Real Estate Debt: The Debt Worth Having

What makes debt so amazing is that it allows you to take action where normally you would not be able to afford. It is through debt that people and companies like Michael Dell and Blackstone are able to own companies several times over their wealth. Entrepreneurs like Richard Branson could not have been a billionaire today if he was not able to finance his business’ expansion (as a matter of fact, one of Branson’s biggest grudge was on a bank that all of a sudden stopped financing him and nearly forced him to stop his business). Lastly, it is through real estate debt that many people, whether they be a teacher, a restaurant worker, or an immigrant who cannot speak English well, to reach financial freedom and security.

All of those above could reach their goals because they used debt as a way to “lever” their strategy. They knew how to utilize their energy and own capital, but with those alone it was not enough. It is as if Sisyphus, the king in Greek mythology who was punished by being forced to roll an immense boulder up a hill only to watch it roll back down, suddenly was able to borrow the strength of five other men, and thus had enough strength to roll the boulder off the hill. The same concept applies to taking a multi-billion company private, financing record store expansion, and buying a $200,000 house.

Why This is the Best Time to Borrow in Real Estate

Today is one of the best times to have debt. Debt has never been so cheap before. In the early 1980s, mortgage rates touched the highs of 18 and 19 percent, rates that would make a credit card company blush! Look at the interest rates that pasted on the glass of banks today and you’d realize how cheap debt has become today. Let’s just see what it would cost to finance a $200,000 house today compared to the 1980s with a 20% down, 30 year fixed mortgage:

• At 19%, the monthly payment principal plus interest equals: $2,542
• At 4%, the monthly payment principal plus interest equals: $764

Over 30 years, that’s approximately $640,000 more in interest you have to pay in the 1980s compared to now.

With such low cost of debt and the depressed market, you can purchase more real estate than you could have been able to in the past and be able to service the debt much easier as well. With the type of payments you are paying you can easily rent the house and have the tenants cover your payment. It is much easier to borrow and purchase 10 houses today than ever before.

Additionally, real estate is a great hedge for inflation. With the current loose monetary policies enacted by the Federal Reserve, we could be looking at some intense inflation in the medium term. Thankfully, inflation is actually a debtor’s best friend. As inflation continues to devalue money, it also devalues the value of your debt. So if inflation was at 100% and the house’s value inflated from $200,000 to $400,000, you still owe $160,000. That means the monetary value of your debt just went down by 50%! So as a result, holding real estate is not only a good protection for inflation, but has the potential to discount your debt.

With Great Debt Comes Great Responsibility

While debt is good to have right now, not all debts are good. Credit cards? Bad. Car loans? Bad. You should not have debt that does not earn you any money (for your own house, it is the opportunity cost of renting that you are earning). Do what you can to avoid that kind of debt.

A real estate investor also needs to watch his/her own real estate debt like a hawk. Unlike tenants who can stop paying rent, you cannot stop making your monthly payments and simply find another place. You have to account for any dangers of vacancy. And as you continue to build your real estate assets by taking on more debt, you have to be careful that you can handle the monthly payments even if something catastrophic occurs. For instance, if you borrowed 10 houses, can you still make the payment if 5 of your tenants suddenly decided to stop paying? So be sure that you either have large cash reserve or you do not take too much risk. Even if on each leverage deal you are cash flow positive, you are adding on risk every time you buy an additional house. So be careful not to grow too fast. Take your time. Real estate is a game that is long, but ultimately rewarding.

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Real Estate Investing Strategy for Regular Investors

Every investment strategy or every business you could possibly conceive is making money for somebody right now. The overall effectiveness of the tool is irrelevant – what matters is whether that tool is the best for the job you need done.

Start with your goals

The basis for success in solving any problem is a clear understanding of that problem. We cannot begin to create an effective real estate investing strategy until we know what we are trying to accomplish. So before you do anything else, let’s start with your investing goals.

A real estate investor whose goal is to double her capital in a short amount of time is very different from another whose goal is to retire in 10 years. And most importantly, the strategies they should employ to reach those goals must be different as well.

