Investing in Real Estate and Other Alternatives

1. Chapter 17 Investing in Real Estate and Other Investment Alternatives

2. Chapter 17Learning Objectives LO17-1 Identify types of real estate investments. LO17-2 Evaluate the advantages of real estate investments. LO17-3 Assess the disadvantages of real estate investments. LO17-4 Analyze the risks and rewards of investing in precious metals, gems, and collectibles. 17-2

3. Investing in Real Estate LO17-1: Identify types of real estate investments. • DIRECT REAL ESTATE INVESTMENTS • The investor holds legal title to the property • Single-family dwellings • Duplexes • Apartments • Land • Commercial property 17-3

4. Your Home as an Investment • A place to live • Shelter income from taxes if you have a mortgage on it; mortgage interest and property taxes are deductible • Possible hedge against inflation. Be aware of fluctuating house prices • Housing is a not-so-liquid investment that promises steady returns over time which depends on timing and location 17-4

5. Your Vacation Home • Tax advantages depend on if the IRS views it as your second home or as a rental property • If you don’t rent it more than 14 days a year, then you can write off mortgage interest and property tax (a second home) • If you rent it regularly, the size of your deductions depend on whether you actively manage it and by the size of your income • Primary reason to own a vacation home is because you want to use it 17-5

6. Commercial Property • Land and buildings that produce lease or rental income • Includes duplexes, apartments, hotels, office buildings, stores, and many other types of commercial establishments • After a home, small investors favor the duplex, fourplex, or small apartment building 17-6

7. Commercial Property(continued) • Tax deductions, such as mortgage interest, depreciation and property taxes, are limited to the amount of rental income you receive • Passive activity is a business or trade in which you do not materially participate, such as rental activity • Passive loss is the total amount of losses from a passive activity minus the total income from the passive activity 17-7

8. Undeveloped Land • Can be tremendous gains but this type of investment poses enormous risks • Investor’s money is riding on a single parcel of land which does not usually produce any cash flow • Most investors buy land with the intention of subdividing the land 17-8

9. Investing in Foreclosures • Financing for a foreclosure is more difficult and expensive than financing a primary residence • Any unpaid liens, including mortgage debt, taxes, construction loans, home equity lines of credit, and second or third mortgages become your financial responsibility • To get a clean and clear title, buy the property after it has been repossessed by the creditor

10. Indirect Real Estate Investments • Investors appoint a trustee to hold legal title on behalf of all the investors in the group • Includes limited partnerships and syndicates, real estate investment trusts, mortgages, mortgage pools, and participation certificates • REAL ESTATE SYNDICATE • A temporary association organized to perform a specific task that takes a large amount of capital; organized as a corporation, trust, or limited partnership • Provides professional management, limited liability for its members, and diversification (if several properties are owned) 17-10

11. Limited Partnerships • A limited partnership is formed by a general partner, who has unlimited liability and sells participation units to the limited partners • The limited partner’s liability is limited to the extent of their initial investment 17-11

12. Real Estate Investment Trusts • REIT • REIT is similar to a mutual fund or investment company and trades shares on stock exchanges or over the counter. • Equity REITs own and operate income-producing properties; 90% of REITs • Mortgage REITs loan money or invest in mortgages; 7% of REITs • Hybrid REITS own both properties and mortgages 17-12

13. Investing in First and Second Mortgages and Participation Certificates • Investing in First and Second Mortgages • Purchased by well-to-do investors; risky • Participation certificates • A risk-proof real estate investment • Equity investment in a pool of mortgages or student loans that have been purchased by one of several government agencies such as Ginnie Mae and Freddie Mac 17-13

14. Advantages of Real Estate Investments LO17-2: Evaluate the advantages of real estate investments. • A POSSIBLE HEDGE AGAINST INFLATION • EASY ENTRY as a limited partner, such as investing $5,000 to own part of an apartment building 17-14

15. Advantages of Real Estate Investments(continued) • LIMITED FINANCIAL LIABILITY — limited partners are not liable for losses beyond initial investment • NO MANAGEMENT CONCERNS for limited partnerships, REITs, mortgages, or participation certificates • FINANCIAL LEVERAGE • Use of borrowed funds for investment purposes; enables you to acquire a more expensive property than you could buy on your own 17-15

16. Disadvantages of Real Estate Investments LO17-3: Assess the disadvantages of real estate investments. • ILLIQUIDITY • DECLINING PROPERTY VALUES • LACK OF DIVERSIFICATION • LACK OF A TAX SHELTER for real estate syndicates • LONG DEPRECIATION PERIOD • MANAGEMENT PROBLEMS when purchasing individual properties 17-16

17. Investing in Precious Metals, Gems, and Collectibles LO17-4: Analyze the risks and rewards of investing in precious metals, gems, and collectibles. • A hedge against inflation and a safe haven during political or economic upheavals • GOLD • Higher prices result from fear of war, political instability, inflation, and lower interest rates • Gold Bullion includes gold bars and wafers • Gold Bullion Coins • Gold Stocks • Gold Certificates 17-17

18. Silver, Platinum, Palladium, and Rhodium • A hedge against inflation and a safe haven during political or economic upheavals • Silver prices have fluctuated from 24.25 cents an ounce in 1932, to over $50 an ounce in early 1980, and then back to less than $17 an ounce in April 2016 • Platinum, palladium, and rhodium are used as industrial catalysts, particularly in automobile production • Storage can be an issue 17-18

19. Precious Stones • Precious stones include diamonds, sapphires, rubies, and emeralds • Appeal to investors because of their small size, ease of concealment, great durability, and potential hedge against inflation 17-19

20. Precious Stones(continued) • Risks include.. • Not easily turned into cash • Difficult to know if you are getting a good stone • De Beers Consolidated Mines of South Africa Ltd. controls 85% of the world’s supply of rough diamonds • Prices can be affected by political instability in diamond-producing countries • Expect to buy at retail and sell at wholesale 17-20

21. Collectibles • 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 a good investment and a hobby, or a financial disaster • It’s “buyer beware.” Be careful of investment scams and forgeries • Consult with reputable dealers 17-21

22. Collectibles on the Web • Advantages • Provides efficiency and convenience for collectors • Easier to find items and compare prices • Sellers can reach a much larger, more varied market 17-22

23. Collectibles on the Web(continued) • Disadvantages • You can’t touch or feel the item and examine it for flaws or trademarks • There may also be some security risk since you don’t know who’s getting your cash or credit card number 17-23