Houses

I find myself in the interesting position of owning 3 residential properties:  1) Our new “dream” house, 2) Our “old” starter home, 3) our rental property.

My wife and I decided to do things differently.  Most homeowners looking to upgrade either make an offer contingent on the sale of the first home, or sell first and buy later.  I decided that was not the optimal strategy for us.  I decided it was best to buy in the upgraded segment before the higher-end markets heated up, and to sell our starter home in a seller’s market.  Part one was buying and moving in to the new house.

The strategy worked very well.  Our “old” home resides in a market where contracts are signed in days, not weeks, and multiple competing offers were becoming common.  Our plan also allowed us to stage the old house without occupying it.   We laid down fresh mulch and 12 tons of rock.  This gave the house tremendous curb appeal.  We also put days of effort into making  sure the house was “white glove” clean from floor to ceiling — even the basement.  We left some furniture and most of the artwork behind (temporarily) for staging.  The place looked spectacular inside and out.

We listed it on a Thursday night, and by Friday night we had had 13 showings and multiple offers.  Saturday morning we discussed the pros and cons of each offer, and made a decision.  We accepted the offer that was $9000 over our asking price.

Before we started the whole process we negotiated a deal with our real-estate agent.  She’d receive the standard 3% on our new home purchase, but only 2% on the old home sale.  This meant paying 5% on the sale, rather than 6%.  This saved us over $2500 in commissions.

So far we are pleased with our new home.  It appraised for more than our negotiated price.  And even though it is about 50% larger than our previous home, our first month’s utility bills are significantly cheaper than our old home built in the 1970s.  Our new home is “high-efficiency”, with a HERS Index of 60.  We anticipate saving $800 to $1000 per year on utilities.  Moreover, we obtained a 3 percent, 15-year mortgage with a negative 1.65 points, which even after 0.5 points of origination, resulted in less than $1000 of closing costs.

All the while, the rental property continues to provide monthly “dividends”.

Simple Plan to Tackle the Home Mortgage Crisis

Houses Up

5&7 Plan

The idea is so simple, it is surprising that no one (that I have heard about) has proposed it.  One big problem the US government faces is the enormous pile of mortgage-backed debt held by Fannie Mae and Freddie Mac.  Another problem is that many “home owners” are underwater with their mortgages.  [How can you be a home owner if you have negative equity?]  Finally, the popping of the housing bubble continues to be a drain on the US economy.

The solution I propose is making interest on mortgage-backed securities tax free for five years.  This plan would immediately drive up the value of these “toxic” assets and drive down mortgage interest rates below historic lows.  This would provide a tremendous boost to Fannie and Freddie and even the Federal Reserve.  Increased demand for tax-free MBS would spur banks to issue more mortgages under easier terms, which would help prop up home prices.  Naturally, fewer home owners would be under water.

This would also be a boon for investors, giving them access to another tax-free asset class.  The incentive of tax-free MBS would be so powerful, it would threaten to take money away from tax-free municipal bonds.  To help offset this risk, part II of my plan would make long-term capital gains on municipal bonds tax free for seven years.  Like Cain’s 9-9-9 Plan, my plan would have a numeric title, the “5&7 Plan”.  (To avoid confusion with the 5-7 Pistol, the “&” symbol is used rather than a dash.)

The long-term capital gains provision gives investors an incentive to hold municipal bonds for at least one year.  The extra two years for municipal bond gains gives investors an added incentive to hold long-maturity municipal bonds.

The 5&7 Plan would expand the tax-free bond universe and introduce the concept of tax-free interest investing to a new group of investors… the middle class.  Typically only high-income earners benefit from tax-exempt bonds because they offer lower interest rates than taxable bonds.  Because high-income taxpayers face higher marginal tax rates, tax-free municipal bonds make sense despite lower interest rates.  If the 5&7 Plan becomes law, higher-yielding MBS will become lucrative to savvy middle-class investors.

I encourage the 2012 presidential candidates to consider adopting the 5&7 Plan.  I could see Romney offering the 5&7 Plan as a way of “cleaning up Newt’s Fannie and Freddie mess.”  Similarly I could see Gingrich pitching the 5&7 Plan as a way of “fixing the Democrat’s Fannie and Freddie problems.”  Finally, I could see Obama selling the 5&7 Plan as “an innovative way to clean up America’s mortgage crisis”.

If the 5&7 Plan gets enough press, it will revitalize the mortgage debate.  It will help turn the debate towards real solutions and away from political blame games.  And, if passed, 5&7 will energize the mortgage and housing markets in explosive ways compared to the tepid response all the other failed legislation of the past 3 years.  If you like the 5&7 Plan, share this link.  If you don’t, please share why.  I will publish all non-spam replies.  Let’s get the 5&7 debate started!

