A Real Estate Investor Who Makes A Lot of Money...
Friday, April 15, 2005
April sure came around fast this year. Before I knew it, I’d turned 30 and already gotten my tax refund before some people even began to gather their scattered tax receipts. Not that I’m better or particularly more organized than others – that’s Parker’s department – but I’m learning to be. Something in me just screams to get a jump on the future by investing my time while I have it to avoid the inevitable rush when things are put off to the end. Not that I always listen.
One thing you shouldn’t put off though, no matter what your age, is retirement planning. I saw a great ad in a magazine the other day. The picture is of a man walking out of his home with his briefcase in a blowing snowstorm in a pair of shorts, a tee shirt, and sandals. The tagline reads: If you think this is ridiculous, why haven’t you started planning for retirement? The point is obvious.
Owning a home is one sure way to get a jump start on your financial future. If you pay off your mortgage and are happy remaining in the same home, you have ensured a relatively relaxed retirement income requirement. Your home is likely the largest investment you will ever make and housing is one of the greatest expenses most people face. Like it or not, the popularity of living indoors does not seem to be declining, nor is it getting any cheaper.
Some would argue that a home is not really so much an investment as a lifestyle choice. The home is a stable, safe, secure and convenient place to raise a family, or for others simply a place to relax after a long week of work in the salt mines. When you own a home, it is easier to put down roots and get involved in your community. I would agree that a home is all of those things, but it is also undoubtedly the only investment vehicle in which you can live while investing. Try living inside a stock certificate, bond or commodity. The dual benefit of a tangible investment with a practical use in one package is quite the ideal. I dare you to find something better. Wait. Read the rest of the article first; then decide if you want to waste your time looking.
First, let’s cover two important aspects any investor wants out of any investment: return on investment and return of investment. When buying a stock, bond, or commodity, such as gold, the investor expects both return of his investment and a return on the investment above the initial asset invested. Keep in mind, an asset can be anything of value: time, expertise, or capital for example.
Let’s take the example of the stock, bond or commodity investments. A stock is the best of the three in terms of growth, as the investment has twofold benefits through both increased value and dividends, if the company pays them – the risk is you can lose everything in the process. A commodity offers a single fold benefit through increased value through scarcity, but does not offer dividends and can lose value too. The trade off for this one sided investment is its desirability – everyone uses commodities. A bond offers a set or fluctuating rate of return, along with the return of investment – safe, but not horribly profitable and sometimes doesn’t even beat inflation.
Yet the benefits of real estate investing rams any of these other investment vehicles right off the highway of returns. Investment real estate returns are four fold. Yes, you read that correctly. There are four separate ways an individual benefits from a real estate investment property. Note I said real estate investment property, not your personal residence. As mentioned above, there are benefits to home ownership, such as tax savings, equity building, safety, stability, and pride of ownership, but investment real estate blows even those benefits out of the water by taking them to the nth degree.
I hear the grumblings out there amongst you already. I know there are those of you who lived through the real estate market of the 80’s with sky high interest rates in the mid teens and also those who remember the devastation of the early 90’s here in San Diego. You couldn’t give away a house in San Diego fast enough after the military cutbacks. People were losing their shirts left and right on real estate. Yet, here we are 10-15 years later looking at astronomical housing prices that have created a new class of citizen: the equity refugee. Who are they? Those former high value homeowners that cashed out of their homes and moved to cheaper locales, paid entirely in cash for their new homes, and realized quickly they are now precluded from ever returning to high priced cities on the East and West coasts.
What’s the lesson here? A simple story should suffice. Back in August of 2001, a Japanese business man closed on a purchase of a high rise building in New York City for approximately 300 million dollars. After 9/11, property values in NYC nosedived. The property value of the building dropped to nearly 100 million. The general US economy was on a slide, and a US business magazine decided to interview the Japanese businessman for insight into his feelings on losing 200 million dollars in a foreign investment in less than a month. The man’s answer was telling. When asked, “How does it feel to lose 200 million dollars?” he replied. “I haven’t lost a dime. I still own the building.”
