Archive for June, 2011
If you’ve read any of my previous articles you most likely know by now that I am a big fan of hard assets. Precious metals are hard assets yet buying physical gold and silver is not an investment! It is simply a wise move to help you and your family maintain your purchasing power when the government devalues the currency (and there’s sure plenty of that going on today!) Keeping dollars in the bank (any bank) today is like putting your money under the mattress (some think it’s actually worse than that).
Real Estate is a hard asset however it may or may not represent a true investment. For years people who owned their own homes considered their residences an investment. Sure, it may have been the “cash cow” for the years prior to the economic Bust when real estate inflationary value was out of control. What most people called “property appreciation” the classic (not modern) economists were calling “a Boom in the making”. It makes me think of a client of mine, a formerly very successful builder, that was telling me how only a few years ago he was worth millions of dollars. Not anymore! His was simply an “artificial prosperity”. Artificial prosperity is created fast (usually during an economic boom) and lost as fast (usually during an economic bust).
Should you decide to invest in real estate take notice that your personal residence is not an investment. Your home is not generating an income for you…unless you own and live in a duplex, triplex, or any other kind of multi-family and you collect rents from your tenants. A real estate investment could be a house, an apartment complex, or a commercial property that provides a monthly cash flow for you. Nowadays I come across plenty of investors who prefer the small residential properties or apartment complexes. This type of investment satisfies one of the requirements for what I call “healthy investment” criteria. It’s a hard asset that provides housing to those who have no ability to own their personal home or have no desire to take on such a responsibility. In addition, there is a large influx of newly evicted homeowners which will most likely go up as more defaults are scheduled to occur in the next few years on the 5 and 7-year Option ARM loans (these loans are due to reset at higher monthly payments and had a negative amortization to start with.)
So, if you are a novice at this kind of investing, how do you determine in a few minutes if a particular property is an opportunity worth further investigation? Following are some of the things that I look at when evaluating a real estate investment.
1. The local economy. First of all let me just say that it doesn’t have to be a big city. I say that because you can invest in a metropolitan area with a large percentage of its population that is unemployed. So what good does it do to you to buy real estate at a bargain price in an area where people can’t afford the rent? Familiarize yourself with the local economy by doing research on the city’s unemployment, major employers, recent news, and crime statistics.
2. Condition of the property. There are four kinds that I can think of: fully renovated, average, poor, and dilapidated. The first kind is self-explanatory and after an inspection you can probably be assured that for the next 3-5 years no major repairs should be required. The average condition is what a thorough inspection should disclose: the work and its estimated cost during the next 5 years. The poor condition is the type where you accurately need to estimate a full rehabilitation; and the dilapidated is the kind that you buy to bulldoze off and rebuild from ground up. This is the case where you ought to know the value is only in land and there may be a while until it can provide you with cash flowing revenues. It takes time, building permits, and lots of headaches. Beside that the prospect of financing the construction is extremely limited at this time.
3. Return on Investment. I saved this for last because this is very important and it needs to be elaborated in more detail. This formula is based on the total amount of money invested and it differs between an all-cash transaction and one where leverage is involved. An all cash transaction will show a lower ROI rate than when leveraged but there are benefits that may offset the lower rate. The two that come to mind are the peace of mind that you own the property free and clear, and eliminating the interest you’d pay on the mortgage.
The way to calculate the ROI is by first subtracting the annual Operating Expenses OE (current and/or projected) and the vacancy factor VAC (5 – 10%) from the total annual rental income (GSI for Gross Scheduled Income). This first calculation determines the Net Operating Income (NOI). Once you have this figure you divide it by the total Purchase Price(PP) and the result is the ROI also known as Capitalization Rate (CAP Rate) in the commercial sector.
GSI – OE = NOI
NOI / PP = ROI or CAP Rate
As an example let’s say you purchase a property for $100,000. The annual rental income is $15,000 and all expenses are $5,000.
$15,000 (GSI) – $5,000 (OE) = $10,000(NOI)
$10,000(NOI) / $100,000 (PP) = 10% ROI or CAP Rate
Since there is no mortgage in this case the property’s NOI represents the annual cash flow. In ten years, Ceteris Paribus, this investment would be fully recouped. In other words based on a $10,000 annual cash flow it would take 10 years to fully recoup your original $100,000 investment. ($100,000 / $10,000 = 10 years.)
If financing is involved things change because you don’t invest your entire $100,000 and you’ll make mortgage payments. In this case here are the formulas you want to use.
