advertising widely and by assisting in the negotiation and closing phases of a sale.

Still, 6% of $200,000 is $12,000 and many find the prospect of keeping that money for themselves irresistible. Here are some things to consider when deciding whether to use an agent or ‘go’ FSBO.

In order to sell a property quickly and profitably, you have to know the market. If your listed price is even 1% off the average you will either sit on the property for a long time or fail to make as much as you could have on the sale.

Beyond the need to get an accurate, professional appraisal — required whether FSBO’ing or using an agent — agents can provide ‘comps’ listing the recent sale price of comparable properties. They also know the market and can often tell you whether your price is reasonable.

However, with the increasing availability of similar information on the Internet, FSBO is becoming a more realistic option. If you can access and analyze the data, FSBO may be for you.

Agents put your property in a database called an MLS, a Multiple Listing Service, to which other agents as well as potential buyers — through the agent — have access. MLS data is more difficult for the average person to gain access to and in some states you need a license to obtain the data. Almost in every case, one is required to be a member of the MLS service and pay a fee.

This is only the first step toward advertising your property far and wide to potential buyers. But, again, with the growth of Internet sites advertising homes for sale, along with other traditional options, you may find you no longer need the service once provided almost exclusively by agents.

Some individuals are natural negotiators and some have learned through long experience how to attract buyers and get the best deal. Some, though, will always be on the losing end of a proposition. Only you can decide how effective you can be in negotiating a fair, acceptable price and whether that process is enjoyable or torture.

Once you’ve listed the property, advertised it widely enough to attract buyers and negotiated a price one will accept, the most difficult part of the process begins. Every state and country has a long and complex list of laws about how a real estate transaction has to be carried out.

Deposits have to be made of the right amounts and at the right times in an escrow account, and insurance regulations have to be met. Title history is investigated and a hundred other details completed before ownership can be transferred and profits (if any) gained. If you don’t have the knowledge or temperament for this sort of thing, FSBO is not for you.

But, on the bright side, there are dozens of books, Internet sites, and low-cost ’seller assistance’ businesses that can guide you through the process, often at a much lower cost than agent commissions.

Investigate before you decide, and best of luck.

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But easier is not the same thing as easy.

The biggest barrier to success in real estate investing for those starting out is the steep learning curve. Real Estate investing, no matter where you live, is a complicated business and you can lose big money quicker than you can say ’stock market crash’ if you haven’t done your homework.

So, to simplify the process, here are some things to consider when getting started.

Before investing money, invest some time. Think about what financial goals you want to achieve and over what time frame. Be realistic. Easy to say, hard to do — especially when home prices have been rising for several years and still are. But like any market, real estate values may go down, and when they do it’s usually a sharp, steep drop.

Once you’ve decided how much of a time and money commitment you want to make, write it down. Make a one year to five year business plan in as much detail as you can, and then review it after six months and again after two years.

Part of that plan should be an estimate of how much capital you’ve got to invest, which will differ depending on whether or not you plan to use your primary residence as your first investment. Just as one example, if you have less than $10,000 to start with you are definitely looking at either using your own home or buying a ‘fixer-upper’ as your first venture.

It’s true you can get into a secondary property with no money down and just a couple of thousand in closing costs if you have good credit. But the market would then have to rise quickly, and you would have to sell right away.

That’s risky and has serious tax and legal consequences. The alternative would be to take on high monthly payments and maybe additional expenditures on repairs. Again, risky and potentially expensive. You stand a high chance to lose more than your initial investment, because even though you only put in a small amount, you’re still legally bound for the entire package.

Unwise move for the newbie.

Another part of that plan should state how much risk you’re willing to take. Be especially honest and consider your personality type. Some investors favor capital preservation, others lean toward maximum return in the shortest time. People differ in their tolerance for risk. Be sure you know yours.

You’ll need to consider your available time commitment, establish a relationship with a lender, learn about the market, contracts, insurance, legal rights and requirements, tax consequences, and many other aspects of real estate investing.

If you still want to take the plunge — bravo! You can make a healthy additional income, or even a full time living, in what remains one of the soundest investments available. And, apart from what can be serious money — it’s a great adventure!
 

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Any ethical professional will insist that the first rule of investing is to diversify your portfolio. Stocks, bonds and other savings instruments usually form one leg of a many pronged platform. Generally no more than 30% of available investment funds should be allocated to any one category.

Direct commodity investing is usually safe only for the savvy investor who has time to closely monitor the market. Whether gold, oil, or other hard good, the commodities market forms the most volatile and risky ventures. Options, commodity oriented mutual funds and other indirect investments are less risky, but still far from wise for the average person.

