How To Raising Startup Money from Friends and Family

For a start-up, initial capital can mean the difference between two founders with just an idea or two founders with a beta product that has real users and could even become the next Uber. While investments from friends and family can be crucial to getting your business off the ground, such investments also come with an additional set of responsibilities. After all, these are the people you grew up with, run into at gatherings, and perhaps even call your father-in-law. Said differently, it is always important to remember you have pre-existing personal relationships with these people that likely trump any need for capital. To that end, below are some important considerations to keep in mind when seeking capital from your friends and family.

1. Be Honest: The great thing about a friends and family round is that these potential investors already know you and have faith in you. They want you to succeed and want to believe that your idea has the potential to make an impactful change. As a founder, however, you should not take advantage of this faith. You should educate these potential investors of the risks associated with investing in start-ups broadly as well as the specific risks unique to your business. Just as important, if you do receive an investment, be sure to provide periodic updates on the status of your business.

2. Explain Investment Terms: Your friends and family may be sophisticated lawyers, doctors, engineers, consultants and so forth, but that doesn’t mean they are sophisticated early-stage investors. Take the time to create a term sheet and lay out exactly what form the investment will take and make sure to explain what that actually means to your potential investors.

While there is a lot of literature on common investment structures for start-ups, like the classic convertible note or the newer SAFE or KISS, your friends and family investors may think they understand the structure when they actually don’t. For instance, an unsophisticated investor may see the interest rate and maturity date associated with a convertible note and think – “Worst case, I’ll get my money back with interest in a couple of years if this doesn’t work out.” The truth is, however, that if the start-up is unable to grow sufficiently before maturity, chances are the investment amount won’t convert into equity because the start-up has failed to raise additional institutional capital, or alternatively, the start-up won’t have sufficient liquidity to pay off the loan.

3. Documentation: A founder should treat an investment from friends and family like an investment from a stranger and should appropriately document the transaction. Documentation does a couple of things: (1) it clearly spells out the intention between the parties and (2) captures the rights and obligations of each party.

4. Offer Fair Terms: Investors in a friends and family round are taking a big risk (if that wasn’t clear from the above) and should be compensated accordingly. As a founder, you should take the time to understand what terms are fair and reasonable given the amount of risk undertaken and offer investment terms that balance such risk. The last thing you want to do is take advantage of your relationship and the trust and offer terms that are less than fair.

Tips to Reduce Attorney Fees for Your Business

Whether you are just starting a business and need to form an entity, have an existing business and are negotiating contracts with third parties or are in the process of selling your business, an attorney will undoubtedly play a critical role. It’s important to keep in mind, however, as vital as an attorney’s advice is in these situations, it doesn’t mean you have to pay an arm and a leg for it. Set forth below are three strategies to minimize attorney fees and stay within your budget:

. Know What You Need

The first step to ensuring you receive quality legal services for an affordable fee is to know exactly what you need from your lawyer. Prior to seeking out a lawyer, write down any questions you would like to ask and take notes of your situation. Will you need help with specific documentation or just need more general legal advice? The more organized you are before you speak with a lawyer, the better off you’ll be.

2. Negotiate Fixed Fees

Small business owners are particularly sensitive to costs associated with hiring counsel when they have a legal need. For this reason, business owners should negotiate fixed fees for their transactional needs rather than paying an attorney on an hourly basis. This is because with fixed fees both the client and attorney are very clear on what the intended objectives of the engagement are. An experienced attorney will know what needs to be done and how much time they will likely spend on the matter and will be able to (more or less) accurately price it upfront.

Sometimes attorneys are resistant to provide fixed fees on the theory that a matter is too complicated to price it up front, say for instance, when purchasing a business. If you do receive pushback, break down the matter into discrete tasks. You could agree to pay (i) a fixed-fee for initial legal due diligence, (ii) a second fixed-fee for the initial drafting of the purchase and sale agreement, and (iii) another fixed-fee for revisions, negotiations and finalization of the agreement. Structuring attorney fees this way ensures that you have control over your costs and clearly defines the scope and involvement of the attorney throughout the process.

With hourly rates, on the other hand, even the most well intentioned attorneys could be inaccurate with their time-keeping, which may ultimately result in unexpected costs for the client. Take for example an attorney that charges $300 per hour and bills for 10 hours of work, for a total of $3,000 at the end of the engagement. If the attorney billed in increments of 6 minutes (which is customary) and is off by 6 minutes in tracking for each hour spent, that would mean an additional hour’s worth of work (or $300.00 in this example) is charged without any actual value in return. Simply put, inaccurate timekeeping can add up if you are on a budget. That said, if you are unable to negotiate a fixed-fee arrangement, you should request that the fee based on the hourly rate is capped at a set amount so that you at least have a sense of the outside cost.

