1) Why is it worthwhile to check out foreclosed properties for sale?

It is worthwhile to check out foreclosed properties because: (1)
amazing deals can be achieved as banks are very willing to negotiate
and anxious to get these off their balance sheets; (2) if purchased
for a great deal, (a quick and dirty calculation of a great deal is
take 2% of the purchase price and this should be the minimum of what
you can rent the property for), a hefty positive monthly cash flow can
be achieved by renting the property; and (3) it helps the economy by
having the enormous amount of excess inventory absorbed by savvy
Investors.

2) What are the risks of purchasing a foreclosed property right now?

The risks of purchasing a foreclosed property right now is that there
potentially could be many more coming on the market. Therefore, you
need to be prepared to hold this property for at least 3 to 5 years,
and have enough cash reserve to support the property for 12 months
even if it can’t be rented during this time.

3) Why is it important to have a foreclosed property thoroughly inspected by
a professional prior to purchasing?

Many foreclosed properties have been neglected and sitting for a long
time. This means that regular maintenance and repairs has likely not
been performed, and unfortunately, theft and vandalism particular as
it relates to air conditioner coils and copper wiring is prevalent.
Additionally, the normal disclosures required by a seller of a
residential home are not required to be made by the bank. Therefore,
a professional inspection is a must before you finalize the purchase
of any foreclosed property.

4) What type of professional inspector is best to hire? Any
tips/suggestions?

An inspector should be a member of one or more real estate inspector
associations. For example, there is the National Association of Home
Inspectors, Inc. (NAHI) or the National Association of Real-Estate
Inspection & Evaluation Services (NARIES). Also, at least 3 referrals
should be supplied by the inspector and the inspector should be a
specialists in the type of real estate being inspected (I.e.
residential, commercial retail, commercial office, etc.)

5) What should the inspector be looking for in the foreclosed property?

First and foremost, an inspector should be looking for things that
can’t be seen by the non-professional eye. For example, structural
issues, electrical issues, mold or mildew, is the roof in good shape,
is their asbestos, is the stucco the fake kind that was subject to
recall due to defects, is the siding the kind subject to re-call due
to defects? In other words, the inspector is looking for things that
a novice couldn’t easily find themselves.

6) What are the major warning signs/red flags that should tell you not to
purchase this property?

If you are buying in a neighborhood where almost every house is
vacant, this is a bad sign unless you are prepared to buy almost every
house in that neighborhood. Otherwise, you will be one of many and
people don’t like to rent in vacant neighborhoods. The other
foreclosed vacant homes could be sitting for a very long time and this
could continue to deteriorate the value of your home. Also, you
should not buy in an area that you can’t get to within one-hour.
Trust me from my own experience, you wont properly maintain your
property if you can’t get there within one hour.

7) What are the important factors to realize before bidding on or making an
offer on a foreclosed home?

The three most important factors are: (1) Knowing the total cost it
will take you to get the property back to rentable or sellable shape;
(2) Knowing what the other comparable homes are selling for within a
1/2 mile area from the home your buying and (3) making absolutely sure
you can afford to fix the house up, maintain the house, and hold the
house even if it doesn’t rent for at least 12 months.

8) Any tips on how to use the results of the home inspection to your
advantage as a bidder or potential purchaser of a foreclosed property,
especially in this buyer’s market?

It is critical that the seller is made aware of the results of your
professional home inspection. The key to using this effectively for
getting a better price is your willingness to walk from the deal. You
MUST NOT GET EMOTIONALLY TIED to any one property. There are lots to
choose from, and I am afraid there will be for a while. If you’re
willing to walk from a deal unless you get your price, then you will
likely get your price.

9) Any other thoughts, tips, suggestions on this topic?

 Buying and
managing real estate is not for the faint of heart.
It’s hard work and very hands on. It is also an illiquid investment.
Go into this with your eyes wide open and make sure you have the time
And resources available to work this type of investment. On my blog
At woodysgoodies.info, I have an article I wrote called ” Basic
Rules on Buying Real Estate Are Good (Learning From my Mistakes is
Also Good)” (click here to read). I strongly recommend this be read before you make your
first purchase.

This is part eight, the last part of an ongoing series on rules for buying real estate. To see the other posts in this series, click here.

Planning For The Worst is Good (because the worst just might happen)

Don’t buy a property where you cant afford to carry it for at least one year if there is no income derived from it or you cant afford to pay the debt off in 5 years or less if all else fails.

