Real Estate and Other Investments Chapter 11

Section 11.1 How to explain the different types of real estate investments How to discuss the advantages and disadvantages of real estate investments Main Idea Real Estate investment opportunities vary widely. Consider the advantages and disadvantages of each type of investment opportunity

Direct vs. Indirect Two main types of real estate investments Direct

Direct vs. Indirect Direct real estate – owner holds legal title Single family homes Vacation homes Duplexes Apartments Land Commercial property

Direct vs. Indirect Indirect real estate – trustee holds legal title on behalf of investors Real Estate Syndicates or Limited Partnerships Real Estate Investment Trusts High risk mortgages Participation certificates

Single Family Homes Home ownership is the largest financial asset of most people Homeowner’s equity is 30% of household wealth Equity, market value of home minus amount owned on loan Good investment Prices risen steadily Average rate of return after inflation is 2.5% - about the same as a bond Tax benefits mortgage interest and property taxes can be deductions

Vacation Homes Provides tax benefits if it is used year round as a second home If rented out for more than 14 days a year, it is considered a rental property If considered rental property, tax deductions depend on how property was managed and size of their income

Commercial Property Land and buildings that produce rental property Apartments, duplexes, hotel, office buildings, and store Most investors start out small Use equity from small business to invest in larger properties

Land Do not produce any income unless rented May not grow in value If planning on parceling off, be certain that utilities are available

Real Estate Syndicates or Limited Partnerships Individuals or businesses organized to use large funds to buy real estate, commonly as a limited partnership Limited partnership General partner takes complete responsibility for all liabilities General partner sells units, or shares, to limited partners Limited partners are only liable for the amount they invested Benefits Can be diversified Professionally managed

Real Estate Investment Trusts Similar to mutual funds but money invested in real estate, construction, mortgage loans Equity REIT – money invested in properties Mortgage REIT - money invested in construction loans and mortgages on developed properties Hybrid REIT – money combined to buy properties and mortgages REITS required to: Distribute at least 90% of net annual earnings to shareholders Avoid risky, short-term real estate to make quick profits Hire independent real estate professionals to do certain management activities Have at least 100 shareholder, no more than half the shares owned by 5 or fewer people

High Risk Mortgages Purchases mortgages of properties not legally clear or insurable Buy cheaper because they are not in demand May make a lot or lose everything

Participation Certificates Risk-free real estate investment Investment in group of mortgages that have been purchased by a government agency Ginnie Mae, Freddie Mac, Fannie Mae, Sallie Mae Are as safe as US Savings bonds

Advantages of Real Estate Investments Hedge against inflation Historically it increase faster than or at least holds value against inflation Easy entry Indirect entry through syndicates Limited financial liability Only liable for money you invest Financial leverage Use borrowed funds to purchase more expensive properties Advantage if property values and incomes are rising

Disadvantages of Real Estate Investments Illiquidity Not easily converted to cash Declining property values When interest rates fall or economy bad, value of real estate falls Lack of diversification Because of cost, hard to buy a lot of different types Lack of a tax shelter Law changes in 1980’s changed how rental income was assessed Management problems Finding tenants, replacing/fixing things

Precious Metals, Gems, and Collectibles Section 11.2

Why do people invest in precious metals? Precious metals – ores such as gold, platinum, and silver Invest as protection, or a hedge, against inflation Price of gold rises when people believe war, political unrest, or inflation is around the corner

What is one disadvantage of investing in a precious metal such as platinum? Other precious metals that rise in value during time of political or economic trouble are silver, platinum, palladium, and rhodium Storage can be tricky Interest bearing investments earn money, precious metals earn nothing In order to make a profit selling metals you must be able to correctly predict the marker

What is one of the advantages of investing in precious gems? Size Ease of storage Great durability Protection against inflation Inflation during the 1970 caused more people to invest in gems and diamond prices increased 40 fold

