Phil Pitts
Investor’s Toolbox





Considering a Vacation Home?

There is a lot to consider when contemplating the purchase of a vacation home. Many homeowners think about purchasing a home for vacation use for years before actually purchasing a home; while others never follow through with their dreams. The time may be right for those truly considering taking the investment leap; a vacation home, or second home can be either a headache or it can be a great escape for the family depending on where the purchase is made and the type of financing used.

2nd Home
Actually, a 2nd home does not need to be a home at all; the investment can also be a motorhome for personal use or even a luxury boat with sleeping quarters. The purchase of a 2nd home provides all the tax write-offs as a personal residence, even if it is on wheels.

A vacation home, or 2nd home, can provide a couple or a family a great escape for weekends and vacations. To truly be a 2nd home, the home is not intended to be a rental property. If the home or condo is purchased for the purpose of renting on a regular basis, this would not be considered a 2nd home. The IRS established limits of personal use to 10 days or less for the home to be used as a rental property. Documented use of more than 10 days per year by the owner will negate many of the advantages of owning a rental home, such as depreciation write-off for tax purposes.

Some advantages of purchasing a property as a 2nd home rather than as a rental property can be substantial. You may choose to rent your property on occasion and you will still have access to the property to use whenever there is spare time to get away. If the home is within a few hours drive, many owner’s find they are at their vacation home a few weekends per month and several weeks per year for vacation. Owning a 2nd home can also be a great way to meet with friends and family for special occasions, such as holidays.

Financing
The type of financing available for 2nd homes is quite extensive. The same financing and interest rates are available for 2nd homes as for owner occupied homes. There is absolutely no difference at all between financing for a 2nd home or an owner occupied home. Those that have purchased a home as a rental are well aware of added costs in the loan for the non-owner occupied financing. Most purchasers of 2nd homes are surprised to find out just how reasonable and easy the financing is to obtain.

Many prospective 2nd home purchasers have saved funds for the down payment; however for those that do not have the 10% or 20% down payment for a 2nd home, a refinance of the existing home at a low rate may be the answer to obtaining the cash. With interest rates at historic lows, the timing couldn’t be better for those that are interested.

Tax Advantages
The same tax advantages of owning your home you live in is available to those owning a 2nd home. The owner can write-off all interest and taxes paid on the property, just as on your primary residence. There are limits to consider for mortgage interest deductions. IRS rules currently limit mortgage interest deductions for mortgages on primary and 2nd homes to a combined amount of $1,000,000. There may be exceptions to this, due to borrowing funds on your home for business purposes; consult with your tax expert.

2nd Home Prices
For those interested in eventually purchasing a vacation home, now may be the time to consider the purchase. Housing prices in vacation destinations are at a low not seen in decades. There is no shortage of vacation homes and condos in resort areas; beach homes, homes in the mountains and ski areas are plentiful. Low purchase prices combined with extremely low interest rates provides opportunities of a lifetime for those considering the purchase of a 2nd home.

For further information regarding mortgage loans for vacation homes or current pricing on homes in desirable locations, please feel free to give me a call.

Refinancing and mortgages in San Jose, Refinance loans in Campbell and Silicon Valley.





Phil Pitts
MBA, Broker, President of Amerimac Cal-West Financial Inc,
Phil can be contacted at 408 558-1350 or phil@amerimac.com






Phil Pitts
Investor’s Toolbox





Real Estate Investments; An Investor or a Collector?

As stated in the last article, during a refinance or sales transactions, title companies normally do not provide information regarding property tax saving; many times it is because they may be unaware of tax savings opportunities and title companies are not fond of providing legal advice at escrow closings.

Parent to Child Transfer, Proposition 58 AH
This proposition provides an opportunity for parents to transfer a property to their children and pass along the parent’s property tax base without an increase in tax valuation or increased property taxes. I have found most people that could take advantage of this tax savings are unaware the proposition even exists. There are also several other advantages of proposition 58 that everyone should be aware of.

With Prop 58 a parent can transfer their home they have had for twenty or thirty years and their child (age of child doesn’t matter) can assume the same property tax bill and avoid paying taxes on a reassessed value. This can be very advantageous if the parents are moving out of the area, going into a rest home or even if the property is left to a child from an estate. Many people that inherit a home from a parent do not claim the exemption and the property is reassessed at current value and taxes are unnecessarily raised substantially.

