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(YAWN!) The difference between asset growth and cash flow

This isn’t the most exciting blog entry – but to my investor friends and agent followers – READ ON FOR WISDOM!

When potential investors tell me they want to purchase real estate, I ask them – tell me what you envision your end to be. Are you looking for a cash flow monthly or are you looking for asset growth?

These two objectives provide different approaches in the beginning of the buying process. For the investor seeking a cash flow, s/he usually has lots of cash and looking for somewhere to park the money and pull down an income each month. That’s different than the investor looking for the asset to grow who may be wanting to leverage their funds with a mortgage so they can count on two things – OPM (other people’s money) paying off the mortgage, and the market growing their asset, thus growing their equity.

Asset growth is how an investor gains a return on investment (ROI) in the double digit percentages consistently. For instance, let’s say you  purchase an investment property with 20% down – say $40,000 on a $200,000 purchase. If that condo grows in value by 5% per year (i.e., $10,000), the investor’s cash growth is actually at 25% ($10,000/$40,000).

Meanwhile, the tenant’s rent is making the mortgage payment each month, thus paying down the mortgage for the investor so  the equity is growing year after year.

For the cash buyer, however, it’s more about – what can s/he take out of the property each month for cash. If the house is purchased for the same amount – and the rent is $1,500 per month, with a $300 condo fee and $150 property tax, then the net cash flow for the year is $12,480 per year. On the initial purchase of $200,000, the cash return is about 6% per year – in cash. It’s like you own a stock paying dividends – on a monthly basis.

When you’re looking to invest – what is your end game? Until next time…

Anthony Carr is the Director of Training for Keller Williams Realty Falls Church, VA. KWFC is in the Top 10 real estate offices in Northern Virginia according in both agent count and sales volume. His real estate career is diverse and he’s a sought out speaker, author, blogger and problem solver. Mr. Carr is the author of “Real Estate Investing Made Simple: A commonsense approach to building wealth”; and he was a contributing writer to “The Best Real Estate Advice I Ever Received,” published by the Donald Trump organization. He holds associate brokers licenses in Virginia, Maryland and Washington DC.

 

The Spring season has started! Following the 2009/2010 blizzards that hit the Mid-Atlantic region, buyers have come out with a vengeance. We’ve been processing a contract or listing a day in the office and there are no signs of stopping. As I reported last month, prices across the Northern Virginia (D.C. suburb) area have turned around. For December, the average sales price jumped 12 percent compared to December 2008.

Now, buyers and sellers alike are focusing on the Expanded Home Buyer Tax Credit passed by Congress Nov. 6, 2009. The expanded CREDIT (not deduction!) provides cash benefits to first-time buyers and to homeowners who are purchasing a second primary home.

First-time buyers are classified as purchasers who have not owned a home in the last three years; repeat buyers are those who have owned within three years or currently own a home and are moving into another home that will be their primary residence. For doing this, either person, if they qualify, can apply for tax credits (up to $6,500 for repeat buyers; $8,000 for first-time buyers).

These tax credits mean cash in the buyer’s pocket. The credit is applied to your tax bill as if you had actually paid it to Uncle Sam. Then it either comes back to you with a lower tax bill for the tax credit amount, or in the form of a check from the U.S. Treasury. The reason for these generous credits is that the federal government figures most home buyers will spend the money on the house – paint, carpet, windows, doors, appliances – thus creating product demand, and thus creating jobs.

The market is lining up to be a perfect storm for buyers and sellers in Northern Virginia:

  • price appreciation (the bottom of the market is passed);
  • historically low interest rates (in the 5% range);
  • tax credits to help fix up your home (up to $8,000).

So What? What does that mean to you? Here’s the catch – you must have a ratified contract by April 30, 2010 and settle on your new home by June 30, 2010. If you’ve been looking to buy a home before prices escalate, with cheap money and get back money from Uncle Sam – now is the time.

With all the stimulus packages being floated out there at costs of up to $5,000 per tax payer (per program), the question comes begging about the Homebuyer Tax Credit.

“At $8,000 for each first-time homebuyer and now $6,500 for move-up buyers – how much is that going to cost the American taxpayers?”

Good question. Not knowing how many people will be able to take advantage of it, we’ll have to start with some guestimates.

Keep in mind, first, that about 4.5 million existing home sold in 2008 altogether and we have been on track to sell roughly the same in 2009.

For 2009, the tax credit was  only for first-time buyers and up to $8,000 (10% of the sales price, not to exceed $8,000). So not everyone received the $8,000 if they purchased a house less than $80,000 – but let’s go ahead and say they did for argument sake.

