Real Estate Investing for Dummies by Eric Tyson (Author), Robert S. Griswold (Author)

Introduction

Part I: Stacking Real Estate Up Against Other Investments

• Chapter 1: Evaluating Real Estate as an Investment
• Chapter 2: Covering Common Real Estate Investments
• Chapter 3: Considering Foreclosures, REOs, Probate Sales, and More
• Chapter 4: Taking the Passive Approach
• Chapter 5: Fast Money: Small Down Payments and Property Flips
• Chapter 6: Building Your Team

Part II: How to Get the Money: Raising Capital and Financing

• Chapter 7: Sources of Capital
• Chapter 8: Financing Your Property Purchases
• Chapter 9: Securing the Best Mortgage Terms

Part III: Finding and Evaluating Properties

• Chapter 10: Location, Location, Value
• Chapter 11: Understanding Leases and Property Valuation
• Chapter 12: Valuing Property through Number Crunching
• Chapter 13: Preparing and Making an Offer
• Chapter 14: Due Diligence, Property Inspections, and Closing

Part IV: Operating the Property

• Chapter 15: Landlording 101
• Chapter 16: Protecting Your Investment: Insurance and Risk Management
• Chapter 17: Recordkeeping and Accounting
• Chapter 18: Tax Considerations and Exit Strategies

Part V: The Part of Tens

• Chapter 19: Ten (Plus) Ways to Increase a Property’s Return
• Chapter 20: Ten Steps to Real Estate Investing Success

Appendix: Sample Purchase Agreement

Index

Excerpts (partial)

(front section)

ERIC AND ROBERT’S PRINCIPLES FOR SUCCESS

Although many people can succeed investing in real estate, rental property investing isn’t for everyone

Are you comfortable troubleshooting problems or hiring a property manager?

Make sure you’re financially fit before investing in rental properties. Pay particular attention to your monthly budget and make sure that you have adequate insurance coverage.

Your first (and often one of the best) real estate investment is buying a home to live in. Real estate is the only investment that we know of that you can live in or rent to produce income. You can also derive large tax-free profits when you sell your principal residence at a higher price than you paid for it.

Focus on residential properties in the beginning

Among residential property options, our top recommendations are small apartment buildings and single-family homes. Attached housing (aka units within a bigger building) makes more sense for investors who don’t want to deal with building maintenance and security issues.

Have your real estate team in place before you begin your serious property searching. Line up a real estate agent, loan officer, tax advisor, lawyer, and so on early because the real estate investor with the best resources can identify the properties to ignore and those worthy of careful consideration. Move quickly — the speed at which you can close a transaction is an advantage in any type of market.

Look for properties in the path of progress

The best real estate investment properties are ones that are well located and physically sound but cosmetically challenged and poorly managed.

For low entry costs, consider real estate investment trusts (REITs) and lease options.

We prefer the adage of “Location, location, value.

Make real estate investments close by. Buy property within two hours away by your favorite mode of transportation. Venture farther only when you really know another real estate market and regularly find yourself there for other reasons or you’ve found an excellent property manager

Any decision about where to invest starts with an evaluation of the overall region’s economic trends

You’re purchasing a future income stream or cash flow when you buy an investment property

The key is identifying which properties sellers have underpriced.

Don’t rely on the seller’s numbers when evaluating a property’s potential

Introduction

Throughout this book, we emphasize three fundamental cornerstones that we believe to be true:

Although you should make money over the long term investing in good real estate properties, you can lose money, especially in the short term.

About This Book

how to invest in single-family homes; detached and attached condominiums; small apartments including duplexes, triplexes, fourplexes, and multiple-family residential properties up to 20 to 30 units

Foolish Assumptions

particular audience in mind.

Beyond This Book

type “Real Estate Investing For Dummies Cheat Sheet” in the search box to find additional tips for investing.

Where to Go from Here

you may also choose to read selected portions

Recognizing the Caveats of Real Estate Investing

Few home runs

Upfront operating profit challenges: Unless you make a large down payment, your monthly operating profit may be small, nonexistent, or negative in the early years of rental property ownership. During soft periods in the local economy, rents may rise more slowly than your expenses or they may even fall

Ups and downs: You’re not going to earn an 8 to 9 percent return every year. Although you have the potential for significant profits, owning real estate isn’t like owning a printing press at the U.S. Treasury.

Relatively high transaction costs: If you buy a property and then want out a year or two later, you may find that even though the property has appreciated in value, much (if not all) of your profit has been wiped away by the high transaction costs... 8 to 12 percent of the purchase price of a property

Tax implications: Last, but not least, when you make a positive net return or profit on your real estate investment, the federal and state governments are waiting with open hands for their share. Throughout this book, we highlight ways to improve your after-tax returns

Chapter 1: Evaluating Real Estate as an Investment

Comparing Real Estate to Other Investments

Our research and experience suggest that total real estate investment returns are comparable to those from stocks — about 8 to 9 percent on average, annually

And you can earn long-term returns that average 10+ percent per year if you select excellent properties in the best areas, hold them for several years, and manage them well.

Chapter 2: Covering Common Real Estate Investments

Seeing the Various Ways to Invest in Residential Income Property

The first (and one of the best) real estate investments for many people is a home in which to live. In this section, we cover the investment possibilities inherent in buying a home for your own use, including potential profit to be had from converting your home to a rental or fixing it up and selling it. We also give you some pointers on how to profit from owning your own vacation home.

