the conflicts of interest you may be subjected to when working with a financial advisor

Here are a couple of stories that highlight the conflicts of interest you may be subjected to when working with a financial advisor.

✓ While serving as an expert real estate wit- ness, Robert had a case  where a retired couple was given some self-serving advice by their financial planner.  This couple owned their principal residence plus three other rental homes valued at $1 million.  All of their real estate was owned free and clear,
and the rentals were in great condition with good long-term tenants. The properties pro- vided a nice monthly income stream that was mostly tax-free due to their deprecia- tion deduction (see Chapter 18). Although the real estate  was clearly their largest asset  and completely debt-free, they also had nearly $500,000 in liquid assets such as stocks, bonds, and IRAs and seemed to be fairly set. That was, until their new financial advisor told them that their retirement was at risk because they had too much invested in real estate. The planner’s recommenda- tion was to keep their own home as their real estate  investment, but sell the three highly appreciated  rental properties and invest the proceeds  in mutual funds and other financial products from companies affiliated with the planner.

The planner failed to disclose his relationship with the sponsors of the new investments and also failed to warn them about the significant capital gains taxes that would be due upon sale. By the time they met with their accoun- tant, it was too late — two of the three rental properties had been sold and over $200,000 in taxes was due. The accountant advised the couple to contact an attorney and file a law- suit against the financial advisor. Although

the couple prevailed, they recovered only a small portion of what they paid in taxes. Even worse — they lost the benefits of cash flow and appreciation on their real estate  while now owning fully taxable investments.

✓ In Eric’s previous work as an hourly-based financial advisor, he  often  had  clients come to him who were disappointed with the biased and confusing advice they got from various so-called financial planners. In one typical case, a widow had been told by an advisor to sell her two investment
properties because  he believed that the stock market would produce better returns. She set the wheels in motion to unload the properties but put the brakes on at the last minute after deciding she needed a second opinion. She met with Eric. The first thing that she noticed working with him was that he was far more thorough in examining her overall financial situation, including all of her investments, insurance, and resources for retirement. She also realized that she was happy with her real estate  holdings and really didn’t have any motivation to sell them. Furthermore, she found out from Eric that over the long-term, the returns from stocks and real estate  were quite com- parable. She thus decided to keep her life simple and stable and hold onto her nicely performing rental properties.

Don’t get us wrong, selling real estate  can make sense  at times. However, you must ask a lot of questions and run any proposed invest- ment strategies by good independent advisors before you make the decision to liquidate your real estate and shift your investments to other opportunities

Should I Buy Rental Property with a Lender or Mortgage Broker?

Before looking  at buying rental properties, you need a budget. And because your  budget for real estate purchases is largely a function of how much you can borrow (in addition to your  cash available for a down  payment), you need to determine the  limits  on your  borrowing power. If you can’t afford  a property, it doesn’t matter what  a great deal it is.

Postpone making  an appointment to look at investment properties until after you examine the  loans available. You have  two resources to consult:

Lender is a generic term for any firm, public or private, that directly loan you the cash you need to purchase your  property. This type  of lender is often  referred to as a direct lender. Most often,  your  list of possible lenders includes banks, credit unions, and private lenders (including property sellers). Lenders tend to specialize in certain types of loans.

A mortgage broker is a service provider that presents your  request for a loan to a variety of different lenders in order to find the  best financing for your  particular needs. Just  like real estate or insurance brokers, a good mortgage broker can be a real asset to your  team

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Buy Rental Property Fix and Refinance Strategy

With the  buy rental property, fix, and refinance strategy, you invest in properties where value can be added to the  property through repairs, upgrades, and  improvements that take  a distressed property and  turn it into a solid  and  well-maintained property. Over the  years, with increased equity in the  property and  as long as interest rates are attractive, you could refinance the  property if you so choose and  use  some of your  equity towards other real estate investments.

We strongly prefer this  method because it has  proven throughout the  years to be the  lowest risk, highest probability way to make money in real estate. You can think  of it as the  tortoise in the  old tortoise-and-the-hare story, where the  hare is the  fast-money, high-risk, high-return strategy. The tortoise may be slow and  steady, but  he ends up winning  in the  long run.  As an example, Robert is a conservative person by nature, yet he has  acquired a significant real estate portfolio by simply  purchasing well-located-but-distressed properties and  renovating, filling them up, and  then refinancing.

