1. Chapter 16: Real Estate and High-Risk Investments Garman/Forgue Personal Finance Tenth Edition PPT slide program prepared by Amy Forgue and Ray Forgue.

2. Copyright ©Cengage Learning. All rights reserved.16 - 2 Introduction  High-risk/speculative investments: Present potential for significant fluctuations in return, sometimes over short time periods.  Real Estate Bubble: Rapid and unsustainable increases in home prices followed by sharp declines in values.

3. Copyright ©Cengage Learning. All rights reserved.16 - 3 Your Next Five Years In the next five years: 1.Focus heavily on the disadvantages before deciding to invest in real estate. 2.Invest only in real estate properties that have a positive cash flow.

4. Copyright ©Cengage Learning. All rights reserved.16 - 4 Your Next Five Years 3.Finance real estate investments with conventional mortgages, not mortgages with adjustable interest terms. 4.Use the discounted cash-flow method to help determine the right price to pay for any real estate investment. 5.If you put money into high-risk assets, limit your investment to no more than 10 percent of your portfolio.

5. Copyright ©Cengage Learning. All rights reserved.16 - 5 Learning Objective #1 Demonstrate how you can make money investing in real estate.

6. Copyright ©Cengage Learning. All rights reserved.16 - 6 Making Money Investing in Real Estate  Real Estate: property consisting of land, structures attached to the land, and accompanying rights and privileges  Direct Ownership: actual legal title to a property

7. Copyright ©Cengage Learning. All rights reserved.16 - 7 Making Money Investing in Real Estate  Current income and capital gains Rental yield is rate of return based on rent Capital gains when property is sold  Current income results from positive cash flow.

8. Copyright ©Cengage Learning. All rights reserved.16 - 8 Making Money Investing in Real Estate  Price appreciation leads to capital gains. Capital improvements Repairs  Leverage can increase an investor’s return. Loan-to-value ratio represents the degree of leverage.

9. Copyright ©Cengage Learning. All rights reserved.16 - 9 Making Money Investing in Real Estate Beneficial tax treatments:  Depreciation is tax deductible.  Interest is tax deductible.  Rental income tax regulations on vacation homes.  Capital gains are taxed at reduced rates.  Tax-free exchanges.

10. Concept Check 16.1  What are the two key questions to consider before investing in real estate?  Distinguish between the price-t-rent ratio and the rental yield as measures of current income. Copyright ©Cengage Learning. All rights reserved.16 - 10

11. Concept Check 16.1  Give an example of how leverage can increase an investor’s return in real estate.  Explain how two beneficial tax treatments are helpful to real estate investors. Copyright ©Cengage Learning. All rights reserved.16 - 11

12. Copyright ©Cengage Learning. All rights reserved.16 - 12 Learning Objective #2 Calculate the right price to pay real estate investment and how to finance your purchase.

13. Copyright ©Cengage Learning. All rights reserved.16 - 13 Pricing and Financing Real Estate Investments  Pay the right price. Use the Discounted cash-flow method  Financing a real estate investment Conventional, fixed-rate mortgage Seller financing (or owner financing) Sweat equity property

14. Concept Check 16.2  Summarize how the discounted cash-flow method helps determine the right price to pay for a real estate investment.  List three ways to finance a real estate investment, and tell why a conventional mortgage might be safer than another financing method. Copyright ©Cengage Learning. All rights reserved.16 - 14

15. Copyright ©Cengage Learning. All rights reserved.16 - 15 Learning Objective #3 Assess the disadvantages of investing in real estate.

16. Copyright ©Cengage Learning. All rights reserved.16 - 16 Disadvantages of Real Estate Investing  Business risk  Complexity  Large initial investment  Dealing with tenants  Time-consuming management demands

17. Copyright ©Cengage Learning. All rights reserved.16 - 17 Disadvantages of Real Estate Investing  Low current income  Unpredictable costs  Interest rate risk  Legal fees  Illiquidity

18. Concept Check 16.3  Summarize why illiquidity, transfer costs, and unpredictable costs are disadvantages in real estate investing.  Identify the four tax deductions that can be taken by an income producing real estate investor. Copyright ©Cengage Learning. All rights reserved.16 - 18

19. Copyright ©Cengage Learning. All rights reserved.16 - 19 Learning Objective #4 Summarize the risks and challenges of investing in collectibles, precious metals, and gems.

