Real estate investing basics

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As it has with almost every business, the growth of the Internet has significantly changed the landscape of property investment.

Many of the traditional requirements still apply, but buying and selling property has been made vastly easier and less costly with the emergence of thousands of sites devoted to Real Estate.

Finding properties is easier than ever, as is finding out more information about them. Not too many years ago finding properties outside a local area required poring over out-of-town newspapers or specialized publications that were expensive and hard to find. Finding information on them often meant relying on local agents' ability to describe them or taking a lengthy, expensive trip.

Now, with a brief search and a few mouse clicks, you can find more properties than you could ever turn over and more information about them than most of the previous owners know. With the arrival of high-bandwidth connections you can quickly access and view photos, 360-degree views of the interior and exterior, as well as the surrounding area and streaming video in close-up and overview.

Title searches, back taxes owed, legal encumbrances, previous ownership history and other pieces of valuable data are easy to obtain along with the current and past selling price. In some cases, you can get past inspection reports and records of repairs made.

And most of that information is available for nothing more than the cost of your time to find and review it.

Of course, mortgage financing has taken on entire new possibilities with the growth of the sites devoted to that subject. Traditional lenders have taken advantage of the technology, but there are also dozens of mortgage lending sites that have no brick and morter presence at all.

Even out-of-state and foreign markets have been opened up across the globe by the growth of the world wide web of property information. A Spanish investor can find a villa in Italy or France, while an American can easily locate wineries for sale in France or a Bed and Breakfast in England. Properties are available for purchase as a pure investment, a second home — which can be rented for part of the year using Internet sites, or even full-time rental.

Selling, too, has been made easier by utilizing any of the hundreds of sites devoted to the subject. For Sale By Owner is now much more feasible and quicker thanks to sites that advertise property — many of which provide low-cost additional services for helping you make that sale. That's an average 6% increase — the average cost of an agent's fee — in profit all by itself. Six percent of $200,000, for example, is $12,000. Subtracting off $100 for a three month listing still leaves a very healthy reduction in cost.

Though it's always a good idea to see any prospective property first hand, much time can be saved by gathering useful information before a site visit. And with the ease with which appraisers, contractors, title companies and realtors can be found — and more so with the growth of Local Search by the major search engine vendors — buying and selling has gotten even easier.

It won't be long before transactions can be carried out entirely electronically without leaving your home office. Many states and countries already allow electronic signatures on documents, eliminating the need for mail or faxing of paperwork.

Now if they could just invent something to legally produce the investment capital…

Property, like any other good for sale, comes in all conditions. But the average home or real property costs 8-10 times or more the amount of other high ticket items. That's what makes it an investment rather than merely a purchase. Essential to ensuring it's a sound one is getting a thorough inspection. Write right into the deal that any offer is contingent on a satisfactory inspection. And what constitutes 'satisfactory'…?

Assuming the property contains wood, first and foremost is a separate termite and pest inspection. Most 'home inspectors' don't check for this, concentrating instead on mechanical and others aspects. Termites, carpenter ants, even mice can weaken walls and floors, chew through wiring, and ruin attics and shelving.

Professional inspectors check every aspect of a property and structure.

Starting with the foundation, they look for large cracks (almost all have minor ones), check for level ground, and influx of water. Evidence can show up as efflorescence — a white powdery material which indicates penetration points, mold or mildew (black stained areas). Some will use lasers to check level and cracking and some even use meters to check for radon gas concentrations.

Houses sit on top of foundations and that flooring has to be inspected for proper joints, angles, and materials used. From those floors rise walls which are similarly subject to incorrect framing and potential water damage. Inside the walls, plumbing and electrical systems are inspected for damage, non-code compliant construction, or simple age or wear. Any leaks are noted and pipes inspected for rust, lead, or other chemical concerns. Flow rate and pressure are sometimes measured.

Electrical systems get a thorough review, checking for faulty wiring, uncovered switches or receptacles, incorrect grounding, inadequate circuit breakers, or bad GFCI trips. The latter are those little red buttons often seen in the middle of outlets. They are somewhat like miniature circuit breakers built into the receptacle itself.

Working up to the attic, framing is checked for angles and strength and the area checked for air or water leaks or damage. The underneath of the roof is examined for tears or holes in papering and proper seal where vent pipes protrude outside.

Up on the roof the inspector will check for holes, loose tile, bad flashing or any other weakness that leads to lack of protection against the elements.

