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xiiCONTENTSWhat Types of Improvements Pay the Greatest Returns?157How Much Should You Budget for Improvements?157Beware of Overimprovement158Other Benefits158No-No ImprovementsBudgeting for Resale Profits159159Estimate the Sales Price First159Estimate Costs160Future Sales Price Less Costs and Profit EqualsAcquisition Price160Comply with Laws and Regulations162Should You Buy a “Fixer”?162Too Little Time?163Put Your Creativity to Work1639 MORE TECHNIQUES FOR HIGH YIELDSAND QUICK PROFITSLease Options165165Here’s How Lease Options Work165Benefits to Tenant-Buyers (An Eager Market)166Benefits to Investors167The Lease Option SandwichHow to Find Lease Option Buyers and Sellers168169A Creative Beginning with Lease Options(for Investors)Lease Purchase Agreements170170“Seems” More Definite171Amount of the Earnest Money Deposit171Contingency Clauses171Conversions172Condominium Conversion172Tenants in Common174Convert Apartments to Office Space175

CONTENTSxiiiMaster Leases176Assignments: Flipping Purchase Contracts178Summary17910 NEGOTIATE A WIN-WIN AGREEMENT180Win-Win Principles181The Purchase Contract183Names of the Parties184Site Description184Building DescriptionPersonal Property184185Price and Financing185Earnest Money Deposit186Quality of Title187Property Condition187Preclosing Property Damage (Casualty Clause)188Closing (Settlement) Costs189Closing and Possession Dates189Leases190Contingency ClausesAssignment and Inspection191192Public Records193Systems and Appliances193Environmental Hazards193No Representations194Default Clause194Summary11 MANAGE YOUR PROPERTIES TO INCREASETHEIR VALUEThe 10:1 Rule (More or Less)197199199Think First200Know Yourself201

xivCONTENTSKnow Your Finances201Know Your Capabilities202Smart Strategic Decisions202Local Markets Require Tailored Strategies203Craig Wilson’s Profit-Boosting Market StrategyHow Craig Wilson Used Market Information to Enhancethe Profitability of His Property203ResultsCut Operating Expenses206210210Energy Audits210Property Insurance211Maintenance and Repair Costs214Property Taxes and Income TaxesIncreasing Value: Final Words12 DEVELOP THE BEST LEASEThe Mythical “Standard” Lease214215216216Your Market Strategy216Search for Competitive Advantage218Craft Your Rental Agreement219Names and SignaturesJoint and Several Liability219219Guests220Length of Tenancy220Holdover Tenants (Mutual Agreement)220Holdover Tenants (without Permission)221Property Description221Inventory and Describe Personal Property221Rental Amounts222Late Fees and Discounts222Multiple Late PaymentsBounced Check Fees and Termination222223Tenant “Improvements”223

CONTENTSxvOwner Access223Quiet Enjoyment224Noxious Odors224Disturbing External Influences224Tenant InsuranceSublet and Assignment225225Pets226Security Deposits226Yard Care228Parking, Number, and Type of Vehicles228Repairs228Roaches, Fleas, Ants229Neat and Clean229Rules and Regulations229Wear and TearLawful Use of Premises230230Notice230Failure to Deliver231Utilities, Property Taxes, Association Fees231Liquid-Filled Furniture231Abandonment of Property232Non-waivers232Breach of Lease (or House Rules)232No Representations (Full Agreement)233ArbitrationAttorney Fees (Who Pays?)233234Written Notice to Remedy235Tenants Rights Laws235Tenant Selection235Property Operations237Evictions237Landlording: Pros and Cons238Possibilities, Not Probabilities238Professional Property Managers238

xviCONTENTS13 CREATE SALES PROMOTIONS THATREALLY SELLDesign a Winning Value Proposition240240Yet Generic Prevails240USP versus WVP241Craft Your Selling MessageUse a Grabber Headline/Lead243244Reinforce and Elaborate244Add Hot Buttons244Establish Credibility245Compare to Substitutes245Evoke Emotional Appeal245Reduce Perceived Risks245Make It Easy for Prospects to Respond245Follow Up with Your Prospects247Reach Potential BuyersFor Sale Signs247247Flyers/Brochures248Networking (Word of Mouth)249Web Sites/Links249Sales Agents249Should You Employ a Realty Agent?249Services to Sellers250Services to Buyers251Co-Op Sales252Listing Contracts25214 PAY LESS TAX255The Risks of Change and Complexity255Homeowner Tax Savings256Capital Gains without Taxes256Rules for Vacation Homes257Mortgage Interest Deductions258

