From REI Academy
If you're retired or saving for retirement, it's likely that
your stock-laden portfolio looks a little less invulnerable than
it did a couple of years ago. It's possible, too, with interest
rates on bonds, money market funds and bank CDs at all time
lows, that you're counting on a fixed income that doesn't fully
meet your needs.
"If only I could increase my monthly income without depleting
my nest egg," you think, "and without losing sleep over the
stock market." Well, there are ways to make this happen: by
investing in trust deeds, or private mortgages loans, by
investing in tax liens certificates, and by investing in real
estate investment trusts or REITS.
Private Mortgage Loans Simply put, trust deeds are
short-term loans to real estate investors secured by the value
of the real property as collateral. Investors who invest in
trust deeds typically make a 12 to 18 per cent return, paid out
monthly, with a minimum investment of just $50,000 and
relatively low risk. As a result, they are able to enhance their
lifestyle significantly without threat to their principal, or
built a large nest egg, safely, in a relatively short period of
time.
When you invest in a trust deed, you are in essence buying a
mortgage secured by real estate. You receive fixed monthly
payments from the borrower based on the terms of a promissory
note.
You can invest in trust deeds on your own, lending your money
directly to a borrower. But it wouldn't be advisable unless you
have the time and expertise to evaluate property and to screen
out borrowers, and know your way around the legal maze of real
estate transactions.
Or, you can invest in trust deeds through companies that
specialize in this type of investment.
By far the biggest attraction of trust deeds is their high
yield. Borrowers, often real estate investors, are willing to
pay interest rates of 12 percent and higher because they need a
quick short-term loan to purchase or refinance a property
without the hassles and red tape they may run into at a bank.
Or sometimes borrowers may not qualify for traditional
financing at lower rates because of minor credit problems or
liens against the property.
Or the property may be too small or located in an area that
makes conventional financing difficult.
Your protection against default is the property that secures
the promissory note. That's why it is so important to invest in
trust deeds with a low "loan-to-value ratio."
In other words, the loan should be only for a certain
percentage of the appraised value of the property (and you must
use a reliable and experienced appraiser). As a guideline,
investors should seek loan-tovalue ratios no higher than 70
percent for single-family homes, 65 percent for apartments and
65 percent for commercial and industrial developments.
One risk of trust deeds is lack of liquidity - you typically
can't get your hands on your principal until the loan is paid
off. Trust deed loans often are for a year or two.
Another risk is the possibility of default and foreclosure.
True, you are likely to recover your money eventually and even
make a profit from the sale of the foreclosed property. But in
the meantime you may go months without receiving any interest
payments.
That said, trust deeds available through reputable and
experienced firms offer an attractive combination of risk and
reward.
But what happens in a recession, particularly one in real
estate?
If you believe property values are going down 10 percent, you
are still protected by having claim to property assessed at a
higher value than the loan amount. Of course, if you believe
property values are going to go down 50 percent, then you are
not protected.
But then many stocks and even some stock mutual funds have
gone down 50 percent or more in the past year. That's why many
investment advisors consider a portfolio of carefully selected
first trust deeds with low loan-to-value ratios and secured by
properties in desirable locations to be a much safer investment
than stocks. And trust deeds historically have delivered similar
or even higher long-term returns, without the nerve-wracking ups
and downs of stocks.
TAX LIEN CERTIFICATES
How would you like to make money paying someone else's real
estate taxes? There's a little-known investment opportunity
available in 31 states where investors can put up as little as a
couple hundred dollars to get in on the action. You're probably
thinking: "I pay enough taxes as it is, why would I want to pay
someone else's taxes, too?" Well, how does an annual interest
return from 18 to 50 percent sound?
These returns are available through tax lien and tax deed
certificates sold throughout the country on a county basis. Tax
liens are what the local government places on properties where
real estate taxes are late. Figuring that they won't get that
money right away, the local government auctions off the lien to
investors once or twice a year. These are called "tax sales."