In my experience, I’ve observed that most new investors are so eager to “start building” that they skip the entire “blueprint” phase. “Who has time for all that grandiose talk – let’s start laying down some bricks!” But as my 8th grade math teacher used to say: Once you figure out what the word problem is asking, the math part is actually quite easy. Before you start to delve into the details, the formulas, the figures – get clear and specific about your goals.

Two types of investors

The way I see it, there are two major real estate investor categories: On one hand, you have folks who are (or aspire to be) professional real estate investors. Their goal is to make a living by investing in real estate full time. If given a choice, they would quit their current job or career and actively pursue real estate deals day in and day out. They are in it for the lifestyle as much as they are in it for the money. For this group of investors, the principal goal is to make enough money from real estate deals to create an income in the immediate term. The real estate investing strategies of choice to accomplish this goal are short term flipping and wholesaling. A long term investment strategy for this group of investors would be useless.

On the other hand, you have regular real estate investors. Unlike their professional counterparts, their goal is to create a large enough income stream in the future to retire on or subsidize their other income. Some investors in this category might seek to quit their current career once they are financially free. But they want to do so, to pursue other endeavors – not live the lifestyle of the professional real estate investor. I believe the overwhelming majority of real estate investors fall into this category – and for their goals, there is no better suited strategy than a well crafted long term investing strategy. Short term strategies may sometimes play a minor role in reaching the principal goal of regular real estate investors but in most cases they are inefficient and downright counterproductive.

Using a Blueprint for Your Real Estate Investing Strategy

In my business, I help long term real estate investors accomplish their retirement goals, and in my contribution to BiggerPockets, I intend to give you a detailed view of all the dynamics that make our investing strategy tick. But for purposes of an introduction, I want to give you its rough and basic outline.

Step 1: Dissect your goal – It’s very important that we pin down exactly what we’re trying to accomplish. If retirement is the goal, what income stream would allow you to retire and how long do we have to get there? Also, what capital are we starting with and what’s our savings capacity per year?

Step 2: Craft a Custom Blueprint – Now that we know what our destination looks like, we can figure out a route to get there. The custom blueprint will tell you how many assets you need to acquire to produce the desired income, how much capital it will take to acquire them and how long it will take to have a free and clear portfolio.

Step 3: Asset Accumulation – This is where we move from planning into execution. Now we know how many properties we need to own, so we go about the business of accumulating them.

Step 4: Capital Growth – Once we’ve acquired the right number of good quality properties, it’s time to grow our capital base. Since the goal is to reach a certain level of income at retirement, we can use the current income produced by our portfolio to aggressively pay down the mortgage debt on our portfolio with focus.

Step 5: Maximum Income – Time for you to get rewarded for your discipline and ninja execution. Your entire portfolio is free and clear and it produces income at its maximum capacity right when you need it – at retirement.

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Life Lessons from a Property Investor

Here is a life lessons shared by a property investor. Learn from these lessons and the rollercoaster ride of your property investment career may not be as dramatic. 

1. Have a plan.

Strategic investors have a plan, know where they are heading and follow a proven system to take the emotion out of their decisions and give them more consistent results. They make educated investment decisions based on research and buy a property below its intrinsic value, in an area that has above average long-term capital growth and then add value to manufacture equity.

2. Take a long-term perspective.

The property market moves in cycles and in every decade there are a few years of flat or falling property prices. However, well-located real estate has increased in value by an average of over 8% per annum over the long term.

Imagine if you could buy the house your parents bought at the price they paid 30 or 40 years ago; how many properties would you have bought then knowing what those properties would be worth today?

3. Treat your property investment like a business.

The successful investors I know have grown a substantial asset base by treating their investments like a business. They do this by surrounding themselves with a great team of advisors, getting the right type of finance, setting up the correct ownership and asset protection structures and knowing how to legally use the taxation system to their advantage.

4. There is not one property market.

While many people generalise about "the property market", there are many sub-markets around Australia. Each state is at a different stage of its property cycle and within each state the markets are segmented by geography, price points and type of property.

For example, the top end of the market will perform differently to the new homebuyers market or the investor segment or the median priced established property sector. And while at any time there are hundreds of thousands of properties for sale in Australia, most are not investment grade properties.

