Back in 1989, I purchased my first buy and hold investment property, a nice duplex that now has some large commercial garages, which I built later on, at the back of the property. At this time in my life, I was 29 years old, and my goal was to buy one property a year for the next 20 years, and then I wanted to pay them all off, all 20 of them. I contemplated my goal for future retirement as perhaps selling one property a year for 20 years, while holding paper on each property as I sold it. My idea was that I would then live off of the cash flow of mortgage interest received, and at the same time, get out of the property management and repair business in my old age.
As time went on, and I became more educated and experienced, my viewpoint on this did a complete 360. I remember asking my accountant if this strategy of paying down rental properties made any sense, and he pointed out that it was pretty much irrelevant, as long as I cash flowed. He said you could write off mortgage interest for as long as you are paying it, and as long as the government didn’t come along and change the tax code. The only thing that would go away would be the depreciation over time. But he said, I could always do a 1031 Exchange into something bigger and better (e.g. Apartments or commercial properties) to pick up my depreciation again. After all, the game plan was to “defer, defer, defer, die,” when it came to taxes.
Then years later, when I began to not only sell real estate, but also insurance and financial planning, I began to study many more wealth building techniques. Many of these seem controversial at first (especially on BiggerPockets), but I think we should all have an open mind when contemplating any new or creative wealth building strategies. After all, it wasn’t long ago that we earthlings thought that the world was flat.
So, here are 10 Equity Management Strategies expressed by one of my favorite, unbiased, financial planners, Doug Andrews, author of “Missed Fortune 101.” He lists these strategies by identifying the common myth and then explaining the reality associated with each (all 10 are listed on page 251 to page 254).
How to Purchase Real Estate With No (or Low) Money!
One of the biggest struggles that many new investors have is in coming up with the money to purchase their first real estate properties. Well, BiggerPockets can help with that too. The Book on Investing in Real Estate with No (and Low) Money Down can give you the tools you need to get started in real estate, even if you don’t have tons of cash lying around.
10 Strategies for Equity Management
#1. Avoid the $25,000 mistake that ensnares millions of Americans.
Myth: The best way to pay off a home early is to pay extra principal on your mortgages.
Reality: No method of applying extra principal payments to your mortgages is the wisest or most cost-effective way of paying off your house.
Strategy: Establish a liquid side fund to accumulate the funds required to pay off your mortgage, maintain flexibility, achieve substantial tax savings, and accumulate excess cash.
#2. Avoid expensive risks.
Position yourself to act, instead of reacting to market conditions that you have no control over.
Myth: Home equity is liquid.
Reality: When you need it most, you may not have it. Home-equity is usually non-liquid.
Strategy: Separate as much equity from your property as is feasible, positioning it in financial instruments that will maintain liquidity in the event of emergencies and conservative investment opportunities.
#3. Separate home and equity to increase safety.
Real properties with high equity and low mortgages get foreclosed on the soonest.
Myth: Home-equity is a safe investment.
Reality: A home mortgaged to the hilt or totally free and clear provides the greatest safety for the homeowner.
Strategy: Separate as much equity from your home as feasible to achieve greater safety of principal and reduce the risk of foreclosure.
#4. The return on equity is always zero-no matter where your property is located.
Myth: Home equity has a rate of return.
Reality: Equity grows as a function of real estate appreciation and a mortgage reduction; however, equity has no rate of return.
Strategy: Separate as much equity from your home as feasible in order to allow idle dollars to earn a rate of return.
#5. Make Uncle Sam your best partner.
Mortgage interest is your friend, not your foe.
Myth: Mortgage interest is an expense that should be eliminated as soon as possible.
Reality: Eliminating mortgage interest expense through traditional methods eliminates one of your best partners in accumulating wealth and financial security.
Strategy: Use the difference between preferred and non-preferred interest expense to make interest work for you instead of against you.
#6. Use debt for positive leverage.
Myth: Any and all debt is undesirable.
Reality: Some debt, when managed wisely, can be desirable.
Strategy: Use debt wisely as a positive lever for equity management purposes, conserving and compounding equity rather than consuming it.
#7. Understand the cost of not borrowing—compare deductible versus non-deductible costs.
Myth: Lower mortgages, resulting in lower payments, mean lower costs.
Reality: If you take opportunity costs into consideration, low mortgage -to- home- value ratios create tremendous hidden costs that increase the time needed to pay off a mortgage.
Strategy: Choose to incur deductible employment costs rather than non-deductible opportunity costs, since you have no choice but to incur one or the other.
#8. Turbo charge your wealth growth rate by creating homemade wealth.
Myth: Borrowing funds at a particular interest rate, then investing them at the same or lower interest rate, holds no potential growth returns.
Reality: You can earn a tremendous profit-regardless of the relative interest rates-by positioning your money in a tax- favored, interest- compounding investment earns a return greater than the real net cost of obtaining that money.
Strategy: Learn to apply the fundamental principle that highly profitable financial institutions use to accumulate and create wealth-arbitrage. Employ equity to earn a rate of return higher than the net cost of separating that equity. By doing so, you will create tremendous wealth and substantially enhance your net worth.
#9. Strategically refinance your home as often as feasible to increase your net worth and put those idle dollars to work.
Myth: Equity in your home enhances your net worth.
Reality: Equity in your home does not enhance your net worth at all. Separated from your home, however, it has the ability to dramatically enhance your net worth over time.
Strategy: Set the stage to substantially increase your net worth. Refinance your home as often as feasible separate equity and accelerate the process of accumulating the resources to cover all your debts.
#10. Keep your mortgage balance high to sell your home more quickly and for a higher price.
Myth: The amount of equity you have in your home has no bearing on how marketable it is.
Reality: Your home may likely sell much more quickly and for a higher price if it has a high mortgage balance (low equity), rather than a low mortgage or no mortgage balance (high equity), especially in soft real estate markets.
Strategy: Always maintain as high a mortgage (with flexibility) on your home as feasible to keep it marketable at the highest possible price should you want to sell the property.
When I first discovered financial planning concepts like these I was very skeptical. Could these all be true? Well, to be quite honest, I have tried out many of these concepts over the years, and they do, in fact, work. They’re the primary reason I’ve successfully accumulated all the wealth that I have. The idea of utilizing equity in a new, tax-saving, and asset protected way is novel to many to say the least. But, it really comes down to being debt free on your balance sheet. For example, the money can be placed in a conservative investment vehicle, such as an IRA/Retirement Account, insurance policy (no variable rate), or an annuity—see my recent article, “Who’s Your Financial Advisor?” This is true financial freedom, without the lost opportunity cost.
Although my early real estate investing career may have seemed archaic by today’s financial planning strategies, at least I had a plan. I do believe that having a plan, regardless of how advanced, is always the smarter choice than not having one. As John L. Beckley (author, businessman, and founder of Economics Press Inc.) wrote, “most people don’t plan to fail, they fail to plan.”
I’m truly blessed that I was persistent in my quest for knowledge and lucky in my choice of occupations, so as to mature my own financial plan into a significantly better investment plan for the millions of dollars in equity that I have accumulated over the last 25 years.
So, tell me, what’s your favorite plan to get the most out of your equity? What’s your favorite strategy to get that equity RISK off the table and into something safer?