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Posts by Adiel Gorel

COVID-19 Effects on Rents & Renters

We hear the concern that some tenants may not be able to pay rent due to the Corona virus crisis.

While this is a valid concern, there are a couple of things to consider:

We talk about buying new homes in good areas. When these are the homes you buy, the likelihood of your tenants being “white collar” is high.

White collar employees are the ones who usually have the easiest transition to working from home. These would be high tech employees, engineers, etc. These types of employment lend themselves easily to working remotely, working from home, using Skype and Zoom for video meetings etc.

Thus, the likelihood of white-collar employees not being able to pay their rents is lower.

This is another example of why it makes so much sense to buy good homes in good areas.

Many new investors are attracted to the lower costs and supposed better cash flow (on paper), of house located in bad areas.

What is happening now is just one example of why that may not be a good idea.

An exception is very low-end areas, where most of the tenants are HUD-and-Section-8-helped tenants. HUD and Section 8 will continue to pay rent for the tenants regardless. However, these types of houses are always challenging and their future appreciation may not be as high as good homes in good areas.

During the last recession, which started in 2008, we obviously bought homes not only in good areas, but picked up bank foreclosures in any areas, including blue collar locations. However, during regular times, buying brand new homes in good areas is a staple of smart investing.

There may also be help on the other end for landlords, if rents aren’t being paid, there are forces now working with lenders to give abatements and postponements of mortgage payments. When there is an issue at one end, the other end has to be addressed as well. In California there are already lender concessions to 90-day delay on mortgage payments by some of the major banks, with no repercussions to the mortgage payers, or late fees.  It is likely that the rest of the nation will follow suit.

We will discuss this, and other issues, during our next big 1-Day Expo on May 16th. If by May 16th large public gatherings are still not happening, we will have the event online.

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Will COVID-19 Cause A Recession?

As we all observe and fear the Coronavirus, we see many cities under “shelter-at-home” restrictions, and many “non-essential” businesses closing. Then on the other hand, the Fed lowered rates almost to zero, and mortgage rates, after a short spike, are starting to settle down near the lowest point ever. Some people fear a recession is likely to follow, and if we remember the recession of 2008, I think it’s quite possible. That depends, of course, on the length of the lock-down.

If a recession does occur, let’s point out some of the differences between the recession of 2008 and the next recession, if it hits.

Before the 2008 recession happened, there was a major boom in many states. Home prices in states like Arizona, Nevada and Florida went through the roof. The media was shouting “It’s a bubble! It has to burst!” Prices of homes in Phoenix, for example, nearly doubled from the beginning of 2004 till the middle of 2006. Not all states participated in the party, for example, Texas and Oklahoma have not gone up very much during that time.

When the 2008 recession hit, the markets that went down precipitously were, of course, the exact markets that had participated in the 2004-2006 boom. Places in Arizona, Nevada, Florida, and other states. Prices tanked and crashed quite a bit. However not across the board, states like Texas and Oklahoma did not go down very much during the recession of 2008.

By contrast, at the present time, especially in affordable markets like Oklahoma City, Tulsa, Baton Rouge, Central Florida, parts of Atlanta, Raleigh and others, there are currently no price bubbles. No major boom has happened, Thus the likelihood of a major price crash in such markets is much slimmer than the markets which crashed in the 2008 recession. There are very high priced markets now, the expensive markets in San Francisco, for example (which has already started going down in price last year). In such markets, there may be a stronger effect on prices. Also, when you invest in a brand new home in a good area in Oklahoma and pay $170,000. You are buying the home not much over the basic construction and land cost. Again, the probability of an “intrinsic value” home like this going down much is small. By contrast, a $2M home in San Francisco, which cost $900K to build, has a lot of “air” in the price, with a higher likelihood of prices going down in San Francisco.