Warren Buffet would be cheering on the sidelines. He was once asked by a stock trader when he felt the best time to sell was. His response: “Never!” For you see that the only way to lose on an investment is to be forced to sell it for less than you bought it! Those who lost in real estate at those times were forced to do things they didn’t want to. You, however, will be a smart investor. And, as promised, I’m going to show you why real estate is the best investment vehicle you can ever take out for a spin.
I find it easiest to deal with acronyms I can easily remember. Being as I live in California, let’s use this one: C.A.L.I. This stands for Cash Flow, Appreciation, Loan Reduction, and Income Taxes. These are the four cardinal benefits of real estate investment property. We’ll take them apart one at a time. If you’d like more detail on any of them, give me a call or email anytime.
C: Cash flow is king. Anyone who’s ever tried to manage a property or business can tell you that if you’ve got cash flow problems, you’ve got a monster hiding in the closet. With a well investigated and inspected investment property, you can make sure you have an operating cash flow above and beyond your expenses, both current and expected. The way you do this is by finding a property with a specific capitalization, or cap rate, and move forward only when all signs point to positive cash flow. Buying an investment property is a complex process. The first question you should ask the seller of an income property is what the cap rate is. If he doesn’t know, walk away. Fast. For the record, a cap rate is the net, not gross, operating income of the property, divided by the market value of the property. 8-10% is ideal; most in San Diego county hover in the 5-6% range.
A: Appreciation is always appreciated by investors. We have many happy investors in San Diego County. Over the last 5 years, home values have increased an average of 21.4% per year. That means that if your home was worth 200K in 2000, today it is likely worth over 485K, or more than double what you paid for it. This is another way investors realize a benefit from investing in real estate. Not only are they getting cash in pocket each month from their property, it is also increasing in value. Have they made money on the appreciation yet? No, it’s a paper gain that is only realized, and taxed, when the property is sold. We’ll get to those pesky taxes soon enough.
L: Loan reduction is the goal. When you take out a mortgage, the idea is not to pay it in perpetuity, although the bank would love it if you did. Just a side note: Do you know what a bank’s return on investment is? Answer: Infinity. How can that be? Well, you and I give them our money to put in their bank for safe keeping. They loan it out to other people for a return, thus the return on their investment, which is zero, equals infinity. Makes you want to pay off your mortgage tomorrow and put all your money under the mattress, doesn’t it? Anyway, loans have terms, such as 15 or 30 years. With a personal property, you are paying down the mortgage, have the benefit of writing off the interest paid against your taxes, and gaining equity in the home. The beauty of real estate investment property is this: Like the bank, you are using someone else’s money to pay off your loan. Just one more way investment real estate benefits you.
I: Income Taxes are as certain as death. You can’t avoid taxes, but you can reduce them each year through depreciation, and possibly offset them in perpetuity through 1031 exchanges of investment property. (I’ll cover 1031 exchanges in a future newsletter.) Residential buildings are allowed by the IRS to be depreciated on a 27.5 year scale. Commercial buildings follow a 39 year scale. The idea is that you can depreciate that amount from your taxes. If the apartment building you own is worth 1.5 million, you can deduct $54, 545 from your taxable income. Income which includes payments other people are making toward your loan on that same building. The same income you received as cash flow and were able to spend throughout the year as your building appreciated. Can you see the circle closing up here?
We’ve seen here that real estate investing can be financially ludicrous to your investment portfolio. Ben Franklin would disagree, saying “If a man empties his purse into his head, no man can take it away from him. An investment in knowledge pays the best return.” I’m inclined to agree with him. As much as the world I operate within revolves around it, not every benefit in life is about money. Lifelong learning and education should be a goal of your life. It is for me.
In fact, a more valuable investment of your time, money and knowledge can be spent helping a child with their education. Read a book or solve a math problem with a child. It will remind you of being that age again, with the benefit of everything you know now adding to the reward of watching someone grow intellectually.