If the stats hold true, and that is about half of all buyers are first-timers, then there were 2.25 million buyers that qualified (assuming they didn’t go beyond the income limits – which many did). But for simplicity, we’ll say they all qualified.

Simple math puts the tax credits at $18 billion for 2009 – that doesn’t have to be paid back. For all the money that’s being floated out there to stimulate the economy, this is probably the best plan in play.

Now, before all my conservative friends blow a vein behind their eyeballs that are now popping – here’s what happens when a homeowner purchases a house (vs., say when someone buys a car or some other depreciating asset). They spend money on it. Lots of money.

The foreclosures/short sales that have made up most of the market for the last 2 years are mostly in paltry condition and need paint, carpet, appliances, countertops, cabinets, windows, landscaping, rot replacement, sump pumps, mold remediation, heat pumps, etc.

Unless you saw these houses, you just wouldn’t understand. I’m not talking “updating” homes that would otherwise be in good living condition, but making them inhabitable altogether. In fact, regular home buyers like you and me can’t even finance many of these houses because of the condition they’re in.

People get into a tizzy about home flippers swooping in and making “all this money” by flipping a house. Let me tell you – without the flippers some of these houses would completely fall apart. Remember, that lenders WON’T LEND MONEY on a house without complete bathrooms, that are mold invested, lack certain appliances, etc. And the REO banks WON’T fix them up to sell them. They just let them deteriorate while they wait for a buyer.

Enter the investor/rehabber who purchases the house with either cash or off-line financing, then fixes it up to pristine condition, sells it at a fair price and moves on to the next project. They are providing a much-needed service to even make the houses salable, much less inhabitable.

Now, as the market turns around in city after city (that’s what the increase in  pending sales is all about across the country), we’ll see an increase in sales and a use of the home buyer tax credit to fix up the housing pool.

The tax credit for home buyers has played its role and now it will go away April 30, 2010. The question for consumers is will they recognize and act on a good deal when they see it?

How would you like to make money paying someone else’s real estate taxes? There’s a little-known investment opportunity available in 31 states where investors can put up as little as a couple hundred dollars to get in on the action.

You’re probably thinking: “I pay enough taxes as it is, why would I want to pay someone else’s taxes, too?”

Well, how does an annual interest return from 18 to 50 percent sound?

These returns are available through tax lien and tax deed certificates sold throughout the country on a county basis. Tax liens are what the local government places on properties where real estate taxes are late. Figuring that they won’t get that money right away, the local government auctions off the lien to investors once or twice a year. These are called “tax sales.”

If owner Smith owes $2,000 in real estate taxes and hasn’t paid it, the county will place a lien on his property and then auction that lien to an investor. The investor gets the lien for $2,000 and the county gets the money it needs right away to pay its ongoing expenses. Meanwhile, the treasury or finance department then starts going after the money from the delinquent tax payer.

They send nasty little notes, warning them of further action and placing stiff penalties and interest charges on the tax. These interest charges can be as high as 50 percent — and that’s how the local government can then turn around and pay these investors 16, 18, 20 percent and more.

The place to find these nifty investments is at the local treasury or finance department. There are also web sites where the information has been compiled. You could end up paying as much as $39 per state for the information or, as on one site I visited, $49 for the whole country (encompassing 3,300 counties).  www.taxliens.com is a good place to start.

Since more than likely you’re going to go after local liens to start with, save yourself the money and just contact your local treasury or finance department. If you don’t know where that is, then just call the main information number for your county or city and ask for the tax department — they can help you from there. An easy search online would be: “<local county> tax liens”.

Basically, these are short-term investment opportunities. After the lien has been auctioned off, the county lets the owner know that they may lose their property to the tax lien certificate holder if they don’t pay the taxes — and now taxes, interest and penalties. This gives the property owner another opportunity to redeem the tax bill and keep his/her property. If they don’t, then the tax lien certificate holder can foreclose on the property.

In some areas, instead of a foreclosure, the government actually sells you a tax deed to the property — meaning if the taxpayer doesn’t pay the taxes, you become owner of the property straight out.

There are the amazing stories about people hitting it rich in these tax sales. There’s one floating around about a gentlemen in Tulsa, Oklahoma who paid $17 at a tax sale for a property he then sold for $4,400 and another where the property was bought for $298 in back-taxes and sold for $8,450.

It’s also true that each year people are hit by lightning. There are risks and hazards with tax certificates. The property might be trashed, you could lose your investment by not following procedures, title may be weak, and — let’s face it — former owners may be both irate and well armed.

Because the liens are auctioned, a hot property might only be available with unattractive terms. In some jurisdictions, you may “win” the property but then be responsible for all unpaid taxes and mortgages. If you have to foreclose, that may result in another round of costs. In some jurisdictions, the owner may have an “equity of redemption” right that allows him or her to re-acquire the property after a foreclosure action.