20. Copyright ©Cengage Learning. All rights reserved.16 - 20 Investing in Collectibles, Precious Metals, and Gems  Collectibles: cultural artifacts that have value because of their beauty, age, scarcity, etc.  Making a profit on collectibles is not easy.  Buying and selling collectibles on the ‘Net: easy and convenient, but not always safe!

21. Copyright ©Cengage Learning. All rights reserved.16 - 21 Investing in Collectibles, Precious Metals, and Gems  Gold and other metals Gold bullion, gold coins Gold stocks and mutual funds Silver, platinum, palladium, rhodium  Precious stones and gems: diamonds, sapphires, rubies, etc.

22. Concept Check 16.4  Identify one collectible that might be an interesting investing, and explain why it might be difficult to make a profit.  Explain why some investors buy gold and other precious metals, and tell why that type of investment might be appealing or unappealing to you.  Identify some risks of investing in precious stones and gems. Copyright ©Cengage Learning. All rights reserved.16 - 22

23. Copyright ©Cengage Learning. All rights reserved.16 - 23 Learning Objective #5 Explain why options and futures are high-risk investments.

24. Copyright ©Cengage Learning. All rights reserved.16 - 24 Investing in Options and Future Contracts  Derivative (or Derivative Security)  Options allow you to buy or sell an asset at a predetermined price. Stock Option Expiration Date Striking Price

25. Copyright ©Cengage Learning. All rights reserved.16 - 25 Investing in Options and Future Contracts  Options are created by an option writer. Option premium Option holder Call option Put option  Conservative writers profit by selling covered calls. Covered Option, Naked Option

26. Copyright ©Cengage Learning. All rights reserved.16 - 26 Making Sense of Options Contracts

27. Copyright ©Cengage Learning. All rights reserved.16 - 27 Investing in Options and Future Contracts  Speculative investors try to profit with options.  Speculative investors buy calls to create tremendous leverage.

28. Copyright ©Cengage Learning. All rights reserved.16 - 28 Investing in Options and Commodities Futures Contracts  Futures Contract  Economic need creates futures markets.  Speculators may trade in futures markets.  Futures are a zero-sum game.

29. Concept Check 16.5  Distinguish between a call and a put for the options investor.  Summarize two ways a person with a conservative investment philosophy can profit in options.  Explain how a speculative options investor can lose a lot of money.  Offer reasons why futures contracts are not appropriate for the average investor. Copyright ©Cengage Learning. All rights reserved.16 - 29

30. Copyright ©Cengage Learning. All rights reserved.16 - 30 The Top 3 Financial Missteps In Real Estate and Investing People slip up in investing in real estate and high risk investments when they do the following: 1. Assume that real estate prices will go up and interest rates will not increase.

31. Copyright ©Cengage Learning. All rights reserved.16 - 31 The Top 3 Financial Missteps In Real Estate and Investing 2. Fail to factor income lost due to vacancies and collection costs for tenants who do not pay. 3. Fail to set enough money aside for maintenance repairs, unanticipated capital improvements, and rising real estate taxes.

32. Copyright ©Cengage Learning. All rights reserved.16 - 32 Do It NOW! Investing in real estate or high-risk investments may not appeal to you. But if you are considering it you can start today by: 1.Imagining what you would do if you came into $50,000 that you could invest without any concern about losing the money. Would you invest all or some of it in high-risk investments? Explain.

33. Copyright ©Cengage Learning. All rights reserved.16 - 33 Do It NOW! 2.Assuming that real estate is an option for this investment. Search your local newspaper for opportunities to buy a house as a rental property and estimate the asking price for the property, the rate of interest you could expect for the mortgage, the likely rent you could charge and other factors.

34. Copyright ©Cengage Learning. All rights reserved.16 - 34 Do It NOW! 3.Then calculating the net present value of the property to determine the price you should offer for the property.