Investing in Real Estate

In "Das Kapital," Karl Marx identified the main economic components as Capital, Labor, and Rents. The IRS goes along with this, taxing us on investment income (capital), earned income (labor) and passive income (rents). In retirement, you may or may not have any earned income, but you certainly would benefit from passive and investment income. For most folks, the main source of passive income is from rental properties.

Let's take a look at some opportunites for passive and investment income from real estate.

Rental properties
There are two basic approaches. The 'regular' approach is for the rental property to have a positive cash flow. This usually means the property is outside of California. Here, we have been used to our rental property having a negative cash flow, but appreciating in value as house prices go up. The tax benefit on the operating losses helps, as does the opportunity to refinance at some point. Some people have built small empires in this way,

With the credit crunch and falling home prices, some of those small empires that were built up using leverage have collapsed, leaving the investor hurting. As we have seen in the articles above, you should not expect quick and easy appreciation in this market, so be very careful of buying rental properties with a negative cash flow. Locally, positive cash flows have been found recently in Sacramento, Antioch, Contra Costa and a few other areas, but these properties have been snapped up quickly by investors. Investors have also been active in the foreclosure market if they see it makes economic sense to buy at the reduced prices. If you are considering purchasing a rental, the best advice at present is to look for one with a positive cash flow. If this means it is in Texas, Oklahoma, or some other far away state, be sure you have a reputable local property manager to represent you.

Rental properties - exotic investing
As an alternative to you buying the rental, you can seek to control it and make a profit without putting too much money down. There are various ways to do this, all of which require you to find an outstanding deal. Maybe it is just a motivated or distressed seller willing to part with the property at a low value. You will take your cut, but there must still be money left for the regular investor or renter that you bring in to complete the deal. Some people will make a business of looking for such deals, and some may just have such a deal fall into their lap. Either way, if you come across one, there are always people to help you complete it. If you don't know any, or how to go about it, give me a call for referrals!

Real Estate Investment Trusts (REIT's)
If the 'Tenants, Toilets and Termites' issues of being a landlord don't appeal to you, and 'outstanding deals' are not showing up, then there are other ways to invest in real estate. The easiest is to buy shares in a REIT. You have invested in real estate while leaving all the work to company employees. The REIT owns properties and rents them out. It distributes 95% of the net income to the investors in the form of dividends. The stock price can go up or down depending on the market generally, and the value of the property holdings in particular. REIT's often specialize in certain property types, such as medical buildings, or retail developments, or timber forests, etc. One REIT in Washington DC specializes in renting buildings to the federal government - the government always pays the rent and isn't cutting back on it space, so this might be a good one.

Some REIT's are private and are not publically traded on stock exchanges. These are less liquid as investments, tend to be smaller, but can offer higher rates of return. For example, one with a 40% loan to value ratio invested in industrial buildings is paying 7.5%; another invested in health care with no debt is paying 6%.

Hard Money Lending
If you cannot come up with an 'outstanding deal' of your own, you can always bankroll someone who has. The credit crunch has meant that many experienced real estate investors are seeing great opportunities yet are unable to finance them through the banks. Their need may be for a short term loan (one or two years) in order to secure the property until the money markets losen up. If the deal is good, then they will pay the going rate for such 'hard money' of between 10 and 14%. Obviously, there is risk. If the 'experienced' investor has it wrong, the deal might implode and you are out your investment. You need to do your 'due diligence' to avoid flaky deals.

If this is too scary for you, similar opportunities are offered by firms that specialize in raising private capital. They do the 'due diligence' and take a couple of percent off the top. You receive a lower return for their professional vetting of the proposal. Returns are in the 9 to 12% range, still with some risk.

Finally, if you like real estate, but don't think you have the money to participate, remember that you can use money in your IRA for all the above investments.

This wasn't meant to be a complete list of the different types of real estate investments, but I hope it has caused you to look at new possibilities. Please call me at 408-725-7135 if you would like more details on any of these investments.

Back to Free Info