GIS – OE = NOI
NOI – DS = Cash Flow
NOI / Capital Invested = ROI
Remember these are all calculated on an annual basis. The Debt Service(DS) is the monthly P&I (Principal & Interest) on the loan multiplied by 12 months. The Capital Invested is the down payment plus all other costs that you invested from your own pocket (such as the cost to renovate). In our previous example if the property was already renovated and if the down payment was 30% of the purchase price here is how the figures would look like.
$15,000(GSI) – $5,000 (OE) = $10,000(NOI)
$10,000(NOI)- $5,700(DS) = $4,300(Cash Flow)
$4,300(Cash Flow) / $30,000(Capital Invested) = 14.3% ROI
The DS was calculated based on a loan starting balance of $70,000 amortized over 25 years at an annual rate of 6.5%. In this case it should take you about 7 years to recoup your investment ($30,000 / $4,300). However, by using financing the property won’t be free and clear until the loan is paid off. After seven years you’ll still have about 18 years of mortgage payments (if you make the minimum required payments.)
What I have just described is a quick way to determine if an investment is worth exploring. If a preliminary ROI is at 8, 10, 12 or higher percentage, and if the other two criteria look good in your eyes it is possible that such a real estate investment may be a good opportunity. Also, because the ROI is higher when financing is used many investors prefer to leverage their investment when they have the ability to do so. One reason is that the $100,000 used to acquire just one property in an all-cash scenario could be used to buy two or more properties when loans are secured. And because many real estate investors view their investments as long-term the end goal is what prevails, and that is the number of properties $100,000 can buy today.
“The potential right now, right here, right at this point for an error in judgment that would set off a loss of confidence is present, clear, and in all probability something that we are going to be facing well into the summer,” Sinclair says. “This is as serious as it gets. … This has gone so far that there is no solution that can be applied and the only practical method is to continue to expand the Fed’s monetary aggregates to continue to hold down interest rates. And hopefully kicking the can down the road until somebody else is in charge — and that’s exactly what they are doing.”
Sinclair adds that if you let go of your gold now, “You are out of your mind.” You can find an excerpt from his interview with King World News here:
Between Feb. 18th and March 12th 2011, the price of oil surged 17% to $101/Barrel. It went as high as $115/Barrel and is around $100/Barrel now! Many are predicting it will soon reach $150/Barrel. When inflation takes off, as many are predicting because of the Fed’s commitment to print, print, print as much money as it takes to keep the economy from sinking now, it is anybody’s guess how high it will go in terms of dollars.
The World’s thirst for energy/oil is rapidly increasing. Much of the
rise in consumption is coming from China and India. See chart below:
So how can you take a position in this commodity where demand is increasing
exponentially and create wealth for you and your family? There is a way that you
can easily realize large profits in a short period of time. It is investing in a new
technology high output horizontally drilled oil & gas well that is a couple of months
away from full production.
With an investment of only $46,875 you own 1% of the wells production, which is
projected to conservatively be 250 Barrels of Oil per day and 800 mcf of gas per
day. Based on today’s oil and gas prices, this would give you a net monthly income
of over $6,000. Your first check would be in three to four months and would continue
month after month for 10, 15 or more years.
Perfect for your self-directed IRA’s and 401K’s. This is a great retirement program!!!
A major benefit of this investment is that it will give you a significant level of financial
security as Americans face an uncertain future because of the unprecedented
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Growing up in a communist regime where food and just about everything was rationed instilled in me a constant need for survival. My parents were always preoccupied with having enough food to feed the family. Whenever they had the opportunity to get anything classified as “life necessity” they would make sure they’d stock as much as they were allowed. That was of course a while back… about 30 some years ago. Being an American for more than two decades however didn’t change much in the way I think despite the abundance that our country had experienced during all this time.
I talk to people everyday and few appear to be concerned with the future. For many it’s still business as usual. Yes, food prices have gone up and so is gasoline but the concept of fiat money or a currency collapse is not really a concern.
So, let’s start with the emerging countries. Brazil, China, India, Russia are working on a plan to trade in currency other than the dollar. What that means for us here in the U.S. is that our dollar will soon not be in demand. Not long ago the Chinese government declared that it intends to strengthen the Yuan to the level of the world reserve currency. The Chinese government and people have been quite busy during the past few years buying gold. That may very well lead to a yuan currency backed by gold and gold is indeed real money. I clearly see a rising of the East and a decline of the West.