Understanding Federal and State Security Registration Laws When Raising Money From Partners is Good

To discuss this rule in detail is far beyond the scope of this book. However, it is imperative that you consult with an attorney before raising money for others to invest in real estate with you. Typically, a complex “private placement memorandum” with lots of risk disclosures and other legal documents is required.

Additionally, federal registration is required, and each state that you raise money in (you to look the residences of your investors to determine which states are applicable) requires a registration fee and has their own registration forms. Not doing so could result in significant federal and state fines, inclusive of a requirement to return all your investors money immediately with significant interest.

Violating these provisions is known as illegally selling unregistered security, and the Security and Exchange Commission is investigating these activities more and more. You must consult a securities attorney if you are planning on raising money from investors to fund your real estate investment.

Buying Foreclosure Properties Can Be Good

Every state has a different set of laws as it relates to foreclosures. Certainly, discussing these laws is also far beyond the scope of this book. However, you certainly can get great deals with foreclosures. But please don’t believe this is easy. It’s very competitive, and again requires an enormous amount of research, time and work.

Not every foreclosure deal is a good deal. Far from it. Foreclosure properties have typically become run down and require a good bit of capital to restore. This must be factored into your purchase price. Also, if you are going to buy foreclosures at the court house steps, you will have to pay cash, and be able to deliver that cash within 24 hours.

A better way to buy foreclosed properties is to attend auctions where banks are auctioning off their inventory. Foreclosure auctions are scheduled regularly all around the country. There are huge foreclosure auction companies that run these auctions for numerous banks at one time. This way, you can give yourself plenty of time to do your due diligence on a particular property (or properties) that you want to bid on.

A great site for getting information on residential home foreclosures is www.ushomeauction.com. They even have an auction calendar, a news letter where they will email you information on upcoming foreclosures, and a toll free number that you can call for auction or property information. Unfortunately, at the time of writing this book, there are literally thousand of homes being auctioned all around the country at one time by this company.

Did I Mention Real Estate is Good?

In my humble opinion, no other investment can provide you with current cash income (most of it sheltered from tax), growth of your assets, leverage (using other peoples’ money to generate wealth for you), and instant equity. Real estate has gone up in value on an almost uninterrupted basis since the early 1800s. Until the late 1970s, real estate went up at a rate of almost twice the Consumer Price Index.

Over the last 20 years, (2008 excluded), real estate has gone up at an average rate of approximately 5% compounded annually. Keep in mind, since we are buying property using leverage, this can represent up to a 50% to 100% cash on cash return on investment (especially with cash flow factored in) over 5 year periods. It’s hands on and requires work, but can be very rewarding.

Remember, real estate is not meant to replace equities or bonds, just another category for your investment portfolio.

This is part seven of an ongoing series on rules for buying real estate. To see the other posts in this series, click here.

Being Aware That Bankruptcy is Your Worst Nightmare is Good

Having had to endure many bankruptcies, and consequently attend many bankruptcy hearings, let me break this down in simple, easy to understand information. Bankruptcy SUCKS!

Typically, your tenant will file a Chapter 11 bankruptcy to start with. This means they are filing a re-organization plan where they are asking the court to temporarily prevent all their creditors from taking any further collection actions, including eviction, until they work their so called re-organization plan. I have never seen one single re-organization plan make any sense, have any details or successfully work. They almost always end up being noting more then an expensive and very effective stall tactic.

The court typically appoints a trustee to represent the filer for free. The courts give the debtor a tremendous amount of lead way and time to work their plan, or amend their plan. You will first be invited to attend a creditors meeting where you will have a chance to hear the court appointed U.S. Bankruptcy Trustee question the debtor on their plan.

Afterwards, the creditors have a chance to ask the debtor questions, but only as it relates to their filed plan. The U.S. Trustee will cut you off if you get into any derogatory questions or ask questions about virtually anything that is not on their plan. However, there are a few things that upset a U.S. trustee in your favor, and bankruptcy judges, and may get them to grant you a “stay” quickly ( a stay means your claim is dismissed from the bankruptcy proceeding, and you now can proceed with your state remedies, i.e. eviction or suing the tenant).

 If the tenant is not carrying proper insurance, is behind on their taxes, or is destroying your property in any way, this will expedite you chances of being granted a stay. So be sure to ask about these things in the creditors meeting and certainly, if you can photograph any damages to your property that the tenant has or is causing, bring that to the meeting. After the creditors meeting, the court will give the debtor time (your tenant is the debtor by the way, and you are the creditor) to act on their –re organization plan.

