DEAR BOB: i am contemplating buying a condominium as an investment. My objectives are to rent it out, sell or refinance it when possible and use the tax shelter for other income in the meantime. What are the pros and cons? Franklin B., Seat Pleasant.
DEAR FRANKLIN: If you want to start an argument among a group of real estate investors, ask if they think condos make good investments.
Some will tell you they are terrific because the common areas of the building are maintained by the management (unit owners pay a monthly assessment to cover it), there is good market value appreciation similar to that of single-family houses and they are superb depreciation deductions (due to the high ratio of building value to land value.
But many investors dislike condo investments because owners are at the mercy of the directors of the homeowners' association, which oversees management of the building.
If the directors vote a special assessment for a capital improvement, you must pay your share whether or not you think the improvement is needed. Similarly, the directors can vote to raise the monthly maintenance fees, perhaps creating a negative cash flow problem for you if your unit's rent can't be raised to compensate. Another problem is the directors can vote in new rules, such as no pets, no children, or no rentals allowed.
My personal preference is to stay away from condos. Having owned and lived in one, I know the potential drawbacks. My biggest objection, and it's not applicable in all areas, is that condos appeal to a limited resale market. Many potential home buyers won't even look at condos. But the demand for single-family houses is insatiable. I prefer house investments instead of condos.
DEAR BOB: My husband and I have a total annual income of about $16,000. He is entitled to a VA home loan. Is there any way we can afford our own home? If not a house, what about a condominium? What is the best way to begin? Paula B., Mount Rainier.
DEAR PAULA: VA fixed-interest rate mortgages are today's second best home finance bargain; (the best is a seller financed mortgage). To find out your VA loan eligibility, contact the nearest Veteran's Administration district office. Many have a person who counsels veterans about their VA home loan eligiblity for purchasing a home or condominium.
Another approach is to contact a loan office at a bank, savings and loan association or mortgage brokerage offering VA home loans. Sometimes real estate agents also can give you eligibility details for VA loans, but many agents don't have this information readily available. Home builders, advertising new homes with VA financing, arae another source of VA home loan information.
If you find your income is insufficient to get a new VA home loan, ask a realty agent to find you a home for sale with an existing VA or FHA mortgage. It's often possible to buy such a home with a small down payment if the mortgage was put on the house within the last year or two.
DEAR BOB: We own a home in a small town. It is listed for sale at $65,000. The realty agent brought us a buyer who offered full price, contingent on his getting a $65,000 VA mortgage. The agent says that if we accept, we must pay the buyer's loan fee of 8 percent. That's $5,200. Are we being ripped off or is this really the way VA loans work? Dave F., Washington.
DEAR DAVE: Unfortunately, that's the way Veterans Administration-backed (and Federal Housing Administration) mortgages work. The law prohibits VA and FHA borrowers from paying more than a one percent loan processing fee. So the home seller can chose between paying the buyer's VA or FHA loan fee or not selling to that buyer.
The interest rate on FHA and VA mortgages is set by the government. It's a political decision. To keep down inflation statistics, the FHA and VA interest rate is below the going rate on conventional mortgages. So FHA and VA lenders charge loan fees to raise their yields up to what they could earn on a conventional mortgage.
DEAR BOB: As we will be selling our home in a few months, please clarify the difference tetween that $100,000 "over 55 rule" and the "residence replacement rule" you often mention. I am 56 and my husband is 54. Our home should sell for about $135,000 with about $90,000 profit. For a year we will be living overseas, but we may then come back to the states and buy a condominium. Which of the two tax rules should we use? Miriam D., Bethesda.
DEAR MIRIAM: The correct order for applying the two principal residence tax saving rules is (1) the "residence replacement rule" (available to taxpayers of any age) and (2) the "over 55 rule" (only for taxpayers age 55 or older).
The residence replacement rule requires (that's right, requires) tax deferral if you sell your old principal residence and buy a more expensive replacement within 18 months before or after the sale. You can take up to 24 months after the sale to build a new home if construction started within 18 months after the sale. You may qualify for this tax deferral rule when you return from overseas in 12 months.
If a taxpayer doesn't buy a qualifying replacement principal residence, then the "over 55 rule" $100,000 profit tax exemption should be used, if eligible. This rule is optional, not mandatory. To qualify, at least one co-owner must (a) be 55 or older on the day of title transfer, (b) have owned and lived in his principal residence at least three of the five years before sale, and (c) never have used this rule before.
