Lesson 15: Real Estate Construction, Ownership, and Investment Principles of California Real Estate

Lesson 15: Lesson 15:

Real Estate Construction, Real Estate Construction, Ownership, and InvestmentOwnership, and Investment

Principles of California Real Estate

Construction

Real estate agents need to know enough about residential construction to evaluate the soundness of a house.

Construction Real estate agents need to know enough

about residential construction to evaluate the soundness of a house.

Sellers and buyers rely on an agent for a preliminary evaluation of the home they’re selling or considering buying.

Construction Real estate agents need to know enough

about residential construction to evaluate the soundness of a house.

Sellers and buyers rely on an agent for a preliminary evaluation of the home they’re selling or considering buying.

In California, agents have a legal duty to perform a visual inspection of any property they sell.

Construction When evaluating the soundness of a home,

a real estate agent should be familiar with the following aspects of residential construction:architectural styleslocal building codes and regulationsthe role of the architectplans and specificationsconstruction methods and terminology

ConstructionArchitectural styles

Architectural style is an important criterion that buyers consider.

ConstructionArchitectural styles

Architectural style is an important criterion that buyers consider.

Style can significantly affect the value of a house.

But one style isn’t inherently better than another; the value of a style depends on buyer’s personal preference.

Some styles common in California:

Ranch: one-story with low-pitched roof

Split-level: a one-story wing and a two-story wing

Modern-style: large picture windows

Bungalow: one-and-a-half stories with gabled roof

Spanish-style: tile roof and stucco exterior

Architectural StylesCalifornia homes

One-story house:least expensive to build and easiest to

maintainbut uses the land least effectively

Architectural StylesOne-story v. two-story

One-story house:least expensive to build and easiest to

maintainbut uses the land least effectively

Two-story house:less expensive per square foot than one-

story house (more living space on one foundation)

but stairs inconvenient for some buyers

Architectural StylesOne-story vs. two-story

ConstructionRole of architect

Architect hired to design a home:creates a design to meet the owner’s needs

and preferences

ConstructionRole of architect

Architect hired to design a home:creates a design to meet the owner’s needs

and preferenceshelps owner obtain government permits and

bids from contractors

ConstructionRole of architect

Architect hired to design a home:creates a design to meet the owner’s needs

and preferenceshelps owner obtain government permits and

bids from contractorsvisits work site to inspect the work and

interpret the plans; acts as owner’s representative at construction site

ConstructionRole of architect

Architect hired to design a home:creates a design to meet the owner’s needs

and preferenceshelps owner obtain government permits and

bids from contractorsvisits work site to inspect the work and

interpret the plans; acts as owner’s representative at construction site

Architect who designed a house can be the best source of information about the house.

ConstructionBuilding codes

Building codes:establish minimum standards for building

materials and construction methods

House ConstructionBuilding codes

Building codes:establish minimum standards for building

materials and construction methodsprevent unsafe and unworkmanlike

construction

House ConstructionBuilding codes

Building codes:establish minimum standards for building

materials and construction methodsprevent unsafe and unworkmanlike

constructionpromote quality and uniformity in home

building; set minimum standards of quality

ConstructionPlans and specifications

Plans: Drawings that show vertical and horizontal cross-sections of a building.Show the placement of foundations,

floors, walls, windows, wiring and fixtures.

Specifications: The text that accompanies plans, specifying construction materials and methods to be used.

Plans and specifications usually prepared by an architect, and take the form of blueprints.

Four types of plans used in the construction process:site plansfoundation plansfloor planselevations

ConstructionPlans and specifications

ConstructionWood frame construction

The most common type of home construction is wood frame building.Popular because of low cost, ease and

speed of construction.Because wood frame construction is so

common, knowing the elements of this type of construction will give real estate agents a good foundation for judging the quality of any home.

ConstructionBasic elements

Basic elements of residential construction:foundationframingexterior sheathing and sidinginterior sheathingroofingfloor coveringplumbingelectrical systemHVAC

Elements of ConstructionFoundation

Foundations are almost always made of reinforced concrete.

Elements of ConstructionFoundation

Foundations are almost always made of reinforced concrete.

Footing: The wide bottom base of the foundation wall.

Elements of ConstructionFoundation

Foundations are almost always made of reinforced concrete.

Footing: The wide bottom base of the foundation wall.

Sill plate: A board on which the wood frame rests that is bolted to the top of the foundation wall.

Framing of house sits on sill plate.

Elements of ConstructionFraming

The frame of a house is typically constructed of wooden boards and dimensional lumber.

