Real Estate Construction, Ownership, and Investment PDF

Real Estate Construction, 15 Ownership, and Investment Learning Objectives After completing this lesson, students should be able to… Recognize split-level, Spanish, ranch, and contemporary style homes Describe the m...

Real Estate Construction, 15 Ownership, and Investment Learning Objectives After completing this lesson, students should be able to… Recognize split-level, Spanish, ranch, and contemporary style homes Describe the main elements of wood frame construction, including the foundation, framing, roofing, and interior systems Discuss California’s structural pest control inspection requirements List the factors that a buyer should consider when choosing a home Discuss how safety, liquidity, and yield interact to affect investment risk Summarize the concepts of appreciation, leverage, and cash flow List the qualities that an investor should look for in a rental property Suggested Lesson Plan 1. Give students Exercise 15.1 to review the previous chapter, “Antidiscrimination Laws and Other Marketing Regulations.” 2. Provide a brief overview of Chapter 15, “Real Estate Construction, Ownership, and In- vestment,” and review the learning objectives for the chapter. © 2021 Rockwell Publishing  Principles of California Real Estate Instructor Materials 3. Present lesson content: Construction – Architectural styles EXERCISE 15.2 Architectural styles – Building codes and regulations – Role of the architect – Plans and specifications – Wood frame construction – Glossary of construction terms To Rent or to Buy? – Advantages of renting – Advantages of buying – Buying vs. renting EXERCISE 15.3 Renting vs. buying Factors to Consider When Choosing a Home EXERCISE 15.4 Neighborhood and home considerations Investing in Real Estate – Types of investments – Investment characteristics – Advantages of investing in real estate – Disadvantages of investing in real estate – Choices when investing in real estate 4. End lesson with Chapter 15 Quiz. Chapter 15 Outline: Real Estate Construction, Ownership, and Investment I. Construction A. An agent should be familiar with architectural styles, building codes, and common construction techniques and materials. EXERCISE 15.2 Architectural styles 2  Chapter 15: Real Estate Construction, Ownership, and Investment B. Construction is guided by local building codes and regulations, which dictate types of materials and standards for construction C. An architect designs buildings according to an owner’s needs and acts as the owner’s representative during the construction phase D. Plans are drawings of the horizontal and vertical cross-sections of the building, while specifications are text that specifies materials and workmanship standards to be used E. Wood frame construction elements include the foundation, framing, exterior sheathing and siding, interior sheathing, roofing, floor covering, and the plumbing, electrical, and HVAC systems 1. Some states require inspections for structural pest problems (such as termites) and require the reports to be filed with the state II. To Rent or to Buy? A. Advantages of renting include less financial commitment, less financial risk, easier mobility, no need to perform maintenance and repairs, and access to amenities B. Advantages of buying include long-term security, privacy and freedom from restric- tions, stable monthly payments, appreciation of the investment, and tax advantages (such as mortgage interest deduction) C. Real estate agents may use worksheets to show prospective buyers the net costs of renting and buying (taking into account increases in equity and income tax deduc- tions) EXERCISE 15.3 Renting vs. buying III. Factors to Consider When Choosing a Home A. Neighborhood considerations 1. A buyer should consider the neighborhood’s percentage of home ownership, conformity, land use changes, presence of streets and sidewalks, availability of utilities and public services, school district, social services, and overall property values B. The home 1. A buyer should consider the site and view, the architectural style of the house, the exterior appearance, the plumbing, electrical, and HVAC systems, the presence of a garage/carport and attic/basement, energy-efficient features, and overall interior design EXERCISE 15.4 Neighborhood and home considerations IV. Investing in Real Estate A. Types of investments 1. An investment is an asset that is expected