Investing in Real Estate 101

Why Real Estate?

Because real estate offers the best rate of return on your investment, and it is low risk. There is some risk as with any investment, however it is easy to calculate and with proper information and tools, the risk can be minimized to a comfortable level. Also, real estate is the most stable investment that is guaranteed to appreciate with time. Just consider the law of supply and demand, there is no more land being produced but populations continue to grow and need homes to live in, so naturally the value of property is bound to appreciate.

How do I calculate my risk?

Evaluate each investment on a deal by deal basis, and only invest in properties where you can see a clear profit. Make sure you understand the pro and cons of the deal and ultimately the positive cash flow or equity that will be realized at closing, during the life of the investment, and after it is sold. Finally, determine based on your own personal needs, whether you are more interested in short-term returns, monthly income or long-term equity. The answer to that question will determine what investments are most suitable for you.

Where are the most common investment strategies?

In general there are four categories of real estate investment strategies:

These strategies usually reflect the condition and building type of the property, the risk factor involved and the strategy employed by the investor.

Where does my investment go?

That depends on the type investment you choose. Some strategies require investing in building materials and labor, while others require investing in a down payment on a property or in some occasions, a monthly note.

How can I learn more about real estate transactions?

The best way to become more familiar with real estate investing and transactions is to immerse yourself in it. Begin with researching library materials - books, tapes and videos. Make a point of attending seminars and workshops, sign up for classes if necessary. And last but not least, networking! The most important component in learning is to interact and communicate with others in the field. By joining local investor groups such as Real Estate Investors Association you’ll have the opportunity to learn from other peoples’ experience and find answers to your questions. Benefits include borrowing library materials and meeting others with similar goals.

What do I need to become a real estate investor?

You need your wit, your motivation, a balanced budget and good credit. It may be difficult to believe that you really don’t need cash in the bank to get started, but it true. First you need wit because you’ll need to understand that the only thing between you and a successful financial future is YOU! Nothing else is preventing you from achieving that goal. You’ll also need motivation to make the first step, it’s your future. A budget under control will be your best friend. As an investor you need your expenses to be calculated and predictable. Good credit is critical for any investor, it gives you the leverage you need to make financial commitments, at some point or another in your investment career you’ll need your credit.

What if I don’t qualify to buy a home?

You don’t need to qualify to buy a home. Most real estate transactions are not conducted through banks and do not require a bank loan, therefore a mortgage or bank approval is not required. There is also no interest involved.

How much does it take to invest in real estate?

It depends on the opportunities available. As a beginner investor wishing to exercise a little more caution, you may be more comfortable combining your investment with another experienced investor in a rehab project. This may give you the first hand experience and practice needed to get started. That amount could be as small as one thousand dollars only, as long as you have a documented agreement with the primary investor outlining your share in the property and profits.

How can I finance my first investment?

Creative finance is the key. As a real estate investor you don’t necessarily need cash in your savings account. The most creative solution is to join your resources with other seasoned investors. To get started use your existing resources, sell something you don’t need, obtain cash advances on your credit cards, take out a home equity line of credit – whatever you do make sure you have the investment opportunity secured first.

Written by Abdulhayy Johnson Copyright © 2003 www.MeccaHomes.com

By Abdulhayy Johnson

Leasing a home with an “option to buy” is just the same as renting in many respects. They have much in common, e.g. a contract exists between you and the landlord, you pay a predetermined monthly rent, the lease is for an agreed period such as one year. The arrangement may appear the same as renting however it is not, since the tenant in reality is being given an opportunity to purchase the house, that is referred to as the “Option”. There are some ownership advantages and responsibilities that come with this option. The tenant assumes the role of the buyer by exercising this option at any time, in most scenarios this will be once he/she finds appropriate financing.

The greatest advantage of all for this tenant is the accumulation of equity and appreciation. In the ‘Lease Option’ contract, the landlord and tenant agree upon a purchase price, monthly rent and down payment. The down payment amount is non-refundable however it is applied in full towards the purchase price. A predetermined amount of the monthly rent is also applied towards the purchase price on a monthly basis, so the tenant is in fact building up their equity (their ownership) in the house. In addition to the immediate investment value being realized, the tenant is also gaining equity indirectly on the market value of the house due to natural appreciation. It is important to emphasize that all these investments can only be realized if and when the tenant exercises the option to buy.

This means that if the tenant changes his/her mind and decided not to buy the home, their investments will be forfeited, and the landlord will keep all the equity. So it is important that when entering a Lease Option contract you evaluate the house carefully and intent on buying and owning it.