If owner Smith owes $2,000 in real estate taxes and hasn't
paid it, the county will place a lien on his property and then
auction that lien to an investor. The investor gets the lien for
$2,000 and the county gets the money it needs right away to pay
its ongoing expenses. Meanwhile, the treasury or finance
department then starts going after the money from the delinquent
tax payer. They send nasty little notes, warning them of further
action and placing stiff penalties and interest charges on the
tax. These interest charges can be as high as 50 percent - and
that's how the local government can then turn around and pay
these investors 16, 18, 20 percent and more.
The place to find these nifty investments is at the local
treasury or finance department. There are also web sites where
the information has been compiled. You could end up paying as
much as $39 per state for the information or, as on one site I
visited, $49 for the whole country (encompassing 3,300
counties). Since more than likely youre going to go after local
liens to start with, save yourself the money and just contact
your local treasury or finance department. If you don't know
where that is, then just call the main information number for
your county or city and ask for the tax department - they can
help you from there.
Basically, these are short term investment opportunities.
After the lien has been auctioned off, the county lets the owner
know that they may lose their property to the tax lien
certificate holder if they don't pay the taxes and now taxes,
interest and penalties. This gives the property owner another
opportunity to redeem the tax bill and keep his/her property. If
they don't, then the tax lien certificate holder can foreclose
on the property.
In some areas, instead of a foreclosure, the government
actually sells you a tax deed to the property - meaning if the
taxpayer doesn't pay the taxes, you become owner of the property
straight out. There are the amazing stories about people hitting
it rich in these tax sales. Theres one floating around about a
gentlemen in Tulsa, Oklahoma who paid $17 at a tax sale for a
property he then sold for $4,400 and another where the property
was bought for $298 in back-taxes and sold for $8,450. It's also
true that each year people are hit by lightning. There are risks
and hazards with tax certificates. The property might be
trashed, you could lose your investment by not following
procedures, title may be weak, and - lets face it - former
owners may be both irate and well armed.
Because the liens are auctioned, a hot property might only be
available with unattractive terms. In some jurisdictions, you
may "win" the property but then be responsible for all unpaid
taxes and mortgages. If you have to foreclose, that may result
in another round of costs. In some jurisdictions, the owner may
have an "equity of redemption" right that allows him or her to
re-acquire the property after a foreclosure action. Be aware of
these and other risks and act accordingly. Investors must carry
out due diligence to limit risk. This means researching the
properties (which are usually publicized in a local newspaper or
on the tax departments web site a few weeks before the sale),
understanding your potential obligations, knowing what the rules
are, speaking with local brokers and attorneys, and realizing
that while you may do well in the best circumstances, the "best
circumstances" may be rare.
Most impacted property owners (about 95 to 98 percent)
actually pay the taxes. So most folks who invest in these
certificates are doing so for the interest paid on their money.
There's a lot more to these sales, and various jurisdictions
have different rules. As an example, visit the Montgomery
County, Md., tax sale web page for a good example of what will
be required of tax sale. For those interested, research the
process, visit an auction first to watch how its done, know the
rules, and then decide if this is an investment for you.
REAL ESTATE INVESTMENT TRUSTS
A REIT is a company that buys, develops, manages and sells
real estate assets. REITs allow participants to invest in a
professionally-managed portfolio of real estate properties.
REITs qualify as pass-through entities, companies which are able
distribute the majority of income cash flows to investors
without taxation at the corporate level (providing that certain
conditions are met). As pass-through entities, whose main
function is to pass profits on to investors, a REIT's business
activities are generally restricted to generation of property
rental income. Another major advantage of REIT investment is its
liquidity (ease of liquidation of assets into cash), as compared
to traditional private real estate ownership which are not very
easy to liquidate. One reason for the liquid nature of REIT
investments is that its shares are primarily traded on major
exchanges, making it easier to buy and sell REIT assets/shares
than to buy and sell properties in private markets.
