Real Estate Archives

rate calculatorOwning a home might be one of the worst investments you can possibly make in the foreseeable short-term, but not for all of the obvious reasons. I am going to talk about the most overlooked cost of ownership that people rarely realize. The opportunity cost of your equity.

Let’s say you are a young couple in their 30’s and you buy a $250,000 house @ 4% (or less) in today’s market. You then make extra payments and by age 40, you have no mortgage! Just think about it, that $1193 monthly(rate calculator) payment is gone forever, but at what opportunity cost.

I am not here to talk to you about the money you could have earned at age 30 to 40, even though you surely have lost a lot if you were able to obtain a larger than 3% return on your investments (approximate effective rate of mortgage until non-itemized), but let’s put that aside.

I want to talk to you about the $250,000 you have your house, in equity.

I personally was able to achieve double digit growth 11 out of the last 13 years in stocks. Let’s say you were able to earn just 7% on investments – your equity is tied up in your home. If you had $250,000 in cash and earned 7%, you could earn $17,500 a year or $1,458 a month – MORE than what you are saving by not having your $1193 monthly payment. If you were able to obtain 10% it would be $25,000 or $2083 a month!

Let me break it down to you this way, if you are able to get a 10% return you would save $890 a month or $10,680 a year by putting the money into stocks and into your home.

Your cash is locked up in your home and odds are 10 years from now you can no longer borrow cash for an effective rate of 3% or even 4% – you have destroyed your mechanism for cheap borrowing. If the market does recover and people start earning 10% annually, I promise rates will sky rocket.

Hypothetically you might be able to get a HELOC (Home Equity Line of Credit) during this time, at a higher rate, let’s assume 7+% versus your old effective 3%. If you were to borrow that $250,000 you would pay $10,000+ more in interest a year at 7% vs 3%. A harsh penalty for paying down your mortgage. I know most people simply would rather live mortgage free, but I for one always like to maximize  the amount of money I have, but hey – that’s me.

Moral of the story – Your home is a very cheap form of debt now a days and should not be paid down unless you either get an extreme psychological benefit or you are sure you cannot out perform your effective rate on your loan. But I’ve said it before and I’ll say it again – if you think 3 or 4% rate of return is good enough, then you are going to have some struggles ever obtaining real wealth.

I know this article makes a lot of assumptions, but I hope you take home the message that if things turn around in the economy or if you think you can out perform 3% in stocks/options – then paying down your mortgage might not be a smart financial move.

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Property ManagementProperty management can make your life as a landlord very easy, but at a cost. Are these property management companies worth the money you pay them and why don’t real estate property management companies just buy their own rentals? These are questions that scare me from being a landlord.

When considering owning rental properties I always come across the same problem, why wouldn’t property management companies simply buy the property I am considering? A while back I was looking at a $35,000 condo and the realtor showing it even offered to be my property manager. I though to myself, I am putting down $7,000 down plus closing if I buy this rental and this guy looks like he has $7,000, why wouldn’t he just buy it and manage it for himself?

The answer is kind of sad. Property management has less risk and more reliable profits by not actually investing in the properties. Don’t get me wrong, lots of property management companies do have real estate of their own, but some companies only manage other’s properties.

If I offered you three opportunities, which would you choose?

Option #1, You Buy and Manage – You Pay $7,000 today and profit $300 a month and have a 10% a year chance of losing $2,000 (to a major repair or bad tenant).  Profit in one year: $3600 – 200 (10% chance of –2000) = $3,400 – Hassle and Risk

Option #2, You Buy and Someone else Manages – You pay $7,000 today and profit $200 a month and have a 10% a year chance of losing $2,000 (to a major repair or bad tenant), but have no phone calls or interaction with the actual tenant. Profit in one year: $2400 – 200 (10% chance of –2000) = $2,200 – Risk but less hassle

Option #3 You Manage – You pay $0 today and you profit $70 a month and possibly an additional $700 every time you sign a tenant and have no risk. Profit for one year: $1,540 – 0% risk, some hassle.