Elements of ConstructionFraming

The frame of a house is typically constructed of wooden boards and dimensional lumber.

Framing elements include:

Joists: Parallel boards used to support the load of the floor and ceiling.

Studs: Vertical members attached to the sole plate, which is a horizontal board that rests on floor joists.

Walls serve two purposes:structural supportseparate the interior space into individual

rooms Walls that provide support are load-bearing

walls:often support a second floor or the roofrarely removed during remodeling

Elements of ConstructionFraming

Elements of ConstructionExterior sheathing

Exterior sheathing: Covering applied to the outside of the frame. Most common form is plywood panels,

four feet by eight feet long.Adds shear strength to the walls, i.e. the

capacity of a wall to resist a sideways force.

Elements of ConstructionExterior Siding

Exterior siding: Visible finish layer placed over the exterior sheathing.Should be resistant to weathering and

have aesthetic appeal. Siding may be:

wooden boardsaluminum or vinyl sidingshinglesother materials (stucco, brick, etc.)

Elements of ConstructionInterior sheathing

Interior sheathing: Covering applied to the interior of the frame, to form wall and ceiling surfaces.

Today, drywall process is most commonly used for interior sheathing. Sheetrock and wallboard are common

drywall products. Joints between panels are covered by

“taping” process.

Elements of ConstructionRoofing

The structural part of the roof is composed of the:ridge board (highest member, at the

peak of the roof)raftersplywood or boards laid perpendicular to

the rafters

Elements of ConstructionRoofing

This sheathing is covered with roofing felt and shingles, tar, tiles, wood, metal or other materials.

Flashing: Sheet metal installed around chimneys and other openings to prevent water leakage.

Styles: flat dutch gable hip mansard gable with

dormer

Elements of ConstructionRoofing

Elements of ConstructionFloor covering

The strength of the floor is provided by tongue-and-groove floor boards or plywood attached to the floor joists, which is called subflooring.The subflooring is covered with finished

flooring, e.g. carpet, tile, linoleum, hardwood, concrete, or other material.

Elements of ConstructionPlumbing

Plumbing consists of:fixtures (cast iron or pressed steel)supply pipes (galvanized steel, copper,

or plastic)drain pipes (cast iron, concrete, or

plastic)

Elements of ConstructionElectrical

Most modern electrical wiring is in the form of cable, an insulated cord containing strands of copper or aluminum wire.Cable is run through conduit, metal or

plastic piping that provides added protection.

Elements of ConstructionElectrical

The electrical cables run in circuits from a supply source (fuse box or breaker panel) to the various outlets in the home.A breaker panel is a series of circuit

breakers that automatically shut off the current in an overload situation.

Most outlets supply 110 volts of power, except for certain outlets designed for major appliances, which supply 220 volts.

Elements of ConstructionHVAC

HVAC: The heating, ventilation, and air conditioning systems in a house or other building.Provides warm, cool, or fresh air to the

rooms of a house, through galvanized sheet metal tubes called ducts.

The ducts open at various places, called registers, which can be opened and closed independently.

Elements of ConstructionHVAC

HVAC systems often have an energy-efficient ratio (EER).The higher the EER, the more efficient

the system. Insulation is important for keeping heating

and air conditioning costs low.R-value: An effectiveness rating for

insulation that measures resistance to heat transfer; higher R-value, less heat transfer and better insulation.

Construction Pest problems

Wood frame construction is vulnerable to damage from wood-eating insects, especially termites.

Pest inspection:good investment for buyeroften required by buyer’s lender or (in some

parts of California) the FHA or VAInspector will provide complete report on

structural soundness and list any defects

Construction Termite problems

Termite problems can be minimized by:chemically treating the soil under and

around the house and lumber that’s in contact with soil or foundation

inserting metal shields between the foundation and the wood frame

A pest inspection is usually ordered by the seller upon first listing a property.Unless otherwise agreed, seller usually

pays for correcting existing problems and buyer pays for preventive work.

Inspection report must be:given to property owner and anyone else

who requests a copy (such as a buyer)filed with the state Structural Pest Control

Board, where it will be kept for two years

Construction Termite problems

Construction Soil problems

Another important consideration is the quality of the soil on which the house is built.

It may be advisable for buyer to request:percolation test (measures soil’s ability to

drain water)soil engineer’s test for possible leakage

from nearby underground storage tanks

SummaryConstruction

Architectural styles Architect’s role Building codes Plans and specifications Wood frame construction Pest problems

To Rent or to Buy?

Real estate agents are often asked to discuss the pros and cons of renting versus buying.Some considerations are subjective,

such as security, pride of ownership, freedom to have pets or remodel.