Is Investment Real Estate Right for you? (So you want to be a landlord?)

Rental House Income

Investing in Rental Property

I have been a rental property manager (landlord) for just over two years now.   I’ve learned many things; two stand out:

  1. Residential real estate can be a great investment.  Rental real estate can provide steady cash flow, excellent asset diversification, favorable tax treatment… all with modest capital gains potential.
  2. Rental real estate can be a real pain to manage at times.  Both tenants and repairs cause headaches.

I currently own one rental property through my LLC.  Because of item #2 above, I’ve recently turned over the property management to property management company.  This choice will probably reduce net revenue about 10-12%, but will help take much of the stress out of finding and screening new tenants and dealing with repairs and tenant issues.  If things work out well, I will consider purchasing a second rental property.

In my local real-estate market it is reasonable to expect about 5-6% net income on a fully-owned rental property.  And over a 30-year period I conservatively estimate 1.5% appreciation.  Further since real-estate prices are a large competent of cost-of-living and inflation, real estate makes a good hedge against real inflation.  Finally, just as property values tend to go up, so do rental rates.  Simply put, residential real estate is the best long-term inflation hedge I’ve found.

The flip side of rental property is the eventual likelihood of landlord/tenant issues ranging from breaking the lease, to late or unpaid rent, to property damage, to eviction — just to name a few. Vacancies without rent can really take a bite out of your cash flow.  Properties can drop in value, and marketable rental rates can fall dramatically.

Somewhat of a wild card is the tax treatment of rental properties.  In the “pro” side are depreciation of the structure which can be deducted, and the fact that “passive income” like other investment income is not subject to Social Security tax.  On the “con” side is that fact that nothing can offset “passive income” except passive losses (and vise versa).  Owner’s of rental real estate (or at least their accountants) will become very familiar with IRS Schedule E of their income taxes.

Rental real estate is not for every investor.  Personally I wouldn’t recommend buying rental real estate until you have a minimum of $250,000 net worth.  Managing a rental property can be time-consuming and challenging.  Alternately, finding a good property management company is also a real challenge.  And unlike infomercials and “Rich Dad Poor Dad” author Robert Kiyosaki suggest, real estate is not a financial panacea.  However, for some higher net-worth individuals, rental residential real estate is worth considering as part of their investment portfolio.

Entrepreneur in Training

Small Biz Business PlanWalking to the Rockies game yesterday, I was struck by the bustling entrepreneurial spirit on display.  From the myriad pop-up game-day parking lots (ranging from $25 – $40 per spot), to the ticket sellers (“I buy tickets”, means “I sell tickets”), to the independent street vendors outside the ballpark marketing peanuts and beverages for half the in-ballpark price.

I have been an entrepreneur in training for most of my life.  For much of that time I didn’t associate the term entrepreneur with what I was doing, nor would I have been able to spell it.  Yet there were several entrepreneurial things I did even before graduating from high school.

  • Ran a paper-route (at age 12)
  • Door-to-door newspaper sales.  To get more revenue and “signing bonuses”
  • Picked up odd jobs to make a few bucks.  Jobs like fence painting, baby sitting & lawn mowing
  • Traded collectible cards… for fun and for profit
  • Built a “sluice-box” and panned for gold

In college I did even more.  I was trading and auctioning collectible cards via Usenet and the Web… in addition to trading face-to-face.  I found that trading up (trading several lower-value cards for one or two high-value cards) was my most lucrative strategy for making money.  I had to give up my personal collector’s mindset; to be willing to break up my collections when good deals became available.    I learned to put together targeted, marketable, ready-to-use (turnkey) sets in order persuade folks to part with one of their rare, sought-after cards.  As I got more market savvy, I learned to trade high convenience for high value.  This helped hone my fledgling negotiation skills.

I built up a reputation as a trustworthy vendor/trader who represented the quality of my cards honestly, who mailed them promptly, and packaged them carefully so they arrived in good condition.  I was doing this before anyone ever heard of eBay.

In college, I developed a software product called Visual Math 3D.  Looking through my notes, the proposed company structure was:

EngimaSoft, a division of Paradigm Software, a branch of Millennium Corp.

No shortage of boldness there!  I see now that others have grabbed most of these names.  Good for them, they are good names.

