What Causes Mortgage Rates To Change?

Posted on July 8, 2006 by Nirav

I’m on a lot of mailing lists, which usually get sold and result in my getting a ton of spam. Most of it is effectively filtered out, but sometimes “relevant spam” filters through. Here’s an interesting example from a mortgage company.

Did you know that one or more rate changes per day is normal? Most people do not know that. Rate quotes can easily change when you call back later that same day. In the lending business, a rate change can also include a change in the point cost for the same rate. In other words, a rate can be no points in the morning, then later that day cost ¼ point. That is a rate change to lenders. Did you also know that regular fixed mortgage rates are not directly affected by what the Fed chairman Ben Bernanke does?

Mortgage rates change primarily based on:
1) the perception of inflation,
2) times of uncertainty and
3) the movement of money in and out of the stock market–that’s it.

When a piece of news shows weakness or uncertainty in the economy, that helps rates fall. The opposite is also true. A drop in the unemployment rate, a rise in durable goods orders, a rise in the consumer confidence index–rates go up.

These influencing factors can present themselves all the time, many without warning, affecting mortgage rates instantly. There is no “delay”. It doesn’t take time to “filter down” like some people think. Reading the paper for quotes doesn’t really work because the information is old by the time you read it. Radio, TV and billboards are not the answer because the details are always missing. They just want to get you on the phone. Competitive lenders can deliver nearly identical rates to each other. Most borrowers don’t ask the right questions and focus only on the interest rate. A professional will always be competitive and deliver what is promised.

To really know about your mortgage I strongly recommend How to Save Thousands of Dollars on Your Home Mortgage. My dog-eared copy is currently vacationing in Egypt with a friend. Its not difficult to understand and is a great resource.

Real Estate and Taxes

Posted on May 16, 2006 by Nirav

No one likes paying taxes, especially not real estate investors. Luckily, congress has been kind and offered a lot of tax breaks. Whenever you make a profit in real estate, there’s usually a way to avoid or atleast defer paying taxes.

The most well-known tax break is the 121 home owners exclusion. If you live in your property for 2 years[or 2 out of the past 5 years] you get to exclude 250k if you’re single and 500k if you’re married from your taxable income.

If you own investment real estate you cannot take advantage of this. Unless you move into it and live there for a full 5 years.

however, there are several ways to get around paying taxes on investment real
estate.

Just pay the tax. long term is 15% fed and whatever your state tax is[max in CA is almost 10%]. If you already have several homes which you can depreciate and thereby create phantom losses, you can offset this passive gain through these passive losses.[You can deduct upto $25k of passive losses against regular income. If you have more, it gets carried forward until you have a passive gain to offset it against].
Do a 1031 exchange to defer paying taxes on the sale.
Put the proceeds from a sale into a Passive Annuity Trust.
Buy and sell your property through a corporation. When you realize a profit, some of it can be expensed out and the rest can distrubuted as salary and used to fund a corporate 401k-pension plan [subject to approximately 15.5% tax]. This is good for short-term flips which would normally be clubbed with your regular income and subject to the maximum tax rate. The disadvantage with this is that you lose the ability to depreciate the losses against your regular income, although you can against corporate profits.[Atleast you do in a C-Corp. Not sure about S-Corp]
Once you have money in your corporate 401k-pension plan, buy and sell property in it. This avoids taxation. This allows loses the ability to write off depreciation losses against regular income.
Never sell the property. Just refinance it to pull out cash tax-free if you need it. When you eventually die, its passed on to your heirs at a stepped-up basis and they don’t pay taxes on it either!
Invest the money in a working interest in an oil well. If set up as a real estate transaction you can do a 1031 exchange. Or they can be set up to give you a 90% write-off in the first year. [However, the deals that are set up to be tax advantageous have a higher premium, losing the benefit of not paying taxes].

Real Estate provides some of the best tax-advantageous investments available. Buy your investment real estate today!

These rules are neither complete nor may they pertain to your particular situation. Infact, they could be blatantly wrong or out-dated. Also, I’d like to stress i’m not a CPA so please consult your advisor before following any of my advice.

How Do 1031 Exchanges Work – Part I

Posted on December 18, 2005 by Nirav

Two of my investor friends told me they were going to ask me about 1031 exchanges. Rather than give them the same spiel, its just easier I wrote my own opinions here so I never have to repeat myself! Since its a long topic I’ll break it down into a few different posts.