Since the Lease Option agreement is considered a road to home ownership, and since the objective is transfer of ownership, it is only a logical conclusion that the responsibilities of maintenance and repair fall on the ultimate owner: i.e. the tenant. As a Lease Option tenant you will be responsible for maintaining the home and performing repairs if necessary, remember - every dime you spend on repairs and improvement will stay in your pocket once you transfer ownership. That’s why it’s extremely important to make sure you enter this contract with the intent to purchase the house.

When the contract is up (e.g. after twelve months) the tenant must make a decision, and the tenant has the right to do one of the following:

By Kenneth D. Eichner P.C.

Calculating the cash flow from an investment in rental property will tell you whether your investment makes economic sense. Here's how to do it.

First, calculate taxable income or loss from the property. Taxable income or loss is rent received minus three types of expenses: operating expense, depreciation, and mortgage interest expense.

Assume the purchase of a single-family house for $125,000, of which $25,000 applies to the land and $100,000 to the building. Depreciation of the cost of the building is a tax deduction even though depreciation is not paid out in cash each year. However, the deduction must be spread over 27.5 years. Divide the $100,000 cost of the building by 27.5 years. Your depreciation expense is $3,636 per year.

Assume a cash down payment of $30,000 and a mortgage loan of $95,000 for 25 years at 10%. The first year's payments would be $10,359 including about $9,459 of tax-deductible interest.

Suppose the property is rented for $12,000 a year, and the total of operating expenses paid by the owner, such as property tax, insurance, and repairs, is $2,500. Subtract from rental income of $12,000 the three types of expense: depreciation ($3,636), interest expense ($9,459), and operating expense ($2,500). The result, for tax purposes, is a rental loss of $3,595.

The tax rules on rental losses are different if you're a real estate professional. But if you're not a professional, here's how your rental loss could affect your income tax.

If you actively manage the property and your adjusted gross income does not exceed $100,000, the rental loss (up to a maximum of $25,000) could be deducted from other income such as salary, interest, and dividends. Multiply the rental loss by your federal income tax rate (in our example, 31%). The federal tax avoided as a result of this deductible rental loss is $1,114.

Cash flow can now be calculated:

Rental Income ................................$12,000
Plus: ............................Tax savings + 1,114
Less: ..................Operating expense - 2,500
Less: .................Mortgage payments - 10,359

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                                      CASH FLOW = $255

The investment just about "breaks even" on cash flow. The owner's equity in the property increases each year as the mortgage loan is paid down. Any increase in the value of the property during the years of ownership will increase the owner's ultimate return.

Calculating the cash flow on a rental property investment you're considering will help you decide whether the investment is a good one. You may want to avoid investments with a negative cash flow because you'll have to come up with additional money to cover operating costs and debt payments.

2003 © Copyright material from http://www.kdepc.com

Rehabbing

Rehabbing refers to the rehabilitating or fixing-up of damaged or neglected homes. Most rehab projects are done on homes that were abandoned by the owner or foreclosed by the bank. Some types of damage (such as structural) can be difficult to estimate and are best left to experts. However most projects can be completed with an experienced crew and proper tools at your disposal. The important components to look at when assessing the repairs are:

How Credit Ratings Work

Consumers have been hearing a lot about the importance of keeping tabs on their credit ratings. After all, a good score can make a difference of around, say, $500 in monthly payments on a $250,000 mortgage, and also can mean much lower credit-card rates. But what's considered a good credit score anyway? And who's actually evaluating you? Here are the answers to these and other common questions about your credit rating.

How is a credit score calculated? A credit score is a value assigned to several criteria used in making lending decisions. Criteria include the amount you owe on non mortgage-related accounts such as credit cards, your payment history and credit history. Scorers take this information from your credit report and plug it into formulas that calculate a value representing the amount of risk you pose to a lender. That value takes into account the track record of other consumers with similar credit profiles. By looking at this value, or score, lenders are able to roughly gauge whether it's a good idea to extend you credit. Fair Isaac calculates the widely used FICO credit score on a scale ranging from 300 to 850 - the higher the better. It is used nationwide by lenders to judge creditworthiness. The scores calculated generally use information from one of the three main credit bureaus: TransUnion, Experian and Equifax. It's possible there are discrepancies among information held at each of the bureaus that could affect your score and the interest rate you receive.

What else affects my chances for a loan? A credit score is just one component of the credit evaluation. This is especially so in the case of mortgages and car loans. In examining these types of applications, a lender will look beyond your raw credit score to scrutinize your payment history, among other things. For instance, the fact that the late payments on your credit report were on a small credit card (as opposed to a mortgage) could work in your favor. Lenders also take into account such factors as your income and earning potential, both indicators of your ability to repay a loan. Two borrowers with above-average FICO scores of 660 can get different interest rates, based on their existing debt burden and ability to meet required payments based on their income.

