Real Estate and REITs

MISCELLANEOUS TOPICS Real Estate and REITs I like to say, “Real estate is tricky.” Translation: “Real estate is a real pain-in-the-…”

Real Estate Investments Types • Direct Real Estate Investments • As the investor, you hold the title to the property • Your home • Your vacation home • Rental property – whole course unto itself! • 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

Real Estate Investments Types (continued) • Indirect Real Estate Investments • Real Estate Investment Trusts (REITs) • Real Estate Syndicates or Limited Partnerships • Hurt by 1986 Tax Reform Bill • Passive versus active income • Tax Credits • Low-income housing, etc. • Equity Sharing • You put up the down payment for someone else and then share in the appreciation • First and Second Mortgages • Not an equity position – you are the loaner • A.k.a. Hard money

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 • 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! • For over 20 years, prices had become untouchable – simply insane • But the 2008/2009 turmoil changed the investing landscape for real estate • Prices plummeted but have recovered somewhat • I think the South Bay is where the great bargains are now 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 normally all too happy to finance a rundown foreclosure on their books … • … during normal times • Avoid property managers • Nobody cares about your property as much as you do(but there are always exceptions)

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

Real Estate Investment Trusts • Real Estate Investment Trusts (REITs) • “Pass-through” investments – kinda’ like a mutual fund • By law, must distribute 95% of their earnings to shareholders • Examples: • Shopping centers • Office buildings, warehouses, etc. • Apartment complexes • Management fees typically range between 1% and 2% per year • Long-term return – 7% to 8% Example: Realty Income Corporation, symbol O

Advantages of Real Estate Investments • 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 / REITs • Easy entry – REITs are easily liquidated • Limited financial liability (limited partners, REITs) • No management concerns • You can’t check the price of your real estate investments every day on the Internet • One of the major problems with stocks • (Well, actually, you can … zillow.com & trulia.com)

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 • Normally there is a lack of diversification • REITs & partnerships offer diversification • Passive tax shelter for real estate syndicates • Management or tenant problems • The PITA Factor! • Property values can decline • Oh, yes, they can!

Your Home as an Investment • A major asset of most households • Possible hedge against inflation • Traditionally, a home produces an after-inflation return of about 2.5 percent a year (San Diego?) • Tax advantages • $250,000 capital gains tax-free for single people • $500,000 capital gains tax-free for married folks • But it is a home first, an investment second • In my humble opinion…

“But my house is the best investment I have ever made!” • “Of course, it is pretty much the only investment that I have ever made, • Except for that penny stock my brother-in-law, the ex-stockbroker, conned me into buying… • But that stuff is worthless now • And those gold coins I bought back when the first Gulf War started back in ’91 • What did I do with those things, anyway?” Bottom Line: A House is a Home First, an Investment Second

“But what about San Diego?!” • Prices in San Diego have gone down in the past • They seem to have hit a bottom • The real estate agents certainly think so • But if you plan on staying here, by all means, buy whatever you can afford • San Ysidro and National City are two of the best values in the region, by the way • Imperial Beach is also a great beach value • But don’t expect what happened in the 2000’s to repeat itself for quite some time…

Sign seen over a desk in a San Diego office, circa 1993 “Please, God, let there be another real estate boom and I promise I won’t piss it all away this time!”

The “Perfect Investment” • “C’mon, Paiano – Admit it! • Real estate is the ‘Perfect Investment’ • Look at what has happened in the past five years” • This is what you heard from people in 2005 and 2006 • 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 still trying to unload that “flipper condo” before the bank forecloses (Oops, too late! Sorry ‘bout that. Well, better luck next time!) • 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 stocks

The “Perfect Investment” (continued) • “But what about Leverage?! Huh? What about the ability to make money with other people’s money?” • We have already discussed leverage, haven’t we? • “But isn’t that what makes real estate such a great investment?” • Well, yes. But there are pitfalls. Just as with margining stocks, leveraging real estate magnifies your gains and magnifies your losses. Worksheet

Real Estate and Capital Gains • “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 Example: Buy your home for $200,000. Sell it for $700,000. If you are married, then you pay no capital gains taxes!

Speaking of Info-mercials • Have you seen the 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 buy our Guaranteed, Sure-Fire Real Estate Investment Kit for $395” • “You will be on your way toward Riches beyond your Wildest Dreams!” No comment necessary.

My Advice on Real Estate • Buy a house • Make it your home • After you have digested that purchase • Then look for some rental property • But learn as much as you can from folks who are already doing it • Maybe even work for a property manager for a spell to get the feel for what you will need to be able to do

Real Estate and REITs