However, there is no pre-set time that the Judge is required to abide by. The Judge can give the debtor as much or as little time as they deem “reasonable”. IT’S RIDICULOUS because they are staying in your property for free, and you have to suffer the consequences of not getting paid. Seems to me this process is fueling just more bankruptcies, because it’s causing creditors to also become insolvent. Anyway, after a few months, and thousands of dollars you will have to spend in engaging a bankruptcy attorney, you can file a “motion to stay” so you can be released from the bankruptcy. You will need to demonstrate that the debtors plan has no merit.

Again, totally in the judge’s subjective opinion as to what that means. However, just as you get close to having your motion heard by the court, be aware that your tenant will then likely convert their case to a Chapter 7 liquidation bankruptcy and dismiss their re-organization case. You then have to wait for yet another court appointed trustee to be appointed, sit through another ridiculous creditor’s meeting where the same question and answer session occurs again, file another motion to stay, and eat up more legal fees.

Finally, after typically a year, you will be giving relief and the granted the right to pursue your state remedies, and get rid of this awful tenant. By the way, at that point your property is typically destroyed, and this tenant has absolutely nothing to go after. If this sounds as if I’m mad at this country’s bankruptcy procedures, you are correct. Furious is a more accurate description. The debtor gets all the benefits, and the creditors, for the lack of a better word, get screwed. So again, I repeat, never ever rent to anyone who has ever filed bankruptcy in the past, because you can bet your bottom dollar they will do it again.

This is part six of an ongoing series on rules for buying real estate. To see the other posts in this series, click here.

Not Getting Emotionally Attached to a Property is Good

In other words, don’t buy it just because it’s pretty. Make sure the economics make sense. Run the numbers conservatively.

Liquidity – Remembering, Real Estate is Not Liquid By Nature is Good

Make sure you can afford the property, and IT won’t cause your a hardship because you may not see the down payment money for at least 5 years. Can you imagine how well investors would do if there stock investments were not liquid? In other words, if they could not sell based upon emotion, but were forced to hold long-term. Real estate by nature really forces investors to analyze buy and sell decisions carefully partially because of its non-liquid characteristic.

Never, Ever Buying a Property With Environmental Problems is Good

This may seem obvious, but you will be tempted because the purchase price will be very attractive. Make sure you have at least a Phase I Environmental Study done on all your purchases. Your liability exposure in this area is enormous, so if environmental issues show up, walk from the deal. There are plenty more out there. It has pained me to leave behind some very sweet deals due to environmental problems.

Zoning

Make sure your property is zoned for your intended use. At least early on, don’t even think about going for a zoning change. It’s easier to get an act of congress passed than it is to re-zone a property, and zoning attorneys are very expensive.

Using The Newspapers’ Classified Ads To Find Deals is Good

Some of the best deals I have ever seen have been out of the newspaper. You can’t believe the gems hidden in the classifieds. It’s time consuming, but worth the effort;

SBA Loans Are Good. Great for your first big commercial purchase

Many banks specialize in SBA financing. You can usually only use an SBA loan once, so do so wisely — perhaps use it on a deal where you don’t have enough money to put more than 10% down. SBA loans are great for those deals where you want to put a low down payment, and you will owner occupy the property;

Appealing Your Property Tax Assessments is Good

Every single year, appeal. Usually, you will get a reduction. It’s a bit of a pain to appear in front of the tax board, but after you calculate the hourly rate from the savings, you will quickly realize its well worth the effort. There are professionals that will do this for you on a contingency fee basis, usually 25% of the savings.

This is part five of an ongoing series on rules for buying real estate. To see the other posts in this series, click here.

After 5 Years, Refinancing to Yield Tax-Free Proceeds is Good.

In other words, your property will have likely appreciated after 5 years and hopefully so has the property’s income stream. Therefore, you can pull equity out of your property tax free by refinancing.

Keeping Your Credit Clean is Good.

If you are going to be successful in real estate, you will need to be able to borrow money. Don’t bog your credit down with credit card debt, auto debt, and especially don’t have late payments. Typically, a BEACON score of 700 and above will be needed to obtain conventional debt financing for investment real estate.

Insurance is Good.

You will have to have property insurance on your real estate. State Farm seems to have some of the best rates, consistently.

Making a Low Offer is Good.

Always do it in writing, perhaps first with a letter of intent. Don’t be shy or afraid to make a low-ball offer. I would start at 20% below asking price. You can always go up, but it’s almost impossible to go down. You have nothing to lose. Remember, if you are using a real estate agent, they must, by law, present all your offers. Also, don’t let the agent, who may be motivated by a higher commission, talk you out of making a low offer. You can save tens of thousands of dollars by being patient and low-balling the offer. Once the letter of intent has been agreed upon, convert it to a contract. It is best use a standardized contract that you should be able to obtain from a realtors office.