What is a 1031 exchange?
Its a means by which you can sell or exchange property and defer paying taxes. Deferring your taxes is a good thing. It allows you to grow you money at a faster rate.

What sort of property qualifies for a 1031?
Any property held as an investment is eligible. Most CPAs will tell you that you need to demonstrate an intent to hold the property as an investment and ideally you want to hold it for atleast 12 months.[some even say 18 months]. Short term flips do not qualify. Apparently the IRS doesn’t equate speculation with investment.

What can I exchange my property for?
You can exchange your property for like-kind property. If you own property you can exchange it for any other kind of property and oil royalties too. However livestock and vehicles are covered under this rule too and you can’t exchange your cows for an airplane or a tractor for land. However within the scope of real estate, land for apartment buildings, SFHs for oil wells and even lease-hold property for fee-simple property is allowed. A lot of investors are cashing out there investments and are investing in tenants-in-common commercial buildings. They 1031 into larger investments with a bunch of other investors and get a fixed rate of return[usually 6-11%]. They essentially exchange management headaches for a fixed rate of return.[More info on that in another post].

What are the steps involved in setting up a 1031 exchange?

You need a qualified intermidary, also called an accomodator. You must not receive any money from the sale of the property. It has to be held by the accomodator. He takes possession of the proceeds from the sale of your property, uses the funds to purchase the new property, then transfers title of the property to you.
You have 45 days from close of escrow to identify the replacement property. You should start looking much earlier than that but you need to give written proof to your accomodator of your selections.
Close on the purchases within 180 days from the sale of the original property, or before you file your tax return. If you sell you original property on December 31st, you have until April 15th to close on the replacement, unless you file an extension.

It gets a lot more complicated than these simple steps. There are rules for mortgage amounts and total property amounts, partial exchanges and taxes owed on boot[the amount that you’ve withdrawn].

One of the funny things is that any equity you put down during the original purchase of the house is locked into the exchange. If you pull that out during the exchange it will be considered boot and you will have to pay tax on that money. One way to get around this is to refinance the house a year before you plan on doing a 1031 and pulling your equity out. Alternatively, you could complete your exchange and then refinance the property to pull your equity out.

Its getting late, more on 1031 exchanges later.

Understanding Real Estate Market Cycles and How To Invest Based On Your Own Research

Posted on October 10, 2005 by Nirav

A lot of people have been asking me how I do my research for places to invest in. Here’s my attempt to explain the process.

It started when I sold my home and was wondering where to invest the proceeds. I moved into a condo that had previously been a rental so I didn’t need any of the money to buy a primary residence. I thought that California was overpriced and I definitely wanted to invest out of state.

I spent a lot of time and money reading books and proprietary reports about market cycles, its causes and effects. One great book is Bruce Norris’s California Countdown. I found out the periodically the California market experiences a rapid run-up in pricing, then it crashes, stagnates, and then rises again. As housing becomes less and less affordable, people start to migrate to neighboring states.

How do you know people are starting to migrate out of your city witout waiting for the 2008 census? You can see these trends through the Unofficial Migration Indicator at www.uhaul.com. Check out the cost of a one-way rental for any given city and any other city. Let’s consider the cost of renting a small truck between San Diego, CA and Phoenix, AZ. It cost $225 to rent to from San Diego to Phoenix but only $101 to bring it back! This means that there are probably twice as many people moving out of San Diego and into Phoenix than the other way around. This is basic supply and demand. So you want to make sure that the price is constant both ways or in your favor.

You can also check out population and job growth trends at a variety of different websites, but don’t always assume the given data is correct. You can get data at cities chambers of commerce sites or by google searches.
here are some useful links:
city-data.com
US Census Bureau
Milken Institute

I also found out that whenever prices in neighboring states start to rise, California property prices have started to peak . This is because at the top of the cycle Californians can’t afford to live here anymore and they start moving out of California and into places where housing is more affordable. Eventually as these places begin to rise and CA prices begin to drop, the lure of California becomes irrestible and the cycle starts all over again. Accordingly, there are states that
1) follow an opposite cycle from Calfornia [contrarian states]
2) follow a similar cycle to California
3) states that do nothing or do their own thing.

Contrarian states are states like Arizona, Oregon, Utah, Colorado,etc
Similar states are Connecticut, Florida, Maryland, Nevada, New Hampshire, etc
Limited movement states are Alaska, Arkansas, Idaho,Indiana, the Carolinas and Dakotas, Ohio,etc.

Each state behaves differently so don’t take this as gospel. Do your due diligence.

