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August 15, 2018

File Under Knowledge is Power and Use This If You Like It

Real Estate is Right for Everyone and it is All About Timing

Despite what you may read in the financial press, real estate has always been and continues to be, the IDEAL investment. The best real estate most of us will ever own is the real estate we bought yesterday (or last year, or ten years ago, or even longer ago.)

Everyone you talk to wants to own real estate. Few people will tell you they purchased more real estate than they should have purchased over their life. In fact, just the opposite is true. Most people will tell you that they wish they had purchased, and held on to, more real estate over their lifetime. The major drawback of real estate as an investment in years past has been its liquidity. 

While good real estate is very marketable, even if one is lucky enough to get an offer the first day a property is on the market, it normally takes 30 days or more for the seller to receive their cash from the transaction.

Today with the Internet, property owners and their agents are able to reach more people faster and at a lower cost than in years past. Properly priced property sells and real estate can be turned into cash. The secret to making money in real estate of course (not much of a secret), is not to be forced to sell but to sell when the market will yield the greatest return to you, the investor. "Buy low, sell high" is sage advice, but when it comes to real estate. "Buy, hold for a long time, sell" will almost always yield fantastic overall investment results.

Real Estate Investment Objectives:

Income - Real estate investments structured with enough down payment, will generate a positive cash flow. As time passes, in most markets, even a highly leveraged, negative cash flow property can turn into a positive cash flow investment.

Depreciation - Theoretical Depreciation is the tax deduction one can use against the income real estate produces. Depreciation is a "noncash expenditure." Residential income property is usually depreciated over 27.5 years. Only the improvements are depreciable, not the land.

Equity Build-up - This results from the periodic pay down of the principal amount of the loan, usually through monthly payments on an amortized loan. Even if there is no appreciation over the life of the loan, the property owner would end up with a free and clear property at the end of the loan payment period on a fully amortized loan. This is usually a 30 year period on residential property.

Appreciation - While the amount of appreciation varies from market to market, real estate is a growth asset and often the largest part of the return on an investment in real estate is the equity gained through appreciation. Even small amounts of appreciation year after year can be considerable. Usually, the longer you hold on to a property, the better. The effect of appreciation is greatly magnified by the use of leverage.

Leverage - Through the use of borrowed money (OPM - Other People's Money), combined with a small amount of money of your own, you can control real property. The best leverage most of us can obtain in the stock market is 50%. In real estate, it is not unusual to obtain 80%, 90%, and even 100% leverage. With leverage usually comes risk, and with risk comes the potential for investment reward.

In addition to the IDEAL as stated above, real estate investments have potential additional tax benefits - Investors are allowed to write-off (within income limitations) all operating expenses, interest on loans secured by the property, and property taxes. Also, Gain from the sale of real estate is treated as capital gain and investors also have the option of exchanging which, if done in accordance with the tax laws (IRC 1031), can result in partial to no recognized gain, which affects the immediate cash tax consequence.

What are you willing to pay today for a real estate investment to enjoy the IDEAL benefits outlined above? In other words, what is the "present worth of future benefits" to be derived from a real estate investment? We would refer to this as the value, and there are different types of value.

Fair Market Value - The highest monetary price which a property would bring, if offered for sale for a reasonable period of time in a competitive market, to a seller who is willing but not compelled to sell, from a buyer, willing but not compelled to buy, both parties being fully informed of all the purposes to which the property is best adapted and is capable of being used.

Loan Value - Since a lenders security for a real estate loan is the sale of the real estate in the event of default on the loan, loan value is usually a conservative estimate of market value.

Value of real estate can be determined in three different ways, known as Approaches to Value by appraisers. The Three Approaches to Value are:

Market Data Approach

Cost Approach

Income Approach.

An appraisal is the process of developing and communicating an opinion about a property’s value, typically required when real estate is sold, financed, taxed, or insured. It is the estimate or opinion of ‘value’ as of a specified date.

Value is the worth of a thing in money or goods at a certain time. Examples are market value, assessed value, loan value, subjective value, and book value.

The main elements of value are (DUST): Demand, Utility, Scarcity, and Transferability. Cost is not relevant to value.

The value of property is created, changed, or destroyed by what is referred to as the Four Great Forces:

Physical Forces - the quality and convenience of schools, shopping centers, playgrounds, transportation systems, etc. It also includes the climatic conditions.

Social Forces - Population growth or decline; Marriage, divorce and birth rates; educational and religious standards.

Economic Forces - Business and real estate cycles, variations in directional growth, natural resources, wage levels, tax levels and insurance schedules.

Political Forces - Zoning, fire and police protection, government loan and other subsidy programs.

When considering the purchase of income-producing real property, keep in mind that future income is impacted, positively or negatively by the "Four Great Forces" that influence value. Investors should be cognizant of these forces in the areas in which they own property or plan to own real estate. These "forces" will have an impact on the income which can be generated from any given property and the value of income producing property is directly related to the income the property produces.

Some of the important principles of appraising are Supply and Demand; Change (Regression and Progression); Substitution; Highest and Best Use, and Conformity.

The appraiser follows a systematic procedure: Define the Problem; Gather data; Classify data under the Market Data, Cost, and Income approaches to value; Correlates the results and prepares the Appraisal Report.

Bottom Line: Figure out how to own more real estate. It is the foundation of wealth.

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