This article was published on: 08/01/2003
FEATURE: How to Achieve Financial Freedom
This article was published on: 08/01/2003
FEATURE: How to Achieve Financial Freedom
Freedom for family
Developing freedom
Hitting the right notes
Think lien
Number of rental homes1 you’ll need to finance
8 Tips from today’s top authors
5 Tips on becoming an investor
5 Tips for making commercial investments
BY MARIWYN EVANS
Let your real estate investments do the work.
A villa on a Greek isle. Retiring securely at 60. Sending your child to Harvard. A Rolls Royce Phantom. Whatever image appears when you hear the words “financial freedom,” you probably already realize that investing in real estate is one of the best ways to get there. Provisions of the new tax law that cut capital gains taxes and temporarily boost leasehold improvement depreciation make real estate a even better proposition. Why should your clients get all the profits?
“No other investment increases net worth like real estate,” says Doug Richards, CCIM, CRS®, of Coldwell Banker Commercial NRT, Salt Lake City. “If you put your money in the stock market, at some point, you’ll have to sell and your net worth will go down. With real estate, you can live off the cash flow. And you still own the asset,” says Richards, who teaches the Council of Residential Specialists course “Creating Wealth Through Residential Real Estate Investment.”
Fellow instructor Marcie Roggow, CRB, CCIM, owner of Creative Learning Concepts in Sioux Falls, S.D., sees a comfortable retirement as the ultimate in financial freedom. “I’ve done my projections to see what income stream I’ll need from my rental properties to net me $80,000 to $100,000 a year,” she says. “I’m building equity now so that when I retire, all the properties will be paid off.”
Like her investing goals, Roggow’s real estate buying strategy is a classic. She looks for solidly built homes, duplexes, and fourplexes from the 1940s and 1950s, homes with “good bones” that she can improve with sweat equity. If more extensive repairs are needed, she looks to the seller to get cash back in the deal. “I want a property to have enough appreciation potential so that it returns my initial cash investment within two years.”
Roggow learned the hard way to stick with investing in property types she knows. She had been planning to retire at 55 and owned enough real estate to accomplish her goals when a friend talked her into borrowing against her equity to become a partner in a commercial development. When the property failed, she lost her portfolio, delaying her retirement date.
Good deals can be anywhere, says Roggow, although she’s found that if you’re experienced enough to accurately estimate your costs and your rental income potential, auctions are a good option. “Last summer, I went to an auction to buy a Waterford vase. I ended up buying the home for $82,000, refinishing the floors, and painting it. Within a month, it was worth $95,000. One year later, it was worth $100,000,” she says. “And I got the Waterford vase for $12.”
If you’re planning to buy at auction, check the wiring and the plumbing—the two most costly items to replace, she says.
Freedom for family
At 40, Don Magalhaes is also planning for retirement. But his current definition of financial freedom is having the time in his busy, $12-million-a-year sales career to watch his kids grow up. To do it, he says, he had to get out of his comfort zone.
“Five years ago, I was grossing $250,000 in commissions and had even bought a couple of homes and fixed them up and sold them,” says Magalhaes, an associate with RE/MAX Accord in San Ramon, Calif. “But every time Jan. 1 rolled around, I was disappointed.” Although Magalhaes was always in the top 5 percent of salespeople in his company, he wasn’t accumulating wealth. “That prevented me from taking the next step toward spending less time working and more time enjoying life.”
Today, Magalhaes spends one-third of his work day buying and selling real estate for himself and the other two-thirds selling homes to clients. In the last year, he’s bought and resold more than $2.5 million in property for his own portfolio.
He once favored fixer-uppers because of his construction background, but Magalhaes now looks for investments that are less time-intensive. Small apartment buildings, he says, are more efficient to manage and generate a bigger cash flow.
To reach his longer-term financial goal of retiring from sales by age 45, Magalhaes is assembling a group of apartment properties in a high-quality area. “You can fix the property, but you can’t improve the area,” he says.
He’s used 1031 exchanges to convert most of his single-family homes into two five-unit, one six-unit, and one 11-unit apartment buildings, which he now manages with the help of his mortgage banker wife, Valerie. When the kids get older, the couple will buy more and eventually hire a full-time manager, he says. “But right now, we want to enjoy the financial freedom we’ve already built to be with our children.”
Developing freedom
Kirk Kessel, CCIM, CRS®, of Kessel Kirschner Real Estate in Melbourne, Fla., is another real estate pro who’s parlayed his single-family home investments into his own version of financial freedom—time to travel. “Single-family homes are a great way to build capital, but they’re too labor-intensive. With renovations, you have to be there every single day,” he says. Land development, on the other hand, requires intense work for a while, followed by a period of waiting for approvals or plans, says Kessel.
