Real Estate 014: To buy or rent, that is the question

For people who are looking to move, there is always the question that one asks themselves, “is it better to buy or rent?”. At the time of this writing, the US real estate market has seen close to 8-9 years of solid year over year appreciation. While no one has a crystal ball, history tells us that the real estate market goes up and down through different cycles that last as short as 6-7 years to as long as 10-12 years. Whether you are single, newlywed, or have a growing family, the decision to buy or rent can have multiple trickle effects to your financial situation and future trajectory. It is a very important decision. Many people see their friends buying their homes, market going up, and wonder if they need to buy now as well. Let's take a look at some of the pros and cons of buying a house vs renting as well as other factors to consider before making this decision.

Before you even jump into the idea of looking for a house to purchase or contacting a realtor for showings, you need to have your finances in order. This can include reviewing your credit score through your annual free checkup via the three major credit bureaus (Transunion, Equifax, Experian) or you can sign up for free services such as CreditKarma.com (I personally use this and love the ability to check my score through a “soft inquiry” that doesn’t negatively impact your score. ALthough the credit score you see on Credit Karma may end up being lower than what your mortgage lender actually sees when they pull your FICO score, in my experience, it has been very close (+/- 5 to 10 points).

Although its widely accepted that owning your own home is part of the “American Dream”, there are alot of things that come along with owning your home. You have to ask yourself if you are ready to handle the extra costs and maintenance that comes with owning a home. Furthermore, look at other areas of your finances to determine if you can withstand any sudden life changes (e.g. new baby, loss of job, job relocation):

1. Do you have an emergency savings account with roughly six months of expenses?

2. Do you have any large student loans or credit card debt that may have variable interest?

3. Do you have down payment + closing costs saved for your new home?

4. Will your new mortgage be under 30% of your debt to income ratio? (DTI) - Lenders look at this as a metric to determine if the borrower’s capacity to repay the loan.

5. Does your job require you to move frequently? (e.g. state to state or military)
   

If you have answered “yes” to any of the above, there is a good chance you may need to wait a little longer before you decide to purchase and think hard about this move.

Assuming you have decided that renting is out of the question and you are ready to buy, let's consider some of the pros and cons of buying a house.

Advantages

1. Building Equity

By purchasing a house with “other people’s money” (e.g. bank or private lender), you are able to lock in a payment (typically fannie mae 30 year fixed rate mortgages) where you build equity as long as you are current on your loan. As the loan is being amortized over 30 years, the first 12-18 years will mostly be interest payments, however, you still will increase share of ownership compared to a lease situation. Furthermore, as your payments are fixed (unless you have variable interest mortgage), you are not impacted if your landlord wants to raise rents 5-10% each year over the next 10 years, or are you impacted if the landlord decides to sell and not renew your lease, in which case you are forced to move.

2. Tax Benefits

The US tax code allows us to deduct interest associated with your home’s mortgage as well as property taxes. Note: There may be other tax favorable treatments, but please consult your CPA to determine what fits your unique situation. Further, starting 2019 tax year, the standard deduction has increased to $12,000, meaning your the break even point on standard deductions vs itemized (tax benefits mentioned above) has gone higher. You need to evaluate the price point of the home, as well as possible tax advantage amounts before assuming one is more beneficial than the other

3. Appreciation

Generally speaking, US real estate has appreciated over a long period of time. However, there also have been multiple down turns that have had negative consequences to homeowners who wanted to sell. I personally consider appreciation to be icing on the cake, as speculation can be a very dangerous gamble from an investment standpoint.

4. Pride of ownership

As a homeowner, you have the freedom to do make updates to your home as you please (within laws/regulations, HOA guidelines, etc.). This means that there is no landlord to stop you from using nails to hang picture frames, paint the baby room purple, or have a vegetable garden in the back lawn. Furthermore, some view a home as a long-term situation compared to leasing, as such you may psychologically feel more attached to your house, neighborhood, and feel grounded.

