Real Estate Investing

Part
01
of three
Part
01

Real Estate Process- California

California's escrow timeline is typically 30 to 60 days. Hiring the right professionals during the buying process will ensure buyers are receiving the best deals and getting the best terms. The state of California allows for dual agents, representing both the buyer and seller.

Financing

  • The California real estate market is highly competitive and making sure that financing is in place is the first step in buying a home.
  • Real estate professionals suggest getting more than one mortgage pre-approval to get the best rate.
  • A mortgage pre-approval shows a potential seller that the buyer is in a financial position to purchase the home and has met the creditors requirements.
  • The minimum down payment is 3.5% for a FHA loan. An additional $15,000 will be needed for closing costs.

Real Estate Agent

Making an Offer

Residential Purchase Agreement and Joint Escrow Instructions

  • The Residential Purchase Agreement and Joint Escrow Instructions acts as the sales contract and offer. Typically, the time to perform due diligence and get all financing in place is 21 days.
  • If the seller accepts the offer they simply sign the Residential Purchase Agreement and Joint Escrow Instructions, they can also counteroffer using the same form.
  • If the conditions are not met in 21 days, or in the negotiated timeline, the buyer forfeits their deposit to the seller.

Hiring an Attorney

  • The state of California does not require buyers to hire an attorney, however it can be beneficial, especially in more complex transactions.

Inspections and Negotiations

  • The buyer will normally be responsible for the home inspection fees. A home inspection will check the condition of all aspects of the home.
  • If during the inspections any issues are discovered the buyer and seller can negotiate to determine who will cover the costs, or if the price of the home will be lowered to cover any repairs.

Homeowner's Associations

  • Complexes and some new California communities are subject to homeowner's associations. The buyer is responsible for reviewing the homeowner association (HOA) documents.

Written Disclosures from the Seller

  • California laws place responsibility on the seller to disclose any issues to the buyer. A written disclosure will document any physical issues, pest or environmental concerns or any material defects.

Closing

  • Once all negotiations are complete closing can occur. At this time an appraisal, or third party valuation, is conducted of the home.
  • A final walkthrough is conducted and the final paperwork is signed. Buyers and sellers are not required to meet face to face and all paperwork can be done through the real estate agents.
  • The final document to sign is the Verification of Property.
  • The closing can take place at the escrow or title company. Once the paperwork has been processed, the keys will be handed over to the buyer.

Real Estate Glossaries and Pictograph

Part
02
of three
Part
02

Real Estate Investing Risks

Investing in real-estate is associated with numerous risks, some of which include buying a bad property, having bad tenants, vacancy risk, negative cash flow, depreciation risk, and location. Below is the explanation for some risks involved in the real estate business in a layman's language.

Real Estate Risks

1. Buying A Bad Property

  • Buying a bad property is a real-estate risk, and this usually occurs when a proper survey and analysis is not conducted properly prior to the purchase. A bad property refers to hidden problems in the asset that are not visible at the time of purchase, and these problems may include structural and foundational issues, mold, and defective appliances. One can avoid regrets of buying a bad property by ensuring due diligence during the purchase period.

2. Having Bad Tenants

  • Having bad tenants in real-estate business is a risk because different tenants can have the following behaviors, such as late or absent payments, disturbing neighbors, and destruction of property that can affect the property value. Lack of proper screening during the renting phase can make a real-estate business owner have bad tenants. A background screening of each tenant can help to mitigate this risk.

3. Location

  • There is always a risk of choosing a poor location for the real-estate business, where the population is dwindling, and the economy is poor. The aforementioned factors would affect your business in a negative way by lowering the value of your asset.
  • The location risk can be done away with by looking at key indicators such as population growth, job growth, and school systems before making a choice. Another way to minimize this risk is by researching the location by talking to a local property manager to educate one's self about the local neighborhoods and making use of internet resources about the local neighborhood.

4. General Market Risk

  • The real-estate market is not insulated from the general market risks, such as the ups and downs associated with the economy, such as interest rates, inflation, and other market trends. A proper study of the market risks such as interest rate risk, inflation risk, currency risk, among others, would assist in making an informed decision. Diversification of investment can assist an investor to better handle this kind of risk.

5. Depreciation Risk

  • There is always a possibility that prices of a real-estate property can drop in the future, hence, making the investor lose money. One can avoid this kind of risk, by carrying out proper analysis, with the indicators showing positive growth and strong positive real-estate appreciation. Carrying out a risk analysis of the local area and the property is the best way to mitigate this kind of risk.