The recession of 2008 was created by housing. Lenders released all limits, and loans were made to virtually anyone that was human, almost regardless of credit or ability to pay. Some loans were up to 125% of the value of the house. This bad debt, called “sub-prime”, was then packaged among other debt, and amazingly, the credit agency gave these packages high ratings, as if it was a quality debt product. Then these faulty packages sold on Wall Street, and financial wizards found way to leverage them enormously. Once defaults on the bad loans started to hit, the entire structure unraveled.

By contrast, at the present  we are still under the Dodd-Frank Act, which was drafted after the 2008 recession. Borrowing is now much harder and lengthier than it was before the 2008 recession. Even borrowers with great credit are finding the current loan processes frustrating. The amount of sub-prime loans is minuscule relative the period preceding the 2008 recession, and steps were taken to make the abuses with rating agencies be much harder to repeat. Thus the next recession is likely not to be caused by bad loans. It is clear that if another recession comes, its effects on rental home investing will be quite different than the recession of 2008.

I believe that the best way to invest in real estate is to buy brand new homes, in affordable large metropolitan areas, where the rent numbers match well with prices. Then finance the homes with a fixed-rate loan. To the best of my knowledge long term fixed rate loans like we get here in the US don’t exist elsewhere. The monthly payment and the mortgage balance never change with the cost of living, while everything else does. That means inflation constantly erodes the true buying buyer of your debt, making your debt ever smaller in real dollars.

For these kinds of homes, purchased anywhere from $150K to $250K, I believe the effects of the next recession will be minimal. Rates are very low, however, so fixed rate loans will retain these great rates forever.

The act of buying good rental homes in large metro areas and holding them as rental for the long term, where  the loan erodes, is a future-changer. It does not change your future instantly or even within a short time, but over the long term, this strategy is a powerful future changer. I have seen people retire well, send kids to college, and look much stronger financially thanks to these simple yet powerful investments.

Since these investments show their power over the long term, and since the interest rates are so favorable now, and since a possible impending recession is unlikely to have effects on prices like the 2008 recession, I believe this would be a good time to invest.

As an extra “bonus”, the virus fear creates more flexibility with sellers, including builders, and the ability to negotiate better prices.

I would be happy to discuss it with anyone who may wish to inquire further.

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Coronavirus and Single-Family Home Investing

 

As we read, daily, about the spread of the Coronavirus (now also called Covid-19, but I will use Corona throughout), we are all concerned about the spread, mortality rates, means to protect ourselves and so on.

The stock market has taken a massive plunge over the past few days, on Coronavirus fears and how they may affect the economy.

Certain industries are already affected, the Olympics may be cancelled, and vacation spots are suffering due to flight and vacation cancellations.

As the stock market goes down, people who own stock feel less wealthy. However, it is reported in many sources that heavy stock concentrations in one’s portfolio occur in the upper quarter of income in the US.

Due to the virus fears, people become less mobile, fly less and stay put more.

The lure of the safety of one’s home gets more into focus.

In the affordable markets in which we invest, the type of homes we buy as investments are the type of homes purchased by homeowners who are squarely in the middle of the pack in terms of income, and even below. It is quite possible that a good segment of this population may not feel less wealthy. Their desire for a home will likely not diminish, and that means the demand for the type of homes we invest in is likely to stay strong.

The Fed is Already hinting that they are considering lowering interest rates to help the economy in the aftermath of the Coronavirus economic effects. That is at a time when interest rates are already some of the lowest in history. If rates go further down, the homes will become yet more affordable, with a potential for even greater demand, and even price appreciation. It is also possible that demand may be increased as some people move out of stocks and seek an alternative investment.

The organic need for families to have a place to live is not likely to diminish in the face of the Coronavirus. If people buy these affordable homes, especially with lowered rates, it bodes well for us investors. If people rent them, it also bodes well for us, as our vacancy rates go down.

There may well be adverse effects such as a dearth of workers due to tighter border controls and less travel, a dearth of building materials which usually arrive freely from all over, including the far east, and other shortages. Ironically, even these adverse effects are likely to increase prices, as supply may struggle to keep up with the usual demand.