For those who want to include ‘paper’ in a well-rounded investment scheme, real estate offers several opportunities. REITs (Real Estate Investment Trusts), options, property oriented mutual funds, and other mortgage backed securities are available in a dizzying array.

REITs are entities that invest in real estate related assets, such as shopping centers, office buildings, hotels, and mortgages secured by real estate. REITs fall into one of three categories. Equity REITs, which invest in or own real estate and make money for investors from the rents they collect. Mortgage REITs which lend money to owners and developers or invest in financial instruments secured by mortgages on real estate and Hybrid REITs which are a combination of the two. To qualify, a company has to pay 90% of its taxable income to shareholders every year and invest at least 75% of its assets in real estate and generate 75% or more of its gross income from investments in or mortgages on real property.

Options are an alternative form of offer. A potential buyer offers a sum, ‘an option consideration’, in order to effectively take a property off the market for a period of time. Option offers generally run anywhere from a few hundred to a few thousand dollars, but higher or lower amounts are possible. Some options bind one party only, some are called ‘bilateral’, requiring each to adhere to contractually specified conditions. Conditions involve contingencies around inspections, financing, and always have a time limit.

Every deal is a little different and, of course, if the option isn’t exercised by the specified time limit, the optionee — the potential buyer — forfeits the money. Risky, but potentially rewarding, since you’ve effectively eliminated alternative bidders. One advantage to the optioner is the time to find a buyer for the property itself, then selling the option. This eliminates the need to pay for transactions costs, keeps debt low, etc. Do your homework, first.

To fill out the other part of your portfolio, nothing beats the ‘real’ in real estate. Historically, buying and selling real property, or even long-term owning, has proven one of the most profitable, least risky investments available. Observe carefully the words ‘least risky’. That doesn’t mean ‘zero risk’ — there’s no such thing in investing. Prices can always go up or down, relative to other goods and investment channels.

Be willing to get educated about the market and the law. Make purchases while minimizing costs like agent fees, repairs, interest rates, etc. Have sufficient cash and other liquid assets to be able to hold until the time to sell is right. Follow these guidelines and you’ll never have any reason to regret making real estate investing a major portion of your portfolio.

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‘Flipping’ is the practice of buying property, then selling for — hopefully — quick profit. The flip side to flipping is keeping property for the long term to take advantage of tax incentives and capital appreciation. Calculate the total costs vs amount saved from tax write off. Don’t forget to include interest charges, property taxes, insurance, repairs, etc., along with the regular monthly payment.

Remember that property values have risen in most markets for several years. But with interest rates increasing no one can predict how much higher they’ll go nor for how much longer. No gain without risk!

Apart from gains from a tax write off and appreciation, some costs can be offset by renting the property. But, consider the amount of time and cash you have to find tenants, manage the property, and pay for or perform repairs.

Foreclosures are another investment avenue, but also not without risk and often requiring substantial cash outlay. A foreclosure occurs when a property owner is no longer able to make payments on a mortgage, usually over a period of several months. But seldom are foreclosed properties all gain and no pain.

Foreclosed properties tend to be in need of repair — someone about to lose their home isn’t usually incented to maintain it in pristine condition. Be prepared to spend time and effort bringing the home back to salable condition, if you have the skills, or laying out cash, time, and effort to find a reliable contractor.

Similar considerations apply to investing in abandoned property, with some possible additional legal hoops to jump through. Foreclosed properties usually have clear title. The lender (a bank, mortgage company, or other financier) reclaims title as a part of the foreclosure process. In the case of abandoned properties, it may not be clear who has title. Factor in the additional time and cost for title searches and possible legal action.

For those who want to take advantage of profit opportunities in real estate, but without actually laying out cash, signing dozens of documents, or worrying about the physical property, there are purely paper investments. As a result of computerization and the explosive expansion of investment options in the 1980s, several types of ‘monetization’ of real estate came into existence. REITs (Real Estate Investment Trusts) are one type. There are others — mortgage backed securities, property bonds, trusts, mutual funds, and stocks oriented specifically toward real estate. Before investing in any of these ‘non-property’ options, talk to a broker.

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In any business deal there are essentially only two ways to achieve the highest profit — keep your costs as low as possible, and attract the highest bidders.

To keep costs low going in, do as much yourself as possible. Two areas to start on are inspections and repairs.