Whatever you do, don’t get emotionally attached to a property. This will certainly cause you to chase it, and the seller will likely be able to read into your eagerness which will kill your negotiating success.

Being Creative with Offers is Good.

Use a standardized Association of Realtors contract in your state. Structure the offer creatively. For example, perhaps you want to become more familiar with the property before purchasing it. Therefore, try to get a lease on the property with an option to buy after a certain period of time. Explain to the Seller that it is to their advantage to give you an option because they will get a higher price for property, option may be forfeited if rent not paid timely (assures Seller of timely rents), gives tenant a sense of pride of ownership which is an incentive to take better care of property, and rent may be higher than fair market value because of the option.

Be sure your option language is drafted by an experienced real estate attorney for assurance that your option is enforceable. The Seller may change their mind and a court of law will examine the language closely. First Rights of Refusal are very powerful tools in tying up a leased property. This could protect you from losing your business, especially if it is location sensitive.

Also, attempt to get owner financing if you can’t get conventional financing. Finally, try to use win/win negotiation techniques. Try to figure out the needs of the Seller and structure your offer to meet both the Seller’s needs and yours.

This is part four of an ongoing series on rules for buying real estate. To see the other posts in this series, click here.

Figuring Your Returns Based Upon a Cash On Cash Return Basis is Good (Don’t Use CAP RATE or IRR Analysis).

Keep things simple. In this regard, when calculating cash flows as discussed in point 16 above, simply figure the annual return based upon real cash outlay. For example, if you purchase a property for $500,000 and have to put 25% down ($125,000), then take your yearly cash flow, after debt service, and divide it by the total cash outlay. Assume for this illustration that your monthly cash flow (cash that you will have left over after paying all your expenses) will be $1,000 per month. Then the resulting yearly cash on cash return, in this example, is $12,000/125,000 = 9.6%. Not too shabby.

Also, remember that you should have additional return from the yearly principal reduction and property appreciation, which is “gravy”. Much of this cash flow will likely be sheltered from taxation due to yearly depreciation write off. Also, you can employ your children for property management duties (have a detailed contract describing the exact duties they are to perform so it’s documented for possible IRS audit purposes). Being that your children are likely to be in a much lower tax bracket, and because this is considered “earned income”, your kids will be taxed at their much lower tax rate, rather then at your higher tax rate. (By the way, the infamous “kiddie tax” where a child under age 18 is taxed at the parent’s highest tax rate on a child’s unearned income is avoided here because this is considered “earned income)”.

This achieves some incredible family income shifting, resulting in fantastic tax savings. The “cap rate” of a property is the yearly net operating income (before debt service) divided by purchase price. I like to see at least a 9-cap rate before investigating a property further. IRR is a complex calculation beyond the scope of this article which factors time value of money into your returns;

Not Using a Management Company is Good.

It comes down to this: no one cares more about your assets than you do. Again, learn from my errors. A management company will not maximize revenues, care for the property, screen tenants, handle the accounting, and properly keep you informed unless you are a very large client. In other words, it doesn’t pay to use one unless you are huge. Count on at least 6% to 10% of your gross revenue as their fee if you must use a management company;

Property Management Tips are Good:

1. Don’t let tenants move in until the agreed date, money has been paid in full, and the check has cleared
2. Complete a “Move In/Move Out” form prior to move in and move out (I have one upon request)
3. Inform tenants in writing that your insurance does not cover their stuff (maybe in lease)
4. Make rents due on first of month, and late by the 5th
5. Don’t provide drapes or curtains
6. Provide incentive for early payment (prior to 5th, reduce by $25 – remember you artificially mark up)
7. Only show units ready for move in
8. Consider longer than 12-month leases and lower rent (never go month to month or less than 12 months)
9. Get rid of bad paying tenants (more than 30 days late) – I use CSS Services – inexpensive and good.
10. Use an approved realtors board lease for commercial property
11. Use QuickBooks to do your accounting. Set each tenant up as a customer to create separate accounting for each tenant using “statement charges”
12. Run a credit report on your tenants prior to signing the lease
13. Never ever rent to a tenant that has previously declared bankruptcy
14. Until you are large (and even then, use caution here before engaging a management company), manage property yourself

BRIEF Real Estate Tax Highlights are Good (Remember This Topic Could Be a Book All To Itself):

