The Importance of the Escrow Process

   When you buy a home there are a multitude of steps that seem to be invisible but turn out to be duties performed by various facets in the buying process. Escrow seems to be one of those mysterious operations which takes place between the time the seller accepts an offer and the buyer gets the keys to his new house. This is a time period that is sometimes called closing. These steps must take place in order for the buyer to become a homeowner. The Realtor has an obligation to keep the buyer informed of every step in this process. 

  The very first thing that occurs in the buying process is that once you and the seller sign a mutually acceptable purchase contract, your agent will collect your deposit or earnest check and deposit it into  an escrow account. This will initially open the escrow at the escrow company specified in the purchase agreement. 

   The escrow company will act as a neutral third party and will collect the required funds and all the documents involved in the escrow process. The initial earnest money will be collected as will the loan documents and even the signed deed. When this step takes place an attorney may get involved to handle this step which may be called 'settlement' rather than escrow. 

   The bank  or financial institution who is financing the purchase will then get involved and will order an appraisal which the buyer usually pays for and this is done to protect the lender and it’s financial interest in case it needs to foreclose on the property. There may be a situation whereby the appraisal comes in lower than the offered price. If this happens the lender may not give the buyer financing unless the buyer comes up with cash for the difference of the lower appraisal or the seller lowers the price. Sometimes a negotiation takes place and the buyer and seller may meet in the middle and the price is lowered and the buyer comes up with a little more cash. 

There are other things that the realtor can do and those options are:

• to provide additional information on why you believe the home should be appraised at a higher amount 
• to get a second appraisal 
• to try going with another lender and hope that lender's appraisal comes out in your favor 

If none of these options are possible, and the negotiation falls through you will be able to cancel the purchase contract. 

   The Realtor will not work with anyone who has not been pre-approved for a mortgage and this should be apparent at the time of purchase. Once the property is chosen by the buyer the lender will give you a "good faith estimate" which is a statement detailing the amount of the loan, interest rate, closing costs, and other costs associated with the purchase. Before signing this document make sure you have negotiated all the costs so that you are satisfied with the figures presented. Once this written loan agreement is signed, it's time to remove the financing contingency in writing. 

   After this step, the disclosure documents must be written and approved with a signature. These documents are written notifications of any obvious problems with the property that have been identified by the seller and his agent. One example would be a garage that has been turned into living space without permit and in violation of city codes. Most of these problems may have already been verbally disclosed early on in the buying process or maybe even mentioned in the listing. 

   During the escrow process all the necessary inspections need to get done. One of the most important is the home inspection which is not required but your realtor should emphasize it's importance and will only cost the buyer a  few hundred dollars. A professional home inspector will inspect the home and report any and all dangerous and costly defects in the home. At this point you can either back out of the deal or have the seller fix the defects. If the seller refuses you may ask the seller to reduce the price and the buyer will fix them. If the contract states you will purchase the property "as is", there is no negotiation. If the inspection process concludes in a satisfactory manner than the inspection contingency must be removed. 

   It is a good idea to do a pest inspection even if the lender doesn't require it but most lenders want to protect their interest in the property and will order one. The pest inspection is done to makes sure that there are no termites, carpenter ants, or other pests such as roaches or rats. Because the pest problems usually aren’t apparent during daylight hours and you don't want to  have a big unwelcome surprise once you move in. These problems need attention and resolution before you move in. Paying for this work can also be negotiated between both parties if it is not in the contract. 

   Other inspections may be recommended like the environmental inspection to check for toxins in and around the home. There could be a soils report or geologic report, if the home is near a landfill or a chemical plant, oil field or gas station. A land survey may be required if there are any boundary issues. Some of these problems uncovered after the sale can be prohibitively expensive to fix. If the home is in a flood zone it may require a flood report. If in a flood zone, flood insurance is required because you can't get homeowners insurance without it. Without homeowners insurance you can't get a mortgage and it would add an extra expense to the price. The flood insurance requirement is usually known to the buyers agent before he shows the home.  

