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Various investment options in real estate

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In this era where property is fast becoming an asset, property ownership has become very important element of wealth creation. Buying real estate can be more than just finding a place to call home. Most people have to do a real estate transaction at some point in their lives, and some find it an intriguing opportunity for capturing and creating value. Real estate has become a common investment vehicle, and it continues to be popular despite the very rocky market correction in 2007-09.

Although the real estate market has plenty of opportunities for making a profit, buying and owning real estate can be a lot more complicated than investing in stocks and bonds.

 

The Power of Leverage in Real Estate

Before we dive into types of real estate investments, it is worth looking at one of the main attractions it holds for investors. Investing in real estate gives you one tool that is not as easily available to stock market investors: leverage. If you want to buy a stock, you have to pay the full value of the stock at the time you place the buy order. But for mortgage, it requires a 20% to 25% down payment. However, depending on where you live, there are many types of mortgages that require as little as 5% down. This means that you can control the whole property and the equity it holds by only paying a fraction of the total value up front.

This is what emboldens both real estate flippers and landlords. They can take out a second mortgage on their homes and put down payments on two or three other properties. Whether they rent these out so that income from tenants pays the mortgage or wait for an opportunity to sell for a profit, they control these assets, despite having only staked a small part of the total value.

 

Below are some basic real estate investments.

Being a landlord

Ideal For: People with DIY and renovation skills and an aptitude for dealing with tenants.

Rental real estate is an investment as old as land ownership. Basically, you buy a property and rent it out to a tenant. The owner is now a landlord, responsible for paying the mortgage, taxes and costs of maintaining the property. Ideally, the landlord charges enough rent to cover all of the aforementioned costs with enough left over to produce a monthly profit right from the start. However, depending on the rental market, a landlord may have to be patient and only charge enough rent to cover expenses or even take a loss to keep a property occupied. Although this can be uncomfortable and requires a capital cushion to absorb periods of loss, landlords tend to invest for the long term. After all, once the mortgage has been paid on a rental property, the majority of the rent becomes profit.

Of course, the monthly income from a property is not the only focus of a landlord. As with all real estate, the property can appreciate over the course of the mortgage, leaving the landlord with a more valuable asset.

 

There are, of course, blemishes on the face of what seems like an ideal investment. You can end up with a bad tenant who damages the property or, worse still, end up having no tenant at all. This leaves you with a negative monthly cash flow, meaning that you might have to scramble to cover your mortgage payments. There is also the matter of finding the right property. You will want to pick an area where vacancy rates are low and choose a place that people will want to rent.

Perhaps the biggest difference between a rental property and other investments is the amount of time and work you have to devote to maintaining your investment. When you buy a stock, it simply sits in your brokerage account and, one hopes, increases in value. If you invest in a rental property, you also acquire the mountain of responsibilities that come with being a landlord. When the furnace stops working in the middle of the night, it’s you who gets the phone call. If you don’t mind handyman work, this may not bother you. Otherwise, a professional property manager would be glad to take the problem off your hands – for a price, of course.

 

Real Estate Investment Groups

Ideal For: People who want to hold rental real estate without the headache of running it.

Real estate investment groups are similar to a small mutual fund for rental properties. If you want to own a rental property, but don’t want the hassle of being a landlord, a real estate investment group may be the solution for you.

In a typical real estate investment group, a company will buy or build a set of apartment blocks or condos, then allow investors to buy them through the company, thus joining the group. A single investor can own one or multiple units of self-contained living space, but the company operating the investment group collectively manages all the units, taking care of maintenance, advertising vacant units and interviewing tenants. In exchange for this management, the company takes a percentage of the monthly rent.

There are several versions of investment groups, but in the standard version the lease is in the investor’s name and all of the units pool a portion of the rent to guard against occasional vacancies, meaning that you will receive some income even if your unit is empty. As long as the vacancy rate for the pooled units doesn’t spike too high, there should be enough to cover costs. In extreme cases investors may be asked to pay back in if costs exceed income for a longer period of time.

Of course, the quality of an investment group depends entirely on the company offering it. In theory it is a safe way to get into real estate investment, but real estate investment groups are vulnerable to the same fees that haunt the mutual fund industry. More important, they are sometimes private investments where unscrupulous management teams take investors for a ride and leave them with nothing but legal proceedings to look forward to. To avoid unpleasant surprises, it is critical to do your research on the company and conduct a thorough review of the details in the investment offering.

