3 Pitfalls That Can Kill Your Real Estate Investment

Countless of people have been known to have made their fortune through real estate investing, and you might have heard of a friend, relative or colleague who likewise, have achieved a significant increase in their net worth when they sold off a property they have invested in years ago. Others have found financial freedom through their property investments, as their portfolio of well-chosen properties has given them a sustainable flow of rental income. Robert Kiyosaki of Rich Dad Poor Dad fame is one of the major advocates of property investing.

However, just like investing in any other assets, investing in real estate requires thorough planning, preparation and implementation work. Here are some common pitfalls to avoid before you invest in your first real estate.

Pitfall #1: Investing in real estate is not a get-rich-quick scheme

Investing in real estate is often promoted as a get-rich-quick scheme by the so-called gurus of real estate investing. However, this cannot be further from the truth. It takes time to pick a great property that will appreciate in value, and in the event if you picked the right property, more time is needed for it to appreciate in value. And just in case you are wondering, the flipping of properties in an attempt to get rich quick can be a risky endeavor!

Pitfall #2: Not doing a thorough preparation and research

Real estate as an asset class works just like any other long-term investment, you will have to plan in advance, work hard to search for worthy property deals (or get a property agent to do it for you), understand how a property can fit into your investment plan, calculate the cash flow that can be derived from the investment, and the list goes on.

Furthermore, unlike liquid assets such as stocks real estate constitutes an illiquid asset class. This means that it is difficult for you to liquidate this asset immediately without the risk of suffering loses to the actual value of the asset. Thus, a more thorough research is needed to justify the investment.

Pitfall #3: Not doing due diligence

Not all properties will appreciate in value over time. Factors such as the future development plan of the vicinity, the population trends of the city, the economic health of the city or country all contribute to the viability of a property investment.

Unfortunately, new investors make decisions to buy properties based on ‘gut feeling’ or on a vague idea or belief that the given properties will appreciate in value. They buy it based on the sales pitch given by their real estate agent. They don’t do their due diligence about the deal, the costs or the market conditions, and they wind up draining their personal savings because the house needs extensive repairs or they can’t sell it.

Conclusion

These are the three major pitfalls of investing in real estate. Read widely and research thoroughly in the property you are keen in investing. If you can commit to thorough research before committing to a property, you will avoid the common pitfalls that has plagued investors and radically increase your probability of making a successful investment.

About The Author

4 Reasons, Many Consider Real Estate, A Good Investment

There are many alternatives, when it comes to, making our decisions, about how, and where, to invest our funds/ monies! Options include: the stock market; bond market; commodities; United States Treasury vehicles; and real estate. Since, historically, many consider, real estate, one of the most secure, long – term strategies, and owning a home, of one’s own, is often, considered, a major component of the so – called, American Dream, this article will attempt to discuss 4 reasons, many feel this way, and use their funds, to purchase family homes, as well as investment properties. With that in mind, this article will attempt to, briefly, consider, examine, review, and discuss, how, and why, this matters.

1. Historically, keeps up with, and/ or, exceeds inflation, and the rate – of – return, many other options, provide: In addition to many other reasons, historically, the appreciation in value of real estate, has kept – up. with, and/ or, exceeded the rate of inflation. It also has been, in the longer – run, one of the safest, most secure, vehicles, available! Many analyses show, also, the overall rate, for real estate, to be better, than most of the other options!

2. Several purposes, including living expenses, and asset appreciation/ value: When one purchases a home, of his own, he satisfies several purposes, including, his living expenses, and pride of ownership! However, it is especially, satisfying, while doing so, the value of houses, over the longer – run, generally increases, by, at least, the rate of inflation. Many also purchase real estate, for investment purposes, such as buying multi – family properties, etc. When doing so, they also receive tax benefits, including being able to depreciate the property, on a schedule, for tax purposes. Also, remember, if you don’t own your house, you are still paying rent, which has no rate of return!