3. Using Legal Forms

One method small businesses often utilize to save on costs is downloading a legal form and filling in the blanks. This certainly will reduce your legal costs since the business owner is deciding to forgo counsel. While it is true that most forms contain “standard” or “boilerplate” provisions, it is the non-standard provisions that really require an attorney’s attention. Instead of just using a stock document form without any modification, a better approach would be to use the legal form as a starting point and have an attorney tailor the form to your particular needs. This should save you significant fees as the attorney can concentrate on the customization and reworking of deficient provisions in the “standard” form rather than starting from scratch.

Tips to Start a Business with No Money

You have a dream but no money to put toward the dream. That’s not uncommon among entrepreneurs. Don’t let the lack of money deter you from a business you know other people would find benefit from. Here are a few ideas of how to get your business off the ground with no money.

1. Some are Easier Than Others

If you don’t have any startup capital, service-based businesses are perfect. Product based businesses require you to purchase and then resell. Service-based businesses like consulting, advising, or things like content creation or web design, only need equipment you probably already have.

2. Get Creative with How You Raise Funds

Consider the story of how Outbox Systems started. The founders had a dream of connecting two software applications together but didn’t have the money to build it. Instead, they worked out a deal with another company where they would build a similar product for a discounted rate yet retain the rights to sell the product to others. That’s creative financing. How can you get creative with how you raise money?

3. Sweat Equity is Free

Starting a business is hard. It’s not comfortable. Expect long days, a lot of hard conversations, and plenty of people telling you it won’t work. You don’t have the money to hire people to do tasks like cold calling and door to door sales so you have to take on the task. If you commit to being the person that does just about everything in the beginning, startup costs are much lower.

4. Creative Fundraising – Part 2

Yes, there’s friends and family but today we have crowdfunding, local and national incubators, accelerators, and microfinancing. If you don’t know what these are, do some Googling and learn about them. Look for communities of investors in your area and tell others about your business. There’s plenty of funding that doesn’t involve banks and credit cards.

5. Start Simple

Your dream might include a pretty big business offering a wide variety of products and services but for now, keep it simple. Sell a single product or service. Build your customer base and later branch out into other products and services.

One of the most expensive parts of running a business is acquiring customers. If you gain their trust with one product or service now, selling something else later is much easier.

6. Start as a Hobby

At some point you’ll have to quit your day job but that day isn’t today. Hobby businesses often come from the person’s love of something. Maybe you have a corporate job during the day but you love to bake when you come home. Start with people you know and allow your network to grow from there. Your marketing costs are zero and you still have money coming in from your day job.

7. Work for Somebody Else

Although they may not admit it, most business owners became entrepreneurs thinking they knew more than what they did. In fact, many businesses fail because the person was ill-equipped to build a successful business.

Before you start your own business, work or intern with somebody in the business already. The experience you gain will allow you to start your business knowing what you truly need to spend money on and what you don’t. You’ll also gain insider knowledge of the industry and possibly a healthy customer list from the beginning.

8. Use Free Services

The Internet is full of high quality services you can use for free. Mailchimp is a powerful e-mail marketing platform that’s free for the first 2,000 e-mail addresses. Wufoo allows you to make online forms, and although Facebook and other social media platforms won’t put your ad in front of large amounts of people unless you pay, you can still gain some traction by telling people what you’re doing.

There’s also freelance platforms like Fiverr, Elance, and Upwork that have quality freelancers willing to help with logo and web design, and other service for cheap. You could get a logo made for $5!

9. Barter

Don’t have any money? Offer to barter your services in exchange for somebody else’s. There aren’t many small business owners that aren’t looking for ways to get quality services for little or no cost. What you have, they want, and they’re willing to trade for it.

10. Hustle!

Finally, go into your business endeavor with a hustling mindset. Be ready to do anything legal and ethical to get your business off the ground. Don’t like cold calling? Do it anyway? Not a graphic designer? You can find templates online for just about anything. Don’t want to do any free work? It might be worth it to get your name out there. If you don’t have the money to pay for services, you have to do them or find somebody who can and will do it for free.

Just as you would do just about anything for your family, you have to have the same mindset about your business.

All About Mortgage Broker

Applying for a mortgage is a more involved and complicated process than it has ever been. Here are five things to avoid when meeting with your mortgage broker to help streamline getting a mortgage.

1. Don’t Show Your Entire Resume: Present Stability
A steady income is what banks look for when handing out a large loan. Although it is not uncommon for people (especially young professionals) to switch jobs every couple of years, it would be advantageous to not highlight every move to your lender. Mortgage lenders want to see a clear path to repayment. Seeing that you’ve changed jobs frequently, regardless of the reasoning, could be viewed as a red flag.

2. Don’t Show Your Inexperience
Most people don’t go into applying for a mortgage knowing everything there is about interest rates, rate shopping or the benefits of 20- vs. 30-year mortgages. While your mortgage broker can be the best person to educate you on certain questions, you don’t need to divulge how much you don’t know. The mortgage market is just that – a market – and, as such, there is always an opportunity to be taken advantage of. Maintaining a stealthy approach to how you find out information could benefit you in the long run and make mortgage brokers treat you more like a partner than a malleable client.

