Real Estate Economics 156 Foldvary

Active Investment in Real Estate

Anti-Discrimination legislation

CA Real Est, ch 10

Civil Rights Act of 1866. Applied to race. 14th Amendment reinforced it.

But court decisions limited its enforcement.

Civil Rights Act of 1968, Title VIII,

prohibits discrimination in housing based on national origin, race, religion, or color.

Dwelling units owned by a religious organization may restrict rentals to those of that religion.

In 1974, sex-gender discrimination added with the Housing and Community Development Act.

Includes selling and renting.

The 1988 Fair Housing Act extended antidiscrimination protection to familial status

and to handicapped persons.

Landlords are required to make reasonable accommodations for the disabled.

Homeowner associations may be restricted with a minimum age, for retirement communities.

It is illegal to rent out dwellings with different prices and terms based on these categories.

It also applies to advertising and loans.

The Americans with Disabilities Act, 1990, prohibits discrimination

that denies the equal use of property due to physical or mental disabilities.

Employers with more than 14 workers must make reasonable accomodations.

Commercial buildings must make the premises accessible.

California Fair Housing Laws prohibit discrimination based on sex, color, race, religion, marital status, ancestry, or national origin.

Federal Equal Credit Opportunity Act prohibits discrimination in extending credit,

race, color, religion, national origin, sex, marital status, age.

Environmental issues

Governments regulate hazardous substances used in buildings.

Asbestos is a mineral that was used for insulation in walls, roofs, pipes, and heating because it is resistant to fire. One fifth of commercial and government buildings contain asbestos.

Airborne asbestos particles are a health hazard.

Its use was banned in 1978.

Asbestos is costly and dangerous to remove.

There have been many lawsuits related to asbestos.

Lead was used in paint and gasoline, and its use in paint was also banned in 1978 as a health hazard.

Radon is a radioactive gas that occurs naturally in the ground.

One can test for its presence, best before buying or renting.

Carbon monoxide is poisonous and can be emitted by improperly working furnaces, fireplaces, and wood stoves.

Mold is a growing problem in California,

a fungus that lives in damp areas.

Damage that could have been avoided might not be covered by insurance.

Buyers and renters should also be aware of earthquake fault line, where the ground can shift.

California Environmental Quality Act of 1970.

CEQA applies to real estate development requiring approval by state or local governments.

Advantages of owning real estate 

Land rent absorbs much of the gain from greater productivity and population growth.

Those who own some will share in the gains.

Those who don’t own real estate get double billed in taxes and higher rent.

Those who own get a subsidy from the government. Also:

1. Tax savings.

2. Inflation hedge 

3. Leverage

Besides borrowing money, one can get leverage with an option.

Ask an owner to sell you an option to buy the property at a specific price during some time interval. The seller gets money. The buyer gets leverage if the property value rises.

The option contract includes the terms, such as “All cash to the seller.”

Have the contract notarized.

Lease with option to purchase.

1. Save money. Live frugally.

How to live rent free: manage an apartment house.

2. Learn. Take courses or read books on land lording, accounting, negotiating, taxes.

3. Look at properties.

The successful active real estate investor sees himself or herself as an entrepreneur.

Decide whether to use a real estate agent. He can help negotiate and prepare the paperwork.

A “realtor” denotes a member of the National Association of Realtors (trademark).

A broker owns his own r.e. business or is a corporation.

Look at newspaper ads, real estate agents, web, signs, auctions by banks.

See 90 houses to get to know the market. Get information on each house.

4. Analyze the property.

After the initial learning, make an offer on all properties you see at prices below market.

“Packaged deals” offered by sales people tend not to be profitable.

Do a personal thorough inspection of the property. Examine the foundation.

Check the roof. Look at the ceilings. Go down to the basement and crawl under the house.

Some inspections require a professional, e.g. a termite report.

Observe the neighborhood. Determine if the neighborhood is changing.

Fixer-upper properties can be good investments.

E.g. ugly front yard full of weeds. Paint peeling.

Can be inexpensively fixed up if the structure is sound and the neighborhood is good.

Property by distressed owners - about to suffer a foreclosure - can often be bought at below market because the owner needs a quick sale.

Unless you are buying your residence, don’t pay for charm. Create charm.

Usually, the best house in a poor neighborhood is a poor investment.

Often, the worse house in a good neighborhood is a good investment.

Talk to the neighbors and the tenants.

Ask the tenants what they pay in rent to verify.

Read the lease agreements.

Gain a knowledge of the market rentals.

A good view can add 20% or more to the value of the land.

A r.e. entrepreneur can create a view, such as with landscaping.

Be aware of the business cycle.

If r.e. prices are rising, use as much leverage as possible.

Do a cash-flow calculation. Understand the tax consequences.