CONTENTSxviiCredit Card Interest258Rules for Your Home Office259Depreciation Expense259Land Value Is Not Depreciable259Land Values Vary WidelyAfter-Tax Cash Flows260260Passive Loss Rules261Taxpayers in the Real Property Business (No PassiveLoss Rules)262Alternative Minimum Tax262Capital Gains263A Simplified Example263The Installment Sale264What’s the Bottom Line for Sellers?265Implications for Buyers265Tax-Free Exchanges265Exchanges Don’t Necessarily Involve Two-Way Trades266The Three-Party ExchangeExchanges Are Complex but Easy266266Are Tax-Free Exchanges Really Tax Free?268Section 1031 Exchange Rules268Reporting Rental Income and Deductions269Tax Credits271Complexity, Tax Returns, and Audits272Use a Tax Pro275Property Taxes276Summary27815 MORE IDEAS FOR PROFITABLE INVESTINGLower-Priced Areas280281What about Property Management?283Tenant-Assisted Management283Property Management Companies283

xviiiCONTENTSEmerging Growth Areas284The Creative Class284Implications for Investing in Real Estate284Right Place, Right Time285Emerging Retirement/Second-Home AreasWhich Cities and Areas?285286Income Investing286Commercial Properties286Property Management287The Upside and Downside287Opportunity for High Reward287Commercial Leases Create (or Destroy) Value289Triple Net (NNN)290Self-Storage291Mobile Home ParksProfitable Possibilities with Zoning292294Tax Liens/Tax Deeds294Localities Differ294Are Tax Liens/Tax Deeds an Easy Way to MakeBig Profits?295Discounted Paper295What Is Discounted Paper?295Here’s How It Works296Broker the Note296Do Such Deals Really Occur?296Due Diligence Issues296Should You Form an LLC?297Different Strokes for Different FolksInsufficient Court Rulings297297One Size Doesn’t Fit All29816 AN INCOME FOR LIFE299Less Risk301Personal Opportunity301Index304

PrologueINVEST IN REAL ESTATE NOW!early everywhere I speak these days, someone from the audienceasks, “Do you feel the real estate market will drop further? Havewe reached bottom yet? When do you think property prices willfully recover?”I answer, “I do not know. I really do not care. And neither shouldyou.”Why do I give such seemingly flip answers? First, because they aretrue. All investment pros encourage you to focus on your wealth-buildinggoals—not profit maximization per se. Waiting for the bottom merely givesyou an excuse to procrastinate. I’ve seen would-be investors make thismistake a thousand times.And second, because the questions are ill-formed. They miss identifying the multiple ways that you can profit with property. To investsuccessfully in real estate, you need not, and should not, focus on predicting market valleys (or peaks). More productively, think in terms ofpossibilities, probabilities, and strategy—not merely the lowest price.NWHAT ARE YOUR POSSIBILITIES?If you asked financial journalists (or their quotable experts) whether youshould now invest in real estate, you would likely receive a variety ofanswers. But nearly all of their answers would focus on one central point:the expected direction of short-term price movements.Journalists and their media molls love to play the game of shortterm forecasting. They do it with stocks, gold, commodities, interest rates,and, for the past 10 years, properties. Are prices climbing? Buy. Are pricesxix

xxPROLOGUEfalling? Get out and go sit on the sidelines. As a result of their obsessionwith short-term price movements, the media have distorted and confusedthe idea of investing in real estate.In contrast to media hype, the most experienced and successful realestate investors do not weight their deal analysis with any significantemphasis on short-term price forecasts. Instead, we typically look to aninvesting horizon of three to 10 years (or longer). More important, werealize that in addition to price increases, property provides us with manypossible sources of return. Here are some (but certainly not all) of theseprofit possibilities. Earn price gains from appreciation.Earn price gains from inflation.Create unleveraged cash flows.Use leverage to magnify returns from price gains.Use leverage (financing) to magnify returns from cash flows.Grow equity gains through amortization.Refinance to increase cashflowsRefinance to generate cash (lump sum).Buy at a below-market-value price.Sell at an above-market-value price.Create value through smarter management.Create value through savvy market strategy.Create value by improving the location.Subdivide your bundle of property rights.Subdivide the physical property.Create plottage (assemblage) value.Convert the use (e.g., residential to offices, retail to offices).Convert type of tenure (e.g., rental to ownership).Shelter income from taxes.Shelter capital gains from taxes.Create and sell development/redevelopment rights.Diversify away from stocks and bonds.I explain each of these possible sources of return in Chapter 1 andthen illustrate and elaborate to varying degrees in the chapters that follow.With this extensive range of possibilities in view, you can always findprofitable ways to invest in real estate.Unlike investing (or speculating) in stocks, bonds, gold, or commodities, you can generate returns from properties through research, reasoning,knowledge, and entrepreneurial talents. In contrast, when you buy stocks,