3. Don’t Disclose Expected Life Changes
Again, a potential borrower’s steadiness is crucial aspect lenders evaluate. Often borrowers will be quick to reveal they are expecting a new position within their company or that they have a new child on the way. While in many cases this can be either passive or beneficial information, depending on your particular financial picture it can be a detriment. Sharp increases or decreases in salary can prolong the loan process, and if a candidate is already on the fence for approval, the announcement of a new dependent (and liability) can tip the scale out of your favor.

4. Don’t Commit to a Specific Rate Without Doing Research
Often when you walk past a bank’s window, you’ll see a sign offering a “one-time” deal to lure you into purchasing one of their products. One of the most heavily advertised packages banks will offer are mortgage rate deals.

There are generally two types of mortgages – fixed or variable rate. Each mortgage type can offer advantages and disadvantages depending on your situation, so it is important to do your research in advance to ensure your decision isn’t swayed by the bank.

Fixed-rate mortgages are pretty straightforward and will lock you into the agreed upon rate for the length of the mortgage. In contrast, with a variable or adjustable rate mortgage, the interest rate will fluctuate over the life of the loan. Adjustable-rate mortgages are usually what you will see advertised when walking past a bank. Banks offer very low rates up front for adjustable rate mortgages, and typically these types of mortgages will sustain the low “introductory” interest rate for a period where the interest rate will remain unchanged. The 5-year adjustable rate mortgage is the most common.

After that introductory period, though, the interest rate will then fluctuate according to the interest rate index chosen by that specific bank. Here is where things begin to get a little tricky. The variable-rate mortgage seems appealing at first, as you can pay a lower rate of interest up front, but you are then undertaking an unknown interest rate in the future. That means your monthly mortgage payments will likely change in the future.

Deciding between a fixed- or variable-interest rate mortgage ultimately boils down to the borrower’s preferences and financial situation. If you seek stability, then a fixed-rate mortgage is a good option, particularly if you believe interest rates will likely rise during the duration of your loan. On the other hand, though, let’s assume you are starting out in your career and need a lower interest rate to purchase a home. If you are a young homebuyer, who anticipates salary increases in the future, which you believe will allow you to withstand higher mortgage payments and variable-interest rates, then you may choose the adjustable rate mortgage. Adjustable-rate mortgages can also be advantageous to investors who are unsure if they will keep the home for a long period and may be able to secure a low interest rate for the brief time they own the home. Again, taking on an adjustable-rate mortgage is a gamble so none of this type of information needs to be revealed to a mortgage broker beforehand. It is best to meet with your mortgage lender after you’ve done your homework and made your decision.

5. Don’t Be Dishonest
One of the biggest problems mortgage brokers run into with prospective buyers is the truthfulness of their intentions. Clients will claim they are buying a primary residence because they think it will help them get approved, then run into problems when their financial documents show otherwise. Lenders will know if you can afford a second home or not, so providing full transparency in your intentions will actually help them achieve your goals better.

Teach Your Teen About Money

Before you know it, your teenager will be talking about college, starting a job, getting her own place to live…the list goes on and on. As we want them to fly the coop and be their own person, we also want them to develop a money-smart foundation.

We know money matters can be confusing to young adults. Here are some questions to discuss with your teen to get her started:

1. What Is a Financial Plan?
Help her create a financial that will help her achieve both her needs and her dreams. The plan should include an income stream, a spending component, a savings component, an investment component and perhaps, a charity component. By learning about savings and investing at an early age, she will have a head start in learning to create wealth. What’s a best practice? As your child gets older, include her in at least some of the conversations with your financial advisor.

2. Why Is a Budget the Most Important Financial Document?
A budget is an excellent tool to help stay in control of money. Your teen can learn how much different items cost and devise ways to earn income to pay for the items in her budget. Whether your teen earns income through an allowance, through work, or a combination, a budget will help her learn the concepts of regulation and restraint.

3. What Are the Benefits of Saving?
A teenager and a savings plan should go hand-in-hand. A savings plan can provide a disciplined process to saving for an expensive item. Or a savings plan can help when unexpected expenses and emergencies arise…a health issue, a smashed wheel on a skateboard, a broken computer. What’s a good tip for savings? Save 15% of every dollar earned or received.

4. What Are Some Key Credit Tips?
Teens need to understand that using credit is equivalent to borrowing money. But instead of borrowing from Mom or Dad, they are borrowing from a bank. Using credit is convenient, however, it comes with responsibility and accountability. What teens need to know is that paying the balance at the end of the statement period is smart. If they don’t pay the balance in full, they will be charged interest.

5. What Do You Know About Identity Theft?
Being on a tablet or phone is native to this generation. For millenials, many, if not most of their financial transactions are online. I’m guessing your teen will only pay for items using her phone. The concept of various credit and debit cards may drift away. Therefore, now is a good time to think about protecting her financial security, especially since hacking is part of our lives. Your child should check her bank account a few times a week to look for unauthorized transactions and at age 18, begin checking her credit report annually. A good time of year? Around her birthday.

