Real Estate Investing 101 with Industry Expert Paul Cohen, Esq.
Navigating the world of real estate investments can be tricky, to say the least. This is why we have taken your most frequently asked questions and handed them over to the experts. The answers will help you move the needle on building wealth through real estate.
What qualities define a good investment property?
At the risk of stating the obvious, a low buy-in price and either high potential rent or high after-repair value (ARV). Beyond that, most investors should stick with low-crime, low-vacancy neighborhoods, and avoid the risks of properties on the very low end.
Smart investors look for neighborhoods not completely saturated by homeowners, but not all renters either. Stick with working and middle class homes as a general rule, unless you intend to specialize in a niche such as student housing, apartment buildings, low-end, etc.
Investors without experience renovating properties should avoid properties in need of serious repairs. The onslaught of permits and inspections is often difficult and frustrating to navigate, and working with contractors can present its own set of challenges.
Generally speaking, look for a property with an urgent seller, who will accept a lower-than-market price in exchange for a fast purchase, and look for a property with cosmetic blemishes that are inexpensively updated without requiring permits.
What is the best way to procure funding for a property?
It depends on whether you’re looking for a quick, short-term loan, or long-term financing. For properties bought as long-term rentals, try to secure an inexpensive 30-year loan up front. If the property needs repairs, banks will still offer standard 30-year financing if the appraiser deems the property habitable.
If it’s not habitable, you may need bridge financing, but try to avoid this if at all possible: refinancing will mean thousands of dollars in extra closing costs. Some local banks still offer “construction-perm” financing, where the loan comes in two phases: an initial high-interest renovation phase (where the bank reimburses you in draws for the repairs), and then the loan converts to a lower-interest permanent mortgage without forcing you to refinance.
Partnering with others can be helpful to bring more cash and expertise to the table. The right team usually includes experience in real estate investing, property management, general contracting and finance. Assembling a group of investors as an entity where each one brings a talent and cash can be a win-win for all, but be sure to use an iron-clad partnership agreement.
And then there is cash. The advantages are many; one is that many sellers will accept a lower offer if it is in cash and it promises a fast settlement. Mortgage loans are notoriously frustrating to close and are never as smooth as the loan officer promises. Mortgages are also expensive, both in the up-front settlement costs (look at all the lender fees, not just the points!), but over the life of a loan it’s not uncommon for a borrower to pay back three- or four times the amount they borrowed.
What is the best mortgage for a property that I am planning to flip?
Hard money lenders are fast and easy, but are expensive and lend a low percentage of the property’s value (low LTV ratio). For buying, renovating and flipping, hard money lenders can be worth the expense.
You might also consider crowdfunding and even credit cards as alternatives to mortgages. Crowdfunding websites offer shorter-term loans, often unsecured, and with a much easier loan approval process than a conventional mortgage. The total lender fees are often lower too, and even if the interest rate is high, you’ll only hold the loan for a matter of months in most cases. The problem is that crowdfunding websites generally have low loan limits, often around $35,000.
Credit cards are expensive and dangerous to use for many reasons, but there’s nothing faster. Only use credit cards for financing real estate purchases or repairs if you can pay the entire balance back within a few months and you have a contingency plan if the property fails to sell as quickly as you hope.
What are the tax consequences of house flipping?
If the profits on the house are realized in less than a year, you will pay taxes on it as regular income. If you own a property for longer than a year, the proceeds from selling will be taxed at the lower capital gains rate instead (15% for most taxpayers).
Consider using 1031 exchanges to defer paying taxes on proceeds from real estate by investing your profits into your next property acquisition.
What types of property laws come into play when a non-U.S. citizen is looking to buy property in the U.S.?
The United States allows foreign individuals or corporations to buy and own real estate in the United States without restriction. In very limited instances, the Committee on Foreign Investment in the United States (CFIUS) may review transactions that could result in control of a U.S. business by foreign persons in order to determine the effect of such transactions on the national security of the United States (the sale of a port, for example, has triggered this review in the past). Also some other countries place restrictions on their own citizen’s purchase of real estate in the U.S.
Important caveat: foreign non-resident individuals and foreign corporations holding property in the United States may be taxed differently on real estate gains than U.S. citizens/corporations. Consult an attorney when deciding how to structure your investment (e.g. “effectively connected income to a U.S. business” vs. “investment property”), and double check if there are any tax treaties your home country has entered with the U.S.