Risks of investing in precious gems Cannot easily convert into cash May have difficulty determining if gems are of good quality Political unrest can affect supply and demand You will like have to buy at high retail prices and sell at lower wholesale prices Greatest risk is fluctuation of prices from global, economic, financial and political factors

How do you know what you are getting? Go to a certified geological lab Certificate will list Stones characteristics Weight Color Clarity Quality of cut Grading of gems not an exact science

5 C’s of a Diamond Certification It is crucial when choosing a diamond to review the diamond certificate, referred to by diamond grading laboratories as a grading report. Carat Diamonds are always measured in carat weight. One carat is the equivalent of 1/5 of a gram. Additionally, there are "100" points in a carat, so that a .50 "point" diamond would be described as a half-carat. Clarity Almost every diamond will contain some blemishes, and inclusions formed during the course of its crystallization. The diamonds clarity grade refers to the visual impact of these characteristics or lack thereof, as viewed under 10X loupe magnification. There is a grading structure (GIA clarity grading scale) used to describe inclusions found within the diamond. Color The "color" of a diamond refers to the presence or absence of inherent coloration in a white diamond. The whiter the diamond is the greater its value since a colorless diamond will allow increased light to pass through it and will consequently emit a greater amount of fire and brilliance. Cut Cut is the most misunderstood and underestimated "C" of the five "C's". Cut is properly referred to as the "make" or quality of the way the diamond has been crafted. "Cut", should never be confused with the "shape" of the diamond. The cut of the diamond is the only "C" that is entirely manipulated by the diamond cutter, and will determine the beauty and value of the diamond.

What are collectibles? Rare coins, works of arts, antiques, stamps, rare books, comic books, sports memorabilia, rugs, ceramics, paintings Sometimes bought for own enjoyment but discover they are worth money

The Internet and collectibles Advantages Made more efficient and convenient Can reach sellers all over the world Use a bidding process and make more money Prices are not lower, but comparison shopping is easier Most sites do not charge a buyer’s commission

The Internet and collectibles Disadvantages Cannot assess dealer face-to-face Cannot assess product face-to-face Fraud is ever present Some online auctions are more reliable than others National Consumers League said that 76% of fraud complaints between January and June 2004 were related to online auctions

Average Annual Return After……. Asset 1 Year 5 Years 10 Years 20 Years Stocks 2.6% 10.4% 15.5% 13.1% Bonds 0.7% 9.9% 14.1% 10.2% 3 Month Treasury Bills 4.3% 5.6% 6.7% 8.3% Diamonds 0.0% 1.4% 5.9% 7.9% Housing 1.8% 2.9% 4.1% 6.3% Gold 4.7% 1.3% -0.2% 4.5%

Collector Beware 76% of fraud complaints in 6 months in 2004 were related to online auctions Learn everything you can about items you collect Only buy and sell with reputable dealers and auction sites Do not offer interest or dividends Cannot sell at a good price on short notice May have to purchase insurance against damage and theft

What are blood diamonds? Stones from an uncertain background, coming from African countries immersed in civil wars and sold by rebels and governments to fund their war campaigns Accounted for an estimated 14% to 20% of diamonds sold in the 1990’s

Sierra Leone Has vast mineral wealth - gold, bauxite (aluminum ore), timber, copper, and diamonds yet it is one of the poorest countries on earth Bordered by Liberia and Guinea, it borders have been a popular route for smuggling raw materials, weapons, and – most – significantly – uncut diamonds 1991, former army corporal Foday Sankoh, led the Revolutionary United Front (RUF) from the jungles bordering Liberia and declared war on the government in a fight against corruption and poverty of his people The revolution was backed by Liberian President Charles Taylor, and it was able to continue for more than 10 years It became clear that the RUF’s political aims came second to their pursuit of mineral wealth as they battled the government for control of the diamond territories RUF sold diamonds to unlicensed diamond traders and corrupt government officials, and the diamonds were never seen by official eyes