Investment in Real Estate Residential and Commercial Mohammad (Mo) Tehrani, Ph.D., CPA motehrani@scorehouston.org tehrani@tehraniandassociates.com Meeting by Appointment: 713 ‐ 845 ‐ 2424 Office Hours: Location: SCORE ‐ Houston 1
Investment in Real Estate Residential and Commercial Part One Why Investing in Real Estate Types of Real Estate Economic Cycle and Real Estate Speculation in Real Estate and Consequences Potential Profits from Real Estate Investment and Role of Leverage Part Two Financing Real Estate investment – Terms Real Estate Loan Origination Types of Real Estate Loans Risk and Commercial Real Estate Required information for a Real Estate Loan SCORE ‐ Houston 2
Real Estate Investment There are a twofold approach to accumulating wealth: • Saving as much as possible Could loose value on the long term (reduced purchasing power) • • Embarking on a long-term Investment Investment in Stocks, Bonds, Collectable, Real Estate, etc. • Real estate is superior to other investments and has both advantages and disadvantages: • Advantages - 1. It is not subject to daily price fluctuations, as stocks are 2. The relative difficulty of buying and selling encourages investors to hold on for a long-term (capital intensive) 3. An investment in real estate provides a return of 5-10% per year 4. It provides tax benefits through depreciation 5. It provides liquidity through refinancing (appreciated property and payoff of mortgage) and rental income SCORE ‐ Houston 3
Real Estate Investment –Con. 6. It is an excellent hedge against inflation, its value tends to rise more than inflation. 7. Leverage – Can be financed up to 80% of purchase price. Disadvantages - 1. Real estate value, like stocks are subject to ups and downs of economy 2. It is not a liquid assets and should be done with surplus asset 3. Real estate requires more hands on management than stocks Investment in Real Estate is different from Fixer Uppers. The purpose of Fixer Uppers is to buy, remodel as quickly as possible with the lowest cost and then selling it as soon as possible. Investment in Real estate is a long-term goal (3-5 years) investment, which bring regular cash flow (through rent and refinancing) and building equity. SCORE ‐ Houston 4
Types of Real Estate Real estate investment can be classified into several categories: 1. Personal Homes and other small residence 2. Other residential properties 3. Land 4. Net leases 5. Build ‐ to ‐ suite 6. Shopping Centers 7. Office Buildings 8. Industrial/Office Warehouses and Storage Facilities The goal is direct investment in real estate. Investment in real estate securities such REIT or share in real estate development corporations are indirect investment. SCORE ‐ Houston 5
Personal Homes and other small residence Personal homes The first real estate investment should be personal home. It is called starter home. It is the soundest investment in real estate because the investor can get up to 90% financing. It should be a modest home and should not go beyond the means of investor. Starter home can be used to purchase a second house down the road. Here is an example of how: Yr. One Yr. Four Cost 100K Selling Price 120K Down Payment 10K Less mortgage Balance 85K Loan 90K Cash Received 35K New Home Cost 150K Down Payment 15K Cash on hand for second home 20K SCORE ‐ Houston 6
Personal Homes and other small residence Small Apartment Complexes Relatively inexpensive with profit potential • It comes in the form of Duplex, Triplex, Quadruplex or six ‐ family Dwelling • The owner can live in one and lease the others • Income from leased apartment can be used to cover total operating costs as well as to some extent mortgage and use • cash flow proceeds to purchase additional properties. Here is an example (15 years mortgage at 8 ½%) Quadplex Four Three Four Three Units Units Unites Units 1. Cost 100K 100K 9. Payment of principle 2,656 2,656 2. Down Payment 20K 20K 10. Total Return 3,202 ‐ 2,800 3. Mortgage 80K 80K 11. Annual % return 16% ‐ 14% 4. Rental Income 24K 18K 12. Appreciation 5,000 5,000 5. Operating Exp. 14K 14K 13. Return + Appreciation. 8,202 2,200 6. Operating Cash Flow 10K 4K 14. Net Return 41% 11% 7. Mortgage Payment 9,454 9,454 15. Depreciation and Tax 2,909 2,182 Saving 8. Net Cash Flow 546 ‐ 5,456 16. Amount Subject to Tax 293 ‐ 4,982 SCORE ‐ Houston 7
Personal Homes and other small residence Advantages: 1. You have opportunity to live in one unit and save on rent 2. Often Owner financing is available 3. The price of multifamily dwelling, regardless of size is a function of income 4. Multifamily dwelling provide a way to learn how to manage a property 5. Provide you with capital to buy “up” Disadvantages: 1. If you live in one of the units, then you have to handle tenets complaints 24 hrs. per day 2. As the owner you will be responsible for collection of rents, filling vacancies, and doing repairs SCORE ‐ Houston 8