A child can also transfer a property to a parent and have the same tax exclusion. This transfer is not as common as the parent to child; however there are times when a family can take advantage of this opportunity. I have seen transactions where a brother wanted to sell his half interest in a home to another brother who also owned a half interest in the same property. The problem is that there isn’t an exclusion for brother to brother transfers. One of the brothers transferred title to his parent and later the parent transferred title to the other brother and thus maintained the original tax base.

Another aspect of Prop 58 is the property being transferred does not need to be a principal residence. A primary residence may be transferred and additional other real estate such as rental properties may also be transferred between parent and child to preserve a low tax base. Up to $1,000,000 in other real estate, besides a personal residence, may be transferred without increasing property taxes.

If you have or will be inheriting real estate from a parent be certain to obtain a Prop 58 Claim For Reassessment Exclusion For Transfer Between Parent And Child.


Grandparent to Grandchild Transfer, Prop 58G
Proposition 58G is very similar to the Parent to Child Transfer except it is intended for grandparents to transfer property to their grandchild when the grandchild’s parents are deceased. As in Prop 58 AH, transfers do not need to be primary residences and can also provide for exclusions of up to $1,000,000 in other real estate.

Disabled Veterans Form 261-G
This little known property tax exemption may very likely be available for someone you know. For veterans that are rated as 100% disabled by the Veterans Administration there are currently property tax exemptions of $111,296. If household income is less than $49,979 in the last year, the exemption increases to $166,944. Surviving spouses and surviving unmarried spouses may also be eligible.

Disabled Person New Construction Exclusion, Form 63
A person that constructs or improves a residence to make the residence more accessible for a disabled permanent resident can file for reassessment exemption for improvements to the property. It is not a requirement that the disabled person is an owner of the property.

Refinance San Jose properties. Mortgage loans San Jose, Santa Clara & Campbell refinance and purchase mortgage loans.

Registered Domestic Partners, Form 62-DP
Transfers of real estate and mobile homes between domestic partners may be excluded from reassessment if filed by June 30, 2009. The exclusion may be from a sale, gift or death of a domestic partner.

If you would like further information regarding this article or to obtain the appropriate forms, please feel free to contact me and I would be pleased to provide you with more detailed information and appropriate forms for filing.


Phil Pitts
MBA, Broker, President of Amerimac Cal-West Financial,
Phil can be contacted at 408 558-1350 or phillip@amerimac.com