1. Allocation of purchase price will impact your taxes greatly – land is not depreciable, FF&E is 7 year life, residential building is 27.5 year life, nonresidential building is 39 year life
2. Sale of real estate subject to depreciation recapture is taxed at 25% (assuming long term capital gains apply)
3. Hold your property for more than 1 year to receive long term capital gain tax rate on sale (generally 20%)
4. If you actively participate in real estate, up to $25,000 in passive losses from rental real estate can be deducted each year against other income (phased out by 50% of amount AGI exceeds $100,000) 
5. If you are a real estate professional, all losses from real estate can offset other income (more than 50% of individuals personal services and you spend more than 750 hours of service per year)
6. If you have more than 1 real estate property, you must make a special election on your tax return to treat them as one activity pursuant to section 469(c)(7)(A) – may need to do this to reach the 50% rule discussed in #5
7. No tax on gain for like kind exchanges – there are 6 qualification rules: First, both the property sold and bought must be for business or investment; Second, the property must not be held for sale to customers, like inventory; Third, must be like kind property like real estate for real estate; Fourth, a discussion on intangible property which is not relevant for this article; Fifth, the property to be received in an exchange must be identified in a written agreement within 45 days after the sold property is transferred; and Sixth, the property in the exchange must be received on or before the earlier of: 180 days after the transfer of the property given up, or the due date including extensions) for the tax return in which the transfer of the property given up occurs. You should use a like kind exchange company to handle these types of transactions for you;
8. Deduct all miles for visiting your property
9. If you own raw land, and none of it is being rented, you can deduct the interest and taxes as investment expenses on your schedule A (itemized deductions schedule) and avoid the passive loss limitation rules

Viewing Real Estate as a Long Term Investment is Good.

Like most investments, real estate performs best if you hold it for at least 5 years. Most of my properties have seen there greatest appreciation at the 5 year point and beyond

This is part three of an ongoing series on rules for buying real estate. To see the other posts in this series, click here.

Not Buying Class “A” Property is Good.

Class “A” properties are the premier properties in your area. For example, if we were in New York City, Trump Tower would be a Class “A” property. Guys like Donald Trump have deep enough pockets to buy and operate this type of space. I own no Class “A” properties — I actually prefer Class “C” and even Class “D” properties (which usually require fix up).

The real opportunities in real estate are to create value by fixing up blighted properties where others don’t have the time, energy, guts or resources to do it. Furthermore, you will typically see that the Class “A” and Class “B” properties have the highest vacancy rates during tough economic times. You would be amazed how much a paint job, new carpet and wallpaper can do to a Class “C” and Class “D” property (as long as the structural integrity is sound).

Creating your own value with inexpensive, cosmetic changes has worked successfully for me time and time again. One of my best deals was a run down, dilapidated, 3.5 acre property with old warehouses on it. The owner did not have the time or inclination to fix up or run the property. We bought it for a song and recently just completed improving the property. The purchase price of the property was approximately $310,000 and we spent approximately $1.8 million improving the property. The property is now the buzz of the town. It is 60,000 square feet of high ceiling, exposed beam, warehouses that are now attracting restaurants, office, high tech, artists, printing, and other hip and cool type tenants.

Even at $8 per square foot (which in this area, FMV rents are more in the range of $10 to $12 per square foot), we will be grossing close to $40,000 per month, in a property that we have $2.1 million invested in. That’s off the charts. But we were willing to take the time and effort to create our own value. In fact, we even acted as our own general contractor (but that’s not easy, and requires you to devote full time to the project if you’re going to attempt this yourself). Also, because this property was in an area where the City of Atlanta wanted to encourage re-development, it qualified for the federal Commercial Revitalization Deduction program. We were required to submit a lengthy application to the local board that administers this program in Atlanta, and were approved. This program allows you to write off the development cost in a much faster period then you would otherwise be allowed to do for Federal tax purposes. Instead of having to capitalize your development cost and writing them off over 39 plus years, we were able to write half of these costs off in one year. This is a huge tax benefit.

Additionally, if we hold this property for 5 years or more, we are exempt completely from paying Federal income taxes on gain. You can learn more about these programs in your local area by typing “commercial revitalization deduction program in [type in your state name]” (every jurisdiction has its areas that qualify). This is part of the federal government’s Community Reinvestment Program in the Community Renewal Tax Relief Act of 2000.

Not Buying Raw Land is Good.

It has been said numerous times that “The Great American Dream” is to own raw land. Is it really? Typically, an individual will invest in raw land, do nothing with it for eight to ten years, sell it for twice the purchase price and mistakenly think they made a lot of money. BIG MISTAKE! With vacant land there is no annual income to offset any expense (the average annual cost of owing a piece of raw land is 15% to 20% of what you paid for it), and there are only minimal yearly tax benefits (right off of your taxes, insurance and interest).

