Mindset

Inflation: The Great Mortgage Destroyer

May 8, 2016

If there is one thing people don’t have an intuition for, it’s Einstein’s Theory of Relativity.

So you’re telling me that the speed of light is the same no matter what speed I’m going? So if I’m standing still it’s X and if I’m traveling the exact same direction as the light, going X speed myself, somehow the light is still traveling away from me at speed X?

So you’re telling me that time itself changes based on the observer? So if you have two twins, and one leaves earth to travel around the galaxy for a while at the speed of light, when he comes back he is somehow younger than the other twin?

Ya sure … sounds a little fishy to me. But ok, whatever you say Mr. Genius.

If There’s One More Thing People Don’t Have an Intuition For, It Is Compound Interest

In fact, Einstein himself might have pontificated on this (or maybe not).

Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.
-Albert Einstein

Compound interest works both ways whether you are lending or borrowing. Another form of compound interest is inflation – something everyone is affected by whether you know it or not.

How can we get these powerful forces to work for us rather than against us?

I believe the best way is to have a mortgage balance that someone else pays off. Alternatively, people can look on websites such as https://www.housebuyersofamerica.com/how-to-get-out-of-a-mortgage for more information on mortgages. More on that soon.

Inflation Over 30 Years

It is hard to comprehend how inflation destroys the purchasing power of the dollar over a long time horizon. But let me try to put it in perspective.

The rule of 72 is a shorthand way to estimate how long it takes for compound interest to double. You just divide 72 by your interest rate and that is the number of years it will take to double.

If we estimate an inflation rate of 4.8%, then in 15 years the purchasing power is cut in half. In another 15 year it is cut in half again. So in 30 years, things would be 4 times more expensive.

In other words, in 30 years a ticket to Disneyland will be approaching $500! Hopefully your paycheck keeps up over those 30 years as everything else will be more expensive too…

Maybe 4.8% is a little high to forecast for inflation over the next 30 years, but that is a discussion for another day.

Let’s look at a more generally accepted inflation rate of 3% over the course of 15 years. I think 15 years is about as far as people are comfortable projecting – that could be your target retirement, or when your toddler will head off to college.

$1 in 15 Years Has the Purchasing Power of 64 Cents Today

Inflation slowly destroys the value of the dollar. Even at just 3% per year, with a pretty long time horizon and the compounding effect, it is significant.

Or put another way, you would have to invest 64 cents today at 3% interest to get a dollar 15 years from now.

Notice that I’m not using some wacky high inflation numbers or time horizons. Yet when we go through the numbers for a rental property it yields some impressive results.

Fixed Monthly Mortgage Payments

Let’s imagine I purchase a $100k property with 20% down at a 5% interest rate 30 year mortgage. It rents for $1000 a month – pretty much exactly the same as the two properties I currently own.

My monthly principle and interest payments on that mortgage will be $430. The real shocker is it will be the same $430 payment every month for 30 years.

It never goes up! Over time this payment will feel smaller and smaller. Let’s look at some numbers:

In the first year, this principle and interest payment is 43% of the rent collected. Every year inflation will tick up the monthly rent, taxes, insurance, repair expenses, and property management fees. Yet the principle and interest payment stays the same.

After 15 years the monthly rent is $1513. The principle and interest payment is now just 28% of the rent collected!

With every passing year, the mortgage payment is easier and easier to make. And since it is fixed while our rents are rising, you’ll notice in the far right column, our monthly cash flow goes up.

What About the Mortgage Balance?

The mortgage payments are fixed and over time the tenant is paying down the mortgage for you. Your cash flow is going up, the mortgage balance is going down, and the value of the dollar is going down as well.

Let’s look at the numbers year by year:

At the end of year 1, we receive $1,540 in cash flow. But the value of the dollar is 3% less due to inflation, so is equivalent to $1,495 at the beginning of the year.

The tenant has paid down the mortgage balance a little bit for us. It is now at $78,820. But here is the crazy thing – at the end of the year the mortgage balance is also easier to pay thanks to inflation. To help your intuition on this, we can translate that loan balance to what it would feel like at the beginning of year 1: $76,524.

Do this for 15 years and where do we stand?

