MISCELLANEOUS TOPICS Real Estate and REITs

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 a “loaner”

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 recent turmoil has changed the investing landscape for real estate 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 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 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

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 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 are going down as we speak How far before we hit bottom, no one knows 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 the past few years 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” 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 early 2006 and are still trying to unload that “flipper condo” 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!

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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