   Hazard insurance is a requirement and includes homeowners insurance and extra coverage in your geological area like flood insurance. Homeowners insurance is a requirement and for the length of the loan. You will be able to choose your own insurance company so you can shop around for the best price or maybe bundle it with you car insurance for a better deal. 

   Also during the escrow period the title report and title insurance are requirements. The title report insures that title to the property is clear and there are no liens and the seller is the only responsible party. These title anomalies have to be cleared before the sale and the title insurance protects the buyer from any legal challenges that could have been missed in the title search. 

   The final walk-through is done just before closing just to make sure that no new damage has occurred after the home inspection. It is also done to make sure that items that were negotiated with the seller to leave with the purchase are still there such as appliances or fixtures. Unless serious damage to the property has occurred backing out is not an option but sometimes the agent is pressured to scuttle the deal for something insignificant because of buyer remorse. 

   One day before closing, a HUD-1 form will be issued which is the final statement of loan terms and closing costs. This HUD-1 statement should be compared to the good faith estimate by the buyer to make sure there are no unexpected or excessive fees or just outright mistakes. 

   The closing process can vary from state to state but the buyer will need to sign a boatload of documents which he should read carefully and they should be explained by the escrow officer. The seller will also have papers to sign. After the signing of all the paperwork, the escrow office will prepare the deed naming the buyer or buyers as the property owners and send it to the county recorder. The buyer will also have a cashier's check for the down payment and closing costs and the loan funds will be wired to escrow so that both the seller and the sellers agent can be paid. 

   Then finally the keys are in your hot little hands and you are a homeowner. The Realtor is the primary person responsible to make sure the escrow process is explained to the buyer and every step is followed through to the end. That is why it is always a good idea to understand the complete escrow process and why it takes at least thirty days on the average, although there is no time limit and it all depends on the sale.

Let's Talk 1031 Exchange

   There is a section in the US Tax Code that deals with an investor being able to sell a property and to reinvest the proceeds in a new property and in the process deferring all capital gains taxes on that sale. This is what is called the IRC section 1031. The tax code states: 

 

"No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment, if such property is exchanged solely for property of like-kind which Is to be held either for productive use in a trade or business or for investment." 

 

   Let's look at how an investor who has a $200,000 capital gain on an investment he has sold would end up with a 70,000 tax bill with depreciation recapture and both federal and state taxes. The remaining amount that would be left to reinvest would only be $130.000 which could be used to invest in another property. With a 25% down payment and a 75% loan to value ratio, the seller would only be able to purchase a new property valued  at $520,000. However, if that same investor chose to exchange that property with a 1031 he or she would be able to re-invest the full $200,000 of equity and would be able to purchase a property in the range of $800,000 in real estate. With the assumption of the same down payment and loan to value ratio. 

  This illustrates that exchanges  protect the investor from capital gains taxes with resulting portfolio growth and an increase in the return on investment. A thorough knowledge of the exchange process and the IRC are needed to access the full potential of these tax benefits. To enable you to fully understand the key term used here as "like-kind" in the code does not necessarily mean the same exact types of property. This can lead most investors into the possibility of dismissing or overlooking this key point in the code. The resource that will give you accurate and thorough information about the entire exchange process is Asset Preservation. 

  The exchange can occur with any property held for productive use in a trade or business or for an investment that can be exchanged for a "like-kind" property. As stated before "like-kind" refers to the nature of the investment and not with the form. In other words any kind of investment property can be exchanged for another type of investment property. For example a family residence can be exchanged for a duplex. Undeveloped land can be exchanged for a shopping center or an office building can be exchanged for an apartment complex. Whomever is doing the exchange has the flexibility to change investment strategies as they see fit their need. 

