Subscribe to our Blog:
- MRREN on How to Analyze the Financials of a Real Estate Investment
- KT on How to Analyze the Financials of a Real Estate Investment
- MRREN on How to Analyze the Financials of a Real Estate Investment
- DONNA on How to Analyze the Financials of a Real Estate Investment
- MRREN on Use LOGIC not EMOTION when Investing
- October 2014
- September 2014
- August 2014
- July 2014
- June 2014
- April 2014
- March 2014
- February 2014
- January 2014
- December 2013
- November 2013
- October 2013
- September 2013
- August 2013
- July 2013
- June 2013
- May 2013
- April 2013
- March 2013
- February 2013
- January 2013
- December 2012
- November 2012
- October 2012
- September 2012
- August 2012
- July 2012
- June 2012
- May 2012
- April 2012
- March 2012
- February 2012
- January 2012
- August 2010
Many of us started out our investment career with a simple savings account, perhaps to save for a car, college or the down payment on a house. Congratulations to those of you who achieved that first goal through savings.
The problem I had with my savings account was that the only time it seemed to grow was when I put money into it. The 1% interest I was receiving hardly made a difference at the end of the year. Although my savings was losing value due to inflation, it did teach me 2 important lessons: Savings accounts are a vehicle to accumulate money to achieve a goal and they pay you almost no return for the use of your money.
Many years ago I had heard that stocks offered a better return on investment than savings accounts or CD’s, so I began to do my research. I will have to admit that my early attempts at stock investing were not all that successful, but I did end up making a little more than my savings account paid. So I learned 2 important lessons from my stock market experience: Stocks can go up and down in value and there is a brokerage fee when you buy and a tax when you sell.
I once had a friend who moved to a larger house and rented out the house he had been living in. When I asked him about how he did it, he explained that he took out a second loan on his first house that was large enough for the down payment and closing costs on his new house. The rent he received covered the loans on the first house and there was a little positive cash flow as well. I didn’t act on this lesson at the time, but it planted a seed for later.
In my pursuit of a better return on investment, I learned that real estate investing offered benefits that other investments did not. The primary advantage being, I could buy more with less. By using leverage, my money could go farther and earn a better return. I also learned the IRS allowed what they call a “depreciation write off” which helped act as a tax shelter for my regular income. It was like getting a raise at work when I could recuperate more of my taxes paid at the end of the year.
In calculating my return on investment (ROI) I was able to add positive cash flow+ depreciation + appreciation + principal pay down. A big improvement over stocks.
When calculating my Cash on Cash return (money in, money out) I could see a big improvement. With 20% down + closing costs, here’s what my calculation looked like: Down payment + closing costs = $25,000. Net rental income after expenses = $250.00 per month or $3,000.00 per year. Divide the $3,000 by $25,000 = 12%.
The 12% return looked pretty good compared to my stock market return which had been averaging about 7%. In comparing stocks to real estate, this is what I found: With a 7% return on $100,000 invested in stocks, the yield is $7,000/ year. The same $100,000 invested in leveraged real estate, controlled $400,000. With the same 7% return in real estate, the yield is $28,000/ year (4 times as much). This is the power of leveraged investing.
Lessons learned: While you can accumulate money in stocks and get a better return than a savings account, you won’t be able to build true wealth until you make use of the leverage that real estate investing allows. There’s a reason why 97% of all millionaires have built their wealth through real estate.
In the financial world, wealth is determined by your net worth not how much you make. Calculating your net worth is actually pretty easy following these steps:
First, make a list of all of your assets. This includes any retirement savings, your current checking and savings account balances, any bonds you might own, the total value of any stock holdings you might have, your home value, and your automobile value. Most net worth assessments do not include physical assets worth less than $5,000, but you can include things like furniture, fine art, and jewelry if you wish. Keep in mind when preparing your list that most of these physical assets depreciate quickly to 50% or less of their original retail value.
Now, make a list of all of your debts. You should list all of your credit card balances, personal loans, student loans, auto loans, home loans, and so forth. Your list should be prepared in an Excel spreadsheet so you can easily keep track of everything and modify if need be.
Lastly, add up all your assets and subtract all your debt. This will equal your total net worth. If you are like most Americans, the equity in your home will be the largest portion of your net worth because real estate is one of the few things we buy that goes up in value over time. Your home becomes a forced savings account.
How can I expand my net worth? Every time you decrease your debt or increase your assets, your net worth will increase. Increase your net worth by paying off debt, saving and investing money wisely, and reducing your spending on depreciating assets like boats and RV’s. Keep in mind when leveraging debt to purchase rental property, your tenants will be paying the loans off for you over time.