5. Using Leverage (Bonus - Investor’s Perspective)

This last advantage has been mentioned less by potential buyers evaluating decisions as most new homebuyers do not think like an investor. However, as an investor myself, I like to purchase my primary residence as I know there are a couple different ways to make money.

In my neighborhood, I was renting a 2 bedroom apartment for close to $1,800 a month. However, after 1 year, I decided to purchase a 3 bedroom townhome which resulted in monthly expenses of $2,700 a month. When normalizing the tax benefits I would receive on this property, I was able to credit about $300 a month to the “buy” side ($2,700 - $300), making it a $1,800 vs $2,400 decision, with the difference being $600. I ended up renting out one of the bedrooms for $750 a month which actually made my decision to buy $150 cheaper per month. Furthermore, the price of the home increased $70,000 over two years when I received an appraisal for a HELOC (home equity line of credit). Using this HELOC, I purchased two additional rental properties that cash flowed $700 a month after all expenses - $200 HELOC payments = $500 additional cash flow, which further brought my “buy” side down to -$650/month. Looking back, this was a no brainer for me, and I would gladly make these decisions again as I am creating equity in my primary home and two rental properties, have tons of tax benefits, reduced my cost of living, and did this all using other people’s money. Note: Not all home purchases can result in my experience, in fact, if you buy too much of a house in coastal markets of LA, NY, SF, etc. then you will probably lose money most of the time vs leasing. However, if you buy slightly undervalued properties at the right time (historical low interest rates 2012-2015), then you have a good chance of success.

Disadvantages

1. Lack of Flexibility

Due to the costs associated with buying, maintaining, and selling a home, there are fixed costs that require you to wait, or season, before you will break even. For example, if you have purchased a home and 6 months down the road you need to sell, unless the home has appreciated 10% or more, closing costs (transactional + commissions, etc.) alone may put you in the red. If you are not sure that you will be staying in a certain location or job for 2 or more years, it may be best to rent until further notice.

2. Dealing with maintenance

As a renter, when there is a leaky pipe, or broken toilet, you call your landlord. Unless there was excessive damages caused by you, the landlord is responsible for wear and tear, as well as general upkeep of the home with due notice. Once you become a homeowner, that switch is flipped and you are responsible both financially and mentally dealing with the stress of the repair.

3. Opportunity Cost

The difference in total cost of owning a home - leasing = financial opportunity cost. You may be better off using the difference to invest in the stock market, real estate, or other self improvement to get you that promotion or new job with better pay and benefits. Also, there are intangibles such as being able to easily relocate to other market, from LA → SF to work for a startup tech company or move from NY → Thailand to drastically lower your cost of living, be with family, or live a lifestyle by design. A mortgage will most likely be the biggest expense in your personal finances, so make sure that it doesn't become your golden handcuffs.

In conclusion, be sure you have adequately planned for any unforeseen expenses that come with home ownership - foreclosure can be a painful and detrimental to your financial health for many years. Furthermore, if you have big life changes ahead of you (e.g. marriage, new job, new child), remember to factor in how each of those events may change you stance in wanting to root yourself in a new home.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Real Estate 013: Pros and Cons of Section 8 Rentals

When placing a tenant in your newly rehabbed or purchased rental property, finding a suitable candidate may often depend on various factors such as neighborhood, schools, type of home (single family, duplex, bedroom/bath count), and time of year (winter vs spring). The US government has a housing assistance program called “Section 8” that is funded by the Federal government but administered by the local authorities. This may present an opportunity for real estate investors to tap into a different kind of pool of tenants. Potential candidates for Section 8 assistance must submit an application and become accepted into the program. Typically these spots are reserved for low income families, disabled persons, and/or senior citizens. As a landlord, you can legally choose to participate or not participate in the Section 8 program. As I have two Section 8 properties, I wanted to share with you my experience with the program and dispel some myths:

Advantages of Section 8

1. Tenant Pool

By choosing to accept Section 8 applicants, you are “widening the net” to include both market rate tenants and Section 8 applicants with vouchers. This will allow you to be more selective in your tenant placement and technically have more candidates that meet your pre-defined criteria.

