Real Estate As An Investment: Part I – Acquiring Real Property

Real Estate Analysis is a detailed process because:

- prices are negotiable

- true costs vary based on payment methods

- sales transaction costs may not be clearly stated

Variable costs are direct costs associated with the purchase price, carrying charges incurred during ownership and costs incurred while evaluating a potential investment property.

Carrying charges are incurred after the sale while evaluation costs are incurred before the sale.

Direct Costs

The purchase price is NOT the real cost and is just part of it. The total costs are:
- Search and Evaluation Costs
- Effect of cash payment on the acquisition costs
- Financing costs

1. Effect On Cash Payment on the purchase price is when cash is usually the strongest inducement to a seller to negotiate terms and to lower the price which increases the values of the investment to the buyer.

2. Extended Payment Terms or Seller Financing may make the sales price higher due to the seller’s risks. The buyers interest rate maybe lower than prevailing market rates and the seller will usually hold a vendors lien. The buyer should specify in the agreement of sale that the seller is aware of the buyer’s intention to prevent subsequent misunderstandings.

Evaluation Costs is the cost for screening and analyzing the property through Investment Property Analysis. It takes time and may require a professional advisor to complete an accurate report. Investors may recover evaluation costs if they purchase the property. Some of these costs may include options, costs of feasibility reports, planning fees, environmental studies and appraisal.

- Option Costs is when the seller guarantees the property won’t be sold for a specific period of time and can be up to 10% of the purchase price.

- Feasibility Reports are a formal study that estimates the likely success of an investment. It usually includes the property evaluation, detailed marketing study, an analysis of any rental structures (occupancy rates, profit and loss statements and comparables).

Usually this is prepared by an appraiser or property manager and the costs are generally the same as an appraisal. Property management firs routinely project returns and base their fees on those projections.

- Planning Fees are professional fees incurred prior to settlement and are done by technical advisors.

- Environmental Studies evaluate the impact on air, water quality and the land itself.

- Appraisal costs are guidelines on setting the price and establish profitable limits for a mortgage loan.

Carrying Charges

These are ongoing charges associated with ownership such as property taxes, interest on financing, insurance and so on. These are usually broken down to monthly expenses and are shown on an Annual Property Operating Date form (APOD) or a Profit and Loss Statement.

Investment Components/Organization Costs

Organization costs occur after the investor has decided to purchase the property. This is mainly for legal and financial fees.

- Legal Costs

The focus now shifts from business concerns to legal concerns. Lawyers are useful while the sale is in place and before it is closed. They are often not part of the negotiation process to speed up the time. Lawyers can review legal documents to protect the investor’s interest and avoid delays in closing, examine title and assure proper transfer, and form an organization for business operations like an LLC.

- Accounting Costs

Accountants can examine and verify the accuracy of financial records for the property, prepare financial statements required by the lender, implement an accounting system for the new business venture and select a cost recovery method.

- Architectural and Engineering Costs

Engineering costs will verify codes and check insurance requirements while Architects will prepare drawings to obtain financing.

- Financing Charges

Most investors use borrowed money to leverage their activity. Closing costs cover brokerage fees, legal fees, insurance costs, title preparation, deed preparation, inspections, notary fees and recording fees as well as possible other charges.

Broker Assistance is more valuable as transactions are getting more complex in nature.

Chip Plumley can be reached at (610) 444-9090 or (610) 357-8635.
Prudential Fox & Roach is an independently owned and operated member of
Prudential Real Estate Affiliates, Inc., a Prudential Financial company.
Equal Housing Opportunity.

ChipPlumley.com

Real Estate As An Investment Part II - The Value of Land

Land is and has always been considered the basis of wealth. Historically landownership distinguished aristocracy from other citizens and is still commonly associated with power.

Land productivity is a major source of wealth. The potential productivity is what determines land value.

Land + Labor + Capital = Valuable Goods for Society and Wealth for the Land Owner

Some examples of productivity are Cultivation, Development, Mining, and Drilling.

