Investing in Residential Real Estate: Achieving Positive Cash Flow

When investing in real estate, it is highly desirable to achieve positive cash flow on a month-to-month basis. This is true even if you are counting on property value appreciation to supply the bulk of your desired return on investment. If you are losing money month-to-month, you may find all of your eventual profits eaten up by the monthly drain on your income. This will be particularly true if there is a downturn in property values for a few years.

Worse yet, you may tire of the monthly outflow of cash, and you may give up on the property before you have a chance to achieve the desired appreciation. You will be much more comfortable waiting for your property to appreciate if you are making at least some money every month, or at least not losing money every month.

One exception to this rule is when you are purchasing a property to fix it up and flip it. While you are fixing it up, you may not be able to rent it out at all (depending on how extensive the work is) or you may have to rent it at reduced rates. The negative cash flow is just part of the expense of rehabilitating the property and will be quickly reversed by your profits upon sale of the property. This assumes that you have properly calculated all of your costs and you have purchased the right property.

In other cases, we think it is wise to achieve positive cash flow, Here are some tricks and ideas involving the financing of the property:

Lower cost properties are generally easier to rent at a profit than higher cost properties. It therefore makes sense to purchase two or three smaller homes than one larger one, if your intention is to rent them out.

If you don’t already own your own home, consider living in the first “investment” property you purchase. (This assumes it is convenient to live in the area where you want to invest.) Interest rates and down payments are lower for a primary residence. Also, you don’t have to deal with the problems of finding and managing tenants, paying for any damage they may cause, and absorbing the cost of an occasional vacancy. This will also give you very valuable experience in dealing with real estate.

If you live in a home for only two out of five years, it probably qualifies as a primary residence from the point of view of the IRS, and therefore appreciation of the property value is probably tax free up to a certain level (for federal income tax). Check with your tax advisor for the exact rules. So one strategy is to purchase a new investment property every couple of years, live in it for the first couple of years, then purchase and move into another property. Rent out the first one while it continues to appreciate. Since you live in each new house for the first few years, you can get a loan at primary residence rates, and you will also have the tax benefits of a primary residence, yet actually own several homes at the same time.

A “second home” (that is, a vacation home) also qualifies for preferential interest rates. You have to be able to state that you live there a portion of each year and you cannot claim rental of the property as income. There are other requirements such as location of the property. If this fits, consider making one of your investment properties a second home. Do check with your lender to be sure you know all the requirements for a home to be considered a second home before you go out and buy one. Note that with a second home, you cannot use any rents your charge as income. You will have to qualify for the loan based upon your income without considering any rental income from the second home.

The easiest and best way to achieve positive cash flow is to get a loan with a ridiculously low interest rate for the first several years. Nowadays, a number of lenders offer “payment option” loans. These loans offer an optional minimum payment that starts with a rate between 1% and 2%, which results in very low monthly payments. As a general rule, these low rates last for about 5 years. During this period, the minimum payment increases year-to-year by a very small amount, usually no more than a factor of 1.075 per year. If you take advantage of the minimum payment, you are actually charged a normal variable interest rate (such as about 4.5% today), but the interest you are not paying is deferred. At the end of the first five years, the interest you have not paid is added to the loan amount, increasing the loan amount by a relatively small amount. Ask your loan officer to calculate the exact amount. At that time, the loan then becomes a standard variable rate loan. This is not a problem because you can assume that property value appreciation will be far larger than the deferred interest. With this plan, you should plan to refinance or sell the property within 5 years, which is commonly not a problem. (Such loans may not be available in all states.)

Another way to minimize monthly interest payments is to obtain an interest-only loan. The interest-only period of most loans is usually 5 to 10 years. You should plan on selling or refinancing by the end of this period.

The interest rate you pay and your eligibility for special loans such as a “payment option” loan is subject to your credit rating, your employment status and the financial reserves (savings) you have on hand. Do everything you can to get your credit scores above average (above 640 and preferably above 680). Make sure you are steadily employed in one profession or engaged in your own business or profession for a period of at least one year steadily, and preferably two, and make sure you can prove it. Extended gaps in employment can make qualifying for a low interest loan much more difficult. Lastly, save up enough to make at least a 10% down payment. This will open the door to better rates.

