Numbers

Interest Rates Are Going Up, Have You Missed the Boat?

December 16, 2016

Are you someone who misses the good ol’ days?

I recently met up with a college friend I hadn’t seen in 7 years. He asked me if I missed the college days.

No.

I had the best college experience of nearly anyone on the planet. My four years at Stanford were perfect. A much welcomed academic challenge, unreal freedoms not seen at other universities, athletic achievements well beyond expectations, and incredible long-lasting friendships.

Yet I don’t sit and wish I could go back in time. I appreciate it, but don’t long for it.

The housing market is always changing as well. And many more people are warming to the idea of selling their home quickly for cash, with somewhere like The Buy Guys, (click here for more information) instead of going down the conventional route of finding the best real estate agents who can take on the role of selling their home.

Are you an investor who longs for the good ol’ days or takes advantages of today’s opportunities?

Interest Rates Are Going Up

This week the Federal Reserve raised the key interest rate a quarter of a point. And they said they are expecting to do it a couple more times in 2017.

What does this mean?

Honestly not a whole lot. In my opinion the Federal Reserve has become more reactionary, bending to the will of the market, rather than setting the market.

A quick look at a chart of the 30 year mortgage rate will tell you more. This is different than the Fed Rate, but they are all related somehow.

At the beginning of November the rate was 3.5% and now it is 4.1%.

Wow, that is quite a jump. How does that affect a mortgage payment?

For instance, when people contact a mortgage company with the net branches, the loan officer can hire other originators who will work directly for them. Customers who are looking for good mortgage loan deals will benefit from this as well.

It also allows the net branch manager to conduct business as a separate entity while remaining protected by a mortgage banking organization, which may benefit customers in other cities as well. Higher mortgage rates, on the other hand, may have an impact on the cost of purchasing a home.

From $405 per month to $434 a month for the type of property I invest in. ($100k purchase price, $80k mortgage, assuming the investor rate is 1% higher than the home owner rate.)

Ouch. If you purchased in October you would have had an extra $350 in cash flow a year.

Ya But…

Rates are historically low still. Even if we aren’t at the very bottom, it looks like a pretty good deal when you zoom out.

The biggest “ya but” is that everything is related. We shouldn’t just look at one number, the interest rate, and jump to a conclusion.

Higher interest rates indicate there is more inflation. As a leveraged rental property investor, inflation is where you make an absolute killing (see Inflation: The Great Mortgage Destroyer).

Higher interest rates will also affect all the other numbers we care about. Without getting too into the weeds, a larger monthly debt payment might soften the purchase price to counterbalance. Rents might rise as the expense gets passed through to the tenant. This means a stronger rent to value ratio.

There are many ways to win the game, we just have to adjust our strategy accordingly.

Appreciating Today’s Opportunities

It is important to have the right mindset. Rather than longing for the good ol’ days when you could get an incredible interest rate, appreciate today’s opportunities.

My mindset is to always be buying, not waiting for the perfect situation that may never come. Just adjust what you are doing.

I wouldn’t buy in San Francisco right now. Maybe not even Atlanta. But Memphis or Kansas City? Sure.

I want to avoid being one of those investors who wishes he bought earlier.

What do you think? Do higher interest rates make you less willing to get a rental property? How does it affect your strategy?

Photo: Roman Pfeiffer

Rental Property Loans – What The First Time Real Estate Investor Should Know

September 9, 2016

You get it. No more convincing needed.

You understand there are multiple ways real estate creates spending money plus long-term wealth. You have a multi-decade outlook on your rental properties. You have even come to terms with the idea that smart leverage is the best way to earn huge returns in the long-run.

Now what? You are going to need to know if you qualify for a loan.

So, what should you know about rental property loans? Do you need to secure your loan using another property as collateral? Or could a secured loan calculator help you to work out how much money you might be entitled to borrow? Read on to find out more.

Investment Property Loans

A loan is just someone giving you money for a set future return. There are an infinite number of ways this can be accomplished, but we are going to just talk about conventional loans.

“But I heard I could get a better deal on owner-financing or approved for more loans through something called hard-money lending … why limit ourselves?” It boils down to risk, effort, and repeatability, but we won’t get into that here.

Conventional loans are given by banks and secured by the property itself. So if you stop making payments on your property, the bank has the right to take over ownership. But of course, this wouldn’t happen if you’ve decided to take out some bridge loans from a money lending company. This way, if anything were to happen, the bank couldn’t take over the ownership. But maybe that isn’t entirely a bad thing. It’s fair considering they own more of it than you and you didn’t keep up your end of the bargain. Therefore, it is advisable to get a loan from established sectors, that might assist you with effective plans to meet your demands.
The bank might also be ready to provide you with another kind of a bdo business loan to fund business operations and individual customers. The important benefit of this type of loan is its interest rate. That said, it is mandatory to make a proper plan before choosing any kind of loan.