to generate a return (or profit) such as interest, dividends, or appreciation in value 3  Principles of California Real Estate Instructor Materials 2. An ownership investment is one where the investor takes an ownership interest in the asset, such as real estate or stocks 3. A debt investment is a loan that an investor makes to an entity, such as a bond B. Investment characteristics 1. Liquid investments can be converted to cash quickly, such as money in the bank (real estate is not considered liquid) 2. Liquid investments are the safest, but they offer the lowest returns (or yields) C. Advantages of investing in real estate 1. Real estate is expected to appreciate at a rate equal to or higher than the rate of inflation; this increases the owner’s equity (difference between the property value and the liens against it) 2. Real estate investors can use leverage, which means using borrowed money to invest in an asset that will appreciate 3. Many real estate investments generate cash flow (spendable income left after all property expenses have been paid) 4. Real estate investments offer tax benefits, such as deductions and deferrals D. Disadvantages of investing in real estate 1. Real estate investment is more time-consuming and requires expert advice 2. Real estate investments are not liquid and may result in a negative cash flow E. Choices when investing in real estate 1. An investor may choose from residential properties (single-family homes, du- plexes, townhouses, apartment buildings, condominiums, mobile homes, etc.), office properties, retail properties, industrial parks, and vacant land 2. The investor should consider a rental property’s condition, location, square foot- age, and design 3. The investor may choose to hire a property manager 4. An investor may purchase a property as an individual, or may invest indirectly through real estate investment syndicates, real estate investment trusts (REITs), or mortgage-backed securities 4  Chapter 15: Real Estate Construction, Ownership, and Investment Exercises EXERCISE 15.1 Review exercise To review Chapter 14, “Antidiscrimination Law and Other Marketing Regulations,” have students match the correct term to each of the following definitions. Equal Credit Opportunity Act Home Mortgage Disclosure Act Americans with Disabilities Act Fair Employment and Housing Act Unruh Civil Rights Act Housing Financial Discrimination Act 1. A California law that is directed at preventing redlining. 2. The federal law that describes a public accommodation as any private entity with facilities open to the public, as long as the operation of the facility affects com- merce. 3. This federal law prohibits lenders from discriminating based on race, color, religion, national origin, sex, marital status, or age, or because the applicant’s income is from a public assistance program. 4. Under this state law, everyone has the right to the full use of the services of any business establishment, regardless of their sex, race, color, religion, ancestry, national origin, disability, medical condition, genetic information, marital status, sexual orientation, citizenship, primary language, or immigration status. 5. Also known as the Rumford Act, this California state law prohibits discrimination in the selling, leasing, or financing of housing. 6. A federal law that requires certain institutional lenders to make annual reports on resi- dential mortgage loans that were originated or purchased during the fiscal year. Answers: 1. HOUSING FINANCIAL DISCRIMINATION ACT. Under the state Housing Financial Discrimination Act, financial institutions may not deny a home loan application because the property is located in a particular geographic area or because the applicant is of a particular race. 2. AMERICANS WITH DISABILITIES ACT. Under the ADA, no one can be discriminated against on the basis of disability in any place of public accommodation. Real estate offices are considered public accommodations. 3. EQUAL CREDIT OPPORTUNITY ACT. ECOA prohibits discrimination in consumer credit transactions, including residential real estate loan transactions. 5  Principles of California Real Estate Instructor Materials 4. UNRUH CIVIL RIGHTS ACT. The Unruh Civil Rights Act applies to all businesses, including real estate companies, homeowners and condominium owners associa- tions, and apartment buildings. 