Should Know Some Risky Moves People Are Making to Buy a Home

These days it seems that Americans may be willing to make some risky moves to buy a home. If you’re considering taking a chance, one of the first questions you need to ask yourself is, “How much can I really afford?”

Mortgage rates are once again above 4%, and after a December rate hike of 0.25%, the Federal Reserve is expected to make additional increases to the federal funds rate. French Bank BNP Paribas SA predicted in January that rates would rise again in the second half of 2017, followed by quarterly increases in 2018. All of which means that buying a home isn’t getting any easier.

4 Risky Moves to Buy a Home That Are Happening Today
So what does this mean for buyers who are gearing up to buy a home this year? According to the 2017 Home Buyer Study of more than 1,000 consumers considering a home purchase in 2017, it seems as if many prospective buyers are willing to let certain financial priorities take a backseat to home ownership. (For more, see Finding the Best Mortgage Rates in 2017.)

In terms of what buyers are sacrificing to land a home, the study reveals two broad trends. Overall, buyers are cutting spending, but they’re also trimming down what they’re saving for emergencies and retirement. For example:

76% of buyers said they’re skipping investments in stocks as they prepare to buy.
72% aren’t contributing to other investment funds.
61% have put contributing to their emergency fund on hold.
And in a move that’s tangentially less risky, but not for long-term health:

84% have stopped gym memberships or fitness classes.
The reason? Nearly seven in 10 consumers included in the survey said they were concerned about not having enough cash for a down payment. They were also worried about increasing interest rates, getting locked into a bidding war for a home and the long-term affordability of their mortgage. president Steve Udelson remarked on what may be driving buyers to re-prioritize their financial goals in a press release: “Market pressures are forcing consumers to take necessary action to stretch their purchasing power. Buying a house is a worthwhile investment for many people, and consumers are demonstrating a willingness to make sacrifices to achieve their goal of home ownership.”

What Else They’re Giving Up
Not all the moves are risky. Dining out (87%) and clothes shopping (86%) are also in the top expenditures consumers are cutting out. And then they’re giving up some “dream home” ideas.

Beyond cutting back on saving and spending, buyers also expressed a willingness to buy a home that doesn’t meet all their criteria if it allowed them to stay within their budget. Fifty-one percent of respondents said they’d consider buying a fixer-upper, while 36% said they wouldn’t discount buying a smaller home. Surprisingly, 28% said they’d be willing to do some of the legwork of buying on their own to avoid paying high fees or commissions to a real estate agent. (For more, see Do You Need a Real Estate Agent?)

Is It Worth It?
Real house prices have jumped by 2% year over year, according to First American’s Real House Price Index. Paired with the prospect of rising interest rates and President Trump’s recent decision to eliminate a mortgage fee cut, which would have saved first-time home buyers seeking FHA loans an estimated $500, it’s easy to understand why buyers may be feeling pressure to get into the market now.

But is it worth it? Luis Rosa, a certified financial planner and financial advisor with Haydel Biel & Associates in Pasadena, Calif., says that the kind of behavior exhibited in the study is typical of first-time home buyers: “Because the future of interest rates and home prices are unknown but most likely expected to rise, it’s not necessarily a bad idea to temporarily forgo certain future goals in order to purchase a home if you can afford to.” As long as buyers don’t lose sight of those other priorities, he adds, they can make it work.

Nicole Peterkin, a financial advisor with Peterkin Financial in Quincy, Mass., cautions buyers to be aware of the risks: “Feeling that the cash that’s been saved for a down payment isn’t enough is usually an incentive to cut back and save more if the house is that important, but then you have homebuyers putting every penny they’ve saved into a home.”

That creates trapped equity, and there’s a cost and lack of liquidity associated with accessing that money. Peterkin says that homeowners may find themselves trying to play catch up when it comes to building their safety net or investing for retirement. In that scenario she recommends that buyers consider purchasing a home that’s less of a stretch financially, so they can still save and invest while making home ownership a reality.

Some Things You Think Add Value To Your Home

Every homeowner must pay for routine home maintenance, such as replacing worn-out plumbing components or staining the deck, but some choose to make improvements with the intention of increasing the home’s value. Certain projects, such as adding a well thought-out family room – or other functional space – can be a wise investment, as they do add to the value of the home. Other projects, however, allow little opportunity to recover the costs when it’s time to sell.

(For more information on buying a home, see: A Guide to Buying a House in the U.S.)

Even though the current homeowner may greatly appreciate the improvement, a buyer could be unimpressed and unwilling to factor the upgrade into the purchase price. Homeowners, therefore, need to be careful with how they choose to spend their money if they are expecting the investment to pay off. Here are six things you think add value to your home, but really don’t.

1. Swimming Pool
Swimming pools are nice to enjoy at a friend’s or neighbor’s house, but can be a hassle to have at your own home. Many potential homebuyers view swimming pools as dangerous, expensive to maintain and a lawsuit waiting to happen. Families with young children in particular may turn down an otherwise perfect house because of the pool (and the fear of a child going in the pool unsupervised). In fact, a would-be buyer’s offer may be contingent on the home seller dismantling an aboveground pool or filling in an in-ground pool. The one exception could be if having a pool is standard in your neighborhood, as it can be in warm states such as California, Arizona, Florida and Hawaii.