 

Real Estate Trading (Better Known as Flipping)

Ideal For: People with significant experience in real estate valuation and marketing.

Real estate trading is the wild side of real estate investment. Like day traders, who are distinct from buy-and-hold investors, real estate traders are an entirely different breed from buy-and-rent landlords. Real estate traders buy properties with the intention of holding them for a short period of time, often no more than three to four months, after which they hope to sell them for a profit. This technique is also called flipping properties and is based on buying properties that are either significantly undervalued or in a very hot market.

Pure property flippers will often forgo putting any money into a house for improvements; the investment has to have the intrinsic value to turn a profit without alteration or they won’t consider it. Flipping in this manner is a short-term cash investment. To take advantage of potentially large returns, flippers have to have cash on hand or access to other people’s money, as traditional financing doesn’t generally work for this type of transaction.

If a property flipper gets caught in a situation where he or she can’t unload a property, it can be devastating because these investors generally don’t keep enough uncommitted cash to pay the mortgage on a property for the long term. This can lead to continued losses for a real estate trader who is unable to off-load the property in a bad market.

A second class of property flipper also exists. These investors make their money by buying reasonably priced properties and adding value by renovating them. This can be a longer-term investment depending on the extent of the improvements. The limiting feature of this investment is that it is time intensive and often only allows investors to take on one or two properties at a time.

 

Real Estate Investment Trusts (REITs)

Ideal For: Investors who want portfolio exposure to real estate without having to go through a traditional real estate transaction.

Real estate has been around since our cave-dwelling ancestors started chasing strangers out of their space, so it’s not surprising that Wall Street has found a way to turn real estate into a publicly traded instrument.

A REIT is created when a corporation (or trust) uses investors’ money to purchase and operate income properties. REITs are bought and sold on the major exchanges, just like any other stock. A corporation must pay out 90% of its taxable profits in the form of dividends to keep its status as a REIT. By doing this REITs avoid paying corporate income tax, whereas a regular company would be taxed on its profits and then have to decide whether or not to distribute its after-tax profits as dividends.

Much like regular dividend-paying stocks, REITs are a solid investment for stock market investors who want regular income. In comparison to the aforementioned types of real estate investment, REITs allow investors into nonresidential investments, such as malls or office buildings that are generally not feasible for individual investors to purchase directly. More important, REITs are highly liquid because they are exchange traded. In other words, you won’t need a realtor and a title transfer to help you cash out your investment.

REITs are, in practice, a more formalized version of a real estate investment group.

When looking at REITs, it is important for an investor to distinguish between equity REITs that own buildings and mortgage REITs that provide financing for real estate and dabble in mortgage-backed securities (MBS). Both offer exposure to real estate, but the nature of the exposure is different. An equity REIT is more traditional, in that it represents ownership in real estate, whereas the mortgage REITs focus on the income from mortgage financing of real estate.

REIT investing isn’t entirely painless, but the research and analysis required is in line with that of any income stock.

 

 

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Real Estate

BUY OR BUILD A HOME?

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The biggest concern these days relating to owning a home comes with either buying or building one. Many are left at the crossroads in making the right choice when it comes to knowing what to do between the two. A home is usually the single largest investment that a person makes. Most buyers end up spending lots of time and energy either searching for or designing “the perfect home” before signing any contracts. Location, price, market trends, property taxes, Homeowners Association fees and the condition of the property are factored into the house hunt. Also, each buyer typically has a wish list that includes specific needs (the things the buyer absolutely has to have) and wants (the features the buyer would like but could do without if necessary).

While the home-buying process involves a number of important choices, one of the very first decisions buyers need to make is whether to shop for an existing home or build a new one. Each path has its advantages and disadvantages.

Buying an Existing Home

There are two primary advantages to buying an existing home: convenience and cost. Once you are pre-approved by your lender, you can shop around, pick out a home and make an offer. A qualified real estate agent can streamline the process by helping you find appropriate properties, guiding you through negotiations and assisting with the paperwork. Once your offer is accepted, you may be able to close and move in within a month or two. 

Even though the process involves numerous steps – such as financing, viewing homes, making offers, home inspections and closing – the convenience of being able to move in right away is compelling enough for many people to choose an existing home over a build. This may be especially true for buyers on a tight schedule, such as those relocating for a new job or whose children will be starting at a new school.

