All Forum Posts by: John Clark

"Even though my tenants are paying the mortgage, it's still ultimately my money."

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You're on the right track, Shane, but ditch the idea that your tenant is paying the mortgage. YOU are ALWAYS paying the mortgage. Why? Because your internal allocations of income streams (this tenant's money to this mortgage, that tenant's money to that mortgage, etc.) is absolutely irrelevant. How so? Because who pays if there is no tenant income stream to allocate? The debt hasn't gone away. Nothing has changed except the lack of an income stream or source.

The question of asset building and wealth is always solely a function of comparative return on investment, as filtered by one's risk tolerance. Leverage works for the initial down payment analysis, but after that, particularly given one's ability to do wrap-around mortgages to utilize equity, one always comes to the issue of what gives you the highest return on investment.

But the idea that tenants pay your mortgage is false. The owner always pays. He simply has allocated income streams.

"Equity is dead money. It is equal to the same thing as equity as it was as cash outside of the property."
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It is dead only to the extent the opportunity cost for some other investment is greater than the interest rate on your mortgage. If you avoid a 5 percent mortgage rate by paying down debt then your payment "earned" 5 percent. That's better than you'll get keeping it in the bank at one percent interest coming in (on which you are taxed). If you have an alternate investment at six percent, then your increased equity is "dead" to the extent of one percent a year.

Nobody said you were increasing your assets by paying down debt. It is all about the return on the asset. If you have a house worth $100k, and it is fully leveraged ($100K mortgage), and you have $100k in the bank, then your net worth is $100k. That is unchanged when you empty the bank account and pay off the mortgage. You have a net worth of $100k (value of the unencumbered house). You are better off, though, avoiding that 5 percent mortgage interest by foregoing the one percent you make on the bank deposit, to the tune of 4 percent a year. Asset amount is unchanged, but your return on capital went up.

Given that one can cross-collateralize loans quite simply these days, liquidity costs are the only costs one is incurring, since one can access the equity in one house for a highly leveraged loan for another house, as opposed to taking that same money out of the bank and using it as a down payment for the next house.

If you pay down mortgage debt, you are earning the mortgage rate on the amount so paid. If you have a better rate of return for your money, don't pay the mortgage down. If you don't have a better alternative, pay it down. It's not a question of increasing assets, it's a question of increasing one's rate of return on one's assets. Increasing the rate of return on one's assets involves risk assessment and risk tolerance. "Dead" equity assets/money is a flawed analysis, because it's only "dead" to the extent there are better opportunities out there, as filtered by your risk tolerance.

I’m always amused by the people who call one’s house a liability or a dead asset, and that equity in the house is dead.

That analysis might ring true if you didn’t have to live somewhere, but you do. Therefore, consider your share of the monthly mortgage payment as rent, and run the numbers accordingly. You cannot avoid the cost of having a place to stay, so treat your house payments, and expenses, as renting from yourself and as capital expenses or whatnot.

Accordingly, when you pay down your mortgage, you are earning your mortgage interest rate on your capital. There may be some adjustment for the fact that your interest deduction goes down, but that is offset by the fact that you pay taxes on the income you make from other investments. It’s essentially a wash, so just ask yourself if you can invest and receive a return greater than your mortgage.

Yes, there are great advantages to having liquid assets as opposed to illiquid assets, but a price can be assigned to that disadvantage, and you can determine your yield accordingly. That’s why everyone here agrees that the dilemma is academic if you do not have sufficient reserves set aside.

Don’t forget, too, that liquid assets are usually more volatile in prices than illiquid assets.

Don’t get too enamored with tax benefits, either. The government giveth, the government taketh away. How many of us have been hammered by the cap on SALT deductions on our personal tax returns?

If you want to be a big player, and don’t mind risk, use leverage. If you don’t care about having an extensive operation, or don’t like leverage risk (and risk tolerance includes your spouse’s opinion on the matter), then pay down the debt.

Either way, equity, and “your house” are assets, and are not “dead.” You have to live somewhere, therefore the ONLY analysis you can use is that you are renting the house from yourself. Run your numbers intelligently – and make sure you have sufficient ready reserves before you get fancy in your maths.

"Over the course of 15 years you could get 7 properties paid off . . . "
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First question: How do you get to those 7 properties? If you already have them, and look to start winding down, that makes sense. If you are just starting out, but you have a chunk of money and can handle 7 properties now, then buying them and then working down the debt makes sense, too -- if you don't want to get much bigger than seven properties. Spending thirty years acquiring the 7 seven properties because you are paying one off and then adding the next one makes your above statement irrelevant.

