Real Estate Investing

Before you invest in real estate, it's important to look at carrying costs, closing costs, commissions and capital gains taxes. Here's why.

3. Commissions. As much as Realtors and mortgage brokers love their clients, we are in this business to make a living. I find that, increasingly, real estate consumers are very cloudy on the matter of exactly how these professionals get paid. Realtors and mortgage brokers only get paid when the transaction closes, but their commissions are part of the standard closing costs -- which either or both the buyer and/or seller must pay. Generally, the seller pays the big one -- the Realtor commissions -- which are about 5 percent to 6 percent of the purchase price (that amount gets split between the two Realtors). Also generally speaking, the buyer pays the much smaller commission, a.k.a origination fee, to their own mortgage broker -- usually in the range of 1 percent of the purchase price. No matter how simple the math seems on those reality shows, know that if you fix and flip a house, you need to subtract 6 percent of your hoped-for eventual sale price off the top for your Realtor commissions, before you project your profits. It can make the difference between a deal penciling out as profitable or not, but you don't want to skimp on the commissions - the only way to get top dollar for your flip property is to make sure all the Realtors bring their clients to see it, and they will never show your place if there is a low or no commission being offered.

4. Capital Gains Taxes. Real estate investing is chock full of tax advantages compared with other investments; nevertheless, the tax {wo}man cometh. I won't go into excessive detail, but when you sell an investment property for more than the total of what you paid for it and invested in it, that "profit" is called capital gains. Capital gains are taxes at the rate of about 15 percent. Yep, 15 percent of every dollar you make goes to the good ole' US of A. With that said, if you are simply trading up - cashing out the equity from one rental property to purchase a bigger or more valuable one - you should research the feasibility and guidelines for deferring your capital gains taxes in a 1031 Exchange. But all you flippers out there should make sure you have a sound tax strategy in place, or sufficient profits in the pipeline, to cover the capital gains tax exposure you create when you dramatically increase the value of your property in a short period of time for resale.

5. Common Sense. It's called *real estate investing*, not MAGIC. There is no such thing as a magic money machine that begins spurting thousands of dollars at you once you buy an investment property. Sounds basic, but if I had a dollar for every otherwise savvy homebuyer who forwarded me an email or Web link to some get-rich-quick scheme where they pay a guy in a glittery suit for the opportunity to make $100,000 per year using no money, no effort, no credit, no nothing of their own, I could probably fund that money machine myself! Managing a real estate investment portfolio takes work - real estate is one of the most lucrative investments around, but the flip side is that it is one of the least passive investments around, too. Finding and maintaining tenants and/or property managers, dealing with vacancies and contractors, even simply finding profitable properties and creating and managing the financials for them - investment properties require money to buy and/or maintain, and energy to keep running successfully on a short- or long-term basis. No money down doesn't mean no money required - someone has to pay the mortgage, property taxes, maintenance costs, etc., and often the high interest on low-down payment mortgages makes the payment high enough that rental income may not cover all the expenses. Not always, but often.

I'm not one to avoid complex deals just because they might be complex, but you really should be able to understand the fundamental story underlying the potential profits of a deal before you do it. Also, ask the hard questions - no matter how basic or suspicious they may seem. If the deal can't withstand your questions, then it can't withstand the market, and it doesn't deserve your money/time/energy/effort, etc.

These are the most commonly ignored expenses that burst the fantasy bubbles of real estate investors. My goal is not to burst bubbles, but rather to inject reality into the calculations so that no nasty surprises come at my real estate investors after they are in the property - especially no surprises that I could have predicted. And I am always reminding them that, yes, our analyses are very tough on properties and investment scenarios. However, if a property passes our scrutiny, after all line items are considered, it's probably a reaaaaallly good one or really well suited for that client's needs. In this respect, real estate investing is like dating - selectivity is key.

When a prospective investor has inadvertently omitted a line item (or several) before purchasing, the worst case scenario is disappointment when they have to reduce their projected paper profits. When an actual investor buys a property without considering a line item, the worst case scenario is negative cash flow beyond what they can bear, resulting in a forced sale or foreclosure. Bad news. Don't be a victim of real estate hype - be a savvy investor and do the math (or ask us to help you with the math), all of the math, including the 5 C's.

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