PROLOGUExxiyou had better pray that the market price goes up, because that’s your onlypossibility to receive a reasonable return. WHAT ARE YOUR PROBABILITIES?In the correction part of the real estate cycle, fear looms. Cash balances inbanks build up. Investors and savers join in a flight to quality. They willingly accept certificates of deposit (CDs) that pay low-single-digit interestrates. Investors think, “Who cares about return on capital? I just want tofeel confident that I receive a return of capital.In his highly regarded book The Intelligent Investor, Benjamin Grahamcreated the parable of Mr. Market. Mr. Market represents that crowd mentality whose moods swing like a pendulum from irrational exuberanceto bewildered fear and confusion. Which market mood provides the bestinvestment opportunities/possibilities? Which market mood throws investors the highest amount of actual risk? Which market mood corresponds to the least amount of actual risk?Booms Increase Actual RiskYou know the answers. During the irrationally exuberant boom times, investors perceive little risk, but actual risks loom larger and larger as pricesclimb higher and higher, income yields fall, and unsustainable amounts ofmortgage debt pile up.In Las Vegas, so-called investors (actually speculators) believed thatflipping properties paved their way to wealth. Few perceived that theirproperty risks actually laid down poorer odds than the slots at Harrah’s.And who but a fool (or Panglossian optimist) would borrow money toplay the slots? Yet Las Vegas property buyers loaded up with excessivelyhigh loan-to-value (LTV) ratios of 90, 95, and 100 percent (or more). Theymerely assumed that the future would continue to pay off as they hadexperienced in the recent past.On many of their properties, loan payments (principal, interest, taxes,and insurance [PITI]) approached 2,000 a month. Potential rents for thesame properties would reach no more than 1,200 a month. When analligator is chewing your leg off, you are in a world of danger (and aworld of hurt). As I have written in nearly every one of my books, highdebt, low income yields, and exaggerated hopes for outsized continuing With property, I have earned per annum returns of 25 percent or more—withouta single dollar of price gain.

xxiiPROLOGUEincreases in price (for either stocks or properties) always trigger a reversalof fortune. (See especially my Value Investing in Real Estate, John Wiley &Sons, 2002.)The speculative buying of Las Vegas houses serves as an outsidethe-norm example. Few other areas experienced such heightened frenzyamong both builders and buyers. Nevertheless, irrational exuberanceinfested the moods and minds of property buyers throughout manyof the world’s principal cities (though during the boom of late, notDallas, Berlin, or Tokyo—each had suffered its own irrationally exuberant property market 15 to 20 years back, and sat out this most recentparty). In nearly every instance, borrowed money fueled property pricesupward without commensurate growth in rent collections or personalincomes.Market Corrections Vanquish Market RiskWithin a few short years, many property markets have shifted from sellers’ markets driven by loose lending and buoyant dreams of fast, easymoney to buyers’ markets sustained by stricter credit standards, recordnumbers of foreclosures, a 25-year high in unemployment, and multiplemajor banks taking hits for unprecedented amounts of losses. No wonderfear and confusion have chased many potential property investors out ofthe game.So here is the 64,000 question: How should you interpret these andother dismal facts from the dismal science? Do lousy economic conditionsdiminish your chance to build a prosperous and secure future by investingin property? Or do they vanquish market risk?To make this question of risk easier, first address the following 10issues. When is the best time to acquire investment property:1. (a) When builders are bringing to market near-record numbersof new houses, condominiums, and condominium conversions,or (b) when new housing starts have fallen to the lowest levelsince before 1959?2. (a) When buyers flock to open houses and beg sellers to accepttheir above-asking-price bids, or (b) when investors and homebuyers remain relatively scarce?3. (a) After economic recovery pushes interest rates higher, or(b) when interest rates sit near the low end of the past 40 years?4. (a) When inflation seems subdued (as occurred during thepast eight years), or (b) (as today) when massive amounts of