Converting your home to a rental

Turning your current home into a rental property when you move is a simple way to buy and own more properties

acquiring rental properties not only with a house but also with a duplex or other small multi-unit rental property where you reside in one of the units

Turning your home into a short-term rental, however, is usually a bad move because

• You may not want the responsibilities of being a landlord, yet you force yourself into the landlord business when you convert your home into a rental.
• You owe tax on the sale’s profit (and recaptured depreciation) if your property is classified for tax purposes as a rental when you sell it and you don’t buy another rental property.

Investing and living in well-situated fixer-uppers

you must actually move into the fixer-upper for at least 24 months to earn the full homeowner’s capital gains exemption of up to $250,000 for single taxpayers and $500,000 for married couples

In our experience, this strategy is not likely to work well for you if any of the following apply:

• You’re unwilling or reluctant to live through redecorating, minor remodeling, or major construction.

Purchasing a vacation home

potential investment returns shouldn’t be the main reason you buy a second home.

Paying for timeshares and condo hotels

We don’t see timeshares or condo hotels as worthy real estate investments as they don’t appreciate and they don’t generate income

Surveying the Types of Residential Properties You Can Buy

in addition to single-family homes, you can choose from numerous types of attached or shared housing including duplexes, triplexes, apartment buildings, condominiums, townhomes, and co-operatives

From an investment perspective, our top recommendations are (whole) apartment buildings and single-family homes. We generally don’t recommend attached-housing units, which have associations (HOA) and shared common areas. If you can afford a smaller single-family home or apartment building rather than a shared-housing unit, buy the single-family home or apartments

always allow for unexpected vacancy or capital improvements like flooring and window coverings, appliances, and/or the water heater.

Single-family homes

single-family homes tend to outperform other housing types for the following reasons:

Single-family homes tend to attract more potential buyers

Attached or shared housing is less expensive and easier to build and to overbuild; because of this surplus potential, such property tends to appreciate less.

Because so many people prefer to live in detached, single-family homes, market prices for such dwellings can often become inflated beyond what’s justified by the rental income these homes can produce

To discover whether you’re buying in such a market, compare the monthly cost (after tax) of owning a home to the monthly rent for that same property. Focus on markets where the rent exceeds or comes close to equaling the cost of owning and shun areas where the ownership costs exceed rents.

Single-family homes that require just one tenant are simpler to deal with than a multi-unit apartment building that requires the management and maintenance of multiple renters and units. Single-family homes in some markets are also currently exempt from rent control laws as long as other conditions are met. The downside, though, is that a vacancy means you have no income coming in. Look at the effect of 0 percent occupancy for a couple of months on your projected income and expense statement! By contrast, one vacancy in a four-unit apartment building (each with the same rents) means that you’re still taking in 75 percent of the gross potential (maximum total) rent.

Attached housing

Shared housing makes more sense for investors who don’t want to deal with building maintenance and security issues.

In this section, we discuss the investment merits of three forms of attached housing: condominiums, townhomes, and co-ops.

Condos

When you purchase a condominium, you’re actually purchasing the interior of a specific unit as well as a proportionate, undivided (meaning, you don’t directly own a portion) interest in the common areas

One advantage to a condo as an investment property is that of all the attached housing options, condos are generally the lowest-maintenance properties (from the perspective of unit owners) because most condominium or homeowners’ associations deal with issues such as roofing, landscaping, and so on for the entire building and receive the benefits of quantity purchasing

Although condos may be somewhat easier to keep up, they tend to appreciate less than single-family homes or apartment buildings unless the condo is located in a desirable urban area.

Be wary of apartments that have been converted to condominiums... Our experience is that these converted apartments are typically older properties with a cosmetic makeover (new floors, new appliances, solid surface countertops, new landscaping, and a fresh coat of paint). However, be forewarned: The cosmetic makeover may look good at first glance, but the property probably still boasts 40-year-old plumbing, heating/cooling, and electrical systems; poor soundproofing; and a host of economic and functional obsolescence

You may then find the property is predominantly renter-occupied and has a volunteer board of directors unwilling to levy the monthly assessments necessary to properly maintain the aging structure. Alternatively, old buildings may have high unit assessments to deal with myriad costly problems. Within 10 to 15 years of the conversion, these properties may well be the worst in the neighborhood.

Townhomes (townhouses)

Townhomes are essentially attached or row homes

As with condominiums, you absolutely must review the governing documents before you purchase the property to see exactly what you legally own.

Co-ops

Co-operatives are a type of shared housing that has elements in common with apartments and condos

Unlike a condo, you generally need to get approval from the co-operative association if you want to remodel or rent your unit to a tenant. In some co-ops, you must even gain approval from the association for the sale of your unit to a proposed buyer.

we highly recommend that you avoid co-ops for investment purposes.

Apartments

Not only do apartment buildings generally enjoy healthy long-term appreciation potential, but they also often produce positive cash flow (rental income minus expenses) in the early years of ownership. But as with a single-family home, the buck stops with you for maintenance of an apartment building

In the real estate financing world, apartment buildings are divided into two groups based on the number of units:

• Four or fewer units: You can obtain more favorable financing options and terms for apartment buildings that have four or fewer units because they’re treated as residential property.
• Five or more units: Complexes with five or more units are treated as commercial property and don’t enjoy the extremely favorable loan terms of the one- to four-unit properties.

