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Is Your Timeline Your Advantage in Investing?

April 2, 2016

You know those cheap little hourglasses that come with board games? I think they are fascinating.

They are a physical representation of time. Zero technology. Impressive accuracy. Thousands of years old.

Have you ever seen one with liquid instead of sand? Even cooler.

That’s what we will be taking a closer look at today. Not hourglasses – liquid and time.

Liquid Dreams

A liquid asset or investment is one that can easily be converted to money. Illiquid is the opposite – it is more difficult to convert into money.

The stock market is a great example of a liquid investment, such as investment opportunities you’d be able to find on a site such as stocktrades.ca and others. You can instantly sell to an anonymous buyer at the set price for that split second. It is instantaneous and has a pretty low transaction cost. Millions of people do stock trading which just proves how amazing it can be. In fact, a few of my friends are using the software at TradeZero and they’ve managed to make a decent profit so far. It’s worth giving it a go in my opinion.

Investing in rare art is illiquid. It has significant value, but is much harder to price. You better not be in a hurry to unload it because you likely won’t receive top dollar. The price is dependent upon what someone is willing to pay – be prepared to pay a broker a huge fee to find the buyer. In today’s day and age, Bitcoin has made vast leaps forward in the trading market, this may be a better option for some who want to invest in this area and have it there ready for a later period. Websites such as broker.cex.io can provide a better background for people who may want to go for this option.

Obviously liquid is preferable – you want to be able to access the money in your investments. It gives you options.

But you might have to give up something for that liquidity…

What’s the Cost of Liquidity?

If everyone wants something, the price goes up. Economics 101.

Everyone would choose a liquid investment compared to an equal return for an illiquid investment. So they are not priced the same.

A simple example is a savings account vs CD (certificate of deposit). A savings account is perfectly liquid – you can remove your money at any time. A CD is similar, but you put your money in for a set period of time determined up front – a 1 year CD is common. You can get these types of accounts from many banks (such as Certificates of Deposits – Bank CD Rates – Atlantic Union Bank), with all the information you’ll need to save as much as you can.

Which one do you think provides the better return on investment? The liquid savings account or illiquid CD? The savings account might give a 0.5% yearly return and the CD 1.5%.

If you choose the CD over the savings account, you get an extra 1% yearly return. Or 3 times the return of the bank account.

Same money going in, but you traded your option of accessing the money at any time for a better return.

The Traditional View

Let’s take a look at the stock market since that is where almost everyone invests their money.

Average Joe wants to retire one day so he invests in the stock market. Index funds, mutual funds, individual stocks, you name it. He slowly builds up his positions over the years, purchasing more and more stock.

The investment is extremely liquid, even though Joe knows he won’t be touching that money for a long long time. He has the luxury to sell at any given millisecond, Monday through Friday.

The stock represents a piece of a company that is attempting to make money and impress investors to further drive up their stock price. The company has a shorter term view than Joe – they have to hit their quarterly numbers. They might choose to sacrifice their long term profit to drive up the numbers in the short term.

Is there something wrong with this picture for Joe? Could he use his timeline to his advantage?

The Luxury to Think in Decades

Joe knows he doesn’t need to touch the money for decades. Ok, there might be a small portion he needs to access, but not unless something really goes wrong.

Just like the CD vs savings account example, he can choose a less liquid investment that will have greater returns than the stock market.

There are many possibilities, but investment rental property is my favorite. It walks the fine line of liquidity – expensive transaction costs and paperwork make day trading impossible. Yet it has a fairly well defined price with many willing buyers (it isn’t a Picasso sketch).

And the returns over the course of a couple decades are roughly three times the stock market.

It Still Spits Out Cash Over Time

Even though the asset itself isn’t very liquid, you will still have the ability to access some of the money.

Every month the tenant pays rent – after factoring in all expenses you will get to pocket some cash every month. As the equity builds, you have additional options like refinancing to access the equity without selling the asset.

As you patiently wait over decades, you are pocketing cash the whole time. It comes at set intervals though, you can’t sell at an exact millisecond.

You are giving up flexibility for greater returns.