Visual Math 3D had a logo and marketing pitch for the cover of the box.  Unfortunately, I had too much school work (and school play) to bring the software to market.  Had I been more business-savvy at the time I would have brought in one or two partners to help market the product.  Who knows… it could have grown into a competitor of Mathematica, AutoCAD, or Excel — it had aspects of all three.

I continue to be an entrepreneur in training.  I’ve learned a few things.

  1. Business cards:  I have business cards now! :)
  2. Smile, listen, and mingle.
  3. Listen to feedback.
  4. Keep your sales pitch short, then converse like a real human being, not a sales droid.
  5. Market both yourself and your company/venture.  Online and offline.
  6. Market to people who are actually interested.  Don’t waste time selling ice to Eskimos.
  7. Advertising.  A necessary evil.  Yes, you will likely have to part with some capital to grab the right people’s attention in a positive way.
  8. Branding.  Logos, tag lines, style.  Done right branding creates a sense of professionalism, familiarity, and trust.

Financially my most successful ventures have not been lofty, swing-for-the-fences efforts.  Balhiser LLC’s rental property has earned over $10,000 and prospects remain good.   The Sigma1 proprietary-trading group is currently up $2700, but markets are fickle.  My card trading activities netted about $1200 over 4 years.  My paper route earned about $1100 over 1.5 years.

Except for the rental property business, all my business ventures have been self financed and operated on shoe-string budgets.  They have also been part-time, night and weekend activities.  I have a full-time career in engineering, and while my employer hasn’t given me the golden handcuffs yet, I do wear a nice silver pair.  Thus entrepreneurship will continue to be a part-time activity

My entrepreneurial successes have been modest, yet I am undaunted (at least most of the time).  Today I am a minor league entrepreneur.   I believe that within the next ten years I am likely to make it to the majors, because I have good ideas, tenacity, and passion.  Luckily I know several successful entrepreneurs, and I listen to and learn from them.  They encourage and inspire me when I need a little emotional support.

Entrepreneurship is not for everyone.  It is difficult, if not impossible, to teach in a classroom; entrepreneurship must be experienced.  It can be fraught with setbacks and dead ends.  Passion can turn lead to burnout and frustration.  Yet entrepreneurship can be exhilarating, stimulating, empowering, fulfilling and fun.

Entrepreneurs continue to drive the US economy.   The best, most concise, most creative ideas come from entrepreneurs .  Entrepreneurs also deliver mundane, but necessary goods and services ranging from car washes, to restaurants, street-side baseball snacks,  and rental properties.

The entrepreneurial spirit is alive and well in the US.   Recessions wipe out jobs, and some of the unemployed try out an entrepreneurial path.  While many fail, some succeed.  Some that succeed thrive, and build the businesses of tomorrow.  These people create not only jobs for themselves, they create jobs for others.  They drive innovation and keep America competitive.

I am not expert on entrepreneurship, but I am an entrepreneur.  I work with other entrepreneurs and admire their spirit.  While Washington pays lip-service to entrepreneurs, it seems to be ignoring the obstacles it puts into place, impeding entrepreneurs:

  • Self-employment taxes.  Small business pays Social Security and Medicare twice on every dollar earned.  Even on the very first dollar.
  • Employment and payroll rules and regulations.  The red tape is one reason I hesitate to hire any employees.
  • Regulations.  The only reason my hedge fund is not open to the public (at least to select accredited investors) is the mountain of regulatory requirements.

Even against daunting odds and government red tape, entrepreneurs find a way.  There are many who let red tape and taxes cause them either not enter the entrepreneurial game or quit it out of frustration.  This is a shame, and a loss for the US economy.  There are those who give up one entrepreneurial path (their first) choice, to pursue an alternate entrepreneurial path.  This, too is a loss, but perhaps not a severe.  Finally, there are some small businesses that simply stop growing… not from lack of opportunity, but to avoid the deep, sticky, red tape of employment law.

Right now I’m the category of entrepreneurs who are forgoing (for now) my first venture: the Sigma1 Hedge Fund, and pursuing my secondary venture — financial blogging.  I have a couple accredited investors willing to invest with me, but I have told them for now to put that on hold.

It’s not that financial blogging is not enjoyable, it’s simply far more difficult to make reasonable profits from a finance blog.   Given a choice, I’d rather make $250,000/year from blogging than managing a hedge fund.  It’s much more likely that managing a hedge fund has a greater chance of making that kind of money.  That, dear readers, is why blogging is my second choice for a business undertaking.

Entrepreneurs, I’d love to hear your stories.  How you succeeded, how you failed, what you learned?  Has government (federal, state, local) red tape gotten in your way?  Have you found ways to succeed in spite of all that?

