FUNDAMENTALS OF REAL ESTATE PURCHASING:

Purchasing real estate can be very simple or very complex, depending on the type of real estate you are purchasing and the purpose for which you are purchasing it. For most purchasers of single family dwellings, including cooperative and condominium apartments, there is a very simple analysis to follow: if owning a property in a given location is going to cost you significantly more (even after income tax deductions) than renting a similar property in the same area, you are probably better off renting and not purchasing. If the cost of purchasing is higher, you must answer a very simple question: why buy?

In other words, why would you want to invest money into purchasing a property that, after you own it, is going to cost you more than if you had rented it (or rented a similar size property in the same vicinity)?

The answer must make financial sense or have a personal rationale.

Examples of financial sense are: the zoning for the area is about to change and construction in the area is about to take off after the change takes place. You have reliable information that some new development, such as a big hotel, arena, stadium, shopping mall, municipal building or big development with positive consequences for the community (not a nuclear power plant) will be built in the area very soon.

Examples of personal reasons are: you’re moving close to your in-laws or some other close relative who’s going to take care of your children when you’re at work. You’re moving close to your elderly parents so that you can help them in their daily lives. You want your children to attend a particular school close to the property you’re buying. The property has some special features that are of some intangible value to you.

If your answer to the question is: property values keep going up and I think the property will appreciate in the future then you’re gambling. You’re betting that someone will come after you with the same philosophy, and will buy this property from you for a higher price, even if it makes less sense to that person than it did to you. This betting process may work for a period of time, and there may be a few owners in the betting chain who will make money by betting that there will be other gamblers behind them, but all along you must keep in mind that, if you are the last gambler in the chain, you lose and the consequences can be devastating.

The recent history of real estate is filled with examples of this devastation. In New York City we have not seen the full impact of it yet, and we may not be as affected by it as other parts of the country already have, but for those affected, the results are grave. You may lose money, you will lose your credit rating for a few years and you may find it difficult to rent, as some landlords will check your credit and probably reject you as a tenant. You may be embarrassed, and you may be delayed in the financial growth of your family.

A sound way to invest in real estate is as follows: calculate what a typical buyer in a given geographical area can afford to buy. Real estate is a local “thing”. With the money to buy a studio apartment in Manhattan you can buy a mansion in other parts of the country. Once you choose the area in which you want to buy, find out the following:

1. How much money does the average purchaser in the area has for downpayment and closing expenses;
2. How much does he/she has in verifiable income;
3. How much the average rentals are (if you plan to buy more than a single family dwelling and plan to rent one or more apartments). You should add this income to the total gross verifiable income from question #2. You can get this information by questioning some experienced realtors in the area or some mortgage officers in banks located in the area.
4. What are the average property taxes for the type of property you want to purchase, as well as the insurance costs for the area.

Once you have this information you can google the question “how much home can I afford?” and input the information into one of the many models on the page such as CNNMoney or Bankrate.com This will give you an idea of the price range you should pay for the type of property you want to purchase.

If you go much above those numbers, you must answer the question: why? And go through the analysis discussed before.

The analysis for purchasing investment property is very similar, except that there should be no personal reason to buy the property if it makes no financial sense. The purpose of an investment is to provide you with some kind of return, either net income at the end of the month, or a gain if you buy for the purpose of resale. If the property that you are planning to buy does not yield a positive income at the end of the month, or a gain if you resell it, then you are gambling that someone else is going to make the same wager you are willing to make and save you from what is in essence a mistake.

Real estate, at the right price, is still the best investment that a person can make. It does not move. You can run it yourself. It is in limited supply, unless we soon discover another planet where humans can live and we find a way to fly there quickly. It is not sensitive to changes in technology or discoveries that might make it obsolete (do any of you remember the telegram?). It is not subject to mismanagement by others, such as a corporation where management runs the company into the ground and your investment with it (how about Enron?).

However, investing in real estate is also not for everyone, and you must be willing to sacrifice your time, your effort and your money. You must be willing to get your hands dirty or have enough money to pay someone to clean, make repairs and maintain the property on your behalf.

Remember, you must run the numbers and at the end, it must make financial sense. If it does not make financial sense, you must have a very good personal reason to buy. And, whatever you do, make sure that you can afford it.