Pssst - Wanna Be a Real Estate Millionaire? (Part 20)

Chapter 20: Overview of Listed Categories from the Chapter 1 Listing

Over 40 separate categories were offered in list format in Chapter 1 primarily to introduce the wide variety of choices that make-up the overall field of real estate investing. Many of those categories have already been discussed in detail above. A few have been mentioned and briefly discussed. This chapter will deal with the balance of that list to give the reader some understanding of what else is available for consideration.

#13: 1031 Exchange: This topic belongs under “Taxes” also, but warrants a separate discussion since it is critical in today’s totally confusing and convoluted tax law. The 1031 Exchange is an IRS tax code regulating how real estate can be legally transferred from one owner to another while deferring any capital gains tax that might otherwise be due on sale. It wasn’t always thus. In the “old days,” we simply found someone that had a property we were interested in buying and offered to trade them for a property we already owned and wanted to sell. The younger investor was typically trying to trade-up to larger holdings while the seasoned investor was beginning to reduce his property inventory by selling. A direct trade offered both investors tax advantages.

The investor with a smaller property exchanging that property for a larger, more expensive one benefited from a complete deferral of any income taxes that might otherwise be due on sale. The larger property owner by trading down instead of selling outright was able to defer part of the tax that might otherwise be due on sale. It made so much sense that naturally the politicians couldn’t leave it be and they changed the tax code to dramatically affect subsequent property exchanges. Enter the 1031 Exchange.

Today, you are still permitted to exchange properties and thereby gain some tax deferral, but the tax laws are extremely strict, limited and absolute regarding the precise procedure that must be followed. If you’ve not done a 1031 Exchange before, seek professional help before you get yourself in trouble. There are many “i’s” to be dotted and “t’s” to be crossed in order to render the exchange acceptable to the IRS. Don’t blow it.

Instead of being required to find another property you like and then having to convince the owner of that property to trade directly with you, you can now sell your property to someone who wants to buy your property but then keep the proceeds of that sale in an escrow until you can find the property you want to buy with those proceeds. You have a very limited time frame in which to get all these puzzle pieces together, but if you’re successful, you can still benefit from the tax deferral on the profits that otherwise would be immediately taxable in the year of the sale. This way, you don’t have to convince the owner of the other property to just take your property in a direct trade.

I’ve used the term “escrow” many times throughout this book but only briefly described the term. For all practical purposes, the term escrow means a disinterested third-party that is licensed and bonded to act as a middleman in financial transactions. In California, actual escrow companies exist as such and do most of the paperwork processing for real estate sales and purchases. In Texas, real estate attorneys handle most of the real estate transactions but you can get a title company to act as the escrow for a real estate transaction, too. Each state has its own method of processing real estate transfers but they all tend to follow the procedure as described for an escrow.

Each party to an escrow provides all their specific information and funds from which the escrow then prepares the legal transfer papers and calculates the various costs and proration for each participant. When all the paperwork is completed and all the parties are satisfied with the result, the escrow closes and makes the property transfer official. The buyer gets the title to the property and the seller gets the net proceeds from that sale. The escrow sees to it that the property is properly registered with the County Recorder’s Office. Any loans associated with the property transfer are also recorded as a lien against the property. Usually included in an escrow closing is a policy of Title Insurance for the buyer. This policy guarantees to the buyer that he now has a clear title to the property he just purchased. Any errors will be corrected by the insurance company at no charge to the buyer.

#17 Prefabricated Structures: This is another term for trailer (wobbly box), mobile home, RV, manufactured housing. The key to profitability in this area is to own mobile home parks or RV parks. There is a huge cash-flow generated in exchange for a relatively small investment. As an investor, you provide the pad on which the trailer or RV is parked and the hook-ups that provide water, sewer, gas and electric service. Especially when regular housing became so expensive during the housing bubble, many folks resorted to mobile home living because it was less expensive. Even today with the poor economic conditions and extremely high unemployment numbers, folks trend towards trailer parks in order to save on living expenses. It’s tempting to become a little snooty, as with my “wobbly box” comment, but don’t dismiss an excellent return-on-investment potential. It can be an extremely time-consuming business, but I know people who make an excellent living from the profits on this type of real estate.

#18 Storage Units: Americans have become collectors of “stuff.” Very quickly, their personal residences seem to fill-up and the overflow crowds-out the cars from the garage. Then where to keep the excess becomes the problem. Enter the ubiquitous Storage Unit. While not a new concept, what is relatively new are the numerous nation-wide companies that specialize in their construction and operation. One company’s business plan dictates finding raw land in the path of expected progress and then building storage units as a land-banking technique until civilization builds-up around them. Then because they intentionally built the storage unit to do so, they convert the storage space to office space and generate an even higher income. They figured a way to get well paid to land bank for a future, higher-use application.

Individual owners have been able to successfully enter and compete in this arena, too. There are local, regional and national associations that provide help and guidance to the individual. Storage units have become an end unto itself and provide a very high cash-flow to investment ratio similar to mobile home parks. It is also a business and the investor needs to be aware of the added time commitment required to run the business.

#19 Shopping Centers: A few comments were made earlier about shopping centers and the holding companies that operate them. REITs are available that specialize in shopping centers and provide a totally passive way of participating as an investor. Recalling my caution about allowing someone else to make day to day decisions and the potential for abuse, you may wish to investigate direct ownership in what is called a Strip Center. Rather than a huge mall-type operation, the Strip Center provides commercial space for mom-and-pop business perhaps adjacent to an anchor tenant such as a grocery store. Once again, this approach is a combination of real estate plus a business enterprise. It needs to be evaluated accordingly.

