Tuesday, December 27, 2016

Real Estate returns can beat Stock market investing

You'll often here people say that they don't like real estate because if you look at the long term returns of the stock market, it seems to have a better return over the long term.

Of course, when they say this, they are leaving a few key things out.

First, when people say the stock market, what they really mean is something like the S&P 500 or the Dow Jones Industrial Average. These are not the stock market. Rather, they are indexes filled with some of the leading companies in the US. You'll often hear that the stock marketing returns anywhere from 7%-10% annually. This is really based on index returns rather than the market itself.

Second, while 7%-10% is a good return annually for the average person, it is not a good return for a professional investor. And when people stack up the returns from real estate against the stock market, they often only factor in one profit center in real estate, appreciation.

The reality is that there are four ways you can make money with real estate that, when added up together, make for considerably higher returns than the stock market. These profit centers are the reason that real estate is one of my favorite investment vehicles.

A word of clarification: as you read about these profit centers, realize that I'm talking about investment real estate-that is property bough specifically to be run like a business-rather than your personal residence. As I've said before, your house is not an asset. It takes money out of your pocket. But your investment real estate is, if you invest properly, because it puts money in your pocket.

Now, here are the four profit centers of real estate.

Cash flow on operations

If you're holding real estate as an investment, you will have tenants. Each month they will pay you rent. Let's say that you own a rental house and get $1,000 per month in rent. Over a year, that is $12,000 in income.

Now, you subtract out your expenses, which include things like your taxes, insurance, your property management, vacancies, turnover expense, allowances for repairs, etc. (This doesn't include your debt-more on that later).

For purposes of this example, let's assume that your monthly average expenses are $100 a month. Your cash flow on operations then would be $900 per month. That is what is referred to as your Net Operating Income (NOI).

Out of your NOI you pay your debt service. Let's assume for this example that you have a $200,000 property with an $180,000 loan at today's rate of 3.7%. That's a debt payment of about $830 a month.

So, that would be rental income of $1,000 minus $100 in operating expenses minus $830 in debt service, equaling $70 in cash flow. That times 12 equals $840 in cash flow per year. That $840 divided by your $20,000 equity stake would equal a 4.2% cash-on-cash return.

But that's not the end of your return story. Let's move on to the next profit center, Amortization.

Amortization

Amortization is the concept of paying down your debt service. Each month, when you make your debt payment (or rather your tenant makes your debt payment) out of your NOI, a portion of that goes towards paying down your principle on the loan. When you hear somebody talk about a 30-year fixed fully amortized loan, it means that when you make all 360 of those monthly payments at the end, the loan is 100% paid off.

Because your tenant is paying rent, and that rent is covering the debt payment, the principle pay down included in that debt payment is actually profit for you. Let's take a look at how this plays out with our $180,000 loan from above.

In the first year of the loan, you'd be paying $6,604 in interest and $3,338 in principle. As the loan matures, the interest amount goes down each month and the principle amount goes up. But we'll use these numbers for now.

That $3,338 is profit to you. It's true equity in your property.

If we add this $3,338 to the $840 in operating income, we now have $4,178 in income for the year, a 20% return on our $20,000 invested into the property. Plus, your interest payment is often tax deductible, so added bonus, but check with your tax advisor to be sure for your specific case.

Already, you're crushing average stock market returns and there are still two more profit centers to look at.

Depreciation

This is often referred to as a phantom return. The basic concept of depreciation is that your investment property is made up of tow parts, the land and the improvements on the land, i.e., your house.

Appraisers will assign percentage values to your property based on these two parts. For this example, 20% of the value is the land and 80% of the value is the improvement. Over time, the house will deteriorate, so the government in the US (check with your tax advisor to make sure you qualify), let's you write down that 80% value over a certain number of years depending on the type of real estate. For residential homes it's 27.5 years.

So, your $200,000 property has $160,000 that can be depreciated over 27.5 years, which equals $5,818 per year. This amount is listed as a loss of income, even though no money is coming out of your pocket. Now let's see why this is called phantom income.

Let's assume you are in a 30% tax bracket. That means that, applying 30% to your depreciation of $5,818, nets you $1,745 in annual tax savings.

Adding that $1,745 to our existing income of $4,178, we now have $5,923, a 29.6% return on your cash of $20,000.

Let's take a look at the last profit center, appreciation.

Appreciation

This is the frosting on your cake. I don't invest in real estate for appreciation. I'm a cash flow investor. But I do appreciate my appreciation.

Let's assume you have a conservative appreciation rate of 3% a year on average for you $200,000 property. That equals $6,000 per year in value added to your house.

Add that to your $5,923 and you have $11,923. That's a 59% return on your $20,000 capital investment in your $200,000 property. And that blows investing in the stock market for the long term out of the water.
Increase your real estate IQ

These types of returns are achievable by anyone, as long as they understand how to find the right deal and run the numbers correctly. And it takes a high financial IQ.


