A few months ago I was thinking (not very seriously) that it would be nice to just pay off all my mortgages instead of buying more properties.  I thought, "Sure it would be a lot less return, but it would simplify my financial statement." Then April 15th came around!  

As I  worked on my taxes, it hit me how much less money I had to give to Uncle Sam by using the leverage provided by mortgages.  Lets look at some numbers.

Just to make the point, suppose you have $100,000 to invest and you have 3 options:
1) You can pay pay off an existing mortgage.
2) You can buy one house for $100,000 cash.
3) You can buy 4 $100,000 houses with 4 mortgages and $80,000 in down payments and $10,000 in loan costs. This leaves you $10k in reserves for emergencies.

Lets say that these houses all rent for $1000/ month and after expense (repairs, vacancy, property management, taxes, and insurance), you net $700/month.  Lets also say that the mortgage rate is 6%.  Lets also assume that these houses will appreciate at the national average of 5%/ year.  And lets say your marginal tax rate is 33% and the improvements on these properties is $80,000.

In option 1, your return on investment is the rate of your mortgage =6%

In option 2, you make a cash on cash return of $700 x 12 /$100,000 = 8.4%.  In addition, you make 5% in appreciation.  Finally you can depreciate the improvements on this property over 27.5 years, yielding a tax savings of $80,000/27.5*33%/$100,000 = 1%.  This makes a total return of 14.4%.

Lets look at option 3.  The total mortgage payments add up to $23,248 per year, so the cash on cash return is ($700 x 4 x 12 - $23,348)/100,000 = 10.4%. You are paying down the mortgage with your payments - $4000 the first year, resulting in a 4% equity gain. Appreciation is $5000*4/$100,000 or 20%.  And tax savings is $80,000 x 4/27.5 x 33% / $100,000 = 4%.  You total gain is then 36.4%.

Now the additional 4% you get in tax savings may not seem huge, but but that is only because it is comparing against the fantastic gains you can make in real estate.  It could keep you from moving to another tax bracket or from AMT or from disqualifying you from contributing to a Roth IRA.  

I don't think I will consider paying off my other mortgages any time soon.

As 2015 draws to a close, it is time to look back.

In some parts of the country, the real estate market has heated up.  Even though there are are not as many great deals as there was 5 years ago when I started this site, there are plenty of great deals.  The fact that prices are higher than they were 5 years ago means that it is even more important to have someone help you along the path.  Let me tell you about the properties I purchased this year.

Property #1.  I bought this property with the intent to "flip" it.  Because this is a short term investment, there are no tax advantages to this investment.  Therefore I bought this one with my IRA.  I bought it in March and paid $42,787 which included all closing costs.  I paid a total of $15,095 to do all repairs.  I paid a total of $409 for all utilities and $296 for insurance for the 5 1/2 months that I held it.  I didn't do any of the work myself - I couldn't if I wanted to (and I didn't) because it was in an IRA.  I sold it on September 1st and the total cash I received was $73,457, which again included all closing costs.  This corresponds to a return of 25.4% in less than 5 months!  A calculation of the annualized internal rate of return, which takes into account when the cash was needed, yields 58.7%!

Property #2.  This property was intended as a long term investment.  On July 1st, I purchased it for $74,000.  I am renting it for $925/month.  My taxes, insurance, and property management come to $275/month.  If I put away $50/month for eventual repairs that comes to a cash flow of $600/month giving a 9.7% cash on cash return.  The great thing is that Zillow estimates this property to be worth $120,000, which gives me a 62% return in appreciation already.  Now I could finance this property, pull out my original $74,000, and effectively have an infinite return!

Property #3. The third property was purchased with the proceeds of 1st.   It will also be a flip. I purchased it in late November, paying $45,322 including closing costs.  So far I have paid $30,000 in repairs and will be putting an additional $10,000.  I hope to sell it for $115,000.  The return should be somewhere around 23% in about 6 months (or an internal rate of return of about 47%.  I will let you know in a future blog.

If you want to get going on real estate investing, leave your contact information.  Happy New Year and Happy Investing!

As a real estate investor, it is crucial that you work with the right realtor.  It is important that your realtor has an investment mindset.  Don't just use your friend that just got his/her license.  You need an experienced realtor that works with investors and is an investor him/herself. 

When I first started, I talked with dozens of realtors.  I would tell them I was looking for a house to invest in and they would ask how many bedrooms I wanted, how many square feet, etc.  They didn't understand that I could care less about those things.  I would ask them questions like "What kind of cash-on-cash return I could expect?".  Often their eyes would glaze over. 

I found some realtors that had rental properties, but did not have an investor mindset.  You need to know what the return on your investment is before you buy.  You want a realtor that will not only help you find a house, but also find your first tenant.  You want them to be able to give you an idea of the rent you can expect and back it up with a renter.  