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owning rental property or buy and flip

But what  if there are some additional problems with the  property when  Joe opens up the  walls to replumb his new investment gem? Maybe  there are termites or roof leaks  or problems with the  foundation. What if the  demand for this  property diminishes and  he has  to hold  the  property for 12 months? (Some  folks got burned in the  late-2000s when  the  demand for housing sud- denly  evaporated.) Even in the  best scenario, where Joe has  accurately esti- mated the  repair and  upgrade costs and  there are no surprises, he finds  that just  owning  the  property for six months longer than he expected doubles the holding costs from $8,000 to $16,000, reducing the  pre-tax profit to $4,000. By the  time he is done paying  30 percent of that in taxes, Joe has  just  $2,800 to show  for his efforts. Owning rental property.

You may be located in a market that has  experienced rapid housing price increases, but be careful. If there is too much excess demand for new housing in the area, real estate speculators — not long-term investors or homeowners — can make up the majority of the purchasers. This tendency can be dangerous when  the majority of buyers in the market are looking  for the quick  profit rather than a long-term, stable real estate investment. When enough of these specula- tors head for the exits (as happened in some areas in the late-2000s real estate market decline) and don’t return, prices can quickly  turn tail. The speculators are then forced to mitigate their losses by renting out their properties (some- times for years) until the real estate market rebounds and they’re able to sell
the property to break even.

But we’re pragmatists — we know that lightning may strike and you may run into a property that turns out to be a buy-and-flip candidate.

Investing in Rental Property vs Flipping

The buy-and-flip strategy can also  work with existing homes that the  investor can purchase from a motivated seller at a wholesale price that is below  the market value.  The investor may not  even  have  to close escrow before finding a buyer willing to pay a retail price. There may be some minor cosmetic work or simple improvements needed before reselling, but  typically, buy-and-flip investors really  make their money when  they  buy at a discount and  then locate a buyer at full market value.  This approach is risky,  but  investing in rental property can also  be rewarding.

This high-risk strategy requires a rapidly rising  real estate market with higher than normal appreciation rates to allow for profits on short term investments. Not only do you have  to have  excessive demand driving up the  prices of real estate, but  you also have  to cover all of the  costs of real estate. With online stock trading firms, you can buy shares of your  favorite company in minutes with relatively low transaction costs. But with real estate, the  costs of buying, holding, and selling  a property are much higher and unknown, and generally include

• Acquisition costs: Due diligence and  inspection fees plus  loan fees/costs and  points
• Transaction costs: Closing  and  escrow fees
• Repair or upgrade costs: Costs to renovate or fix property to make it more desirable and  generate the  highest resale price (unless the  property  is brand-new)
• Holding costs: Property taxes, insurance, and  any negative cash flow while the  property sits  vacant or if the  rental income doesn’t cover the carrying costs
• Sales costs: Commissions and title insurance from the sale of the property

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4 Ways To Increase Your Chances of Getting Money For Buying Rental Properites

Some ways you can alter your approach to getting money for buying rental properties without having  to find money elsewhere are as follows:

1. Seek low money down  loans  with private  mortgage insurance: Some lend- ers may offer you a mortgage even though you may be able to put down only 10 percent of the purchase price. These lenders will likely require you to purchase private  mortgage insurance (PMI) for your  loan. This insur- ance generally costs several hundred dollars per year  and protects the lender if you default on your  loan. (When  you do have  at least 20 percent or higher equity in the property, you can generally eliminate the PMI.)
2. Delay  your gratification: If you don’t  want  the  cost and  strain of extra fees and  bad  mortgage terms, postpone your  purchase. Boost your  sav- ings rate. Examine  your  current spending habits and  plan  to build  up a nest egg to use  to invest in your  first rental. Often real estate investors get started by actually buying a new home and  simply  keeping their old home as a rental. For more information, see  the  section “Make saving  a habit” later in the  chapter.
3. Think smaller:  Consider lower-priced properties. Smaller  properties and ones that need some work can help  keep  down  the  purchase price and the required down  payment. For example, a duplex where you live is one unit and  rent out  the  other is also  a cost-effective way to get started.
4. Turn to low entry cost options: For the  ultimate in low entry costs, real estate  investment trusts (REITs) are best. These stock exchange traded securities (which can also  be bought through REIT-focused  mutual funds) can be bought into for several thousand dollars or less.  REIT mutual funds can often  be purchased for $1000 or less  inside retirement accounts. (See Chapter 4 for more on investing in REITs.)

