Real Estate Investment
WHAT IS IT?
Real estate is land and the buildings and improvements on land. Real estate, by definition, includes natural assets, such as minerals, under the land. Because of the obvious limited supply of land, especially in “desirable” locations, real estate has long been viewed as an attractive investment alternative.
Real estate can be classified into four major categories:
1. land;
2. residential;
3. commercial; and
4. industrial.
“Land” can be subdivided into five categories: (a) unimproved; (b) farm land; (c) recreational; (d) ranches; and (e) subdivided lots.
“Residential” can be subdivided into three categories: (a) single family dwellings; (b) multiple family dwellings (such as apartments and condominiums); and (c) hotels and motels (transient dwellings).
“Commercial” can be subdivided into five categories: (a) residential rental; (b) office buildings; (c) retail stores; (d) shopping centers; and (e) specialty buildings (such as banks, movie theaters, stadiums, and bowling alleys).
“Industrial” can be subdivided into four categories: (a) factories; (b) warehouses; (c) industrial parks; and (d) utility facilities (such as power plants).
An investor should select the type of real estate that will best meet the specific objectives of the investment plan. For example, unimproved land can provide substantial, long-term appreciation, but cannot be looked to for a significant current flow of income.
ADVANTAGES
1. Real estate has numerous different tax related advantages:
a. Expenditures that are considered ordinary and necessary in the production or collection of income or in the preservation of its value as an investment are deductible.
b. The costs of supplies, labor, and other components necessary to keep the property in good repair can be deducted.
c. Real estate property taxes are deductible.
d. A tenant leasing business property may deduct reasonable rental costs.
e. Interest on the unpaid balance of the mortgage is deductible (subject to limitations imposed by the tax law).
f. The full cost of buildings and real estate improvements (i.e., cost excluding land) is depreciable.
g. Gain on the sale of real estate can be reported over more than one taxable year. This may allow the investor to defer the payment of tax until cash proceeds from an “installment sale” of the property are received (although interest payments may be due on certain deferred tax liabilities).
h. Losses incurred on the sale of real estate are deductible (subject to limitations discussed below).
i. One parcel of real estate can be exchanged for another without the immediate recognition of taxable income. Tax on appreciation can be postponed an indefinite number of times (and for an indefinite period of time) if each trade meets the strict requirements of the tax-free exchange rule of the Internal Revenue Code (IRC Section 1031).
j. Upon the “involuntary conversion” of real estate (such as through fire or condemnation), the investor does not have to pay any tax upon the receipt of cash from insurance or condemnation award, so long as the cash is reinvested in “qualified property” (essentially property of similar use) having equal or greater value.
k. Liquidity (cash) can be obtained from real estate, including any appreciation, without paying taxes, through a mortgage on the property. (Of course, upon sale of the property, the investor is taxed upon the entire appreciation.)
l. The cost of rehabilitating certain buildings or structures may qualify for a special investment tax credit.
However, real estate is also subject to special “passive activity” tax rules that may limit the ability to use real estate losses to offset income from other sources.
2. Real estate is tangible. As mentioned above, many investors prefer an asset that can be seen, touched, fenced in, and built upon. It feels more “real” than intangible investments, such as life insurance or common stocks, which do not exist in a physical sense.
3. Real estate has historically proven itself as an excellent hedge against inflation. Real estate tends to increase in value while prices are rising and the value of the dollar is declining.
4. Each parcel of real estate is unique. Because no two parcels can share the same location, no two can be exactly alike. The “monopoly” each real estate owner has on each individual location is itself of value.
5. Because of its great value as security for a loan, real estate enables an investor to obtain maximum potential leverage.
DISADVANTAGES
1. Real estate is almost always relatively illiquid. Because there is no organized market on the national or local level for real estate comparable to the stock or commodity exchanges, real estate is difficult to convert to cash quickly.
Other reasons that real estate is not as liquid as other investments include: (a) the usual difficulty in finding a “willing buyer” at the desired selling price (because the property must suit the buyer with respect to a multiplicity of factors, including location, financing, timing, potential income, etc.); (b) the length of time involved in the “closing” process (typically 30 to 90 days); and (c) the need for the purchaser to obtain financing in most cases.
2. Some degree of management is necessary with all real estate investments. For example, a properly managed real estate investment requires that someone maintain the physical premises, collect rents, and pay bills. If investors do not possess the requisite expertise (or have the time or inclination to obtain or exercise that expertise), they must hire a professional manager. This makes many small real estate investments impractical.
3. Typically the investment in real estate is large in amount and will require the commitment of investable funds for a long period of time. Compared to stocks, which can be purchased for as low as pennies per share and can be sold within a matter of hours, real estate requires many thousands of dollars (not all of which need be put up by the investor, but can be leveraged) that may remain “locked in” for many years.
4. Costs related to the purchase or sale of real estate reduce its value as an investment that can produce a short-term gain. Such costs, which include transfer taxes, title insurance, appraisals, financing fees and “points,” title recording and notary fees, and sales commissions, may run as high as 10% to 15% of the cost of the real estate itself.
5. Real estate, by definition, cannot be moved. This immobility can become a distinct disadvantage when the investor moves to a new location and can no longer properly manage the investment personally.
6. Once land has been improved with a building, that “improvement” is often difficult and expensive to modify or remove. For instance, a building designed as a warehouse can be converted to an apartment house to meet a shift in market demand, but only at great expense and considerable trouble. This disadvantage is often referred to as “fixity” of investment.
7. It is often difficult or impossible to assess the economic risks and projected return on a real estate investment with exactness. This is because unpredictables (such as changes in consumer demand, levels of maintenance and repair expenses, changes in tax laws) are involved in the analysis.
8. Because the investment return on real estate is significantly affected by the available tax benefits, such investments are most susceptible to the risk of challenge by the IRS.
WHAT FEES OR OTHER ACQUISITION COSTS ARE INVOLVED?
An investor purchasing real estate on his own can expect to pay a number of acquisition costs. These include broker’s commissions, legal fees, title examination and registration fees, title insurance, and state and/or local transfer taxes.
The costs of investing in a syndicated real estate venture will be higher than an investment where the owner finds, develops, and manages the property because these responsibilities are assumed by the developer/promoter. An investor can expect to pay more when investing through a public offering than a “private placement” (one that is not required to meet certain state and/or federal securities commission disclosure standards). This is because a private placement does not involve all the costs associated with full SEC registration.
Total fees and commissions in a typical public syndication will range from 16% to 26% of the amount invested. In the case of a private offering, total costs generally range from 13% to 25%. Obviously, the actual total costs will vary considerably with each investment. It is therefore critical that the investor thoroughly review the offering materials and factor the estimated costs into any investment analysis.
HOW DO I SELECT THE BEST OF ITS TYPE?
Because of the unique nature of real estate, “best” is a relative term – at best. An investor should study each of the following major criteria:
1. Location of the property. This is the most important single factor and will determine present and future market demand.
2. Soundness of construction and appropriateness of design for intended use. Maintenance costs will be higher with poor construction and rental income may be lower than anticipated if the project is not suited for its intended use.
3. Cost of capital. The interest rate that must be paid on the purchase debt will significantly affect the ultimate profitability of the venture.
4. Financing fee. Requiring payment of “points” has become a prevalent practice. These are paid to the lender on both the construction financing and the permanent mortgage. Each point is 1% of the borrowed amount.
5. The cost of operating and maintaining the property. A review of the track record of the promoter/manager in similar projects is particularly helpful.
6. Organization and offering expenses.
7. Sales commissions.
8. Construction costs. (Check to see if the general partner’s fee will be reduced if costs of construction are higher than projected.)
9. Fees paid to the general partner for managing the partnership and the underlying investment property.
10. Projected cash flow and tax results from operations.
For more Information:
Investing in Real Estate
Winning Strategies for Real Estate Success, How to Create Wealth with Real Estate Investing, The Real Estate Investor’s Pocket Calculator.
WHAT IS IT?