5. FAIR EMPLOYMENT AND HOUSING ACT. The Fair Employment and Housing Act prohibits housing discrimination based on race, color, religion, sex, gender, gen- der identity, gender expression, sexual orientation, marital status, national origin, ancestry, disability, familial status, source of income, veteran or military status, or genetic information. 6. HOME MORTGAGE DISCLOSURE ACT. Reports required by the Home Mortgage Disclosure Act reveal areas where few or no home loans have been made, alerting investigators to the possibility that redlining has occurred. EXERCISE 15.2 Architectural styles Activity: Ask students to use the internet to find photos of at least five homes built in different architectural styles (ranch, split-level, modern, bungalow, Spanish, Cape Cod, colonial, and so on). Listing information and photos are available through the websites of most large brokerage firms. You might consider using www.realtor.com, www.remax.com, or www.coldwellbanker.com. Copy and paste the photos you find into a document. Identify the architectural style of each house. EXERCISE 15.3 Renting vs. buying Activity: Have students pair up or break into small groups for a role-playing exercise. (Note: students will need a financial calculator, or you may want to give them the answers to the more complicated calculations in advance.) Situation: A potential buyer has visited a brokerage to talk to an agent about the pros and cons of buying a home vs. renting one. Participants: One person plays the buyer; one person plays the agent. Instructions: The agent asks the potential buyer questions about the buyer’s income, price range, downpayment ability, and current rent costs. Current monthly rent: $1,300 Income tax bracket: 28% Proposed purchase price: $250,000 6  Chapter 15: Real Estate Construction, Ownership, and Investment Proposed downpayment: 10% The agent and the buyer then use the “Renting vs. Buying” worksheet (see following pages) and the information below to help determine whether renting or buying makes more sense for the potential buyer at this time. Loan term: 30 years Interest rate: 7% Closing costs: $7,500 Estimated appreciation rate: 3% Yield on money not spent on a downpayment: 4% Property taxes: $3,800 Homeowner’s insurance: $900 PMI: $78/month Calculations: Determining the principal and interest payment ($1,497) requires a financial cal- culator. Many of the other figures, such as the loan amount and downpayment, can be determined with straightforward arithmetic. Here’s how to calculate the less familiar figures that the worksheet requires (figures are rounded to the nearest dollar): Average monthly principal amortization: $225,000 (loan amount) ÷ 360 months (30-year term) = $625 per month Average interest portion of payment: $1,497 (monthly payment) × 360 months = $538,920 (total P & I) $538,920 – $225,000 (principal) = $313,920 (total interest) $313,920 (total interest) ÷ 360 months = $872 per month Monthly value of tax deduction: $1,189 (deductible items) ×.28 (28% tax bracket) = $333 per month Average monthly appreciation: $250,000 ×.03 = $7,500 ÷ 12 = $625 per month Interest from savings not used for purchase: $32,500 ×.04 (4% return) ÷ 12 = $108 per month 7  Principles of California Real Estate Instructor Materials Comparison of Estimated Net Cost of Renting and Buying Buying Purchase price _________ Cash required (downpayment and closing costs) _________ Loan amount _________ Loan term _________ Interest rate _________ Property taxes _________ Homeowner’s insurance premium _________ Property appreciation rate (estimated) _________ Income tax bracket _________ Out-of-pocket costs: Monthly payment    Principal and interest _________   Property taxes _________   Homeowner’s insurance _________    Other monthly expenses (PMI) _________ Total monthly payment _________ less: Average monthly principal amortization _________ Tax benefit    Average interest portion of payment _________    Property tax portion of payment _________   Other _________    Total deductible items _________    Monthly value of tax deduction _________ Effective monthly cost of ownership _________ less: Average monthly appreciation _________ Monthly Net Cost of Buying _________ Renting Out-of-pocket costs: Monthly rent _________ less: Interest from savings not used for purchase _________ Monthly Net Cost of Renting _________ 8  Chapter 15: Real Estate Construction, Ownership, and Investment Comparison of Estimated Net Cost of Renting and Buying Buying Purchase