Look at prospective states or cities and find out how they’ve done historically. I looked at several states before I settled on Utah.
AZ – already too much appreciation in the residential market. I had missed the boat. vacancies are sky-high. commercial still seems good.
TX – It really hasn’t done anything exciting in the past 25 yrs. its a safe place to park money. plus the 3% property tax kills your cashflow.
NM – its looks like a safe place to park your money. a few people I know used to live there and said the local government was not pro-biz.
FL – too late to the party. plus 2% property tax. i had bought 2 pre-construction houses there in early 2004, but the builder had gone under, so I basically lost out on several months of appreciation.
WA – mainly looked at seattle since i went there in july 2004. local economy not
diverse enough for my liking. only 2 main biz – starbucks and microsoft. although the projected job growth is there, the salaries still seem low compared to the house prices/rents.
NY – looked at upstate new york. property tax is over 5%. job growth and population growth are both negative. good cashflow but i’ll wait for the indicators to turn before venturing into this territory.
UT – finally something i like! Positive job and population growth. The market was been flat for several years and had just started to perk up. saw 6.5% avg appreciation state-wide last year – that made front page news!!! govenor is pro-biz (he would be, he’s the son of a billionaire!). SLC is land locked. There’s limited land, always a good sign. Saint George is a hot market too. Also, Utah follows an opposite cycle from california. During the last cycle between 1993 and 1997, Utah saw a 64% appreciation, while California saw only 3%. Between 1999 and 2004, while Southern California saw a 125% gain, Utah saw less than 5%.

In 2003 Utah was 49th in the country in terms of appreciation, beating only Texas. However in 2004, it jumped to the 36th spot. Between 2001 and 2003, Utah saw 21 months of zero or negative job growth, which is why prices didn’t boom in a low interest rate period. 6 months ago, it was 2nd in the nation in terms of job growth (3.7%) lagging only behind Nevada. Since the beginning of 2005, the unemployment rate has been lower than the national average.

Utah also has the nation’s highest birth rates and life expectancy. Over the next 25 years, its estimated that the population will grow between 58 and 75% making it the 5th fastest growing state.

At this point I stopped looking for places to invest and started looking for deals and a team. [feel free to email me for contacts and I’ll hook you up with them]. I also tied up with local builders and developers. I booked several pre-construction homes there and have already closed on 5 of them. I just bought another lot there next to Lake Utah with a build-out time of 12 months. Some of them have gone up 10-20% since the time i’ve booked them.

It definitely pays to do your own research!

Living off dividends [or how to invest in Real Estate for cashflow]

Posted on October 4, 2005 by Nirav

While surfing onlne, I came across this blog post: Real Estate as an asset class.

Basically this guy wants to be able to live off his dividends at some point and his blog is devoted to that. He’s wondering how real estate fits in. He invests in REITS but isn’t too sure about actual investing in Real Estate.

Well here’s the skinny on investing in Real Estate for cashflow.

You definitely want to buy in an area thats reasonably priced.

How do you define reasonable? As a rule of thumb, the monthly rents are 1% or higher of the purchase price. for example, if you’re buying a $90,000 house and the rent is $900 per month or more, thats a reasonable price.
You want to make sure that after paying for property management, utilities, taxes, insurance and maintenance the rent still covers the mortgage. You may need to learn how to do this. I strongly recommend reading What every Investor Needs to Know About Cashflow.
Make sure you figure out the return on investment, or as I like to call it, the Cash on Cash return. for example, if you put down $5,000 and cashflow $125/mo, thats an annualized return of 30%. These are actual figures.I’ve also done better. It sure beats the stock market!
Make sure your know how to get the best mortgage for your goals. I recommend this excellent book: How to Save Thousands of Dollars on Your Home Mortgage

Make sure you’re making atleast $125 over your expenses or you’ll be negative on the cashflow. I usually want atleast 16% cash on cash return for properties that are in appreciating states like Utah. If there in states which dont experience much appreciation I shoot for atleast 30% Cash on Cash, which isn’t difficult to get at all.

here’s an example:
I invested 4.5k to purchase a 90k 3/2/2 house in a city in the midwest.(4.5k is 5%. i added in closing costs to price which the seller paid)

monthly rent = $945 (1050 less a 10% vacancy)
mortgage payment = $517.5(1st at 6.5% interest only and second at 8.5% interest only)
taxes = $120
maintence = $50
property mgmt = $110 (i’m generous)
insurance = $40

cashflow = $147.5
annual cashflow = $1,770
Cash on cash return = 44% (thats 1.770/4,500*100)

Note, this is a theoretical cash on cash scenario. Often times, significant vacancies or repairs will trash these numbers. Make sure you don’t over-leverage and have sufficient reserve funds.