What do you think, can you use your timeline to your advantage?

Photo: Nick Olejniczak

Tenant Turnover From Thousands of Miles Away

March 29, 2016

Have you ever played the game of telephone? Where you pass a secret message around a circle and see how garbled it becomes by the end. Always shocking.

Communication is hard. Or more accurately, communication is hard for the other idiots playing the game. You are perfect right?

Communication in Rental Properties

It is pretty easy keeping an eye on my properties, even though I’m thousands of miles away. During most times there is very little effort required to keep things running smoothly. The property manager handles almost everything and deposits the rent into my bank account each month.

The big exception is tenant turnover.

Tenant turnover is when one tenant moves out and another moves in. Even though I have a property manager to do most of the work, I stay actively involved to make sure things run smoothly.

The Old Tenant

I purchased the property in Memphis during the summer of 2014 and the property management company quickly signed a tenant to a year lease.

After a year, he decided not to sign a new lease and to stay month to month for a while. This automatically increased the rent $100 per month, which was just over 10%. Since there was such a significant increase, I was surprised he stayed an additional 6 months.

He paid on time every month. Only one minor repair the whole time. But all good things come to an end.

In early December I heard from the property management company that the tenant would be moving out at the end of December.

Dag Nab It

Rental property investors want their tenants to stay in the property for a long time, gradually raising the rent along the way. A tenant turnover involves significant expenses that cut into profits.

To make it worse, he would be moving out at the end of December. Who moves during the winter? Perhaps he had his heart set on moving out west for the warmer winters. To be fair, the luxury apartments los angeles are attractive enough to make people consider moving out of their current accommodation in favor of them at any time of the year! Although, now seems like the worst time to find a new tenant.

I knew I would have to keep on top of the property manager to ensure a successful turnover.

The Property Management Company

My Memphis property is managed by a huge company that oversees a thousand plus homes. They are a behemoth with different divisions for rent collection, repairs, and tenant placement.

In contrast, my Atlanta property is managed by a mother and her daughter. It’s a little two person company who handles everything.

I already was a little hesitant about such a huge company, especially since they are expensive. Since this is the first time we have gone through a tenant turnover together, I approached it as a tryout for if we will be working together long term.

The main test is how well they communicate.

Create a Sense of Urgency

Every day that the property sits empty is another day without rent.

This is a bigger deal to the investor than to the property manager. So the goal of the investor is to keep pressure on the property manager to make sure things are getting done.

I averaged two phone calls per week week throughout the process and sent emails as well. Add it all up, I spent roughly 5 hours communicating with the management company.

At the end of December I called to make sure they were planning to get in the property right away after the New Years holiday.

Next were emails going through their damage report and deciding what to fix. Then more calls making sure the various contractors were scheduled to come in (plumber, carpet cleaner, gardener, etc).

Phone calls to understand how and when they would start showing the property. More emails and calls to find out why I wasn’t getting the regular updates I requested.

And then finally it was over. They found a tenant who met all the requirements and moved in on February 25th.

The Overall Cost

There are a lot of minor repairs when a tenant moves out. The standard things are carpet cleaning, so I will get in touch with a professional service like Rug Cleaning Malvern to help get it back looking brand new. Then I need to organise touching up the walls with paint and re-keying the locks.

In addition, my property had several items the tenant paid for from his security deposit. Some damaged sheetrock, a whole bedroom that needed painting, yard that wasn’t maintained, and additional cleaning that was necessary. Luckily the work that needed carrying out was minor. A fellow landlord and friend who also owns properties had a tenant move that had caused quite a lot of damage, so the property was sat empty whilst they repaired everything. Luckily they had the forethought to get landlord insurance which covered a lot of the damage. It has come recommended highly to get a quote today to prevent it from happening to me.

I ended up paying $300 for a few things as well. Since it was winter and the house would be sitting empty, we winterized the pipes. If the pipes froze they might burst and cause water damage, which would be a huge expense. So better safe than sorry.

We also did a pest spray to kill the few bugs and keep more from coming back. And a couple minor things like replacing the side gate latch.