2. Guaranteed Monthly Income & Higher Rent Rates

One of my favorite parts about participating in the Section 8 program is that a portion of the rents (70-80% average for my rentals) is being paid on the 1st of each month by the Government. As long as the tenants do not lose their voucher or you, as the landlord, do not fail multiple Section 8 inspections, you should be receiving these checks via ACH like clockwork.

Further, as the Government determines the appropriate rent range in a given market for the type of house (3 bedroom 1 bath $750-850 vs 4 bedroom 2 bath $900-1,050), the landlord is able to select the higher rate of the range as long as the tenant has the voucher to support the rent (3 bedroom vouchers vs 4 bedroom vouchers).

3. Lower Vacancy

Tenant turnover is one of the single biggest expense an investor faces. When your property sits vacant, it generates no income, but there are many fixed expenses such as the mortgage, taxes, and other fees that occur monthly. Based on conversations with other investors who have done Section 8 for 10+ years, if the Section 8 tenant is happy with the property and landlord, they will stay put for a longer time than their market rent counterparts who often move more frequently for their children’s schooling, new job opportunities, and to find a larger home/purchase their residence.

Disadvantages of Section 8

1. Section 8 Inspections

On an annual basis, you are required to undergo a Section 8 inspection with the housing authority’s designee. This may cause you to make some rehabs sooner than later if the inspector feels that updates need be made immediately. There is not cost involved for the landlord (other than your property manager potentially charging you for their time to meet the inspection and perform the updates).

My take: I personally feel that having an annual inspection at no charge is a benefit for real estate investors as it forces me to take a look at my property and ensure everything is up to code, there is an liability exposure, and preventive maintenance items are taken care of. As the inspector is not looking to make cosmetic improvements, but make sure the property is functionally sound, it serves as an additional line of defense.

2. Wider selection, but “rougher” tenants?

Generally speaking, it appears to be widely accepted by real estate investors that Section 8 tenants are rougher on the homes and cause more wear and tear on their properties. This idea stems from the fact that since they are receiving assistance, and not pouring all of their own hard earned cash into the rent, they have less skin in the game to care about what happens to the property.

My take: I think that regardless of market tenant, or Section 8, you still need to do your due diligence and be thorough in your tenant selection process. Contrarily, as tenants may lose their voucher if they cause excess damage than normal wear and tear, and as Government funding gets tighter, Section 8 tenants will think twice before “trashing a property” that they live in. I’ve had B class market rate tenants trash a unit, and also had C class Section 8 tenants who were very clean and left my property in great condition.

3. Dealing w/ a Government Agency

As this is a Government program, you will have to work with local authorities when issues arise and that may mean time lost. Some counties are notorious for not responding to an email for weeks and taking up to two or three months to setup a new tenant in the system for payout. However, all strategies have their pros and cons, risk and rewards. As for Section 8, after it has been initially setup, it has been on autopilot, and I have received the Government’s ACH and tenants money order every month without issues along with an addition $100-200 what I would have received with a market rent rate tenant.

In conclusion, I think there are different strokes for different folks and some may not see the benefit of working with Section 8 tenants. I personally feel like in the markets which I invest in have a great Section 8 tenant pool, with above market rents that will allow me to cash flow a minimum 5% higher with little to no additional risk. Furthermore, on a personal level, it gives me a sense of pride that I am providing a roof over the heads of those who need it most: senior citizens, disabled persons, and/or low-income families.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!

