2010 Rockwell Publishing Lesson 15: Real Estate Construction, Ownership, and Investment Principles...

© 2010 Rockwell Publishing

Lesson 15: Real Estate Construction, Ownership, and Investment

Principles of California Real Estate


ConstructionArchitectural styles

Agents should be familiar with various architectural styles including modern, ranch, Spanish, and so on.

One story ranch is easiest to maintain. But two-story construction costs less per square foot and makes more economical use of land.


ConstructionBuilding a home

The three phases of building a home are:land acquisitiondevelopmentconstruction


ConstructionBuilding codes

Building codes specify standards for construction methods and materials.

These standards promote building safety and provide certain degree of uniformity for community.


ConstructionPlans and specifications

Plans: Drawings that show vertical and horizontal cross-sections of a building.

Show placement of foundations, floors, walls, windows, wiring, and fixtures.

Specifications: Text that accompanies plans, specifying construction materials and methods to be used.


Foundation plan: Shows details of foundation construction, such as footing and piers.

Plot plan (or site map): Shows contours of land and location of improvements.

Elevation: Shows side view of each side of house.

ConstructionPlans and specifications


ConstructionBasic elements

Most common type of construction is wood frame building (relatively inexpensive and easy to construct).

Basic construction elements include:foundationframingroofingplumbingelectrical systemHVAC


Elements of ConstructionFoundation

Foundations are almost always made of reinforced concrete.

Footing: Wide bottom base of the foundation wall.

Sill plate: Board attached to top of concrete foundation, on which framing of the house sits.


Elements of ConstructionFraming

House frame is typically constructed of dimensional lumber.

Elements include:Joists: Horizontal members that hold up

floor and ceiling.Studs: Vertical members attached to the

sole plate, a horizontal board that rests on the subfloor.


Walls provide structural support and separate the interior space.

Interior walls are either load-bearing or non-load-bearing.

Load-bearing walls:are sturdier and support upper structureare not easily moved in remodeling

Elements of ConstructionWalls


Ridge board: Peak of the roof. Rafters: Diagonal roof members.Roofing felt: Tar-impregnated paper that

covers sheathing attached to the rafters.Pitch: Steepness of the roof.Hip roof: A roof that rises from all sides to a

short ridge.Flashing: Metal sheeting installed on roof to

prevent water seepage.

Elements of ConstructionRoofing


Elements of ConstructionPlumbing

Plumbing systems include:fixturessupply pipes (galvanized steel, copper,

or plastic)drain pipes (cast iron, concrete, or

plastic)Soil pipe: Heavy clay drain pipe for

sewage outflow.


Elements of ConstructionElectrical

Most modern electrical wiring consists of cable: insulated cord containing strands of copper or aluminum wire.

Cable is enclosed in conduit: metal or plastic piping that provides added protection.


Elements of ConstructionHVAC

HVAC: Heating, ventilation, and air conditioning system in house or other building, which provides warm, cool, or fresh air to rooms through series of galvanized sheet metal tubes called ducts.



HVAC systems have energy-efficiency ratio (EER).

The higher the EER, the more efficient the appliance.



Insulation: Material resistant to transfer of heat; important for keeping heating and air conditioning costs down.

R-value: Effectiveness rating for insulation that measures resistance to heat transfer; higher R-value is better.


Construction Pest problems

Wood frame construction is vulnerable to wood-eating insects, especially termites.

Always a good idea to have pest control inspection when property is listed:

good investment for buyeroften required by buyer’s lender or (in

some parts of California) FHA or VA


Inspection report must be:given to property owner within 10 days, and

to buyer as soon as possible before closingfiled with state Structural Pest Control

Board, which will retain it for two years



Unless parties agree otherwise, seller usually pays for fixing existing pest problems, and buyer pays for preventive work.



Construction Soil problems

Soil may be expansive, adobe, or alkaline. Backfill is soil used to fill excavated areas. It may be advisable for buyer to request a:

percolation test, which measures soil’s ability to drain water

soil engineer’s test for possible leakage from nearby underground storage tanks


SummaryConstruction

• Plans and specifications• Elements of construction• Pest problems• Soil problems


To Rent or to Buy?Advantages of renting

Advantages of renting:less financial commitment and riskgives person greater mobilitycarries fewer responsibilitiesaccess to amenities


To Rent or to Buy?Advantages of buying

Advantages of buying:security and stabilityprivacy and freedom from restrictionslower monthly payments (eventually) investment appreciationtax advantages (mortgage interest

deduction)


Choosing a homeNeighborhood considerations

Neighborhood considerations include:percentage of home ownershipconformity among propertiespresence of changing land usescondition of streets and sidewalksavailability of utilities and public servicespresence of quality schoolsavailability of social servicesneighborhood condition: stable or

changing?


Choosing a homeHome features

Buyer should consider:site and viewexterior appearanceplumbing and electrical systems, HVACattic and/or basementgarage or carportenergy-efficient featuresinterior floor plan, design deficiencies


Home FeaturesDesign deficiencies

Examples of design deficiencies: front door opens directly into living roomno front hall closetback door difficult to reachdifficult access to dining room, stairways

or basementno eating area in kitchen


SummaryChoosing a Home

• Advantages of buying• Advantages of renting• Neighborhood considerations• Evaluating the house• Design deficiencies


Investing in Real Estate

Real estate agent shouldn’t claim to be investment counselor, but should have some familiarity with investment options in real estate for interested clients.