Be aware of these and other risks and act accordingly. Investors must carry out due diligence to limit risk. This means researching the properties (which are usually publicized in a local newspaper or on the tax department’s web site a few weeks before the sale), understanding your potential obligations, knowing what the rules are, speaking with local brokers and attorneys, and realizing that while you may do well in the best circumstances, the “best circumstances” may be rare.

Most impacted property owners (about 95 to 98 percent) actually pay the taxes. So most folks who invest in these certificates are doing so for the interest paid on their money.

For those interested, research the process, visit an auction first to watch how it’s done, know the rules, and then decide if this is an investment for you.

by M. Anthony Carr

Many sellers in today’s market are bemoaning the fact that prices have stabilized or are falling in their communities. While year-over-year numbers regionally and nationwide have demonstrated strong appreciation, the latest month-to-month declines in some markets have made headlines and struck fear in the hearts of homeowners everywhere.

Despite very robust long-term housing appreciation, many observers of the market and prognosticators write scary reports about how appreciation has slowed, prices have dipped, etc.

Stories from the field go something like this: The seller won’t accept a $150,000 lower offer on his $1.2 million listing because he’s already dropped it $200,000 from his original asking price. When asked how much he bought the house for 15 years earlier, he answers, “That has no bearing on my situation now.”

The real answer is that the seller actually bought the house for around $400,000 15 years ago and believes the roughly $600,000 gain on the property is not enough — since last year the same type home sold for $1.4 million.

My dear sellers, sell in the market you’re in, not the one you wish it could be. This particular seller’s story (and stubborn attitude) could be blocking a great opportunity for him to take advantage of the current market instead of the market taking advantage of him.

The mindset goes something like this: “I’ve already lost $200,000, why would I give up another $150,000 to sell my house?” If we’re going to talk about how much has been lost (on paper) and how much as been gained (once you sell the house), then let’s look at the real cash gain on the above property. In just a moment you’ll see how many homeowners are sitting on more than 1,000 percent gain in their homes — they just haven’t realized it yet (nor will they) until the house is sold.

Let’s use the above example. The homeowner bought the house for $400,000 and is standing in front of a $1,050,000 offer that could net him more than $600,000 if he signs the bottom line. So what’s his gain?

At an initial glance, it looks like his house has grown in value by 162 percent, thus he’s gained a 162 percent return on investment, right? Actually, while the asset has grown by 162 percent, his return on the investment of his actual dollars is much higher.
Here are the assumptions:

Purchase price: $400,000
Down payment: $40,000
Mortgage amount: $360,000
Sales price: $1,050,000
Cost of sale: 8 percent (commission, closing costs, seller subsidy, etc.)
Net gain: $606,000

With the above numbers, his $40,000 investment several years ago has resulted in a net gain of 1,515 percent. That’s right — one thousand-five hundred-fifteen percent.

My question to the seller is: “How much is enough?”

According to the Office of Federal Enterprise Housing Oversight reports that the average quarter over quarter appreciation (for 2Q 2006) for housing was more than 10 percent over the same period a year ago. Of course, the report itself and the media jumped on the statement of, “The quarterly rate reflects a sharp decline of more than one percentage point from the previous quarter and is the lowest rate of appreciation since the fourth quarter of 1999.”

Now, that sells newspapers and gets the “email this article” link a hefty workout. What wasn’t reported everywhere is that the average appreciation nationally has been 298.85 percent since 1980. In the last five years, the nationwide average has been 56.49 percent in appreciation. Where it really comes down to a level of importance is what has happened in your state or community. For instance, in my home state of Virginia, the 26-year appreciation has been 360.29 percent; the 5-year appreciation has been 83.38 percent.

Now let’s look at the latest appreciation/depreciation in my marketplace — down about 1 percent compared to the same month a year ago. Ouch. That smarts. (I will point out though, that also in my market area, sellers have been overpricing to the tune of 13 percent higher than their counterparts from last year, while they are selling at 5 percent less than asking price. It’s not so much a loss in “value” as it has been an overpricing of the inventory.)

Regardless of price, the basic investment strategies still apply here — buy low, sell high. It’s just all relative. If the seller thinks he’s “losing” tens of thousands of dollars because 1) that’s what the houses were selling for last year; and/or 2) that’s how much he’s had to reduce the asking price, then he has a long emotional row to hoe.
On the other hand, the seller could look at the numbers calculated above and start dancing all the way to the bank with his ROI of 1,515 percent. So, again I ask, “How much is enough?”

The biggest challenge a seller has to face in today’s market isn’t the market, it’s actually the person he’s looking at in the mirror.

Published: October 6, 2006

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