An in-ground pool costs anywhere from $30,000 to more than $100,000, and additional yearly maintenance expenses are part of the package. That’s a significant amount of money that might never be recouped if and when the house is sold. Put one in for your own pleasure, perhaps, but know that it could cost you when you sell your home.

2. Overbuilding for the Neighborhood
Homeowners may, in an attempt to increase the value of a home, make improvements that unintentionally make the home fall outside of the norm for the neighborhood. While a large, expensive remodel – such as adding a second story with two bedrooms and a full bath – might make the home more appealing, it will not add significantly to the resale value if the house is in the midst of a neighborhood of small, one-story homes.

In general, homebuyers do not want to pay $250,000 for a house in a neighborhood with average sales prices of $150,000; the house will seem overpriced even if it is more desirable than the surrounding properties. The buyer will instead look to spend the $250,000 in a $250,000 neighborhood. The house might be beautiful, but any money spent on overbuilding might be difficult to recover unless the other homes in the neighborhood follow suit. If your area is in the midst of a gentrifying burst of teardowns and rebuilds, then an extensive remodel might be worth it. But only then.

3. Extensive Landscaping
Homebuyers may appreciate well-maintained or mature landscaping, but don’t expect the home’s value to increase because of it. A beautiful yard may encourage potential buyers to take a closer look at the property, but will probably not add to the selling price.

If a buyer is unable or unwilling to put in the effort to maintain a garden, it will quickly become an eyesore, or the new homeowner might need to pay a qualified gardener to take charge. Either way, many buyers view elaborate landscaping as a burden (even though it might be attractive) and, as a result, are not likely to consider it when placing value on the home.

4. Inconsistent High-End Upgrades
Putting stainless steel appliances in your kitchen or imported tiles in your entryway may do little to increase the value of your home if the bathrooms are still vinyl-floored and the shag carpeting in the bedrooms dates back to the ’60s. Upgrades should be consistent to maintain a similar style and quality throughout the home.

A home that has a beautifully remodeled, modern kitchen can be viewed as a work in progress if the bathrooms remain functionally obsolete. The remodel, therefore, might not fetch as high a return as if the rest of the home were brought up to the same level. High-quality upgrades generally increase the value of high-end homes, but not necessarily in mid-range houses where the upgrade may be inconsistent with the rest of the home.

In addition, specific high-end features – such as media rooms with specialized audio, visual or gaming equipment – may be appealing to a few prospective buyers, but many potential homebuyers would not consider paying more for the home simply because of this additional feature. Chances are that the room would be re-tasked to a more generic living space.

5. Wall-to-Wall Carpeting
While real estate listings may still feature “new carpeting throughout” as a selling point, potential homebuyers today may cringe at the idea of having wall-to-wall carpeting. Carpeting is expensive to purchase and install. In addition, there is growing concern over the healthfulness of carpeting due to the chemicals used in processing and its potential for trapping allergens (a serious concern for families with children). Add to that the probability that the carpet style and color you thought was absolutely perfect might not be what someone else had in mind.

Because of these hurdles, it’s difficult to recoup the cost of new wall-to-wall carpeting. Removing the carpet and restoring (or even installing) wood floors is usually a more profitable investment.

6. Invisible Improvements
Invisible improvements are those costly projects that you know make your house a better place to live in, but that nobody else would notice – or likely care about. A new plumbing system or HVAC unit (heating, venting and air conditioning) might be necessary, but don’t expect it to recover these costs when it comes time to sell.

Many homebuyers expect these systems to be in good working order and will not pay extra just because you recently installed a new heater. It may be better to think of these improvements as part of regular maintenance, not an investment in your home’s value.

Rates Affect Property Values


Interest rates, especially the rates on interbank exchanges and Treasury bills, have as profound an effect on the value of income-producing real estate as on any investment vehicle. Because the influence of interest rates on an individual’s ability to purchase residential properties (by increasing or decreasing the cost of mortgage capital) is so profound, many people incorrectly assume that the only deciding factor in real estate valuation is the mortgage rate. However, mortgage rates are only one interest-related factor influencing property values. Because interest rates also affect capital flows, the supply and demand for capital and investors’ required rates of return on investment, interest rates will drive property prices in a variety of ways.

Valuation Fundamentals
To understand how government-influenced interest rates, capital flows, and financing rates affect property values, you should have a basic understanding of the income approach to real estate values. Although real estate values are influenced by the supply and demand for properties in a given locale and the replacement cost of developing new properties, the income approach is the most common valuation technique for investors. The income approach provided by appraisers of commercial properties and by underwriters and investors of real estate-backed investments is very similar to the discounted cash flow analysis conducted on equity and bond investments.

