All Forum Posts by: Adam Hershman

Hey Gary,

This is a pretty common myth in the credit industry, and there is actually a much better way to approach the situation. Basically you have to understand how derogatory accounts work on a credit report, and how debt collection agencies work.

Essentially by sending a letter to the credit bureaus disputing the validity of the debt, you give a positive indicator to whoever holds that debt that you are trying to do something. If they can provide verification of the debt to the reporting agencies, then you're stuck in the water, and more likely to receive calls and letters attempting to collect the debt. The collection company now knows they have leverage on you, because you now want to pay those debts, which means you want to pursue an opportunity but it requires that you clean up your credit. 

A much simpler idea is to use a "pay for delete" arrangement. Essentially you offer a sum of money based on the age and amount of the debt, and offer this to the collection company in return for the collection company DELETING all reporting of the debt. They have the absolute right to report, not report, or delete these records. You will want to make it very clear that the offer is not an acknowledgement of the debt, but simply and effort to remove it from the credit score. Also remind them that you are aware of the fact that whether a collection account is paid or unpaid, it still has a negative impact on credit, so there is almost no chance that the debt will be paid if a "pay-for-delete" arrangement can not be made.  

Usually collection companies are happy to accommodate these arrangements for a few reasons. It isn't their debt, you don't owe them the full amount of the debt, and they usually buy debt for around 4% of loan value on average. This means that while the original debt may be for $1000 you may be able to settle with the collection agency and have the record deleted for less than half of that amount. Again you will want to look at the age of the debt, usually older collection accounts are easy to negotiate because they have gone unpaid for so long, most collection companies have written it down as a bad debt purchase, so they are even more excited to get any return on the purchase. 

I don't believe that people should default on debt, and it should be viewed as a moral obligation as well as a legal obligation in my opinion. That being said mistakes are made and people need a way to rebuild, and besides, I certainly have no love for collection companies.

Many people are scared or nervous to deal with debt collectors, and it is an embarrassing thing to have someone calling you daily to collect money that you might have been obligated to pay. What you need to remember is you have what the collection agency wants, MONEY! If they want any money from you (or whoever you are helping to repair credit) make them work for it, and make sure it actually benefits you to pay them.

Adam

 I get what the point is, the more properties you have, the more cash flow coming in and in addition the more property you are paying off, my biggest issue is debt risk. It seems no one minds going into debt at an astounding rate for long periods of time to accomplish this, I would feel much better reducing my debt exposure for a smaller gain, because in my opinion the additional gain is not worth the additional debt.

This is all I care about, if you can charge $750/mo for a 75k house, i need to buy some houses where you are. If you could assume a 33% appreciation in 6 months on every property you buy, you should buy property in perpetuity with cash, credit, and when that runs our beg and borrow for more.

Even if you can get $750 for a $75k house, and the property value staying flat @ $75k, you would have a $287ish (60K cash out leaving 20% EQ @ 4.03% national average) mortgage on each, and you use the 50% rule its still only $88 positive cash flow per property. If you look at leaving 50% EQ in the property you end up with a $180 mortgage (37.5k down or cash out leaving 50% EQ @ 4.03%) use the 50% rule and positive cash flow $195 per property.

You would effectively be doing this 5 times over ($15k x 5 = $75k), where I would be doing it twice ($37.5k x 2 = $75k). You would have a positive cash flow of $440 monthly ($88 x 5), and I would have $390 monthly ($195 x 2). Granted that's not including any costs associated with purchasing the properties, where I would clearly have the advantage. This also leaves me with equity that can be tapped before hitting the 20% EQ line.

I guess to answer my own question, even if I could get $750 a month for a 75K house, I think I would rather have 2 houses cash flowing $390 and be $75K (2 loans for $37.5K each) in debt, than be $300K (5 loans for $60k each) in debt for an extra $50 a month. It doesn't make sense to me because in your scenario, I am effectively taking on $4,500 of debt for every $1 of additional cash flow over my scenario.

To put it another way you would incur an average of $681 in debt for every $1 of cash flow, my way incurs $193 of debt for every $1 of cash flow. 

Again I'm not a real estate pro, it just doesn't seem like the meager additional income is worth the considerable amount of debt liability, perhaps if the debt was non-recourse, I could see the benefit, but if you are personally liable for that debt, I don't think the numbers work for me.

Adam

My post was mostly about if more properties at higher levels of debt really have better returns (including risk) than fewer properties with lower levels of debt.