What laws govern commercial or residential investment property mortgages?
There are many complex intricacies to both commercial and residential property mortgage law. However, there are some key aspects to the law of which you should be aware. Mortgages are governed by each state’s statutory and common law and regulated by federal or state agencies, depending on their source of origination. For example, federally chartered savings associations are regulated by one entity (the Office of Thrift Supervision) while national banks are regulated by another (the Comptroller of the Currency).
Even the legal theory behind mortgages varies from state to state: for example some states follow title theory: title to the security interest rests with the mortgagee (lender). Alternatively, under lien theory, the legal title remains with the mortgagor (borrower) unless there is a foreclosure (and an intermediate theory applies the lien theory, but upon default title theory applies).
The law of contracts and property govern the transfer of the mortgage's interest. In the event of a foreclosure where there are multiple liens on the property, state law determines the priority of the lien interests (who gets paid first).
While title companies are not supposed to give legal advice, it may not hurt to ask them questions about your specific transaction.
What is the purpose of hiring a property manager?
In a word, delegating. For a fee, the property manager takes over the work and headaches of managing your rental properties. They handle repairs and tenant phone calls at 3 A.M. They prepare vacant rental units and advertise them. They run credit and criminal background checks, and prepare and sign lease agreements.
Generally, landlords pay 8-10% of gross rents to property managers, plus a fee of one month’s rent for filling a vacant rental property. For vacation rental units, the fees may be higher, as management is more labor-intensive.
Real estate investors just starting out should manage their own rental properties. They will learn invaluable insights into what makes a good long-term investment, the pros and cons of different neighborhoods and what to avoid in the future. That said, investors with portfolios that are out of state or a long distance away certainly benefit from hiring a property manager.
If you decide to use a property manager, do your homework to find one who’s both diligent and qualified for your particular type of property. Use social media, and websites like Zillow or HomeLight.com to get ratings to be sure the manager you hire is trustworthy.
So, I just decided to rent out my property for the first time; what will make the property more attractive to renters?
Pricing the property competitively is number one. Be sure that you take a look at the surrounding areas and similar properties to keep the rent viable. Then, start with the basics: tasteful fresh paint, new flooring (appropriate to the quality of the neighborhood and property), modern kitchen and bathrooms, a washer and dryer. For low-end properties, landlords may stop there.
For mid-range properties, look for little things that make a big difference. This could be a “smart” appliance or feature, a few higher-end finishes (counters, sinks, doorknobs, etc.), perhaps even a luxury amenity like a gas fireplace. The goal is to make your property stand out from the competition, to grab attention and tug heartstrings, without spending much money.
Higher-end properties need higher-end materials: hardwood or bamboo floors, granite or marble counters, chic cabinets, fancy faucets, the works. Consider putting in a high-tech feature or two to grab attention. Do a cost/benefit analysis on amenities like fireplaces, hot tubs, deck—how long would it take to recover the initial expense in higher rents? Remember that each expense must be justified with higher rents, so only put money where it will earn a return for you.
Are there restrictions on how many investment properties I can own?
“Restrictions” may be a strong word, but there are consequences and limitations. It is nearly impossible to secure a conventional residential mortgage if you own more than ten properties – investors must use either hard money loans or commercial lenders if they want a mortgage rather than cash, credit cards, crowdfunding, etc.
As investors accrue more real estate, they become increasingly tempting targets for IRS audits. QuickBooks has evolved as a great tool for real estate investing and bookkeeping. With features like attaching a copy of receipts to costs, easy preparation of reports, and setting up properties separately, it can help you track costs and income for straightforward reports for your accountants. The more information you keep in one place, the easier managing becomes.
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About Paul Cohen, Esq.
A veteran landlord-tenant and real estate attorney, Attorney Cohen Paul helped rewrite the Pennsylvania Landlord & Tenant Act, and chairs the Pennsylvania Joint State Government Commission Subcommittee on Landlord Tenant Law.
The information provided herein is intended as a general discussion of legal issues concerning landlord tenant law. Information provided is not legal advice or a legal opinion, and it is recommended that the reader seek independent counsel for any specific issue.