Also, it is difficult, (these days, more like impossible), to get conventional financing on raw land. Accordingly, if you do not sell the property for twice what you paid for it within three to five years, you are not going to make any real money, (especially when you factor in yearly inflation). Maybe, and I mean maybe, after you have made many other successful real estate investments in income producing property should you consider raw land. Obviously, if you were going to develop the land, this could influence your raw land purchase decision. However, development is not for the faint of heart.

Additionally, if you begin to develop your raw land, and then for some unexpected reason have to stop in the middle of a project (i.e. running out of funds, which isn’t uncommon) you will be faced with having to make sure your land is not violating EPA (Environmental Protection Agency) rules and regulations. Runoff from partially completed construction problems is a hot spot area these days and the fines can be enormous. You will have to have constant on going maintenance done on your property to assure there is no runoff. This is particularly important if it’s near rivers, streams or lakes.

Understanding That Development Projects Are Not For The Faint of Heart is Good.

Having been involved with numerous residential and a couple of commercial development projects, let me tell you this is tough, and sometimes very stressful stuff.

First, if you are considering such a project, run your numbers at least three times. Then have somebody who has actually done such a project review your numbers. Second, if you are not going to be the general contractor on your project, your risk of making money is greatly increased. Third, if you are going to use an independent general contractor, you better be ready for litigation expenses. Have an attorney carefully review the contract and make sure it is written on an AIA (American Institute of Architects) contract. General contractors (GC) love change orders, and believe me, you will have them. In other words, any changes you make to the original proposed architect plans will incur a hefty cost by the GC once the project has started.

Fourth, have a good architect who can serve as your construction supervisor who will examine the project during various phases of construction, and ultimately be responsible for approving draw requests. Finally, in your projections, include at least a 15% cushion over and above your projected cost of construction. I’ve never come in under budget, or even on budget for that matter. But I’m happy to say I’ve always made money with development projects by measuring three times, and cutting once. This is an area for the very experienced and thick skinned. If you are going to take a crack at development, perhaps try it first with a small project in your own home (like finishing your basement);

Buying Real Estate With a Partner (or Partners) Can Be Good (and/or a Detriment).

Both the best and the worst thing I have ever done in real estate are having partners. Most of the times, it’s been great. Occasionally, I have truly regretted it. My advice is to be very, very careful in choosing your partners. Try to pick a partner that compliments your skill sets. In other words, if you are good at accounting, then pick a partner who has the repair and maintenance skills. Perhaps you will be the working partner, handling all aspects of the property that will actually structure the deal and provide management services, and you are looking for a money partner who will up the down payment and working capital. I have found the more partners, the more headaches. Have everything drafted in writing by an attorney up front so you can limit the misunderstandings down the road.

Typically, when things are going well in terms of money flow, the partner problems seem to be minimal. But once a deal begins to go “south”, requiring additional capital from the partners, you will quickly find your partners to be your adversaries. MAKE SURE ALL PARTNERS HAVE SOMETHING TO LOSE IF THE DEAL GOES BAD. MAKE SURE THAT YOUR PARTNERS ARE FINANCIALLY AS STRONG OR STRONGER THAN YOU ARE, BECAUSE WHEN THINGS GO BAD, THE PARTNER WITH THE DEEPEST POCKETS IS GOING TO BE FOOTING THE BILLS (WITH VERY LITTLE, IF ANY, RECOURSE AGAINST YOUR OTHER PARTNERS). Finally, it helps if you have a clear delegation of responsibilities among the partners. In my case, being a CPA, I tend to partner with a person who is excellent at the day to day running of the property, taking care of renovations, repair and maintenance, and I handle the accounting, leasing and tax aspects of the property. It has and continues to work well. But we tested the waters by starting slowly with a small project and then gradually did more and more together. Be careful.

Remember, the test of a good partnership is not when things are going well, it’s when things are going bad (and unfortunately, bad projects and bad times are going to happen);

Holding Your Real Estate in an Entity is Good.

Each property you own should be owned in a separate legal entity. This shelters each property from one another’s liability. An LLC typically is best for tax and legal purposes. Inside an LLC, you get what is known as “tax basis” even if you funded some or al of the purchase with debt (important for tax purposes, so you can utilize the tax write-offs that will flow from your real estate investment);

Running The Numbers Before Buying is Good (1% to 1.5% Rule).

 There are many categories of expenses that could be associated with owing real estate. Additionally, you should expect vacancies. In general, in determining your projected cash flows, take 90% of your projected gross rents plus any other income sources, such as vending or laundry, and subtract your estimated expenses.