  There are some things that you cannot trade and this includes  trading partnership shares, notes, stocks, bonds, certificates of trust or other such items. Other restrictions are that you cannot trade a personal residence for an investment property or property in a foreign country or offered for sale houses built by a developer called "stock in trade". Investors who buy and flip houses (buy fixer-uppers and sell as soon as they are improved) cannot use 1031 as these houses are considered "stock in trade". 

  Sometimes when an investor attempts to exchange a property too quickly or trades too many properties during one year, this investor may be considered a dealer and thus the properties could become "stock in trade". If the property is held strictly for investment purposes and the investor can prove this than he could be allowed to use 1031. No clear rules define a dealer but the purpose and motivation for acquiring a property and how long the property is held and the principle business of the owner are things that can differentiate dealers and investors. 

  If a property is being relinquished and does qualify for a 1031 exchange, the question becomes what will the replacement be. Section 1031 applies to both personal property and real property, but the primary difference is what is the definition of "like-kind".  

    There are complications and that is why if you are contemplating doing a 1031 exchange make sure you talk to a professional. Some of the things you have to consider are that 1031 exchanges are not for personal use, in other words you can’t swap your primary residence for another home. This provision is only for investment and business property. There are oddities whereby a painting which is personal property can qualify for a 1031 exchange. That is why a tax professional who has dealt with this part of the code would be the best person to guide you through this process.

Understanding the Appraisal

   For Realtors and several real estate professionals, the value of a property along with real estate financing, listing, investment analysis, property insurance and taxation is one of the most important endeavors to be undertaken. This number will certainly be one of the determining factors in the asking price or purchase price for buyers. For sellers it is often used as one of the factors to set the selling price. This could very well be one of the most useful tools for the application of real estate valuation. The following paragraphs will give an insight into the basic concepts and methods of real estate valuation in relation to real estate.
 The appraisal is the main tool used by realtors to appraise a property's value. These attributes that must be taken into account when estimating a property's value are economic and social trends along with government regulations and controls and  the environmental conditions that may influence the four elements of value.

•    Demand - the desire and willingness to pay a price for a property while holding all other factors constant, the price increases as its demand increases and vice versa; 
• Utility - the ability to satisfy future owners' desires and needs; 
• Scarcity  the short supply of competing properties  
• Transferability - the ease with which ownership rights are transferred.  

   What are the differences between the value versus the cost and price? Value is not necessarily the same as cost or price. Cost refers to the actual expense, for example the cost for materials and labor. Price is basically referring to what someone would pay for an item. While on the other hand price is what someone pays for something.while cost and price can affect the value of an item, they do not determine its value. Let's take for example if a house has a price of $200,000, the actual value may be significantly higher or lower. One of the mitigating factors that could affect value would be if the new owner found a serious flaw in the foundation, the value of the house could be much lower than the actual price.
   An appraisal would be an opinion or an estimate in regards to the value of a property at the time of the appraisal. Appraisal reports can be used by a multitude of organizations and individuals Realtors, businesses, government agencies, investors. and mortgage professionals when they make decisions regarding real estate transactions. The main purpose of the appraisal is to determine the market value which the property will likely bring in a competitive and open market. The market price is what the property actually sells for and doesn’t always represent the market value. Some mitigating circumstances that could influence value would be if the seller is under duress and is under the threat of foreclosure which doesn't expose the property to the open market and would probably sell below market value.
   There are several  appraisal methods and the most accurate approximation depends on the methodical collection of data to determine price. Very specific data which covers the details of a particular property and general data which pertains to national, regional and local data including the neighborhood location are collected and analyzed to determine the value. There are three specific methods  that are used to to determine the most accurate appraisal.
   The first method is the sales comparison approach, which is used mostly for homes and land. This method is sometimes called the market data approach and the value is derived by comparing a property with recently sold properties with similar characteristics within a certain location. These similar properties are often called comparables (comps) and are able to provide a true comparison but each must have the following characteristics:

• Be as similar to the subject property as possible; 
• Have been sold within the last year in an open and competitive market; 
• Have been sold under typical market conditions;

   When comps are chosen, they must be as similar to the subject property as possible and at least three or four are used for the appraisal process.The size, number of bedrooms and baths and location of the subject property are the most important factors to consider when selecting comps. The location of these properties are the most important factors in determining a properties value and similar homes in the same neighborhood or adjacent localities will mostly be used.
   These comps should be two properties that are exactly alike unless they are found in a newer development where buyers pick from a choice of a few models.That is why adjustments must be made to compensate for the dissimilar features and other factors that could make a tremendous difference in the market value.