#20 Raw Land and Land Development: Similar to the land-banking concept introduced under mobile home and RV parks, investors do buy raw land and just hold it until civilization builds-up around them. They buy acreage with the idea of selling it later as city lots. The risk that you correctly identified the growth path is large. If you guessed incorrectly, you’re stuck with the land and years’ worth of property tax payments. You can overcome an unknown holding term by directly improving the land by building a housing tract or shopping center. That, of course, takes knowledge that you probably don’t yet possess. It is a real estate investment category but it is fraught with high risk. I watched folks purchase desert land in Southern California in the early 1960s thinking that a new proposed Palmdale airport would be built in the high desert. The airport was never built and the folks held on for decades. Ultimate, normal urban sprawl bailed them out but at what cost? Did they even break even after taking inflation into account? Careful!

#25 Section 8 HUD Rentals: In an effort to provide affordable housing to low income people, the government came up with a subsidy plan called Section 8. An individual investor purchases a rental property and then submits an application for it to be approved as a Section 8 rental. When approved, the government then provides a qualified tenant who contributes part of the rent and the government makes up the difference. As the investor, you are guaranteed your rent and the repairs of any tenant-caused damage to your property. The disadvantage is the type of tenant you must accept. Not all, by any means, but many are totally inconsiderate of your property. For example, you are required to have screens on all windows. Yet within a week, some tenants will have already destroyed your screens and you have to replace them. There are income advantages to participating in this program but the disadvantages must be carefully weighed before you jump into this program. I know investors who have done well and I know other investors who were ready to jump off a bridge, they were so distraught over the nonsense they encountered from the class of tenants they were forced to accept. One tenant carelessly caused a fire that totally destroyed a friend’s rental house. Then that same tenant waved his Section 8 agreement under the nose of my friend demanding he be provided with the rental accommodations to which the agreement referred. You can imagine how my friend responded. What type of personality do you possess and would that personality permit you to operate under these conditions?

#26 Resort Condos: In Chapter 10, item #2, I briefly described my investment experience with an ocean-front condo on the big island of Hawaii. If you plan to personally use the condo and/or use it as a house exchange location, then you have a realistic reason for the purchase. If, however, you are thinking it is a good rental income unit, think again. Just a word of caution to the wise.’’

#36 Condo Conversions: Some apartment buildings lend themselves to what is called Condo Conversions. Initially, the structure(s) is a normal rental building. Later due to economic conditions and the local demand for ownership, some buildings are converted from rentals to personally owned condos. Most condos are purposely built as condos. A few are created as the end result of a remodel and restructure of an existing building; usually an apartment complex. This is a very specialized area and requires extensive expertise. State and local laws provide incredible hoops through which you must jump in order to obtain permission to convert such a property. Conversion can certainly be profitable. Individual Condos sell for much higher prices than the implied value of an individual apartment unit as part of a larger complex. If you can buy at reasonable apartment prices and then sell at reasonable condo pricing, you can make a great deal of profit. You also have a built-in potential buyer’s list since you will first offer the units for sale to your existing tenants. Just do not run afoul of the bureaucrats when executing the conversion. Make sure you know what you are doing and have competent legal advisors guiding you.

#38 Parking Lots: After the end of WWII, parking meters appeared for the first time on city streets in many towns and cities across the country. If I recall correctly, a penny purchased 12 minutes and a nickel bought you an hour. How times have changed! It is my understanding that folks pay more to just park their cars in downtown Manhattan than most folks pay in rent or mortgage payments. This is another combination real estate investment/business operation. Your option is to purchase the land and then lease it to the parking lot operator or also be the lot operator as well as the land owner. How much time do you have to devote to this sort of endeavor?

#39 Foreign Real Estate (meaning real estate outside the US): As transportation facilities have improved and travel costs have gone down, more and more people travel outside the United States on a fairly regular basis. As you might expect, some of those travelers wind up purchasing homes and other property in foreign countries as a result of their travels. We have some strange laws in the United States but so far, owning real estate outside the United States is still permissible. Furthermore, it does not have to be reported on your income tax return as do foreign bank accounts and stock investments. If you are so inclined, this might provide the ideal opportunity to combine the second house and/or rental property objective. I’ve not owned foreign real estate in the past but I am seriously considering doing so as I write. I have been fortunate to have been able to travel extensively and have found numerous places in the world that are extremely appealing. I’m also aware of the pitfalls one encounters in a foreign market. If this area of investment is of interest to you, be sure to research it thoroughly and then get expert advice in the process. I note numerous cable channel TV programs now offer programs showing regular folks shopping for accommodations in various parts of the world. Watching a few of these programs might trigger an interest for you.

#42: Bed and Breakfast: I just noted above that I’ve been fortunate to travel extensively. On many trips, I’ve enjoyed staying at Bed and Breakfast locations. Many times, the buildings are historical landmarks of one sort or another. Others are just architecturally interesting. Especially when traveling outside the US, a B&B gives you the chance to see the inside of a private home and meet local folks you might not otherwise encounter during your travels.

In recent years, B&Bs have also become popular in the United States. The investment aspect is ownership of an architecturally interesting property or perhaps even a historical one. I tried to purchase just such a building in the small Texas town in which I live but I was out-bid. It was a perfect building suitable for B&B use. Dating back to the mid 1800’s, it even had a well in the center of the kitchen.

There is no way I would have operated the B&B business, however. Can you say 24/7/365? No thanks. I would have enjoyed owning the real estate itself.

NOTE: Stay tuned for Part 21