Other Residential Properties Residential properties come in a variety of sizes, price range and diverse tenants. Location of property determine the type of tenants and demands (e.g., students are tenants of an apartment complex near university). Residential properties includes: ‐ Apartment complexes ‐ Attached rows of townhouses ‐ Low and high rise apartment buildings ‐ Boarding and rooming houses The value of investing in one over the other is relative. If an attached row of townhouses reflects a higher rate of return on cash than a high rise apartment building, then you might decided on the former. SCORE ‐ Houston 9
Garden Apartment Complexes Garden apartment complexes consist of groups of two ‐ to ‐ three story walk ‐ up with up to 12 apartments per building or rows of apartments similar to townhouses Advantages They are more management intensive, so sold for lower price and giving a higher rate of return They are build on larger areas of land and often its value goes up over the years It normally requires lower percentage of down payment Disadvantages Maintenance and management cost are higher Insurance costs are higher Due to size it has a higher security risk It is very much subject to local economy In purchasing a garden apartment complex, rent revenue is not the only main factor. Location, land, building conditions and operating expenses must be analyzed. SCORE ‐ Houston 10
High Rise Buildings High rise buildings are defined as an elevator building compromising many floors with many apartments They are built in strategic locations where land is limited and expensive Advantages It offers economy of scale (everything is in the building) Easier and cheaper to operate Offer a higher rate of appreciation (difficult to duplicate) It is easier to get financing Disadvantages It is sold for a higher price and not suitable for small investors In certain areas like NY, there might be rent control and other protection regulations It is not easy to demolish and use the land for other purposes. SCORE ‐ Houston 11
Shopping Centers The term shopping centers refers to a variety of commercial spaces, ranging from small group of stores on a parking area to megamall shopping centers. Shopping centers can be classified differently, but the most common classification is: Anchored shopping centers The anchor is a major store. The anchor is the main draw which indirectly generate business for other tenets. Examples of anchor stores are: 1. Supermarkets 2. Drug chains 3. Department stores 4. Movie theaters Advantages Easy to manage – responsibility include ground and structural upkeep, management, insurance and real estate tax payment As community around shopping center increases, the value of land increases and the land can be used for other purposes in the future. The presence of an anchor store make it easier to get financing. SCORE ‐ Houston 12
Shopping Centers Disadvantages Most of the income comes from anchor stores, so if one or more anchor store move out or go out of business, the shopping center need retrofitting Unless there is a cost of living adjustment (COLA) or other escalations, a long ‐ term fixed lease can results in slow increase in the value of property (no income increase) Anchor tenants are very much tough negotiators and often impose certain requirements such as who should other tenants be. Anchor shopping centers are excellent investment for new small investors as part of a group (partnership). SCORE ‐ Houston 13
Shopping Centers Strip Centers or Strip Malls They are made up a series of retail stores with average size of 1,000 square feet They have good visibility and are located in a densely populated neighborhood They normally have access to freeway Advantages They are an income producing real estate investment and income increases as community develops There is no major risk of loosing a draw tenant They represent a smaller investment Leases tend to be shorter term (re ‐ adjustment of rent for inflation) Easy to manage Disadvantages Tenants may not come if it is not well located Tenants tend to leave if their business is not doing well, the rate of vacancy is higher Strip centers are good investment in commercial real estate with lower down payment requirement. They are normally sold below the replacement cost. SCORE ‐ Houston 14
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