Following WWII, the demand for real estate funds skyrocketed
and President Eisenhower signed the 1960 real estate investment
trust tax provision which established the special tax
considerations qualifying REITs as pass through entities (thus
eliminating the double taxation). This law has remained
relatively intact with minor improvements since its inception.
REIT investment increased throughout the 1980s with the
elimination of certain real estate tax shelters.
Investments in real estate provided investors with income and
appreciation. The Tax Reform Act of 1986 allowed REITs to manage
their properties directly, and in 1993 REIT investment barriers
to pension funds were eliminated. This trend of reforms
continued to increase the interest in and value of REIT
investment. Today, there are over 300 publicly traded REITs
operating in the United States their assets total over $300
billion. Approximately two-thirds of these trade on the national
stock exchanges.
REITs fall into three broad categories:
Equity REITs: (96.1%)
Equity REITS invest in and own properties (thus responsible
for the equity or value of their real estate assets). Their
revenues come principally from their properties' rents.
Mortgage REITs: (1.6%)
Mortgage REITs deal in investment and ownership of property
mortgages. These REITs loan money for mortgages to owners of
real estate, or invest in (purchase) existing mortgages or
mortgage backed securities. Their revenues are generated
primarily by the interest that they earn on the mortgage loans.
Hybrid REITs: (2.3%)
Hybrid REITs combine the investment strategies of Equity
REITs and Mortgage REITs by investing in both properties and
mortgages.
Individual REITs are able to distinguish themselves by
specialization. REITs may focus their investments geographically
(by region, state, or metropolitan area), or in property types
(such as retail properties, industrial facilities, office
buildings, apartments or healthcare facilities). Certain REITs
choose a broader focus, investing in a variety of types of
property and mortgage assets across a wider spectrum of
locations.
The current REIT industry's investment choices can be broken
down by property type as follows: Retail 20.1% Residential
21.0% Industrial/Office 33.1% Specialty 2.3% Health Care
3.8% Self Storage 3.6% Diversified 8.5% Mortgage Backed
1.5% Lodging/Resort 6.1%
Both foreign and domestic sources provide investment in the
REIT market. REITs are owned by thousands of individuals, as
well as large institutional investors including pension funds,
endowment funds, insurance companies, bank trust departments and
mutual funds. Investment goals for REIT share ownership are much
the same as investment in other stocks--current income
distributions and long-term appreciation potential.
The majority of REIT shares can be purchased on the major
stock exchanges, and orders can be placed through stockbrokers.
Financial planners and investment advisors can help to match an
investor's objectives with individual REIT investment. REITs
also provide an annual report, prospectus and other financial
information directly to an investor. Recently, mutual funds have
emerged specializing in REIT investment.
In general, REITs and their performance have some common
characteristics with small-cap stocks and bond-like investments.
The market capitalization of the average REIT on the Wilshire
Real Estate Securities Index is $340 million. REITs comprise 6%
of the small-cap index, the Russell 2000. However, REITs have
advantages over stocks and bonds in terms of dividends: between
1995 and 2000, the average dividend yield on REITs (7.3%) is six
times that of the Russell 2000 average dividend.
Furthermore, all REITs pay dividends, whereas less than half
of the Russell 2000 stocks pay dividends.
The long term performance of an individual REIT is determined
by the value of its real estate assets at any given time. One of
the primary incentives for REIT investment is the low
correlation of its value to that of other financial assets.
Because of this, REITs possess low relative historical
volatility and provide some degree of inflation protection. In
addition to the advantages of an investment which avoids double
taxation and requires no minimum investment, REITs offer
investors current income that is usually stable and often
provides an attractive return. Another factor attractive to the
investor is that a REIT's performance is monitored on a regular
basis, by independent directors of the REIT, analysts, auditors,
and the business and financial media.