Chapter 4: Taking the Passive Approach

Using Real Estate Investment Trusts

Real estate investment trusts (REITs) are for-profit companies that own and generally operate different types of property. The options for REIT investments are extremely broad and cover virtually every type of real estate. You can choose your favorite REIT from the following income property types:

Office

Residential

Retail

Industrial

Hospitality

Healthcare

Self-storage

Cell towers:

Other rental income properties, even timberlands

REITs can be a good way to invest in real estate for people who don’t want the hassles and headaches that come with directly owning and managing rental property

Distinguishing between public and private REITs

asking for full disclosure of the relationship between the REIT, its advisors, and the management companies. REITs often involve conflicts of interest that aren’t clearly disclosed or pay significant above-market fees to directly or indirectly related entities or affiliates that ultimately lower the cash flow and return

Public REITs are traded on the major stock exchanges and thus must meet strict SEC reporting requirements:

Liquidity

Independent board of directors

Financial reporting

We recommend that you stay away from private REITs unless you’re a sophisticated, experienced real estate investor

Taking a look at performance

Over the long term, REITs have produced total returns comparable to stocks in general. REITs add diversification because their values don’t always move in tandem with other investments. Having a diversified and balanced portfolio of different asset classes that react independently of one another can mitigate some of the risk and allow you to achieve overall higher returns on your investments.

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

Investing in REIT funds

You can research and purchase shares in individual REITs, which trade as securities on the major stock exchanges. An even better approach is to buy a mutual fund or exchange-traded fund that invests in a diversified mixture of REITs. Some of the best REIT mutual funds charge 1 percent per year or less in management fees, and have long-term track records of success while taking modest risks. Vanguard’s Real Estate Index Fund charges just 0.13 percent per year in fees and has produced average annual returns of about 8.8 percent since its inception in 2001.

REITs offer an additional advantage that traditional rental real estate doesn’t. You can easily invest in REITs through a retirement account such as an IRA.

If you really have your heart set on becoming the next Warren Buffett and you enjoy the challenge of selecting your own stocks, you can research and choose your own REITs to invest in.

Chapter 5: Fast Money: Small Down Payments and Property Flips

Purchasing with No Money Down

Someone who has the time to develop and host hundreds of hours of podcasts on “How to Make Money with No Money Down” or “Buy and Flip to Become a Millionaire in Your Spare Time” isn’t likely to be as successful as they claim

You should pay attention if a Counselor of Real Estate (CRE), a Certified Property Manager (CPM), or a Certified Commercial Investment Member (CCIM) offers you real estate investment or management advice. Find the most experienced and credentialed real estate industry professionals in your area and listen carefully. They will inform you that real estate investing takes time, hard work, persistence, and a lot of patience

The concept of buying real estate without using any of your own money is clearly dependent on finding an extremely motivated seller. A motivated seller is one who faces circumstances that don’t allow them the flexibility to achieve full market value for their property. For sure, a certain number of motivated sellers exist in any market

A seller who’s relocating and needs to sell in a hurry

A seller who’s desperate to sell and exasperated by the effort: The owner of a property that has been vacant for an extended time period or that requires extensive renovation may be eager to sell.

An owner who is burnt out on self-managing a rental property:

No-money-down sellers are in greater abundance in a weak real estate market (or buyer’s market) because sellers have fewer options

Buying, Fixing, and Flipping or Refinancing

In a solid real estate market, you often find properties appreciating at an annual rate of 3 to 5 percent — a solid and sustainable rate of appreciation that rewards investors with long-term investment horizons who take the buy-and-hold approach with their real estate assets.

Recent returns in some markets on certain types of high-demand real estate have been nominally higher, but inflation of virtually every expense category (especially labor, utilities, and insurance) in recent years has quickly devoured short-term gains due to rising rents

That is why we have always found that over time this buy-and-hold strategy works and should always be the foundation of your wealth building.

But in some areas the demand for housing has been so great that the limited supply of new and existing properties available in the market is insufficient to meet the demand. It’s in these markets of high demand and rapidly escalating prices that real estate speculators with a buy-and-flip strategy tend to appear.

We prefer the more conventional and lower-risk strategy of buy, fix, and hold.

The buy, fix, and refinance strategy

With the buy, 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 with a good stable tenant

Chapter 6: Building Your Team

IN THIS CHAPTER  Assembling your team from the get-go*  Hiring tax and financial advisors*  Seeking lending professionals*  Finding top real estate agents and brokers*  Adding appraisers and attorneys*

for most real estate investors, real estate investing is hands-on and complicated enough to require the services and knowledge of a team of professionals. Although you may be skilled in your chosen field, it’s unlikely that you possess all the varied and detailed skills and knowledge necessary to initiate and close a good real estate transaction.

You should understand the economic climate and potential for growth, the current physical and economic condition of the property, the tenants, and the value of the property in the marketplace. Then you should ensure that you’ve got a solid negotiating strategy to orchestrate a deal, that the financing comes through without surprises, and that the transfer of real estate is handled properly. This requires a team approach.

Knowing When to Establish Your Team

We recommend that you have your team in place before you begin your serious property searching, for two reasons:

You can move quickly. The speed at which you can close a transaction is an advantage in any type of market

You can effectively research the property before making an offer.

you really need to perform due diligence even before making an offer. You don’t want to waste time or money on a property that can’t meet your goals.