How to Save Money To Afford Buying Rental Properties

Here are two tips to help you be able to afford buying rental properties

Boost your income: To increase your  take-home pay, working  moremay be a possibility, or you may be able  to take  a more lucrative career path. Our main  advice on this  topic is to keep  your  priorities in order. You shouldn’t put  your  personal health and  relationships on the  back burner for a workaholic schedule. We also  believe in investing in your education. A solid  education is the  path to greater financial rewards and leads to all of the  great goals  we discuss here. Education is key not  only for your  chosen profession but  also  for real estate investing. Consider getting a real estate license or learn to be an appraiser or property man- ager  — skills that not  only help  you with your  property investing but that also  may allow you to take  on part-time work to supplement your income.

Reduce your spending: For most people, this  is the  path to increased savings. We have  both routinely generated cash flow for investments by living well beneath our  means. Start  by analyzing how much you expend on different areas (for instance, food, clothing, insurance) each month. After you’ve got the  data, decide where and  how you want  to
cut back.  Would you rather eat out  less  or have  a maid  come less  often? How about driving a less  expensive (but not  less  safe)  car versus taking lower  cost vacations? Although the  possibilities to reduce your  spend- ing are many,  you and  only you can decide which options you’re  willing and  able  to implement.

Why Real Estate Experts are Important

The most effective research is done with the assistance of real estate professionals to give you the advice and information you need to make an intelligent decision. This pre-offer period is critical; it’s the one real opportunity for a prospective buyer to investigate a property while retaining the ability to terminate the transaction without a significant monetary loss. You may invest time and several hundred to several thousand dollars to perform the necessary due diligence, but this  is a small amount compared to the potential losses from the purchase of a bad  property. This is why a rental property expert is important

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Real Estate Limited Partnership Tax Advantages

Limited partnerships have been available for many years. Prior to the extensive overhaul of the federal taxation of real estate investments in the 1980s, they were a common method of real estate  investing. Up until that time, all losses from real estate  were fully deductible, and these loopholes created opportunities for aggressive tax management to avoid legal tax liabilities. To learn more about the real estate limited partnership visit
http://buyrentalproperty.hubpages.com/hub/real-estate-limited-partnership

In 1986, Congress passed new tax regulations that eliminated the favorable tax treatment of most losses unless the real estate investor was an active participant. To qualify as an active participant, an individual must be involved in direct management decisions of the property, although the day-to-day rental activities of collecting rent, overseeing repairs, and paying bills can be delegated to a property manager.

Further, the federal tax code limits the deductibility of your passive  losses  against  your earned  income (salary, dividends, and interest) to a maximum of $25,000, as long as your adjusted gross income doesn’t exceed $100,000. The maximum $25,000  passive  loss  deduction phases out at a ratio of $1 for every $2 in adjusted gross income between $100,000 and $150,000. For real estate owners with adjusted gross income exceeding $150,000, any passive losses are carried forward to future years or until the property is sold.

How Much Cash Do You Need to Buy a Rental Property?

Determining how much cash you need to close on a rental property  is largely a function of the  estimated purchase price. Suppose you’re  looking  to buy some modest residential housing for $100,000. For a 25 percent down  payment you need $25,000, and  adding in another 5 percent for closing costs brings you to $30,000. If you have  your  heart set  on buying a property that costs three times as much ($300,000 sticker price), you need to triple these amounts to a total of about $90,000 for the  best financing options.

Real Estate Notes

The safest approach to making  secured loans on property is to thoroughly evaluate the  pledged collateral to protect your  investment and  determine the fair market value  if you had  to foreclose. Never  make a loan on a property that you wouldn’t be willing to own if that becomes your  best way to protect your  investment. Some lenders actually hope that the  borrower does default so they  can obtain the  property for a fraction of its market value.

Real Estate Notes for Sale

However, don’t  forget that you’re  responsible for legal fees and  foreclosure costs in addition to the  unpaid balance of your  loan and  accrued interest in the  event that the  borrower defaults.

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Triple Net Lease Properties Warning

On a triple net lease property the owner should regularly inspect the  property under any type  of net lease that isn’t a bond lease because she  retains ultimate control — and  thus the liability — if the  tenant fails to properly maintain the  building. Robert has seen a litany  of litigation between the  owner and  tenant over  issues of exactly what  type  of net lease exists, with the  key dispute being  an interpretation of who is responsible for the  repair and  maintenance of building components. These lawsuits often  result from third-party injuries, with the  landlord and the  tenant each accusing the  other of failing to properly inspect, maintain, and/or repair the triple net properties.
http://www.buyingrentalproperty.org/triple-net-lease/

REIT Mutual Fund Performance

So what  about performance? Over the  long term, REIT Mutual Funds have  produced total returns comparable to stocks in general. In fact, over  the  past 35 years, REIT returns have  actually been higher. In the  context of an overall investment portfolio, REITs add  diversification because their values don’t  always move in tandem with other investments.