• Age and condition of properties must be considered; 
• The time between date of sale and date of the appraisal and which economic changes occurred between those dates if any; 
• Location, since similar properties might differ in price from neighborhood to neighborhood; 
• The Physical features, which includes lot size, landscaping, type and quality of construction, number and type of rooms, square feet of living space including amenities and upgrades with  floors, garages (size), kitchens, bathrooms (number), bedrooms (number),  fireplaces, pools, central air, etc. 
• Terms and conditions of sale, such as if a property's seller was under duress or if a property was sold between relatives (at a discounted price).  

   The estimate of the market value of the appraised property should fall within the range formed by the adjusted sales prices of the comps.
  Another method used for appraisal is called the cost approach. This method can be used to estimate the value of properties that have been improved by one or more buildings.This approach uses separate estimates of value for the buildings and the land and taking into consideration the depreciation of the buildings. These estimates are usually added together to calculate the value of the entire property. In the cost approach the assumption is that the buyer will not pay more for an existing improved property than he would for a comparable lot and constructing a comparable building. This approached is often used when the property is one of a kind and not sold frequently and is not an income producing property. Examples for these types of properties are schools, churches. hospitals and government buildings.
The cost approach for real estate valuation involves five basic steps:

• Estimate the value of the land as if it were vacant and available to be put to its highest and best use, using the sales comparison approach since land cannot be depreciated. 
• Estimate the current cost of constructing the building(s) and site improvements. 
• Estimate the amount of depreciation of the improvements resulting from deterioration, functional obsolescence or economic obsolescence. 
• Deduct the depreciation from the estimated construction costs. 
• Add the estimated value of the land to the depreciated cost of the building(s) and site improvements to determine the total property value.  

   The final method that's used for appraisal is called the Income Capitalization Approach. This third method of real estate valuation is based on the relationship between the rate of return of an investment and the net income that it produces. This method is mainly used for income producing properties like apartment complexes, office buildings and shopping centers. This method is straightforward when the property being evaluated can expect to have future income and expenses are steady and predictable.
   Appraisers will use these steps which helps with the direct  capitalization appraisal method:

• The annual potential gross income must be evaluated; 
• The effective gross income has to be taken into  into consideration as do vacancy and rent collection losses; 
• The calculation of the annual operating expense deduction must be made to find the annual net operating income; 
• The capitalization rate or rate of return is accomplished by estimating the price that a typical investor would pay for the income produced by that particular type and class of property;  
• The property's value is found by applying the capitalization rate to the property's annual net operating income;  

   The GIM or Gross Income multiplier can be used to appraise some properties that are not purchased as income properties but could be rented out like one or two family homes. The GRM (Gross Rate Multiplier) method relates to the sales price of the property to the expected rental income. This method used for residential properties is the gross monthly income and for commercial and industrial properties, the gross annual income is used. Recent sales and rental figures can be used on three similar properties to establish a more accurate GIM.
   The importance of accurate real estate valuation is important to mortgage lenders, investors, insurers and buyers and sellers of real property. Appraisals are usually performed by Appraisers who are skilled professionals, Realtors especially should have a  basic understanding of the different methods of real estate valuation and will help them when  they are asked for a home market analysis which is very important in setting the value of a property. Although Realtors are not professional licensed Appraisers they need to know the basics to establish the home value for prospective sellers.

