the Unofficial Guide ® to Real Estate Investing Second Edition Spencer Strauss and Martin Stone the Unofficial Guide ® to Real Estate Investing Second Edition Spencer Strauss and Martin Stone Copyright © 2003 by Wiley Publishing, Inc. All rights reserved. Published by Wiley Publishing, Inc., Hoboken, NJ No part of this publication may be reproduced, stored in a retrieval system or trans- mitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8700. 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ISBN:0-7645-3709-1 Manufactured in the United States of America 10 9 8 7 6 5 4 3 2 1 Second Edition Book design by Lissa Auciello-Brogan Cover design by Wendy Mount Page creation by Wiley Publishing, Inc. Composition Services Spencer Strauss dedicates this book to Marty Stone for his friendship and never-ending support and to his late father Marty Strauss: “Dad, today I am a fountain pen.” Martin Stone dedicates this book to his wife Lori for her love and encouragement and to his longtime teacher, mentor, and friend Jack Buckingham. Acknowledgments W e would like to thank all the fantastic people at Wiley Publishing, Inc., who made this book possible: most notably Kathy Nebenhaus, Keith Covington, Suzanne Snyder, and the remarkable Roxane Cerda. Thank you all for your commitment to this book and making our job easy. We also would like to acknowledge the staff at Hungry Minds who worked so hard on the first edition, including, Matthew X. Kiernan, Randy Ladenheim-Gil, Jessica Faust, Jennifer Perillo, Brice Gosnell, Faunette Johnston, Georgette Blau, William Bronchick, Warren Ladenheim, Ed Stevens, and Amy Lepore. Finally, we owe a debt of gratitude to the following people, without whom we wouldn’t have been able to write this book: Steven D. Strauss, Lori Stone, Sheree Bykofsky, Blake Mitchell, Chris Stone, Sandi Strauss, Larry Strauss, Maria Strauss, Jillian Lewis, Kirk and Leslie Melton, Aaron Cook, Adam Cook, Hans Harder, Ben Walton, Jay Treat, Shelly Stone, James Waedekin, Ned Mansour, Jim Frings, Marianne Choy, Michael B. Moynahan, Kerry and Mia Daveline, Glenn Bozarth and Seymour Fagan. Thanks to all of you for your support. C o n About the Authors ...............................................xi t Introduction .....................................................xiii e I Understanding Real Estate As an Investment...............................1 n 1 Planting the Seed .....................................3 t A new world order ......................................4 Investing versus speculating .......................7 s Taking a chance .......................................10 The roots of lending .................................11 Great government subsidies .......................13 Leveraged compound interest .....................16 Just the facts ..........................................19 2 The Process and the Plan ........................21 Short-term profits ....................................22 Middle-years payoffs .................................24 The retirement years .................................30 A systematic approach to investing ............31 Just the facts ..........................................40 II The Secrets of Real Estate Investing...41 3 Elements of Return .................................43 333 Richmond Street ................................44 Cash flow ................................................45 Equity growth from loan reduction ..............49 Equity growth from appreciation .................50 Tax shelter benefits ..................................56 v vi CONTENTS Modified Accelerated Cost Recovery System...58 Calculating the return ...............................60 Just the facts ..........................................63 4 Appraising Like an Appraiser ..................65 Methods of valuing property ......................66 A summary of value ..................................81 The gross rent multiplier ...........................82 Finding hidden value ................................85 Highest and best use ................................87 Just the facts ..........................................88 5 Borrowing Big Bucks ...............................91 Show me the money .................................92 Locating a lender .....................................94 The conventional route .............................98 Fixed-rate mortgages ..............................103 Adjustable-rate mortgages (ARMs) ............104 Assumable loans .....................................112 Private-party financing ............................113 Hard money loans ...................................118 And most important ................................119 Just the facts ........................................119 III Mastering the Market.....................121 6 Real Estate, the Economy, and Your Target Market .......................................123 The big picture .......................................124 Regional economic trends ........................125 Your target market ..................................130 Researching local markets ........................135 The “comfort zone” .................................141 Just the facts ........................................141 7 Subdividing Your Options ......................143 Land ho! ...............................................144 Condominiums ........................................148 Single-family homes ................................149 CONTENTS vii Vacation homes ......................................156 Two- to four-unit properties .....................157 Five units and up ...................................160 Big apartment buildings ..........................161 Commercial and industrial properties .........163 Just the facts ........................................166 8 Tricks of the Trade ................................167 The fixer-upper ......................................168 Management fixer-uppers .........................173 Bank-owned properties ............................178 Short sales ............................................184 Low- or no-down deals ............................187 A word of caution ...................................189 Just the facts ........................................189 IV Setting Your Investment Goals........191 9 Building an Investment Plan .................193 Good intentions versus planning ...............194 Writing a winning investment plan ............195 Section 1: Your long-term investment goals ....................................196 Section 2: Determining your general plan ...202 Section 3: Establishing a detailed plan ......208 Section 4: Follow-up and goal review ........215 Just the facts ........................................217 10 Planning for the Tax Man ......................219 Deductions, deductions, and more deductions .............................................220 Limitations on deductions ........................223 Calculating capital gain ...........................225 The 1031 exchange .................................227 Three categories of exchanges ..................228 The installment sale ................................235 Refinancing your loan .............................238 A tax lesson summary .............................240 Just the facts ........................................241