3. Better than average returns, over – time: Statistically, on an historic – basis, real estate values have increased, over – time, not only, at a rate, greater than inflation, but, also, better returns than many other investment vehicles.

4. Paying yourself, instead of your landlord: Your personal home, can either be owned, by you, or by your landlord! When you rent your residence, it provides your housing, but you receive no other financial benefits! Who would you rather pay, monthly, yourself, or your landlord?

It is wise to fully consider your personal situation, comfort zone, and priorities, and perceptions, before making any investments. After this process, remember to include housing, and real estate, in your overall analysis!

2010 Real Estate Investment Outlook and Perspective

What’s next for real estate?

For most people, real estate remains a critical part of personal net worth. Despite the stock market’s recovery, the average net worth of an American family is down about 25% because of tumbles in real estate values and investment assets.

Overview of Market Trends – Focus on Boston

While still suffering because of continued turmoil in the anchor employment areas of Financial Services, Insurance, Real Estate (FIRE), there have been signs of stability in and near major metropolitan areas like Boston. Although the employment picture remains bleak, the Boston metropolitan statistical area (MSA) showed the strongest gains in property values during 2009 according to a recently released report by Zillow Real Estate Market Reports.

Even with the strong gains helped along by the federal government’s first time home buyer credit and continued low mortgage interest rates, there remain nearly 25% of homes that are “upside down” on their outstanding mortgages.

High unemployment persists as companies continue to announce layoffs or delay hiring. And given the expected wave of creative mortgage products like Alt-A loans, interest-only loans and “pick-a-payment” adjustable rate mortgages resetting to higher rates putting pressure on homeowners who are unable to refinance because of lack of jobs or lack of value, there will likely be an increase in the number of foreclosures.

According to research reported by HousingPredictor.com, the major metropolitan areas in the US will likely not see a boom in real estate until after 2020. With more than 7 million people unemployed and another 20 million listed as underemployed, it may be 2017 or 2020 when these workers are absorbed. And real estate sales depend on those who have jobs.

Real estate booms have typically run in seven to 10 year cycles with some outside trigger precipitating a crisis that popped the bubble. The current situation is unlikely to be different.

Implications for Investors

Apartment vacancy rates are expected to rise through 2010 to about 7% to 10%. The continued collapse in confidence about jobs hampers household formation as individuals may delay marriage or move back in with parents or relatives or double up with friends.

As foreclosures rise, there will likely be greater demand for replacement housing so vacancy rates may fall. And as workers try to keep their options open to accommodate moving for job opportunities, demand for rentals will likely increase as well. The caveat is that there will also likely be a range of supply options that will put pressure on rents. And as a result of continued poor economic conditions, landlords can expect that credit quality of tenants will erode.

Apartments will have to compete with an increasing supply of single-family homes. Currently, the single-family homes available for rent has ballooned to nearly 10% compared to the long-term average of 4.5%. And a change of policy by mortgage servicer Fannie Mae will allow renters living in homes or apartments where the landlords have been foreclosed on to no longer be evicted. This will likely mean that largest landlord of single-family rentals in the US will be a quasi-governmental entity.

The volume of sales in the multi-family market is way off and likely to continue. Potential buyers continue to wait for prices to stabilize. There will continue to be an upward shift in cap rates by 1% to 2% approaching the cap rates of 2002 (8.2%) which will directly contribute to downward pressure on prices in the range of another 10% to 20%.

And given the more stringent underwriting criteria like higher down payment requirements, the number of investors capable of acquiring a property will likely be limited. But there will be opportunities for those investors with the capital and credit to buy when prices stabilize.

Real Estate and the AMT: Rental Or Investment Property

The Alternative Minimum Tax is a very important consideration for taxpayers who own real estate because just about every tax rule applying to real estate is different for the AMT than it is for the Regular Tax. This article on Real Estate and the AMT will address those situations where the individual holds the real estate as an investment, typically as rental property. The differences in tax treatment between the Regular Tax and the AMT can be significant.