Investing in Real Estate Foreclosures

   There were more than a million foreclosed or "distressed" properties that hit the market this past year. And about the same amount or maybe more will be going on the market this year. These homes come in all shapes and sizes from two bedroom cottages to million dollar mansions. While the big banks may own a large majority of them and may be preparing to sell most of them at auction, the majority of them, in fact the best of the lot will be sold many months before the auction date.

   Homeowners who are unable to refinance due to reasons not under their control but have plenty of equity will probably just put their houses up on the market for sale. Other sellers who most likely are underwater (meaning that their homes are worth less than what the market will pay for their mortgage balance) will likely plead with the banks to allow them to do a "short sale". The majority of those homeowners that can't sell their homes in time will probably be foreclosed upon. When this happens the property owners are evicted and their homes will be auctioned off. The sale of these properties will either be done on the steps of the courthouse or through private sales. Bidding on these homes typically starts at or below the actual still outstanding mortgage, plus any fees and any court costs. This typically inflates the price of the home and wouldn't be considered any type of deal considering that most of these properties need rehabilitation of some sort.

   In the majority of these foreclosed homes the bank will hire a real estate agent to sell it and usually will sell it for far less than what's owed on the mortgage. So let's look at what opportunity at any stage of the foreclosure will most likely give the buyer the best deal.

   The best stage in the foreclosure process that will offer both the worst and the best of the often messy business of investing in foreclosed homes is the pre-foreclosure. If you can contact a homeowner as soon or even before their payment troubles hit public knowledge which is usually when a "notice of default" listing hits the local newspapers. You'll be way ahead of all the competition if you can find a home in this pre-foreclosure situation and you can probably make a better deal at this point. It is of course a disadvantage to you since the homeowner will be in denial of the situation he faces and may feel that instead of giving his home away (selling for less), he can rescue his family. It will also be a reality that most homeowners are wary of strangers approaching them with quick solutions. Because many hapless owners are already on edge that's when the real fraudsters start showing up often posing as foreclosure specialists and often trying to entice the homeowner into trusting their fate on a way out. These low-lifes will take money from the homeowner and will do nothing to help them.

   At this point in the process is when a would-be can actually help the homeowner and do some good things to help him avoid the taint of a foreclosure. A foreclosure, like a bankruptcy will stay on your credit report for years and bring down your FICO score. Although at this point you are being forced to sell and may be a heart wrenching experience, a fair offer can most likely create a pathway to financial recovery instead of financial ruin. Buyers are warned however that all that is owed the seller is a reasonable offer and they should not get involved in the seller's personal problems.

   To avoid direct contact with a distressed seller there is always another option, which would be the short sale. Homes on short sale are put on the market with the help of a real estate agent. These homes are priced below what the owner owes on the mortgage and the price has to be approved by the bank. This is advantageous to the buyer because if he does his due diligence the buyer can make an offer directly to the bank bypassing the seller. The only problem with this scenario is that everybody and their brother is shooting for the same deal and the bank may wait for the best offer. The only drawback with short sales is that even if your offer is accepted it may take weeks or even months for the bank to respond to your offer.

   If you want to invest in foreclosures, it will require some sophistication and an uncanny ability that is beyond what most people possess. To be able to succeed in the foreclosure investmet market you have to study the strategies and tactics that are used by other successful investors and you need to put time and resources into making market contacts. This is a real necessity to be able to create a competitive advantage over the totally of market competition that exists in this real estate niche market. If you put the time and money into getting to know the local property market where you'll competing will be only one of several strategies that investors will need to win in this market space.

   To be able to invest in the foreclosure business and come out ahead can be a positive and rewarding experience. To succeed in this area, your approach must mirror any significant investment. Your strategy will require focus, diligence, and strategic research into the local property location and must include the economic conditions and the demographic trends occurring at that time. The trick is to form a strategy for acquiring properties and then for eventually selling them.