Land had always fascinated him, and seeing an uptapped market demand prompted him four years ago to take the plunge. When several clients called and asked him about available self-storage facilities, Kessel saw his opportunity. Working with a partner and tapping funds he’d built up from his single-family investments, Kessel spent a year and a half becoming an expert in self-storage. “I spent $15,000 on a market analysis. We hired consultants and flew all over the country attending seminars on self-storage development and visiting dozens of facilities to determine what unit features were most in demand and how to construct the property for maximum efficiency,” he says.
Convinced they could make it work, the pair bought a 12-acre parcel on a major interstate in Palm Bay, Fla., sold off three outparcels, and netted enough to own 8.5 acres free and clear.
“I try to avoid leverage whenever possible,” says Kessel. “When the market falls, you can lose your investment.” Instead he invests his own capital and forms limited liability companies with investment partners he’s met through business contacts. “I look for partners who can bring both money and expertise about a particular investment to the table,” he says.
If you do want to borrow for a commercial venture, local niche bankers are probably your best bet, suggests Tony DeRosa, president of WestVest Associates, a commercial real estate company in Miami. Because commercial loan terms can vary significantly from bank to bank and project to project, it also pays to talk to several different lenders, he says. “Every bank has its own risk tolerance.” Try to secure an interest-only loan for the first year or two of the project, says DeRosa. You’ll need the extra money to renovate or to cover tenant build-out and leasing commissions.
After a few false starts under a third-party manager, Kessel found an experienced onsite manager who has boosted occupancy at his self-storage facility from 50 percent to 92 percent in less than a year—netting a positive cash flow of $35,000 a month. “Having someone with expertise means I can call him once every week and know things are running smoothly,” he says.
Paying for this expertise is well worth it considering that Kessel still spends two or three days a week selling around 35 homes a month.
In a year or two, Kessel hopes to make land development his sole, but part-time, career. “My ultimate goal is to do one project a year and have the free time to travel,” he says. His first destination—Asheville, N.C., where he’s bought 1,250 acres he wants to develop and sell to builders.
Hitting the right notes
A similar search for a less time-intensive form of real estate investment was one of the reasons Greg Flaniken began investing in mortgages. “You don’t have nearly as many headaches with notes, since there’s no maintenance involved,” says Flaniken of Greg Flaniken & Associates in Freeport, Texas.
Mortgages also gave Flaniken a good way to diversify his portfolio of rental properties. “I felt I had too much of my retirement tied up in one kind of investment,” he says.
Flaniken first entered the lending business by selling some of his properties and taking back the notes through seller financing. “Selling to current renters, we had some idea of their track record,” he says. “Of course, we also did credit checks. Usually people who borrow from private lenders don’t have really good credit, but I look for job stability and the level of other debts.”
Flaniken’s strategy is a great way to create an annuity secured by real estate, says CRS® instructor Richards. It also allows you to defer taxes on the sale for as long as the note runs. Of course, if you need the cash from a note, you may have to sell the note for less than its face value. Another downside: Sooner or later the mortgage is paid off, and your cash flow evaporates.
Before he buys a note, Flaniken checks the title and evaluates the loan-to-value ratio and the quality of the property itself—in case he has to foreclose. He wants an owner who’s been in the property for several years and has built up some equity.
And he’s learned the hard way not to take the noteholder’s word on past payment history. “Sometimes, noteholders will tell you they’ve received regular payments when they haven’t seen any money in six months. I always call the property owner to see if what the person selling me the note says is true.”
Think lien
Paul Porrecca Jr. also finds mortgage notes a great way to supplement his income from the 30 or so single-family homes and duplexes he holds as investments.
When it comes to his real estate purchases, Porreca is a value investor, who looks for foreclosures, deferred maintenance, and sellers who need out fast. “I try to buy the worst house in an improving neighborhood and work with subcontractors to improve it,” says Porreca, broker-owner of Porreca Real Estate in Millville, N.J. But as competition for even foreclosed properties has become fiercer, he found that buying tax liens was a creative, if somewhat risky, way to acquire properties.
“If a property has delinquent taxes, the city or township will hold a tax certificate auction. If you’re the winning bidder, you have to immediately pay the back taxes. You then receive a tax certificate assignment, which gives you the right to collect all back taxes, interest, and penalties due. Tax liens take precedence over mortgages, so if the taxes remain unpaid, you can end up owning the house for taxes plus costs,” he says.