Estimated expense categories include: principal and interest, taxes, insurance, advertising, lease commissions, management fees, repairs and maintenance (estimate between $50 to $60 per month per unit for multi-family residential), water/sewer, garbage, electricity, licenses, advertising, supplies, pest control, accounting, legal, misc. (5% of gross rents).

Obviously, your goal is to end up with a positive cash flow at the end of this analysis. A QUICK AND DIRTY RULE IS THAT YOUR MONTHLY RENTS SHOULD BE AT LEAST 1% TO 1.5% OF YOUR TOTAL PURCHASE PRICE. Example: If you buy an apartment building for $500,000, your monthly gross rents should be at least ($500,000 X 1%) = $5,000. If you pass this test, then the property is worth exploring further with a detailed analysis;

This is part two of an ongoing series on rules for buying real estate. To see the other posts in this series, click here.

Getting an Updated Survey Prior to Closing is Good.

Again, I have learned that hard way that title insurance policies almost always have exclusion for possible problems arising from not having a current survey. For example, your drive way, set backs, building structure, etc… may be built on someone else’s property.

When you close, unless you order an updated survey, you will never know that and will just be under the assumption that everything was built on your property. However, when you go to sell your property years later, a savvy buyer may require you to get a current survey, and that’s when you may discover you have a big problem. These problems will be costly to fix, and definitely require an attorney. In some cases, your neighbor may be cooperative and grant you an easement to be on the property without much hassle. However, if they don’t, get ready for litigation.

If your property has been there for 20 years or more, you likely can suit the neighboring property owner forcing them to give you an easement through what is known as a “quiet title action”. However, it’s a lengthy process and can be expensive. But once you have been there for 20 years, it will be next to impossible for the neighboring property owner to prevail in making you remove your property that infringes on their property.

If your property has been there less then 20 years, you will likely lose and be forced to either meet their demands in buying the property you infringed on, or be forced to remove the structure that is infringing on their property.

Only Buying Real Estate In Your Local Area is Good (No More Than 1 ½ Hour Drive From Where You Live).

 Trust me on this one. Having violated this rule myself in the past, I assure you that you will regret having a property further then 1 ½ hour’s drive away. You will ignore a property further then this property just because of the long drive the drive.

Also, it is difficult to become an expert in far away areas (knowing the police, knowing the crime level in the area, knowing the neighbors, knowing the demographics, knowing the permitting offices, knowing the best contracts in that area, knowing the FMV rental rates, knowing the magistrate judges for eviction matters, absorption rates in the area (impacts how long it will take to sell your property), knowing future commercial and residential development plans in the area, knowing the City Council members in the area, knowing the realtors in the area, knowing the local schools in the area, knowing the property taxes and possible property tax exemptions in the area, etc…).

You need to know the area inside and out is of vital importance for making a proper analysis of your real estate investment and running numbers and projections.

Never Buying Real Estate Solely For The Tax Benefits is Good.

This unfortunate error occurs over and over again. Many people jump into a poor real estate investment because they were excited that their taxes would be lower. Of course, they end up never making money on the deal, inclusive of any tax savings. In other words, the tax benefits of real estate are secondary to the economics of the deal. Yes, there are significant tax benefits to investing in real estate but they rarely, if ever, overcome the loss from a bad deal;

Using a Professional Inspector is Good.

The cost for having a professional inspector look at your property is usually nominal compared to the potential problems they can help you avoid.

Unless you have significant experience in construction, you will never locate all the problems that they will find. Make sure they are licensed and members of their related professional associations. They should look at basements, foundations, structural members, roofs, roof supports, equipment on the property, alarm systems, elevators, boilers, heating and air units, etc. Their written reports will identify deficiencies and recommend the type of repair and perhaps the estimated cost. This could assist you in your negotiations to get a reduced price.

You may also want to consider purchasing an extended warranty for appliances.

Buying Residential, Commercial and Maybe Industrial, But Never Office is Good (Unless It Is Office Space For Your Own Use).

When times are bad, office is the first to lose value and have high vacancy rates. There is too much office space in this country, end of story. Your best bet is to start with residential and then slowly venture into a small commercial investment.

This is part one of an ongoing series on rules for buying real estate. To see the other posts in this series, click here.

I love real estate. However, I respect it at the same time, meaning you must treat this type of investment with care, love and lots of attention to be successful with it. In my 20 years of experience with investing in real estate, I have learned a great deal, sometimes the hard way. But, perhaps the most important lesson I have learned is that it is not a get rich quick investment, and it is HANDS ON.