For investments that move  perfectly in lock step, their beta or correlation
to the  overall stock market is 1. For investments always moving in opposite directions, the  correlation is 0. Over the  long term, the  correlation between stocks and REITs has  been about 0.6 (which is about the  level of correlation between foreign  stocks and U.S. stocks).

One final attribute of REITs we want  to highlight is the  fairly substantial  divi- dends that REITs usually pay. Because these dividends are generally fully tax- able  (and thus not  subject to the  lower  stock dividend tax rate), you should generally avoid  holding REITs outside of retirement accounts if you’re  in a high tax bracket (for instance, during your  working  years).

In case you care, and  you may well not,  the  reason for the  high dividends is the legal requirement in REIT charters that they  have  to distribute 95 percent of their income. In other words, REITs can legally only retain a maximum of 5 percent of their net income; they  must distribute everything else to the shareholders.

http://buyrentalproperty.hubpages.com/hub/REIT-Mutual-Funds

Buying a Short Sale

The short-sale concept has received a lot of notoriety, and late-night gurus promote semi- nars touting that they can teach  you every- thing you need to know about short sales. Even Donald Trump has gotten into the game. Trump made the headlines when he proposed a short sale to help retired TV host Ed McMahon and his wife from losing their home in Beverly Hills. The McMahons  were  apparently  $643,597 behind in payments on their $4.8 million loan. The Donald offered to buy the house,  with Countrywide Home Loans taking a discounted payoff, and allow the McMahons to continue to live in the property as renters. Ultimately, the parties reached another solution, but this was a well-known example of how the short sale process works.

If you want to learn more about buying a short sale visit http://www.buyingrentalproperty.org/buying-a-short-sale/

Simple Rental Property Repairs Yield High ROI

Here are some easy fixes that will help with your rental properties ROI. Avoid shared housing units in suburban areas with substantial undeveloped land that enables building many more units. Attached housing prices tend to perform best in fully developed or built-out urban environments.

For higher returns, look for property where relatively simple cosmetic and other fixes may allow you to increase rents and, therefore, the market value of the property. Examples of such improvements may include but not be limited to

1. Adding fresh paint and flooring
2. Improving the landscaping
3. Upgrading the kitchen with new appliances and new cabinet/drawer hardware that can totally change the look
4. Converting five-unit apartment buildings into four-unit buildings to qualify for more favor- able mortgage terms

Look for property with a great location and good physical condition but some minor deferred maintenance. Then you can develop the punch list of items with maximum results for minimum dollars — for example, a property with a large yard but dead grass, a two- or three-car garage but peeling paint or a broken garage door. You can also add a garage door opener to jazz up the property for minimum cost. You can also really add value to a property with a burnt-out, absentee, or totally disinterested owner who is tired of the property.
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Buying Timeshare Rental Properties

From an investment standpoint, the  fundamental problem with timeshares is that they’re overpriced, and  like a condominium, you own no land  (which is what  generally appreciates well over  time). For example, suppose that a particular unit would  cost $150,000 to buy. When this  unit is carved up into weekly ownership units, the  total cost of all those units can easily  approach four to five times that amount!

To add  insult to injury,  investors find that another problem with timeshares is the  high maintenance or annual service fees. Is it worth buying a slice of real estate at a 400 to 500 percent premium to its fair market value  and  pay high fees on top  of that? We don’t  think  so.

Many owners of timeshares find that they  want  to vacation at a different location or time of year  than what  they  originally purchased. To meet this need, several companies offer to broker or sell timeshare slots. However, timeshare availability and  desirability have  so many  variables — including location, time of year,  and  quality of the  particular resort — that it has  been difficult  to fairly value  and  trade timeshares. As a result, resort rating sys- tems have  been developed (Resorts Condominiums International and  Interval International are two of the  most well known) to compare resort location, amenities, and  quality.

The developers and  operators of condo hotels love the  concept because
one of the  most consistently successful principles of real estate is increasing value  by fractionalizing interests in real estate. As with timeshares, the  devel- opers are able  to sell each individual hotel room for much more than they could get for the  entire project.