You have your CDs, stocks, bonds, mutual funds and other investments. You want to diversify your investments more with real estate. There are some real deals out there in the current bargain market. Just like with any other investment, with real estate you have to do your homework.
Purchase agreement is key. A common mistake I see many people make is to sign a purchase agreement, also called an offer to purchase, with the seller and then bring the signed agreement to their attorney for review. What many do not realize is that once the purchase agreement is signed by the buyer and seller, it is binding upon both. All of the terms and conditions that govern the purchase are in that agreement. The time to have a real estate purchase agreement reviewed by your attorney is before you sign it.
Here are some matters to consider when purchasing investment real estate:
Have appropriate contingencies. Your purchase agreement should include contingencies so that you can conduct your due diligence before you decide to close on the deal. There should be contingencies for:
● Survey of the property in which all four corners of the lot are “staked” so you know where all the lot lines and corners are located.
● Legal review of the title to the property to insure you have clear title to the real estate with no unwelcome guests after you purchase the property, such as a surprise liens from the IRS or a mortgage lender.
● Inspection of the building and property in order that you do not purchase a building which is unsafe or requires substantial repairs.
● Environmental testing so you do not end up having to pay for a costly environmental clean-up.
● Radon testing if there is a crawl space or a basement, to insure that the building occupants do not get exposed to this toxic gas.
If anything is discovered in these contingencies that is unsatisfactory, you can walk away from the deal and get your deposit back. Or you could use the results to re-negotiate the purchase price.
Know what you are buying. Make sure that you are aware of exactly what you are purchasing. Is the land a separate lot or a condominium? Are there deed restrictions? Do all fixtures and other personal property come with the property? Are you buying just the building or also the land under it? Some medical offices around hospitals are subject to 50 or 100 year land leases, after which, the land and building may revert to the hospital. Make sure that the zoning is proper for your intended use. If there are existing tenants in the property, review the terms of all the leases.
Know what you are getting into. If you do not have experience with the real estate you are contemplating on purchasing, research it. You may want to start out small or hire it out to experienced real estate professionals. If you have never managed residential rental real estate, it may not be particularly wise to purchase a self-managed 30 unit apartment or rooming house.
Know your purchasing costs. Your purchase agreement should state who is paying which closing costs. Try to negotiate that you are paying as few of the closing costs as possible. If you are financing the purchase, review your mortgage lender’s costs. Know how the real estate property taxes are being prorated. Make sure that the seller is going to provide title insurance, at seller’s expense. Special assessments should also be paid off by the seller by closing.
Know your ongoing costs. Calculate what real estate taxes will be. Review historical utility, maintenance (building and common area), insurance, cleaning, lawn and landscape care, association dues and other recurring costs. What is your monthly principal and interest payment on your mortgage? Make sure that you are aware of all ongoing costs before you obligate yourself to purchase the property. Prepare a cash flow projection. Will the property pay for itself or do you have to feed it every month. If you have to continually fund it, do you have adequate capital?
Have an exit strategy. Whenever you get into the real estate business, make a plan to get out of the real estate business. What would happen to the real estate when you can no longer manage it? This could be in the near future, such as with an unexpected disability or death, or could be many, many years down the road. If you have family members that can manage it, your exit strategy may be to leave it to them upon your death. If not, your plan should include professional management of the real estate until it can be sold.
So if you are going to invest in real estate, make sure that you do your homework and you are properly capitalized and properly educated. Happy investing.
By: Matthew M. Wallace, CPA, JD
Published edited May-June, 2013 in Savvy magazine as: Tips for buying investment real estate