There were also some repairs mentioned in the report that I opted to skip. Things like painting the shed in the backyard and replacing some damaged sheetrock in the garage (but there isn’t a hole for critters to get in).

The out of pocket cost to me was $300, and there is also a tenant placement fee of one month’s rent.

I am also responsible for paying the mortgage, taxes, and insurance even though I wasn’t receiving rent during this time. It took almost 2 months, which is roughly $1100.

The total: $2400. Ouch.

Back to the Good News

Unless there are significant repairs needed, I should still be cash flow positive for this property in 2016.

And there is a two year lease signed, which means 2017 will not have a tenant turnover and generate significant cash flow.

The two year lease is one thing I really like about this property management company.

The first year is leased at $995 a month and the second year at $1020. There is a 2.5% rent increase already worked in! The $995 per month is also almost a 5% increase over the original lease of $950.

The lease is very friendly to the owner – the property management company is very demanding of their tenants. A $1295 security deposit, which they are not shy about using. No pets. No smoking. Month to month after 2 year lease is $1120. The tenant is responsible for appliance fixes. And the tenant pays for minor maintenance under $500!

Overall Thoughts

I wasn’t too happy with the communication and how long it took to get the tenant in place. But, the end result isn’t too shabby.

I received an extra $600 from the previous tenant in month to month rent. I ended up paying roughly $2400 for the turnover process. $1800 is about what I was expecting for the tenant turnover, so if you include the extra rent, it comes out as on target.

The two year lease makes me very happy. A 5% increase in rent year 1 and 7.5% in year 2 compared to the 2014-2015 lease is awesome. That comes out to roughly $1400 in additional rent over the next two years.

What do you think? Would you be happy with this tenant turnover?

Is Effort Your Advantage in Investing?

March 22, 2016

If I had a way of buying a couple hundred thousand single-family homes and had a way of managing … I would load up on them and I would take mortgages out at very, very low rates.
-Warren Buffett

It sucks to be a billionaire. Do you know how hard it is for Warren Buffett to find a nice return on investment at this point?

His company is worth $350 billion dollars, and if his goal is a 10% return per year, he is trying to make $35 billion a year. Where the heck is he going to be able to do that?

Even purchasing entire billion dollar companies isn’t going to make much impact. A billion dollar company might have $100 million in earnings a year. So he would have to acquire 350 companies that size to get $35 billion in earnings.

Smaller deals for companies in the $100 million range are inconsequential for the overall return of his portfolio. Even if they return 25% or 50% a year, they aren’t worth the time.

So even though Buffett sees a good deal in single family homes, he would have to purchase a couple hundred thousand for it to be worth his effort, and handle the paperwork for each accordingly, from the investment memorandum real estate documents to the insurance and deeds.

You Have an Advantage Over Warren Buffett

Did you ever think you’d actually be in a better position than the legendary investor Warren Buffett?

If you are investing $20 thousand, $100 thousand, or even a million dollars, you have way more options. You don’t have to compete with the huge Berkshire Hathaways, hedge funds, pension funds, or university endowment funds. You can do the smaller deals that take too much effort for the big guys to consider.

Your effort is your advantage. It is a worthwhile use of your time to seek out a $20 thousand dollar investment that has a projected return of 25% per year.

But most people don’t look for opportunities to use this advantage.

Real Estate is Unique

Efficient markets require commodities. Meaning one unit is equal to all of the others.

A share of stock is exactly the same as any other. You can buy one not caring whether you get share number one or one million. If each one were different, how would you be able to quickly know the price?

A barrel of oil is a commodity as well. There is an agreed upon standard, and as long as a barrel meets it, each barrel is considered equal and therefore there can be markets for these, and how for instance, oil investments are possible.

Real estate is a lot messier. There are hundreds of unique markets spread across the United States. Different neighborhoods and sub-divisions within those markets. Different housing types like 3 bed, 2 bath or 4 bed, 2 bath. They were built at different times and rehabbed at different times.