Acquire the skills, and even licensing, needed to perform professional level inspections. Professional inspectors get up to several hundred dollars for a thorough review and detailed report. And they earn it. A good inspection can save you thousands in the form of foregoing falsely attractive deals and providing negotiating bargaining chips.

After the purchase, carry out any repairs needed yourself — to the extent you can do professional level work. Be thrifty, but not foolish. Amateur repairs lead to larger costs down the line. Shop around for low-cost quality roofing materials and superior carpet deals. When you can’t do the work yourself, seek out skilled handymen from small outfits. Companies whose prices include overhead for bonding of employees eat into your profits.

Shop around for low-cost loans with lesser known lenders. Major banks and mortgage companies tend to have higher fees and less than competitive rates. Never pay anyone an ‘application fee’. Perform the same exercise with respect to title and insurance. You’re not required to use anyone the lender recommends.

Once you’ve selected them, don’t passively accept unnecessary fees with ridiculous prices. In today’s world it’s absurd to pay $50 to deliver a few dozen papers across town, but tacking on charges like that is common practice. Take your time looking for property, lenders, title companies, insurance brokers, agents, etc. Shop as carefully as you would for a new car — no more so, you’re investing much more.

Educate yourself about real estate law and basic accounting. Professionals in those areas charge large fees — and earn them. Good advice costs heavily for a good reason. These professionals can save you thousands by avoiding costly mistakes. But you can perform many of those services yourself if you’re willing to study. You don’t need a law or accounting degree, just an active mind and a lot of patience for detail.

When you’ve found an attractive property, negotiate firmly but in good faith. Be willing to state clearly what you want and prepare to compromise. Individuals who feel they’ve been burned often find ways to sabotage your profits in ways you discover only later.

When you’re on the selling side, perform the same thorough shopping process and negotiate agent percentages, closing costs, and other high-ticket items.

Prepare the property for sale at the maximum price by investing in a few flowers and having the property thoroughly cleaned. Leave the lights on even during the day. Put on some “mood music” at a low volume; put out some attractive flyers with photos and little snacks for visitors.

Market your property heavily to get a large pool of interested buyers. Competitive bidding always benefits the seller. Be willing to take your time during the process. He who is most eager, makes less.

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Before you take the plunge, ask yourself — and try to answer — some of the following questions.

1.How much capital do you have?

Real estate investing is first and foremost just that — an investment. It requires money. Sometimes a relatively small amount, sometimes big sums. But whatever you layout initially, once you sign the papers, you’re legally liable for a serious chunk of change. That suggests you should have enough capital to invest — either in the form of savings or ability to finance which means carrying debt and paying interest. ‘Enough’, obviously, depends on your personal circumstances. How much savings do you have?, how much can you afford to lose?, how much debt can you carry and how much interest can you afford to pay?

2.What’s your tolerance for risk?

Capital and risk are inseparable partners. A person with five million in the bank can absorb a risk of five hundred thousand without serious, though maybe painful, consequences. Someone who is putting up their hard earned five thousand, hoping to turn it into fifty, is in a different situation. I’m not suggesting the one with five should stay home and watch television. Taking risks is admirable and exciting. But you should estimate realistically how much actual money you can put into an investment. The mirror half of that is to be honest with yourself and think about how much risk you can live with emotionally. Some people are natural adventurers, others prefer a cautious approach.

3. What are your long-term financial goals?

Some individuals are interested in capital preservation, others want maximum return in the shortest period. Each carries a level of risk, and also an implied time commitment. Each demands a particular level of investment of time and money. If you’re looking for a ten percent profit on your investment in a matter of weeks, real estate isn’t for you. If you’re after high percentage gains, that’s possible but risky and usually requires a year or more commitment. During that year, your investment is not liquid apart from the ability to borrow against it. Along with having your funds tied up for other potential uses, property values can change dramatically in a short time frame. The last few years have been steadily up in most areas, but with changes in interest rates, that can (and probably will) change.

4.What kind of person are you?

Real estate investment, unless you just enjoy losing money and enduring stress, requires a tolerance for risk, a commitment of time and effort, and an interest in details — especially legal details. Beyond all that, the more basic requirement is an interest and aptitude for learning. Market study, advertising, contracts, construction, property law, even a fair amount of psychology, all form a part of real estate investing. You don’t have to become an expert in these, and other, areas before making a move. But if you don’t enjoy learning about these and the host of other subjects that are part of the business — well, come on in because the sharks love fresh meat.

If you still haven’t been scared away — bravo! You stand to make a lot of money in one of the oldest businesses and biggest adventures still around in the modern world.

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