Intangibles

Intangibles, short for intangible assets, are what economists and accountants call things that are not easily measured, valued, or counted. In life, it is the intangibles that matter.

Summer-like weather has me thinking about the reasons I work hard, save hard, and invest. My home has tangible value, and has appreciated in spite of the rough housing market.  The intangible aspects also have value to me.  Planting trees and watching them grow, year after year.  Maintaining my yard, and enjoying the first emerald green grass of the year.  Watching the flowers and flowering bushes come out in their sequence.  And of course, enjoying summer parties in the backyard.

I enjoy my modest home and the myriad home improvements I have made over the last decade.  Not only has been a reasonably good investment, my home has made me feel a greater connection to my community.

When I bought my house, I was approved for a much larger mortgage.  But I insisted on buying a cheaper house.  My first real estate agent kept showing me homes 10 of thousands of dollars above my price range.  After a couple months of that, I fired him, and selected another agent.  My next real estate agent actually respected my price range… only going over by a few thousand dollars, under the idea that we could make a lower offer conforming to my price range.

It worked.  After another several months of near misses, I found a house I really liked and offered $2500 below the asking price… valid for 24 hours.  After about eight tense hours at a friends house, my realtor called and said that the sellers had accepted.

For the last couple years I’ve been thinking that I’d like a larger house, with amenities like a 3-car garage.  We’ve even thought about buying land and building a custom home and looked at a few lots.  But so far I’ve resisted, partially because real-estate commissions and seller-side closing costs could eat easily up $15,000 of net worth.  In-town moving expenses would probably add another 3,000 dollars, and buyer-side closing costs (assuming we buy rather than build) another 7,000 dollars.  Something like $25,000 down the drain  to step into a new, upgraded dream home.

So the plan is to stick it out in the current home or another 5 or so years.  In order to enjoy it more we continue to make upgrades large and small.  About half of the upgrade work is DIY, the rest we contract out.  The return on investment for DIY work is probably 200%, the work contracted out will only pay back 50-60 cents on the dollar.

There is something nice about working on the home.  A sense of progress and accomplishment that is enjoyable.

I keep telling myself the cons of buying a dream home for twice the cost the current home.  Property taxes will double, utilities will go up, real-estate commissions and other costs will eat up a big chuck of equity, moving will be a hassle, etc.  And of course, do I want to live here for the next 10, 20 years?  Hard to say.  Until I make the next big move on the housing front, I plan to delay and enjoy my current home and neighborhood.  Take some walks, host some parties, and do some gardening.  Enjoying the intangibles of home ownership and try not be to hasty in my desire to keep up with the Joneses.

The Thrill is Gone, but the Love (of Finance) Remains

When I was born, my birthday gifts included US savings bonds ($50 dollar face value, I believe).  I’ve had a savings account since about age 7, and started reading brokerage account statements at around age 9.  My brokerage college fund started with $1000 and nicely grew to about $4000 by the time I started college at the tender age of 17.

Before the age of 10, I was enthralled by the concept of compound interest.   I was curious about the difference between monthly, weekly, daily, hourly, and by-the-second, even instantaneous compounding.  Little did I know at the time that this concept lead to the mathematical concepts of limits, calculus, and the number e, Euler’s  number.

Needless to say, I love math and finance.  But I first experienced a truly heart-pounding thrill when I started online trading sometime in the late 90’s.  I could see the bid and ask constantly moving, and tried limit orders.  The asks kept rising, and I kept inching up my bid.  Eventually my bid got hit and I was an owner of my first online stock.  This was different than buying mutual funds on the phone from Vanguard, and getting quarterly paper statements.  This was in real time and it was exciting.

I’ve read a lot about Peter Lynch, including his books, and I’ve learned some lessons good and bad.  The bad lesson, as I read his words, was “Don’t buy bonds unless they paying at least 8 or 10 percent.”  The good lessons were “Don’t buy what you don’t understand.” and “boring investments are good… boring names, unsexy, but solid investments are good.”

My next financial thrill revolved around options sales and purchases.  I even recall making a 20-option spread trade that was scary, but ended up netting me about $3000 in a very short time.

I have also has some thrill involving real-estate offers, counter-offers, counter-counter offers, and purchases.   Mostly, tension and anxiety are better descriptors than excitement.  Mild disappointment mostly describes failed attempted real-estate purchases.  Moderate to exuberant happiness describes my successful real-estate bids.

