Real Estate and investing

[The Rabbi]

This was told to me by one of my colleagues who belongs to some sort of weird stockpicking/life insurance/financial scheming cult. He told me the worst place to put your money is into a house. Having more than 40% equity makes your property attractive for foreclosure because the bank can at that point turn a profit on it, more equity=more gain to them.

Anyone believing this has no knowledge of banking practices, banking regulations, real estate law, or accounting regs.  I could go into detail.

[...has left the building.]

If someone bought his house with zero down and no principle 20 years ago AND he took the extra principle he wasnt paying and dollar cost averaged into a low cost index fund he would probably have more than enough to pay off his loan and his house would be worth about 3 times what he paid for it.  But that takes discipline and most people lack that.

I would agree and nobody is doing that today either. But the difference is those products were unheard of 20 years ago and generally looked upon as foolish. Today, they're looked at as just another way to afford a bigger house.

I do not insist on my approach to investing.  But I do insist that a lot of what I see posted is stuff that has "worked" for 18 months maybe.  When the environment changes the model doesnt work anymore.  What I recommend is not just what has worked for me but what will work for different people in different situations.
Investing is not quick and sexy.  It is slow and takes time and there is no magic formula.

You said the key to short term high risk investment: "When the environment changes the model doesnt work anymore." Do you think that I, and the people that invest like me, are not keenly aware of that fact? I have been on arbitrage-type opportunities before that closed after 2 months but still netted me a greater return than I would have in 2 years on an index fund. Mind you this was done with a relatively small dollar figure to minimize my exposure. Also, many of these opportunites are with private individuals which is of course very high risk. So if it has worked for 18 months, my strategy/investments/etc. may have changed up to four times at that point. The only market that I plan on playing long term right now is the FOREX market. I understand long term investing, but since I'm not a trust fund baby, I might have to take on some risk at this point in my life.

[The Rabbi]

"When the environment changes the model doesnt work anymore." Do you think that I, and the people that invest like me, are not keenly aware of that fact? I have been on arbitrage-type opportunities before that closed after 2 months but still netted me a greater return than I would have in 2 years on an index fund.

Since I dont know you I am not sure what you are or are not aware of.  But I do know that most investors lose money.  They do it through a combination of ignorance, greed, and myopia.  This is not my opinion, it is a fact.
As for arbitrage, Google search Long-Term Capital Management or look at a book on the topic.  Very instructive.

[...has left the building.]

ha! I was just waiting for LTCM to come up. I had to do a case study in undergrad on them. Even their name is contrary to how one should play arbitrage. And I also agree that most investors lose money. Their goals are generally too lofty, their information cloudy, and their strategies too complex.

[Felonious Monk/Fignozzle]

Old school vs. new young turk.

Again, both CAN be profitable, short term Grand Slams ARE sexy.
Few have the patience at 20 when they can truly maximize the advantage of the power of compounding over time.
At 43, I'm torn between feeling it's too late to grow a slow, stable retirement and having missed the huge opportunities of the dot com boom etc...  The only investments I currently have are company-matched 401k and discounted company stock, which is purchased using dollar cost averaging.  

My dream, and that's all it is at this point, is to be able to retire prior to being too old or sick to do anything other than stare at cable all day and catch the early bird buffet at the steak house.

I'm not onto anything that will get me there; I'd love to have someone (either/both of you as well as others) point me to some good starting points on BOTH of your approaches.  If either of you have removed yourselves from the enslavement of corporate servitude by your approach, and this can be replicated, then I'm all the more interested.

Drop me a line if you're willing to share a few pointers or books that influenced your approach.
fignozzle at yahoo dot com.

Thanks,
Ben

[The Rabbi]

Fig,
I'll respond here and email you off-list.
Obviously I dont know you or your situation so what I say might not be helpful.  That is the first rule: no one size fits all.
I am also 43, so I understand something of where you are.
The first issue is how much time you want to take on investing.  It isnt for everyone and there are varying degrees of involvement.  But the more time you spend the more you learn and the better able to generate superior returns you will be.
At the low end, I would say you need to diversify out of your company's stock.  I dont know who you work for but even if it is GE I would still recommend it.  I am not saying dump it all, but diversification is good.  Remember all those Enron employees?  Dont be them.
In its place, the time-proven formula is dollar cost averaging into index mutual funds.  Boring, I know.  But after 20 years a person doing that will have beaten about 99% of all the fund managers out there.  And historically the market has returned about 8% after inflation in any 20 year period.  That is a good return,btw.  Your money will double every 9 years at that rate.
More aggressive: dollar cost average ALSO into a mid-cap index fund.  
More aggressive still: dollar cost average also into non-US index funds.  The beauty of index funds is their low cost.  The SEC has a website where you can see what mutual fund costs actually cost you.  It is an eye opener.
More aggressive still: residential real estate.  It is not for everyone.  It takes time and knowledge.  I cant tell you how many tenants I have evicted and the trouble I have had.  Depending on where you are it is not a great market for buyers right now but I think good buys probably exist.
More aggressive still: buying your own business.  Obviously not for everyone.
Books to look at:
Anything about Warren Buffet.
The Intelligent Investor, by Graham, Buffett's teacher.
A Random Walk Down Wall St.  A good book altho I dont agree with him.
The Millionaire Next Door.  An incredible book.  One of the most influential on me I have ever read.
Rich Dad, Poor Dad, or any of the others in that series.  I cant agree with everything there but he makes some excellent and thought-provoking points.
the Wall St Journal.  Every day.