A lot of people think dealing with tenants is stressful. It is. Thats why you don’t want to be cheap. Always hire competent property management. You should still cashflow after including this expense.

How I Started Investing In Real Estate

Posted on September 29, 2005 by Nirav

In September 2000 i caught the flu and while I was probably well enough to go to work, I decided to take a week off and relax. I spent a whole week sitting in Barnes and Nobles reading all sorts of business and investing books.

That week I read the Rich Dad Poor Dad and it got me thinking about how to achieve financial independence. At the time I was fresh from being slaughtered in the stock market crash, had $3k in savings, $25k car loan and $8.5k on credit cards. [luckily the credit card APR was 0% for life]. But I was getting married in a few months and didn’t really do anything about it.

A month after I got married, I realized that if I was ever to buy any real estate in the San Diego market I needed to get in quickly, before it escalated beyond my reach. I got an FHA loan for where I only had to put down 3%. along with some closing costs I needed 6k and i needed 4k to pay off some off one of the credit cards. I borrowed the 6k from a close friend and my wife’s aunt. Luckily I was able to pay them off within 4 months from my tax refund.

In October 2001 I lost my job directly due to the attacks on the World Trade Center. I was unemployed for 4 months and it sucked! I vowed I’d start working on becoming financially free. In Feb 2002 I finally found a job and revisited the Rich Dad books. Kiyosaki makes a great story but he’s low on ideas for actual implementation. I then spent the next several months reading probably a hundred books on investing. It was at this time I learnt about real estate investing and the power of leverage. I joined the local real estate investment club and I’ve been going somewhat regularly ever since. In August 2002, I refinanced my condo and pulled out $20k to pay off my remaining car loan and credit card debt. It cost me around $3.5k to refinance but I’ve been debt free ever since!

I spent the next several months looking at deals. I found a few stellar deals and not having enough money to pull it off myself, I tried to rope in my friends. But nothing worked out. I just didn’t have the power to convince them. Long story short, I decided to go my own way. I bought another condo in the same complex where I lived in July 2003. it was a full $100k more than the first one I bought 2 years earlier, but i was pretty sure that it would still go up another $55k in the next 12 months. I bought it 100% financed with 4.5k in closing costs. I rented it out and I was $100 negative per month. actually only $50, if you consider i rented it out 2 weeks before i had a payment due.

Six months later i bought a small rental house in Victorville, California. I rented it out under the section 8 program. The government paid $629 of the rent. the tenant was supposed to pay another $389 but he only paid every 2nd or 3rd month. My payments were only $550 so I was still cashflowing.

In July 2004 I sold my original condo for twice what i originally paid for it and moved into the rental close by. Now i had so much money, I didnt know what to do. I definitely didnt want to buy anything else in CA. So I did a lot of research about real estate market cycles and correlations between CA prices and prices in other states. I found there was a correlation but thats enough data for another post. Anyway I decided that I was going to invest in Salt Lake City, Utah. Based on my study of historical price trends, I predicted that SLC was going to experience a boom in the housing prices and they would jump atleast 50% over the next 4 years. Incidentally this optimism wasn’t shared by anyone else, including the agents I worked with in Utah!. It’s always good to be the first person in an a good investment.

In November I both 2 houses for around $215k including closing costs. I decided to do Lease-Options so i could get better cashflow. Over the next several months I booked several more, some of which have already closed. Seeing the way the markets jumped this year, I’ve decided against doing anymore lease-options. One of the tenants is currently exercising his option after only 4 months!!!

In July 2005 I sold the rental condo that I moved into, for $70k over what i paid for it after living in it for 12 months. I’m actually renting it back from the buyer and she’s actually negative several hundred dollars every month. thank god i’m not in the business of subsidizing my tenants!

In august 2005 i also sold the house in Victoville netting around 75K in profit. its part of a 1031 exchange which i’m using to buy 2 more homes in Salt Lake City.

In July I booked 5 homes in Boise, Idaho in partnership with my friends. I get 50% of the profit but the downpayment is coming out of my Corporate pension plan while my friends are using their credit for the rest. They’ve gone up 50-60k since then and they still haven’t been built out. We plan to flip at closing. lets see how that works out.

So thats the story so far. send me your comments about how you guys started.

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