Investing in Real EstateReturn on investment

Investment: Asset that is expected to generate return (profit).

Return on investment may take various forms, including:

interestdividendsappreciation


Investing in Real EstateReturn on investment

Interest: Money paid to investor for use of borrowed money.

Dividends: Share of earnings paid to an investor by a business.

Appreciation: Increase in the value of an asset.


Investing in Real EstateTypes of investments

Investment is either ownership investment or debt investment.Ownership investment: Investor takes ownership interest in asset. Also known as equity investment.

Examples: real estate, stocks.Debt investment: Investor lends money to another person or entity.

Examples: government bonds or mortgage loan.


Investing in Real EstatePortfolio

Because ownership investments appreciate, instead of just paying interest like debt investments, they are considered better hedge against inflation.

Investors usually try to diversify their investments, with mix of ownership and debt investments.

This mix of investments, plus cash reserves, is known as portfolio.


Investing in Real EstateInvestment characteristics

Investments are usually evaluated on basis of three characteristics:

liquidity (ability to be converted into cash quickly)

safetyreturn on investment (yield)


Highly liquid investments are usually quite safe but offer low yields.

Generally, the more liquid an investment the lower the risk and the lower the rate of return

Example: savings accounts.

Real estate is not liquid investment, since it can take months to sell property.

Investing in Real EstateInvestment characteristics


Investing in Real EstateAdvantages

Potential advantages of investing in real estate include:

appreciationleveragecash flowtax benefits


Advantages of Investing in Real EstateAppreciation

As property appreciates, owner’s equity increases.

Equity: Difference between property’s market value and liens against it.

Increase in equity:increases owner’s net worthcan be used as collateral for loan (cash)


Advantages of Investing in Real EstateAppreciation

Initial downpayment on property creates equity right away.

Equity financing: Buyer makes home purchase using her own funds (not borrowed funds). Disadvantage to having money tied up in

equity is that money can’t be invested elsewhere for (potentially) greater returns.


Advantages of Investing in Real EstateLeverage

Leverage: Using borrowed money to invest in asset.

If asset appreciates, investor earns money on borrowed money as well as on money directly invested.


Advantages of Investing in Real EstateCash flow

Cash flow: Spendable income generated by investment, after all expenses have been paid (operating costs, mortgage payments, taxes, etc.).

So income property can increase investor’s:net worth (through appreciation)income (through cash flow)



Cash flow may be increased with sale-leaseback:Building owner sells and then leases property

from new owner.Rent paid by seller is deductible business

expense.

Sale-leaseback may include buyback agreement:Building owner agrees to buy property back

from investor after specified period.



Having long-term lease is stable source of cash flow, much like annuity.

Investors often evaluate investment by looking at “cash on cash,” which refers to property’s first year cash flow divided by initial investment.

This formula pinpoints ratio between cash invested (equity) and cash received.


Investing in Real EstateDisadvantages

Disadvantages of investing in real estate include:

need for expert adviceexpense of property managementlow liquidityhigh risk


Investing in Real EstateProperty management

Large properties usually require property manager to oversee day-to-day operations.

Property manager duties often include:maintaining propertyhandling tenant complaintscollecting rentslocating new tenantsacting as tenant/owner liaison


State law requires apartments with more than 15 units to have resident manager living on premises.



Property manager may be paid flat fee or commission.

Commission could be percentage of gross receipts, new leases, or expected rents.

Manager’s authority to engage in acts on owner’s behalf comes from property management agreement (contract between owner and manager).



Investing in Real EstateCommercial properties

Investors considering commercial properties must look at various economic factors.

Main consideration when investing in shopping centers is purchasing power of surrounding area.

Investor will also evaluate center’s largest tenants (anchor tenants).Kiosk is small, low-overhead booth

within a shopping center.


Investing in Real EstateCommercial properties

Commercial tenants tend to avoid the northeast corner of intersections because this corner receives the greatest amount of sun during business hours.In strip development, stores may be located in a line along major arterial.A turnkey project is a completed project that is ready for immediate occupancy.


Subdivision planners will rely on initial market analysis in making planning decisions.

Subdivision developers tend to use longer blocks, which are more economical since less land is devoted to streets.

Investing in Real EstateResidential properties


A real estate investor will need to pay insurance premiums to protect property against loss.

Policy can be canceled only if insurer gives written notice within reasonable period of time.

Refund of premiums (short-rating) will be determined according to schedule approved by Insurance Commissioner (rather than prorated).

Investing in Real EstateInsurance


SummaryInvesting in Real Estate

• Ownership investments• Debt investments• Liquidity, safety, and yield• Leverage • Equity• Cash flow• Property management• Commercial properties• Residential properties• Insurance

2010 Rockwell Publishing Lesson 15: Real Estate Construction, Ownership, and Investment Principles...

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