Real Estate Investment
Real estate investment involves purchasing properties primarily to generate income or profit,
rather than for personal residence. Common examples include rental houses and apartment
buildings, where owners earn ongoing rental income and potentially benefit from property value
appreciation over time. Unlike investing in stocks or bonds, real estate investment is more
complex and comes with unique tax implications. Over the past 50 years, it has grown into a
popular and profitable investment strategy, offering opportunities for both income and long-term
capital gains.
Types of Real Estate Investment:
1. Basic Rental Properties:
This is the most common form of real estate investment. A person buys a property (like a house
or apartment) and rents it out. The goal is to charge enough rent to cover maintenance, taxes, and
other expenses—and still make a monthly profit. The property also gains value over time.
2. Real Estate Investment Groups (REIGs):
These work like small mutual funds for rental properties. A company builds or buys apartments
or condos and sells units to individual investors. While investors own their units, the company
handles maintenance, tenant selection, and rent collection for a cut of the rental income.
3. Real Estate Trading or Flipping:
This strategy is all about quick profit. Investors (known as flippers) buy undervalued or fast-
rising properties, hold them briefly (usually 3–4 months), and resell for a profit. It’s risky—if the
market turns or the property doesn’t sell, losses can pile up quickly. A second class of property
flippers make their money by buying reasonably priced properties, adding value by renovating
them and selling them with profit.
4. Real Estate Investment Trusts (REITs):
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A REIT is a company that owns or operates income-generating real estate, like malls or office
buildings. Investors buy shares of the REIT on stock exchanges, just like stocks. REITs must pay
90% of profits as dividends, so investors enjoy regular income. It's a way to invest in real estate
without owning physical property.
5. Leverage or Debt Financing:
People use loans to purchase assets for investment purposes. A person can purchase a property
with as little as a 10–25% down payment through loans, then generate rental income from
owning a larger valuable asset. Through this method, investors can spread their funds across
multiple properties.
Common Mistakes Real Estate Investors Should Avoid
Real estate can be rewarding, but it’s not a guaranteed path to wealth. Many beginners fall into
traps that cost time, money, and energy. Here are the most common—and dangerous—mistakes
to watch out for:
1. Planning as You Go:
First, find the plan, then find the house to fit the plan. Pick investment model, and then find
property to match that. Don't find the strategy after find the home.
2. Expecting to "Get Rich Quick":
Real estate is a long-term investment. Success takes time, effort, research, and patience. If you're
in it for quick cash, you're likely to be disappointed—or worse, lose money.
3. Going Solo (Lone Ranger):
Real estate is a team sport. Investors need a strong relationship with professionals like, reliable
agent, appraiser, lender, lawyer, and contractors. Building the right team saves time, avoids
mistakes, and increases the chances of success.
4. Overpaying:
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Profit is locked when the investor purchases property. If investors pay too much when
purchasing, it’s hard to recover, no matter how great the property seems.
5. Skipping Homework:
Learn before you leap. Read books, attend seminars, or even pay an experienced investor for an
hour of their time. Know the market and the risks before investing real money.
6. Ignoring Due Diligence:
Don’t buy based on hopes or assumptions. Verify everything—property condition, neighborhood
trends, rental potential, and local laws. Always do your homework.
7. Misjudging Cash Flow:
Make sure the rental income can cover expenses like maintenance, taxes, and mortgage. Don’t
assume it’ll all work out—plan for worst-case scenarios.
8. Having No Backup Plan:
Always have multiple exit strategies. If you can’t flip, maybe rent. If not, maybe lease-to-own or
wholesale. Flexibility protects individual investment.
9. Underestimating Maintenance:
Owning property isn’t passive—things break. Budget for regular repairs and unexpected costs. A
good property manager helps, but they need to be vetted and trusted.
10. Miscalculating Renovation Costs:
Rehab projects often cost more and take longer than expected. Get multiple estimates and leave
room for surprises. Don’t rely on guesswork—be precise.
Pre-Acquisition Cost of Real Estate
Pre-acquisition costs refer to the expenses incurred before purchasing a real estate property.
Common pre-acquisition costs include:
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1. Scrutinizing the alternative options
2. Legal expenditure, including eviction and rehabilitation charges
3. Architectural Design Fee
4. Structural Design Fee
5. Electrical Design Fee
6. Plumbing Design Fee
7. Other professionals' fees
8. Cost of zoning and traffic studies
9. Cost of environmental studies
10. Cost of survey
11. Cost of feasibility study
12. Cost of appraisal
Principles for the Capitalization of Pre-acquisition Cost
1. Payments for alternative options to acquire real property are capitalized.
2. Pre-acquisition costs other than the cost of alternative options can only be capitalized if the
acquisition of the property (or an option to acquire the property) is probable, and if the costs
meet the following two criteria:
The costs must be directly identifiable with the property.
The costs would be capitalized if the property were already acquired.
The requirements for the capitalization of pre-acquisition costs
1. The purchaser should actively seek to acquire the real estate property
2. The purchaser should have the ability to finance or obtain financing for the property,
3. There should be an indication that the real estate property the purchaser seeks to acquire is
available for sale.
4. Any costs (other than costs relating to an option to acquire a probable real estate) incurred
before a project is considered probable have to be expensed as incurred. If the project
becomes probable at a later point in time, costs incurred prior to the project becoming
probable cannot subsequently be capitalized.
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Making an Offer:
When interested in buying a property, the next step is to make an offer, which means telling the
seller how much is being offered for the property. This is usually done through a real estate
agent, as buyers and sellers typically don’t communicate directly unless neither party has an
agent.
