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Kevin J. Daum
This article was originally published in the June 11th,
2004 edition of the East Bay Business Times.
Bay Area real estate is a fascinating investment. It is incredibly
forgiving. It allows intelligent people to make foolish, emotional
mistakes costing them hundreds of thousands of dollars and
still come out looking like heroes. Take for example the case
of rental houses in the East Bay. According to public records
the number of landlords for Single Family Residences is at
an all time high. In Alameda and Contra Costa counties alone,
individual landlords own more than 70,000 houses. Many of
these people became accidental landlords.
You know the story, Baby Boomers marrying late in life. The
young single professional hit 35 and was making good money
so she bought her starter house in 1996 for $150,000. It was
better than paying all those taxes. Finally, in 2001, she
finds the perfect spouse and settles down in their $750,000
dream home. No need to sell the other home since it’s
cash flowing and appreciating. Besides, there was plenty of
down payment money from the spouse’s home. Now they
have a sound real estate investment outperforming their stock
portfolio. With low interest rates and a refi or two the $1,750
monthly rent more than covers the $1,200 monthly payments
giving the couple extra monthly cash and an investment worth
more than $650,000 today
Sounds perfect! So what’s the problem? Nothing if this
couple likes throwing away profits and tax benefits worth
more than $35,000 each year. Also the return on their $500,000
in equity is a fraction of what they could be getting, if
they could get to that money without paying capital gains
tax. They would like to do something, but it seems too complicated
and not worth all the effort. Besides, the property is still
making money. Odd that when a $10,000 mutual fund starts under-performing
by 3 percent people move heaven and earth to fix it yet happily
throw away 100percent plus earnings on real estate investments.
Let me state the obvious: Aside from ethical considerations,
there is no advantage to leaving any money on the table with
any real estate investment decision.
Here is a different approach:
· Understand Rent to Value (RTV)
– Once a property exceeds $400,000 in value the percentage
of rent diminishes relative to the value of the property.
For example; a three-bedroom, one-bath house selling in
Alameda for $675,000 today will only rent for $1,800 a month.
By contrast, a $225,000 house near Stockton will rent for
$1,300 per month. By selling the Alameda house and buying
three rentals in Stockton, the monthly income increases
from $1,800 to $3,900 per month. With no additional risk,
the annual income increases by $25,200 on the same investment.
Some may complain about managing more properties and the
inconvenience of the distance but even if you pay for home
warranties and a property manager you can still net more
than $20,000 for your trouble.
· Use Leverage to Your Advantage
– In spite of the fact that we all still hold on to
foolish Depression-era wives’ tales that paying off
real estate is a good thing; most of us know that leverage
is the only sure way to dramatically increase your investment
return. The math is simple. A $400,000 rental house free
and clear appreciating 5 percent annually, makes $20,000
or 5 percent on your money. If you borrow $300,000 to invest
elsewhere, the house now only ties up $100,000 in capital.
With 5 percent appreciation still returning $20,000 you
are now making 20 percent on your capital investment. If
the rent and payments are breaking even, you now have $300,000
of tax-free cash to make additional money. Why would anyone
not want to do this?
· Talk to Tax Professionals –
This is the part that intimidates people. Most people have
heard of using a 1031 tax deferred exchange to sell and
buy property but there are rules and timelines that can
be confusing. Believe me, it’s worth the education.
By refinancing and reselling, you can readjust a $650,000
rental house into a $1 million portfolio and still put $250,000
cash in your pocket. Also you can restructure your interest
deductions to make rental income tax free while putting
tax-free cash in your pocket.
Of course there are many more tricks in the rental property
game. All of this requires time and effort but how many opportunities
are there for tax-free yields on secure investments that can
exceed 25 percent annually? We live in a place where real
estate investments outperform employment income and savings.
By talking with knowledgeable Realtors, loan officers and
CPAs and taking action, you can easily retire on California
real estate in 15 years. That is certainly worth a few conversations
and a little research.
Kevin Daum is the Founder and CEO of Stratford Financial
Services, a Real Estate finance and education company, founded
in 1989. Stratford specializes in Purchase loans, Refinance
loans and Custom Home Construction finance and has successfully
financed thousands of clients. He is the author of "Building
Your Own Home for Dummies" (Wiley), as well as "What
the Banks Won’t Tell You." Mr. Daum was an Underwriter
for Plaza Savings and Loan and Key Bank of New York. He is
an INC 500 CEO and has been listed as one the 40 Most Influential
People Under 40 in the San Francisco Bay Area. He is the Global
Chair for the Edison Innovation Program with the Young Entrepreneurs'
Organization (YEO) and is a founding Board member of the Bay
Area Chapter of YEO.
Mr. Daum is a frequent contributor to numerous business
publications on the subjects of Real Estate and Small Business
leadership and speaks regularly on both subjects. He can be
contacted at kevin@stratfordfinancial.com.
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