There is a trade-off between price and terms.

In negotiation, be aware of subjective values:

Find out what the other party wants. Look for non-monetary wants.

You may be able to offer something of low value to you, but high value to the other.

(Example: naming a shopping center after the seller.)

Terms: interest rates, loans, closing costs.

With a really good deal, act quickly, and pay the asking price.

You will know intuitively when the deal is good because you will know the market.

Other buyers will be thinking about it, and lose the deal.

If the deal is already a bargain, you don’t need to bargain.

See if you can generate extra income by renting out parking, storage, or with laundry machines.

5. Make an offer.

Below market.

The contract: purchase agreement and deposit receipt.

Contingencies: subject to buyer’s obtaining financing on [state the terms].

For example: buyer to obtain financing commitment for 80% or purchase price, at 6% interest, 30-year term, 1 point or less, within 20 working days.

Escrow instructions with contingencies: subject to rezoning, etc.

Also subject to approval of the termite report and possibly other inspections.

Such contingencies are an escape clause. You get back your deposit.

Warranties by seller that appliances, plumbing, electrical systems are in good working order.

Specify that particular improvements or repairs will be paid by the seller

(he might give you a cash allowance to do it).

Designate a portion of the purchase price as a payment for “component personal property”.

Personal property such as furniture and appliances are depreciated over a much shorter life.

Pay attention to fuzzy boundaries, such as chandeliers. Get these in writing.

Inscribe “This property is being acquired as a long-term investment and not for resale.”

This documents your intent. You need to avoid being designated as a dealer.

Dealer status applies to the property, not the person.

If someone offers you a contract, read all of it very carefully. Clarify anything puzzling.

Do not sign unless you understand everything.

6. Financing.

From banks, private mortgage companies, real estate firms, seller.

Internet has information. Shop around. Borrow as much as possible.

First and second mortgages. (Aka First trust deeds).

The mortgage is secured by the property, and has a lien or legal claim on that property.

The lender can take the asset if the borrower defaults.

7. Closing costs, paid in cash to the escrow.

“Escrow” from French, meaning a scroll.

The deed scroll was given to a third party to be given to the buyer upon performance of particular acts, such as making good payment.

An escrow is a deed and funds held in trust by an escrow agent, for a fee.

Not required by law, but in practice, always used.

The real estate agent is not a party to the escrow, but the broker usually opens the escrow after getting a deposit receipt. The escrow is then signed by the parties.

Escrow agents include banks, legal firms, brokers, title insurance companies.

In northern California, most escrows are with the title insurance company.

The title insurance company does a search to make sure the title is valid.

The seller usually pays the transfer tax.

Closing costs includes a notary fee, title insurance, pro-rate property taxes.

They buyer receives credits, such as security deposits and pro-rate rents.

Put security deposits in a separate savings account, so they are considered to be held in trust,

avoiding paying an income tax on the interest.

The buyer can ask the seller to pay all the closing costs.

One can negotiate adding this to the selling price.

That then gets included in the loan amount.

Can also raise the price to cover repairs.

8. Installment sales. Sale price paid over several years.

A seller may prefer to have the gain spread over several years for income.

9. Contract of sale (land contract)

An installment contract, the seller retains title until a future date.

The buyer has an equitable ownership.

Used when the buyer does not qualify for a loan.

The seller’s deed should be with the escrow company.

10. Property exchanges (sec. 1031) should be closed simultaneously.

11. Management.

Record keeping. Keep records separate for each property. Use separate checking accounts.

Maintenance and repairs are expenses that reduce net gains.

Remodelling is an investment that is capitalized over the life of the structure and increases the rental. Swimming pools and third bathrooms usually cost more than the value added.

Dealing with contractors. Do not assume they are honest.

Avoid paying too much in advance. Can reimburse for materials rather than pre-pay.

Put all terms and changes in writing.

Stay fully insured.

Getting good tenants. Visit where they live. Ask parents of young tenants to co-sign.

Take a look at their car. Make tenants responsible for minor repairs.

Provide a discount for prompt payments of rental.

If a tenant falls into hard times and can’t pay, consider getting something in trade.

If you want to keep a low profile, put the title in the name of a partnership.

If you are sued, try to settle out of court, to save on legal fees.

Send a confirming letter after an oral agreement.

12. Selling real estate

Disclosures: caveat venditor

The seller and his agent must legally disclose any significant flaws and defects in the property.

Cracks, leaks, broken appliances.

Ask a mortgage lender to prequalify you for a loan.

You are not obligated to apply with that lender.

Decide whether to use a real estate agent. 15% sell by owner.

If you do it on you own, use an attorney.

The agent might get you a better price and provide the paperwork.

Agent should perform a comparative market analysis CMA.

Agent will put it in the Multiple Listings Service and advertise.