If you follow these basic rules, you can do very well with real estate. If you don’t, then you’re better off investing elsewhere. The purpose of this chapter is to make sure you know what you’re getting into when you invest in real estate. Many have been influenced by get rich quick infomercials regarding real estate. Today, there is a buzz that buying foreclosures can make you rich. Let me be crystal clear, and for the sake of not understating this important message, I repeat REAL ESTATE IS HANDS ON, LONG TERM, AND NOT LIQUID. But it can you make you a fortune if managed properly and expectations of what it takes are realistic.

However, this is NOT TO SAY that real estate is a better investment than stocks or bonds, in fact, to the contrary. Stocks have actually outperformed real estate over the past 100 years. However, real estate can be and in many cases should be an important diversification strategy in a portfolio. In fact, for most people, there largest asset is real estate, namely their home.

Below is yet another list (I love making lists) related to important rules on buying real estate. Much of this list has been compiled over the years of experience I have had in this area. I have made many, many mistakes. Therefore, I feel uniquely qualified to teach you to avoid the pitfalls I stepped into. As mentioned above, (repetitively), understand that investing in real estate is very hands on, and a non-liquid investment. Follow these hard learned rules, please.

The rules that follow are not necessarily listed in order of importance.

Making Your First Real Estate Purchase Be Your Personal Residence is Good.

Why should you even begin to buy a rental, investment property if you are in fact renting yourself? Buying a house opens up many tax advantages, builds equity over time, gets your feet wet with a real estate closing, and gives you some basic experience in the rewards and headaches of owning rather than renting;

Making Your Second Real Estate Purchase For Your College Aged Child is Good (If Applicable).

In general, buying real estate for your children has numerous financial advantages. For example, if you buy your child in college a small 2 or 3 bedroom home near their school:

1. You will probably save money over the dormitory cost because your child can rent the other bedrooms which may cover the entire cost of owning the property (mortgage, taxes, insurance, repairs);
2. Instead of giving your child spending money which is absolutely non-tax deductible, you now pay your child for managing your property. Your child pays taxes on this money at their rate, which, in 2008, on the first $5,450 is ZERO, and the rest will probably be taxed in the 10% to 15% tax bracket,
3. Your property will probably appreciate (but be prepared to hold it for at least 10 years, as with all investments, a long term mindset is important;
4. You probably will not pay any taxes on the rental income received from the other tenants due to depreciation write off; and
5. You have given your child perhaps the best learning experience with a business transaction that they have had up to this point in their lives.

Making Your Third (or Maybe Second) Real Estate Purchase Your Office or Business Location is Good.

Again, why pay rent when you can own your own real estate and build equity over time? You will have the flexibility to do what you want with your space without having to get landlord approval. Typically, you will not incur any additional cost in owning your own office space or business location. In fact, if you rent out the additional space, you can many times occupy your space rent-free. What easier way is there to get involved with real estate and experience the management involved with real estate then to do it with the property you will be at everyday? Buying my own office building was one of the best real estate investments that I have ever made.

Not Believing Real Estate is an Easy Get Rich Quick Program with No Money Down is Good.

Let me make this very, very clear. If you are going to invest in real estate, you will need to have at least 25% of the purchase price available in liquid funds.

Maybe, and I mean maybe, you will eventually get lucky and find some owner financing deals. But they are rare. Also, you more than likely will have to be hands on in managing your property. For example, advertising coordination, showing the property to tenants, drafting leases, handling maintenance and repair calls, collections, evictions, dealing with bankruptcies, accounting related work inclusive of tenant statements, and becoming familiar with specialized tax issues related to real estate are but a few of the management tasks associated with directly owning real estate.

After some point, you may have enough properties where you can afford to have some of these tasks done for you by professionals. But early on, you better be prepared to handle these things on your own because more than likely, the economics of your first few deals will not allow for payments to outsiders for these services. With that said, don’t get scared — I just want you to know what your getting into. I REPEAT, I ABOSLUTELY LOVE REAL ESTATE, AND WITH THE HARD WORK COMES LONG-TERM REWARDS THAT ARE POTENTIALLY ENORMOUS;

Developing a Relationship With a CPA and Attorney With Real Estate Experience is Good.

I realize I just stated above that you probably will have to handle at least the accounting on your own in your first few deals (Quickbooks is great for this, by the way), but an attorney must do the legal work. Make sure you get a closing attorney that has good E&O insurance, can ABOLUTELY assure you of clean title by issuing you title insurance at closing, and can advise you of the best way to structure the contract. Believe me, there are good and bad professionals in both of these categories. Unfortunately, errors on closing can lead to lengthy and expensive litigation;