$1 in 15 years is equal in purchasing power to 64 cents today. Our yearly cash flow has gone all the way up to $4,974 (remember it increases due to the fixed principle and interest payments with rising rents and expenses) – or translated into today’s purchasing power it is $3,193. The purchasing power from the cash flow has more than doubled!

In 15 years the mortgage balance stands at $54,307, which the tenants have been kind enough to pay it down for us. But that $54k doesn’t seem as significant when inflation has raised the prices of everything. Translated into today’s purchasing power, it is equivalent to just $34,858!

Inflation is the Great Mortgage Destroyer

Prices keep rising, the mortgage payment stays the same. The mortgage payment is easier and easier to make and the mortgage balance feels less and less significant. Thus, if you feel like you should look for homes and would opt for a mortgage payment system for it, you could look at lenders similar to a Mortgage Broker Colorado who can help you out!

If you can master the concepts of compound interest and inflation, you can use them to your advantage.

There really aren’t any other opportunities where an average Joe has the ability to borrow money like this and return a cash flow. The fact that you can go get an extremely reasonable rate for an investment mortgage is frankly amazing, whether you get one to purchase a property in your own country or consult with someone like simon conn with a view to buying a property overseas to let to holidaymakers. It is a gift everyone should take advantage of. However, if you are simply a military veteran after an affordable mortgage so you can own your home then it might be worth using this mortgage calculator.

All you have to do is sit tight while the tenant pays down the mortgage for you and inflation does the rest.

What are your thoughts? Do you understand how powerful a mortgage destroyer inflation is? What’s holding you back from taking advantage of it?

If you are interested in playing around with the numbers yourself, here is the spreadsheet I used.

Forget Risk-Reward, With Rental Properties Think About Effort-Reward

May 3, 2016

I am a ruthless competitor.

I just prefer not to show it – if I can secretly work harder than anyone else, I will.

Some people make small-talk during Scrabble. I’m constantly thinking through possibilities and just nodding along to whatever you are saying to me. “Ya, uh huh, sure”.

When it comes to investing, I am also going to put in more effort than the average person. To me the average person is lazy and accepts poor results. See the mutual fund industry for more info.

But effort takes time and time is non-renewable. So maybe I shouldn’t put in too much effort… ?

Investors Talk Risk-Reward

When investing there is a trade off between potential return and how risky it is.

As an example, an established company like Coca-Cola isn’t going away any time soon. If you invest in it, you can be pretty certain the company will keep on chugging along as it has for the last hundred years.

If your friend’s cousin has an iPhone app company that is running out of money and needs investors, run for the hills. Well, unless they make it worth your while. Since there is a decent likelihood the company will implode, they will offer you significant upside for investing.

With the potential for downside losses comes the potential for upside profits. Otherwise, you would just go with the sure thing every time. This could be similar to investing in a listed company, if you analyze the financials of a company before buying its shares, you may be able to predict the future of that firm. With the rise in numbers of investors across the world, service providers like Debtwire tend to provide necessary tools for stock analysis. Debtwire launches new platform to analyze the liquidity status and financial operation of any listed company. Such services can come in handy for an investor while adding new firms to the portfolio.

Rental Properties Risk-Reward

With rental properties there can certainly be a risk-reward component. You can invest in a Manhattan sky-rise condo, rent it out, and pray the value increases.

I call that gambling.

Is there potential for huge returns? Yes, but it isn’t worth it because you can lose everything.

If the market softens, your tenant will move out because rents are lower elsewhere. It already didn’t quite provide enough cash flow to cover your monthly expenses – now it is vacant and will rent at a lower price. It bleeds money every month and if your day job can’t support it, you can’t even sell because it is underwater. So bankruptcy is the only option.

This scenario might be unlikely, but it isn’t worth the risk because you can make excellent money in rentals without it.

I prefer to take the most conservative approach possible, investing in low-cost cities with excellent rental income. The cash flow provides enough cushion to wait out any downturn. I use my decades long timeline to my advantage. The leverage on these low risk rentals makes it a homerun.

Effort-Reward

We don’t have to worry about the risk-reward trade off since we are going with the most conservative properties.

Instead real estate investing should be considered an effort-reward trade off.

There are an incredible number of ways to be a “real estate investor”. For business developers, it can mean checking commercial building loans in florida or a place where they are planning on starting a business. That can also mean speculating on condos or flipping homes in your suburb. Those two have almost nothing in common.