price $250,000 Cash required (downpayment and closing costs) $32,500 Loan amount $225,000 Loan term 30 years Interest rate 7% Property taxes $3,800 Homeowner’s insurance premium $900 Property appreciation rate (estimated) 3% Income tax bracket 28% Out-of-pocket costs: Monthly payment    Principal and interest $1,497   Property taxes 317   Homeowner’s insurance 75    Other monthly expenses (PMI) + 78 Total monthly payment $1,967 less: Average monthly principal amortization – 625 Tax benefit    Average interest portion of payment 872    Property tax portion of payment 317    Other + 0    Total deductible items $1,189    Monthly value of tax deduction – 333 Effective monthly cost of ownership $1,009 less: Average monthly appreciation – 625 Monthly Net Cost of Buying $384 Renting Out-of-pocket costs: Monthly rent $1,300 less: Interest from savings not used for purchase – 108 Monthly Net Cost of Renting $1,192 9  Principles of California Real Estate Instructor Materials EXERCISE 15.4 Neighborhood and home considerations Read the following True/False questions aloud to students and have them jot their an- swers down on a piece of paper; discuss the answers together. 1. Neighborhoods with a large percentage of home ownership are generally more desirable than neighborhoods that consist primarily of rental homes. 2. Home buyers should avoid neighborhoods where the houses are very similar in design, as the visual monotony harms property values. 3. The value of a property is likely to decline if surrounding properties are changing from residential to commercial uses. 4. A steeply sloped lot is preferable to a level lot, since it’s more likely to offer a pleasant view. 5. Placing a bedroom next to the living room or family room is considered a design deficiency. 6. Clock-controlled thermostats, insulation-wrapped water heaters, and weather stripping are all features that make a house more desirable. 7. A house with three or more bedrooms should have, at a minimum, two bath- rooms. Answers: 1. TRUE. Houses that are owner-occupied are usually better maintained and have less frequent turnover, promoting higher property values throughout the neighbor- hood. 2. FALSE. Some conformity among houses is desirable, as it protects property values. 3. TRUE. Changing uses of nearby properties are likely to cause a decline in a prop- erty’s value. 4. FALSE. A steeply sloped lot may present construction problems because of soil instability or difficulty with drainage. 5. TRUE. A bedroom should be isolated in a quiet part of the house. 6. TRUE. All these features make a house more energy-efficient. That reduces the heating and cooling expenses, and thus makes the house more desirable. 7. TRUE. Two bathrooms are desirable in houses with more than two bedrooms. 10  Chapter 15: Real Estate Construction, Ownership, and Investment Chapter 15 Quiz 1. The sheet metal used to prevent water seepage 7. The steepness of a roof’s angle is called its: around the chimney is called: A. pitch A. a gutter B. gable B. a gambrel C. hip C. insulation D. span D. flashing 8. Which person would be responsible for per- 2. Which of the following would be the best hedge forming periodic inspections of an investment against inflation? property? A. Municipal bonds A. Property owner B. Equities B. Property manager C. Interest-bearing savings accounts C. Leasing agent D. Trust deeds D. Maintenance contractor 3. Typical duties of a property manager include: 9. Compared to other investments, real property A. handling tenant complaints takes more time and effort to invest in, and B. maintaining the premises must be purchased in more expensive units. C. collecting rent Therefore, its return should be: D. All of the above A. higher than the return on bonds or first trust deeds B. higher than the return on bonds, but lower 4. A joist is a: than the return on first trust deeds A. girder C. about the same as the return on bonds B. parallel member D. less than the return on bonds or first trust C. rafter deeds D. load-bearing wall 10. The type of investment that will serve best as 5. The vertical pieces in wood frame construction a hedge against inflation is a/an: are known as: A. extremely liquid investment A. joists B. income property that tends to appreciate B. rafters C. investment like an annuity C. sills D. no-risk investment D. studs 11. A roof that rises upwards from all four sides to 6. If an appraiser sees that an abandoned