Real Estate 012: 4 traits of successful real estate investors

For real estate investors who have recently taken the plunge and picked up rental properties, its very easy to be excited about this new venture and idea of financial freedom. My personal method of achieving success in anything I do is first seek out mentors and experienced investors who may have walked down a similar path, had failures, but overcame them to reach their goals. This way, I shorten the distance between a new and experienced real estate investor and also can save myself from costly mistakes. Below are 4 traits of successful real estate investors that I have met throughout my journey:

1. Continuous education

Knowledge is a powerful tool. Brandon Turner, Host of the BiggerPockets podcast frequently says, “you need multiple tools in your toolbelt to meet the needs of different problems that you will encounter as a real estate investor. To an investor who only has a hammer, every problem will appear to be a nail.” You will often hear from other investors that real estate is simply about solving other people’s problems. Whether it be buying a rental from a seller going through personal life issues, financial struggles, or a wholesaler who is looking to unload/assign their rights to a property, or an investor with a great deal but needs capital or a partner to walk them through the process. If you continue to educate yourself in this field you can become more creative with deals (e.g. seller financing, subject-to, land contracts, BRRRR, commercial financing, partnerships, syndication). Do your due diligence and become your own best adviser.

2. Maintain control of your investments

One thing that I really appreciate about real estate is that it is tangible, easy to understand, and you have control of your decisions. Prior to investing in real estate, I invested in stocks and bonds for over 7 years, and although I knew how to read financial statements, proformas, and general fee structure. I never once remember who my portfolio manager was, how exactly they are being paid and incentivized to take care of my hard earned cash. Nor did I understand the detail behind market fundamentals that drove a stock price up and down. As a direct real estate investor, I get to control who I work with in terms of acquisitions (e.g brokers, wholesalers, agents), rehabs (e.g. contractors), property managers, and lenders and the buck stops with me. These people have been coined the “core 4” by investor David Greene (check out his book “Long distance real estate investing” for more valuable information on investing out of state). Once I have my core 4 in place, you have more control in terms of running your numbers to fit your cash on cash criteria, as well as getting creative to create even more equity or cash flow (e.g. adding an extra bedroom or bath, going section 8 in certain markets, etc.)

3. Invest with the end in mind

A prudent investor will set goals and stick to his/her predefined criteria. Of course, you are free to update your criteria as markets change and you gain more knowledge into the subject matter at hand. However, do not get “trigger happy” and fudge the numbers to take down a deal. If you start compromising (e.g. 14% CoC → 9% CoC as this house is “well rehabbed”), it will become a slippery slope and you may find yourself holding a bag of loser rental properties that are difficult to unload in a downward market. Real estate is a long game, so think of your exit strategies whether it be 1031 exchanging into bigger, nicer neighborhoods, getting into multifamily apartments or private lending, you want to understand what you are purchasing instead of going for quantity in the short run. In other words, be a prudent, long-term value investor, never a get-rich-quick gambler, speculator, or flipper. Invest only in properties that make good financial sense the day you buy them.

4. Use leverage to create wealth

Many successful investors will tell you the one word that build them their wealth: leverage. Leverage can come in many forms such as other people’s money (e.g. banks, private lenders, hard money lenders), other people’s time (e.g. wholesalers, brokers, contractors), and lastly, other people’s knowledge (e.g. partners, mentors). You may run into student’s of Dave Ramsey’s teachings who proclaim debt is bad and you should make purchases all cash. However, this advice, while safe, is not going to get you to financial freedom anytime soon. There is a reason why Dave’s teachings focus on saving your first $1K, creating reserves, debt snowball methods, and budgeting to create a better financial future. I agree the aforementioned strategies are important if you are heavily drowning in consumer debt. The debt I am referring to relates to good debt, which is used to create assets that positively cash flow. There is a difference between a person who has $5k on their credit card from purchasing clothing, jewelry, and the latest electronics and pay a minimum balance with 22.58% interest vs an investor who obtains a 80K loan at 6% interest amortized of 30 years for a rental property in the midwest that cash flows $350/month after all expenses and debt payment.

I personally have debt on my personal residence as well as my 10 other rental properties. However, my 10 rental properties all cash flow positive a minimum of $200/unit and my primary residence was used to obtain a HELOC (home equity line of credit) that creates even more cash flow through the use of leverage. By simply using leverage, I have been able to add $100K to my net worth during the past year and this is all through use of other people’s time, money, and knowledge. Let other people’s money work for you, reduce your risk, and make you wealthy.

As always, please make sure you do your due diligence and talk to your CPA/Attorney/Financial Adviser before making any investment decision.

Good luck!