When it comes to rental properties, there are still many ways to go about it. You can take care of everything end -to-end, finding a distressed property, rehabbing it yourself, and showing it to prospective tenants. Or you can pay someone to do that for you.

It shouldn’t surprise you that if you do less work, you can expect fewer returns. An extreme example of this is investing in real estate through a REIT (real estate investment trust). You do no work, purchase it just like a stock, and get an 8% to 12% return. Of course, it is not the same as commercial real estate investment which tends to be a lot more intricate. Businesses often get aid from companies such as CRE PropTech to carry out the transactions and manage their investment funds.

If you buy turnkey properties like I do, you put in significantly more work. You have to build relationships, perform due-diligence, and muddle through legalese. But once the property is purchased, the property manager makes it so you average less than an hour spent per month. You can expect a 20% to 30% return when you factor in all 5 components.

If you take on more responsibility, you can certainly up your returns: less middle-men make a profit off you. You can be the property manager for an extra hundred dollars a month. You can do the wholesaling to save thousands off the purchase price. You can schlep your toolbox over there on weekends to rehab it.

But is the reward worth the effort?

Don’t Forget to Evaluate the Effort Involved

You might hear statements like “I made ten thousand dollars flipping a house.” How much work went into it? Were you rehabbing yourself on weekends or dealing with pain-in-the-butt contractors? How many dozens of properties did you look at before your offer was finally accepted?

They want to tell you the good part and leave out the work required.

It’s similar for people who save money by being their own property manager. You might hear “I get an infinite return by managing it myself” because they put in no additional money. But you know better – putting in time and effort is just another form of the same thing.

This helps keep me grounded. I am not doing as well in real estate investing as plenty of people. It is easy to hear their success stories and feel like I’m not doing enough. It is natural to want more.

But at what cost? What is the effort required? How can I put in 20% of the effort and get 80% of the results?

For me the answer is purchasing buy-and-hold rental properties from out-of-state turnkey operators who do most of the work. I’m still able to get a 29% annual return and that’s good enough for me!

Looking for Motivation? Tie it Into a Bigger Purpose

April 19, 2016

Hundreds of millions of people have marched into battle and died.

Jeez that’s a heavy opener. I really hope I can turn this article around, wouldn’t want everyone to leave depressed…

Do you ever wonder – what the heck were they thinking? Looking back, a lot of those wars didn’t matter. Worse still, most of the deaths were on the losing side, so it’s not like their death affected the outcome. So why bother?

The human mind is amazing – somehow we are able to convince ourselves to march into battle to meet nearly certain death. Let that sink in for a second. Wow.

How do we harness that power?

A Bigger Purpose

Each and every one of those men who died in the wars had their own reason. A purpose.

It might have been protecting their family or homeland. Or stopping injustice. Or spreading their religion so more can access heaven.

It might have been more personal, like proving their manliness. Or earning money to feed their kids.

With a big enough purpose, we can take any action.

Start With Why

There is a great Ted Talk by Simon Sinek “Start With Why”.

It is about how successful leaders and organizations inspire others. But it is just as powerful thinking about this for ourselves. How do we inspire ourselves to take action?

You need to know why! Not just what. Not just how.

Taking Action in Rental Property Investing

Most people on this website already know what – they want to invest in rental properties.

Some even know how – the steps necessary to get there.

But I bet you won’t take action without knowing why. There are too many obstacles in the path to just waltz right in and be instantly successful. You need a purpose for motivation.

What is Your Why?

Take some time to think about this.

Why do you want to invest in the first place? Why do you want cash flow or passive income? Why, why, why?

If your answer is something like “so my money works for me”, you need to keep going. Keep chaining together whys until you get to something that gets to your purpose or identity.

I want freedom and flexibility – not a standard job where I have to show up every week for the next 35 years. I want to be able to spend time with my family with the ability to take days or weeks off when I want. The time freedom to put family and friends first rather than being too busy. I want the ability to control how much money I make rather than just whatever the employer decides to give. The flexibility to earn more if that’s what our family wants or needs.

That is why I want the passive income and wealth from rental properties.

That is what gets me through the scary aspects like writing my first $20k down payment check.

