HIS Experts

Member Question: What will be the effect of the changing interest rates just decided by the Fed? There’s a lot of talk whenever the Fed changes rates on how it will impact the overall economy. But how will this affect the real estate market?

Answer from the Boardroom:  Generally, when the Fed adjusts interest rates it affects how banks and other lending institutions loan money for things like real estate.  While there may not be a direct correlation between mortgage rates and the Fed’s discount rate, it does affect the bank’s willingness to lend money and at what rates. 

If the Fed has a loose monetary policy, it will make more money available to banks at lower rates which can then be filtered into the economy in the way of loans for various things such as purchasing real property or financing business growth. 

If the Fed raises rates, the lending institutions will still make money available to borrowers, but may tighten their lending requirements to borrowers by requiring more documentation on the borrower’s ability to repay the loan and charging a higher interest rate.

In a higher interest rate market, the debt service on real estate is greater and makes it  more expensive to maintain a property.  Cash flow can turn negative for investors if the debt service and maintenance costs exceed the property’s income from tenants. 

A negative cash flow proprty is not a good investment.  The only “positive” for a negative cash flow property is the hope of appreciation.  As interest rates rise, generally less people can afford the monthly payments on a house, so property values may decrease.  It will take longer to realize that “hoped for” appreciation, but  historically, the appreciation will happen over the years. But be prepared to wait out the down times.

Member Question: How “liquid” are the different kinds of real estate investments? How easy would it be to sell if I needed my money right away?

Answer from the Boardroom:  Real estate is not a liquid market.  The most liquid real estate is one that makes sense to the largest group of investors who are interested in purchasing that type of property.  There are more individual investors than institutions buying real estate, therefore, the types of properties that individuals can purchase are probably the most liquid. 

However, if the price of your property is not in line with the market prices of similar properties, then you will not be able to sell it and it will not be “liquid” until you bring the price in line with the market.  If you are willing to discount a property to a price well below market value, then it will be more attractive to any investor or end user and you will be able to liquidate it quickly.

In the commercial real estate market, cash flow is what sells a property.  If an investor can purchase the property and his down payment combined with financing allows him to have positive cash flow, then it will be attractive to other investors as well.  Price does make a difference in how the cash flow numbers work out, so the better the price and financing terms, the more liquid the property.

Generally, raw land is the most illiquid since it must be developed before it can be used by an owner.  Most purchasers of raw land have a longer term investment horizon because they are waiting for development to move in their direction.  The longer that takes, the more illiquid the property.

Member Question: What do you think of the government’s proposal on the table where they are thinking of possibly enacting a government-sponsored foreclosure bailout? How might this affect the real estate marketplace if it happens? How might it affect us as taxpayers?

Answer from the Boardroom:  Proposals from Congress or the President will have an impact on those investors who are trying to buy pre-forclosures or foreclosures.  If the government steps in to rescue home owners who are potentially going into default or lending instituitons forgive late payments or restructure loans for homeowners, there will be fewer properties available at the foreclosure auctions.  However, the current proposals have many qualifiers for existing homeowners, so not all potential foreclosures will be affected by them.

If there are fewer foreclosures on the market at depressed prices, it should stabilize the market.  But with all the past foreclosures, the appraised values have already dropped and many appraisers are having difficulty determining true value for lenders to loan new money on.  It will take a while for the market to sort itself out, even if the foreclosures dry up some.

We the taxpayers always pay for the government bailing out poor decisions on the part of lenders and borrowers.  Write your Congressman if you want to try to change this.

Member Question: How can I form an investment group or small company to buy rental properties? 

Answer from the Boardroom:  Any group of investors can form an LLC or partnership to purchase property together.  As a general rule, an LLC has become the best investment vehicle to use since it can choose its tax structure and the LLC’s Operating Agreement can include many variations of payouts to owners.

If you are thinking about setting up any kind of entity to purchase real estate as a group, I highly recommend that you seek out the counsel of an attorney and an accountant who are familiar with real estate investments.  Once you get the first one set up by a professional, you will know what to expect and how to structure all your other deals.�

At HIS Real Estate Network, we always work together with our legal and accounting experts before structuring any property purchase.