We recommend only making offers when you have done enough due diligence to feel comfortable that your further, thorough physical inspection and financial review of the property interiors and books probably won’t reveal any surprises that will lead to canceling the purchase.

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

You may invest time and several hundred to several thousand dollars to perform the necessary due diligence

Adding a Tax Advisor

Seek a knowledgeable advisor who has many years of experience and has worked through the real estate cycles and understands that markets can go up and down, and that real estate financing can be reasonable and easy to obtain as well as expensive and elusive

We cover the ins and outs of real estate accounting and taxation in Chapters 17 and 18.)

You need specific feedback and ideas from a tax expert regarding your unique financial situation and which types of real estate investments work best for you.

whether your best real estate investment is the direct ownership of properties or perhaps owning triple net leased properties with lower returns but fewer management headaches. Accountants can inform their

meet the active participation required for certain tax benefits while hiring a property management company to handle the bulk of the day-to-day tenant/landlord issues.

Finding a Financial Advisor

Everyone entering into investments like real estate should seek holistic financial advice from an advisor who charges an hourly fee... in pracice, many financial consultants sell investment and insurance products that provide them with commissions or manage money for an ongoing percentage in stocks, bonds, mutual and exchange-traded funds, and the like. Such salespeople and money managers can’t provide objective, holistic advice, especially on real estate transactions

Lining Up a Lender or Mortgage Broker

Postpone making an appointment to look at investment properties until after you examine the loans available.

You have two resources to consult:

A lender is any firm, public or private, that directly loans 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).

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.

On the upside, we’ve found that lenders can also serve a valuable role by preventing you from making serious mistakes. Particularly in overheated seller’s markets where prices are irrationally climbing with insufficient fundamental economic support, your lender and the required appraisal from a competent, independent, professional appraiser can keep you from getting caught up in a buy-at-any-price frenzy.

Lenders require collateral to protect them if the borrower doesn’t make the debt service payments as required. Collateral is the real or personal property that’s pledged to secure a loan or mortgage

Typically, the property being purchased is the pledged collateral for real estate loans or mortgages.

Building relationships with lenders

Working with Real Estate Brokers and Agents

Your investment team should include a sharp and energetic real estate broker or agent

Whether you use a broker or an agent, make sure that this person has a solid track record with investment property transactions in your area. And although having a real estate agent on your team is an excellent strategy that gives you a competitive edge, don’t completely ignore the various online listing services; the Multiple Listing Service (MLS), which is still popular in some areas; or in-house listings of brokers. Such sources often include properties that other investors overlooked because they didn’t have the vision or the right team members to see a potential opportunity.

Seeing the value of working with an agent

In many metropolitan areas, looking at the properties on a Multiple Listing Service (MLS) or in online listings isn’t enough. The best deals are often the ones that don’t make it into these sources. This is where the “insider information” from real estate sales agents can make you the bride and not the bridesmaid

You want to be the first one contacted about the best properties coming on the market rather than one of many when everyone knows about the property

Grasping the implications of agency: Who the agent is working for

Single agency: This is when an agent only represents the buyer or the seller. The other party either represents themself or is represented by an agent who doesn’t work for the same broker as the other agent

We strongly recommend that you work with an agent who operates as a single agency representative.

Dual agency: A situation in which the same individual agent represents both the seller and the buyer or when two different agents representing the seller and buyer are from the same firm (with the same broker).

Getting a feel for compensation

Individual residential properties, such as single-family homes and condos, have commissions of 5 to 6 percent of the sales price. Small multifamily and commercial properties are often in the 3 to 5 percent range*

These commissions are typically split between the firm listing the property for sale and working with the seller and the agent representing the buyer

Finding a good broker or agent

Making the most of your agent

Considering an Appraiser

an appraiser can be an effective team member if your real estate investment strategy involves buying and selling properties with somewhat-hidden opportunities to add value.

insight into the factors that can lead to an increase in the market value of a property

Finding an Attorney

You may think that adding an attorney to your real estate investment team seems like an expensive luxury that you can’t afford. Indeed, you may be able to purchase properties when you’re just starting out as a real estate investor without consulting an attorney, because buying a small rental property is often not much different from purchasing your own home. The process is relatively simple with preprinted forms that seem so easy to complete. And you usually have an experienced real estate agent to guide you through the process.

For simple transactions, the retention of an attorney is strictly a function of whether attorneys are traditionally involved as the intermediary or closing agent. If you live in an area where attorneys aren’t usually involved in real estate transactions, an attorney may not be necessary. In some states, having an attorney is essential to handle the transaction and closing

Robert’s late father, a real estate attorney, taught him early in his real estate investment career that the best time to consult with an attorney is before you finalize the proposed transaction

Part II: How to Get the Money: Raising Capital and Financing

Chapter 7: Sources of Capital

Overcoming Down Payment Limitations

Most people, especially when they make their first real estate purchase, are strapped for cash. If you don’t have 20-plus percent of the purchase price, don’t panic and don’t get depressed — you can still own real estate

Seek low-money-down loans with private mortgage insurance: Some lenders 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 insurance generally costs several hundred dollars per year

Delay your gratification: If you don’t want the cost and strain of extra fees and bad mortgage terms, postpone your purchase. Boost your savings rate

Think smaller: Consider lower-priced properties. Smaller properties and ones that need some major work can help keep down the purchase price and the required down payment. For example, a duplex where you live in one unit and rent out the other is also a cost-effective way to get started (and is known as “house hacking” if you like such lingo).