That is what gets me through the tough days when there is a repair or tenant issue.

It is a powerful why.

What is your why?

It’s All About the Ratios Baby – Why I Invest In Rentals from Thousands of Miles Away

April 14, 2016

Have you heard someone say “the DOW is up 250 points today”? Or that is a specific stock has gone up $10 in the last year?

Well that sounds great, but how the heck am I supposed to know that that means without knowing where it started?

In the words of Einstein, it’s all relative.

What was the DOW at before and what is it now? What is the ratio or percent change?

It’s All About the Ratios Baby

Let’s look at an example to see why this is important. Let’s say you purchased 1 share of Dingle Enterprises at $10,000. And lucky you, it goes up 50 points!

Sweet, you made $50 with no work at all! But is that a good return?

Obviously you have to evaluate it based on how much money you originally put in … in this case your return was half a percent. Not so exciting now.

When we are evaluating rental properties, we won’t deal in absolutes (only a Sith deals in absolutes). We have to look at the ratios – in this case the rent to purchase price.

Example Time

Look at Zillow for a home in your area and let’s evaluate if it would be a good rental. Here is one in my part of San Francisco. Every property has a Zestimate, which is the estimated sale price, and a Rent Zestimate, which is the estimated rent. Those numbers aren’t all that accurate, but they can give us an idea of the ratios. As of the time of this writing, the numbers for this property are $1,091,542 and $4,500.

Don’t be the idiot that says “wow, I get paid $4,500 every month for doing nothing? Awesome!” The ratio of rent to purchase price is 0.41%.

Or to put it another way, the monthly rent is about 1/243rd of the purchase price.

Ok, now let’s look at a random property in a market I would potentially invest in. Here is one in Atlanta. The Zestimate is $104,430 and the Rent Zestimate is $1,110.

The ratio for this is 1.05%. The monthly rent is about 1/95th of the purchase price.

Wow, see that difference? In terms of ratios, it is a 2.5x improvement!

If you think I cherry-picked these examples, go ahead and take a look yourself. Look up a property in your area and see the rent to purchase price ratio.

Expensive markets will reliably be below 0.5%. Areas with potential for cash flow rental property investing are reliably over 1%.

There is More to Consider

Don’t be the idiot that just looks at the numbers though. The area has to have job growth and new people moving there.

But this is a quick way to eliminate markets from consideration. Especially if you live on the East or West Coast, you’ll see you should look out of state.

Also don’t be the guy who says “if I drive just 2 hours to Stockton then the ratios are just about .1%” (or insert any podunk “suburb” where people generally don’t want to live).

Really? So you want not quite as good of returns in a town that is miserable with poor job prospects so you can spend your weekends driving there to keep an eye on it? Uh ok.

Don’t be the person who says “ya but the appreciation is better in San Francisco”. It could be. Or it could crash. Sounds a lot like gambling – you will probably be just as good at timing which color the roulette ball is going to land on. And besides, over decades the appreciate will trend equal to the more boring linear markets that keep chugging along.

An Investment, Not a Part Time Job

The numbers told me to invest out of state. The properties are also way less money, so someone can get started with just $20k rather than $60k for the cheapest properties a couple of hours away from me.

But the thing I like most is that it helps me approach my rental properties as an investment, not a part-time job. It certainly is a thing. Whether you invest in real estate, shares, or crypto through an agent from bit index ai offizielle seite (bit index ai official website) or on your own, the more effort you put in, the better results you get. If you treat it like a part-time job, it will fetch you results likewise.

If my properties were local (or even a couple of hours away), I would likely be the landlord and way more active in maintenance. For instance, I would have checked the condition of the roof, windows, doors, home flagpole, and rain gutters and got them repaired. This would certainly save some money. But would that allow me to set up for long-term success?

All those hours of work would weigh upon me and make me hesitant to add to my portfolio. At some number of properties (4?) I would probably not want to purchase another because I’m already devoting enough time to it.

With the out of state investing, my rentals are much more passive. Yes there is still a little time required with the property managers, but it is more scalable. I am not afraid of the on-going time investment with 10 properties.

More passive with better returns? Sign me up!

What do you think? Have you found investing in your local area more appealing than out of state? What are the ratios like?

Photo: Juli