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Real Estate and REITs

MISCELLANEOUS TOPICS

I like to say, “Real estate is tricky.”Translation: “Real estate is a real pain-in-the-…”

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Direct Real Estate Investments As the investor, you hold the title to the property Your home Your vacation home Rental property – whole course unto itself! Undeveloped land

Can be tremendous gains but this type of investment poses enormous risks

All the money is riding on a single parcel of land Plus there is no cash flow and you still have to pay the

property taxes And there is often no guarantee that you will be able to

develop the land

Real Estate Investments Types

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Real Estate Investments Types Indirect Real Estate Investments

Real Estate Investment Trusts (REITs) Real Estate Syndicates or Limited Partnerships

Hurt by 1986 Tax Reform Bill Passive versus active income

Tax Credits Low-income housing, etc.

Equity Sharing You put up the down payment for someone else and

then share in the appreciation First and Second Mortgages

Not an equity position – you are the loaner A.k.a. Hard money

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Investing in Commercial Property Most common investment of this type is a

duplex or small apartment building Also includes hotels, office buildings, stores, and

many other types of commercial establishments Do not be surprised if you are looking at negative

cash flow for several years Rule of Thumb: Price = 7 to 10 times Rent

In San Diego? Ha! Ha! Ha! Ha! Ha! For over 20 years, prices had become untouchable –

simply insane But the 2008/2009 turmoil changed the investing

landscape for real estate Prices plummeted but have recovered somewhat

I think the South Bay is where the great bargains are now if you are so inclined

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Investing in “Fixer-Uppers” Concentrate on smaller properties first

Two to four units and live in one of them Look for low down payments and seller

financing of rundown properties Banks usually do not want to loan to distressed

properties, however… Banks are normally all too happy to finance a

rundown foreclosure on their books … … during normal times

Avoid property managers Nobody cares about your property as much as

you do (but there are always exceptions)

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Investing in “Fixer-Uppers” Most Importantly,

Are you savvy dealing with repairs? …and… Are you savvy dealing with renters? Fixing a tenant is just as important as fixing a

toilet One bad tenant can set you back thousands

Make improvements that add perceived value Example: Install a white picket fence

Investing in Fixer-Uppers, Jay P. DeCima

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Real Estate Investment Trusts

Real Estate Investment Trusts (REITs) “Pass-through” investments – kinda’ like a mutual fund

By law, must distribute 95% of their earnings to shareholders

Examples: Shopping centers Office buildings, warehouses, etc. Apartment complexes

Management fees typically range between 1% and 2% per year

Long-term return – 7% to 8%

Example: Realty Income Corporation, symbol O

8 Advantages of Real Estate Investments A hedge against inflation Financial leverage

The use of borrowed funds for investment purposes allows you to acquire a more expensive property than you could own on your own (more later)

For Real Estate Partnerships / REITs Easy entry – REITs are easily liquidated Limited financial liability (limited partners, REITs) No management concerns

You can’t check the price of your real estate investments every day on the Internet One of the major problems with stocks

(Well, actually, you can … zillow.com & trulia.com)

9 Disadvantages of Real Estate Investments Liquidity may be poor

It may be hard to sell the property (or your share of the property if a partnership)

Not a problem for REITs – buy/sell like a stock Normally there is a lack of diversification

REITs & partnerships offer diversification Passive tax shelter for real estate syndicates Management or tenant problems

The PITA Factor! Property values can decline

Oh, yes, they can!

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Your Home as an Investment A major asset of most households Possible hedge against inflation

Traditionally, a home produces an after-inflation return of about 2.5 percent a year (San Diego?)

Tax advantages $250,000 capital gains tax-free for single people $500,000 capital gains tax-free for married folks

But it is a home first, an investment second In my humble opinion…

11 “But my house is the best investment I have ever made!” “Of course, it is pretty much the only

investment that I have ever made, Except for that penny stock my brother-in-

law, the ex-stockbroker, conned me into buying… But that stuff is worthless now

And those gold coins I bought back when the first Gulf War started back in ’91 What did I do with those things, anyway?”

Bottom Line: A House is a Home First, an Investment Second

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“But what about San Diego?!” Prices in San Diego have gone down in the

past They seem to have hit a bottom

The real estate agents certainly think so But if you plan on staying here, by all means,

buy whatever you can afford San Ysidro and National City are two of the best

values in the region, by the way Imperial Beach is also a great beach value

But don’t expect what happened in the 2000’s to repeat itself for quite some time…

13 Sign seen over a desk in a San Diego office, circa 1993

“Please, God, let there be another real estate boom and I promise I won’t piss it all away

this time!”

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The “Perfect Investment”“C’mon, Paiano – Admit it!

Real estate is the ‘Perfect Investment’ Look at what has happened in the past five years”

This is what you heard from people in 2005 and 2006Beware the Permanent Trend (Andrew Tobias)

Real estate goes up and down in cycles Ask those who bought in 1990 and sold in 1994

And those who bought in 2006 and are still trying to unload that “flipper condo” before the bank forecloses (Oops, too late! Sorry ‘bout that. Well, better luck next time!)

But if you plan to hold for the long-term, you should do well

By the way, there is no “Perfect Investment” Folks were saying the same things back in 1999

about stocks

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The “Perfect Investment” “But what about Leverage?! Huh? What

about the ability to make money with other people’s money?” We have already discussed leverage, haven’t we?

“But isn’t that what makes real estate such a great investment?” Well, yes. But there are pitfalls. Just as with

margining stocks, leveraging real estate magnifies your gains and magnifies your losses.

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Worksheet

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Real Estate and Capital Gains “Wait a minute. Did you say that there are

no capital gains taxes on real estate?” Currently, as the law stands now, as long as the

real estate is your primary residence for 2 out of the last 5 years, you pay no capital gains on the first… $250,000 if you are single $500,000 if you are married

By the way, capital losses on your primary residence are not tax-deductible

Example: Buy your home for $200,000. Sell it for $700,000. If you are married, then you pay no capital gains taxes!

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Speaking of Info-mercials

Have you seen the ads? “Start your real estate empire with No Money

Down!” “You, too, can take advantage of the tremendous

opportunities now in the wide-open Real Estate Foreclosure Market!”

“Just buy our Guaranteed, Sure-Fire Real Estate Investment Kit for $395”

“You will be on your way toward Riches beyond your Wildest Dreams!”

No comment necessary.

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My Advice on Real Estate

Buy a house Make it your home

After you have digested that purchase Then look for some rental property But learn as much as you can from folks who are

already doing it Maybe even work for a property manager for a

spell to get the feel for what you will need to be able to do