Understanding Cap Rates

All investments have their breaking point. It happens when the risks become greater than the rewards. Some investors believe that will never happen for income property. Those people usually think that way because they (1) are not investing their own money, and/or (2) don’t understand that income property is cyclical. This type of thinking usually indicates a failure to understand the mathematics of investment recovery. The law of mathematics dictates that whatever percentage an investment declines, it must increase by a geometrically higher percentage to achieve parity.
Finding the breaking point where the risks of buying property are greater than the rewards has become an important issue. When you add Wall Street’s recent large capital infusions into privately and publicly held property to the enormous number of 1031 exchange transactions by individual investors, you have investors under pressure to buy property. The result is that a sense of urgency has emerged.
Why the concern? This urge to buy has increased the price of income property while driving down its capitalization rates (cap rates). The number of income property purchases being made at 5% cap rates is on the rise. Buyers of income property who earlier vowed never to buy real estate below a 7% cap rate are now trying to hold the line at 5%. Consequently, recent cap rates have forced investors to ask the question: When currently buying income property, is 5% a safe cap rate? The answer to that question, when one looks at the numbers unemotionally, is a resounding no!
Two economic truths decide the result of real estate investments: (1) When the demand for real estate is more than the supply (strong market), rents go up, vacancies go down, and concessions decline or disappear. (2) When the supply for real estate is more than the demand (weak market), rents stay the same or go down, vacancies go up, and concessions increase.
Economic truth number one (strong market) covers the mistake of buying real estate at a 5% cap rate. Economic truth number two (weak market) aggravates the problems of buying real estate at a 5% cap rate. Economic truth number two is the reason that 5% is not a safe cap rate.
The following assumptions illustrate the financial problems of a 5% cap rate during a weak market (economic truth number two).
• Purchase price: $1,000,000
• Economic occupancy on purchase: 95%
• Cap rate: 5%
• Down payment: 50%
• Mortgage: 30 year amortization, interest rate 5%
• Operating Expenses: 40% of first year’s income
• Economic vacancy: declines each year by 5%
Results of Assumptions
Economic Vacancy 5% 10% 15% 20%
Cap Rate 5% 5% 5% 5%
Property Value $1,000,000 $916,660 $837,500 $762,300
Property Income $83,333 $79,166 $75,208 $71,448
Property Operating Expenses (40%) ($33,333) ($33,333) ($33,333) ($33,333)
Net Operating Income $50,000 $45,833 $41,875 $38,115
Debt Service ($32,208) ($32,208) ($32,208) ($32,208)
Cash Flow $17,792 $13,625 $9,667 $5,907
Return on Purchase Price (%) 0% (8.3%) (16.3%) (24%)
Current Yield On Down Payment (%) 3.6% 2.7% 2% 1%
ROI (PP-PV+CF) (Cash) $17,792 ($69,715) ($152,833) ($231,793)
ROI (PP-PV+CF÷DP) (%) 3.6% (14%) (31%) (46%)
Summary of Results
Let’s look at the results of a real estate purchase at a 5% cap rate when economic occupancy moves from 95% to 80%. Is 80% economic occupancy unrealistic? It’s as unrealistic as 88.33% physical occupancy plus a one-month rent concession. Put in those terms, 80% economic occupancy becomes and is very realistic. Additionally, 50% leverage is conservative and there is no allowance for reserves which in this case would be $20,000 (usually 2% of the purchase price). Finally, when economic vacancy increases, operating expenses don’t remain the same, they increase. Now let’s look at the numbers.
1. When the economic occupancy declined from 5% to 20%, the cash investment declined 46%.
2. The investment losses do not consider the costs of a sale.
3. The investment losses do not consider the financial terms (income guarantees, warranties, seller financing, etc.) the next buyer would probably negotiate.
4. The property is not generating enough to fund reserves.
What would have happened if our real estate investor bought the property at a 7% cap rate? Using the same assumptions from the prior example, here’s what happens with a real estate purchase at a 7% cap rate when economic occupancy declines from 95% to 80%.
Results of Assumptions
Economic Vacancy 5% 20%
Cap Rate 7% 7%
Property Value $1,000,000 $750,000
Property Income $116,666 $99,166
Property Operating Expenses (40%) ($46,666) ($46,666)
Net Operating Income $70,000 $52,500
Debt Service ($32,208) ($32,208)
Cash Flow $37,792 $20,292
Return on Purchase Price (%) 0% (25%)
Current Yield On Down Payment (%) 7.6% 4.1%
ROI (PP-PV+CF) (Cash) $37,792 ($229,708)
ROI (PP-PV+CF÷DP) (%) 7.6% (46%)
Summary of Results
The difference between buying real estate at a 5% cap rate and a 7% cap rate is not in the decline of investment value. Using the same economic occupancy and the same leverage results in an equal investment change.
The difference between the two cap rates is in the cash flow and cash yield. The 7% cap rate funds the reserve account and pays the investor a positive yield. The 5% cap rate does not fund the reserve account and does not have funds to pay the investor a yield. This means that the 5% cap rate does not have enough cash available to maintain the property as planned and compete against properties purchased at a 7% cap rate. The conclusion: For real estate buyers, currently a 5% cap rate is the breaking point when risks become greater than rewards.
Another way of saying the risks are greater than the rewards is that the investment lacks staying power. How important is staying power? Consider our two earlier facts. (1) Real estate is cyclical, and (2) whatever percentage an investment declines, it must increase by a higher percentage to achieve parity. Given those two factors, staying power (a 7% cap rate) becomes the real estate buyer’s insurance policy for achieving investment success.
We specialize in mortgage loans in San Jose, and the south bay area.
Contact me personally for further information regarding residential or commercial real estate investments.
Phillip Pitts
President/CEO Amerimac Cal-West Financial
408 558-1350
phillip@amerimac.com



Phil Pitts
Investor’s Toolbox





Landlords: Finding Good Tenants II

Finding a good tenant is one thing; keeping good tenants is another issue. Many landlords are under the assumption that once a vacancy is filled, the job is over; this certainly is not the case when it comes to maintaining gross rents at the optimal point. Losing good tenants is very costly to the bottom-line; it is far more prudent to be pro-active rather than reactive with tenant selection and retention.