The point of this article is to ask one question, why are their companies who only manage other people’s properties. If there is enough money for them to make their cut and also give you your cut – why wouldn’t they simply buy these properties and cut out you out. They wouldn’t have to hassle with setting you up as a client or giving you a call when something goes wrong. Why would they not manage their own properties – since there is so much money to be made.

You might say, maybe they don’t have the money to invest – but if they were really this successful, they could find an investor. The fact of matter is there is no risk to the property management company. If the $1200 a month house doesn’t rent, they aren’t out $1200, they are out $120 of revenue. If the roof caves in or the a/c or furnace gives out, they aren’t footing the bill (if anything they are sending you a bill and possibly getting a kickback from the handyman performing the service). Make no mistake, these managers are making money when repairs are performed.

If you really think about what I am saying, I think you will see that the writing is kind of on the wall – Rentals are far from risk free and the hassles can be worth paying someone to handle them. Is there money to be made? Yes, but just something to consider.

How to Be a Landlord with Positive Cash Flow

If you want to be a landlord, then you need to get positive cash flow on your investment properties. The days of counting on the appreciation are over (at least for the foreseeable future).

I know that getting positive cash flow is easier in some housing markets, but I am a firm believer that if your rental property does not net you money each month – You have made a financial mistake.  The only way to have a good chance of making money each month is to run the numbers and then run the numbers again.

I myself have been using a very basic spreadsheet I call the “Property Analyzer.” The spreadsheet shows your Purchase Price, Down Payment, Closing Costs, interest rates, number of units, occupancy rate, appreciation rates, rents collected, etc. The idea here is to make good faith estimates on what’s going in and what’s going out.

But figuring out what is going in and out can actually be a very hard task.  Let’s take a big picture look at what you end up making with rentals.

How Much Do Landlords Make

Rent is straight forward, they pay and you collect (hopefully). But what about occupancy rate? Is this property going to be occupied 100% of the time? Assuming you think you can rent it 11 out of 12 months, it would be occupied approximately 91.6% of the time and you would discount your estimated cash inflow’s accordingly.

Security Deposits are hopefully returned in full, meaning that your property was returned to you in pristine condition. Keeping the deposit will most likely not be worth the hard ache that your tenant left you.

Tax Benefits are your property’s basis / 27.5 * marginal tax bracket (for example $100k property @ 25% rate is: 100,000 / 27.5 * .25 = $909.09 a year or $75.75 a month.

Appreciation on your property is something that is virtually out of your control.  The neighborhood might become better or the housing market might go gang busters, don’t count on it.

Now let’s move onto the cash outflows.

Mortgage – just be careful to not assume you are getting a 30 year loan @ 3.9% — interest rates can vary on investment properties. Note: Owner occupied property usually receive lower interest rates than strictly investment properties. Also don’t forget CLOSING COSTS.

Insurance varies on numerous factors. Note: Some insurance companies do not insure LLC owned properties.

Taxes and death the only two things that are certain. You might be paying $3000 in taxes for your duplex this year, but don’t be surprised if you are suddenly paying an extra $150 or more next year, especially if a major levy passes.

Potentially an accountant or lawyer might need to become involved in your rental properties for legal or financial counsel. You also run the risk of lawsuit for various reasons if you are a landlord. You may also want to establish an LLC, which might also take some minor consulting fees.

Maintenance is general work on the property to keep it up to the working condition it was in when you rented the property. For example you have to call a plumber, HVAC guy, or have a neighbor kid cut the lawn. Just be careful that the neighbor kid doesn’t get hurt while doing it – or you are going to need to read the cash outflow above again.

Repair or Replacement can be incredibly costly and you hope that it is not frequent, but you never know. The roof, siding, appliances, water heater, toilets and plumbing, windows, and driveways all have to be replaced someday. You better assess any property you are considering buying for these major factors, because one major mistake can erase an entire year of profit.  Did I mention that you might have to paint the place between tenants? Have you seen paint prices these days?

