How to Buy or Sell an Investment Property
in Silicon Valley
Helpful Tips for Real Estate Investors in Silicon Valley
Here are a few essential tips from a San Jose Realtor that you should keep in mind as a potential investor in Silicon Valley's real estate market.
1. Define The End Purpose of Your Investment
The main reasons why investors prefer to buy real estate rather than stocks are the following:
- Appreciation (hoping that the real estate market will go up)
- Cash flow (rents to be paid over time)
- Tax breaks (depreciation)
- Amortization (mortgage pay-off)
Can you really accumulate those four factors at the same time? Probably not for a few obvious reasons.
For instance, you will not have the same tax relief if you buy cash or if you borrow money. The price at which you buy a property is dependent on the overall health of the real estate market, i.e. you will pay more in a seller’s market (with low housing inventory) than in a buyer’s market where is housing supply abounds. To take another example, the rental market is greatly impacted by interest rates levels, i.e. when rates are high, renting is a better option.
Therefore, as an investor wishing to take advantage of the lower prices of Silicon Valley real estate today, your first challenge will be to define precisely for which one(s) of the four reasons described above you are interested to invest in real estate.
If you already owe properties, your challenge will be to decide whether to keep or sell depending on market conditions. If you opt to sell, timing is everything in order get to get the best ROI (return on investment).
If you decide to keep your properties, renting it out or using it for your
own needs are the two available options. In both cases, you should be
prepared for potential renovation/rehab or upgrade costs to keep up with
the latest housing standards as well as real estate market trends.
Your end strategy will determine how much time and money you should be ready to invest in your real estate portfolio.
2. Take Time To Understand The Local Market
Before anything, bear in mind the main expenses related to ownership, which can vary greatly from one real estate market to another, even in Silicon Valley: mortgage rates, property
tax, insurance, HOA fees, property management, maintenance, utilities,
repairs, turnover (lost rent, clean up, etc).
Above all, take the time to study and compare current market prices and transactions history with the help of a Realtor very familiar with the Silicon Valley area you are interested in. Leverage local Bay Area resources as much as possible and spend time in the target area with your Real Estate Agent to form your own opinion.
While most real estate agents will tell you that location always remains the critical factor, there are other soft factors worth considering such as crime rate, hazards risks such as fire (most common in California) or flooding as well as attractiveness of the area to potential buyers or tenants such as school ratings.
3. Buy From An Investor’s Perspective
When shopping in any real estate market as an investor, you can either look for quality homes or snap houses on the low end of the market.
There is no golden rule, just a few common sense tips. Unless you plan to use the property you are purchasing for your own needs somewhere along the way, you should understand the potential long-term ROI when looking to buy homes on the high end of the Silicon Valley real estate market. Luxury homes are always in demand in Silicon Valley, but depending on "tech bubbles", supply and demand for luxury homes can vary greatly from one year to another.
If possible, try as much as possible to identify and invest in low to mid-priced properties. Remember the old maxim: buy low, sell high.
Cheaper and inhospitable homes might turn you off first as a home owner but should inspire you as an investor. Cheap neighborhoods might turn into upcoming areas in the next few years. Ask your Silicon Valley Realtor to look for fixer-upper (aka TLC) houses or starter homes that will require varying levels of restoration and/or renovation.
4. Make An Offer Based on Market Trends
In a buyers' market you can consider making an offer below the asking price depending on the comparable properties in the area. In a sellers’ market you most likely will have to bid over asking price. How much more over asking price will depend on the desirability of the property and number of competitors
At the end of the day, it is always your choice that should prevail, not just the advice from your Realtor, no matter how reputable and knowledgeable he or she can be.
As I always say to my customers, I am here to give you the tools to make the right decision but you are the ultimate decision-maker.
Know the Key Anti-Flipping Rules
First and foremost, remember that it is not illegal to buy and flip a short sale property as long as you disclose in the purchase contract that you intend to rehab the home and resell it for a profit.
Here are some of the key legislation you should be aware regarding house flipping today.
1. Fannie Mae & Freddie Mac Title Transfer Requirements
Since January 18, 2013, the following guidelines apply to all Fannie Mae and Freddie Mac short sales with or without an offer:
- The buyer is prohibited from selling the property for any sales price for a period of 30 days from the date of the deed.
After a 30 day period, and until 90 days from the date of the deed, the buyer is further prohibited from selling the property for a sales price greater than 120% of the short sale price.
2. Anti-Flipping Disclosures
Nowadays, addenda to the contract such as Anti Flip Affidavits and Arms' Length Transaction disclosures must systematically be signed by the buyer of a short sale property.