When you find a good realtor, treat them right. You want them part of your team.
Typically they do not make as much per transaction when working with an investor because the price of the home is not as high.   They are willing to work with you because they hope to have your repeat business.  Give it to them. And never use up their time looking for houses and then go off and buy with someone else. And never go into new builds without your realtor.  If they know they can count on you, you will generally be able to count on them for the best deal possible.

If you need a reference for a good realtor in you area - or in other areas - leave your contact information.  We do not sell or give contact information to anyone.

In the last post I discussed some advantages of real estate as an investment over the stock market.  Two more are market efficiency and control.

Market efficiency  The stock market is a very efficient market.  By this I mean if you and someone else buy a stock at the same point in time you will pay exactly the same price.  The real estate market is different.  Two identical houses on the same street can be bought at the same time for vastly different prices. The reason for this is twofold.  First, the market is smaller.  The number of people wanting to buy or sell a certain type of house in a certain location is much smaller than the the number of people that want to buy or sell IBM stock at a certain time.  The second reason is that the motivation of the seller (or buyer) varies greatly.  Someone who is moving out of state, for example, may be very motivated to sell and would be willing to let the house go for a lower price than someone who is not in a hurry.  This inefficiency in the real estate market creates great opportunities to an educated investor.

Control.  When you buy a stock, you have virtually no control in how well it does. There is nothing you can do to make it go up or down.  When you buy real estate there is almost a limitless number of things you can do to increase its value or increase the rental income you can bring in.  For example, you could convert a carport to a garage and both increase the value and the rents.

To illustrate these two advantages, lets look again at the first house I bought.  When I bought the house, it was filthy.  The previous owner had pets that left a mess everywhere.  She needed to leave town and was having a hard time selling it because of the condition of the home.  She was very motivated.  I was able to buy it for $90,000, when the comparable homes in the neighborhood were going for $100,000.  I paid someone $200 to clean it and for about $1000 got new paint and flooring.  Because of the motivated seller and some cheap repairs, I immediatly gained $10,000 in equity.  You can't do that with a stock.

I am often amused when I hear the financial pundits compare stocks and real estate as an investment.  They talk about how the US stock market has historically grown at a rate of a bit over 9% and real estate has grown about 5% nationally and therefore stocks are a superior investment.  They ignore a few factors, three of wich are leverage, income, and tax advantages.

1. Leverage.  It is possible to borrow money to buy stock.  A broker will lend up to 50% of the value of the stock.  If the stock goes down too much, you will get a margin call, meaning you need to send more money or they sell the stock at a loss.  Alternatively you could get leverage by purchasing an option to buy a stock.  Buying a stock with leverage should not be used as a long term investment strategy and is very risky without lots of knowlege, experience and risk tolerance.

Borrowing money to buy real estate on the other hand is much less risky.  Knowlege and experience reduce risk, but the learning curve is much shallower.   Typically you can borrow 80% of the value of the home at relatively low interest rates.  This means that your return on investment is 5 times greater. For example, if you buy a $100,000 home, you would only need $20,000 in cash.  Let's assume the property goes up 4% in one year, making it worth $104,000. Your equity went from $20,ooo to $24,ooo - a 20% per year  increase.  This sure beats the 9% stock return!

2. Income.   Some stocks have quarterly dividends which give you an income stream.  These dividends are low or non-existent for stocks that tend to appreciate.  To get any kind of reasonable dividend, you would have to buy a stock that doesn't appreciate, such as a utility.

Real estate investments provide monthy income in the form of rent.  In my experience, this income, as a percentage of investment is greater than what you could get from a low appreciation stock.

3. Tax advantages.   The best you can do with stocks, from a tax advantage point of view, is to get tax deferral.  This is only if you buy them in an 401k or IRA, which means that if you won't be seeing any of that money until age 65 without stiff penalties.

With real estate, you can save quite a bit on your income tax bill.  You can deduct "paper" losses even though you had a net cash gain.  If you run your real estate investment like a business, you can deduct a number of business expenses.  Whole books have been written on this topic, so I can only scratch the surface here.

Let me give you an example of one of the first investment houses I bought that puts this all together.  I paid $90,ooo and was able to put 9000 as a down payment plus $3000 closing costs.  My mortgage payment was about 450 and I charged a rent of $850. Within 2 years, the value of the home became about $150,000.  Lets look at the return on investment.  We will take away $250/ month from the income for maintenance, property management, and vacancy, bringing it down to $150 / month from a $12,000 investment, or 15% per year.  The appreciation netted me $60,000 out of $12,000 or 250% per year. During those 2 years, I was able to save quite a bit on my taxes as well.  For example, I hired my daughter to help with the bookkeeping, giving her experience and money for college, and me a write off. Do you see why it's hard for me to get excited about a 9% return from the stock market?