Buying a Rental Property, pt.4

This story just gets better and better. One reason, maybe the main reason, that my partner and I haven't purchased a home is that the amount of interest that one pays over the life of a 30 year loan sticks in our combined craw. I am reminded of this as I look over the loan lock-in documents for our recent rental property purchase. For a loan of 103K at 6.875% we will be paying $143,131.82 in interest. Since it is a rental property and a tax deduction and the renter will be paying 100% of the mortgage, we can swallow this info fairly easy. But think about it if it is a home purchase. Yes, we get to write the interest off but we still have to pay the mortgage out of our pocket. And since home prices in our area, the beach in SoCal, are hovering at $550,000 to $780,000, the resulting interest we would pay for just the lower amount would be close to $700,000. Imagine the retirement fund we could have with $700,000 invested in an index fund over 30 years. Oh yeah, I should mention that our current rent for a large 2 bedroom, 2 bath, with office, and clubhouse and swimming pool is $1600 a month.

Insurance, assurance . . .

Today, I sat down to ruminate over our new whole and term life insurance policies. After much thought and some careful (we thought) research, we chose to buy $100K of whole life and $500K of convertible term. The whole life comes with a guaranteed annual premium and will be completely paid up in 22 years. We will have contributed at that point $49,261 and the benefit amount will be $105,479 guaranteed. This insurance is for my partner T. and assures her that when she dies she will be leaving an inheritance to her son. The term life is also for her son and in her mind guarantees that if anything happens to her before the 20 years is up, her son will receive that death benefit, too. Originally, the plan was for T. to convert the term insurance gradually over to whole life so that sometime before the 20 years ran out she would have $600K of whole life insurance to pass on.

They say you buy insurance for one of two reasons: you love someone or you owe someone. They also say love can make you blind. I love my partner so I worked with her to set this up. But all the way through the process I knew that there were other choices that would provide the same thing and still let us be in better control. Once the insurance company has our money, the only way we can access it is through borrowing against the current cash value. At 8%. Of course the money we contribute is guaranteed to, at the least, double while it is in their care. And that is worth something. But the same $300 a month place in a 4% savings account will reach $168K over the same time period and we could use it if the need arose without any penalty. And if we put it in a long term investment fund like the Vanguard 500, the return might be 10% which would mean its value would compound to $268K. But in order for us to choose either of those two options we would need to have the assurance that our continually growing net worth would be the legacy that she would pass on to her son. Because that's the real key to deciding about whether to buy insurance, isn't it? Do you trust yourself or some insurance company?

Buying a Rental Property, pt.2

So things are moving a pace, Watson. Our lender, a very friendly and hardworking guy, has added a new wrinkle to our tax write-off question. Just as we were about to enter escrow, he suggested to the agent that we would like to roll the approximate non-recurring closing costs into the loan. He figured them at @ $3000. So now a quick calculation at www.bankrate.com shows us that this will increase the amount of the interest we might pay over the life of the loan to $7200 at 7%. We are just ball parking here because the lender has told us already that he is looking to use a stated income basis for the loan because of our son's credit history. His FICO is 730 but for real estate, especially these days, since he has only about a year of payroll background, the FICO is not as important as it normally is. The question for us though is the value of the tax write-off this year. If we pay the closing costs, we get to claim them now. However, since this property will be a cash flowing entity, the $20 a month interest will decrease our income from the property and so affect out tax basis that way too. Now, I have to think about this property from its other purposes (retirement income, early mortgage reduction value, property appreciation, etc.) point of view.

Today, we meet with the lender. It will be interesting to hear his perspective. I'll get back to you.

Lists: More things that I've been thinking about . . .

What is the real truth behind the economics of the velocity of money? Other people's money is really just our own money coming around again, isn't it? Now that the sub-prime lending industry has been acknowledged for the financial boondogle it always was what's going to happen to all those gurus who preached getting rich on no money down? Well, their seminars might go out of favor but the need that drove people to attend them will still need an outlet wont it? Meanwhile, it's now becoming apparent with the convergence at Blackstone that OPM will more than likely coming from China.

Is this one of those emergencies we should be preparing for? The growing transfer of power to China. Last month, after writing a post about Deep Economy by Bill McKibben, I decided to check out the market for reusable shopping bags for our farmer's market. I found five companies that we're ready and willing to fill my need in six to eight weeks. The time it would take their Chinese production facility to deliver my order. So there I was, faced with the same old investing dilemma with a new twist. Now I could choose to save the ecology while exploiting the slave labor market. Ha! Which comes first the world or the people in it?

Ads in our restrooms. I was cruising along being a passenger on a trip to LA when I suddenly realized that the billboard we were passing was animated. Yes, it had changed its message as we drove by. Hmmm, I thought. Technology ain't it grand. But then last night I was perusing my latest edition of the magazine for change AdBusters and came across this disturbing article. It's too far fetched isn't? Governments and corporations file sharing our private info to track us, sell us things, to further control our freedom. To what end, I wonder. Maybe this is a clear signal that that emergency fund should be moved back to its old favorite spot under the mattress.

Money Matters

The other day a friend called up to talk about his son's new job. The son is 22 years of age and has been working for the last six months with a real estate company that specializes in the foreclosure market. As you can imagine, business is great what with the bank re-sales averaging 10 a month and the foreclosure listings up to 1500 since January. They can barely keep up. Meanwhile, the son is making a ton of money which is driving him slightly crazy because of how much he is going to have to pay in taxes. His anticipated 1099 salary is $100,000 for the year. Yes, you heard me, the employer has all of his staff on 1099s. If I understand it right that means he gets to write them off as an expense but doesn't have to contribute anything to their social security, etc. Right now that means the kid could be looking at paying out well over 50% of his income in taxes. So far, he has come up with the following strategies to deal with this: He has formed a sole proprietorship and leased a car for his real estate business, and he bought into a rental property with his parents that they are going to let him claim on his income tax this year. He's also spent $6,000 on deductible improvements to the rental property. The big question that seems to be looming on his financial horizon is whether he should buy more rentals or buy his first home?

Lets look at the rental idea first: Because of the unique position he finds himself in, he has ongoing access to a tremendous amount of property listings. And because he still has 6 months in the year to find and make a purchase, he can be patient and select the best option available. An unfortunate aspect of this is that he works in San Diego County where the median home price is currently around $500,000. Rentals, however, should produce cashflow income so his tax situation might get worse instead of better.

In several ways, the situation is similar if he decides to purchase a home. Lot of listings, half a year to make a choice, and an average home price $500,000. However, since the money he will use for the down payment is not tax deductible, the only tax gain he will get is in the interest write off and the property tax benefit. One detracting factor here is that if the real estate market changes or he loses his job he could find himself in the very same boat as his present clients.

I don't find either of these options to be perfect but the fact that the rental property uses other people's money (the renters) to pay the costs has me leaning in that direction.

Meanwhile, I don't think he's done anything about IRA or emergency funds or for that matter long term investing. I told my friend that it is an interesting situation that I am going to have to spend more time thinking and researching about before I can say I really have some good answers.