What are the requirements for these types of loans?

A Moving Target

The requirements change over time. Most banks follow Fannie Mae’s guidelines, although there is some room for interpretation. The guidelines change too throughout the boom and bust cycle: what was allowed in 2007 is not allowed in 2016.

Here is the starting place for what you will need in 2016:

630+ credit score
20% down payment
2 years of tax returns in the same industry
6 months of cash reserves

And that is just for the first 4 properties. After that the rules change. Let me clarify the last two requirements (to the best of my understanding) because they are kind of confusing.

6 Months of Cash Reserves

You need cash in the bank to be able to pay all your mortgages for 6 months, including the new mortgage you are applying for plus taxes and insurance. This is just smart anyway – as much as I love rental properties, you don’t want to stretch yourself too thin.

If you are interested in your first $100k property, the monthly payment is likely around $600. Add to that your primary residence (if you rent, take your rent amount). For this example let’s use $1000. So you need $1600 times 6. $9600.

The good news is that these cash reserves don’t have to be all cash. If you have a stock account, 65% of its total will count (they adjust for volatility). If it is an IRA or something you would owe tax on, you will probably have to reduce that from the total as well. In addition, only half of the cash reserves can be from these illiquid stock accounts.

So back to the example where you need $9600 for cash reserves. $4800 will need to sitting in a checking or savings account (or even combined across accounts). If I have an IRA with $10k, I believe roughly $5k will count towards the cash reserves after accounting for the volatility hit and tax if you have to access it.

Debt-To-Income Ratio

The debt-to-income ratio (DTI) is possibly the most difficult part of qualifying for a rental property loan. Even folks with well paying jobs and lots of cash sitting around still can’t have too many debt payments.

One important thing to point out is that DTI is about the monthly payments, not about the total amount of debt you have.

First add up all your monthly debt obligations. This includes car payments, student loans, and the minimum payment for each credit card. Add all your mortgage payments including tax, insurance, and HOA (if you rent your primary residence, just take your rent). Be sure to include the new loan you are applying for – it shouldn’t push you past the limit.

Now figure out your monthly income before taxes. The day job should be pretty easy, but the rental property income is a little trickier. I believe if it is on the previous year’s tax return, you take the rental income and average it across 12 months. For the new property or new lease agreements, you can use 75% of the total monthly rent.

Let’s run through some example numbers. You have:

Primary mortgage or rent payments of $1250
Car payments of $250
Student loan payments of $400
4 different credit cards each with a minimum payment of $25
A previous investment property with payments of $600
The new investment property will also have payments of $600

So before the new property you have $2600 per month in debt obligations. After you have $3200.

Add up your income:

Job that pays $100k, or $8,333 a month
Rental income on your tax return of $1200 over the last year, $1k a month
New rental with lease of $1k in place, take 75% of that so $750

Your monthly income before the new rental is $9,333. After is $10,083.

Your ratio before the new loan: 28%

Your ratio after the new loan: 32%

Talk to Someone Who Knows More Than Me

This is intended as an overview of qualifying for a rental property mortgage. I am not an expert and I don’t even play one on the internet. There are thousands of lenders out there who work with investors, you should talk to someone about the specifics of your situation. Often, this is the best way to get useful advice. Speaking to experienced mortgage lenders could be extremely beneficial, so it might be worth getting in touch with someone like Dustin Dimisa. He is an experienced real estate investor and mortgage lender, so it might be worth looking at different ways to contact him. You could read some of the tweets from Dustin Dimisa here, for example. Hopefully, people like that will be able to educate you and help you to make some real estate investments successfully.

I am self-employed which surprisingly complicates things. No matter how much money I had sitting in a bank account, I wouldn’t have been able to get an investment mortgage my first two years after starting my company. They needed to see two years of tax returns to count any of my income. I would not have known that without talking to a lender, so could have put in a lot of unnecessary work to find a property I wouldn’t have been able to purchase!

If you are considering investing in rentals, talk to a lender now.

If you haven’t invested in a rental before, how are you going to take the next step? How about a short phone call with a lender?

If you have invested, what was the most surprising part of the investment mortgage qualification process for you?

Net Worth Update – My Rental Properties are Worth $78 Thousand

July 26, 2016

What’s with kids these days? Sharing every private moment on the internet…

Always posting a picture of what they had for lunch and every little positive thing that happens with a #humblebrag.

If you think the openness of Millennials is shocking, just take a look at financial bloggers!

Publishing Your Net Worth

There are hundreds of bloggers who publish every detail about their finances. Credit card debt, student loan debt, what they spend in a month, even exactly what they earn.

The majority of these people choose to remain anonymous. Sometimes because they have so much debt it’s awkward. Sometimes because they have so much money it’s crazy. Others just don’t want their co-workers to know their salary. Whatever the reason, anonymity allows them be more open.