6. The Negative Cash Flow Risk

  • Negative cash flow in real-estate occurs when the expenses in the form of maintenance, taxes, and mortgage payments are all higher than the rental income, which results in losing money. The risk of negative cash flow can be avoided by accurate calculation of income and expenses to determine the rent price that would bring profit. An asset should also be located in a prime location that yields a positive cash flow, thereby bringing a high return on investment.
Part
03
of three
Part
03

Real Estate -Assessing Deals

Two best practices when assessing real estate deals as an investor is to use the one-percent rule as well as calculate a property's capitalization rate.

The One-Percent Rule

  • The one-percent rule was selected as a best practice for evaluating real estate deals as an investor given that top-tier business media (Forbes), financial trades (Wealthy Nickel, Investopedia), real estate outlets (Roofstock, Mashvisor) and other investment media (Under30Wealth, Master Passive Income) routinely identified this assessment as an "easy" and effective real estate "screening tool."
  • The one-percent rule is a relatively straightforward principle that both new and seasoned investors use to quickly and efficiently narrow a list of potential real estate investment opportunities.
  • In its totality, the one-percent rule recommends considering an investment opportunity only if it seems likely that it could rent on the market for one-percent or more of its total upfront cost.
  • Notably, the rule applies not to purchase price, but to a property's total upfront cost (e.g., purchase price, closing costs, repair costs).
  • For example, a $100,000 property that requires $50,000 in repair work to make it usable would need to rent for $1,500 per month or more to satisfy the one-percent rule, and thereby make it an investment opportunity that is "worth considering."
  • This calculation would appear as 1% * ($100,000 + $50,000) = $1,500.
  • Ultimately, the one-percent rule is used as a first filter through which the near limitless investment opportunities can be reduced to a set that is worth further investigation through site visits, other financial calculus, etc.
  • Although some investors swear by a higher threshold (aka the two-percent rule), and others note that some real estate deals which fail the one-percent rule can still have "upsides in potential investment," the large majority of financial and real estate investment experts recommend deploying this best practice when initially assessing a real estate investment.

The Capitalization Rate

  • Meanwhile, calculating the capitalization rate (cap rate) of a deal was similarly identified as a best practice in assessing real estate investment opportunities given that top-tier business media (Forbes), real estate trades (Sharestates, BiggerPockets, Mashvisor) and investing outlets (Investopedia) consistently highlighted this analysis as a "must-have" component in evaluating a potential real estate deal.
  • The cap rate analysis is typically deployed when a real estate investor has narrowed his/her options down to a "handful of potential properties," and is looking to asses these top choices with greater scrutiny by considering the potential return on investment (ROI).
  • To do this, investors recommend calculating each property's ROI by dividing its net income (i.e., estimated full year of rent income minus monthly utilities, taxes, maintenance and other expenses) by the purchase price.
  • Next, this calculation is multiplied by 100 to compute the cap rate, or percentage of expected return on the deal.
  • For example, a property with an estimated annual income of $49,920, monthly expenses of $12,751 and purchase price of $418,000 would have a cap rate of 8.89%.
  • This calculation would appear as ($49,920 — $12,751) / $418,000 * 100 = 8.89%.
  • Notably, the cap rate is agnostic to any financing details, given that it this calculation does not traditionally include mortgage payment estimates.
  • Additionally, the standard for an acceptable ROI can vary by investor, although many areas see a maximum cap rate of 8-12%.
  • Overall, the capitalization rate provides a consistent lens through which a real estate investor can evaluate a final set of potential properties, and get a better understanding of whether a property is likely to deliver a strong return.

Additional Information

Please note, other key analyses that were frequently cited by industry experts as "must have" tools in evaluating a potential real estate transaction include comparative market analysis, assessing potential cash on cash return and cash flow analysis.

Research Strategy

Please also note, a robust review of credible media sources, real estate industry reports and articles by experts in real estate investing resulted in limited public information on “best practices” for new real estate investors. This is likely due to the proprietary nature of real estate investing, as well as the numerous approaches and strategies employed to assess potential real estate deals. However, a deeper search into recommended industry practices revealed that the one-percent rule as well as the capitalization rate were consistently discussed as must have or fundamental assessment strategies for both new and seasoned real estate investors. Given the consistency with which these analyses were mentioned, as well as the variety of relevant experts and media outlets which highlighted the importance and benefits of leveraging these assessments, the one-percent rule and capitalization rate analyses were determined to be best practices for new real estate investors in reviewing potential deals.


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