This is a good lesson for us about the risk of investing in “vacation rentals”. Many younger investors may not be aware, or have forgotten, the devastating effect of the last recession on vacation rentals. I constantly talk to investor wondering why they shouldn’t buy vacation rentals. Just as in a recession, vacations are a luxury, and this luxury is one of the first to get dropped when circumstances are difficult. Even Airbnb’s may experience pain during a recession, as well as, possibly, in the face of the virus scare.

Investing in single family homes in good areas in large metropolitan areas in the Sun Belt states for affordable prices, looks even more solid in the face of difficult circumstances, relative to vacation rentals. That is one of the reasons this is what we focus on.

One of the reasons I have been so steadfast about investing in single family homes is their vast future benefits, in addition to their great relative safety.

Morgan Stanley just released, on February 28th, a 3-scenario report as to how the virus spread may affect the economy. Currently they are estimating what they call “Scenario 2”, in which the recovery we now experience is stunted in a relatively minor way before means are attained to stop the spread of the virus, as the most likely senario. The 3rd and worse scenario may lead to a recession (albeit after all the checks and balances congress installed after the major 2008 recession, I believe a future recession to be quite a bit milder than the last one, especially since one of the reasons for the severity of the 2008 recession was the massive amount of sub-prime loans, a phenomenon that has been greatly reduced by congress since, and is not nearly as prominent currently.

We have seen prices of homes in many markets drop sharply during the recession, but we also know that simply holding on to the homes, while the 30-year fixed rate loan continues to be eroded by inflation, gets us out of that cycle and into the correction. I myself have already experienced it several times in my investing career.

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Wisely Putting Down Payments on Single-Family Rental Home Purchases

One House too many? There's no such thing when investing in your future! - Down Payments

A few times a week I talk to investors planning on putting a large down payment on the purchase of a single-family rental home. The goal is to have a better “cash flow”. It may sound logical – the greater the down payment, the smaller the loan, and hence the monthly payments. However, the foundational piece of buying rental homes in the United States is the “gift” called “the 30-year fixed rate loan”. This loan sounds like a miracle to most foreigners, since neither the monthly payment nor the mortgage balance EVER keeps up with the cost of living around the world, while everything else does.

The magical 30-year fixed rate loan

The 30-year fixed-rate loan is at the heart of life transformation for investors when the homes are held for 10 years or more (preferably over 15). The loan keeps getting eroded by inflation (or CPI– the cost of living), while the home, rent, and everything else keeps requiring more dollars to buy (hence in dollars, their value goes up – even without intrinsic appreciation). The 30-year fixed rate loan starts looking quite puny after 12, 14, 16 years. It may be years before it is paid off, but since it never keeps up with the cost of living, inflation hammers the real value of the loan.

These loans are a great financial gift, with future-changing potential. Why, then, would you want to make the gift smaller? Especially at today’s low rates? The answer is, you don’t. A larger down payment will mean the magical loan will be smaller.

May be wise not to exceed 20% down payment

This is not fully utilizing the power of the fixed-rate loan, and it means the borrower has expended more of their scarcest resource: cash! Even very wealthy people, who can afford to put down a large down payment or buy for cash, choose to put down less money. They do this to leverage their cash with the 30-year fixed-rate loan.

I think that in normal cases, a 20% down payment should not be exceeded. The small additional cash flow due to having a smaller loan is insignificant at the present time. Right now, your main “cash flow” should come from your own earnings (salary). It is later in life during retirement that the rental homes can replace your income.

In cases of big 1031 exchanges, with not enough properties to identify, or in cases of not being able to get the FNMA loan anymore, then larger down payments are merited and that is a different blog post. I still think the down payments should be less, rather than more, in any circumstance. Currently, in our Membership area on our website, we have podcasts and a webinar that discuss loans and cash flow in depth. You can learn more about it at icgre.com/members

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White House Pushes Fed to Cut Interest Rates

At the end of March 2019, it became known that the White House is pressuring the Fed to lower its benchmark federal-funds rate by half a percentage point, according to an article in the Wall Street Journal by Nick Timiraos and Kate Davidson. There has been no movement yet.