Of course, it’s not quite that simple. There may be competitive bidders, and you may have to pay a premium to get the assignment rights. Then you allow the property owners a certain amount of time (two years in New Jersey) to pay off the lien. If they do, you get only the amount of the lien. Furthermore, during the waiting period, you’ll have to keep paying the taxes.
Although he’s acquired about three properties this way and netted considerable profits, tax liens aren’t for everyone, cautions Porreca. “If you don’t know the laws in your area and fail to follow proper notification procedures, you can lose everything you’ve invested.” You also need ready cash and good credit, since you’ll have to pay for tax liens promptly if you’re the winning bidder.
If these investors haven’t convinced you that financial freedom is in reach, then you’re still looking for wealth in the wrong places, according to Jock Barker, CRB, CRS®. The former general sales manager of 20 offices with Moore & Co. in Denver is now living well off his real estate investments, which include 24 single-family homes and several apartment buildings.
“Look at the wealthiest people around you, and you’ll see that most of their wealth didn’t come from the stock market. It came from real estate,” Barker says. “Take that money for a fancy car and make a downpayment on a house. Buy two houses a year and pay them off. If you’re not investing in real estate, you’re losing ground every day on the road to financial freedom.”
8 Tips from today’s top authors
Gary W. Eldred, Ph.D. www.stoprentingnow.com
Co-author of Investing in Real Estate (2003, John Wiley & Sons, fourth edition)
1. Keep a log of trends in home prices by neighborhood. Watch for trends and buy early in undervalued neighborhoods.
2. Investigate zoning laws and homeowner association restrictions. See if you can add onto a property or convert a room to another use. It’s a great way to increase value.
Diane Kennedy
Co-author of Real Estate Loop-Holes: Secrets of Successful Real Estate Investing, part of the Rich Dad/Poor Dad series. (2003, Warner Books)
3. Get more from your depreciation. Take the extra trouble at tax time to list items on a property—from air conditioning to light fixtures—as personal property. As personal property, items can be depreciated over shorter useful lives.
4. Remember, when you flip, you pay. If you sell a property that you’ve held for less than 12 months, profits are taxed as short-term capital gains at your regular tax rate. That can take a big bite out of your profits.
Robert Shemin
Author of Secrets of a Millionaire Landlord (2001, Dearborn Financial) and Unlimited Riches (2002, John Wiley & Sons)
5. Don’t fall victim to analysis paralysis. If you don’t make offers, you won’t buy property.
6. Build a de facto board of directors for your investments. Partner with an attorney, a mortgage broker, a property manager, and a contractor. That way, you’ll cover all parts of real estate.
William Bronchick www.legalwiz.com
Legal guru and co-author of Flipping Properties (2001, Dearborn)
7. Look for bargains. Avoid the speculation mentality that prices will always go up.
8. Have a cash reserve. Be prepared so that if cash flow doesn’t cover costs, you don’t jeopardize your investment.
5 Tips on becoming an investor
1. Use tax-free money. Live in your house for at least two years; then sell it. Take a part of the $250,000 in tax-free gain and buy two homes.
2. Put your commission in the deal. Buy a home you’ve listed, leaving your commission in the deal to serve as part of the downpayment.
3. Find an angel. Tap a former client, family member, or friend for the funds; you contribute the real estate expertise.
4. Practice equity stripping. Take out a home equity loan on your residence, and use the proceeds to make a downpayment on an investment property. But be aware of the risk involved in putting your home’s equity on the line.
5. Buy one of the first homes in the first phase of a new subdivision, preferably at a builder’s discount. As build-out is completed, you’ll probably be able to sell your home before it’s built for more than you paid for it.
5 Tips for making commercial investments
Ready to take the plunge into commercial property investment? Ken Rosen, CCIM, of Kendar Realty in Coral Gables, has bought and sold more than $300 million worth of real estate. He chooses investments that offer
1. Great location An area with appreciating values, near other properties with higher rental rates, near transportation, and on the line of current development
2. Diverse tenant profile An average office size of 1,000 square feet, so that losing one tenant won’t be catastrophic
3. Upside Undermarket rents with leases that will turn over within the next two years, so you can increase rents, and options for renovations that can increase rents and value
4. Efficient design Good location of core elements (elevators and bathrooms), so rental space isn’t lost, and no more than 15 percent common area
5. Positive leverage An interest rate that’s less than your cap rate, and the biggest mortgage for the longest period of time
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