Key Considerations:
Agent Guidance: A real estate agent can advise on how much to offer, but keep their
incentives in mind. Agents earn more commission on higher prices and may encourage a
higher offer to secure the sale, but it’s common for agents to suggest offering slightly less
than the asking price.
Negotiating for a Better Deal: To secure a better price, offering slightly less than the
asking price or requesting concessions (like the seller covering part of the closing costs or
making repairs) is often a good approach.
Offer Equal to Asking Price: If the house is worth the asking price and there’s no
interest in negotiating, offering the full asking price may be the simplest option.
Offering More Than the Asking Price: In a competitive market, especially when
demand is high, offering above the asking price may be necessary to stand out. This is
common when multiple buyers are competing for the same property.
The Contract
Once the seller accepts the offer, both parties sign a contract, which secures the property and
takes it off the market. This gives the buyer time to inspect and appraise the house, ensuring it’s
worth the price. Typically, a standard contract form is used, but if the seller insists on a custom
contract, it’s wise to consult a lawyer to avoid hidden issues. Real estate agents often guide
buyers through the contract process, though it’s important not to sign before the house is
inspected for potential problems.
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Earnest Money
When executing a real estate contract, buyers present earnest money deposits that demonstrate
their serious buying intentions. The earnest money becomes part of the purchase price once the
deal concludes successfully. When an agreement fails due to contract validation, the buyer
normally recovers their payment. The buyer can lose their earnest money payment if they fail to
comply with the contract terms. The quick examination of inspections and appraisals shields the
earnest money from potential loss.
Title Company
The title company plays a key role in real estate transactions by handling three main tasks:
1. Holding the earnest money as a neutral third party.
2. Issuing title insurance policy to protect against ownership issues.
3. Handles all paperwork related to closing, including calculating final costs, preparing the
Settlement Statement, collecting signatures, and recording the sale with the local
government.
The seller usually pays the title company fees, so it's one less cost for the buyer to worry about.
Title Insurance Policy
The title basically refers to the right as an owner to a piece of property. Title insurance protects
the legal ownership of a property from past issues such as unpaid taxes, contractor liens, or
disputes over ownership. These problems, if not addressed, can lead to claims against the
property, even after the sale is complete.
Before issuing a policy, the title company conducts a thorough check to ensure there are no
existing claims. If a claim does surface later, the title company manages the issue directly,
shielding the new owner from legal or financial complications.
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In some regions, title insurance is not automatically included, so the purchase contract must
specify an owner’s title policy. This policy is generally a low-cost offering, strong protection for
the owner’s rights.
Survey
A survey represents an official document which shows the property boundaries together with
house dimensions. The title company and lender normally need a survey to verify property
boundary accuracy. If an outdated survey comes from the seller at the time of their purchase, the
title company will usually need a new updated survey for property accuracy verification.
Direct and Indirect Costs
Direct costs (or hard costs) in real estate refer to expenses that are easily identifiable and directly
related to the construction process. These include costs for labor, materials, and construction
management fees.
Indirect costs (or soft costs) cover expenses that are not directly tied to construction but are still
necessary for the project. These can include costs for legal services, accounting, permitting, and
construction period interest. Indirect costs also cover overhead, like administrative and support
costs, that are spent away from the construction site.
Recurring Operating Expenses of Real Estate:
1. Accounting Expenses
2. License Fees
3. Maintenance and Repairs (e.g., security, cleaning, pest control)
4. Advertising
5. Office Expenses
6. Supplies
7. Attorney Fees and Legal Fees
8. Utilities (e.g., telephone, gas, electricity, water, sanitation)
9. Insurance
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10. Property Taxes
11. Travel and Vehicle Expenses
12. Leasing Commissions
13. Salary and Wages of Property Management (e.g., president, secretary)
14. Salary and Wages of Property Employees (e.g., caretaker, guard, accountant)
Top 10 Financing Methods to Purchase Real Estate Investments:
1. All Cash
Investors use 100% of their own cash to buy properties. This method is quick, often allowing
for the purchase of properties at a lower price without needing to finance.
2. Delayed Financing
This method allows investors to purchase a property with cash and then finance it afterwards
to recover the cash spent. It's ideal for buying properties quickly and rehabbing them before
securing financing.
3. Hard Money
Hard money loans are backed by the property’s value rather than the borrower’s
creditworthiness. They are usually short-term loans for rehabbing properties and come with
higher interest rates than traditional loans.
4. Private Money
Private money loans come from personal connections like family or friends, rather than
professional lenders. These loans are often more flexible with lower interest rates and
informal agreements.
5. Portfolio Lenders
Portfolio lenders provide specialized loans and keep them in-house rather than selling them
to larger institutions. This offers more flexibility in loan terms, especially for investment
properties.
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6. Self-Directed IRA
A self-directed IRA allows investors to use their retirement funds to finance real estate
investments. This method helps diversify retirement savings and generate passive income.
7. Self-Directed Solo 401(k)
Similar to a self-directed IRA, a self-directed Solo 401(k) gives investors control over their
investments, including real estate, while allowing tax-free growth.
8. Partnerships
Partnerships involve multiple people pooling funds to buy properties. This approach divides
the costs and profits among partners, making it easier to afford more expensive properties.
9. 203K Loan
A 203K loan is a government-backed mortgage that combines a standard FHA (Federal
Housing Administration) mortgage with funding for home renovations. This is ideal for
properties in need of repair.
10. Mortgage
A conventional mortgage can also be used to finance investment properties. Though it
typically requires a down payment of 20% or more, it is a standard option for smaller
investors looking to buy fewer properties.
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