Thursday, December 22, 2016

How spending money can make you a winner


A mantra of my rich dad was, "Savers are losers." By that he didn't mean it as a personal insult to people who save their money. Rather, he meant it very literally. If you bet on saving money as a path to financial security, you will lose.

As I wrote back in July, "In an economy where almost everything is built to take your money, saving it is of little value. From inflation to taxes to hidden fees in your 401(k), the system is stacked against you."

Why, "Money is not backed by anything. It is a currency, which like a current of electricity, is always moving. Today, money flows from one sector to another. If it stops moving, like a current it dies. If your money isn't moving, it is dying, slowly, losing value day by day."

In the new economy, it is spenders who are winners. Not those who spend on liabilities that take money out of their pocket each month, but rather those who spend money on assets that put money in their pockets each month.

Again, as I mentioned earlier in this post, you should be stuffing extra money into an account meant specifically for investing in assets. This could be construed as savings, but it is a very different way to save. It is saving to spend. The aim should be to move that money as quickly as possible into assets that generate money rather than to let it sit and die.

Tuesday, December 20, 2016

Make this money move instead of adding to your 401K

At Rich Dad,we've made no secret about why we despise 401(k)s. Take for instance one reason from the horse's mouth, John Bogle, the head of Vanguard: 
"…The financial system put up zero percent of the capital and took zero percent of the risk and got almost 80 percent of the return, and you, the investor in this long time period, an investment lifetime, put up 100 percent of the capital, took 100 percent of the risk, and got only a little bit over 20 percent of the return."

Rich Dad's advice: invest in cash-flowing assets

If you want to be rich, the last thing you should be doing is increasing your contribution to your 401(k). Instead, you should use any raise you get or extra money you can squeeze out to increase an account you can use to invest in cash-flowing assets of which you have control over and of which you can keep all or the majority of profits. And if you want the tax benefits of a 401(k) to do this, you can use a vehicle like a self-directed IRA.

The best part of this strategy is that the more cash-flowing assets you acquire, the more money you make each month from those assets that you could redirect into even more cash-flowing assets. This compounding of assets, not just money, creates true wealth.

Thursday, December 15, 2016

Your house is not an asset

Last week we kicked off the first in a monthly series called, "Ask Robert". It was fun to see all the questions asked, and hard to choose which one to answer. We'll be doing "Ask Robert" once a month, so start thinking now about your questions for the next installment. In the end, I answered Martin's question on whether to put his savings into paying off his personal residence or to invest in a rental property.

My response to Martin was that it's always preferable to invest your money into a cash flowing investment instead of paying down a mortgage on your home—especially in a market that is declining. 

Interestingly, I came across an article in The New York Times this week on real estate entitled, "Real Estate's Gold Rush Seems Gone For Good". The article highlights what I've been saying for over a decade since the publishing of my book Rich Dad Poor Dad: Your house is not an asset!

Here are some interesting statistics from the article:

-    It could take up to 20 years to recoup the $6 trillion loss in housing values since 2005
-    Housing values have dropped over 30 percent since the bubble popped
-    Sales figures for July are expected to show a drop of 20 percent over last year
-    The supply of housing might rise to 12 months—more than twice what's considered normal and healthy (Not only did it rise to 12 months but it surpassed it. Yesterday's report stated an inventory of 12.5 months)
-    When surveyed, people feel that housing will rise by as much as 10 percent a year over the next decade

That last statistic is frightening to me. Financial ignorance is so high in our country that we still believe that a house is an asset and a sure way to build wealth. It's not.

Monday, December 12, 2016

I'm buying properties that can cash flow

In the popular Back to the Future movies, Marty McFly goes back in time, accidentally gets his mother to fall in love with him, and has to work with his future friend, Dr. Emmett Brown, to make things aright. If he doesn't fix things-and learn from his mistakes-a different future will emerge where his parents don't marry, and he never exists.

The whole movie, Marty does everything he can to get back to the future.

For the last decade, many homeowners have been waiting to get back to the future as well…the future where their home prices are the same as they were ten years ago. It's been a long wait.

But it's finally come. As "The Wall Street Journal" reports, "The average home price for September was 0.1% above the July 2006 peak, according to the S&P CoreLogic Case-Shiller U.S. National Home Price index released Tuesday."

Of course, in the fine print is the fact that while prices are the same, value isn't, "Adjusted for inflation, the index still is about 16% below the 2006 high. Home prices jumped 5.5% over the past year."

Speaking of going into the past, in 2010, "The New York Times" wrote about how people-in the midst of the housing crisis-still believed that real estate would go up 10 percent a year. That of course hasn't happened. Back "The Wall Street Journal Article": "Home prices have grown at an inflation-adjusted annual rate of 5.9% since 2012, while incomes have grown by just 1.3%, according to Case-Shiller. By contrast, from 1975 until the present, prices grew at a rate of 1.1% a year, while per-capita incomes grew 1.9%."

The WSJ article goes on to point out that the "recovery" in housing isn't all roses. "The country is building far fewer homes than normal, the homeownership rate is near a five-decade low, and mortgages remain difficult to come by, especially for less-affluent buyers. Rising mortgage rates could also begin to pose headwinds to further price growth."