• (Bill notes: I've seen other people suggest doing this with a four-unit building - of course, you have to be happy living in the same "quality" of building that you rent out.)

We know numerous folks who have used this entry strategy into rental property ownerships to achieve two goals: an owner-occupied place to live and a rental property that is convenient to manage.

Turn to low entry cost options: For the ultimate in low entry costs while adding real estate to your investment allocation strategy, real estate investment trusts (REITs) are best

Lease options represent another low cost (although more complicated) opportunity. With these, you begin by renting a property you may be interested in purchasing down the road

friendly little reminder: Monitor how much of your overall investment portfolio you place into real estate and how diversified and appropriate your holdings are given your overall goals

Some employer plans allow you to borrow against your retirement account balance, under the condition that you repay the loan within a set number of years. Subject to eligibility requirements, first-time homebuyers can make penalty-free withdrawals of up to $10,000 from IRA accounts. (Note: You still must pay regular income tax on the withdrawal, which can significantly reduce the cash available.)

Borrowing against home equity

Most real estate investors that we know began building their real estate portfolio after they bought their own home. Conservatively tapping into your home’s equity may be a good down payment source for your property investments.

Unless your current mortgage was locked in at lower rates than are available today, we generally recommend refinancing the first trust deed loan and freeing up equity that way versus taking out a home equity loan or line of credit

A variation on the borrowing-against-home-equity idea uses the keep-your-original-home-as-a-rental strategy. You build up significant equity in your owner-occupied home and then need or want a new home

Refinance the existing home (while you still live there for the best owner-occupied rates), and then convert it into a rental.

be sure that you can handle the larger payments

Understand the tax ramifications of all your alternatives

Be careful to understand the tax-deductibility issue when you refinance a home mortgage and borrow more than you originally had outstanding on the prior loan. If any of the extra amount borrowed isn’t used to buy, build, or improve your primary or secondary residence, the deductibility of the interest on the excess amount borrowed is limited.

Fully comprehend the risks of losing your home to foreclosure: The more you borrow against your home, the greater the risk that you may lose the roof over your head

Moving financial investments into property investments

Capitalizing on advanced funding strategies

Sophisticated investors who develop an extensive real estate investment portfolio can employ more complicated strategies

Leveraging existing real estate investments

properties you buy do what they’re supposed to do, they’ll appreciate in value. Thus, you may be able to take extra tax-free cash from your successful investments to make more purchases. This tactic is called hypothecating your real estate. As we discuss in the section “Borrowing against home equity” earlier in this chapter, many investors begin by employing this strategy with their owner-occupied home.

Bringing in partners or other investors

Seeking seller financing

Taking on margin debt

If you own stocks and other securities in a brokerage account, you can actually borrow funds against those investments

Be careful when using margin debt. Stocks, bonds, and other investments can drop in value, sometimes sharply. When that happens, as it did in 2008, you may face what is known as a margin call

Chapter 11: Understanding Leases and Property Valuation

Establishing Value Benchmarks

they’re only quick and simple indicators of value. Don’t make investment decisions without calculating the Net Operating Income (NOI), which we cover in detail in Chapter 12.

Gross Rent Multiplier (GRM): GRM is most commonly used for residential income properties

Experienced investors know that much more analysis is needed because these formulas don’t consider future appreciation, financial leverage, the risk of the investment, or operating expenses. They focus on gross income only, which can be deceptive.

As we discuss in Chapter 12, the operating and capital expense levels can make a tremendous difference in the overall cash flow and the value of the property

Price per unit and square foot

Like the GRM calculation, the price per unit does have its limitations

The price per square foot is a widely used yet simple calculation most often associated with commercial, industrial, and retail properties (and sometimes used for residential properties).

Replacement cost

The calculation of replacement cost is usually done by comparing the price per square foot to an estimate of the cost per square foot to build a similar new property, including the cost of the land.

Chapter 14: Due Diligence, Property Inspections, and Closing

Determining How to Hold Title

Maintaining your privacy, minimizing your tax burden, and protecting your assets from claims and creditors are critical elements to most real estate investors

Sole proprietorship

advantages include the following:

Exclusive rights of ownership

Minimal legal costs to establish

Simple recordkeeping

also has its downsides, including the following:

Unlimited liabilities: You have no legal protections against lawsuits or other claims

No real tax advantages: Sole proprietorships offer no real advantages in the area of death and taxes!

Joint tenancy

Joint tenancy is only available to individuals (not legal corporate entities) because a unique feature of holding title in a joint tenancy is the right of survivorship. Upon the death of one of the joint tenants, the entire ownership automatically vests in equal shares to the surviving individual

unique advantage to joint tenancy, besides the right of survivorship, is that you get a stepped-up basis on your deceased joint tenant’s portion of the property.

 Although marriage isn’t a requirement to use this method of holding title, traditionally, joint tenancy has been the most common way for married couples to hold title to investment properties. One of the primary advantages of joint tenancy is that the death of one spouse can result in a complete step-up in basis to the fair market value at the time of death rather than just a step-up for the portion owned by the deceased joint tenant.