Undeveloped Land
Raw Land, undeveloped, lacks the facilities to support building construction, remains unproductive, and creates a tax burden for the owner.

Attractive Resources
The value of raw land for surface development depends on its proximity to resources that attract people. The availability of jobs causes people to settle in an area.

Population and Land Use
Once people are attracted and settle to an area, then the main factor is the lands potential value. The most critical factors for land speculation is the population and the potential land use.

Population Growth Patterns

Population, Investment and Development change raw land into productive land. Population Growth follows work, traffic and living patterns.

Work Patterns follow the principle that where there are jobs people will follow. This creates a demand for schools, shopping, recreation, and housing. New jobs provide pressure for land developments.

The availability of transportation is a major influence on growth patterns. People like the idea of trains, bike paths, bus routes and anything else that would make getting from point A to B as fast and simple as possible.

The style of living is what people expect or want but is limited to work and traffic patterns. If people want to have a park or major shopping center nearby they are more likely to live as close to those points as possible.

Land Development
As people are attracted to an area, land becomes more useful and valuable. Land in a growing area increases in value because of its location which determines its use.

Zoning Directs Land Use
There are generally only major 4 types of land use; Single-Family Residential, Multi-Family Residential, Commercial and Industrial.

Single-Family Residential
Housing density is a minimum of 3.5 or 4.3 building lots per acre for local and FHA requirements. Subdivisions must meet local and federal standards of housing density. Small lots are considered 60’ x 100’ and large lots are considered 80’ x 120’.

The value of a building lot is the Land Costs divided by the Total Property Value. For example if the land costs $20,000 and the Total Property Value is $100,000, than the value of the lot is 20%. The value maybe as small as 20% or a maximum of 80%.

50% of the land price goes towards development. The other 50% usually covers land costs, risk, profits, and potential lawsuits.

Increase in costs have encouraged Higher Density Housing such as townhouses and patio homes. A Zero Lot Line is where one or more exterior walls are adjacent to the property line or share common walls with another property. The density can be increased to 6 or 7 units per acre lowering the per-unit land costs.

Multi-Family Residential
Land density can vary greatly but it generally begins around 18-20 units per acre for a two story garden apartment and can increase with additional stories. If you can get 28 apartment units per acre compared to 4 single homes per acre, you now have a 7 to 1 ratio. That means the land value can increase 7 times! Builders try to keep land value at 20-25%.

Commercial Land
This is land that is suitable for stores, service facilities, offices and warehouses. Public access is important so commercial land frontage along major road are more valuable. Often land is valued by the front footage line, but each use will determine how to value land. A store facility wants high traffic or a high number of people walking, where a warehouse is looking at truck traffic and railroad siding.

Industrial Land
Industrial businesses use land for manufacturing, refining or processing. Good land provides access to extensive support facilities such as, transportation, power, materials, manpower, services and supplies. The land value has no direct pattern but it must comply with environmental standards, fit the purchase requirements, and most significantly the value can reflect the financial strength of the purchaser.

Chip Plumley can be reached at (610) 444-9090 or (610) 357-8635.
Prudential Fox & Roach is an independently owned and operated member of
Prudential Real Estate Affiliates, Inc., a Prudential Financial company.
Equal Housing Opportunity.

ChipPlumley.com

Real Estate As An Investment: Part I – The Basics

The first step to investing is determining what type of ROI (Return on Investment) you are looking for. There are generally only 3 different ways to make a profit.

INCOME – A stream of money an investment produces (cash flow),
APRECIATION – A passive increase in value from scarcity and inflation and,
VALUE GAIN – An active increase in the value from the development and good business management of the investment.

The Basics of Income, Appreciation and Value Gain
Income is the most popular type of ROI because it generally meets the needs of most investors. An income return is usually a fixed income investment and is very liquid. Common types are Corporate and Government Bonds, Treasury Bills, and Savings Accounts.
Be careful of inflation since it can decrease the value of a fixed income investment. For example, if you put money in an account that gave you 7% interest, but inflation was at 3%, your real return is only 4%.