Interest expense

Interest paid on the mortgage taken out to acquire the property is fully deductible, both for the Regular Tax and the Alternative Minimum Tax. Unlike itemized deductions that allow a tax benefit for what amounts to personal expenses, the tax law generally allows all deductions a taxpayer has to make in the pursuit of business income. Thus, the limitations discussed in the previous article on home mortgage interest do not apply.

If, however, the equity in the rental property is used as security for an additional loan – a second mortgage, for example – then the taxpayer must look to how the proceeds of that loan are used to determine interest deductibility. If the proceeds are used for a car loan or to finance a child’s education, for example, then the interest is nondeductible personal interest. If the proceeds are used to improve the rental property, the interest is deductible.

Suggestion – it is best that taxpayers keep personal borrowings separate from business borrowings. Mixing the two creates recordkeeping challenges and can result in disputes with the IRS.

Property taxes

Property taxes paid on rental or investment property are allowed in full both for Regular Tax purposes as well as for the Alternative Minimum Tax.

Planning idea – if you have an opportunity to pay your property tax bill either this year or next, pay it in a year when you have enough income from the property so as not to generate a rental loss. This strategy can help avoid triggering the passive activity loss limitations described below.

Example – in Florida property tax bills are mailed in October, and are payable under the following discount schedule: November – 4%, December – 3%, January – 2%, February – 1%. If you have a loss from the property in 2010 but expect to generate income in 2011, do not pay your bill in November or December – forgoing that small discount could help you avoid the loss-limitation rules.

Depreciation

Depreciation is allowed for property held for investment. The portion of the cost allocable to land is not depreciable, but for the building itself and the furniture, appliances, carpeting, etc. a depreciation deduction may be taken.

Real property (this is the legal definition of the house or other building) held for rental/investment may only be depreciated for Regular Tax purposes under the “straight-line” method, over a useful life of 27.5 years. Thus, a property with $275,000 allocated to the building would be depreciated at the rate of $10,000 per year.

Personal property (this is the legal definition of things such as furniture, appliances, carpeting and the like) may be depreciated for Regular Tax purposes under an “accelerated” method over a useful life of five years. An accelerated method allows a larger depreciation deduction in the early years, in recognition of an obsolescence or decline-in-value factor that you see in new property (cars are a good example).

For purposes of the AMT, however, personal property may be depreciated only by using a straight-line method. Thus, an AMT item will be generated in the early years if the accelerated method is used.

Planning idea – for personal property consider electing the straight-line method for Regular Tax purposes. While giving up a little tax benefit from the greater depreciation in the early years, it could mean avoiding paying the AMT.

Active/passive investment rules and the “at-risk” rules

A taxpayer who is not “active” in managing investment property may not use losses from rental property to offset other income such as salaries and wages, dividends, interest, capital gains, etc. Instead, these losses are deferred until the taxpayer either sells the property or generates passive income from this or other passive investment sources.

The at-risk rules similarly deny using these types of losses to the extent the taxpayer has acquired the investment with borrowed money and does not have personal liability on the debt.

Planning idea

If these loss limitations apply, consider the planning ideas mentioned above to minimize the losses being generated each year. They are not doing you any good anyway.

Sale of the property

Several different AMT issues can arise on the sale of rental/investment property. One is that your gain or loss may be different for the AMT than it is for Regular Tax purposes. This would be caused if different depreciation methods were used. For example, if the personal property was depreciated using an accelerated method for Regular Tax purposes, then the basis in that property when calculating gain or loss on sale would be different because the straight-line method had to be used for Alternative Minimum Tax purposes.

Gain on the sale of investment property generally is capital gain, although a portion may be treated as ordinary income depending on the accelerated depreciation method was used. Capital gains in and of themselves are not an AMT item, but nonetheless they can result in AMT being paid. This is because the AMT exemption amount is phased out for taxpayers at certain income levels, so this additional income can have the result of reducing the exemption which in turn increases taxable income for purposes of the Alternative Minimum Tax.