Tenancy in common

One of the most common forms of co-ownership is tenancy in common (also known as tenants in common or TIC). A tenancy in common is the ownership of real property in which several owners each own a stated portion or share of the entire property

each owner can own a different percentage

 Tenancy in common is a popular way to hold title for real estate investors but can be a problem unless there are clear understandings, preferably in writing, as to the asset and property management decisions of operating the property. But even then, problems and challenges are possible:

Death of an owner

Sale by an owner

Financial problems of an owner

Different plans

Income and expenses from operations of the property are reported on the individual’s tax return, but a problem with tenants in common is that new investors acquiring a TIC interest may not qualify for the tax-deferral benefits generally associated with a 1031 like-kind exchange

Partnerships

business enterprise in which two or more persons join together to pool their capital and talent to purchase, manage, and ultimately sell real estate

Limited liability company

LLC is a hybrid form of doing business that combines characteristics of a partnership and a corporation. This setup is an unbeatable combination for many real estate investors and a great way to hold title to real estate holdings.

LLCs have essentially replaced corporations and partnerships as the most common way to hold title to real estate because they offer the advantages of allowing each member to have a say in the management while extending limited liability to all members, without the burden of double taxation that occurs with corporations

An LLC is a separate entity like a corporation and therefore carries liability protection for all of its members, but it can be structured like a partnership so that the taxation flows through to each member individually. This feature simply requires the LLC to declare itself a joint venture with the IRS and indicate how it wants to allocate the taxation of income and expenses. Like a partnership, an LLC is required to prepare and file an IRS Form 1065, Partnership Tax Return, unless it makes the joint venture election.

Check with your own tax advisor, but many advisors recommend that their clients use a limited liability company because it offers the best of both worlds

Have an attorney prepare the articles of organization and an operating agreement (which are usually filed with the secretary of state

a husband and wife are considered two members when forming an LLC.

 Despite all these advantages, seek the counsel of an attorney who specializes in the formation of LLCs to help you with the following issues:

IRS limitations

Costs: The costs can be much greater than for other forms of ownership. Be sure to consult with a local tax advisor for details on the typical costs for operating an LLC in your state. Currently, the highest base cost for an LLC is found in California: a minimum franchise tax fee of $800 per year plus additional taxes based on gross receipts.

Corporations

Part IV: Operating the Property

Chapter 15: Landlording 101

Chapter 16: Protecting Your Investment: Insurance and Risk Management

Chapter 17: Recordkeeping and Accounting

Chapter 18: Looking at Tax Considerations and Exit Strategies

IN THIS CHAPTER  Mastering the tax advantages of real estate investing*  Exploring tax-deferred exchanges*  Understanding tax perks in the 2017 Tax Cuts and Jobs Act bill and their potential 2025 expiration*  Looking into other exit strategies*

Applying tax strategies properly allows rental real estate investors the ability to shelter income and even to eliminate — or at least defer — capital gains.

Understanding the Tax Angles

deduct the costs of operating and the repairs and maintenance of their home

Also, the benefits of depreciation apply only to rental real estate

Depreciation is an accounting concept that allows you to claim a deduction for a certain portion of the acquisition value of a rental property because the building wears out over time

you treat the depreciation amount as an expense or deduction when tallying your income on your tax return, which decreases your taxable income and allows you to shelter positive cash flow from taxation. Depreciation lowers your income taxes in the current year by essentially providing a government, interest-free loan until the property is sold.

Real estate investors can use depreciation to defer, but not permanently eliminate, income taxes

is a reduction in the basis

which is recaptured (added to your taxable profit) in full and taxed upon sale. Currently, all deductions taken for cost recovery are recaptured and taxed at 25 percent when you sell the property.

Depreciation is only allowed for the acquisition value of the buildings and other improvements, because the underlying land isn’t depreciable.

To determine the appropriate basis for calculating depreciation, many real estate investors have traditionally used the property tax assessor’s allocation between the value of the buildings and land.

cost-effective method that the IRS accepts is the Comparative Market Analysis (CMA) that most brokers offer at a nominal charge or even for free.

Residential rental property: The recovery period is 27.5 years

Minimizing income taxes

Taxpayers generally have two types of income:

• Ordinary income
• Capital gains:

Long-term: For property held for longer than 12 months, gains are taxed at lower rates than ordinary income with a current rate of 0, 15, or 20 percent, depending on your overall tax bracket

Part V: The Part of Tens

Chapter 19: Ten (Plus One) Ways to Increase a Property’s Value

As we cover in Chapter 12, you can receive a return on your real estate investments basically in four ways — cash flow, equity buildup from loan paydown, tax benefits, and property appreciation. A great aspect of real estate is that you can buy properties according to your particular financial and personal needs. Different properties are geared more toward achieving one of these types of return than another.

In this chapter, we highlight more than ten of the best ways that you can enhance your return on investment with rental properties

Raise Rents

setting the proper rent and maintaining the optimum market level rents upon turnover of tenants is one of the most common challenges faced by property owners

Many rental property owners are reluctant to raise rents because they’re concerned that their good tenants may leave. This is a valid concern, but it shouldn’t prevent you from getting rents to market level

We recommend raising the rental rate modestly each year rather than waiting for two or three years and then hitting your tenants with a major increase all at once.

If your rents are already at market levels, look to make upgrades to the property to justify higher rents. Maybe adding a combination microwave/exhaust vent unit above the stove, granite countertops, mirrored closet doors, reserved parking, storage lockers, or a deck or awning can provide an improvement that justifies higher rent. Use your market analysis or rent survey of competitive properties, especially ones that have the rents you would like to achieve, to see what they are offering and at what rent level.