Member Question: What exactly is a Letter of Intent and when is it advisable to use one for the purpose of making an offer to buy property?

Answer from the Boardroom:  

A letter of intent can be used in a number of circumstances, but for our purposes, we use it to set up the purchase of a property so that a seller is locked into an agreement and can’t shop around for another offer, while we on the other hand, have a chance to evaluate things.

Another time we would use a letter of intent is when we need to make an immediate offer on a hot property and we don’t have time to draft a full purchase agreement. 

Finally, you may want to use a letter of intent when you aren’t quite sure how to structure a purchase but you want to get the owner moving toward selling the property to you.  Some of the finer purchase details can be worked out after the letter of intent is signed.

The general structure of a letter of intent is up to the person creating it.  There is no standard language, but there are essential elements which we cover in our training module on this specific subject.

Essentially, the parties spell out the general terms and conditions of the purchase.  If you don’t know something, you can always put in the language “to be determined”.  However, a letter of intent can become a binding contract since both parties will sign a written  agreement about the property, so make sure you have some solid contingency clauses to allow you to back out if you need to.

Review the Letter of Intent Training Module for more specifics.

Member Question: Should I sign a non-binding Letter Of Intent if I think it has questionable info on it?  One of the real estate brokers involved in a deal stated that the seller is requesting that I sign a non-binding Letter of Intent…is it non-binding?

Answer from the Boardroom:  There is no such thing as a non-binding Letter of Intent (LOI).  One of the main purposes of an LOI is to get the parties to agree on the terms of purchase.  It can require you to negotiate in good faith to complete the real estate transaction. Additionally, if it contains sufficient material facts and signatures, it can become the purchase contract necessary to require you to complete the purchase. I would never recommend a client sign an LOI that he didn’t draft himself and with the terms he is willing to carry out.  I don’t recommend that you sign any LOI without it being reviewed by a knowledgeable attorney, particularly if it is one that is provided to you by some other party. 

Please review our training module on Letters of Intent for a more detailed discussion on how and when to use them.

Member Question: How can I find out what the zoning and building laws and regulations are in my area?

Answer from the Boardroom:  For the most part, zoning codes are established locally by either the county or municipality where the paroperty is located.  Building codes may be state wide, with additional county or municipality regulations.

The easiest way to find out more about the applicable codes and regulations for a particular property is to call the local authorities.  In each area, they may go by different names such as Housing and Code Enforcement, Building Department, Zoning Board, Zoning Authority, or County Commission (in smaller less populated areas). 

You may also want to check to see if there is any kind of property owners association like a Home Owners Association that may regulate use of the property.  Information on an HOA should be available in the county records.

Most of the people in these offices are very helpful and if they cannot help you, they can refer you to the person who can get you the answer you need. 

If  the issue is complex, you will need to seek the counsel of a real estate attorney familiar with the local laws in the area.

Member Question: Can an LLC be a member of another LLC?

Answer from the Boardroom:  The short answer is “Yes”.  There are no restirctions on ownership in an LLC. 

An LLC can elect how it wants to be treated by the IRS.  If an LLC is a member of another LLC, it may limit certain choices on how the LLC is treated by the IRS .  For example, if you want your LLC taxed as an “S” corporation for tax purposes, then you must follow the IRS’s rules for “S” corps, which do not allow for ownership by another LLC or non-U.S. citizens.  However, your LLC can still be taxed as a C corporation or partnership.

Anytime you are setting up an entity to purchase real estate, it is best to discuss your plans with your accountant and an attorney to cover the tax, business and estate planning aspects.  All can have a major impact on your success.

Member Question: What is a “homestead” and a “homestead exemption” in real estate and legal terminology?

Answer from the Boardroom: A “homestead” is real property where an individual or married couple has established their primary personal residence. This is used in some states that give special rights and protection to such property against the claims of creditors or for property tax purposes (commonly called a “Homestead Exemption”). In probate law, many states allow the surviving spouse certain rights in homestead property which cannot be given away to others by a will.