Real Estate Basics
Real estate has been one of the favored ways for people to
grow their wealth. But why is this so? In a word - leverage.
Because a large proportion of the money necessary to buy an
asset is someone else's (namely your friendly neighborhood
bank) you can control a large asset with relatively small
amounts of your own money involved. If prices for your property
rise, the return on your investment as an absolute figure
and as a percentage can be huge. Of course, leverage is a
double-edged sword with leverage having the same dramatic
affect on your finances on the downside should prices fall.
Real estate investment can span the gambit from limited partnership
shares in commercial property to owning your own home to raw
land speculation (among the riskiest of real estate transactions).
Investors should understand that although real estate investing
has historically offered attractive returns to investors,
there are several other unique considerations for real estate
investing. Real estate is not a very liquid investment, meaning
that it may be difficult to find a buyer for your property
when the time comes to sell. As well, the down payment for
real estate transactions is high in dollar terms (in percentage
terms it is low when compared with the size of the asset)
and the transaction costs (legal, brokerage etc.) are high.
Real estate also involves substantial managerial time to keep
the property in top form.
The most common real estate investment in the U.S. is private
home ownership. Home ownership provides several unique advantages
to investors. Some of the advantages of home ownership are:
it is an excellent hedge against inflation; taxes can be deducted
from income for interest and property taxes paid. As well,
the gains on the sale of a property are not included for the
purposes of calculating income tax if the home sold is a principal
residence and the amount of the gain is $250,000 ($500,000
if it is a married couple filing jointly) or less.
Real estate investments are financed by the investor contributing
a portion of the total sale cost (equity) and a special type
of loan (mortgage) from a financial institution. Mortgages
can be categorized by a) the lender or guarantor, b) their
duration (time) or c) the structure of interest payments.
Some of the typical types of mortgages are as follows:
• Fixed rate mortgage: Interest
rates do not change over the life of the mortgage
• Adjustable rate mortgage:
The rates are tied to interest rate changes in the economy.
• Bi-weekly mortgages: Payments
are made every two weeks. Because the payments against the
mortgage are so frequent, this loan is paid off quickly
• Balloon Mortgage: Payments
over the life of the mortgage are fixed but at a certain point
(usually 5 to 7 years), the entire balance of the mortgage
is due.
• Graduated payment mortgage:
Both the duration (time) and the interest rates are set for
the life of the mortgage. Generally, payments are lower in
the first few years and then adjust upward for the remaining
payments.
• Conventional mortgages: Are
made by commercial lenders in the private sector.
• VA mortgages: Are guaranteed
by the Department of Veterans Affairs
• FHA mortgages: Are guaranteed
by the Federal Housing Administration
• Farmer's Home mortgages: Are
guaranteed by the Farmer's Home Administration.
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