In simple terms, the valuation starts by forecasting property income, which takes the form of anticipated lease payments or, in the case of hotels, anticipated hotel occupancy multiplied by the average cost per room. Then, by taking all property-level costs, including the financing cost, the analyst arrives at the net operating income (NOI), or cash flow remaining, after all operating expenses.

By subtracting all capital costs, as well as any investment capital to maintain or repair the property and other non-property-specific expenses from NOI, the result is the net cash flow (NCF). Because properties don’t usually retain cash or have a stated dividend policy, NCF equals cash available to investors and is the same as cash from dividends, which is used for valuing equity or fixed-income investments. By capitalizing dividends or by discounting the cash flow stream (including any residual value) for a given investment period, the property value is determined.

Capital Flows
Interest rates can significantly affect the cost of financing and mortgage rates, which in turn affects property-level costs and thus influences values. However, supply and demand for capital and competing investments have the greatest impact on required rates of return (RROR) and investment values. As the Federal Reserve Board has moved focus away from monetary policy and more toward managing interest rates as a way to stimulate the economy or stave off inflation, its policy has had a direct effect on the value of all investments.

As interbank exchange rates decrease, the cost of funds is reduced, and funds flow into the system; conversely, when rates rise, the availability of funds decreases. As for real estate, the changes in interbank lending rates either add or reduce the amount of capital available for investment. The amount of capital and the cost of capital affect demand but also supply, capital available for real estate purchases and development. For example, when capital availability is tight, capital providers tend to lend less as a percentage of intrinsic value, or not as far up the “capital stack.” This means that loans are made at lower loan to value ratios, thus reducing leveraged cash flows and property values.

These changes in capital flows can also have a direct impact on the supply and demand dynamics for property. The cost of capital and capital availability affect supply by providing additional capital for property development and also influence the population of potential purchasers seeking deals. These two factors work together to determine property values.

Discount Rates
The most evident impact of interest rates on real estate values can be seen in the derivation of discount or capitalization rates. The capitalization rate can be viewed as an investor’s required dividend rate, while a discount rate equals an investor’s total return requirements. K usually denotes RROR, while the capitalization rate equals (K-g), where g is the expected growth in income or the increase in capital appreciation.

Each of these rates is influenced by prevailing interest rates because they are equal to the risk-free rate plus a risk premium. For most investors, the risk-free rate is the rate on U.S. Treasuries; these are guaranteed by U.S. government credit, so they are considered risk-free because the probability of default is so low. Because higher-risk investments must achieve a commensurably higher return to compensate for the additional risk borne, when determining discount rates and capitalization rates, investors add a risk premium to the risk-free rate to determine the risk-adjusted returns necessary on each investment considered.

Because K (discount rate) is equal to the risk-free rate plus a risk premium, the capitalization rate is equal to the risk-free rate plus a risk premium, less the anticipated growth (g) in income. Although risk premiums vary as a result of supply and demand and other risk factors in the market, discount rates will vary due to changes in the interest rates that make them up. When the required returns on competing or substitute investments rise, real estate values fall; conversely when interest rates fall, real estate prices increase.

Buy Property on Leased Land

The most traditional form of home ownership is to own both a house and the land upon which it is built. Those who can’t afford houses, or who do not want to be bothered with outside maintenance and upkeep, may purchase condos or townhouses. However, there is another home ownership option: buying only the home and leasing the land it occupies.

Tutorial: How To Buy Your First Home

Purchasing a home in a leased land community enables you to own a home that you otherwise wouldn’t be able to afford. However, this type of purchase lacks some of the benefits of traditional home ownership and has other significant drawbacks. Would this unusual ownership setup work for you? Read on to find out.

The Basics
With a trained eye, you can usually spot a leased-land property, even when it is not explicitly stated. Key words to look for include “manufactured home” and “leasehold interest.” Exterior features of the home might be described in terms, such as “association pool” or “association tennis courts.” Also, the price of leased property tends to be far below market value. For example, if the going rate for a traditional three-bedroom, two-bathroom, 1,600 square foot is around $500,000, a comparable home on leased land may only cost $150,000. A leased property home may also have unusually upscale features for its price.

Steep homeowners’ association (HOA) fees also indicate that a listing may be for a leased-land property. A normal HOA fee might be around $250 per month, while an HOA fee on a leased-land property might be $900 per month. Another giveaway is that if you look at a satellite map of the neighborhood where the home is located, you may notice that the homes are closer together than usual and are extremely similar to one another. Finally, in a typical neighborhood, some homes have their own pools, while in a leased-land community none of them will.

Real estate listings don’t always list leased-land property. Sometimes, key information is left out of a real estate listing because of an agent’s sloppiness, or because the agent or seller is trying to hide something. Investigate the hidden facts, and never purchase a leased-land property without thoroughly understanding the unusual features of this type of home ownership.

Types of Leased-Land Properties
There are several types of residential leased-land properties, and the most common type varies by region. In Hawaii and Delaware, there are leasehold condos. In areas with Native American reservations, such as Palm Springs, you may be able to purchase property on leased reservation land. In Los Angeles, where even homes in the suburbs far exceed prices the average person can afford, there are leased-land properties in suburban areas, such as Simi Valley and Canyon Country. Florida and Arizona have a number of leased-land retirement communities as well.