Around the house outside all faucets are tested for leaks and proper flow, inside all heating and air conditioning systems will be checked for duct leaks, filter condition, and adequate capacity and flow. Thermostats get a thorough going over.

Any inbuilt appliances, such as stove and water heater are checked for compliance with standards. Installed propane or wood stoves and piping are checked for physical integrity and proper function.

Carpets are checked for inappropriate levels of wear or damage and tested for mold or water damage. Any paint damage, particularly due to water infiltration, get noted.

All these items, and many more, are noted on a report available to whomever ordered and paid for the inspection. To the potential buyer, defective items can be used as bargaining chips when negotiating price and other terms of sale. But the inspection can also benefit the seller by allowing for the opportunity to repair or improve items before putting the property on the market.

To either party, an inspection for a few hundred dollars can save thousands during the process. Information isn't just power, it's money, too.

Apart from possibly medicine, there's no area of human endeavor more intricately intertwined with legal trappings than Real Estate. Because of the larger amounts of money involved, and the centrality of property for living and carrying out so many commercial transactions, the rules have become complicated and many hands are in the pie.

The history of property law goes back millennia, to at least the Sumerians in 3000 BC - and it's been evolving ever since. Every aspect of property is ruled by a dizzying array of laws worldwide. Financing, buying and selling, tenancy and use, environmental aspects, tax considerations, even defining where and what is property is governed by laws, many of which are as clear as coffee.

But for the investor it's essential for long-term profitability to gain a healthy familiarity with property-related law.

One good place to start is: The Contract.

In any real estate contract there must be 'mutual assent'. Each party has to agree to an exchange - in writing. The old saw is true: a verbal agreement isn't worth the paper it's written on.

The contract has to identify who those parties are and the property being exchanged and for how much. And to be enforceable, consideration - the benefit that induces a promise - must exist. Then the contract has to be signed by parties of legal age and sound mind. This latter must be loosely defined, given the inherent insanity of real estate investing as a business.

As part of the consideration aspect, the property itself must be worth what the seller and lenders claim, as determined (at least approximately) by appraisals and other means.

Flipping (buying and rapidly re-selling property) for example, is perfectly legal — until an unscrupulous investor buys a cheap, run down property and conspires with a mortgage broker to doctor documents to bring an inflated price. When government bodies guarantee the loans on such properties, you can be assured they'll take an interest in the transaction. And they don't look favorably on fraud.

Commercial properties have whole other sets of regulations covering their exchange and use.

Tenants in almost all countries have certain rights independent of specific contractual clauses. Even Communist China, for example, has recently adopted legislation defining and protecting property rights. As an example, even in triple-net leases - an arrangement in which the lessee is responsible for maintenance, repairs, insurance, etc - landlords have to do more than simply collect a check each month.

Lenders are governed by complex rules that direct or restrict how much can be loaned, what paperwork is required in terms of title, insurance, even what kinds of advertising offering financing can be made.

Tax law introduces yet another layer of complexity into real estate investment. Very few autos or boats end up with tax liens against them, but it's hardly unknown in real estate deals to have to clear them before title can be passed.

So for those considering real estate investing, or beginning to become involved in one of the lowest risk, most potentially lucrative businesses around, one can offer no more sound advice than this: When it comes to real estate law, do your homework - before it's needed. It's much more expensive to do afterward.

According to one study 23 percent of all homes sold in 2004 were purchased as investments. Considering the historical returns, and the high percentage increase in prices over the last few years, this shouldn't be surprising. But there are several ways to profit from an investment in property.

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

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

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

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

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

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

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

Set your own hours, spend a lot of time outdoors, make lots of money. Sound good? With a career in Real Estate it is possible to have those things. But free lunches are hard to come by and this is no exception. Being a Real Estate Broker or Agent is a tough career choice.

Realtors (Agents, Estate Agents, Brokers and other legal categories which vary by state, country and license or experience level) all face many of the same challenges every day. Since property transactions are complex, filled with legal requirements and human factors, and usually involve significant amounts of money, agents have to negotiate a labyrinth of often murky details when closing every deal.

Part businessperson, part psychologist, part friend and always far too busy, an agent participates in every phase of a transaction. He or she needs to know the local and larger market, have at hand an encyclopedic knowledge of related law and oversee dozens of details on several simultaneous deals. And all this while sometimes working from early morning until late at night, any day of the week.