[...has left the building.]

Fig,

I would check out what the Rabbi recommends. All the stuff he said is solid advice. I would recommend that most people follow the approach he has listed, but it isn't the path that I want to be on personally.

[Otherguy Overby]

For the most part, investing in real estate (especially one's home) is a great plan for most people.

First, let's start with a basic rule:  Inflation is built into the current system.  The value of the dollar will generally never be worth more than it is now, except for short periods.  This makes borrowed money attractive because you'll be paying it back with tomorrow's reduced value dollars.  (You can count on the Federal Reserve to continue this)

Note:  My calculations show a 5% inflation rate takes almost 14 years to reduce the value of the dollar by 50% and just 7 years if the inflation rate is 10%.  You also note who makes up the inflation figures for you to trust.  

This tends to make savings a poor choice for the long run by reducing their value through inflation and also taxing one on the interest earned.   Financially you are much better off having assets than a big savings account.

Stocks, bonds, notes and whatever are taxed on gains realized as you go, so a chunk goes off to the government regularly.

The current tax system subsidises real estate ownership through allowing deductions for property taxes and interest and tax free allowances on gains on the sale of principal residences ($250k single, $500k married).   This can be done every two years and is prorated for times less than 2 years.

On investment property, you can do tax deferred exchanges if you jump through some hoops.

What this means is that if one can avoid or put off paying taxes on gains, you can increase your net worth at a higher rate.

This is what I'm working on, anyway.

BTW, a theory in investing is to use someone else's money to help make money for oneself.  Real estate loans are a great access to this.  For the tenants here that means you are helping someone else buy real estate by helping them make their loan payments.   :/

[Felonious Monk/Fignozzle]

Outstanding info, you guys. Thanks.
I've got to go get my daughter, but will write more later tonight or tomorrow.

[Art Eatman]

To add some "This worked for me":  I learned how to do a lot of stuff besides the basics of being a civil engineer in a state agency.  Auto mechanics,  carpentry, plumbing, wiring.  Coin collecting/dealing.  Gun trading.  Buy collections when possible; retail out individual pieces.

At age 60 I built my own house.  I ran the foundation job, and contracted the dried-in shell.  I had two helpers on the ceiling and one guy and I did the panelling and wiring.  I did everything else myself, the porches & roofs, the doors, trim and plumbing.  My wife did the staining.

Every used-book store around has "how-to" books on every subject known to man.

, Art

[Paddy]

brimic said:

This was told to me by one of my colleagues who belongs to some sort of weird stockpicking/life insurance/financial scheming cult.

Would that be Primerica?  I got sucked into that 4 years ago and emerged with a CA insurance license I've never used, but renew every two years. The 'Regional VP' sold me a mutual fund with a 5.75% front end load that's doing ok, I guess.

It seemed Primerica's main deal was to encourage people to cash in their whole life policies, buy term, and invest the rest.  Which to some degree makes sense; life insurance policies are a lousy place to keep money.

BTW brimic, how's your friend doing?  Is he making money?

[Brad Johnson]

Real estate (rental) is a good bet only if you know that there are some headaches you will face.

First, make absolutely sure you are buying a rentable property

Second, make sure that your rent will cover your combined debt service, taxes and insurance, plus at least a 10% cash overage.

Third, put that cash overage back into a money market or cash savings until you have enough to cover at least half, preferably ALL, the single largest repair most landlords face - the HVAC system. This will also serve as a bffer in times when you may have a month or three between tenants, or have unexpected repairs from destructive clients.

You will have headaches. People who rent generally have little sense of responsibility when it comes to other people's property. They will not hesitage to paint some ghastly color on the walls, start making strange alterations, or simply trash the place through irresponsible behavior (or just being plain shack-nasty).

Consider the pro - someone else is buying the house for you. Few other places offer the chance for a 10-14% ROI with the relative security.

Consider the con - it's a pain in the ass sometimes.

There are all kinds of wierd "corner the market" and "get rich quick without lifting a finger" schemes for sucking your hard earned money out of your pocket. The only consistent performer, at least for long-term gains, is diversify and sit on it. And don't panic when the market takes a dip. People get a wild hair when the market fluctuates and sell off when it's on a downswing (often at the lowest point) when they lose confidence. They were so worried they might lose money that they lost a LOT of money. Remember, even if the stock market is down, you only lose money if you sell.

Brad

[Smoke]

Interesting reading others takes on investing.  Best advice I've seen so far is: "One size does not fit all"

Real Estate is regional.  Real Estate is varied.  To invest in real estate means many different things, one can invest in commercial real estate, rural development, residential rent properties or ag production land (or Whitetail Hunting Ranches!)