All of these documents state that you, as the buyer who intends to flip a property, will not be allowed by the lender(s) to resell the property for a given period of time, usually anywhere from 30 to 90 days.
3. HUD- FHA 90-days Anti-Flipping Rules
In November 2012, the Federal Housing Authority (FHA) announced that they would maintain and extend until 31 December 2014 their moratorium regarding their “90-Day Anti Flipping” rule for all FHA insured loans.
The waiver was instituted to encourage speculators to enter the housing market and provide cash for turnover of properties during the foreclosure epidemic. The waiver allows speculators to sell properties to home buyers who are purchasing with FHA-insured mortgages.
On December 10, 2014, the Federal Housing Administration (FHA) announced that it will not extend the temporary waiver of FHA’s regulation that prohibits the use of FHA financing to purchase single family properties that are being resold within 90 days of the previous acquisition.
As a consequence, speculators will now be required to wait at least 90 days from their purchase before they may sell to home buyers who are purchasing with FHA insured mortgages.
Also, as a buyer, still using the date the deed was recorded, the FHA has further rules you must follow. If the seller bought the home within the last 91 and 180 days, you must determine if any of the following pertain to the property:
Is the purchase price 100% or more higher than what the seller paid for the home?
Do you have a higher-priced loan and the home’s sales price is 20% more than the seller’s purchase price?
If you answered ‘yes’ to these questions, you must get a second appraisal. The good news is that you don’t have to pay for it, though.
The FHA lender can also request a second appraisal if the seller owned the home for 91 to 365 days and the resale price is greater than 5% more than the home’s lowest sales price in the last year.
FHA do allow certain exceptions to the rule, including: homes acquired by an employer or relocation company, inherited properties, HUD resales, homes sold by nonprofit agencies, homes sold by government agencies.
4. FHA Flipping Rule Exceptions
There are some exceptions to FHA flipping rules, including:
Resales by HUD, other government agencies, or the REO program
Properties acquired by employers in connection with relocating employees
Properties sold by nonprofit organizations
Properties residing in a Presidentially Declared Major Disaster Area (PDMDA) that are permitted by HUD
New construction properties
Non-FHA Loan Flipping Options
If you’re attempting FHA financing for a new home and the owner acquired the property less than 90 days ago, you likely won’t be approved by an FHA lender.
Fortunately, if an FHA loan won’t work, there are many other types of loans to consider, both government-backed or conventional.
While VA loans have similar requirements for buying a flipped home, you could qualify for other non-conforming loans such as USDA loans or for for a conventional loan. These loans usually don’t have home flipping rules.
5. 1031 Exchange for Real Estate Investors
The Tax Deferred Exchange, as defined in Section 1031 of the Internal Revenue Code, aka as the "1031 Exchange" offers real estate investors an opportunity to legally build wealth and save on taxes.
By completing an exchange, any Real Estate investor (aka as the Exchanger) can dispose of their investment property, use all of the equity to acquire a replacement investment property of equal or greater value, defer the capital gain and depreciation recapture taxes that would ordinarily be paid, and leverage all of their equity into the replacement property.
Two requirements must be met to defer the capital gain tax:
- The Exchanger must acquire a “like kind” replacement property and
- The Exchanger cannot receive cash or other benefits (unless the Exchanger pays capital gain taxes on this money).
What Properties Qualify as “Like-Kind”? For the record, "Like-Kind" is the most misunderstood word in 1031 Exchanges.
In essence, all real estate is like-kind with all other real estate. In
other words any kind of real estate can be exchanged for any other as long
as both properties are used for investment purposes or in a productive use in
trade or business. Also, the property can be anywhere in the United States.
Selling in California to buy in Hawaii or Texas is fine, but you can’t buy in
Mexico or Canada.
Also, the property can be anywhere in the United States. Selling in California to buy in Hawaii or Texas is fine, but you can’t buy in Mexico or Canada.
Here are a few examples of acceptable "Like-Kind" exchanges:
- A rental house to an apartment building
A rental condo to a shopping center
- An industrial building to a farm
- 4 rental houses to buy a retail mall
- A four-plex to 10 rental houses
NB: In the last 2 examples, selling one property to buy multiple is fine.
Also, bare in mind land can be considered to be held for appreciation. So even
though it may not be producing income like a rental property, it is
still investment real estate and can be exchanged for rental homes,
commercial property, etc.
Now, what kind of real estate does not qualify? Primary residences, secondary residences, property purchased for resale (i.e. “flips”) and property held for development are generally not considered to be investment real estate.
From the date
escrow closes, there are two statutory deadlines. You have 45 calendar days to
identify the property you are going to purchase and 180 calendar days to close
on your replacement property. There are no extensions for weekends or holidays.
More information about the 1031 exchange.