Sales, of course, is central to any successful agent's career. The ability to initiate, negotiate and close a deal that's acceptable and fair to all parties is a skill with many facets. Enthusiasm and the desire and ability to work with people is a paramount.

But a sale starts before a property is listed and doesn't end when the agreement is reached. Before properties are listed they're discovered, appraised and compared. When agreement is reached, a new phase begins involving escrow accounts, title companies, insurance requirements, inspections and a host of other complex undertakings. In between, properties have to be prepared for sale and advertised and potential clients sought and brought for showings. And you thought brain surgery was complicated!

Since real estate transactions usually involve large sums, individuals involved can and often do get very upset when things don't go exactly as planned. And things rarely go exactly as planned when so many things have to happen just right, many of which are interdependent. Keeping everyone satisfied, or mollifying them when they can't be, and moving the process forward requires a very special set of skills.

There are also definite slow sales periods, sometimes a particular month, sometimes longer, where there may be lots of activity and a hundred things to do but few sales to show for the effort. This is especially true given the continuing amount of fierce competition from the large number of agents in the same geographical area. In 2004 in the U.S., brokers and agents numbered about 460,000, many of whom worked only part-time.

And all for a commission of a few percent. Although the potential for a high income is definitely present, particularly in the healthy market of the last few years, many agents make much less than many think. In the U.S. the middle 50 percent earned between $23,500 and $58,110 per year.

But on the upside, and there assuredly is one, there are those attractive features mentioned at the outset. For the entrepreneurial type, the freedom to set one's hours, to take risks and reap rewards consequent with one's own efforts and the varied locations and kinds of activity can be extremely gratifying. And sometimes the money isn't bad, either.

There is no more Byzantine human invention than the complex tax codes, and among the most complicated are the laws surrounding real estate investing. So, what follows is NOT to be considered legal advice — consult your attorney or tax accountant before making any decisions.

Well, now that the rear is covered, what considerations should the real estate investor keep in mind? Since laws vary between countries, and between states within the U.S., any general advice would be worthless. But here are a few particulars that apply in many areas.

Many investors still believe they can purchase a residential home, not take up residence, make repairs and then sell for substantial profit. And that's often true. But profits can be lowered by neglecting current tax law. The rule they're mis-remembering applied only to property used as a personal residence and, in the U.S., is no longer law.

In 1997 that rule was replaced by one that allows for tax-free sale of a personal property, occupied for two years or more. Investment income, whether from stock sales or real estate is considered capital gain. If the asset was held for a year or less it's a short-term gain, taxed at ordinary income tax rates — sometimes as high as 35 percent. Hold the asset more than a year and any sales is now a long term capital gain, taxed (usually) at 15 percent. One day more or less could make a 20 percent difference.

If you keep the property for 730 days, not necessarily sequential, as a residence and you can pay no tax at all — provided the money is reinvested in a home of equal or greater value. (There is a one time exemption.)

For the investor not looking to occupy the property, there is an alternative, in the U.S. — the 1031 exchange.

As long as you trade an investment or business property for another of "like kind", you can defer any tax owed. "Like kind" is defined somewhat loosely. You can swap undeveloped land for developed land, a residential rental home for commercial property, etc. The only restriction is the exchanged property has to be an income producing asset, not a personal one.

You have 45 days to identify up to three replacement properties and must close within 180 days. You must also find a neutral intermediary — a "facilitator or accommodator" — to hold funds and keep records.

Keep in mind this option is not tax avoidance, merely tax deferral and can't be used in conjunction with your personal residence. See your tax accountant or attorney before taking advantage of this.

For married couples, tax law changes allow a profit of up to $500,000 on the sale of the personal residence, $250,000 for singles, with no tax penalty.

Mortgage interest deductions continue to be one of the best write offs, with up to $1 million loans qualifying, as well as any points or loan origination fees.

Always keep accurate records and consult with professionals before making any investment decisions. This is especially true for those lucky enough to have inherited property, or those involved in estate sales and trusts. Their fees will be more than paid for by avoiding penalties and unexpected taxes.

Real Estate - Getting Started: Think FirstIt's often been claimed that Real Estate investing is one of the easiest ways to make money. In one way, that's true. With a modest financial investment and a fair amount of sweat equity, a property can be bought and sold for a healthy profit and the future still looks pretty good.

But easier is not the same thing as easy.

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

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

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

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

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

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

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

Unwise move for the newbie.

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

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

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