When you file your 1980 income tax returns, on IRS Form 2119 (Sale of a Residence) indicate that you plan to buy a relacement residence within 18 months after the sale. If you don't buy that residence, assuming you are eligible for the "over 55 rule" $100,000 tax exemption, you can amend your 1980 tax returns to claim this benefit. Ask your tax advisor for further details.
DEAR BOB: We have been thinking for several years of buying a summer home in a resort area. The prices just seem to keep going up and up. Do you think now is a good time to buy or should we wait until next year? Mrs. Lanny K., McLean.
DEAR MRS. LANNY K.: This is an excellent time to buy in a summer resort area. The end of the season, as winter approaches, is when prices are seasonally the lowest. If you wait until next year, you'll probably see prices on those vacation homes go up again.
DEAR BOB: Your recent item about tax-deferred exchanges interested me. I own a rental condominium for investment. It is rented most of the year. As it has greatly appreciated in value, I'd like to trade it for some nearby land on which I want to build a home for myself. My CPA says I can't do this without paying tax on my profit. Is he right or wrong? Charles B., Washington.
DEAR CHARLES: Your CPA is right. To qualify for a tax-deferred Internal Revenue Code section 1031 exchange, both properties must be "like kind." That means they must both be held for business or investment use. Neither property can be your personal residence.
But if you move into your rental condo and convert it to your personal residence, then you can sell it and defer the tax when you buy that more expensive land and build your new home. Personal residences qualify for the generous "residence replacement rule" of Internal Revenue Code section 1034. Ask your tax advisor to explain further.
Tax deferred exchanges are explained in my special report "How Tax-Deferred Property Exhanges Can Pyramid Your Wealth (including new "Starker" delayed exchanges). To obtain a copy send a $2 check, payable to "Newspaperbooks", to The Washington Post, P.O. Box 259, Norwood, N.J. "07648.
DEAR BOB: We own a home in a small town. It is listed for sale at $65,000. The realty agent brought us a buyer who offered full price but contingent on his getting a $65,000 VA mortgage. The agent says if we accept, we must pay the buyer's loan fee of 8 percent. That's $5,200. Are we being "ripped off" or is this really the way VA loans work? Dave F., Washington.
DEAR DAVE: Unfortunately, that's the way VA (and FHA) mortgages work. The law prohibits VA and FHA borrowers from paying more than a one percent "loan processing fee." So the home seller has the "opportunity" to pay the buyer's VA or FHA loan fee or not sell to that buyer.
The interest rate on FHA and VA mortgages is set by the government. It's a political decision. To keep down inflation statistics, the FHA and VA interest rate is below the "going rate" on conventional mortgages. So FHA and VA lenders charge loan fees to raise their yields up to what they could earn on a conventional mortgage.
DEAR BOB: We are having trouble finding a home to buy which we can afford. But our agent did show us a nice two-bedroom home in a very desirable area. The only problems are (1) to get to the bathroom you've got to walk through one of the bedrooms and (2) to get to the second bedroom, you've got to walk through the first bedroom (the one with the bathroom). The house has been for sale about four months. Do you think we should buy? Norla M., Alexandria.
DEAR NORLA: No. A bad floor plan is an incurable property defect. Professional appraisers call it functional obsolescence. Unless you have some inexpensive way to cure the floor plan problems, you'll regret buying that house. Keep looking. Be persistent. Eventually, you'll find a better house you can afford.
DEAR BOB: You're always saying it's best for home buyers to buy a home which has seller financing. Our agent showed us a home we like. But the seller is willing to finance its mortgage for only two years. The agent assures us we can refinance the mortgage at a bank or savings and loan association within two years. Do you agree? Morris T., Ellicott City, Md.
DEAR MORRIS: No. Mortgage moneymight be expensive and tight for a considerable time, perhaps as long as two years. At today's high interest rates, if they continue for an extended period, it will be very difficult for you to qualify for a refinanced mortgage.
Instead of a "short fuse" mortgage, I prefer seller financing for at least five years. Surely within five years it will be possible to refinance. Or you may sell the home within that time period. The longer the seller financing term, the less pressure on the buyer.
DEAR BOB: With mortgage interest rates sky-high there is no way we can qualify for a new mortgage. Several times you've said it's possible to get the home seller to finance the buyer's purchase. How is this done? Agents here don't seem to know much about this type of financing. Steven McG., Annandale.
DEAR STEVEN: Unfortunately, too many realty agents still think the only way to finance a home purchase is with 20 or 25 percent cash down payment and a new mortgage for 75 or 80 percent of the sales price. But in times of tight and expensive mortgage money like now, those agents will starve.