Depreciation on your property is something that is virtually out of your control.  The neighborhood might become worse or the housing market might tank for one of various reasons.

Your time, I know I am going to get grief for this cash outflow because no cash actually leaves your hands. You absolutely MUST value your time. If you are spending 100 hours to find, bid, purchase/close, repair, show, screen, rent, and maintain and you value your time at $10 an hour – you just burned $1000 in your first year. You really should figure out what your time is worth and treat it as if it is a cash outflow in my opinion.

Could you have a disaster with your rental property that costs you thousands or even tens of thousands of dollars? Yes – but developing statistical models for this would vary far too much based on countless variables (location, crime levels, rent rates, etc.).

Making good faith estimates on all of the factors mentioned in this article can be tough, but it gets easier with experience. Just remember to run those numbers multiple times and be confident of any deal you are considering. 

The Housing Market With Increasing Interest Rates

Housing Market 2012The housing market was slightly down, but relatively stagnate in 2011. The housing market has become increasing segmented, (meaning some areas are showing very small gains while others are still showing giant losses) and many people are wondering if now is the time to buy. My opinion? If you are looking at a house as an investment or way to “save”, you should stay out of the housing market.

Let me first say that I am a home owner. I own a home that was recently appraised for $160k and I owe about $117k on the mortgage. I have not paid down the mortgage what so ever, but I have basically completed a very costly rehab of the house. I have skin in the game, which is why what I might say next is relatively shocking.

The housing market might be doomed. I believe the housing prices will not increase and could even decrease in most areas of the nation for anywhere as long as 5+ years. The bottom line here is that we haven’t bitten the bullet of how bad the housing market really is right now.

One of the biggest threat we have to housing is interest rates. A 30 year fixed mortgage loan is at roughly 3.9% today. Many people might find current interest rates as exciting, but to me it’s terrifying.  Interests rates are bound to increase and just for the record – I’m aware increasing interest rates are usually a good sign of economic growth.

Let’s assume you purchase a $200,000 home today @ 3.9%. You payment would be: $943.34 a month for the mortgage alone.  Now let’s say the economy picks up and interest rates go up to 6% – Now suddenly your payment is $1199.10 ($255.76 more / 27.1% more). To keep that $943.34 payment at the new rate of 6%, your house would have to have a selling price of $157,342 ($42,658 / –21.3% of your home’s value) .

Now you could be quick to assume that because of the interesting interest rates, that means a better economy and more jobs, but do you really think things are going to go back to they way they were? If anything we have a glutton of homes, a young population that doesn’t want to own (or can’t), a ton of foreclosures in the pipes, and an aging baby boomer population that will soon be selling their homes for an easier lifestyle (condos / assisted living), adding to the already excess inventory. There are a lot of things holding the market down that could actually making housing prices worse regardless of increasing of interest rates.

Housing has to return to what it simply is, a place to live.

I read articles and blogs talking about how it is “now cheaper to own than rent.” Are you kidding me? It is only logical that it is cheaper to own than rent. Just think about what you are doing, you are locking a large sum of your liquid cash in a down payment, you are committing yourself into a home and a community, and you are subjecting yourself to potential losses if your community or the housing market in general continues to fall, and did I mention that you just lost 6% of your home’s value the minute you sign the paperwork and your closing costs?

The housing market has a heck of an uphill battle. I know the Fed has promised to keep interest rates where they are for at least 2 more years, but if they increase the rate before a real recovery – You are going to see massive losses across the board in the housing market.  Did I also mention that you need the housing market to go up with inflation just to break even, so every year it’s stagnate is effectively another loss?

I’ve said it before and I’ll say it again – without the $8,000 incentive I received for buying my home – I wouldn’t have seen it as a viable option. It appears the the days of free money for buying a home are over, at least for now.

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