DEAR BOB: You have referred to real estate leverage as being an advantage of buying a home or investment property with a low down payment and a big mortgage. I don't understand what "leverage" means. Rick Q., Upper Marlboro.
DEAR RICK: Real estate leverage means buying property with borrowed money to maximize profit per dollar of your own money invested.
Suppose you buy a $50,000 home. Imagine also that you can sell it in one year for $55,000 (disregarding sales commission). If you had invested $50,000 cash, you would make a 10 percent profit. But if you make only a $5,000 down payment and financed $45,000 on a mortgage costing 9 percent interest ($4,050), your profit would be only about $950 ($5,000 minus $4,050).
However, as a return on your $5,000 cash invested, that's a 19 percent return. It's far better than the 10 percent no leverage profit.
The leverage idea is to earn more from borrowed mortgage money than it costs you to borrow that money. The less cash invested, the higher your return on your invested dollars. Of if you should suffer a loss (it rarely happens with well-located property), your loss is minimized since you made only a small cash down payment.
DEAR BOB: Your article a few weeks ago about real estate dealers hit home with me. Although I am a physician by trade, I make more money from real estate investments. In 1977 I bought 14 properties and sold nine. Do you think my sale profits, which totaled about $275,000, can be taxed as ordinary income instead of as long term capital gains? Doc B., Annandale.
DEAR DOC B.: Maybe. The borderline btween being taxed as a real estate investor (at low, long-term capital gains tax rates) or as a real estate dealer (at ordinary income tax rates) is unclear.
The IRS considers factors such as frequency of salaes, your primary occupation, whether or not you hold a realty sales license and have a realty sales office, realty profits related to your other income, and holding period of the properties sold.
The best insurance against being highly taxed as a realty dealer is to spread out your property sales and to thoroughly document each one to show you are a real estate investor. Ask your tax advisor for further details.
The new Bruss Report "How Two or More Persons Should Take Title to Property" is available for 25 cents plus a STAMPED self-addressed envelope sent to Robert J. Bruss, P.O. Box 6710, San Francisco, Calif. 94101.
DEAR BOB: My tenants left my rental house in terrible shape when they moved out. It's in a low-income part of a town and will cost at least $1,000 to paint and repair. Is it worth spending the money or should I rent it as it is? Maude M., Washington.
DEAR MAUDE: You'll attract a much better quality tenant if you fix up that rental house before advertising it for rent. While some tenants will paint and fix up a run-down rental, too often they do a sloppy job or cause damage by improper work.
It's usually faster and cheaper to either do the fix up work yourself or have it done. While I've had a few bad tenants myself in my rentals, I've found that if you have attractive rentals you'll usually get good tenants.
But run-down rentals attract bad tenants. Of course, screen your tenants carefully, by use of a rental application, to eliminate tenants who might be destructive, as were your last tenants.
DEAR BOB: I've noticed newspaper ads for VA and FHA foreclosed homes. My husband and I went to look at several but found them to be in undesirable neighborhoods. Do you think such homes, offered for very low down payments, are good buys for rental? Victory J., Fairfax.
DEAR VICTORY: The quality of FHA and VA home foreclosures varies from area to area. The best ones are usually purchased by buyers who want to live in them. Such buyers have first priority on such foreclosure purchases.
But it's smart to check the foreclosure list weekly because sometimes good homes don't get purchased by live-in buyers and they then become available to investors like you.
Frankly, if such homes were in top neighborhoods and in good condition, the defaulting owner wouldn't have lost them by foreclosure. He could have sold the home profitably before foreclosure. So be careful.
DEAR BOB: How long should our home sale listing be? We just listed it for six months and are having second thoughts. Jack W., College Park.
DEAR JACK: The shorter the listing, the harder, smarter, and faster your agent will work. Ninety days should be the maximum time for a home exclusive listing. Vacant land sales take longer, of course. Since you've already signed the listing, if the agent doesn't contact you at least once a week, call him to keep him motivated to get your home sold quickly.