Second question: How much risk are you willing to take and still sleep at night? Landlords without debt are in better position (I didn't say great, I said "better") to weather downturns and rent moritoria than those leveraged to the hilt. Check with your wife before you answer.

Third question: What is your desired scale of operation? If you want to be small and solid then a low growth, high return, probably suits you better. If you want a hundred doors in the next 15 years, you won't do it without leverage.

Fourth question: What are the alternate uses for you money? What are the returns on those investments?

Ignore ideological answers like "always be buying" and other brainless crap like that. ideology is an excuse for not thinking. Answer for yourself the above questions and proceed accordingly. You might wind up with a hybrid approach, or with a straight line doctrinaire answer. The answer is in your gut.

1. Don't do kitchen cabinets by yourself unless you have plenty of experience. You will do a bad job, it will stick out like a sore thumb, and you will have to redo them, thereby blowing your October move in. Pay the money and get them done right by someone who specializes in painting kitchen cabinets.

2. Scratch the microwave from your appliance package unless you're doing built in. Spend extra on your stove vent -- you do not want grease and smells building up.

3. $1,600 for white quartz countertops? No. Something's wrong there. Too cheap. Also, Quartz WILL get burned/melted. The tenants won't care. Do granite and on your six-month walk through inspection re-seal the counter top then.

4. Floor -- What are your competitors doing? If they are doing select grade red oak, then you are doing select grade red oak. If they are doing less then you can get away with less. Personally, I go to the top of the line on fixtures like that, on the grounds that I can get higher rents, it's easier to raise rents, it's easier to sell when you want to sell, and the tenants will stay longer. They grow accustomed to nice oak floors and when they shop around rather than pay your rent increase, they will notice that the floors in your competition aren't as good, bite the bullet, and re-sign with you.

5. I skimp on the stove and splurge on the fridge and dishwasher. Usually the husband isn't cooking, so he's neutral on the stove. He does use the fridge, though, and he does use the dishwasher, so both spouses pay attention to those. Also, you can upgrade the stove after a few years if the tenants renew (an enticement). Again, they bite the bullet and re-sign.

It's not your expenses that kill you, it's you loss of income from vacancies.

If a property isn't appreciating then I want to know WHY it isn't appreciating. Some people are okay with C/D neighborhoods. Others aren't. I can tell you right now, however, that A/B neighborhoods with stagnating property values aren't going to stay A/B neighborhoods very long. As we all know, property class indicates the type of tenant you wind up getting. 
I'm not talking about getting crazy bubble appreciation like Vancouver, Canada or or San Francisco, but the steady, constant , appreciation that comes from a well maintained, solid community with competitive advantages over other places (near mass transit, etc).

So a lack of appreciation is a warning sign and I have to ask myself; "Do I want to be in this neighborhood (or city)?"

Appreciation isn't something to buy for, it's something to buy into. Use it to help select the neighborhoods you want to invest in. Try to cash flow in areas that are on the cusp of appreciation.

" Overpriced." Always the answer. Overpricing takes a variety of forms -- Is your unit an illegal rental (cash flow)? Does your unit need work/upgrades that you are low estimating the costs for? Is your unit on a lower floor? (I once had a landlord tell me that my unit, on the second floor facing away from both the City and the lake was comparable to a unit on the 14th floor facing the City with some lake views.

Layout?

"However and more concerning for people here would be ...  inheritance issues for business owners."
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Please take a 101 US history survey course about the late 1800s,early  1900s. You could also search the internet for the phrase "malfactors of great wealth" and note the party of the president who said it. AND, before people start whining, note the size of estates before estate taxes commence. Most sales of the "family farm" came not from having to pay estate taxes, but from the one sibling desiring to carry on not being able to buy out the others -- the number of siblings is a real factor, as even in the late 1950s, the US department of agriculture had a question on its farm loan applications: How many sons do you have?

"OK. So I have no incentive to sell in my lifetime. My kids have no incentive to sell in theirs. Same for the grandkids. Lands stays in families forever. Leave it to Joe Biden to come up with a formula to get us back to the middle ages. "
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Estate taxes. Your kids sell when you die.

"IMHO you can have an income requirement that requires funds equal to the duration of the lease term (which could likely be around $50k or a little more than $4k/month for one year) as part of your policy as long as you apply it consistently."

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I thing you will encounter that courts would not find requiring a year's lease amount in liquid assets separate and apart from income to be commercially reasonable. Rather, the court would find that such a requirement is a pretext, and had a disparate impact on a protected class (race).