Chapter 16: Real Estate and High-Risk Investments Garman/Forgue Personal Finance Ninth Edition PPT slide program prepared by Amy Forgue and Ray Forgue.

Copyright ©Houghton Mifflin Company. All rights reserved Learning Objectives 1.Demonstrate how you can make money investing in real estate. 2.Calculate the right price to pay real estate investment and how to finance your purchase.

Copyright ©Houghton Mifflin Company. All rights reserved Learning Objectives 3.Assess the disadvantages of investing in real estate. 4.Summarize the risks and challenges of investing in collectibles, precious metals, and gems. 5.Explain why options and futures are high-risk investments.

Copyright ©Houghton Mifflin Company. All rights reserved Making Money Investing in Real Estate Real Estate: property consisting of land, structures attached to the land, and accompanying rights and privileges Direct Ownership: actual legal title to a property

Copyright ©Houghton Mifflin Company. All rights reserved Making Money Investing in Real Estate Current income and capital gains –Rental yield Current income results from positive cash flow.

Copyright ©Houghton Mifflin Company. All rights reserved Making Money Investing in Real Estate Price appreciation leads to capital gains. –Capital improvements –Repairs Leverage can increase an investor’s return. –Loan-to-value ratio

Copyright ©Houghton Mifflin Company. All rights reserved Making Money Investing in Real Estate Beneficial tax treatments: 1.Depreciation Is tax deductible. 2.Interest Is tax deductible. 3.Rental income tax regulations on vacation homes. 4.Capital gains are taxed at reduced rates. 5.Tax-free exchanges

Copyright ©Houghton Mifflin Company. All rights reserved Pricing and Financing Real Estate Investments Pay the right price. –Discounted cash-flow method Financing a real estate investment –Seller financing (or owner financing) –Sweat equity property

Copyright ©Houghton Mifflin Company. All rights reserved Disadvantages of Real Estate Investing Business risk Complexity Large initial investment Dealing with tenants Time-consuming management demands

Copyright ©Houghton Mifflin Company. All rights reserved Disadvantages of Real Estate Investing Low current income Unpredictable costs Interest rate risk Legal fees Illiquidity

Copyright ©Houghton Mifflin Company. All rights reserved Investing in Collectibles, Precious Metals, and Gems Collectibles: cultural artifacts that have value because of their beauty, age, scarcity, etc. Making a profit on collectibles is not easy. Buying and selling collectibles on the ‘Net: easy and convenient, but not always safe!

Copyright ©Houghton Mifflin Company. All rights reserved Investing in Collectibles, Precious Metals, and Gems Gold and other metals –Gold bullion, gold coins –Gold stocks and mutual funds –Silver, platinum, palladium, rhodium Precious stones and gems: diamonds, sapphires, rubies, etc.

Copyright ©Houghton Mifflin Company. All rights reserved Investing in Options and Future Contracts Derivative (or Derivative Security) Options allow you to buy or sell an asset at a predetermined price. –Stock Option –Expiration Date

Copyright ©Houghton Mifflin Company. All rights reserved Investing in Options and Future Contracts Options are created by an option writer. –Option premium –Option holder –Call option –Put option Conservative writers profit by selling covered calls. –Covered Option, Naked Option

Copyright ©Houghton Mifflin Company. All rights reserved Investing in Options and Future Contracts Conservative investors reduce risks by purchasing covered puts. Speculative investors try to profit with options. Speculative investors buy calls to create tremendous leverage.

Copyright ©Houghton Mifflin Company. All rights reserved Commodities Futures Contracts Futures Contract Economic need creates futures markets. Speculators may trade in futures markets. Futures are a zero-sum game.

Copyright ©Houghton Mifflin Company. All rights reserved The Top 3 Financial Missteps In Real Estate and Investing People slip up in investing in real estate and high risk investments when they do the following: 1. Fail to factor in income lost due to vacancies and collection costs for tenants who do not pay.

Copyright ©Houghton Mifflin Company. All rights reserved The Top 3 Financial Missteps In Real Estate and Investing 2. Fail to set enough money aside for maintenance, repairs, unanticipated capital improvements, and rising real estate taxes. 3. Assume that real estate prices will go up and interest rates will not increase.

Copyright ©Houghton Mifflin Company. All rights reserved Good Money Habits in Real Estate and High-Risk Investments Consider the disadvantages before investing in real estate. Invest only in real estate properties that have a positive cash flow.

Copyright ©Houghton Mifflin Company. All rights reserved Good Money Habits in Real Estate and High-Risk Investments Finance real estate investments with conventional mortgages, not mortgages with adjustable interest terms. Use the discounted cash-flow method to help determine the right price to pay.

Copyright ©Houghton Mifflin Company. All rights reserved Good Money Habits in Real Estate and High-Risk Investments If you put money into high-risk assets, limit your investment to no more than 10 percent of your portfolio.