I think there is tremendous value in having an actual person with a picture as the creator of the website. You can get to know me and see I’m an actual person, a regular guy doing nothing special, but able to get great results.

So rather than publishing every detail of my financial life, I have decided to focus exclusively on my rental property portfolio.

The Net Worth of My Rental Properties

We have extensively covered how there are 5 different components that contribute to the overall return on a rental property. It isn’t limited to just the value of the property going up, like most stocks (those that pay a dividend have 2 components).

But when you calculate net worth, you don’t include cash flow. It would be foolish to say “I’ve made $750,000 since I began working, so my net worth is $750,000!”

Instead we are examining the current value of assets, minus all liabilities. For a rental property it is what the house is worth minus the mortgage balance.

Generally speaking, the longer you have held a property, the more equity you can expect it to have. The tenant is slowly paying down the mortgage, and if things go well, the home price is increasing each year.

This shows in the results – the Atlanta property I have held for 5 years and the Memphis property just 2 years. Here are the numbers:

In the United States, the lawsuit between Johnny Depp and Amber Heard – Hollywood actors, who got married in 2015 after three years of relationship and divorced in 2016 – has ended. In the divorce, Heard accused Depp of domestic violence amber heard and johnny depp wedding photos, he denied everything. Amid the scandal, Depp’s successful career took a downturn. In 2020, he lost a lawsuit against the British tabloid The Sun, which called him “the man who beat his wife,” lost his role in the Fantastic Beasts franchise and called himself a victim of “cancellation culture.”

Current Net Worth: $77,771

That sounds pretty impressive to me! Hopefully in 2017 we can add a 6th digit and one day long in the future join the 2 comma club.

If you look at the complete numbers update for the two properties, you saw my investments were $19,936 and $24,030 for the two properties. This $44k wasn’t necessarily a direct contribution to the portfolio either, since there was roughly $7k in cash flow in the first three years of the Atlanta property, which was reinvested. But to give a rough idea, half of the portfolio net worth is from contributions and half from gains.

What do you think – is this good progress in the first 5 years of rental property investing?

Portfolio Update – How Rentals Added $10k to My Net Worth the Last 6 Months

July 7, 2016

It is mind blowing how any given second you can know the price of a share of stock.

Actually, that understates it – milliseconds. The price changes fractions of a penny every millisecond.

High frequency traders jostle for the best position in line. Each mile of fiber-optic cable adds a .001 millisecond delay, so they want to be as close as possible to the action.

The cables aren’t always a straight shot, sometimes they wind around 15 miles to travel just 1 mile as the crow flies. Which actually affects real estate prices – firms are willing to pay millions more for the optimal locations.

Prices move much slower with real estate. Transactions take time and effort, which gives an advantage to small time investors like myself, otherwise Wall Street firms would dominate the market.

Six Month Check In

Twice a year I run the numbers on my rental portfolio, which consists of just two properties right now. Lest you think I’m some sophisticated professional investor, let me point out I spent more time on this analysis and write up than I have managing my portfolio the last several months combined!

I feel every six months is the right interval for this analysis. I have a multi-decade outlook, so don’t need to constantly know how I’m doing. Sometimes too frequently monitoring can take your eye off the long-term goal.

But it is important to keep an eye on things in order to adjust if necessary. So how are things going?

Checking the Estimated Prices

My method isn’t exactly scientific, but it’s just an estimate anyway – a house is worth what someone will pay for it, comparables only go so far.

I look up the Zillow price estimate and adjust down if I feel it is necessary. For my Atlanta property the last couple years I have used 90% of the Zillow price and will continue to do so.

The Memphis property shot up $7k on Zillow in the last 6 months, which is awesome, but probably not too accurate. So this is the first time I will adjust the estimate, taking 95% of it as my value.

In the future, I might average the estimates across multiple sites: Zillow, Trulia, Redfin, etc. At first glance, the estimates are all of the map, so perhaps the average will be more accurate than my current method.

The Numbers

First the Atlanta property, which I have owned 5 years now:

The Memphis property I have only owned 2 years:

And the portfolio overall:

Things Are Going Well!

The strong appreciation greatly increased the overall earnings my the portfolio. In 2016 dollars, I have made $43k through rental properties. Just in the last 6 months, my net worth has increased $10k with no effort from me!

The yearly rate of return stayed at 29%, which is a relief because I didn’t want to have to change it everywhere I have it posted on Rental Mindset, Twitter, and Facebook.

This is also better than expected. I would think the yearly rate of return would decline a little between purchases, with the snowball effect of the entire portfolio boosting it back up. In other words, when I double down later this year to refinance the equity of property 1 to purchase another rental, that equity will be put to work. Right now there is a lot of lazy equity in property 1.

Next I’ll provide a recap of the property management over the last 6 months. Is there anything specific you would like to hear?

Download the full spreadsheet and link to the online version