Asking for return of your investment in this case is impossible; however the return on investment proves more valuable than anything the financial world has to offer…even investment real estate. And you heard that from a REALTOR®.
One thing you shouldn’t put off though, no matter what your age, is retirement planning. I saw a great ad in a magazine the other day. The picture is of a man walking out of his home with his briefcase in a blowing snowstorm in a pair of shorts, a tee shirt, and sandals. The tagline reads: If you think this is ridiculous, why haven’t you started planning for retirement? The point is obvious.
Owning a home is one sure way to get a jump start on your financial future. If you pay off your mortgage and are happy remaining in the same home, you have ensured a relatively relaxed retirement income requirement. Your home is likely the largest investment you will ever make and housing is one of the greatest expenses most people face. Like it or not, the popularity of living indoors does not seem to be declining, nor is it getting any cheaper.
Some would argue that a home is not really so much an investment as a lifestyle choice. The home is a stable, safe, secure and convenient place to raise a family, or for others simply a place to relax after a long week of work in the salt mines. When you own a home, it is easier to put down roots and get involved in your community. I would agree that a home is all of those things, but it is also undoubtedly the only investment vehicle in which you can live while investing. Try living inside a stock certificate, bond or commodity. The dual benefit of a tangible investment with a practical use in one package is quite the ideal. I dare you to find something better. Wait. Read the rest of the article first; then decide if you want to waste your time looking.
First, let’s cover two important aspects any investor wants out of any investment: return on investment and return of investment. When buying a stock, bond, or commodity, such as gold, the investor expects both return of his investment and a return on the investment above the initial asset invested. Keep in mind, an asset can be anything of value: time, expertise, or capital for example.
Let’s take the example of the stock, bond or commodity investments. A stock is the best of the three in terms of growth, as the investment has twofold benefits through both increased value and dividends, if the company pays them – the risk is you can lose everything in the process. A commodity offers a single fold benefit through increased value through scarcity, but does not offer dividends and can lose value too. The trade off for this one sided investment is its desirability – everyone uses commodities. A bond offers a set or fluctuating rate of return, along with the return of investment – safe, but not horribly profitable and sometimes doesn’t even beat inflation.
Yet the benefits of real estate investing rams any of these other investment vehicles right off the highway of returns. Investment real estate returns are four fold. Yes, you read that correctly. There are four separate ways an individual benefits from a real estate investment property. Note I said real estate investment property, not your personal residence. As mentioned above, there are benefits to home ownership, such as tax savings, equity building, safety, stability, and pride of ownership, but investment real estate blows even those benefits out of the water by taking them to the nth degree.
I hear the grumblings out there amongst you already. I know there are those of you who lived through the real estate market of the 80’s with sky high interest rates in the mid teens and also those who remember the devastation of the early 90’s here in San Diego. You couldn’t give away a house in San Diego fast enough after the military cutbacks. People were losing their shirts left and right on real estate. Yet, here we are 10-15 years later looking at astronomical housing prices that have created a new class of citizen: the equity refugee. Who are they? Those former high value homeowners that cashed out of their homes and moved to cheaper locales, paid entirely in cash for their new homes, and realized quickly they are now precluded from ever returning to high priced cities on the East and West coasts.
What’s the lesson here? A simple story should suffice. Back in August of 2001, a Japanese business man closed on a purchase of a high rise building in New York City for approximately 300 million dollars. After 9/11, property values in NYC nosedived. The property value of the building dropped to nearly 100 million. The general US economy was on a slide, and a US business magazine decided to interview the Japanese businessman for insight into his feelings on losing 200 million dollars in a foreign investment in less than a month. The man’s answer was telling. When asked, “How does it feel to lose 200 million dollars?” he replied. “I haven’t lost a dime. I still own the building.”