Leased-land properties exist in other areas, but because leasing land is an unconventional way to purchase property, this option is not available in every state. Trailer parks, perhaps the most common form of leased-land community, can be found almost anywhere.

When you buy a house or condo on leased land, you’ll take out a mortgage on the property as usual. The monthly mortgage payment will be less because the home’s purchase price is lower, but you’ll also have to pay a significant monthly land lease fee. Because land lease properties are often located in entire communities of similar properties, a leased-land property may also come with HOA fees to cover the upkeep of landscaping, community pools, community buildings, etc.

General Considerations
If you think that buying a property on leased land may be right for you, you should consider the following.

How much time is remaining on the lease? If the length of the remaining lease is shorter than you plan to remain in the home, it is imperative to find out what happens to your interest in the property at the end of the lease term. The lease term will also affect your ability to finance the home. It may be difficult or impossible to get a mortgage if the remaining lease term on the land is 20 years and you want a 30-year mortgage. Ideally, a lease that exceeds your potential remaining lifespan will protect your financial interests and your peace of mind. Of course, while you may not live in this home for the rest of your life, it’s nice to have that option. And if you sell the home, a long remaining lease term will positively affect your sale price.

What are the terms of the surrender clause? Check the terms of the surrender clause if the lease will run out while you still own the house. If the lease expires and is not renewed, you will have to give up the use of the land upon which your home is built. Some surrender clauses stipulate that you also must surrender any improvements to the land (i.e., your condo, townhouse or house). Avoid ugly surprises by getting the information before you buy.

How much is the monthly land lease payment, how often does it adjust, and by how much? If there are HOA fees, ask the same questions about those. You want to make sure that you really will be saving money by buying a leased-land property, and that you won’t one day be forced to move by escalating costs.

Am I better off renting? Consider whether owning a home on leased land is really superior to renting. The two are similar in many ways, including a payment of monthly fees that are determined by another party. Owning a traditional home may give you a greater degree of freedom; if that is important to you, it may be worth the wait to save up for a down payment or increase your income enough to qualify for a good mortgage on a traditional home.
Buying a home on leased land offers the following advantages.

You purchase the home for much less than a traditional home because you don’t have to buy the land.

Leased-land properties are often better than apartment living for children and pets, and you can invest the money that leasing saves you.
Buyers can live in a high-priced location they could not otherwise afford. For example, in Huntington Beach, Calif., there are several mobile home communities near the Pacific Ocean. To buy even an entry-level house in Huntington Beach, you might need around $400,000. Buying an entry-level home in a trailer park, by comparison, could cost as little as $40,000.

Leased-land communities often include amenities not always found in traditional neighborhoods, such as clubhouses, pools, tennis courts, playgrounds and golf courses. Because of the community association aspect, any HOA fees may include having your lawn mowed on a regular basis.

Because you don’t own the land, you’ll likely have low or no property taxes, which can help take some of the sting out of paying leased land and HOA fees. In some areas, local laws restrict the amount by which leased land fees can increase annually. (For related reading, see Five Tricks For Lowering Your Property Tax.)
The following are the disadvantages to this form of home ownership.

The most significant downside to owning a home on leased land relates to building equity. For many people, home ownership is a major source of wealth. With a leased-land property, you risk losing all of your equity at lease expiration, depending on the terms of the surrender clause. The resale of the home is likely to be more difficult than the resale of a traditional home, especially because with each passing year, the remaining term on the lease shortens. For this reason, if you want to leave something to your heirs, a home on leased land will not be nearly as valuable to them as a traditional home.
Leased-land properties are often part of an HOA, which means extra monthly fees that are somewhat unpredictable. While HOA fees are typically a set amount each month, they can rise annually. The HOA can also levy a special assessment for major community property repairs or upgrades, creating a large, unexpected bill. HOA fees can be particularly troublesome for those who do not make use of common amenities like pools, or who would prefer to do their own landscaping to save money.

While traditional home ownership can be a good hedge against inflation, owning a leased-land property is not. When you buy a home with a fixed-rate mortgage, your payment remains the same each year as inflation goes up. Eventually, the monthly payment to own your home might be lower than renting in your neighborhood. And while home values fluctuate, over the long-term price increases typically match or surpass the rate of inflation. In a leased-land community, your monthly lease payments and HOA fees will probably increase at least by as much as the rate of inflation. Meanwhile, your home will become less valuable as the end of the lease term approaches.

If you have a manufactured home on leased land and the lease expires (and the surrender clause does not require you to relinquish the property), you can theoretically take the home with you to another leased-land community or to a plot of land you have purchased. However, this is not very realistic unless you are purchasing a trailer home. Otherwise, you will have to have the house disassembled and transported to a new plot of land. This may be very impractical and is likely to be prohibitively expensive.