Other aspects are primarily financial, and a real estate agent can evaluate these elements more objectively.

To Rent or to Buy?Advantages of renting

Advantages of renting:less financial commitment and riskgives person greater mobilitycarries fewer responsibilitiesaccess to amenities (e.g. swimming pool,

recreational facilities, tennis courts)

To Rent or to Buy?Advantages of buying

Advantages of buying:security and stabilityprivacy and freedom from restrictionslower monthly payments (eventually)investment appreciationtax advantages, such as mortgage

interest deductions

To Rent or to Buy?Comparison worksheet

Agent talking to potential buyer may want to use comparison worksheet to demonstrate the true net costs of buying versus renting.

To Rent or to Buy?Comparison worksheet

Agent talking to potential buyer may want to use comparison worksheet to demonstrate the true net costs of buying versus renting.

Worksheet shows the benefits of buying by accounting for:tax deductions, andincreasing equity.

To Rent or to Buy?Comparison worksheet

To calculate the true cost of buying:Start with the monthly payment

(including taxes and insurance).Subtract average monthly principal

amortization.Subtract tax savings from mortgage

interest and property tax deductions.Subtract average monthly appreciation.

To Rent or to Buy?Comparison worksheet

To calculate the true cost of renting:Start with the monthly rent on a

comparable property.Subtract the monthly yield on an

investment equivalent to the downpayment.

Choosing a HomeFactors to consider

Several features are important when choosing a home, both in terms of the subjective attractiveness to the buyer, but also with respect to the property’s objective value, as estimated by an appraiser.

Key factors to consider include:neighborhood characteristicshome features (design, site, age,

condition, energy efficiency, etc.)

Choosing a HomeNeighborhood considerations

Since the surrounding neighborhood has a big impact on the home’s desirability and value, careful attention should be paid to neighborhood characteristics.

Choosing a Home

Neighborhood considerations include:percentage of home ownershipconformity among propertiespresence of changing land usescondition of streets and sidewalksavailability of utilities and public servicespresence of quality schoolsavailability of social servicesneighborhood condition: stable or changing?

Choosing a Home

To evaluate the home itself, buyer should consider:site and view

Choosing a HomeEvaluating the home

To evaluate the home itself, buyer should consider:site and viewexterior appearanceplumbing and electrical systems

Choosing a HomeEvaluating the home

To evaluate the home itself, buyer should consider:site and viewexterior appearanceplumbing and electrical systemsHVACattic and/or basement

Choosing a HomeEvaluating the home

To evaluate the home itself, buyer should consider:site and viewexterior appearanceplumbing and electrical systemsHVACattic and/or basementgarage or carportenergy-efficient features

Choosing a Home To evaluate the home itself, a buyer should

consider:site and viewexterior appearanceplumbing and electrical systemsHVACattic and/or basementgarage or carportenergy-efficient featuresinterior floor plandesign deficiencies

Choosing a Home

Examples of design deficiencies that real estate agents and home buyers should be aware of include:Front door opens directly into living roomNo front hall closetBack door difficult to reachDifficult access to dining room, stairways

or basementNo eating area in kitchen

SummaryChoosing a Home

Advantages of buying Advantages of renting Comparison worksheet calculations Neighborhood considerations Evaluating the house

Investing in Real Estate

A real estate agent shouldn’t claim to be an investment counselor, but should have some familiarity with investing in real estate.An investment is an asset that’s

expected to generate a return (a profit).

Investing in Real EstateReturn on investment

A return on an investment may take various forms, including:

Interest: A fee paid to an investor for use of borrowed money.

Investing in Real EstateReturn on investment

A return on an investment may take various forms, including:

Interest: A fee paid to an investor for use of borrowed money.

Dividends: A share of earnings from a business paid to an investor.

Investing in Real EstateReturn on investment

A return on an investment may take various forms, including:

Interest: A fee paid to an investor for use of borrowed money.

Dividends: A share of earnings from a business paid to an investor.

Appreciation: An increase in the value of an asset, due to inflation or increased demand.

Investing in Real EstateTypes of investments

Investments can be divided into two general categories:ownership investments, or debt investments

Investing in Real EstateTypes of investments

Ownership investment: When an investor takes an ownership interest in an asset. Also called an equity.Examples: real estate, stocksReturn on investment usually takes form

of dividends or appreciation (or both)

Investing in Real EstateTypes of investments

Debt investment: When an investor lends money to another person or an entity.Investor lends money for a set period of

time, and receives interest for the service.Examples: government bonds, mortgage

loans, etc.