Warren Buffet would be cheering on the sidelines. He was once asked by a stock trader when he felt the best time to sell was. His response: “Never!” For you see that the only way to lose on an investment is to be forced to sell it for less than you bought it! Those who lost in real estate at those times were forced to do things they didn’t want to. You, however, will be a smart investor. And, as promised, I’m going to show you why real estate is the best investment vehicle you can ever take out for a spin.
I find it easiest to deal with acronyms I can easily remember. Being as I live in California, let’s use this one: C.A.L.I. This stands for Cash Flow, Appreciation, Loan Reduction, and Income Taxes. These are the four cardinal benefits of real estate investment property. We’ll take them apart one at a time. If you’d like more detail on any of them, give me a call or email anytime.
C: Cash flow is king. Anyone who’s ever tried to manage a property or business can tell you that if you’ve got cash flow problems, you’ve got a monster hiding in the closet. With a well investigated and inspected investment property, you can make sure you have an operating cash flow above and beyond your expenses, both current and expected. The way you do this is by finding a property with a specific capitalization, or cap rate, and move forward only when all signs point to positive cash flow. Buying an investment property is a complex process. The first question you should ask the seller of an income property is what the cap rate is. If he doesn’t know, walk away. Fast. For the record, a cap rate is the net, not gross, operating income of the property, divided by the market value of the property. 8-10% is ideal; most in San Diego county hover in the 5-6% range.
A: Appreciation is always appreciated by investors. We have many happy investors in San Diego County. Over the last 5 years, home values have increased an average of 21.4% per year. That means that if your home was worth 200K in 2000, today it is likely worth over 485K, or more than double what you paid for it. This is another way investors realize a benefit from investing in real estate. Not only are they getting cash in pocket each month from their property, it is also increasing in value. Have they made money on the appreciation yet? No, it’s a paper gain that is only realized, and taxed, when the property is sold. We’ll get to those pesky taxes soon enough.
L: Loan reduction is the goal. When you take out a mortgage, the idea is not to pay it in perpetuity, although the bank would love it if you did. Just a side note: Do you know what a bank’s return on investment is? Answer: Infinity. How can that be? Well, you and I give them our money to put in their bank for safe keeping. They loan it out to other people for a return, thus the return on their investment, which is zero, equals infinity. Makes you want to pay off your mortgage tomorrow and put all your money under the mattress, doesn’t it? Anyway, loans have terms, such as 15 or 30 years. With a personal property, you are paying down the mortgage, have the benefit of writing off the interest paid against your taxes, and gaining equity in the home. The beauty of real estate investment property is this: Like the bank, you are using someone else’s money to pay off your loan. Just one more way investment real estate benefits you.
I: Income Taxes are as certain as death. You can’t avoid taxes, but you can reduce them each year through depreciation, and possibly offset them in perpetuity through 1031 exchanges of investment property. (I’ll cover 1031 exchanges in a future newsletter.) Residential buildings are allowed by the IRS to be depreciated on a 27.5 year scale. Commercial buildings follow a 39 year scale. The idea is that you can depreciate that amount from your taxes. If the apartment building you own is worth 1.5 million, you can deduct $54, 545 from your taxable income. Income which includes payments other people are making toward your loan on that same building. The same income you received as cash flow and were able to spend throughout the year as your building appreciated. Can you see the circle closing up here?
We’ve seen here that real estate investing can be financially ludicrous to your investment portfolio. Ben Franklin would disagree, saying “If a man empties his purse into his head, no man can take it away from him. An investment in knowledge pays the best return.” I’m inclined to agree with him. As much as the world I operate within revolves around it, not every benefit in life is about money. Lifelong learning and education should be a goal of your life. It is for me.
In fact, a more valuable investment of your time, money and knowledge can be spent helping a child with their education. Read a book or solve a math problem with a child. It will remind you of being that age again, with the benefit of everything you know now adding to the reward of watching someone grow intellectually.
Asking for return of your investment in this case is impossible; however the return on investment proves more valuable than anything the financial world has to offer…even investment real estate. And you heard that from a REALTOR®.
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