5. The crowd is usually wrong.

"Crowd psychology" influences people's investment decisions, often to their detriment. Investors tend to be most optimistic near the peak of the cycle, at a time when they should be the most cautious and they're the most pessimistic when all the doom and gloom is in the media near the bottom of the cycle, when there is the least downside.

Market sentiment is a key driver of property cycles and one of the reasons why our markets overreact, overshooting the mark during booms and getting too depressed during slumps. Remember that each property boom sets us up for the next downturn, just as each downturn sets the scene for the next upswing.

6. There will always be reasons not to invest.

Every year brings its own set of crises and lots of reasons not to invest. You can go back as far in history as you like and there won't be a crisis-free year. Sure some years are worse than others, but there is always bad news and much of it is unexpected. Where investors get into trouble is that rather than focusing on their long-term goals, they see these crises as once in a generation events that will alter the course of history, when in reality they are just the normal path of history.

7. The devil is in the detail.

With so much market analysis available to us today, it's easy to get caught up in the detail and scared into inaction. It's better to keep an eye on the big picture and look at the property markets through a telescope and not a microscope.

8. Remember it's about property.

You're in the business of property investment, yet at times investors forget the age-old rule of buying the best property they could afford in proven locations. Instead they get sidetracked by get-rich-quick schemes or glamorous finance or tax strategies and lose out.

Fact is; property is not a get-rich-quick scheme. Don't get carried away by the next hot spot or latest fad – make your investing boring, so that the rest of your life can be exciting. Warren Buffett was right when he said; "Wealth is the transfer of money from the impatient to the patient."

9. Use debt as a tool.

While many people worry about debt, smart investors use "good debt" and leverage to build their asset base. They then protect their assets by buying time though having a "rainy day" cashflow buffer set aside in a line of credit or offset account.

10. The two big drivers of property values.

While in the short term our property markets will be driven by market sentiment, interest rates, supply and demand and microeconomic factors; in the long term, the value of well-located properties will rise, propelled by the twin factors that have always driven long-term property prices – population growth and the wealth of the nation. Both of which will increase substantially over the next few decades.

Remember, both fear and greed will send you down the wrong path, but sense and sensibility will keep you heading in the right direction – toward real estate riches.

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Location Rules When Buying Property

Your choice of location for any residential property investment will generally hinge on personal finances and the level of risk you are willing to shoulder.

Here are some things to consider once you have worked out how much you can afford to spend.

Economic basics: Look for areas with good prospects. Promising signs include strong population growth, investment in local industry, job openings, new supermarkets and chain stores. Vacancy rates can be a guide to good areas.

Low vacancy often means there's strong economic growth and development is not keeping pace. You can usually hedge against volatility in demand if you buy in a major population centre with many renters.

Renter convenience: Your future tenants will want good transportation links and access to schools, universities, shopping, dining, medical facilities and local amenities. Convenience for tenants will keep demand high.

Emotional baggage: Think like a tenant. Avoid making choices based on personal preference about where you would like to live or holiday. Consider the average income for the neighbourhood and rental affordability for those who live in the area.

Vision: What you see today might be a very different proposition tomorrow. Be wary of developments with similar offerings as they may be rental or sales competition. As Apple's late Steve Jobs would say, think differently. A unique property can boost your marketability, yield and long-term gains.

Diversity: If you live in Newcastle and invested there your home and investment properties would be exposed to the same economic swings. Manage your risk by putting your eggs in separate baskets. Land taxes and stamp duty are another incentive to diversify. Most state and territory governments base land taxes on the cumulative value of unimproved land other than your principal place of residence. Land tax on investment properties can generally be minimised or eliminated by dividing your holdings between states and territories to stay below their given thresholds. Stamp duty varies significantly from state-to-state so it pays to sit down and do your math.

Property management: Buy where you know you can hire a great property manager if you can't commit to doing it yourself. The best property in the best location can collapse under the weight of poor management and maintenance.

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Things to Consider Before Investing in a Property

There are so many vested interests in promoting the positives of property investment that it's increasingly hard to differentiate between data that is realistic or promotional.