Some Things That Determine a Home’s Value

Many first-time homeowners and experienced real estate investors seem to focus on the functionality and style of their proposed purchases, expecting these characteristics to lead to increased property value. Many fail to remember the slogan of the real estate industry —”location, location, location” — when trying to find the property that will be a great investment.

The reality is that the physical structure depreciates over time. It is the land underneath the structure that appreciates in value. This is a significant distinction, considering that the purchase of a home is the single greatest investment that most retail investors will make in their lifetimes. Failing to look at one’s home as an investment and understand the drivers of value, or concentrating on functionality and accommodation, can limit the property’s overall performance and opportunities to maximize wealth.

Land as an Appreciating Asset

Making the distinction between the improved portion of a property and the land on which it sits may seem trivial. But it is not until the real estate investor focuses on these differences that it becomes easier to find more efficient investments that provide the highest return for the amount of risk or capital invested. Because property prices are a function of local supply and demand, the appearance, functionality, and maintenance of the physical structure will certainly impact value, but these factors have less impact than one may think. Understanding how location and the future prospects of land values influence property returns allows investors to make better choices between competing assets.

The reason that land is an appreciating asset is a simple one. It is in limited supply, and no one is producing anymore. The demand for land is constantly growing as the population increases, and since its supply is limited, its price must increase over time. Unless something happens to limit demand for a given area or make it unusable, the grounds should be expected to increase in value over time.

The question is how much the land will appreciate and how much the improvements will enhance or degrade overall value. The physical structure on a property is a depreciating asset. As it ages, it requires capital infusions for maintenance, updating to stem functional obsolescence and, depending on its design, updating to prevent it from falling out of style. Even the Internal Revenue Service (IRS) acknowledges this fact by allowing depreciation of the physical structure for tax obligations. The land underneath the structure, however, is not depreciated.. (To find out which home improvements are worthwhile and which are a waste of money, read Add Value To Real Estate Investments and Do-It-Yourself Projects To Boost Home Value.)

The degree of depreciation or physical obsolescence will be specific to each property, but it is fair to say that if left alone, a property will continue to lose value until it no longer adds value to the land, or even reduces its value. Some land parcels with inferior structures, as compared to the surrounding properties, will actually be worth more unimproved. Owners will often raze the physical structure to maximize the value of the parcel. So why are advisors always suggesting that property owners commit capital to update their homes? The reason is to counteract some or all of the depreciation that is slowly reducing the value of the structure. Experienced real estate investors realize that this asset class is capital intensive, requiring periodic capital input to maximize value.

Implications for Investment

Once an investor understands the impact of land value on total appreciation, the market’s mantra of “location, location, location” makes more sense. The implication is that home buyers have to look past the physical attributes of the home and focus how its location in the market will affect overall return. This is extremely difficult for home buyers who expect to live in their homes for an extended period of time. However, even the most lackluster of purchases can be improved over time and create significant wealth if located in an area of high demand. The following are some considerations for new home buyers to consider:

Smaller or less attractive homes can provide greater investment returns.
To understand this point, envision two functionally sound houses on equal land parcels in the same neighborhood, one valued near the maximum for houses in that neighborhood and another trading at half that price. Since local supply and demand factors drive land values, houses in a neighborhood tend to appreciate by approximately the same amount per year. If the more expensive house appreciates by 10% (not including any specific improvement or capital projects), this would be equivalent to a 20% return for the other – a much more efficient use of investment capital.

Locations within neighborhoods will affect land values.
Locations, such as cul-de-sacs, due their constraint on traffic and implied safety for children, are usually in higher demand than houses on more frequently used roadways.

The appreciation of land values underscores the importance of choosing between neighborhoods. Most middle- and upper-class, single-family-home neighborhoods already limit new construction when developers purchase most of the available land to construct residential neighborhoods and subdivisions. Because of this, most neighborhoods evolve their own social, cultural and demographic characteristics that impact demand for houses there.

The average age of neighbors can provide clues to appreciation.
Many investors do not consider this when selecting locations. New home buyers with small children will often avoid locations with older homeowners that will not provide playmates for their children. Also, most homeowners are aware of the influence that specific public schools have on the demand for homes in that particular school district. Since homes in the area are not homogeneous, the appreciation is all due to location and the value of land.

Future development can change your property’s value for better or for worse.
Homeowners must be cognizant not only of the present state of local amenities but also the future prospects for commercial and governmental development in the area. Government plans concerning schools, hospitals, traffic patterns and other public infrastructure will have as much influence on land values as present and future development of commercial amenities in a particular locale.

Single-family property investors must factor into their purchase offers the potential effect of vacant or developable land on future supply and home prices. This is a continual risk borne by purchasers of condominiums. Condo prices are affected by the same demand factors as single-family homes and the appreciation of the land that their building is on.

A unique issue for condo owners is supply. Unlike most single-family homes, which are built in infill locations, a significant number of condos can be built on small parcels of land and in short periods of time, increasing supply and potentially driving down prices. It is difficult for condo owners to gauge the potential for new development and land values since multi-unit structures and high rises can easily be built on parcels that were initially home to other types of residential or commercial real estate.