Payment option loans as described above generally require 20% to 25% down payments. A down payment of 20% or more will also eliminate the need to pay for mortgage insurance. Mortgage insurance is charged by all lenders for loans with less than 20% down payment, even if it is not explicitly stated as such. The extra expense may be built into the rate (as is the case with so-called “sub-prime” or high risk loans), rather than stated separately, but it is there. Mortgage insurance covers the lender against the risk of a default, when there is not enough extra value in the property to pay off the loan and the expenses of foreclosure.

Who Are You? – Protecting Yourself From Identity Theft

In the movie “The Net,” Sandra Bullock played the role of a victim of identity theft. In fact, she was basically erased from the community. Another woman consumed her identity, taking with it everything Sandra Bullock’s character had – including her bank accounts, license and social security number, and even her home. It seems crazy to think this could happen; after all it’s only a movie. But just as fairy tales can come true, so can your worst nightmare. Theft of identity is happening at an alarming rate. Over 100,000 identity theft complaints are filed each year.

Identity thieves work in various ways. One of the most common is to open up a new credit card in your name, using your date of birth and social security number. They rack up charges, don’t pay the bill and the delinquent account is reported on your credit report. They can also change the mailing address so that your credit card will be sent to a false address, giving them more time to make purchases, until you realize there is a problem. They may also establish cellular phone services and bank accounts in your name, making costly phone calls and writing bad checks.

Identity theft today is much more than losing your wallet full of cash. You could lose your entire savings account. Some victims are stuck paying false loans and huge credit card debt. At the very least victims will lose their good credit rating. Most people spend endless hours trying to clear up security and financial problems that arise. This can be costly, time consuming and causes enormous stress to the victim and their family.

Don’t wait to take actions to prevent identity theft. You can be proactive in reducing your chances of becoming a victim using some simple strategies. Don’t put this off – you can do it a little at a time and it’s easier than you think – and the irony, is that other areas of managing your life will be more organized as well! Here are some tips you can do right away.

• Never give out your social security number to anyone – unless the agency requesting it can guarantee confidentiality.

• Take your social security number off your Drivers license and checks.

• Cancel and cut up unused or “extra” credit cards.

• Check your credit card statements for any purchases that seem odd to you – keep track of what you buy!

• Watch your phone bill, cable bill, internet bill, etc., for any increase in charges.

• If your credit card bill is late or you suspect it is lost, call the credit card issuer immediately.

• Check with your creditors on their policy for stolen cards or fraudulently accessed accounts. (You could be liable!)

• Mail bills from the post office or official postal box instead of your home.

• Keep important documents, (passport, birth certificate, stocks, savings accounts), locked in a safe or file drawer.

• Shred old bank and credit card statements, making sure account numbers, passwords, and addresses are unreadable before discarding.

• THINK about what you are throwing in the trash. Assume anyone can and will go through it after it leaves your home!

• Keep a written record or photo copy (locked away) of the contents of your wallet or purse. Don’t carry your wallet with you when it is not necessary.

• Create passwords that make sense to you but are not the usual birth date, anniversary, pet or maiden name.

• Use only web sites that are encrypted and secure and have a privacy policy -before you type in your credit card number.

It is helpful to check your credit report annually as well. You should request this information from all three credit agencies (TransUnion (800) 888-4213; Experian (888) 397-3742; Equifax (800) 685-1111) and verify that the information they give you is correct. In addition, ask these agencies to put a “Fraud Alert” on your account, so that before anyone can borrow money they have to contact you in person.

Unfortunately, even with extra effort, identity theft can still happen. We trust total strangers with our personal information everyday – applying for a car loan or mortgage – writing a check – patient care at a hospital – even stamped on our children’s back pack! It would be ludicrous for us not to give out this information from time to time, but knowing where we give it out and to whom is helpful. The key to quick recovery from such a disaster is to notice it quickly and take immediate action. Here’s what to do if you think you may be a victim of this crime: