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Real Estate and Other Investment Alternatives

LECTURE

If you have the older (bigger, hardback) book, this material is from chapter 17.

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Direct As the investor, you hold the title to the

property Your home as an investment

A major asset of most householdsTax advantagesPossible hedge against inflation

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

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

Real Estate Investments Types

3 Examples of Direct Real Estate Investments

Vacation home Tax advantages depend on if the IRS views it as

rental property Rental property

Whole course unto itself! (More later) 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

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Real Estate Investments TypesIndirect

Real estate syndicates or limited partnerships Real Estate Investment Trusts

REITs are kinda’ like closed-end real estate mutual funds

Investing in first, second, etc. mortgages Equity Sharing

You put up the down payment for someone else and then share in the appreciation

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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 Look for income to be greater than expenses

“Duh! Good advice, guys!” But 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! Again, I think the South Bay is where the bargains

are 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 all too happy to finance a rundown

foreclosure on their books Stay away from 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

(continued)

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 Easy entry as a limited partner Limited financial liability as a limited partner No management concerns

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

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 Declining property values

Yeah, Right, Paiano! Yeah, Right, Paiano…

Lack of diversification Although REITs do offer diversification

Management or tenant problems

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

Real estate is the ‘Perfect Investment’” This is what people were telling me a few years ago

Beware 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 now in foreclosure…

The real estate bubble is now deflating 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 Internet 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?” I already told you about it, didn’t I?

“But isn’t that what makes real estate such a great investment?” Well, yes. Let us look at the two problems in the

older book that illustrate the power of leverage Financial Planning Problems 1 & 2

Page 563 (from the old book)

(continued)

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Real Estate and Leverage1. Calculating the Return on Investment. Dave bought a

rental property for $200,000 cash. One year later, he sold it for $240,000. What was the return on his $200,000 investment?

2. Calculating the Return on Investment using Financial Leverage. Suppose Dave invested only $20,000 of his own money and borrowed $180,000 (90% financing). What was his return on investment?

Page 563, Financial Planning Problems 1 & 2From our previous text book

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Real Estate and Leverage666. Calculating the Return on Investment using Financial

Leverage and things do not go as planned. Suppose Dave invested only $20,000 of his own money and borrowed $180,000 (90% financing) … and the property value went down 20%. What is he going to tell his wife?

Page ???, Financial Planning Problem that was conveniently left out of the previous text book…

(continued)

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Real Estate and IRAs Yes, you can do it

Many people believe it is prohibited But there are strict, complicated rules Do not try to go it alone!

There are huge penalties if you break the rules (15% to 110%)

Few knowledgeable regulated trustees & advisors Find a reputable, experienced trustee

Usually have high operating fees and expenses Can not be your home or business

Nor your parent’s nor children’s But it can be your brother’s or sister’s (?)

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Real Estate and IRAs Must have sufficient cash in the account to

perform necessary transactions If not, you must either sell the property, or Deposit more cash into the IRA

But if you go over the annual maximum contribution level, then you will be penalized 6% per year on the amount over-deposited until there is sufficient cash in the IRA and you are able to withdraw the amount over-deposited

For this reason, often people “pool” their IRAs Which is normally forbidden (?) Again, seek a reputable, experienced trustee

(continued)

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Real Estate and IRAs The advantages can be dubious

Investment real estate often has many of the same advantages as an IRA without any the constraints of an IRA Capital gains taxes are deferred until you sell the

property which may not be until retirement Income is usually negative or minimal for years Real estate offers many tax deductions which you

will not get if it is inside an IRA And capital gains on real estate can currently be

eliminated if you simply live in the property for two years before you sell it – “principal residence” $250,000 single / $500,000 married

(continued)

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Real Estate and IRAs Or the advantages can be compelling

If the real estate investment is in a Roth IRA, then any capital gains and rental income will be tax free in retirement

Plus you can not check the price of your real estate investments every day on the Internet

(continued)

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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

The property must be your principal residence. Be careful! If you own two or more properties and frequent each regularly, the IRS can

rule that none of your properties is your principal residence!

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Investing in Precious Metals Gold

Bouillon – bars and wafers Gold bouillon coins Gold stocks Exchange-Traded Mutual Funds (ETFs)

Silver Platinum, palladium and rhodium

If you believe that the world economy is going to fall apart anytime soon, put your money here!

“…if your reason for owning gold has something to do with the end of the world as we know it, shotguns and canned food probably would be more practical

investments.” – Tom Petruno, Los Angeles Times

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Growth of $1 Investment 1801 – 2011

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Investing in Precious Gems Precious stones

Diamonds Sapphires Rubies Emeralds

Video. Sorry, Ladies…

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Investing in Collectibles Includes rare coins, works of art, antiques,

stamps, rare books, sports memorabilia, rugs, Chinese ceramics, paintings and other items that appeal to collectors and investors

Can be both a good hobby and investment, or a financial disaster (Example: El Cajon Barbie Guy)

Be careful of investment scams Know the dealer’s reputation

Comparison shop“Don’t buy art as an investment.”

Christopher Burge, Christie’s Auctions

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Metals, Collectibles & Taxes The maximum capital gains taxes on most all

financial and real estate investments is currently 15%

The capital gains taxes on precious metals, art, and collectibles is 28%

Plus precious metals, art, collectibles are not allowed into an IRA (or any other tax-qualified plans)

Do ya’ think the Congress is trying to tell ya’ something?

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Speaking of Info-mercials Have you seen the Robert Allen 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 take our Guaranteed, Sure-Fire Three-day Real Estate Investment Seminar for only $2,995 that will pay for itself in just one month”

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

No comment.

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Bottom Line(s?) Buy a house and make it your home

It should reward you well over the long-term Both personally and financially

Learn the ropes regarding being a landlord Possibly working for a property manager And do not overextend yourself with too many

properties Stay away from precious metals and gems,

art, or collectibles as an investment Unless you absolutely love it as a hobby first

Good Luck, by the way. You will need it…