 Sure banks push leverage to 10:1 on performing assets, and they take losses when those assets don't perform. That is pretty central to my point, no equity = complete losses. If there is no equity in a property and the property stops performing, or even starts under-performing, you don't simply take a hit on value which is time based, which you would if you owed no money on the property,  You now take a hit on net cash flow which, if you lose the ability to rent the property for any reason, could move into a negative cash flow. 

Again the idea that you put money into something and then replaced that money with debt somehow equals you not spending money is kind of absurd, really the only way you could say that and have it be true is to say you bought the property and net no money out of pocket, which also seems crazy because it would require a 100% cash out refi. Or I guess you could just believe any cash loan made to you, regardless of collateral or future payment obligation, is just free money. 

There is a large difference between equity and cash flow, most notably that cash flow is largely based on equity/debt and expenses. It's a pretty basic principle, the less you have in expenses the more you have in positive cash flow. I.e $1000 rent - $0 mtg payment is better cash flow than $1000 rent - $1 or more mtg payment, all other things being equal. I'm not really sure where you're going with the whole pizza analogy, both of our scenarios have cash flow, my scenario just has less debt and fewer sources of cash flow, where yours has more sources with higher debt. 

Your last paragraph makes me very nervous. I believe debt is supposed to be paid, unless there is no reasonable way to do so. I do not believe that investors who defaulted on loans lost less than those who saw their investment property values decline and either owned the property outright, or made payments even when cash flow was negative. In fact I think those people, whether investors or homeowners, who managed to keep things afloat should be commended. Unfortunately the culture we have bred is one that makes defaulting on debt quasi acceptable, which I whole-heartedly disagree with. This is where traditional finance pays a big role, other than real estate, there are very few assets that a personal investor can have 10:1 leverage on, now the reason that banks and institutions can leverage assets to a higher level than an average investor is because the banks and institutions are regulated very heavily, and if they have losses (with the exception of the TARP bailouts) they are much more likely to absorb those losses. That's why an individual investor, and even most institutional investors are limited to 2:1 leverage, if any, on most assets. In the case of securities they're also monitored daily and if the leverage limits are exceeded due to losses, you have the option to add funds or sell securities. This is another big issue, if you cash our refi 80%, you effectively have no usable equity in the property, so if the worst happened you would be forced to liquidate, add funds, or default. Unfortunately RE can be fickle when it comes to liquidity, and its not easy to liquidate a suitable amount, you cant sell 10 shares of a house, you have to sell the house. Essentially a bank or institution is much less likely to default on debt than an individual is. 

Generally from an investment perspective, debt is a neutral idea, lots companies are in debt 100% time they operate, but leveraged assets are generally considered very risky because gains/losses are amplified. 

So yes you saying that the "risk is in the lap of the person the cash is moving away from...not to" is true, assuming you don't believe that debt is a true obligation, or something that can be defaulted on. 

I really feel like this has turned into semantics, I simply want to know:

Is the margin or difference between rent and mtg with 20% equity better versus rent and mtg with 40% equity, and if so, is it enough to account for the additional risk?

 Adam

 Joe

So really are spending the money, and then taking a loan on the property. The idea that you "never spend the money" makes it sound like you're selling vacuums door to door. It's like saying I never spend money on transportation because I don't put money down when I finance a car, you're still obligated, whether you pay with cash or not.  20% equity in a $75k house means you would max out at 10 properties (thats assuming you can find a lender to finance those 10 properties). My real question was are the margins on loans rates vs market rents so high that its better to own 10 $75k properties with $60K loan balances than say 5 $75k properties with with $30 loan balances. Like I said, I am no RE pro, so I would really like to know if the margins are better, and if they are, is the increase in return worth the additional risk. 

Like I said, my mind works in terms of traditional finance, what you're describing would be laughable in ANY OTHER field besides real estate, where the regulations are incredibly lax in terms of debt. You say I think like a homeowner because I think debt is a liability? Most financial professionals in any capacity agree that debt is a liability, usually by definition, and that being over leveraged in an exceptionally non-diversified portfolio containing 1 type of asset, especially when that asset is potentially illiquid, would be down right silly in any other investment realm. If anyone is thinking like a homeowner in this scenario its the person who is leveraged to the max in non diversified property thinking it is going to appreciate in perpetuity.  There's lots of foreclosed properties out there of investors who thought the same thing in 2007, "I don't need equity, property increases in value, and rent will cover the bills in any case." I know quite a few people who would blatantly laugh in the face of that assumption, as it has been proven false with their own investments. 