To find a home with seller financing, when you're inspecting a house ask the realty agent two vital questions: (1) what financing is available and (2) why is the seller selling?
If the answers indicate the seller needs an all-cash sale, such as for purchase of another house, don't waste your time. Go on to the next house for sale. It's a buyer's market so don't spend your time with unrealistic sellers who won't help finance your purchase.
When you find a home you like and the seller doesn't really need much cash from the sale, in your purchase offer spell out the exact mortgage terms you want the seller to finance. After he sees your offer on the table, with a good interest rate and substantial monthly payments, he's going to think twice before rejecting it. Until you make that offer, you'll never know if the seller will say "yes" so you can buy that home.
DEAR BOB: Several months ago you gave a formula for estimating the after-tax cost of mortgage borrowing. As a realty agent, I would appreciate your repeating that formula. Please use 13 percent interest rate mortgage and a 30 percent tax bracket. Alic M., Washington.
DEAR ALICE: To estimate the after-tax cost of a mortgage, multiply its interest rate by the taxpayer's combined state and federal income tax bracket.
For example, a 13 percent interest rate multiplied by a 30 percent tax bracket is 3.9 percent. This represents income tax dollars saved by the itemized interest deduction. Subtracting 3.9 percent from 13 percent gives a 9.1 percent after-tax borrowing cost.
DEAR BOB: I strongly disagree with your suggestion that home buyers should make a minimum cash down payment when buying a home. As a real estate agent, I often suggest that my buyers make the largest cash down payment possible. This minimizes their monthly mortgage payment and often enables them to buy a larger home than they could qualify for if they got a maximum mortgage. I think you should change your thinking on this important matter. Phil S., Rockville.
DEAR PHIL: You aren't doing your buyers any favors. In future years, when they try to resell their home with its small mortgage, they won't be thinking good thoughts about you.
The homes which sell easily in today's market are those which have big assumable mortgages. The tough sales are homes which have small mortgages (unless the seller is willing to help finance the sale with a second or a wraparound mortgage). But easy resale is just one reason home buyers should obtain the maximum available mortgage.
Another reson is to maximize the home buyer's return on his invested dollar With homes going up in value, depending on location, 10 to 15 percent per year, borrowing "costs" very little even at today's high mortgage interest rates. But a home buyer who makes a big cash down payment is minimizing his resale profit return per dollar invested.
Additional reasons for making minimum down payments include repayment with cheaper inflated dollars and maximum income tax dollar savings from the interest deduction. Instead of investing excess cash in the down payment on one's home, that money should be used to buy more good property as a further inflation hedge.
DEAR BOB: You did such a splendid job of helping us once before; I hope you do as well this time. We are wondering if we should sell our home and rent an apartment. The yard work and upkeep of the house is getting too much for us. I am 68 and my wife of 42 years is 64. You always say the more property a person owns, the better protected he is against inflation. Since we sold our other properties, our home is our only real estate asset. Waht should we do? James M., Alexandria.
DEAR JAMES: Inflation is your enemy, not the work around your house. If you sell and become a renter, you'll become another inflation victim.
Your best alternative is to sell or rent you home and buy a condominium. The condo should give you the benefits of property ownership, including probable appreciation in property value, but without the work of home ownership.
DEAR BOB: I have recently become interested in real estate through your newspaper articles. What books should I read to gain basic real estate knowledge? David McG., Fairfax.
DEAR DAVID: There are many excellent real estate books at your library or bookstore. Start with these.
(1) "The Real Estate Handbook" by Maury Seldin (Dow Jones-Irwin, 1980) is an superb survey of real estate basics, (2) "Questions and Answers on RealEstate -- Ninth Edition" by Robert W. Semenow (Prentice-Hall, 1978) offers detailed real estate information in an interesting format, (3) "How You Can Become Financially Independent by Investing in Real Estate" by Albert J. Lowery (Simon and Schuster, 1977) shows how to apply the basics to earn profits from real estate, and (4) "Nothing Down" by Robert G. Allen (Simon and Schuster, 1980) is a bestseller about how to buy real estate without much cash.
DEAR BOB: Thank you for sending your report "How Tax-Deferred Exhanges Can Pyramid Your Wealth (including Starker delayed exchanges)." Do I understand that "like kind" property qualified for a tax-deferred trade can be any real estate except my personal residence? Will a trade of my rural land for a city warehouse qualify as tax-deferred? Ed G., Bethesda.
DEAR ED: Yes to both questions. "Like kind" means any realty held for either investment or use in a trade or business. Virtually any property, except your residence, can qualify. Ask your tax advisor for details.