But, more than likely, people will read a headline that says, "Home Prices Recover Ground Lost During Bust," and start thinking things will be as they were before. Unfortunately, this future of housing will most likely much different than the decade that led up to the bust. But what remains the same is that people will continue to think that buying a house is an investment-that it is an asset-when it is not.

So since we are back to the future of housing, it's a good time to remind folks of the reality that your house is not an asset, and if you heed the word, maybe we can avoid another housing bubble…maybe.

Your house is a liability

Since the lesson still hasn't sunk in for many Americans, I'll repeat here: Your house is not an asset. It's a liability.

Very simply, an asset is something that puts money in your pocket. A liability is something that takes money out of your pocket. The reason people are confused and think that a home is an asset is because from the 1970's through the early 2000's they were able to pull money out of their house in the form of loans, like a real estate ATM. Now that prices are back, they might start thinking the same thing again.

As that 2010, "New York Times" article states: "The wealth generated by housing in those decades, particularly on the coasts, did more than assure the owners a comfortable retirement. It powered the economy, paying for the education of children and grandchildren, keeping the cruise ships and golf courses full and the restaurants humming."

The problem is that wealth wasn't generated. Only debt. People didn't sell their homes to pay for things like college educations and vacations; they borrowed against them. In the process they bought into the illusion that they were tapping an asset when in reality they were growing a liability by taking on more and more bad debt.

How a house can be an asset

Despite the fact that housing prices have not recovered in real terms, I'm buying. This may sound contradictory, but it's not. As you may have guessed, I'm buying investment properties that cash flow.

To me it matters little property appreciates in price. I care only whether it provides cash flow every month. And while investing for cash flow won't provide the home-run returns that speculators saw in the early 2000's, it's the only sure way to build wealth and assure a secure retirement in terms of real estate investing.

The key is to make your money on the buy, not the sell. What I mean by that is that by doing proper due diligence you can find deals that will provide substantial cash flow for years to come. By doing so you don't have to worry about the price of your asset. If it goes up, that's a bonus. If it doesn't, you still have a great property that puts money in your pocket every month.

So, your house is not an asset. But a house can be an asset-if it cash flows.

My hope his that you-and the world-will learn from the past and begin to build for a secure financial future. In that future, you do not rely on your home to be your primary nest egg. Ask people ten years ago, on the cusp of retirement, how that worked for them.

In that future, you rely on financial intelligence to find cash-flowing assets that provide income month in and month out.

Your house is a liability

Since the lesson still hasn't sunk in for many Americans, I'll repeat here: Your house is not an asset. It's a liability. Very simply, an asset is something that puts money in your pocket. A liability is something that takes money out of your pocket. The reason people are confused and think that a home is an asset is because from the 1970's through the early 2000's they were able to pull money out of their house in the form of loans, like a real estate ATM.

As The New York Times article states: "The wealth generated by housing in those decades, particularly on the coasts, did more than assure the owners a comfortable retirement. It powered the economy, paying for the education of children and grandchildren, keeping the cruise ships and golf courses full and the restaurants humming."

The problem is that wealth wasn't generated. Only debt. People didn't sell their homes to pay for things like college educations and vacations; they borrowed against them. In the process they bought into the illusion that they were tapping an asset when in reality they were growing a liability by taking on more and more bad debt.

It's amazing to me that people still think their house will gain value given the true statistics about the housing market. The reality is that the housing market will take decades to regain value—and may fall in value in the short term—and most gains will only be keeping up with inflation. Buying a home and counting on it to be your retirement is financial ignorance and recklessness at its worst.

How a house can be an asset

Despite the fact that housing prices may never actually recover in real terms, I'm buying. This may sound contradictory, but it's not. As you may have guessed, I'm buying investment properties that cash flow.

To me it only matters if a little property appreciates in price. I care only whether it provides cash flow every month. And while investing for cash flow won't provide the home-run returns that speculators saw in the early 2000's, it's the only sure way to build wealth and assure a secure retirement in terms of real estate investing.

For many, the fact that housing prices might drop again is a bad thing. For me it is exciting. It means that more deals will be out there for great properties that bring in money every month in the form of rent. As I've said before, we're experiencing the greatest wealth transfer in history. If you're smart with your money, wise in your looking for deals, and ready to make a move, you can find great investments at bargain prices.

The key is to make your money on the buy, not the sell. What I mean by that is that by doing proper due diligence you can find deals that will provide substantial cash flow for years to come. By doing so you don't have to worry about the price of your asset. If it goes up, that's a bonus. If it doesn't, you still have a great property that puts money in your pocket every month.

Your house is not an asset. But a house can be an asset—if it cash flows.

Monday, December 5, 2016

Failure is a part of success



Robert Kiyosaki is a Japanese American investor and author of the popular book 'Rich Dad Poor Dad' where he wrote of his two dads. His rich dad taught him to think differently, inspired and helped him get rich on his own.