gas sta- meet at the ridge is called a: tion is located next door to a residence she is A. flat roof appraising, she should recommend which of B. gable roof the following? C. hip roof A. An EPA review D. gambrel roof B. A rezone C. A soil engineer’s report D. A toxic waste report 11  Principles of California Real Estate Instructor Materials 12. Which of the following is a home ownership cost? A. Land appreciation B. Appreciation on property improvement C. Amenity value D. Loss of interest on owner’s equity 13. Percolation is the: A. filtering that occurs when water passes through soil B. measure of water potability C. depth of a sewer line D. soil and other material used to fill in excava- tions 14. Structural pest control reports are filed with the Structural Pest Control Board and kept on file for two years. They are available for inspection upon request and payment of a fee by: A. the buyer B. the seller C. any party involved in the transaction D. any person 15. Mary, a fee simple owner, enters into a transac- tion that converts her interest in her property into a less-than-freehold estate. This transaction is a: A. grant of a life estate B. sale of mineral rights C. short-term lease of the property D. sale-leaseback 12  Chapter 15: Real Estate Construction, Ownership, and Investment Answer Key 1. D. Flashing is sheet metal (or other mate- Therefore, investors expect a higher rial) used to deflect water from areas in return, or yield, from real property a roof with joints and angles, such as than from other investments. around a chimney. 10. B. An investment whose value generally 2. B. An investment that increases in value increases at least as fast as inflation faster than inflation will increase the will maintain its value, despite the in- owner’s equity and is a hedge against flation. inflation. 11. C. A hip roof has four sloping sides that 3. D. A property manager usually handles all meet at a short center ridge. of the above responsibilities. 12. D. The owner cannot earn interest on the 4. B. Joists are the parallel members that money he has invested in the property support the floor and ceiling loads. (his equity). If it weren’t invested in the property, it could be earning inter- 5. D. Studs are vertical members that form est in a bank account (for example). the walls in wood frame construction. Joists and sills are horizontal members, 13. A. Percolation refers to the filtering pro- while rafters are diagonal members cess that occurs when water passes that form the roof frame. through the ground. Water percolates easily and quickly through porous 6. C. The appraiser will want to know soils. whether any seepage from the gas station’s underground tanks has con- 14. D. Any person may obtain a copy of a re- taminated the residential property. port by placing a request and paying a nominal fee. 7. A. A roof’s pitch is its slope, or degree of angle. 15. D. In a sale-leaseback transaction, the owner sells the property and then 8. B. It is one of the responsibilities of the leases it back. In this way, she converts manager of an investment property to her fee simple interest into a leasehold periodically inspect the property for interest. maintenance or upkeep problems. 9. A. Because real property is expensive and requires management, it is considered riskier than other types of investments. 13  Principles of California Real Estate Instructor Materials PowerPoint Thumbnails Use the following thumbnails of our PowerPoint presentation to make your lecture notes. Principles of California Real Estate Lesson 15: Real Estate Construction, Ownership, and Investment © 2021 Rockwell Publishing 1 Construction Architectural styles Agents should be familiar with various architectural styles including modern, ranch, Spanish, and so on. One-story ranch is easiest to maintain. But two-story construction costs less per square foot and makes more economical use of land. © 2021 Rockwell Publishing 2 Construction Building codes Building codes specify standards for construction methods and materials.  