The idea that the roles between the East and the West could reverse is not far-fetched. When the Chinese people were working numerous hours for little wages in what could be known as “slave conditions” they were indirectly providing the West – including the U.S. – with a high standard of living. They were the producers and we were the consumers. Our purchasing power was phenomenal as a result of a powerful (petro)dollar and the Chinese products that were manufactured at a very low cost. After all these years of hard work at minimal wages Chinese standard of living has already started a major improvement. I see both, literally and figuratively, gold on their horizon. A nation of producers and savers, the birth of a sound currency with a strength that comes with the world’s reserve status, these events can all be “threatening’ to the American way of life.
Then we have a government that is spending like there is no tomorrow. The Central Bank in cooperation with most of the politicians have diluted the dollar to the point of no return. Take a glass of a good old scotch and throw it in the ocean…the strength and quality of the scotch are gone. That’s exactly how our beloved dollar is dissipating in an ocean of Quantitative Easing. The dollar is during its last breath and when it dies drastic changes will occur. It’s hard for many to comprehend such an “absurd” idea of living through an economic depression, or that a loaf of bread or a gallon of gas could cost $50 or more. I don’t know of any people who think incomes will go up at the same rate as the prices of goods. That would – for sure – be a naive thought. But advancement in technology does not necessarily imply a societal or economic advancement. The pendulum is moving from our part of the world and a few smart Americans have already made the steps to preserve their hard earned assets.
So, how do you keep your dollars from being stolen through inflation? A few smart people convert their dollars to real money such as gold and silver. Ron Paul, the biggest advocate of sound money, in his book Pillars of Prosperity claims that buying precious metals is not an investment but a requirement of asset preservation. Statistics of American investments in gold show an astonishing 0.6% of all financial assets investments. This does not come as surprising to those who know that the 1980’s was the beginning of Wall Street “manufacturing” a myriad of paper assets.
I also believe in investing in tangible assets such as real estate. Of course, not every real estate deal qualifies for a good investment. First, the price must be right. During the credit boom era price was not anymore an issue. Most buyers were assured price would go up and terms were more important. Not so anymore. The lending industry has gone through a major shift in the underwriting and qualifications criteria. Today, it’s either cash or the borrower and the transaction must be very strong. Going back to pricing, I say price must be right so that it’s low enough where investors can benefit from steady and large enough monthly cash-flow (after all expenses are paid.)
The type of real estate is also key to a successful investment. There are two kinds that I find exceptional. One is the multi-family real estate, you know the apartment complexes. The CNNMoney 2011 Spring Housing Guide predicts the rents to go up much higher and in a relatively short period of time, thus they are alerting renters to lock in their leases. Demand is up, supply is down…all thanks to the banks that are unwilling to negotiate a decent loan modification and are sitting on millions of vacant foreclosed houses while keeping their prices at unrealistically high levels.
Second type is the Assisted Living Facility (ALF), again the result of high demand and short supply. The aging population is becoming less independent and more dependent on a facility that is equipped with the right staff and living conditions, and so far for many residents money has not been an issue. They are willing to pay so long as they are well taken care of. This kind of investment could be a potential cash cow when purchased in the right area, at the right price, and operated by the right team.
If leverage is needed I found that lenders are much friendlier and more willing to lend on these kind of real estate transactions. After all valuation of such kind is based on the occupancy (and these tend to have higher occupancy rates in many areas) and Net Operating Income (again these tend to have a higher NOI). One of the qualifications of a good investment is that it is an asset that satisfies one or more human needs and with these types of real estate it is obvious that it satisfies the housing need.
Lenders also know that these two particular investments if managed and operated properly they have the potential to generate substantial revenues for its owners not only during good times but also and especially during rough economic times. That’s another reason they have more money to lend on these kinds in comparison to a shopping center whose tenant retailers are suffering due to revenue drops. This is what my experience had taught me and I am eager to share with all of you.
Can we fix the economic problems that our beloved country is going through? Certainly not, as we can’t make most politicians become honest. But I believe that by taking responsibility of our own future individually there will be less people hurt and fewer negative statistics. And I am all for it!
James Turk of the GoldMoney Foundation speaks about currency devaluation and the rising gold price. How the gold price is rising against all major currencies and monetary policy is political, having abandoned all pretense of seeking monetary stability. He warns of the dangers of a hyper-inflationary crisis. James also explains why gold should be considered money and not an investment.
He also talks of the coming dollar collapse and the waterfall decline in the dollar, especially since Ben Bernanke’s words on QE. He talks of different examples of hyperinflation from paper money hyperinflation in Weimar Germany to deposit currency hyperinflation in Argentina. The presentation was held on 29 April 2011 in Munich, Germany and you can watch the 15 min. presentation right here…
In today’s economy, one thing is guaranteed. The world is attempting to ditch the US dollar as the reserve currency and keeping your money in CDs and money market accounts is straight forward unsafe. For decades savers and investors found it safe to keep their money parked with their banks however the current near zero rates of interest and volatility of the U.S. dollar are justified reasons that compel more folks to find better investment strategies for their money. That’s why many investors start looking for investments which keep up with inflation (real estate, gold/silver, commodities, and certain foreign currencies and stocks.)