Investing in Real EstateDiversification

Investor usually try to diversify investments, by choosing a variety of different types of investments, rather than putting all money into one or two types of investments. The mix of investments, plus cash

reserves, is called a portfolio.

Investing in Real EstateInvestment characteristics

Every investment can be evaluated on the basis of three (interrelated) characteristics:liquidity (the ability to be converted into

cash quickly)safetyreturn on investment (or yield)

Highly liquid investments:are usually quite safe,but offer low yields.

Example: savings accounts

Real estate is not a liquid investment, since it can take months to sell a property.

Investing in Real EstateInvestment characteristics

Investing in Real EstateAdvantages

People invest in real estate for many reasons; the advantages of investing in real estate include:appreciationleveragecash flowtax benefits

Advantages of Investing in Real EstateAppreciation

As a property appreciates, the owner’s equity increases.Equity: The difference between a

property’s market value and the liens against it.

Advantages of Investing in Real EstateAppreciation

As a property appreciates, the owner’s equity increases.Equity: The difference between a

property’s market value and the liens against it.

Increase in equity:increases owner’s net worthcan be used as collateral for a loan (cash)

Advantages of Investing in Real EstateLeverage

Leverage: Using borrowed money to invest in an asset.

Advantages of Investing in Real EstateLeverage

Leverage: Using borrowed money to invest in an asset.

If asset appreciates, investor earns money on the money borrowed as well as on the money invested.

Advantages of Investing in Real EstateCash flow

Cash flow: The spendable income generated by an investment, after all expenses have been paid (e.g. operating costs, mortgage payments, taxes).

Advantages of Investing in Real EstateCash flow

Cash flow: The spendable income generated by an investment, after all expenses have been paid (e.g. operating costs, mortgage payments, taxes).

Income property can increase investor’s:net worth (through appreciation)income (through cash flow)

Advantages of Investing in Real EstateCash flow

Cash flow can also be increased through a sale-leaseback arrangement:Building owner sells to another investor

and then continues to lease the property from the new owner.

Seller can deduct the rent paid to lease the property as a business expense.

Advantages of Investing in Real EstateCash flow

Sale-leaseback sometimes includes a buyback agreement:Building owner will buy property back

from investor after specified period.

Advantages of Investing in Real EstateCash flow

Investors may evaluate an investment by looking at “cash on cash,” which refers to the property’s first year cash flow divided by the initial investment.This formula pinpoints the ratio between

cash invested (equity) and cash received.

Advantages of Investing in Real EstateTax benefits

The tax benefits of real estate investment include:deductions for deprecation, mortgage

interest, and operating expensesdeferring taxes with tax-free exchanges

and installment salesSee Chapter 13 for full discussion

Investing in Real EstateDisadvantages

The disadvantages of investing in real estate include:the need for expert adviceproperty management expenseslow liquidityhigh risk

Property value could go down, or income may not be enough to cover expenses

Investing in Real EstateMethods of investment

Direct investment: Purchasing real estate as an individual investor, and leasing it.

Investing in Real EstateMethods of investment

Direct investment: Purchasing real estate as an individual investor, and leasing it.

Indirect investments:real estate investment syndicates,real estate investment trusts (REITs),real estate mortgage investment conduits

(REMICs), ormortgage-backed securities (e.g. Fannie

Mae or Freddie Mac).

Investing in Real EstateTypes of property

Many investors begin by buying a single-family home or duplex.

Investing in Real EstateTypes of property

Many investors begin by buying a single-family home or duplex.

These properties are:relatively easy to sell and affordablelikely to attract stable tenantseasy to manage without a

property manager

Other types of investment properties include:apartment buildingsoffice buildingsretail propertiesindustrial propertiesvacant land

Investing in Real EstateTypes of property

Investing in Real EstateProperty management

Large properties usually require a property manager to oversee day-to-day operations.

Investing in Real EstateProperty management

Large properties usually require a property manager to oversee day-to-day operations.

Property manager’s duties may include:maintaining the propertyhandling tenant complaintscollecting rentslocating new tenantsacting as tenant/owner liaison

State law requires apartments with more than 15 units to have a resident manager living on the premises.

Investing in Real EstateProperty management

State law requires apartments with more than 15 units to have a resident manager living on the premises.

Property managers may be paid a flat fee or a commission.

The commission could be a percentage of gross receipts, of new leases, or of rent expected over the term of the lease.

Investing in Real EstateProperty management

SummaryInvesting in Real Estate

Interest Dividends Appreciation Ownership investments Debt investments Liquidity Safety Yield Leverage