Transcript LECTURE Real Estate and Other Investment Alternatives If you have the older (bigger, hardback) book, this material is from chapter 17.

LECTURE
Real Estate and Other Investment
Alternatives
If you have the older (bigger, hardback) book,
this material is from chapter 17.
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Real Estate Investments Types
Direct
 As the investor, you hold the title to the
property
 Your home as an investment
 A major asset of most households
 Tax advantages
 Possible 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…
Examples of
Direct Real Estate Investments

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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 Types
Indirect
 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
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”
(continued)

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
Advantages of
Real Estate Investments

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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
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”
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“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”
(continued)

“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)
Real Estate and Leverage
1. 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 & 2
From our previous text book
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Real Estate and Leverage
(continued)
666. 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…
Real Estate and IRAs
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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
(continued)

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
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Real Estate and IRAs
(continued)

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
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Real Estate and IRAs
(continued)

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
Real Estate and Capital Gains
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“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!
Investing in Precious Metals

Gold
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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
Growth of $1 Investment
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1801 – 2011
Investing in Precious Gems
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Precious stones
 Diamonds
 Sapphires
 Rubies
 Emeralds
Video. Sorry, Ladies…
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Investing in Collectibles

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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
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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
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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…