Market analysis and rent surveys are discussed in Robert’s bestseller Property Management Kit For Dummies

Reduce Turnover

A tenant moving out almost certainly means a loss in rental income, plus you’re hit with the increased expenses (marketing, leasing commissions, tenant screening, maintenance and repairs, and often capital or tenant improvements) to make the rental unit or suite available to show prospective tenants

Another effective tool to reduce the loss of rent during tenant turnover is to prelease the rental unit or commercial tenant suite. After you receive a tenant’s notice to vacate, immediately seek permission to enter and determine what you need to do to make the property ready for the next tenant. Also begin advertising for a new tenant and gain the cooperation of the departing tenant to show the property.

Consider Lease Options

A lease option is an agreement that allows the tenant the right to purchase the leased property at a predetermined price for a certain period of time. Sellers typically use lease options in slow real estate markets to create additional interest in the property — even a potential buyer currently without a down payment has the opportunity to eventually become a property owner.

Develop a Market Niche

Rental properties catering to seniors have always been popular

Some senior properties are targeting those in need of special care and food services, and that is difficult for many landlords. But there is a growing need for properties with activities and social programs that appeal to active seniors and don’t require specialized skills or significant capital investments

Robert has had success in Las Vegas (of all places!) with smoke-free apartments

additional costs upfront in thoroughly cleaning, completely repainting, and installing all new flooring and window coverings

student housing is also a potential opportunity

Maintain and Renovate

curb appeal or first impression

The easiest way to increase cash flow and value is to simply clean up and address the deferred maintenance found in most properties.

Besides curing the simple deferred maintenance, another great way to increase cash flow (and value) is to renovate the property. The key here is to spend money only on items that enhance the property and provide a quick payback. Examples include submetering utilities, replacing old carpet with new flooring, upgrading appliances, sealing and striping of the parking lot, or adding new features that tenants desire.

For residential rentals, the best return on investment inside the units is found in updating the baths and kitchens.

One of the most cost-effective ways to increase the aesthetics and curb appeal of any type of property is through landscaping improvements. Often you can simply replace declining or dead plantings.

Cut Back Operating Expenses

particularly without negatively impacting your tenants

energy audit

LED lighting, solar energy, and hydronics heating systems

Converting existing wasteful lighting to LEDs

Tracking your natural gas usage can also alert you (if you see an unexplained spike) to possible minor leaks that can be expensive (and dangerous)

Another great way to reduce your operating costs without any reduction in types and extent of coverage and policy limits is to combine your various rental properties under one insurance policy

SHIFTING UTILITY COSTS TO TENANTS

In the last few decades, numerous states have mandated that gas and electric utilities directly meter individual apartment units. (However, most water utilities allow the installation of a single master meter for an apartment building

Landlords of multifamily rental properties may now choose to shift utility costs via submetering or allocation systems:

Scrutinize Property Tax Assessments

property tax expense is often one of the largest costs in owning real estate

If that’s true for your area and real estate values decline, contact your local assessor and inquire about getting a reassessment

If there are no limitations, they may even raise the assessed value each year until you react.

If you feel that your assessment is too high, contact your assessor. They may be willing to make an adjustment if you back up your opinion with careful research and a good presentation. Or you may need to make a formal property tax protest to initiate an appeal.

Refinance and Build Equity More Quickly

refinancing to a lower rate can have a tremendous impact on your cash flow.

You can enhance your equity buildup through refinancing to a shorter-term loan

after you’ve owned the property for several years, you may find that the cash flow has improved to the point that the property can handle a higher mortgage payment.

Another way to achieve similar results is to arrange to make additional payments designated as principal reduction

Before refinancing or making additional principal payments, make sure that your loan doesn’t have a prepayment penalty.

Take Advantage of Tax Benefits

Even novice real estate investors can take advantage of the generous tax savings with the capital gains exclusion for their principal residences. This exclusion allows sellers to completely eliminate any income tax on their capital gain of up to $500,000 if they meet the simple requirements we outline in Chapter 18. For investors willing to live in the property during renovation, the serial home-selling investment strategy can be used every couple of years to produce tax-free profits.

As we cover in Chapter 18, depreciation or cost recovery allows the owner to take a noncash deduction that reduces the taxable income from the property

Depreciation deductions are a noncash item, so they often result in a taxable loss even though the actual cash flow for the property is positive. Ask your CPA or tax advisor about cost segregation (determining separate and often accelerated depreciation schedules for various building components) to maximize your depreciation write-offs. Even if you can’t immediately use a taxable loss to offset other earned income, you can use it in years that you have passive income such as a profitable taxable sale of another rental investment property.

Be Prepared to Move On

When most people think about real estate, they correctly determine that appreciation is where the real money is made. Over time, real estate has proven to be an investment that retains and increases in value. Even an average annual rate of appreciation of 5 percent dramatically increases your net worth over time.

Improve Management

The reality is that to properly manage a property using the techniques we describe throughout this book to obtain the best financial results takes a lot of time and effort and requires frequent visits to your rental properties.

As we discuss in Chapter 15, you need to determine whether you are the best person to manage your income properties or whether you are better off hiring a professional (management company). The answer will depend on a variety of factors, but in the early days the right answer for many is to self-manage.