When you want to sell a house, you first need it to be appraised by an expert to get the attention of more buyers. For instance, while selling your house, you might have to first consider booking building inspection. The inspection report can portray your house in a favourable light, thereby attracting more buyers. Anyway, after this, it is compared to the most similar nearby homes that were recently sold. Only then do you know what is actually worth?

What a pain! It is an inefficient market with imperfect information, significant transaction costs, and slow transaction speed.

Luckily that pain creates an opportunity for the little guy. If you can navigate the hassle, you will be rewarded.

Note: One of the primary causes of the 2008 financial crash was because banks tried to treat mortgages as commodities. They claiming thousands and even millions of mortgages were all equal based on some shady rating agencies (see the movie The Big Short for an entertaining overview).

Your Effort is Required

There are many ways to do real estate. Which one leverages your advantage?

There are dozens of crowdfunding sites that let you participate in deals for as low as $1000. There are Real Estate Investment Trusts that are similar, just easier. Those looking to make a success of real estate investment may want to look at all the available investing services out there for help with this – check out the 1031 tax deferred exchange to see how you can benefit from simpler exchanges and smart investments.

I have a feeling someone else is doing the work on those and reaping most the rewards that come with it. You need to be the person in charge of the deal, putting in your own effort, and ending up with the property in your name (or an LLC or other entity you own).

This takes effort. Most people aren’t willing or able. It’s too messy for the big fish. That leaves a perfect opportunity for you.

Put in the effort and get the rewards.

What’s holding your back? What are your other unique advantages?

How Do You Know When to Refinance Your Investment Properties?

March 17, 2016

Oops, I did it. I upset the internet masses last week.

I asked if it made sense to refinance my investment property in Atlanta to use the money, combined with a little of my own, to purchase a new rental (see Let’s Double Down! Cash Out Refinance on a Rental Property for the analysis).

The reader comments include “I would not refinance for a measly 17k” and “I would be very concerned about needing to borrow $15k to make a purchase”.

Both true. Valid points. I asked for opinions and that’s what I got.

However this isn’t where the analysis ends. Let’s dig a little bit deeper.

Reviewing Investment Property Refinance Basics

Imagine a property with a $45k mortgage that is worth $100k. It has $55k of equity, or 55%.

The return on investment doesn’t really change if I have 20%, 55%, or 85% equity. Either way it has the same cash flow and appreciation benefit.

A cash out refinance is basically starting a brand new mortgage with only 25% equity. There is a fee to do the refinance and you get the difference in cash.

For the example with $55k in equity on a $100k house, the new mortgage balance would be $25k. If the fee is $3k, you would get to pocket $27k. Untaxed. Lump sum.

This is why it is important for people to do their research into mortgage refinancing from websites like sebastianfriedman.com so that they are equipped to move onto this stage at the right time to align correctly with their finances. That said, besides gaining knowledge regarding mortgage refinancing from websites, it would also be a good idea to talk to a certified mortgage broker who might have more in-depth knowledge regarding the same. Wondering how to find them? For instance, if you are from Etobicoke, Canada, then looking up keywords like CMB Etobicoke on the Web can help you find them easily.

The Power of the Cash Out Refi

The cash out refinance can be a powerful way to more quickly build up your portfolio of rentals. You can take that $27k and use it as a down payment on a new investment property.

Just like that, Property 1 clones itself and creates Property 2. Then seven years down the line, after slowly building equity, perhaps you do it again: Property 1 clones itself and creates Property 3. Property 2 clones itself and creates Property 4.

Same initial investment, but after 7 years it has turned into four properties!

The Patient Alternative Approach

Rather than doing a cash out refinance, you can certainly leave the equity in the house. Once the equity gets to 100%, you no longer have a mortgage to pay and the cash flow is much greater.

If you want to buy more rental properties with this approach, you have to do it the old fashioned way – save your money for a down payment!

There’s nothing wrong with this approach, but it will take much much longer to get to 4 properties (or whatever number of rentals you are shooting for).

More importantly, it will also take much longer to hit whatever cash flow goal you have to be financially independent.

Viewing My Rental Properties as a Portfolio

I want to go about rental property investing as would a portfolio manager. All proceeds are reinvested to grow the portfolio. I also contribute an additional $1000 a month to save up for more investments.