Then there’s cost. In many (but not all) cases it’s cheaper to buy an existing home, according to research. Once you’ve found a prospective, existing home, use a mortgage calculator to get a better estimate of the total cost of purchasing that home based on today’s interest rates.

Convenience versus Customization 

Another reason an existing home may be a better option is if you would like to be in a particular established neighborhood – near work, school, friends and/or family. Odds are, too, that the home will have mature landscaping, so you won’t have to worry about starting a lawn, planting shrubs and waiting for trees to grow. And if you want to live close to town, your best bet will be an existing home since most, if not all of the land, will have already been built upon.

On the flip side, the biggest disadvantage of buying an existing home may be that you won’t get exactly what you want. You may not be in love with the floor plan and may wish that half bath on the first floor was a full bath or that there was another bedroom on the main floor. Older homes, in particular, may be functionally obsolete, no longer meeting the needs of most buyers. For example, an otherwise beautiful four-bedroom house may only have one bathroom, or the kitchen may be too small with no room for expansion.

Unless you find an existing home that has exactly what you want and is in perfect condition, you will have to spend additional money on remodeling, repairs, decorating and/or landscaping. These additional expenses should be factored into the overall price, especially when choosing among various properties or comparing the cost to building your own house.

Building a Home

Building a new home doesn’t offer the same convenience as buying an existing house. Not only do you have to find the land, which may not be in an existing neighborhood, you also have to factor in the time to find an architect or builder, and choose every element of the new structure. Joining an existing development can streamline the process, though it may limit your degree of choice. You also need to worry about systems, such as whether the land gives you access to municipal water and sewage, or requires a well and septic system, along with any environmental and other permits.

The big advantage is you are much more likely to get exactly what you want. For many, this factor alone is enough to choose to build over buying, but there are other advantages too. A new home is more efficient, especially with the new energy codes including better HVAC [heating, ventilation, and cooling], insulation and air filtration standards. Better efficiency is good for the environment and can save you money on your utility bills each month.

Another perk? A new house may literally be better for you. A new home is less likely to have the health concerns or toxic materials of an older home – things such as asbestos, lead paint, mold, etc. And it can be built with certain materials making it better for the environment such as Green appliances/Energy Star rated appliances, and more efficient toilets, plumbing fixtures, and electrical fixtures that allow one to build “green” for a more sustainable home in the long run. Also, there’s the option to install, sleeve and/or wire for future technology upgrades, such as home automation and solar. One can have more significant profits with the resale of a new home. A newer home is typically more appealing than an older home to most people. In addition, a new home will require fewer repairs and less maintenance, which can save both money and time. One will have a warranty with a new home, so even if something does go wrong, you may still be covered.

Money and features aside, building a house can lead to a level of satisfaction that one can’t achieve through buying an existing home. There is a definite feeling of an emotional connection to living in a new home that one has created. The new-home smell, no one else has stepped foot (or pets) on your carpet. This is your creation that matches your style and personality that you created from scratch.

Time and Money

The biggest drawbacks to building a house tend to be the higher costs and longer timeframe, both of which can increase throughout the home-building process. That said, you can limit the risk that your house will go over budget or take longer than you expected by working with a reputable builder and having a good contract in place. To be on a safer side, have a potential builder provide references and then check their past homeowner references. To avoid unexpected price increases, try to use a lump-sum contract, instead of a cost-plus contract. A lump-sum contract specifies a fixed price for construction, putting the risk of cost overruns on the builder instead of the buyer.

In addition, the contractor should work with you to help you reduce costs. The builder should provide a list of cost-saving items, if requested. Substituting different materials and fixtures can save a lot, so if costs are a concern, ask ahead of time if there’s a cheaper alternative. And keep in mind that anything out of the ordinary is going to cost more.

To control the timeframe, try to have a contract that includes a construction time duration. Avoid the open-ended deadlines, and have a game plan and schedule. In case you are not available, make sure your builder keeps you up to date with the progress. Request for progress photos on a regular basis, and determine who will be your main point of contact throughout the process.

In addition, to save both money and time, maintain good communication with your builder and make sure you are happy with the design/specs before the build begins. It’s not good for you or the builder if you change your mind about something that has already been installed.

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