We now see homeowner rates for mortgages at the 4.1% range; some of the lowest in history. If the White House succeeds, the benchmark federal-funds will not translate to lower mortgage rates right away, but mortgage rates will inevitably drop. Possibly even lower than at any time during the past decade. It is a waiting game and time will tell over the coming months.

This would likely create more buyers, push prices higher in most markets, and create an upward push in strong economy cities (and even not-so-strong).

The magical 30-year fixed rate loan 

Since we are aware of the uniquely special anomaly called the 30-year fixed rate loan, (we are the only country that has this type of loan) where neither the monthly PI (principal and interest) payment (not the loan balance) keep up with inflation and the super low rate will be locked for 30 years, we are fully protected.

If you qualify for the best loan, under the FNMA (Fannie Mae, officially the Federal National Mortgage Association, or FNMA is a government-sponsored enterprise (GSE)—that is, a publicly-traded company which operates under Congressional charter—that serves to stimulate homeownership and expand the liquidity of mortgage money by creating a secondary market.) guidelines this is a great time to buy where the numbers make sense. Taking action is important.

Many are not aware that they can purchase up to 10 homes with this type of loan. Married couples (if they qualify separately) can purchase 20. This is already a great time to lock these rates in with the magical 30-year fixed rate loan. If the White House succeeds in lowering rates, the terms will become more attractive.

In my experience, I have seen people look back and lament over not making use of these great circumstances to build a solid portfolio for their future. I hope you are not one of them.

This summer in our Membership area we will have a couple of podcasts where I will talk about this solo and in interviews with experts. I will also be talking about the 30-year fixed rate loan in detail in my show produced for public television called “Remote Control Retirement Riches with Adiel Gorel” that will be airing over the next several days across the country. Take a look at our website here for details and to check for showtimes in your area.

Here is a recent video on the show currently posted on my YouTube channel: https://youtu.be/8eiUYcsOPiQ

 

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Setting Up an LLC With Single-Family Rental Home Purchases

Should I start an LLCIn a podcast I recorded recently, I gave my take on the question I get asked almost daily: “Before I start buying investment homes, should I create an LLC?” I begin by stating that this is a legal question and should be posed to a lawyer.

The 30-Year Fixed Rate Loan

As a non-lawyer, I point out some issues:  We talk about the benefits of getting the fixed-rate 30-year loans.  These loans are referred to as “FNMA loans” ( since they follow the FNMA – Federal National Mortgage Association guidelines). The FNMA loans will not be given to a new LLC. They will be given to an individual with income, a credit score, etc. Thus if you create a new LLC and buy the property in the name of the LLC, you will likely be giving up on one of the most powerful pillars of single-family rental investments: the 30-year fixed-rate loan.

Also, again, speaking as a non-lawyer (always fact check with a lawyer), an LLC has protective qualities only if it adheres to being a completely separate entity from you. It needs its own bank account, checks, (checkbook) books (bookkeeping or software like Quickbooks), etc. If there is a shortage in the LLC, you cannot just transfer money to it. That would be commingling funds and may destroy any protective qualities the LLC might have had.

Multi-Member LLC

In addition, lawyers have been telling me that court cases indicate more and more that for meaningful protection, you need to have a multi-member LLC and not just a single member one.

A single-member LLC is liked because it is a “pass-through” entity. That means the financials of the LLC flow through to the owner’s taxes and no separate tax return is needed for the LLC. However, a multi-member LLC needs its own separate tax return, K-1’s issued to the various members (and who is that other member, by the way?). That means more costly accounting fees and time spent.

In addition, some states require (besides a tax return), a yearly fee. California, for example, charges $800 per year per LLC.

I also mention that when you buy a home for $180,000 and put 20% down, you have a loan of $144,000. If a lawyer considered suing you and looked at this home, it would be unattractive – since the lawyer may not be a real estate professional, and he or she would assume that selling a $180,000 that has a $144,000 loan on it, will yield virtually no money after commissions, expenses, and perhaps selling quickly (it is not always an ideal time to sell). Thus the very existence of the mortgage is already a good protective measure.

