printer friendly version

Investing in Real Estate

My Philosophy: Food for Thought

Have you ever wondered what it would be like to wake up in the morning with enough money coming in so that you could do what you want that day? Would you consider yourself "Rich?"

"'Rich' is the ability to walk up in the morning with the physical health, knowledge, friends, financial freedom, and passion to do what you want that day."

Financial freedom occurs when your annual investment income (your money at work) exceeds your annual lifestyle expenses. This is when you have what we call "Wake-up Money."

I have many customers who have achieved (or are on the path to achieving) this "Wake-up Money" lifestyle. Many of them have modest incomes but have become "Rich" through their investment in local real estate - specifically homes, condos, and 2-4 unit buildings.

These customers understand that we have three choices in life.

1. You at work. Do you worry you will have to work the rest of your life?
2. Your money at work. Do you dream of someday not having to work?
3. Charity. Do you worry about being dependent on others?

A Simple Investment

Homes are one of the three basics of life: food, shelter, and clothing. Homes and condos are simple investments that most people understand because they already own them. Ask yourself these questions: Do I own a home? Has it been a good investment? What would my net worth be like if I owned ten of them? What would my lifestyle be like if they were all free and clear?

What If!

If you purchased ten houses 15 years ago (average price then was about $70,000/each) and financed them on 15-year loans, today your houses would be free and clear. Today, they are probably worth about $175,000 each and your portfolio of ten houses is worth about $1,750,000. Your houses are probably earning you a net income of about $10,000 per month in "Wake-Up Money."

Will Rogers said, "Just the name 'the real estate' implies that all other forms of investment are illusory."

Three "Rules of Thumb" Help Investors Build Wealth Quickly

1. The "Rule of 72" is used to estimate how long it will take your money to double itself at a given rate of return on your investment. If you divide your rate of return into 72, the answer is how long it will take your money to double. For example, if you earn 6% on a savings account, it will take you 12 years for your money to double in value - 72 divided by 6. If you are able to increase your return to 10%, your money will double in 7.2 years - 72 divided by 10.
2. The "Rule of Leverage." One of the beauties of real estate (as opposed to other forms of investment) is that you can use leverage to increase your rate of return. You leverage your investment by using a loan on the property and reducing the amount of your own money you invest. The tenant makes the payments for you by paying rent. When you leverage (Use a loan), your rate of return is increased. For example, if you purchase a property for $100,000 cash and it goes up in value by 5%, you have earned 5% on your money ($5,000 divided by $100,000) plus the amount of rent collected. However, if you purchased the property with a 10% down payment ($10,000) and a $90,000 loan, your rate of return will be 10 times greater or 50% ($5,000 divided by $10,000).
3. The "Rule of Return." Here's a simple way to figure your return on investment:
   1. Convert your down payment to a fraction.
   2. Multiply the denominator times the appreciation rate to find your first year return on investment.
   For example, if your down payment is 20%, when we convert it to a fraction your down payment is 1/5. The denominator is 5. Multiply the denominator (5) times the property's appreciation rate (say 10%) and your first year return on investment is 50%.

   Let's test this rule to see if it works. Let's say we buy a $100,000 property and put 20% down ($20,000) with an $80,000 loan. Our down payment of 20% converted to a fraction is 1/5. If the property appreciates 10%, it will go up $10,000 in value. $10,000 divided by our investment of $20,000 equals a 50% first year return.

   The Benefits of Residential Real Estate Investment

   Residential real estate offers five major benefits. Most other investments offer only one or two.

   1. Cash Flow — The rent provides income, i.e. "Wake-Up Money." This is your ultimate goal. When your property is "free and clear", you have the maximum cash flow and "Wake-Up Money."
   2. Leverage — You can own $100,000 worth of real estate with only 0% - 20% cash. You can also borrow cash out of one property to buy another. Your short-term goal is to use leverage to acquire a portfolio of real estate. Your long-term goal is to pay the loans off and own your properties free and clear.
   3. Debt Reduction — Real estate is one of the few investments where someone else will make your payments. In essence the tenant makes the payments and reduces your debt.
   4. Tax Savings — You are allowed to depreciate the house and write off your expenses in order to reduce your taxes.
   5. Appreciation — Over time the value of houses and condos have risen. The average sales price of a home has more than doubled over the past 15-years.

   "Free and Clear"

   These are three magic words for the person who's committed to creating "Wake-Up Money." Many investors consider "free and clear houses" as the ultimate investment for three reasons:

   1. The house generates large amounts of cash flow.
   2. The house is appreciating in value.
   3. There is very little risk because there is no debt.