PROLOGUE5.6.7.8.9.10.xxiiigovernment borrowing and huge increases in the money supplyseem sure to push inflation (and interest rates) to higher levelswithin the coming decade?(a) When properties sell for prices at a 20 to 50 percent premiumabove their replacement costs, or (b) when you can buy propertiesat a 20 to 50 percent discount below their replacement costs?(a) When millions of home buyers overleverage to purchasehouses that they cannot afford, or (b) when stricter credit andhigh unemployment lead many people to double up (or eventriple up) on their housing?(a) When most sellers can hold out for top dollar, or (b) whenfinancial distress and more than one million foreclosures/REOscreate millions of desperately motivated sellers?(a) When property prices sit in the clouds well above the levelthat rents will support, or (b) when market values fall to thepoint where income yields make sense and investors can reasonably expect to achieve positive cash flows—either immediatelyor within a few years?(a) When hundreds of thousands of new investors overleveragethemselves to buy rental properties that they do not know howto manage, or (b) when those same starry-eyed investors rudelyawaken to the fact that successful investing requires reserves ofcash and credit, knowledge, thought, and an operating systemand strategy?(a) When economic recovery and increasingly positive news propel millions of backbenchers into the game, or (b) now?If you’ve answered (b) to each of these 10 issues, you display thecourage and foresight to become a great investor. You know that marketcorrections vanquish risk and multiply your possibilities for profit.Never Wait for Market Peaks or BottomsTo invest successfully, never try to time a market bottom—or a market top.Neither you, I, nor anyone else can develop that skill. Why? Because moreoften than not, random events trigger short-term turns in markets. Wecan tell when markets are becoming too pricey. We can tell when marketconditions greatly favor investors. But only by extraordinary luck can wepick the one best time to sell or buy. (Just as importantly, the way younegotiate a deal can create as much or more opportunity for you than themarket conditions themselves.)

xxivPROLOGUEMy Texas Example I owned properties in Texas in the early 1980s. Bymid-1984, I had sold all of them (at substantial gains). The market continued to go up. Property agents told me that I shouldn’t have sold. Later,after the crash in 1985, they told me that I had sold too soon. What do youthink?When do you replace the tires on your car? At the last possiblemoment before they blow out? Or when you see the tread wearing downand the risk of a blowout increasing? If you want to save your life, do nottry to run your tires until the last possible moment.Likewise with property, when irrational exuberance fuels prices everhigher and these prices are unsupported by rent levels or personal income growth, risk builds excessively. Prudence sells to save profits. Onlyfools hold on to capture the last dollar—or the last 1,000 miles from thatrisky, worn tire. And only bigger fools believe that tires or booms will lastforever.Look for Solid Value—Not Necessarily a Market Bottom or Market BoomToday’s markets offer multiple low-risk, high-profit possibilities. Overa time horizon of three to five years—if you follow the principles laidout in this book—you will enjoy strong profits. I encourage you to getin the game now. No one can predict the course of prices during thenext year or two. But today, you can certainly find solid values in mostmarkets.In my experience, two major mistakes prevent people from profitingwith property: (1) They wait too long to exit an irrationally exuberantmarket, and (2) they wait too long to take advantage of the possibilitiesthat are theirs for the taking.DEVELOP AND EXECUTE YOUR STRATEGY NOWAs you read through the following pages, you will discover how propertyprovides at least 22 sources of financial returns. Plus, you will discovermultiple ways to harvest those returns.Buying, improving, and holding income properties—especiallywhen you purchase them at bargain prices and finance with smartleverage—offers the surest, safest, and, yes, even the quickest way to buildwealth. But even long-term investors such as myself will venture alongother avenues when clear opportunities arise.In addition to the buy, improve, and hold approach, other techniques include discounted paper, real estate investment trusts (REITs),

PROLOGUExxvcondominium conversions, fix and flip, adaptive reuse, tax liens, mobilehome parks, self-storage centers, lease options, triple net leases, and otherpossibilities to profit through property.If you want a secure f

Investing in real estate / Gary W. Eldred.—6th ed. p. cm. Includes index. Rev. ed. of: Investing in real estate / Andrew J. McLean and Gary W. Eldred. 5th ed. 2006. ISBN 978-0-470-49926-9 1. Real estate investment—United States. I. McLean, Andrew James. Investing in real est