"A: Again, thinking like a homeowner. There is a difference between a cost and an expense...even though they describe the exact same bill....and equity doesn't pay anything...the cash flow does. Equity doesn't exist except in the virtual world...or, until you access it through a refi or sale."

Still don't understand this, apparently you don't think that equity pays nothing and cash flow does? You do realize that's two sides of the same coin right? The cash flow is the income on the investment and in terms of rent would be a fixed number regardless of how the property was purchased. If you pay cash for a house vs finance it, the house value and market rent doesn't change, only your net cash flow from the property does. If you buy the property cash, all income (less expenses to maintain the investment) is net positive income. On the other hand a leveraged property has the additional liability of debt, and therefore you net positive income is reduced. So I guess in your scenario, equity pays whatever % of interest you avoided paying if you had a loan. Obviously I don't believe all debt is bad, and there are scenarios where you can pay less to borrow money than the return you get from the same funds, which makes perfect sense. However, when you increase the leverage on any asset to the maximum, you risk those assets not being self sustaining, which means you have to use more funds. Whether you call that an expense or a cost, it's still money that you can't use the equity in the investment to cover, why? Because that equity has been spread so thin that if say the housing market were to decline by 10% you would be more leveraged than a traditional mortgage with no way to support or maintain those investments other than the rental income, which means your further eating into your net positive cash flow (if there is any left at this point), or personal funds. Additionally if you couldn't maintain those assets for any reason, you wouldn't even be able to liquidate the asset for any real sum of money as the leverage is already so high, after costs of liquidating or selling costs, you really aren't left with a whole lot anyway. 

I assure you, if there is a homeowner and an investor in this scenario, I'm certainly not the one thinking like a homeowner.

Adam

 I think you're going to get a pretty broad set of answers, I usually do my taxes myself but I have a CPA who I know through other business dealings that charges me a small bar tab to use him as a sounding board when I run into issues I don't fully understand. 

Adam

 Hey Rodney,

Essentially as long as you structure the income as distributions from the retirement account, you will usually pay tax @ your normal income rate plus a 10% penalty if you are under 59 1/2. So you can see why most people would recommend against using those funds, additionally those funds are included as income so depending on how much you take over the course of the year, it could actually move you up a tax bracket which is never a fun scenario.

Adam

I dont think I understand the end game here. Is the idea to have multiple properties that your leveraged 100% in? If so it seems like you're really just playing with the difference in a mtg payment vs market rent? If so are the margins really so wide that its better to endlessly leverage on multiple properties than to invest in a few good deals with a lesser degree of debt and higher equity? My mind works in terms of traditional financing, less equity is more risk and therefore I would assume the loans would dry up at a certain point? I am certainly not a real estate pro, but in terms of investments, this seems like a uniquely RE suited strategy if it works. My fears would be the massive debt obligation you would be assuming, yes rents would hopefully cover expenses, but when your leveraged to the max in anything, there is always the risk that the equity cant pay to maintain the investment, so any funds in will have to be yours. 

I would be interested in seeing a comparison of if there is additional margin in multiple highly leveraged properties vs less properties with more equity, how much more margin there is, and if that would be worth the additional risk.

Just my 2 cents.

Adam

 Hey Rodney,

Definitely speak with a tax professional who is knowledgeable regarding retirement accounts. I can't believe that in 2015 professionals in certain fields are still giving bad advice on such basic rules, but you're certainly not alone in getting bad advice. 

There is no way to flip houses with qualified funds in your name, you can use the retirement funds to invest and flip real estate, but you can not provide services to those properties including "sweat equity". Basically the IRS requires that your qualified accounts be treated as a separate legal entity that you are prohibited from doing business with as an individual. 

There is no way to take a loan or "draw from and pay back" an IRA, money out of an IRA will be subject to tax and possibly penalties, unless directly transferred to another custodian. You may be able to avoid the penalty if the funds will be used for higher education or the purchase of a first home, but you should speak to a tax advisor. The only way a loan would be possible is through a 401k, which is capped at $50,000/50% vested balance.

Adam

Hey Michael, 

Are the asking for proof of funds or proof of payment of the car loan? I would assume the former since providing proof of the paid off car loan should be fairly easy. If they are asking for proof of funds, I can't really imagine them accepting any type of account statement for bitcoin even if you could figure out some way to generate it. Your best bet is to explain the situation to a loan officer, and see if those funds being included is critical to the loan. If it is you may be stuck cashing out the total amount, to be able to provide proof of funds. Not many lending institutions consider bitcoin a reliable currency or asset, so this my just be their attempt at "playing dumb"

Adam