These standards promote building safety and provide certain degree of uniformity for community. © 2021 Rockwell Publishing 3 14  Chapter 15: Real Estate Construction, Ownership, and Investment Construction Plans and specifications Plans: Drawings that show vertical and horizontal cross-sections of a building. ⚫ Show placement of foundations, floors, walls, windows, wiring, and fixtures. Specifications: Text that accompanies plans, specifying construction materials and methods to be used. © 2021 Rockwell Publishing 4 Construction Basic elements Most common type of home construction is wood frame building (relatively inexpensive and easy to construct). Basic construction elements include: ⚫ foundation ⚫ framing ⚫ roofing ⚫ plumbing ⚫ electrical system ⚫ HVAC © 2021 Rockwell Publishing 5 Elements of Construction Foundation Foundations are almost always made of reinforced concrete. ⚫ Footing: Wide bottom base of the foundation wall. ⚫ Sill plate: Board attached to top of concrete foundation, on which framing of the house affixed. © 2021 Rockwell Publishing 6 15  Principles of California Real Estate Instructor Materials Elements of Construction Framing House frame is typically constructed of dimensional lumber. Elements include: ⚫ Joists: Horizontal members that hold up floor and ceiling. ⚫ Studs: Vertical members attached to lumber resting on subfloor. © 2021 Rockwell Publishing 7 Elements of Construction Walls Walls provide structural support and separate the interior space. ⚫ Interior walls are either load-bearing or non-load-bearing. Load-bearing walls: ⚫ are sturdier and support upper structure ⚫ are not easily moved in remodeling © 2021 Rockwell Publishing 8 Elements of Construction Exterior and interior sheathing Exterior sheathing is typically plywood laid over frame. ⚫ It is covered by exterior siding (boards, vinyl, shingles, etc.). Interior sheathing is typically drywall (sheetrock, wallboard, etc). © 2021 Rockwell Publishing 9 16  Chapter 15: Real Estate Construction, Ownership, and Investment Elements of Construction Roofing ⚫ Ridge board: Peak of the roof. ⚫ Rafters: Diagonal roof members. ⚫ Roofing felt: Tar-impregnated paper that covers sheathing attached to the rafters. ⚫ Pitch: Steepness of the roof. ⚫ Hip roof: A roof that rises from all sides to a short ridge. ⚫ Flashing: Metal sheeting installed on roof to prevent water seepage. © 2021 Rockwell Publishing 10 Elements of Construction Plumbing Plumbing systems include: ⚫ fixtures ⚫ supply pipes (galvanized steel, copper, or plastic) ⚫ drain pipes (cast iron, concrete, or plastic) ⚫ Soil pipe: Heavy drain pipe for sewage outflow. © 2021 Rockwell Publishing 11 Elements of Construction Electrical Most modern electrical wiring consists of cable: insulated cord containing strands of copper or aluminum wire. ⚫ Cable is enclosed in conduit: metal or plastic piping that adds protection. © 2021 Rockwell Publishing 12 17  Principles of California Real Estate Instructor Materials Elements of Construction HVAC HVAC: Heating, ventilation, and air conditioning system in house or other building, which provides warm, cool, or fresh air to rooms through series of galvanized sheet metal passageways called ducts. © 2021 Rockwell Publishing 13 Elements of Construction HVAC HVAC systems rated by energy-efficiency ratio (EER). ⚫ The higher the EER, the more efficient the appliance. © 2021 Rockwell Publishing 14 Elements of Construction HVAC Insulation: Material such as fiberglass that’s resistant to transfer of heat; important for keeping heating and air conditioning costs down. ⚫ R-value: Effectiveness rating for insulation that measures resistance to heat transfer; higher R-value is better. © 2021 Rockwell Publishing 15 18  Chapter 15: Real Estate Construction, Ownership, and Investment Construction Pest problems Wood frame construction is vulnerable to wood- eating insects, especially termites. Always a good idea to have pest control inspection when property is listed: ⚫ good investment for buyer ⚫ often required by buyer’s lender or (in some parts of California) FHA or VA © 2021 Rockwell Publishing 16 Construction Pest problems Inspection report must be: ⚫ given to property owner within 10 days, and to buyer as soon as possible before closing ⚫ filed with state Structural Pest Control Board, which will retain it for two years © 2021 Rockwell Publishing 17 Construction Pest problems Unless parties agree otherwise, seller usually pays for fixing existing pest problems, and buyer pays for preventive work. © 2021 Rockwell Publishing 18 19  Principles of California Real Estate Instructor Materials Summary Construction Plans and specifications Elements of construction Pest problems © 2021 Rockwell Publishing 19 Rent or Buy? Advantages of renting Advantages of renting over buying: ⚫ less financial commitment ⚫ no