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Real estate investing has traditionally served as a strong potential source of wealth creation in the United States. Prior to the Industrial Revolution, wealth was measured primarily in terms of the amount of land owned by an individual. Real estate continues to serve as an important asset class in properly managing investor wealth and goes far beyond the ownership of raw land or a home.
While it is possible to build an investment portfolio limited to the more traditional asset classes such as stocks, bonds and cash, we believe that allocating a portion of an investor's assets to real estate is important for diversification and portfolio risk management. Equally important, real estate may provide a steady stream of income and the potential for capital appreciation depending on the investment approach and asset ownership structure chosen.
Basic Rental Properties
This is an investment as old as the practice of landownership. A person will buy a property and rent it out to a tenant. The owner, the landlord, is responsible for paying the mortgage, taxes and costs of maintaining the property. Ideally, the landlord charges enough rent to cover all of the aforementioned costs. A landlord may also charge more in order to produce a monthly profit, but the most common strategy is to be patient and only charge enough rent to cover expenses until the mortgage has been paid, at which time the majority of the rent becomes profit. Furthermore, the property may also have appreciated in value over the course of the mortgage, leaving the landlord with a more valuable asset. According to the U.S. Census Bureau, real estate has consistently increased in value from 1940 to 2006, then proceeded to dip and rebound from 2008 to 2010.
There are, of course, blemishes on the face of what seems like an ideal investment. You can end up with a bad tenant who damages the property or, worse still, end up having no tenant at all. This leaves you with a negative monthly cash flow, meaning that you might have to scramble to cover your mortgage payments. There is also the matter of finding the right property; you will want to pick an area where vacancy rates are low and choose a place that people will want to rent.
Perhaps the biggest difference between a rental property and other investments is the amount time and work you have to devote to maintaining your investment. When you buy a stock, it simply sits in your brokerage account and, hopefully, increases in value. If you invest in a rental property, there are many responsibilities that come along with being a landlord. When the furnace stops working in the middle of the night, it's you who gets the phone call. If you don't mind handyman work, this may not bother you; otherwise, a professional property manager would be glad to take the problem off your hands, for a price, of course.
Real Estate Investment Groups
Real estate investment groups are sort of like small mutual funds for rental properties. If you want to own a rental property, but don't want the hassle of being a landlord, a real estate investment group may be the solution for you. A company will buy or build a set of apartment blocks or condos and then allow investors to buy them through the company, thus joining the group. A single investor can own one or multiple units of self-contained living space, but the company operating the investment group collectively manages all the units, taking care of maintenance, advertising vacant units and interviewing tenants. In exchange for this management, the company takes a percentage of the monthly rent.
There are several versions of investment groups, but in the standard version, the lease is in the investor's name and all of the units pool a portion of the rent to guard against occasional vacancies, meaning that you will receive enough to pay the mortgage even if your unit is empty. The quality of an investment group depends entirely on the company offering it. In theory, it is a safe way to get into real estate investment, but groups are vulnerable to the same fees that haunt the mutual fund industry. Once again, research and partnering with the right brokerage is the key.
Real Estate Trading
This is the wild side of real estate investment. Like the day traders who are leagues away from a buy-and-hold investor, the real estate traders are an entirely different breed from the buy-and-rent landlords. Real estate traders buy properties with the intention of holding them for a short period of time, often no more than three to four months, whereupon they hope to sell them for a profit. This technique is also called flipping properties and is based on buying properties that are either significantly undervalued or are in a very hot market.
Pure property flippers will not put any money into a house for improvements; the investment has to have the intrinsic value to turn a profit without alteration or they won't consider it. Flipping in this manner is a short-term cash investment. If a property flipper gets caught in a situation where he or she can't unload a property, it can be devastating, because these investors generally don't keep enough ready cash to pay the mortgage on a property for the long term. This can lead to continued losses for a real estate trader who is unable to offload the property in a bad market.
A second class of property flipper also exists. These investors make their money by buying reasonably priced properties and adding value by renovating them. This can be a longer-term investment depending on the extent of the improvements. The limiting feature of this investment is that it is time intensive and often only allows investors to take on one property at a time.