Is the score treated the same for all kinds of loans? Generally speaking - no. A mortgage loan, by virtue of its size and long repayment terms, will usually require you to have a higher score to qualify for a favorable rate than, for example, a credit card. But the nature of the loan may also play a role. For instance, a borrower with a low credit score applying for a 15-year mortgage with a 25% down payment may qualify for a better rate than someone applying for a one-year adjustable-rate mortgage. Mortgage lenders will typically look at all the risks involved before deciding on a rate. A lender whose loan portfolio has a high concentration of risky clients may require you to have a higher score to qualify for a prime interest rate than a lender with relatively lower risk in its portfolio. So it's possible that given a particular score, you might get a prime rate from one lender and a less favorable rate from another.

What can I do to improve my score? It's a good idea to make sure that the data each bureau has on you is consistent and up to date by ordering a copy of your credit report about once a year and disputing any inaccuracies. You also should be aware of what affects your score to help minimize the damage you can potentially do to it. People tend to get nervous when they receive credit-card solicitations in the mail. However, scorers treat these solicitations as "spot" inquiries, which do not affect your score. Whenever you apply for credit, on the other hand, it's treated as a "hard inquiry" that is factored into your score. Too many inquires over too short a time can have a negative impact. But scorers make special provisions for mortgage and car-loan inquiries because people tend to shop around more for these products. Overall, though, credit inquiries account for only about 10% of the total score. Also, keep in mind that the two main components of the score are your payment history and the amounts you owe. A bankruptcy filing, which can remain on your credit report for as long as 10 years, and foreclosures can "significantly lower" your score, you should avoid taking on more credit than you can handle. Late payments will also work against you, so it is important to make all loan payments on time even if it means paying the minimum balance. Ideally, you should avoid "maxing out" your credit lines and strive instead to maintain low balances. This will improve your score over time, because people owing smaller amounts on their credit accounts are viewed as having a lower repayment risk than those who owe more. By carefully managing your credit, it is possible increase your credit score by up to 50 points per year. There is nothing that you can do to your credit from which you can't recover.

How much should I worry about my score? Not all that much, unless you have an especially troubled financial history. Much of the current anxiety over credit scores stems from the public's misunderstanding of the way in which these numbers are used and factors that affect them. People spending a lot of time and money trying to modify their scores should only do so if it’s necessary for them to get preferential interest rates.

2003 © Lion, Inc. Copyright material from http://www.mortgage101.com/Articles/

Debt-to-Income Ratios

To determine your maximum mortgage amount, lenders use guidelines called debt-to-income ratios. This is simply the percentage of your monthly gross income (before taxes) that is used to pay your monthly debts. Because there are two calculations, there is a "front" ratio and a "back" ratio and they are generally written in the following format: 33/38.

The front ratio is the percentage of your monthly gross income (before taxes) that is used to pay your housing costs, including principal, interest, taxes, insurance, mortgage insurance (when applicable) and homeowners association fees (when applicable). The back ratio is the same thing, only it also includes your monthly consumer debt. Consumer debt can be car payments, credit card debt, installment loans, and similar related expenses. Auto or life insurance is not considered a debt.

A common guideline for debt-to-income ratios is 33/38. A borrower's housing costs consume thirty-three percent of their monthly income. Add their monthly consumer debt to the housing costs, and it should take no more than thirty-eight percent of their monthly income to meet those obligations.

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Your Debt to Income Ratio

Our underwriting system will use two different debt ratios for analysis when underwriting your mortgage. One is based on just your housing expense “front ratio” and the other (and more important one) is your “back end” debt ratio. This includes your housing expense and all of your other long term obligations.

By taking your monthly obligation(s) and dividing it by your gross monthly income you can calculate your debt to income percentages. To calculate your “back end” debt ratio be sure to include the following monthly payments: car loans, student loans, credit card minimum monthly payments, and your total monthly principal, interest, taxes, and insurance payment for your new mortgage).

In the years past, the best borrowers were those with a 28% “front ratio” and a 40% “back end” debt ratio or less. But, in today's world more and more lender's allow for higher debt ratios (as high as 55%) with other compensating factors (good credit, two years or more in the same line of work, sizable down payment, additional money in reserve after making your down payment, etc). We asked that you never assume that you don’t qualify because of your debt ratio. Allow one of our trained Mortgage Specialists assist you in calculating your debt ratio. These are only guidelines and we can get exceptions from the underwriters most of the time and there are more ways we can restructure your debt to help you qualify!

Copyright © 2003 Simplicity Mortgage. http://www.simplicitymortgage.com/consult/debt.asp