REI Explainer: Acquisition, Sources & Earnest Money

Real estate investing is a broad term that covers the management, purchase, rental, sale, or ownership of real estate for profit as opposed to the acquisition to be used as a primary private residence. Real estate development, a sub-specialty of investing, is the strategic improvement of specific realty property. Relative to the other investment kinds such as stocks, real estate is a form of asset that has fixed liquidity.

Although there are some notable exceptions, primarily real estate is capital intensive and highly dependent on cash flow. Risk factors come into play if the investor is not educated and properly manages inherent risks. One of the main causes of real estate investment failure occurs when the investor experiences a zero cash flow and can no longer sustain their agreed-upon payments.  This will result in a forced reselling of the property because the mortgage or lender note has gone into foreclosure and is no longer a solvent account.  

Acquisition and Sources

Although, acquiring and looking for sources of real estate seems pretty straight forward, even in today’s technological world with numerous real estate applications to fall back on, in some countries the market is not efficient or organized especially when you compare real estate to having instruments of liquid investment. Individual properties are not interchangeable and are unique by themselves so this presents a challenge to investors who want to evaluate investments and price opportunities. 

Education and understanding the competitive nature of this market is important for real estate investors.  Investors of real estate usually use a number of appraisal methods in order to figure out the value of the property before the purchase.  In addition to that, savvy investors will constantly be reading and bulking up their specific market knowledge in the area(s) they wish to invest.  By doing so, this provides a lot of opportunities for investors to acquire properties at cheaper prices.

There are many different sources of properties for investment.  The main categories are:

  • Real Estate Agents
  • Market Listings (MLS)
  • Private Sales
  • Public Auction
  • Wholesalers

Investors sometimes spend weeks in one particular area they feel comfortable, perhaps a specific neighborhood or area of town, making sure they are as up-to-date as possible on the data that affects the type of purchase they wish to make.  If an investor is looking for a single-family home to provide steady rental income, some of the questions they might as are:

  • What is the current occupancy rate of single-family homes in a specific monthly rental amount range?  
  • How long do renters stay in these types of homes?  
  • What class are these rentals considered to be in and what type of amenities are considered the standard that renters are looking for that will need to be a feature of the property?  
  • What is the crime rate?
  • and many other qualifying questions that help the investor hone in on the properties that meet the parameters they are seeking.

The moment a property fit for investment is located, the investor will be tasked with contacting the seller or seller’s agent, negotiating a sale price and terms with them and hopefully, if there are no counter-offers or other buyers that come into play, the contract for sale will be executed. 

Before that, however, the investor will typically want to enter into an Earnest Money Contract with the seller.  This is a monetary deposit made by the buyer to the seller as a good faith offer on the home. Once that is executed, no other offers are allowed to go through and the deal becomes “pending”.  This allows the investor to spend the money needed to conduct the title search, property appraisal, inspections before closing and secure the best possible financing for them without worry that the property will be sold to another investor after they’ve made such time and cash investments in vetting the property.   

Earnest money contracts have a contingency period that protects the investor by having refund clauses if the property turns out to not have a clear title or is unable to pass inspections due to previously undisclosed or hidden issues.  They also protect the seller if the buyer is unable to secure financing ensuring that some monies will be able to be retained to match the loss of monthly earnings or mortgage payments that will have to be paid during the time the property was unable to be sold to someone else.  Once the contingency period expires, it’s not unusual for rescinding to require the forfeit of money deposits as well as a penalty payment.

That is why, to avoid such penalties, the investor must have a great deal of understanding and knowledge on the venture.  It’s always wise to employ real estate agents or attorneys well-versed and specialized in the type of property to acquire.  Real estate transactions do possess a number of complex issues if the paperwork is not drawn up and executed properly. 

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