The goal is to optimize the portfolio so it makes the most money in the long-run. How do I do it?

I actually sat down and ran some numbers over 10 years.

Here is the complete spreadsheet with all the calculations. Disclaimer: this is a rough model

The Inputs

Start with my portfolio now (a property in Atlanta purchased in 2011 and a property in Memphis purchased in 2014) and $10k in cash. Contribute $1k per month to the portfolio for the first 5 years. Assume the cash flow from each property is $167 per month, principle pay down is $100 per month, and appreciation is 3% per year.

Each new property purchased will be 20% down for a $100k property. With $3k in closing costs and $2k added to cash reserves for unexpected repairs, let’s assume each new property requires $25k in cash. A refinance will cost $3k.

The calculations also won’t go beyond 10 properties (although the spreadsheet includes notes when additional properties can be added).

The Scenarios

Even though the model isn’t perfect, it should help compare different strategies – the relative numbers is what matters, not that it is a perfect calculation.

Scenario 1: Never Refinance

This approach is to just use the cash flow and $1k per month contribution to build the portfolio.

Scenario 2: Refinance only for a full property

This approach is to wait until a property has enough equity built up that it can be used to purchase a complete new property. With the assumptions, it takes 53% equity in order to get the $28k required ($20k down payment, $6k fees for refi + new mortgage, $2k in reserves). It takes almost 8 years to build up that much equity.

Scenario 3: Refinance now and for a full property

This is the approach I was asking about in last week’s article. Refinance now when Property 1 is at 44% equity, then from now on, wait until each property has 53% equity to refinance.

Scenario 4: Refinance aggressively at 40% equity

Rather than waiting to get to 53% equity, what if I refinanced every time a property reached 40% equity? With the given assumptions, it takes just under 6 years to get to the refinance rather than 8.

The Results

It should come as no surprise that doing cash out refinances will significantly improve the results.

Scenario 1: Never Refinance

Purchase 5th property after 3 years 8 months
Will have 9 properties after 10 years
After 10 years, the portfolio value is $434,750

Scenario 2: Refinance only for a full property

Purchase 5th property after 2 years 5 months
Purchase 10th property after 7 years 5 months
After 10 years and stopping at 10 properties, the portfolio value is $509,067
Could purchase another 5 properties if I wanted, or put $53,667 in cash to work in another way

Scenario 3: Refinance now and for a full property

Purchase 5th property after 2 years 9 months
Purchase 10th property after 6 years 10 months
After 10 years and stopping at 10 properties, the portfolio value is $505,217
Could purchase another 4 properties if I wanted, or put $70,167 in cash to work in another way

Scenario 4: Refinance aggressively at 40% equity

Purchase 5th property after 2 years 9 months
Purchase 10th property after 5 years 10 months
After 10 years and stopping at 10 properties, the portfolio value is $542,950
Could purchase another 7 properties if I wanted, or put $97,300 in cash to work in another way

Interpreting the Data

It should come as no surprise that doing cash out refinances will drastically improve the results over 10 years.

The ending portfolio value is very similar in Scenario 2 and 3. The only difference between those scenarios is whether or not to refinance Property 1 now, so perhaps it doesn’t matter either way.

However, if I were to continually refinance at 40% equity, it would lead to a substantially better result. This jump is comparable to the jump from not refinancing at all to refinancing at 53% equity.

So in conclusion…

I still don’t know that there is a conclusion yet.

If I have a set number of properties I would like to get to, it is a good idea to refinance aggressively.

If I want to keep adding properties past 10, it is a good idea to refinance aggressively.

If using this for an actual long term plan, I would have to build a more complex model and possibly look to get more info about software that could help me with scenario analysis. We can draw some simple conclusions from the data above, but shouldn’t read too far into it.

Also, with new blockchain companies (if unclear, check what is a block chain company) introducing tools for new market overviews, neighbourhood insights, property analysis, I do have other options to consider. It’s nice to have choices. Let’s see.

What do you think?

Are these results surprising?

Does it change your opinion of refinancing now?