Real estate has been around since our cave-dwelling ancestors started chasing strangers out of their space, so it's not surprising that Wall Street has found a way to turn real estate into a publicly-traded instrument. A real estate investment trust (REIT) is created when a corporation (or trust) uses investors' money to purchase and operate income properties. REITs are bought and sold on the major exchanges, just like any other stock. A corporation must pay out 90% of its taxable profits in the form of dividends, to keep its status as an REIT. By doing this, REITs avoid paying corporate income tax, whereas a regular company would be taxed its profits and then have to decide whether or not to distribute its after-tax profits as dividends.
Much like regular dividend-paying stocks, REITs are a solid investment for stock market investors that want regular income. In comparison to the aforementioned types of real estate investment, REITs allow investors into non-residential investments such as malls, or office buildings, and are highly liquid, In other words, you won't need a realtor to help you cash out your investment.
With the exception of REITs, investing in real estate gives an investor one tool that is not available to stock market investors: leverage. If you want to buy a stock, you have to pay the full value of the stock at the time you place the buy order. Even if you are buying on margin, the amount you can borrow is still much less than with real estate. Most “conventional” mortgages require 25% down, however, depending on where you live, there are many types of mortgages that require as little as 5%. This means that you can control the whole property and the equity it holds, by only paying a fraction of the total value. Of course, your mortgage will eventually pay the total value of the house at the time you purchased it, but you control it the minute the papers are signed.
This is what emboldens real estate flippers and landlords alike. They can take out a second mortgage on their homes and put down payments on two or three other properties. Whether they rent these out so that tenants pay the mortgage or they wait for an opportunity to sell for a profit, they control these assets, despite having only paid for a small part of the total value.
The Foreclosure Process in Arizona
In Arizona, foreclosure can be a swift and simple procedure by a mortgage company. Foreclosure is the legal process by which a mortgage company can obtain legal ownership of a property. It relinquishes a home owner from any all right to the property and evicts the homeowner from the premises.
In most cases, foreclosure can begin a soon as a home owner is late with the mortgage payment. If the payment is due on or before the first of the month, for example, the lender has every legal right to initiate foreclosure proceedings against the home owner.
However, most institutional lenders will try to work out alternatives with a home owner in default before trying to repossess a home. If a home owner works with his or her lender, the lender will an additional three month window on average before foreclosure is initiated.
If an alternative cannot be worked out between the lender and the home owner, the lender may begin foreclosure proceedings. Because most home owners have a trust deed, the foreclosure timeline is simple and quick because it does not have to go to court to foreclose upon a home.
In Arizona, a lender must appoint its trustee, the person or entity that has the legal right to sell the home in a trustee sale, to handle the appropriate paperwork. By law, the trustee must record in the county recorder's office a “Notice of Trustee's Sale”. This is the legal notice that the home is to be sold no sooner than 90 days from the recording date of the notice. This notice must also be published a minimum of once a week for four consecutive weeks in a “newspaper of general circulation” in that county. The trustee will mail a notice within five days of the recorded notice of trustee sale to the home owner and other parties affected by the foreclosure.
Assuming that the home owner has not reinstated the loan, the trustee will conduct the sale at a previously disclosed location. Every bidder is required to provide a $1,000 deposit to bid on the home. At such time, the home is sold to the highest bidder, which may include the mortgage company. If the bidder successfully wins, he or she has until 5:00 p.m. of the following day (assuming that it is not Saturday or a legal holiday) to pay the remaining balance in cash or other acceptable forms of payment as determined by the trustee. In addition to the forfeit of deposit, a highest bidder who fails to pay the amount bid by that bidder is liable to any person who suffers loss or expenses as a result, including attorney fees.
Should the bidder fail to pay by 5:00 p.m. of the following day, his or her $1,000 deposit is forfeited and the second highest bidder is given until 5:00 p.m. of the next day.
Proceeds from the sale are used to pay off the primary lien (trust deed) against the home (as noted on the trust deed). If any proceeds remain, payment is made to junior lien holders in order of priority. In the event that any remaining balance is left over from the sale, the trustee will remit the balance to the ex-home owner.
Title is conveyed to the winning bidder by a trustee's deed. This transfer of title relinquishes any right the previous owner has from reinstating the mortgage or redeeming the property after foreclosure. In addition, the trustee's deed clears the title of any liens and encumbrances that are junior to the trust deed.
In certain situations, junior lien holders may pursue a deficiency judgment against the previous owner to recover the balances owed. However, an Arizona home owner may be protected by such lawsuits under the law. Very few options exist under the law that prevent or impede a foreclosure.