   "Wake-Up Money" Example

   Here's an example of how to purchase a "Wake-Up Money" property. This property was priced at $150,000 and sold at full price. Here's how the investment works on this property.

   $150,000	Price
   $37,500	25% down payment
   $112,500	Loan @ 7.5%; 30-year; fixed rate
   $781.73	Monthly principal and interest payments
   $100.00	Monthly taxes and insurance payments
   $25.00	Monthly reserve for maintenance and repairs
   $925.00	Monthly rental income
   $906.73	Total monthly expenses
   $18.27	Monthly cash flow

   Here are the 5 Major Benefits of owning this "Wake-Up Money"" house.
   1. Cash Flow — $219.24/year; $219.24/$37,500 = 0.6% Return on Investment
   2. Leverage — You own $150,000 of real estate for a $37,000 cash investment.
   3. Debt Reduction — $1,037 in principal reduction the first year. In essence the tenant is buying you the house and giving it to you at the end of the loan. $1,037/$37,500. = 2.7% Return on Investment.
   4. Tax Savings — About $3,300/year in depreciation. This means that your income from this property will not be subject to tax.
   5. Appreciation — If this house goes up 5% in value this year, it will increase by $7,500. $7,500/$37,500 = 20% Return on Investment.
   (If the house doesn't go up at all, there is no return from appreciation.)

   Total Return on Initial Investment of $37,500:

   0.6%	From cash flow
   2.7%	From principal reduction
   20.0%	From appreciation
   23.3%	Total Return on Investment

   When this property is free and clear, you will have nearly $10,00 a year in "Wake-Up Money." Of course by then the rents (and the "Wake-Up Money") will probably be a lot higher, as will the property's value. Home values and rents have more than doubled in the last 15-years.

   Top Ten Tips for Creating "Wake-Up Money"

   1. Buy residential properties. Houses, condos and town houses. Stay away from land and commercial real estate unless you are an experienced investor or are buying as a business "user".
   2. Buy "mainstream" houses and condos. Buy properties that are at or below the average sales price. Buy properties that appeal to most buyers. Avoid high priced or unusual properties. Buy houses with at least three bedrooms and condos with at least two. If possible, buy properties with a garage
   3. Don't buy with partners, unless you have to. If you have to have partners, make sure they have the same goals and values, are of similar age, and have job, geographic, and marriage stability.
   4. Believe in the long run. Real estate markets are cyclical but the long-term trend has been up. Hang in there for the long run. The great investor's lament is "I should never have sold that property." The other investor's lament is, "I could have bought that property for $_____!"
   5. Take care of your property and it will take care of you… It's your "golden goose." If you don't like property management or are too busy, either higher a professional property management firm or buy condos and town houses. They take a lot less management. The homeowner's association takes care of most of the property management.
   6. Get started early. Put time on your side. Albert Einstein was once asked what he thought was the most powerful thing in the world. His reply, "compound interest." Don't wait to buy real estate. Buy real estate and wait!
   7. If you don't have the money, make a plan and a commitment to get it. (Consider borrowing your investment money out of the equity in your personal residence.)
   8. Know your "enough." How much "Wake-Up Money" do you need? Know when you are ready to stop accumulating property and start paying off what you have - and enjoying life!
   9. Work with knowledgeable people. Pick Realtors, accountants, attorneys, and property managers who know what they are doing.
   10. Have a goal and a plan. Develop your goals and a plan to achieve "Wake-Up Money."

   Invest Near or Far: Great Agent Referrals Nationwide and Abroad

   The Council of Residential Specialist

   As a Residential Specialist, I have access to the best real estate agents around the country. My clients utilize me as a resource when they buy or sell a property outside of San Francisco. My client relationships are paramount so I will take your needs seriously whether you are doing business here or somewhere else.

   For example, I will personally contact and interview agents in your location of interest to find the best fit for you. Whether you are looking for a ski condo in Tahoe, a beach getaway in Hawaii, or an income property in Austin, I will make sure you get great service, expertise and experience.

   The Leading Real Estate Companies of the World

   Zephyr Real Estate is one of only two San Francisco brokerages with membership in the Leading Real Estate Companies of the World (formerly known as RELO). LRECW is a cooperative network comprised of the largest independent real estate companies in the United States and abroad. The network's purpose is to provide a systematic and reliable process for sharing relocation referrals among participating companies and agents. It's important to note that LRECW is the largest relocation network in the United States, larger even than the largest network offered by brokerages with national and international affiliates.

   As a Zephyr client, you gain access to the best, independent Realtors around the world.