   If you've ever bought a car at an auto auction, investing in foreclosures is a similar type of investment but with a higher price tag and more money and research involved. You definitely need the knowledge to be able to take a gem and make it a jewel. The secret is to take the property at a significantly lower price than it's value. To be able to make money you have to significantly win more good deals than bad because you will not win all the time but if you are a smart investor the winners will overshadow all the losers. If you are seeking that one deal that turns out to be a lemon and you lose your shirt on it, you may not have more money to buy anymore shirts.

   The knowledge of the investment and the risk in mitigation strategies is important because many foreclosure buyers go to the courthouse steps without any idea as to the property's intrinsic value and the auction price, This is a dangerous move for any investor. Well-seasoned investors in the foreclosure market will never make the mistake of relying on price differential as the main source of investment income. Buying properties takes more than picking cherries. Investors need to select properties that are in a locale that is destined for redevelopment or improvement. The property selected needs to have unique qualities in the neighborhood it is situated in and must stand out from the rest of the homes or it has to present some opportunity to create value.

  The strategies used for foreclosure property investment includes the goals and manner for acquiring property, holding the investment, and then selling that investment for a substantial profit. This type of strategic investment is most important in the foreclosure business. The location is of strategic importance because market trends tend to shift quickly and can affect price.

   Researching your investments in the local market of purchase is paramount. Supply and demand becomes very important in the real estate market and can affect the investment return in that local area, I can't emphasize enough that the things you will need to consider are the function of population growth, job growth, disposable income and demographic changes which can greatly affect the price as well as the ability to sell properties when your investment is ready to go on the market. Your research must include the probability for infrastructure development, such as roads, traffic conditions, schools, community support and projects and the support of local and state governments. Business growth in the area and the future growth and repair of any particular issues are important as is air quality, crime in the area, taxes or any other property or locality improvements will affect the value of your investment property.

   In the flow of the foreclosure process in acquiring the property most investors are taught to scour publications that list the assets that will be on auction and to inquire about your intent to purchase the property before it goes to auction. Although deals do occur at the courthouse steps finding a way to eliminate the competition will greatly enhance the investors chances of getting a better deal and will enable the investor to properly inspect the property before taking title.If it is possible to help the home owner re-negotiate their mortgage with the lender that enhances the investors chances for future referrals from other distressed sellers. This will also result in magnifying the investors reputation with both owners and lenders because you will have gained the owner' and the lender's trust. As a result the lenders may be willing to let you purchase some distressed loans at a discount. Most banks and lending institutions do not like acquiring foreclosures. To avoid REO properties some institutions will sell the non-performing loans at a significant discount.

   After the property is acquired it can be rehabbed and flipped immediately or it can be held and seasoned awaiting market conditions to change favorably in order to sell. The smart way for investors to make more money is to find ways to improve the property to make it more favorable, marketable and more valuable. The improvements can include more bedrooms, more bathrooms, remodeling kitchens and or bathrooms, finishing basements or other unused space.

   To hold the property for longer periods you may decide to turn it into a rental unit until the market conditions change favorably for your investment. The demand for rentals in the area must be there and the price should cover the mortgage payment and maintenance. A rental will need rehab after the rental agreement has ceased so count on a small sum for security so you can get it back into selling condition. Landlord duties are a drain on time and money so make sure the rental price includes enough for maintenance and property management.

   Having an exit strategy for selling your foreclosure investment is very important. Time is money and making sure that it goes up for sale in the minimum amount of time off market is crucial to making a bigger profit off your investment. When you invest in non-performing real

estate assets to build some wealth makes perfectly good sense. However, it will never become a quick rich scheme and the only way to succeed is to execute a carefully crafted plan to acquire properties with the goal to have an exit strategy designed to achieve very specific investment goals. For every success story, there are many more who have lost out on their investment because they do not plan strategically and keep abreast of the changing market or have a plan to mitigate the risks inherent in foreclosure investing.