But there does seem to be a string of recent signals indicating property price drops have at least stabilised on the back of last year's interest rate cuts, lack of new development and increased migration.

Many are ringing the bell for the bottom of the market. We're not so sure about that, but if you are being tempted back into property, here are seven questions to ask yourself before taking the leap.

1. Can I put down at least a 20 per cent deposit?

Gone are the days when money was cheap, easy and property buyers could borrow 110 per cent of the asset's value. The global financial crisis has forced financiers to tighten credit rules and be more selective in who they lend too.

Even when money was cheap and easy, our view was always that a minimum 20 per cent deposit was a good personal litmus test on whether you could afford the loan and had the financial discipline to cope with a mortgage. If you can't save enough for a 20 per cent deposit, how are you going to have the discipline to pay down that home loan early?

2. Who will lend me enough money? 

Having finance organised early is an enormous negotiating weapon when you've found that dream home.

Sellers are under pressure, buyers are scarce so the ability to go in and do a deal quickly is worth real money to a vendor.

And it presents a great opportunity to squeeze a better price. Look outside the big four banks for a potential funder. Mortgage originators, credit unions and brokers offer a huge range of options with tailored terms and interest rates. They are all regulated by the same authority that oversees banks.

3. Have I targeted a price, type and location?

Knowledge will save money. Having a definite shopping list of the type of property you want, the desired area and price range is essential.

Then do your homework. Today there is an enormous amount of data available covering everything from recent sales in a particular area or street through to how a neighbourhood's demographic is changing.

The sale history of an individual house is also easily found.

To find out more details, go to any of the major real estate websites and read their reports.

4. Do I have a reliable income? 

Buying a house with a mortgage can be a massive financial commitment. Every month that home loan has to be fed and financiers get narky if repayments are missed.

Make sure you have one very reliable income that can be trusted to continue or alternatively downscale your borrowing expectations and purchase price range.

5. Is there an adequate safety net? 

The best-laid plans can come unstuck through an unexpected emergency. It could be an unexpected pregnancy or injury through to a car accident or theft. You have to have a buffer to cope with the unexpected. Make sure you have adequate life, income and home insurance.

Add an emergency stash of three-to-six months salary as an extra safeguard.

6. Am I happy to settle down for 5-7 years? 

Renting gives flexibility to move at reasonably short notice but no guaranteed security of tenure.

Ownership is the opposite. Because the transaction costs involved in buying a property (stamp duty, legal fees, mortgage establishment costs) are so high, it can take up to 5-7 years before the home's value rises to a level where you're back in front. You must be prepared to settle down in a house for at least that period.

7. Do I understand the running costs? 

Many first-home buyers (and also those trading up) are stunned at the amount they have to pay out on a regular basis to just maintain their home.

Not just the council, water and electricity bills but also the costs of maintaining the property to the standard (or better) at which it was bought.

Maintaining or improving the garden, the paintwork, the pool, flooring ... the list is extensive and expensive.

Make sure you understand the amount of these expenses and have budgeted for them.

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Tips on Buying or Renting a Home For Extra Income Purpose

Low mortgage rates have made buying a home more affordable and turned rentals into an attractive option for investors.

Throughout the downturn in the housing market, average investors, sometimes pooling their money, have bought foreclosures at a sharp discount and turned them into rentals. Many homeowners also have purchased a second home and rented out their first property.

Although the housing market is showing signs of recovery, demand for rental housing is expected to remain strong. The national unemployment rate remains high at 7.9 percent, banks are still working through a backlog of foreclosures and tight lending requirements prevent many renters from becoming homeowners.

And the Fed has said it will keep its short-term interest rate, the federal funds rate, at a record low until U.S. unemployment falls below 6.5 percent, something many economists don't expect to happen until late 2015 at the earliest.

"In this market, at this point, it's a sweet spot," says Chris Princis, a senior executive at financial advisory firm Brook-Hollow Financial and owner of two rental properties in Chicago. "You're getting the market where it's just starting to rebound, but still at the bottom, with what's looking to be a great recovery."

Here are six tips on becoming a landlord or investor in rental property:

1. Understand what it means to be a Landlord.

Residential real estate generally provides three possible ways to get a return on your investment: when it's sold, assuming it has grown in value, by collecting rent and through tax savings, such as the mortgage interest deduction.