Appreciation is speculating that something will increase in value over time, such as collectibles. There is no guarantee of an increase in value and it is very difficult to measure any increase precisely.

I saw an episode of Pawn Stars last night on TV and someone brought in a rare Nintendo system from 1995. Unfortunately for him, about 6 months earlier, someone found a cargo crate filled with the same Nintendo systems that were brand new in the box. It went from being worth $300 to $80 just like that. I also saw on American Pickers where the guys found a Schwin Autocycle for $1,000, but since only 10 have ever been found, it was worth close to $5,000!

Value Gain Investments leverage the knowledge and ability of the owner to create a positive return. There may also be an increase in value from inflation. Two examples would be developing raw land or buying stocks. The disadvantages are the risks associated with market trends, fluctuation in management and economic unpredictability.

Mixed Return investments are a combination of 2 or 3 of the ROI categories. For example you could buy a stock that pays dividends.
Dividends = Income
Inflation = Appreciation
Company Growth = Value Gain

For real estate you could:
Take a mortgage = Income
Own a piece of undeveloped land = Appreciation
Develop the Property = Value Gain

When comparing investment opportunities, they need to be reviewed on a case by case basis. You need to ask yourself:
- What are your needs in terms of security and income?
- What are your investment goals?
- What are your tax requirements?

Real Estate As An Investment
Most real estate investors want low risk and high returns, but expect high returns for higher risks. Real estate investing is speculative and may not produce the right amount of income an investor wants, needs or expects.

Inflation plays a role in appreciation. Although real estate can be sensitive to inflation, it often maintains it’s real value better than other investments. When land scarcity inflates property values, the land appreciates in value.

You could increase potential returns by improving/expanding the property or by creating a different use for it. If you have a 10 acre piece of land and then develop a town home community or have an industrial site than can become residential, you might gain value. Creative and proactive property management can greatly increase a property’s value.

All property improvements and personal property may be eligible for depreciation deductions for an added tax advantage.

Remember that real estate can also be used as collateral since it is tangible and ownership is recorded and legally protected from third party claimants.

Real Estate Investment Disadvantages
You need to know the good, the bad and the ugly when it comes to any type of investing. If you only smell roses you might find yourself in a pile of something else later on!

Lack of Liquidity

Real estate is not easily converted into cash. The market is limited to people who want the property and who can afford it. Financing requires considerable time and effort.

Term of Investment

Usually real estate is a long term investment (minimum of 3-5 years but more likely 5-7 years) before gaining value from inflation and good business management. Just as we’ve seen during the past decade, real estate can depreciate in value. Although, investors that bought in 2000 saw huge appreciation and even with the downturn in the market have still realized some gains. Short term gains are possible, such as “flipping”, but are very speculative.

Business Management

Real estate requires ongoing management of sales, rentals, maintenance, operation, customer and employee relations, tax related issues and tax reporting. Property owners must devote personal time and effort to managing the property OR hire a professional property manager.

Property Hazards

Losses can be recovered through insurance but is rarely a profitable procedure. If a multi-family home is destroyed in a fire, you might not be able to build and re-lease for months if not years and you lose the income that was coming every month.

Legislative Concerns

Issues such as land use laws, environmental controls, rent controls, and development set-asides could affect your bottom line. Land use laws and environmental controls may restrict development which effects property values as well as rent controls limit gross rental income. Development set-asides affect the investment return such as low income housing only.

Hopefully this will give you a basic idea of investing in real estate. It should have answered most of the concerns I hear on a daily basis. Everything doesn’t always turn out as pretty as you see on TV. It takes time, patience and effort to make the right decision.

Chip Plumley can be reached at (610) 444-9090 or (610) 357-8635.
Prudential Fox & Roach is an independently owned and operated member of
Prudential Real Estate Affiliates, Inc., a Prudential Financial company.
Equal Housing Opportunity.

ChipPlumley.com