If Real Estate investing has been on your mind but aren’t sure where to invest, how to find the best deals or how to properly evaluate one, you may want to explore the opportunity of a passive way to invest in a Syndicated Real Estate Fund. A real estate syndicate is simply a group of investors who pool their money to purchase real estate. By pooling their money together these investors are able to purchase larger real estate properties with or without bank financing. This method of real estate investing has been a popular method of financing the purchase and sale of commercial properties such as shopping centers, office buildings and warehouses.
Private Real Estate syndicates raise funds through a private placement which is a security – an ownership interest in a company that owns and operates investment real estate. Unlike the REITs (Real Estate Investment Trusts), these investment vehicles are not publicly traded and are not priced to market on a daily basis. While REITs may have high dividend returns their publicly traded shares are subject to a significant degree of price volatility, an event less likely to occur with private syndicated funds.
Many real estate syndicates are offered as private placements, so it is important for you to understand the process and risk factors related to private placements. One of the most common risk is that the underlying investment is real estate, as a result these investments may be less liquid than shares in a REIT; when time comes the fund may be unable to sell the real property at a high enough price to generate the expected profits; or outside factors such as a further deterioration of the economy might negate the value added through rehabilitation work. Then, there is that uncertainty of unforeseen future expenses, taxes, and liability, all of which being typical real estate issues that seasoned investors are familiar with. My recommendation is that you thoroughly evaluate the risks directly from the private placement memorandum.
Syndicated real estate funds are carefully crafted by using the expertise of attorneys, accountants, contractors, investment bankers, mortgage bankers, and real estate brokers. They are structured in form of a partnership agreement or limited liability company (LLC), whose code of ethics requires full disclosure of all material facts. To further determine whether this kind of investment is for you, you’ll want to find out the experience and accomplishments of all directors and managers, the minimum required investment, the time-frame of your investment, and the potential annual return and capital gains on your money.
What I found enticing is the fact that one can invest in a private real estate syndicate by using his retirement account (IRA). A self-directed IRA is a unique hybrid tool that uses a self-directed IRA custodian and a specialized legal structure. Investments made with a self-directed IRA may grow untaxed provided the income generated is passive income.
Some other potential benefits associated with investments in these funds are:
- Gaining net spendable cash flow through a passive investment. Owning real estate individually requires skills in assessing property values, negotiating purchase agreements, financing, negotiating leases and managing the property. An investor in such a fund has access to a group that has proven knowledge and experience to deal with all aspects of real estate.
- Achieving a higher yield by investing in larger and more profitable properties. By pooling the funds of a number of investors, real estate syndicates can achieve overall better returns when compared to many individual investors.
- Taking advantage of the distressed commercial real estate market by using the expertise of vulture investors.
- Hedging against Inflation. Because inflation erodes the value of hard earned money and reduces the individual purchasing power, investment diversification in tangible assets may potentially represent a more desirable way to maintain your current living standard.
- Potential profit from property appreciation. Commercial real estate value is determined by its level of stabilization. High occupancy rates, stable revenues, carefully assessed expenses, and experienced property managers overall largely contribute to the increase in value.
- Favorable tax treatment. Check with your tax adviser regarding tax savings on private real estate syndicates which may not be available when investing in a public company.
- Various Investment Positions. As an investor, you can choose from a variety of positions that best suits your investment requirements.
Overall I still think it’s a smart move to diversify your investment portfolio with a hard asset such as real estate. But no matter what you invest in keep in mind that a “healthy investment” is the kind that…
- generates substantial revenues for you during good times and bad times;
- is made out of real assets that don’t vanish;
- does not lose its earnings potential with time;
- maintains its capital value;
- keeps up with inflation;
- is made out of assets that satisfy one or more human needs (housing, food, energy);
- can be passed on to your heirs and generate passive income for them.
Finally, if you’re seriously considering placing a chunk of your money into such a fund don’t forget to ask the hard questions such as if the managers and directors are investing their own money in the fund; how can you verify that the company is real and not a hoax; what could go wrong and if it does what happens to your investment. Use common sense and your own instinct, learn as much as you can, make decisions, and act on them quickly so that when the economic dust finally settles, your egg nest will still be there, intact and unharmed.
Contact me if you think investing in a Private Real Estate Fund is for you.