Real estate is land and the buildings and improvements on land. Real estate, by definition, includes natural assets, such as minerals, under the land. Because of the obvious limited supply of land, especially in “desirable” locations, real estate has long been viewed as an attractive investment alternative.
Real estate can be classified into four major categories:
1. land;
2. residential;
3. commercial; and
4. industrial.
“Land” can be subdivided into five categories: (a) unimproved; (b) farm land; (c) recreational; (d) ranches; and (e) subdivided lots.
“Residential” can be subdivided into three categories: (a) single family dwellings; (b) multiple family dwellings (such as apartments and condominiums); and (c) hotels and motels (transient dwellings).
“Commercial” can be subdivided into five categories: (a) residential rental; (b) office buildings; (c) retail stores; (d) shopping centers; and (e) specialty buildings (such as banks, movie theaters, stadiums, and bowling alleys).
“Industrial” can be subdivided into four categories: (a) factories; (b) warehouses; (c) industrial parks; and (d) utility facilities (such as power plants).
An investor should select the type of real estate that will best meet the specific objectives of the investment plan. For example, unimproved land can provide substantial, long-term appreciation, but cannot be looked to for a significant current flow of income.
ADVANTAGES
1. Real estate has numerous different tax related advantages:
a. Expenditures that are considered ordinary and necessary in the production or collection of income or in the preservation of its value as an investment are deductible.
b. The costs of supplies, labor, and other components necessary to keep the property in good repair can be deducted.
c. Real estate property taxes are deductible.
d. A tenant leasing business property may deduct reasonable rental costs.
e. Interest on the unpaid balance of the mortgage is deductible (subject to limitations imposed by the tax law).
f. The full cost of buildings and real estate improvements (i.e., cost excluding land) is depreciable.
g. Gain on the sale of real estate can be reported over more than one taxable year. This may allow the investor to defer the payment of tax until cash proceeds from an “installment sale” of the property are received (although interest payments may be due on certain deferred tax liabilities).
h. Losses incurred on the sale of real estate are deductible (subject to limitations discussed below).
i. One parcel of real estate can be exchanged for another without the immediate recognition of taxable income. Tax on appreciation can be postponed an indefinite number of times (and for an indefinite period of time) if each trade meets the strict requirements of the tax-free exchange rule of the Internal Revenue Code (IRC Section 1031).
j. Upon the “involuntary conversion” of real estate (such as through fire or condemnation), the investor does not have to pay any tax upon the receipt of cash from insurance or condemnation award, so long as the cash is reinvested in “qualified property” (essentially property of similar use) having equal or greater value.
k. Liquidity (cash) can be obtained from real estate, including any appreciation, without paying taxes, through a mortgage on the property. (Of course, upon sale of the property, the investor is taxed upon the entire appreciation.)
l. The cost of rehabilitating certain buildings or structures may qualify for a special investment tax credit.
However, real estate is also subject to special “passive activity” tax rules that may limit the ability to use real estate losses to offset income from other sources.
2. Real estate is tangible. As mentioned above, many investors prefer an asset that can be seen, touched, fenced in, and built upon. It feels more “real” than intangible investments, such as life insurance or common stocks, which do not exist in a physical sense.
3. Real estate has historically proven itself as an excellent hedge against inflation. Real estate tends to increase in value while prices are rising and the value of the dollar is declining.
4. Each parcel of real estate is unique. Because no two parcels can share the same location, no two can be exactly alike. The “monopoly” each real estate owner has on each individual location is itself of value.
5. Because of its great value as security for a loan, real estate enables an investor to obtain maximum potential leverage.
DISADVANTAGES
1. Real estate is almost always relatively illiquid. Because there is no organized market on the national or local level for real estate comparable to the stock or commodity exchanges, real estate is difficult to convert to cash quickly.
Other reasons that real estate is not as liquid as other investments include: (a) the usual difficulty in finding a “willing buyer” at the desired selling price (because the property must suit the buyer with respect to a multiplicity of factors, including location, financing, timing, potential income, etc.); (b) the length of time involved in the “closing” process (typically 30 to 90 days); and (c) the need for the purchaser to obtain financing in most cases.