Chapter 20: Ten Steps to Real Estate Investing Success

finding well-located, fiscally and physically sound properties that are available at below-market prices isn’t simple

In our experience, successful real estate investors tend to be savvy, hard-working, conscientious individuals who enthusiastically perform comprehensive due diligence before buying a property

Build Up Savings and Clean Up Credit

the best opportunities and the most options are available to real estate investors who have both cash and good credit

Get a copy of your credit report and correct any errors — pronto!

Most people generate wealth and achieve a higher standard of living through sacrifice and living below their means in the short term

Buy Property in the Path of Progress

Locate properties that are in the path of progress — areas that will continue to improve through new investment and economic activity (see Chapter 10).

• Walkability
• Amenities like parks, shopping, and restaurants
• A growing job market
• A low crime rate

After you locate the best cities or neighborhoods, there are commonly two types of underachieving real estate assets to look for:

• tired and worn and have extensive deferred maintenance
• physically sound but poorly managed

Your preference will depend on your specific talents and resources

Robert favors well-located, physically sound properties that simply have underperformed due to poor management. He’s able to use his skills and expertise as a property manager to renovate and upgrade the properties, which repositions the property to appeal to a different target tenant mix. Then he can increase the rents while controlling costs through capital improvements that enhance efficiency. Particularly attractive properties are those in which the current owner or manager has failed to adequately screen tenants and has poor tenant quality and likely has failed to keep rents at the market level or those properties that haven’t been properly maintained cosmetically.

Buy the Right Property at the Best Price Possible

may be more easily said than done

As a general rule, most of your real estate acquisitions should be candidates for renovations and upgrades (the classic “fixer-upper”) and priced accordingly. A good strategy is to negotiate with the seller to make certain repairs or reduce the price by 150 percent of the repair costs. You want to buy those properties that offer specific challenges that match your personal talents so you can use your skills to upgrade and enhance the value of the property

A real estate investor using the “Get-Rich-Right” method doesn’t buy a new or fully renovated property unless it’s in the path of progress or a prime location, because the value-added or appreciation to date has already accrued to the current owner.

However, in some special situations, buying a new or fully renovated property is a good investment alternative. For example, buying a residential rental property in the first phase of an oceanfront community or another unique location that’s difficult to replicate may be a great investment in the long run.

Renovate Property the Right Way

You only want to make those renovations or upgrades that increase the desirability of the property to your target market

Improvements should allow you to increase the rent or add to the property value so that you receive a return of $2 for every $1 spent on the improvements over a reasonable payback period of one to two years

Painting, landscaping, and minor repairs generally offer excellent results for only minor costs.

These simple repairs are also within the skill set of most real estate investors

Although doing the work yourself is typically cheaper, don’t forget to look at the time and experience factors

Robert recommends requiring your contractor to obtain all permits as they should know what work requires a permit, plus they have the knowledge and information to properly complete the permit application forms

Keep Abreast of Market Rents

After you’ve acquired and upgraded your new rental property, immediately test the new rental rate structure by offering your vacant rental units or space at the higher market rates you determined in your rental survey

One strategy is to renovate units upon turnover and offer an excellent, financially well-qualified, and stable existing tenant an opportunity to transfer to the upgraded unit at the higher rent.

We recommend that you keep the rent level slightly below the full market rent for existing long-term tenants to show your appreciation for their long-term tenancy and to encourage them to stay.

Recover Renovation Dollars through Refinancing

you also have increased the income, and likely decreased your expenses due to better efficiency and fewer repairs, which has created additional value through increased net operating income. You can now use this increased value to refinance the property to cover your initial costs of acquisition and renovation.

You should always own your own home and have (and always maintain) a good cushion of equity before looking to acquire investment real estate

Reposition Property with Better Tenants

reposition the property with new, more financially qualified tenants

marketing to a new target tenant profile

Robert co-authored Landlord’s Legal Kit For Dummies with Laurence Harmon [Wiley], which can help you with finding and retaining great tenants

Become or Hire a Superior Property Manager

Superior management makes the difference between average and excellent returns in the long run. After you renovate and reposition a property with new tenants at higher rents, you need to retain the tenants

achieve maximum value as if you were going to refinance or were preparing the property for sale. Your target buyer is going to be someone who wants to buy a turnkey property*

Refinance or Sell and Defer Again

too much equity just sitting in a property lowers your overall returns.

Our “Get-Rich-Right” strategy recommends that you use the equity in your current properties to expand your real estate holdings by investing in additional properties with a view toward diversifying to reduce your overall risk

take advantage of favorable financing terms when available to refinance your stabilized long-term properties

Or you can sell the property and use the 1031 tax-deferred exchange to keep your equity working. Besides excess or lazy equity, some owners prefer the tax-deferred exchange option because they can enhance their use of depreciation to shelter their real estate income

Consolidate Holdings into Larger Properties

Although owning a diversified portfolio of rental properties has some inherent advantages, the day will come when your extensive real estate holdings create management burdens.

Finding and paying for a qualified property manager for a diversified portfolio of small rental properties isn’t easy or cost-effective. The potential efficiencies of property management are diminished when you have a large number of single-family or condo and/or small rental properties dispersed over a wide geographic area. This is known as “scattered site” management and it can be extremely inefficient, especially as the time and cost to travel to each of your properties

*Instead, look to the tax-deferred exchange and consolidate your real estate holdings into one or a handful of larger properties that can be professionally managed. *