Buy a Real Estate

I cannot keep track of how many times people tell me that they were thrilled to sell a property at a handsome profit, and then a few years later recoiled with total remorse when they realized that the property had doubled or trebled in value yet again. That doubling or trebling in value, if they had kept the property, would
have come at the expense of very little marginal effort. There would have been no contracts to study, no due diligence to perform, no finance applications to make—none of the activities normally associated with buying a property. In fact, by not selling the property, they would have saved all the contractual work associated with a sale.

There are, to be sure, extenuating circumstances when there may be some legitimate reasons to sell. For instance, with the restaurant premises that I bought for $120,000 discussed earlier, I had a succession of tenants, and then the building ended up being vacant. After many months of applying all my techniques to attract a tenant, I finally got a call from a couple in Switzerland who were keen to sign up as tenants. I was all excited at the prospect of having the premises leased once more. Then, just before they were going to sign the lease, they contacted me to say that after a lot of thinking, they decided that they would only proceed with their dream of opening their own restaurant if they could own the freehold of the property. I was faced with two options: Hold out for the gamble of a new tenant (which could take a long time), or sell the entire property to the Swiss couple at a handsome profit. It was an easy decision.

At public events I cajole the audience into coming up with valid reasons to sell a property. Few of the reasons proffered are truly valid. The most common reason given is to take the profit out of an existing investment, and then to use this profit to invest in another property. There are two arguments against this.

First, when you sell, as we have seen, you will pay capital gains tax and depreciation recapture tax. Second, while you may release the equity in a property by selling, you could release that same equity by refinancing the property and still retaining it.

For example, imagine you bought a property for $500,000 with a mortgage for $500,000 (you bought it vacant, but with a tenant in place it went up in value and the bank was willing to fund the entire purchase price). Assume it is now worth $2 million. You do not need to sell it to release the $1.5 million of equity. You could achieve the same result by simply refinancing with your existing bank or a new bank. You simply get a new appraisal and submit a new proposal for finance. Now admittedly, if the bank will only go up to a 70 percent loan to value (LTV), then they will only lend you $1.4 million, which is only $900,000 more than your present loan.

However, if you sold the property, you would lose perhaps 6 percent in selling commission ($120,000) and at least 15 percent of the capital gain to tax ($225,000), more to depreciation recapture tax, and even more to selling costs, leaving you with perhaps barely a million in net, after-tax profit. Which would you rather have, a million dollars in cash, or equity of $1.5 million (from which you could easily borrow another $900,000), secured against an asset worth $2 million, and rental income for life? The property only has to go up by 5 percent for you to make yet another $100,000 (which would be tax-free so long as you continue not to sell).

Since the Great Depression, history has been supporting the Fed in making the economy stable during a monetary crises such as the 1987 stock market crash, the 1997 Asian currency crisis, or the 9/11 terrorist attacks. In December 1930 the Fed was given a hard lesson as it failed to bail out the official-sounding Bank of the United States. Its failure to act properly precipitated the Great Depression. Ever since that time, the Fed has stepped in quickly and acted as the true last resort lender.
Working out the current real estate credit crunch may take longer, but I’m a quite confident that the Fed will be able to stabilize the economy and the financial markets once more. Nevertheless, it is still possible that history might repeat itself. Considering the fact that the Fed is a source of significant instability (easy money – tight money cycle), it is beneficial to hedge one’s bets.

Is purchasing a house at the time of foreclosure similar to buying a house that has already been foreclosed upon?

No. There are two different types of home foreclosures purchases. The first is when the lender actually forecloses on the property. If you’re interested in purchase you can show up in court and bid on the home foreclosure. The second type is when the lender or insurer actually owns the property and is selling it as its rightful owner.

Is the escrow the same as a typical real estate transaction?

No. When you’re buying home foreclosures at the time the lender takes the property back, you must show up in court, bid on the property, and if the bid is accepted, you are obliged to buy the house with a cashiers’ check, without inspections, and without any contingencies. When you’re buying from a lender or insurer after the house is already foreclosed on, there is still the opportunity to negotiate the price and terms, but because of the competitive market, the lender will normally end up calling most of the shots.

Do home foreclosures involve any additional legal concerns or fees?

No. With proper inspection, home foreclosures are unlikely to be accompanied by any additional legal concerns or fees. Bearing that in mind, remember that usually home foreclosures are sold “as is,” and due to the fact that the lender has never occupied the actual house, they are often not aware of the intricacies that may typically be required on a disclosure (for example leaking roofs or problems with electricity).

Does buying a foreclosed house involve any risk?

No. Purchasing a foreclosed home is unlikely to be risky if you do a thorough investigation. Be aware of the two facts: lenders will have limited information to work with for disclosures; secondly, people tend to get excited by the idea of a “sale,” and fail to notice the actual value of house foreclosures because of a “perceived value” issue. Consider the following hint: try to forget that it’s a foreclosure and think of it as a piece of real estate.

Is a foreclosure always an “as is” deal or can I negotiate with the bank for repairs or improvements?

As a buyer you can always try to negotiate, but conditions of the home foreclosures market are more likely to favor the lender, who will in most cases be able to sell the property “as is.”

As a person with a lot of experience in insurance I suggest that if you’re a real estate owner you should check your coverage each year in order to find out whether you have enough insurance to rebuild your house and replace your belongings if everything is lost in a fire or other unexpected event. What you should ask yourself is:

• Is the “replacement cost” covered by your policy acceptable taking into consideration the costs of labor and materials in your area? For instance, it’s rather doubtful that many homes in Silicon Valley could be rebuilt for less than $200 a square foot.
• Does your policy involve “extended or modified replacement cost coverage?” This gives you a certain percentage above the policy limit to rebuild your house.
• Does your policy include a “building code endorsement”? It covers the costs of bringing your home up to building safety codes when it is being rebuilt.
• Getting reimbursed for a claim after a fire is easier when you have prepared an inventory of the objects present in your home. There is some free software available that can help to speed up the process.