risk from deteriorating home prices (though rising home prices mean higher rent) ⚫ greater mobility ⚫ fewer responsibilities © 2021 Rockwell Publishing 20 Rent or Buy? Advantages of buying Advantages of buying over renting: ⚫ security (can’t easily be evicted) ⚫ privacy ⚫ protection from rising rents ⚫ property appreciation (generally, home values rise) ⚫ tax deductions © 2021 Rockwell Publishing 21 20  Chapter 15: Real Estate Construction, Ownership, and Investment Choosing a home Neighborhood considerations Neighborhood considerations include: ⚫ percentage of home ownership ⚫ conformity among properties ⚫ presence of changing land uses ⚫ condition of streets and sidewalks ⚫ availability of utilities and public services ⚫ presence of quality schools ⚫ availability of social services ⚫ neighborhood condition: stable or changing? © 2021 Rockwell Publishing 22 Choosing a home Home features Buyer should consider: ⚫ site and view ⚫ exterior appearance ⚫ plumbing and electrical systems, HVAC ⚫ attic and/or basement ⚫ garage or carport ⚫ energy-efficient features ⚫ interior floor plan, design deficiencies © 2021 Rockwell Publishing 23 Home Features Design deficiencies Examples of design deficiencies: ⚫ no front hall closet ⚫ back door difficult to reach ⚫ difficult access to dining room, stairways or basement ⚫ no eating area in kitchen © 2021 Rockwell Publishing 24 21  Principles of California Real Estate Instructor Materials Summary Choosing a Home Neighborhood considerations Evaluating the house Design deficiencies © 2021 Rockwell Publishing 25 Investing in Real Estate Real estate agent shouldn’t claim to be investment counselor, but should have some familiarity with investment options in real estate for interested clients. © 2021 Rockwell Publishing 26 Investing in Real Estate Return on investment Investment: Asset that is expected to generate return (profit). Return on investment may take various forms, including: ⚫ rent ⚫ interest ⚫ dividends ⚫ appreciation © 2021 Rockwell Publishing 27 22  Chapter 15: Real Estate Construction, Ownership, and Investment Investing in Real Estate Return on investment ⚫ Interest:Money paid to investor for use of borrowed money. ⚫ Dividends: Share of earnings paid to an investor by a business. ⚫ Appreciation: Increase in the value of an asset. © 2021 Rockwell Publishing 28 Investing in Real Estate Types of investments Investment is either ownership investment or debt investment. Ownership investment: Investor takes ownership interest in asset. Also known as equity investment. ⚫ Examples: real estate, stocks. Debt investment: Investor lends money to another person or entity. ⚫ Examples: government bonds or mortgage loan. © 2021 Rockwell Publishing 29 Investing in Real Estate Portfolio Because ownership investments appreciate, instead of just paying interest like debt investments, they are considered better hedge against inflation. Investors usually try to diversify their investments with mix of ownership and debt investments. ⚫ The mix of investments, plus cash reserves, is known as portfolio. © 2021 Rockwell Publishing 30 23  Principles of California Real Estate Instructor Materials Investing in Real Estate Investment characteristics Investments are usually evaluated on basis of three characteristics: ⚫ liquidity (ability to be converted into cash quickly) ⚫ safety ⚫ return on investment (yield) © 2021 Rockwell Publishing 31 Investing in Real Estate Investment characteristics Highly liquid investments are usually quite safe but offer low yields. ⚫ Generally, the more liquid an investment the lower the risk and the lower the rate of return. ⚫ Example: savings accounts. Real estate is not liquid investment, since it can take months to sell property. © 2021 Rockwell Publishing 32 Investing in Real Estate Advantages Potential advantages of investing in real estate include: ⚫ appreciation ⚫ leverage ⚫ cash flow ⚫ tax benefits © 2021 Rockwell Publishing 33 24  Chapter 15: Real Estate Construction, Ownership, and Investment Advantages of Investing in Real Estate Appreciation As property appreciates, owner’s equity increases. ⚫ Equity: Difference between property’s market value and liens against it. Increase in equity: ⚫ increases owner’s net worth ⚫ can be used as collateral for loan (cash) © 2021 Rockwell Publishing 34 Advantages of Investing in Real Estate Appreciation Initial downpayment on property creates equity right away. ⚫ Equity financing: Buyer makes home purchase using her own funds (not borrowed funds). ⚫ Disadvantage to having money tied up in equity is that money can’t be invested elsewhere for (potentially) greater returns. © 2017 Rockwell Publishing 35 Advantages of Investing in Real Estate Leverage Leverage: Using borrowed money to invest in asset. ⚫ If asset appreciates, investor earns money on borrowed money as well as on money directly invested. © 2021 Rockwell Publishing 36 25  Principles of California Real Estate Instructor Materials Advantages of Investing in Real Estate Cash flow Cash flow: Spendable income generated by investment, after all expenses have been paid (operating costs, mortgage payments, taxes, etc.). So income property can increase investor’s: ⚫ net worth (through appreciation) ⚫ income (through cash flow) © 2021 Rockwell Publishing 37 Advantages of Investing in Real Estate Cash flow Cash flow may be increased with sale-leaseback: ⚫ Building owner sells and then leases property from new owner. ⚫ Rent paid by seller is deductible business expense. Sale-leaseback may include buyback agreement: ⚫ Building owner agrees to buy property back from investor after specified period. © 2021 Rockwell Publishing 38 Advantages of Investing in Real Estate Cash flow Having long-term lease is stable source of cash flow, much like annuity. Investors sometimes evaluate investment by looking at cash on cash―a property’s cash flow divided by the initial investment. ⚫ It’s one way for an investor to calculate the rate of return. © 2021 Rockwell Publishing 39 26  Chapter 15: Real Estate Construction, Ownership, and Investment Investing in Real Estate Disadvantages Disadvantages of investing in real estate include: ⚫ need for expert advice ⚫ expense of property management ⚫ low liquidity ⚫ high risk © 2021 Rockwell Publishing 40 Investing in Real Estate Property management Large properties usually require property manager to oversee day-to-day operations. Property manager duties often include: ⚫ maintaining property ⚫ handling tenant complaints ⚫ collecting rents ⚫ locating new tenants ⚫ acting as tenant/owner liaison © 2021 Rockwell Publishing 41 Investing in Real Estate Property management State law requires apartments with more than 15 units to have resident manager (meaning one who lives on premises). © 2021 Rockwell Publishing 42 27  Principles of California Real Estate Instructor Materials Investing in Real Estate Property management Property manager may be paid flat fee or commission. ⚫ Commission could be percentage of gross receipts, new leases, or expected rents. Manager’s authority to engage in acts on owner’s behalf comes from property management agreement (contract between owner and manager). © 2021 Rockwell Publishing 43 Investing in Real Estate Commercial properties Investors considering commercial properties must look at various economic factors. ⚫ Example: main consideration when investing in shopping centers is buying power of area residents. ⚫ Investor also evaluates center’s largest tenants (anchor tenants). ⚫ Kiosk is small, low-overhead booth within a shopping center. © 2021 Rockwell Publishing 44 Investing in Real Estate Commercial properties—misc. Commercial tenants tend to avoid the northeast corner of intersections; it receives the most sun. In strip development, stores may be located in a line along major arterial. A turnkey project is a completed project that is ready for immediate occupancy. © 2021 Rockwell Publishing 45 28  Chapter 15: Real Estate Construction, Ownership, and Investment Investing in Real Estate Residential properties Subdivision planners rely on market analysis in making planning decisions. ⚫ Subdivision developers tend to use longer blocks, which are more economical since less land is devoted to streets. © 2021 Rockwell Publishing 46 Investing in Real Estate Insurance A real estate investor will need to pay insurance premiums to protect property against loss. ⚫ Policy can be canceled only if insurer gives written notice within reasonable period of time. ⚫ Refund of premiums (short-rating) will be determined according to schedule approved by Insurance Commissioner (rather than prorated). © 2021 Rockwell Publishing 47 Summary Investing in Real Estate Ownership investments Debt investments Liquidity, safety, and yield Leverage Equity Cash flow Property management Commercial properties Residential properties Insurance © 2021 Rockwell Publishing 48 29