Real estate investment is no hobby for the amateur, says financial planner Carl Richards. As illustrated by his most recent sketch in the New York Times, buying real estate without doing the math is akin to running a marathon without training: it hurts a lot.

Richards advises investors to operate with discretion within the bruised and delicate reality of the current real estate market. We are no longer living in the cash-flush glory days of the Millennium Boom when real estate investment appeared to be a smooth and easy golden ride to financial profit and security.

Today, it’s a tough world out there. California homes sales volume decreased 3.3% from March 2011 to April 2011, and is down 6% from a year ago. Home prices in California are experiencing a similar decline. [For more information on April’s home sales volume data, see the May 2011 first tuesday article, April 2011 home sales volume.]

With prices and interest rates so low, the logic suggests it is now time to buy some of the ubiquitous distressed real estate. However, investors take note: there is nothing inherently wrong with real estate investments, but buying distressed real estate without careful analysis is a potentially financially disastrous idea. Investors and buyers must take into account all of the often overlooked costs and responsibilities of owning real estate, such as property taxes, maintenance, insurance – and oh yes – management.

The bottom line is the same for any smart consumer purchase. Take the time to do your research.

first tuesday take: Agents and brokers need to consider if the expressed financial goals of their buyers can be attained based on the probabilities presented by a distressed real estate investment, especially in California. Essentially, this is a reminder for selling agents and brokers to do their homework. Before undertaking the representation of a novice investor, a licensee must:

  • assess the financial health and real estate knowledge of the buyer; and
  • assess the value of the real estate property the subject of the investment.

Agents and brokers, educate and counsel your buyers. Does your buyer have the cash for a down payment, closing costs and fix-up costs? Is he aware of the nuances between different financing programs? Does he have an understanding of the costs of operating the property? Does he have the cash resource for six months of operating expenses and mortgage payments if the property were to sit vacant?

Sure, the idea of investing in real estate sounds like a “cool” thing to do – a no-brainer quick path to riches for the misinformed – but does your buyer have the profile to handle it? If he doesn’t, then do him a favor and break the news to him: stop dreaming in a Millennium Boom mindset when you must respond and act in a post-financial crisis reality. [For more information on agent-buyer counseling, see the May 2011 first tuesday article, Financially illiterate homebuyers in distress – agents to the rescue!]

The suitability of qualifying a property as an investment is another task compelling agents and brokers to either investigate on behalf of their buyers, or get someone else to do it.

For example, how much spendable income will the property truly generate? Does the buyer know everything the seller knows about the property, including what the listing agent knows (a condition called transparency)? What is the likelihood of resale at the anticipated asking price? [For more information on how to analyze properties for investment, see the April 2011 first tuesday article, Income property analysis for investor review.]

In order to provide the answers, agents must obtain sufficient property operating data in order to determine the property’s net operating income (NOI), a figure which determines the price a buyer is willing to pay. Property operating data includes readily available information on:

  • location and zoning;
  • property improvements;
  • price and terms;
  • current rental income;
  • the rent roll;
  • current operating expenses;
  • anticipated returns;
  • loan arrangements and acquisition costs;
  • income tax aspects; and
  • the seller’s disclosure of service providers.

Selling agents must present this information to prospective buyers in a clear and comprehensive manner. They can only accomplish this objective if they know more about the property than the seller and the listing agent are willing to tell them. [Download the first tuesday Income Property Brokerage (IPB) Program]

RE: “The Dangerous Allure of Distressed Real Estate” from the NY Times