Investment Property

If you're like most of us, you've no doubt seen the infomercials on television that promise you can get rich buying real estate (usually with no money down). Like the various magic diet aids and wrinkle creams, we wish we could tell you this is absolutely true, but we can't. So what's the scoop? Is real estate a good investment vehicle? For some people it is, but for the large majority of us, the drawbacks may be too great.

A huge drawback of any investment in real estate is the unpredictability of the real estate market. The risk factor increases because your investment is not liquid. With the exception of some very small or very desirable-at-any-price properties, you don't just up and sell real estate. Why should you care about how liquid an investment is? Well, because none of us has a crystal ball, and you never know when you might need to get your hands on some cash in return for your investments. Despite your best investment planning, you don't want to be in a situation where you're doing great on paper, but might have to sell at a loss (if you can sell at all) to get a hold of needed funds.

Planning Note The exceptions to this investing in property drawback are real estate investment trust (REIT) funds and mortgage-backed securities. If you invest in real estate in this manner, you can obviously buy and sell your investments with the same ease you do other mutual funds.

That being said, let's take a look at the different types of investment real estate you might contemplate owning.

Fixer-uppers. You can make money through investing in real estate if you buy houses, condominiums, buildings, etc., that need some work at a bargain price and fix them up. You can probably sell the real estate for a higher price than you paid and make a profit. However, don't underestimate the work, time and money that goes into buying, repairing and selling a home when you are determining whether it will be profitable for you to invest. Also, remember that different tax rules will apply to the purchase and sale of a home if it is not your principal residence.

Rental property. You can buy real estate for rental purposes and receive an income stream from renters. The property may be residential or commercial. You may also be able to eventually sell the property for more than you bought it for and make a good profit. Although, don't forget that you will now be a landlord who may have to deal with nonpaying tenants and destructive tenants. Even if you have the world's best tenants, you still have to deal with upkeep of the property and any problems that come up. Some investors hire a property manager or management company to manage their investment real estate. This is fine, but don't forget to factor in the management fees when you're calculating your profit from the investment.

Tip A popular method of investing in real estate for many investors is to not sell their present home when they buy a new one and rent it out instead. This is especially common for folks who move from a condominium or starter home to a bigger home in the same general area. If you don't need the proceeds from the sale of your present home to purchase a new home, this may be an investment alternative for you. It's much more manageable because you will probably only own one or two properties other than your home. If you own your present home outright without any mortgages, you may even consider seller financing--holding a mortgage for a new homeowner and receiving an income stream from his mortgage payments.

Please remember that rental real estate is subject to different tax rules than the home you reside in. You may be able to take tax deductions for losses, capital expenditures and depreciation if you meet certain requirements, but other deductions specific to principal residences may not be available to you.

Unimproved land. Unimproved land is a difficult investment to make a profit in. Unless you manage to buy a piece of land that is extremely desirable at a good price and are certain that it is not barred from profitable use for the neighborhood it is located in (because of zoning or other issues), it will probably cost you more to own the property than you will ever make selling it. (Remember, you will still have to pay property taxes and will also likely incur other upkeep costs on the land, and you won't be receiving any income from rents.)

If you have some sort of inside scoop on a piece of land (for example, the person in the house on the lot next to the land is a wealthy recluse and does not want the property built upon so you can name your price to sell it to him) or plan on developing it yourself (building your home on a piece of property next to a lake), in that case it may be a good investment.

Financial Calculators Meeting your long-term investment goal is dependent on a number of factors. This not only includes your investment capital and rate of return, but inflation, taxes and your time horizon. Use this Investment Returns Calculator to help you sort through these factors and determine your bottom line. Click the "View Report" button for a detailed look at the results.

Second homes. Second homes or vacation homes should be purchased primarily for vacation purposes, not investment purposes. Most people end up with a loss on their vacation home properties because even if you can manage to rent the home, the costs of owning the home almost always exceed the rental income it bring in.

Tip If your vacation home costs are more than you get in rental income for the year, you may be eligible to deduct the losses from your adjusted gross income. Also, if you have a mortgage on your second home you may be eligible for a mortgage interest deduction. However, as we must always repeat, investing in anything primarily for a tax benefit is almost never a good idea.

Timeshares. If you had to pick a rotten apple out of the barrel of real estate investments, it would almost surely be timeshares. Timeshares are best defined as buying a set period of time (usually one or two weeks) during a certain time of the year at a certain location (for example, a condominium in Florida or a villa in France). What's the advantage for you if you buy a timeshare? You get a fixed vacation cost each year, and you can trade weeks and locations with other timeshare owners in the same company.

So what's the problem? The problem is that, first of all, you're not buying any property, just time, and at an expensive price too, particularly if you're interested in the most popular locations and times of year (Hawaii during the Thanksgiving holiday will cost you plenty). Also, trading with other timeshare owners is not as easy as it sounds, especially since most people want the same popular locations and times of year. Even after you pay off your timeshare, you must still pay maintenance fees every year that could probably pay for a nice vacation.

But isn't it still an investment? If you simply go on vacation, you have nothing but pictures and bills to show for it. Don't you own something with a timeshare, something you can sell and make a profit from? In a word, don't count on it. Chances are great that you couldn't sell your timeshare at any price, much less a profit. We know of cases where people couldn't even give them away to charities, because of the maintenance fees involved! And it may be telling that in bankruptcy cases, timeshares are often assigned zero value as an asset.

So remember, if you're ever lured by a sales pitch (or the free dinners or theater tickets and the like given away by timeshare companies as an inducement to get prospective customers to listen to their sales pitch), ask yourself, if this is such a wonderful investment, why must they give away all this free stuff to sell it and why is this deal only good for today (timeshare salespeople typically demand that you sign right then and there)? When is it ever a good idea to sign on the dotted line and commit to paying thousands of dollars without thinking it over and doing some research? Unless you are so certain about a location and facility that you are sure this is where you want to vacation for two weeks for the next ten or more years, for investment purposes forget about timeshares!

Tip If you already own a timeshare, make sure you're availing yourself of any tax benefits you're entitled to.