Real Estate can be inflated in one area and depressed in another, often in the same state.  Long term investment in a home is a good thing.  Houses are appreciating assetts.  I advise 90% of people to stay away from HELOCs.  Most people will not use the money for making sound investments that will offer greater returns.  Most use the money for trips they otherwise couldn't afford, or plasma TV's or lavish lifestyles.  Then end up with long-term debt paid out monthly at low principal reductions.

My investment strategy has been carefully thought out.  Only moderate risk, high yield vehicles are utilized.

Arabian Horses
Santa Gertrudis cattle
LLamas
Emus
Foreign Currencies ( I particularly like the Botswana Pula & the South African Rand )
Beanie Babies
Pork Belly Futures
and off shore oil production.

I expect to net a large windfall soon from a Nigerian prince that will be wiring me a couple of million soon, I plan to parley that by bulk buying power ball lottery tickets.

Smoke

[brimic]

Would that be Primerica?  I got sucked into that 4 years ago and emerged with a CA insurance license I've never used, but renew every two years. The 'Regional VP' sold me a mutual fund with a 5.75% front end load that's doing ok, I guess.

It seemed Primerica's main deal was to encourage people to cash in their whole life policies, buy term, and invest the rest.  Which to some degree makes sense; life insurance policies are a lousy place to keep money.

BTW brimic, how's your friend doing?  Is he making money?

That name sounds like it might be right.

Don't know if he's making any money, last time I talked to him about it was several months ago.

[brimic]

Real estate headaches-

I don't own any rental properties but looked for 2 years for a suitable property to start out with, most of what I could afford was run down beyond my ability to repair it in any reasonable amount of time.
My FIL owns several properties, you should hear the complaints, its almost humorous. All of his properties are low rent apartment houses.

-He's had to deal with drug dealers. Nothing like having one of his properties raided just to have the tennant put in jail who is no longer making payments.
-He's had to deal with tennants trashing his apartments- nothing like having to replace all of the carpeting because the tennant had cats piss all over it for a year. Some of them leave rotting food int he refrigerator, toilets and sinks plugged solid, or left behind personal items, which by law he has to store for a certain period of time.
-He's had tennants that were Mexicans- (legally here) that allowed 15 of their border jumping relatives to move in.
-He's had to send many tennants to collections only to reclaim little if any of the money that's owed to him.
-He has to be careful to whom he rents or does not rent to. Damned if you do, Damned if you don't, when dealing with minorities and possible discrimination lawsuits if he doesn't rent to them even if he suspicious of them.

[garrettwc]

What about Real Estate Investment trusts?

[Paddy]

My FIL owns several properties, you should hear the complaints, its almost humorous. All of his properties are low rent apartment houses.

Your FIL is what is known as a 'slum landlord'.  He has problems with tenants for a couple of reasons.

 1) His rentals are in an area that doesn't offer much other than low rents.  He has nothing to attract 'desireable' tenants.

 2) Therefore, his 'prescreening' methods have to be especially stringent.  You can eliminate 95% of tenant problems with proper prescreening and move in procedures.

a) Require that income (verified) be a minimum multiple of rent (about 3x).
 
b) Run a credit report to: verify previous addresses, especially those not disclosed on the rental application; determine if there are any liens or judgements which may affect the ability to pay rent; and verify employment.

 c) Get a substantial (or what the market will bear) security deposit, up front, in cash before move in.

d) Do a move in walkthrough checklist.  Go through the rental with the tenant, making note of any defects, damage, stains, missing screens, etc.  This will be compare to the condition at move out and provides a basis for withholding the security deposit.

e) Execute a comprehensive rental agreement that is up to date and consistent with your state law.  Don't use something off the shelf from the stationery store.

 f) Be strict about rent collection.  If rent is not on time, immediately serve the 3 day notice (or whatever document is appropriate in your state).  Don't make verbal deals for payments; you wind up legally altering/voiding the original agreement and losing your rights.

I professionally and successfully managed rental properties for several years.  Even those in 'low rent' areas can be run efficiently, and provide a good return for their owners.

[Brad Johnson]

What about Real Estate Investment trusts?

I've had pretty good luck with mine. Everything over my ROTH contribution limit goes into a REIT (mine is Inland Western). Returns as regular as clockwork. The actual paid returns average about 6.5%, but they allow a dividend reinvestment at a 5% discount ($9.50 per share vs. $10). 11.5% average return is pretty good for the relative security of a REIT (meaning that they actually own a tangible asset that can be liquidated or leveraged if economically necessary). The downside is that you have to keep your shares for a specific period of time before you can liquidate without a penalty. Not a problem for me as I am in it for the long haul anyway.

Brad

[Paddy]

I looked up Inland Western, and they do have an impressive list of properties.  However, I notice that most were acquired during 2005, and the earliest acquisition date is only a little over two years ago.  I'm wondering how highly leveraged they are.  Also, they seem to be particularly retail-heavy, which could be highly volatile if there is some economic downturn and they lose tenants.

Nonetheless, real estate can be and usually is, the soundest of investments.  Ask Donald Trump.