So, if you elect to buy a property for the long-term investment potential, the goal should be to ensure that the rental income covers the cost of your mortgage and monthly maintenance costs.

If you buy a foreclosed home, you'll have to factor in the cost of repairs to ready the home for rent. And if you have a mortgage on the property, you'll need to be prepared to cover the costs for however long it takes to find a tenant.

"Real estate is a great investment if people are paying their rent," says Princis. "If they're not paying their rent, it's a horrible investment."

2. Buy in an area with a history of strong rental demand.

Neighborhoods near universities are a good option. For homes in residential areas, proximity to schools can be a good draw for families.

Condominiums and similar properties in communities with a homeowners' association can be a great option because the association arranges for upkeep on the property.

But check the fine print on your mortgage and homeowners' association rules to make sure turning your property into a rental isn't forbidden.

If you're going to buy a foreclosure, be prepared to compete with other investors, many of them paying in cash. And because many require upgrades and repairs, expect that it will take longer until you'll be generating rental income.

Websites like Zillow.com and Trulia.com list foreclosures, as well as rentals in a given area.

Foreclosure tracker RealtyTrac Inc. recently ranked U.S. metro areas, with a population of 500,000 or more, according to the supply of available foreclosures for sale and their discount versus other homes, among other criteria. Among the top 20 cities deemed the best places to buy: Miami, Chicago, Philadelphia, El Paso, Texas; and Poughkeepsie, N.Y.

Claire Thomas, a retiree in Phoenix who owns 10 rental condos in Las Vegas, says that landlords looking to keep their properties as income-generating rentals for many years should look into areas that are not too expensive.

"I would rather have a middle-of-the-road rental that stays rented than a higher-end (property)," she says.

3. Consider a using a management firm.

Determine whether you want to select the tenant and handle property issues or hire a company to do it. If you take on the responsibility, you are obliged to fix any problems (leaky faucets, broken furnace, etc.) or find professionals to do it.

"Are you prepared to do all of this this on your weekends or evenings or get calls while you're at work because a pipe burst and it's flooding?" asks Jim Warren, chief marketing officer for property management company FirstService Residential Realty. "What's that threshold worth to you?"

Property management firms can charge a percentage of the rent, sometimes 10 percent or more.

Hiring out the hands-on landlord job also makes sense if your rental property is not in the same city where you live.

4. Do the Math.

Although prevailing rental prices will go a long way toward determining what you can charge, getting the best return on your investment starts with making sure you're going to get enough rent to, ideally, cover expenses and costs.

Princis' formula is charging 15 percent above monthly mortgage and maintenance costs. So if those costs add up to $1,000, he'll look to charge $1,150.

Of course, flexibility might be called for if you're unable to get a tenant in for months and months.

Experts recommend starting with popular rental listings in newspapers or on Web sites such as Craigslist.com, Trulia and Zillow, to see what comparable apartments or rooms are going for. Another option is rent analysis website Rentometer.com.

The good news: Rents for single-family homes rose 2.3 percent last year from 2011, according to Trulia.

5. Screen tenants thoroughly.

Once your rental starts drawing inquiries, it pays off to screen prospective tenants by asking for previous landlord references and running a credit and a criminal records check.

Experts also recommend asking for a deposit equal to one month's rent, plus extra if the tenant has pets. That will help cover any damage to the property and protect you if a tenant moves without paying rent.

Also, have a walkthrough of the unit with the tenant and ask that they sign off on the condition of the property before they move in. That will help avoid conflicts over the security deposit if there are damages once they're ready to move out.

6. Get familiar with Landlord Laws.

As a neophyte landlord, it's important to know your exact responsibilities under the law.

Two good resources for rental rules are the U.S. Department of Housing and Urban Development's Web site ( www.hud.gov), and The Landlord Protection Agency ( www.thelpa.com), which includes state-specific rental guidelines and standardized forms for rental agreements.

An attorney or the Landlord Protection Agency also can help you craft a well-written lease, which is crucial to protect your property. It will help you evict a tenant or hold them accountable for damage if necessary.

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