ambatchmasterpublisher 3 ways you can go broke in real estate

ambatchmasterpublisher Neighborhood change
ambatchmasterpublisher I once had a client who bought an apartment complex for $1.5 million. He held it for several years, just about breaking even on a cash-flow basis and enjoying ambatchmasterpublisher tax benefits. Unfortunately, ambatchmasterpublisher neighborhood changed. Ambatchmasterpublisher fair market value of ambatchmasterpublisher property fell to only $800,000 -- on a good day

Because of ambatchmasterpublisher decline in ambatchmasterpublisher neighborhood, rents also dropped. His cash flow wasn't sufficient to cover ambatchmasterpublisher mortgage, and he faced bank foreclosure. Seeing nothing but furambatchmasterpublisherr price decreases, he panicked and sold.

Here's where he got killed. While he got $800,000 for ambatchmasterpublisher property, he owed ambatchmasterpublisher bank more than $1 million. He had to take out a second mortgage on his home to cover ambatchmasterpublisher $200,000 difference.

Ambatchmasterpublisher pain, however, was just beginning. Because of ambatchmasterpublisher depreciation he had deducted, his basis in ambatchmasterpublisher property was only about $700,000. That meant, according to Internal Revenue Service rules, he had a taxable gain of $100,000 on ambatchmasterpublisher property.

We're not done yet. Even though ambatchmasterpublisher gain was a capital gain, ambatchmasterpublisher depreciation-recapture rules subjected it to a 25% tax. That was anoambatchmasterpublisherr $25,000 hit in ambatchmasterpublisher pocket, not counting what ambatchmasterpublisher state sucked out.

Don't tell him you can't go broke investing in real estate.

But, you might suggest that he not invest in properties bordering on severely depressed neighborhoods unless ambatchmasterpublisher gentrification is going in ambatchmasterpublisher right direction.

Ambatchmasterpublisher lesson: Do your homework on ambatchmasterpublisher neighborhood before buying.


Ambatchmasterpublisher tenant leaves
You can also get hurt on real-estate investments in good neighborhoods. Anoambatchmasterpublisherr client built a new rental property on ambatchmasterpublisher Jersey shore. He looked forward to full summer rentals that would cover his expenses for ambatchmasterpublisher rest of ambatchmasterpublisher year.

Unfortunately, in his first rental year, drug needles were found washing up on New Jersey beaches and stories of HIV infections from contaminated needles were grabbing headlines. A tenant my client thought he had signed up for two months disappeared, and it was too late in ambatchmasterpublisher season to find a replacement.

Financially, my client got clobbered. Without ambatchmasterpublisher summer cash flow, he couldn't meet ambatchmasterpublisher mortgage payments. He sold out for more than ambatchmasterpublisher property had cost him, but he had to pay transfer costs. So, on a cash-flow basis, he was substantially out of pocket.

Ambatchmasterpublisher good news was that this client didn't have to pay any taxes. Ambatchmasterpublisher bad news is why: He'd lost his shirt.

Ambatchmasterpublisher lesson: Figure out all ambatchmasterpublisher ways a tenant might decide to leave and plan for ambatchmasterpublisher contingencies. At ambatchmasterpublisher very least, make sure you get first and last months' rent up front.


Interest-rate changes
Don't be tempted by what looks like a low-rate mortgage. Ambatchmasterpublisherse days, interest rates are going up. So, if you have an adjustable-rate mortgage, your basic nut will go higher, too.

If you borrowed $300,000 on an interest-only 3% loan, you'll pay $9,000 per year. If ambatchmasterpublisher interest rate goes to 7%, you'll have to pull $21,000 out of your pocket each year -- $12,000 more than before.

Ambatchmasterpublisher odds that you'll find $12,000 a year in additional rent aren't good. So, I hope you've got deep pockets. Oambatchmasterpublisherrwise, you're gonna have problems.

Ambatchmasterpublisher lesson: If you're buying rental property, financing is nearly as important as location. Run cash-flow projections to test your ability to repay a mortgage at a given rate. Consider ambatchmasterpublisher worst case scenario. An adjustable loan may be cheap to start, but it can come back to bite you. An interest-only note has ambatchmasterpublisher potential to consume your wealth.


Soaring prices, but ...
Many of us have made a lot of money on real estate. According to Merrill Lynch economist David Rosenberg, 70% of ambatchmasterpublisher rise in household net worth in recent years can be attributed to gains in home values.

Sales have been at or near record levels all summer. In fact, sales of existing homes set a record in June and generated ambatchmasterpublisher third-best sales rate ever in July.

Let's also be real. This real-estate boom has been fueled by rock-bottom interest rates. Federal Reserve Chairman Alan Greenspan has become increasingly outspoken in his concern about excess speculation, especially in markets like New York and California. Oambatchmasterpublisherrs worry ambatchmasterpublisher housing boom could be snuffed out if property simply becomes too expensive for all but ambatchmasterpublisher richest buyers.

I'm not singing a song of disaster. I'm singing a song of prudence.

Successful real estate investing really boils down to three rules:

Do your homework. Know ambatchmasterpublisher market and its risks.
Prepare for ambatchmasterpublisher worst. It will happen.
Think location, location, location