In the last year or two, my trades have not elicited an significant cardiac or endocrine event.   While almost always cerebral and well-considered, my trades have occasionally made my heart go pitter-patter and my endocrine system give me a pleasant rush.  But lately the trill is gone.  My pulse is steady and the motions are vaguely methodical and systematic.

My love of research, introspection, and contemplation remains.  Trading, for me, is just a means to an end.   Increasingly dispassionate.   In the end I hope and believe this makes me a better trader.  As always, time will tell.

Balhiser LLC Financial Handbook

Even though it is very unlikely that Balhiser LLC will do any hiring in 2010, it makes sense to lay out a rough sketch of expectations and policies.   In many ways I’d like to follow the HP Way as outlined in David Packard’s excellent book.  So here is a first pass.

Balhiser LLC is:

  • A for-profit financial company seeking to produce long-term returns for its shareholders.
  • A company where every employee is a shareholder.
  • An innovative, conservatively-managed company that values bold ideas and prudent actions.
  • As true of a meritocracy as humanly possible.

While I as president retain final say-so, salary and other financial information will be governed as follows (as permitted by law):

  • Transparency.  All employees and stockholders will have access to the company’s financial books.  This includes salary, other compensation, and ownership information.
  • Employees will play a key role in hiring their co-workers.
  • Employees will, as much as possible, have say-so on who is on their project team.
  • Friendly competition between project teams is encouraged.
  • Competition between project team members is generally discouraged.  Teamwork is strongly encouraged.
  • Salary and compensation adjustments will be based on the following (in descending order of precedence):
    • Company performance
    • Project performance
    • Individual performance
  • Company performance is #1 because without reasonable performance the wants of the shareholders and employees simply cannot be met.
  • Project performance is #2.
  • Individual performance is #3 because:
    • It is often difficult to measure objectively.
    • Competition between individuals for salary, position, etc is frequently at odds with teamwork.
    • Time spent on “getting credit” and “looking good” is time wasted.  What matters  is enjoying work, finding solutions, and making money.
  • In the long term individual performance is still rewarded because:
    • The teams with the strongest individual performers will tend to be more successful.
    • The importance of project team success will result in high-performers being highly sought-after.
    • Long-term low performance that is detrimental to the team is unlikely to be tolerated by the team.

As a final bit here is what currently constitutes Balhiser LLC:

Business:

  • Invests company resources to make cash-flow and profit.
  • Financial commentary and general (not-individualized) investment advice.
  • Financing long-term investments and constructing a long-term financial portfolio with a strong balance sheet.

Assets:

  • An investment property (that is currently generating positive cash-flow).
  • A business checking account.
  • A handful of websites/domains.
  • Over 75 articles on various financial topics.
  • A computer, and other office equipment.
  • A modest collection of accounts receivable.

Disclaimer:    The Crazy Ivan Account (CIA) is not a Balhiser LLC asset.  Commentary about the CIA is.

Creative Finance

The last few weeks have been busy for Balhiser LLC. First the small biz was denied a $50,000 line of credit from a bank despite an excellent credit credit score, collateral and cash flow. That’s where creative financing come into play. It occurred to me, as president of Balhiser LLC, that the real estate venture was a good investment, and the the bank had made an error by rejecting the application on the basis of “industry: real estate”. I came up with the idea of a risk-sharing loan that would pay the lender a percentage of gross revenue from the income property in proportion to the loan-to-value of the property. The “angel” lender turned out to be a non-bank individual. The terms of the gross revenue agreement include a minimum 6-month term at which point the loan becomes callable and repayable in full or in part.

The lender gets a good deal because they realize proportional gross revenue. Balhiser LLC gets a good deal because it receives financing to close the capitalization gap with a non-bank lender sharing the revenue risk. The classic win-win business deal. So long as the property goes unrented no “interest” is due.

As it turns out, a 12-month lease on the property was signed on January 27th. If all goes according to plan both my small biz and the private lender will do reasonably well. The lender stands to receive just over 8% return.

Real Estate Diversification

Balhiser LLC is entering the real estate investing world. As president, I am working on the last steps of financing a payoff and transfer of a ~$175,000 property to Balhiser LLC. So far, I have secured 65% of the capital and financing. Financing the remaining 35% is in the works, and I am hopeful that a line of credit Balhiser LLC has applied for will help close the gap. Alternately, I am prepared to liquidate some of my Vanguard portfolio, as required to complete the transfer.

The goal is to lease the property, a 3 bedroom townhouse, for $1150/mo. Info about the property is available here.

Investing can be more than just stocks, bonds, ETFs, and options. It is exciting to extend Balhiser LLC into the arena of real estate investment.