Keeping Good Tenants
Many times, new landlords will provide incentives to tenants to move in, such as first months rent free or reduced rent because the tenant appears to be a good prospective tenant. In most instances, providing these types of incentives may be counter-productive. A free months rent or discounted monthly rent will never be recovered and can continue for years due to the apprehension to raise rents for these “good tenants.” If good tenants are provided with rent discounts, are bad tenants given a higher monthly rent? You shouldn’t be renting to bad tenants in the first place and this practice could get you in some hot water. By far, it is best to have a tenant move in because they like the property and it is well maintained, rather than from an incentive such as a free months rent.

As stated in the previous article regarding tenants, investment property owners are not thrilled when a tenant decides to move. The loss of rents, costs to clean, meeting with and screening applicants takes time and money. One of the best methods to prevent some of these hassles and expenses are to lose as few existing tenants as possible.

Once a new tenant is moved in, maintain a method of contact; email is a great method for the tenant to contact you regarding any issues and you can respond on your time. Taking phone calls while you are working or when you are trying to relax in the evening can be quite upsetting, especially if you own or manage apartment complexes with several tenants or have many rental homes.

Encourage your tenants to contact you as soon as possible if there issues, such as a leaky faucet, a disposal that does not function or other issues that may develop into costly repairs. Have these items repaired immediately rather than inconveniencing the tenant; the same expense will be incurred if it is taken care of in one day or three weeks. A quick response and repair from the landlord will let the tenant know you care about their living conditions and will also encourage the tenant to maintain the property.

Maintain rents at current market rates. The landlord that does not raise rents for five years will continually be behind market rents and this revenue will never be recovered. Increase rents as market conditions change; a tenant that does not receive a rent raise for five years will be quite upset if the rent is then raised to market rates. Small increases in rent each year or so are not devastating and become expected.

Improvements
Anybody that owns real estate knows that a well maintained property with curb appeal will sell quicker and for a higher price than a similar property that is run down and looks bad. Well, the same can be said for renting an apartment or other housing rentals. Tenants value a nice looking property that is well maintained, much more than a very similar property in the same area that needs yard work, paint etc. By maintaining the property in appearance and function, the value to tenants are much higher and will justify market rents, increase tenant retention and will result in quicker rental of vacant units or houses.

Some of My Personal Tenant Retention Methods
Not only do I make certain my properties are painted, I use contemporary colors for the body and trim. An apartment building may be painted all white and be well maintained and clean, but the color is bland and usually does not provide the type of curb appeal to gain the attention of tenants. Depending upon the area the property is in, I will try to maintain colors that not only are appealing, but blend in well within the area. Driving through the immediate area to look at colors of similar properties which look outstanding is a great way to come up with a color scheme.

Maintain the paint, yard and grounds; if a wall was tagged repaint immediately, if a light fixture is broken, replace or repair it immediately; and remember to change the outdoor light timers to match daylight savings. Update the yards occasionally, this doesn’t mean you need to completely re-landscape, but replace old shrubs and plants and fertilize the lawn, repair sprinklers etc.

One of our apartment buildings we upgraded by installing some solar lights with copper caps, installed awnings over the windows to provide cooler interiors and provide depth and style to a very plain building. Patio furniture with umbrellas, some new plants and a new lawn were installed. The transformation was very well received, tenants do not want to move and vacancy factor has been reduced to zero for the past four years after the work was completed. I still have prospective tenants contacting me, wanting to rent if an apartment becomes available.

By making the proper improvements to your rental property, the expenditures can be taken as a tax write-off for either improvements or maintenance and you will be repaid by your tenants with higher rents and far less vacancies.

If you would like to receive further information concerning this article, or would like a referral to a few really good property managers, either commercial or residential, you may contact me by email or phone. Specializing in refinancing in the San Jose Area and mortgages San Jose area for purchases of primary residences and investment properties.


Phil Pitts
MBA, Broker, President of Amerimac Cal-West Financial Inc.
Phil can be contacted at 408 558-1350 or phil@amerimac.com