Financial freedom is the point at which passive income from your investments generates more income than your fixed expenses. Example: your total monthly expenses for housing, utilities, cars, gas, insurance, food, clothing, etc. add up to $4,000. When the passive income from your investments exceeds $4,000 you are considered financially free. This calculation assumes you are debt-free except for your home and cars. Being financially free is not to be confused with being wealthy. Building long lasting wealth begins after you are financially free.
“HELOCs” (Home Equity Lines of Credit) and “Cash-out Refinances” are both ways to access the equity in your existing home. Interest rates on both can vary between banks and will be dependent on your credit. Both loans will require an appraisal to determine the amount of available equity and will allow you access to up to 80% of your equity. The primary difference between the two types of loans is the HELOC charges you interest only on the amount of money you draw out, whereas with the cash out refinance loan, you pay interest on the entire amount since you receive all the money up front.
HELOCs are usually variable rate loans and may have an annual maintenance fee to keep the credit line open. There are many variations of HELOCs depending on the bank where you obtain it. As with any loan, ask lots of questions and read the fine print. Most HELOCs have a10-year term with a balloon payment due at the end. Some banks offer streamlined processing on HELOC loans for faster funding.
Cash-out Refinances are usually fixed rate loans with a fixed payoff term. Monthly payment amounts are set up front and there are no additional fees charged after initial funding. Most banks are willing to lend you up to 80% of the appraised equity on your primary residence and 70 % on non-owner occupied properties. Formula: Equity = appraised value – existing debt
Whatever type of loan you consider, make sure to compare the loan’s upfront costs as well as interest rates. Some banks are willing to absorb the cost of the appraisal and upfront fees on home equity loans. I have always done better with fixed rate fully amortized loans. Balloons and surprises might be fun at parties, but not in finance. It is a given that future interest rates will go higher, the only question is how soon and how much.
There are many reasons people seek equity loans, some are better than others. The most common reasons are: debt consolidation, home improvements, or a source of funds for investing. Whenever you enter into new debt you should weigh carefully the cost vs. benefit. Does the end use of the money justify the cost of the loan?
Example: You have $25,000 of credit card debt at 25% interest with a minimum monthly payment of $600. New $25,000 equity loan @ 4.5% for 10 years has a monthly payment of $260.00/month, saving $340.00/month. This is good loan use.
Examples of questionable loan use: To expand lifestyle by purchasing toys that rapidly depreciate in value, such as boats and RV’s. It is considered a financial planning mistake to further encumber your primary residence to use the funds to supplement your regular income. The long term goal should be to pay off your primary residence. If you can’t afford it on your regular income, taking out an equity loan will probably add to your financial problems, not help cure them.
Home improvement loans for things like a pool or room addition must be weighed carefully for the cost vs. benefit. If you are considering adding a pool or room addition, it is sometimes cheaper to sell and move to a home that already has the amenities you are looking for than to add them. You rarely get out of a home the cost of the improvements you put into it. It makes this category of loan a difficult decision, especially when emotional considerations are factored in.
The ideal scenario is when the cost of the new loan is covered by cash flow from the new investment. Example: Borrow $30,000 at 4.5% for use as a down payment on a rental income property. Monthly cost of loan for principal + interest amortized over 10 years is $311.00. Monthly cash flow from rental after all expenses is $300. Appreciation at 5% annually and tax shelter benefits would justify this loan.
In most circumstances, you’ll find that a HELOC will offer a better short-term solution, and a cash-out refinance will give you a better long-term solution. Wise use of equity loans can substantially improve your financial future. Over-leveraging can cause financial ruin. Build on a strong financial foundation!
Opportunity Cities are areas where you can start your family, buy an affordable home, attend good universities, start a career, and lead an overall comfortable life. By moving to one of these cities people will avoid the high living cost headaches as we see in Orange County, CA for example.
So how did Forbes recently narrow down Memphis, TN as one of their top picks? They analyzed home prices using Sperlings analysis of median home sales from the first quarter of this year, only used cities with a population over 15,000, unemployment rates from the Labor of Statistics on a year over year basis, and pulled data from the Census survey from 2008-2012. A full analysis points to Memphis being a great area for investors and home buyers.
A number of other sources highlight this market including Zillow which has recorded almost a 4% increase in home values over the past year and predicting another 4% rise over next year. Median home values in this market currently sit at $68,100. It’s pretty clear that buyers can get the “biggest bang for their buck” here.
Memphis, TN’s central location has contributed greatly to its economic growth. It’s actually home to more Fortune 500 companies than LA and is a major center for medicine and the biomedical field.
Memphis, TN has been on our top investment market list for over ten years now and consistently provides investors with good cash flow on affordable properties. This is equally a wonderful place for those who want to move somewhere for a respectable career or to start a family.