2. Some degree of management is necessary with all real estate investments. For example, a properly managed real estate investment requires that someone maintain the physical premises, collect rents, and pay bills. If investors do not possess the requisite expertise (or have the time or inclination to obtain or exercise that expertise), they must hire a professional manager. This makes many small real estate investments impractical.
3. Typically the investment in real estate is large in amount and will require the commitment of investable funds for a long period of time. Compared to stocks, which can be purchased for as low as pennies per share and can be sold within a matter of hours, real estate requires many thousands of dollars (not all of which need be put up by the investor, but can be leveraged) that may remain “locked in” for many years.
4. Costs related to the purchase or sale of real estate reduce its value as an investment that can produce a short-term gain. Such costs, which include transfer taxes, title insurance, appraisals, financing fees and “points,” title recording and notary fees, and sales commissions, may run as high as 10% to 15% of the cost of the real estate itself.
5. Real estate, by definition, cannot be moved. This immobility can become a distinct disadvantage when the investor moves to a new location and can no longer properly manage the investment personally.
6. Once land has been improved with a building, that “improvement” is often difficult and expensive to modify or remove. For instance, a building designed as a warehouse can be converted to an apartment house to meet a shift in market demand, but only at great expense and considerable trouble. This disadvantage is often referred to as “fixity” of investment.
7. It is often difficult or impossible to assess the economic risks and projected return on a real estate investment with exactness. This is because unpredictables (such as changes in consumer demand, levels of maintenance and repair expenses, changes in tax laws) are involved in the analysis.
8. Because the investment return on real estate is significantly affected by the available tax benefits, such investments are most susceptible to the risk of challenge by the IRS.
WHAT FEES OR OTHER ACQUISITION COSTS ARE INVOLVED?
An investor purchasing real estate on his own can expect to pay a number of acquisition costs. These include broker’s commissions, legal fees, title examination and registration fees, title insurance, and state and/or local transfer taxes.
The costs of investing in a syndicated real estate venture will be higher than an investment where the owner finds, develops, and manages the property because these responsibilities are assumed by the developer/promoter. An investor can expect to pay more when investing through a public offering than a “private placement” (one that is not required to meet certain state and/or federal securities commission disclosure standards). This is because a private placement does not involve all the costs associated with full SEC registration.
Total fees and commissions in a typical public syndication will range from 16% to 26% of the amount invested. In the case of a private offering, total costs generally range from 13% to 25%. Obviously, the actual total costs will vary considerably with each investment. It is therefore critical that the investor thoroughly review the offering materials and factor the estimated costs into any investment analysis.
HOW DO I SELECT THE BEST OF ITS TYPE?
Because of the unique nature of real estate, “best” is a relative term – at best. An investor should study each of the following major criteria:
1. Location of the property. This is the most important single factor and will determine present and future market demand.
2. Soundness of construction and appropriateness of design for intended use. Maintenance costs will be higher with poor construction and rental income may be lower than anticipated if the project is not suited for its intended use.
3. Cost of capital. The interest rate that must be paid on the purchase debt will significantly affect the ultimate profitability of the venture.
4. Financing fee. Requiring payment of “points” has become a prevalent practice. These are paid to the lender on both the construction financing and the permanent mortgage. Each point is 1% of the borrowed amount.
5. The cost of operating and maintaining the property. A review of the track record of the promoter/manager in similar projects is particularly helpful.
6. Organization and offering expenses.
7. Sales commissions.
8. Construction costs. (Check to see if the general partner’s fee will be reduced if costs of construction are higher than projected.)
9. Fees paid to the general partner for managing the partnership and the underlying investment property.
10. Projected cash flow and tax results from operations.
For more Information:
Investing in Real Estate
Winning Strategies for Real Estate Success, How to Create Wealth with Real Estate Investing, The Real Estate Investor’s Pocket Calculator.
Real estate investing is a good way to invest your money and it has many benefits. You will get a good return on your investment in real estate and also it is low risky investment business. It has pro and cons both so you should be careful while investing in real estate and try to take professional assistance.
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