Knowledgeable lawyers I know recommend using insurance as the first line of defense. Get good liability insurance on the home, and get umbrella insurance to cover up to your entire net worth.

Recently, I interviewed one of the best lawyers I have met on this subject, Brett Lytle, partner at McDowall Cotter out of the San Francisco Bay Area. Brett is also one of our expert guest speakers at our quarterly Expo once or twice a year. The podcast interview can be found in the Member’s area on our website:  www.icgre.com/members

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Some Markets Starting to Shift from Seller’s Markets to Buyer’s Market

Culdesac Single-Family Homes Shifting from Seller's Markets to Buyer's MarketIn a Fortune Magazine article by Chris Morris, published in February,  it is reported that in January 2019, there was more inventory available and houses sat on the market about a week longer than in January 2018.

As of January, there was an available inventory of 1.59 million homes overall, versus 1.53 million in December 2018.  Of course, the article is lacking by treating the entire country as one monolithic real estate market. Needless to say, there are hundreds of markets, and they don’t always perform in lockstep.

Nevertheless, there is a subtle shift, even in mentality, that is more favorable to buyers as opposed to sellers, who until recently reigned supreme. Since we are primarily buyers  (and then we hold for the long term), a buyer’s market is a positive for us.

Adjusting expectations

It is interesting to note, and one of the reasons I am posting this blog based on an article several weeks old is that while in January 2019 sales were flat, in February 2019 sales surged up, but then dropped only slightly. This is likely to continue to lower rates and sellers having to adjust expectations. Overall, we can see that while there is a shift towards buyers in many markets, the market is still hovering near a relatively stable point. With the low-interest rates and more friendly sellers, this becomes a positive for the investor.

We like to buy brand-new homes. Clearly, the sellers for us are builders. Some builders don’t want to sell to investors. Our market teams successfully convince the builders that it pays to work with our investors, as they get good volume from us. As the mood changes, these very builders may become more receptive to working with buyers, and perhaps even offer more incentives.

This will be discussed in more depth in a podcast on our Premier Members area soon. We will also talk about this during our next ICG Real Estate 1-Day Expo on May 18, 2019

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Is a Downturn in the Air?

Downsize and Downturn image blogAs we head into spring, there is a saying, “…spring is in the air.” And that is not the only thing being felt in the air. There seems to be a persistent notion that the “real estate market” has been going up for too long and is due for a correction. People also point out that the last big recession started in 2008, and perhaps the “cycle” is indicating that the new one may be upon us.

 

Of course, there really is no “real estate market” in the United States. There is the Phoenix market, the Dallas market, the Kansas City market, and the markets in every other metro area, such as Los Angeles, San Francisco, and so on. Not every local real estate market behaves in the same way others.

 

All markets do not experience a boom

 

Even during the major boom of 2004 to 2006, not all markets went through the boom. Some entire states “sat out” that of that one.  Similarly during the big recession, between 2008 and 2011, not all markets tanked. In fact, most of the markets that tanked were the ones which had boomed before.

 

Some states did not move down very much, even during the recession. This is an important point. If the San Francisco Bay Area (for example) does go down and corrects for its fast rise over the past few years, it is not “an automatic” that affordable markets like the Sun Belt states, (like the markets in which we invest) will do the same.

 

During past recessions, the rentals actually were better than usual. The reason is likely that if a tenant had been saving up to buy their own home, during a recession they are likely to shelve those plans till better times. Thus, even more, people rent than during stable conditions. Even if a downturn hits, the investor would likely benefit by just sitting and doing nothing, letting the loan balance pay down and get eroded by inflation, while enjoying lower vacancies.

 

How the Dodd-Frank bill helps

 

In addition, measures taken by congress after the last recession, like the Dodd-Frank bill, have mitigated the unbridled risk in lending that existed prior to the 2008 recession. My belief is if and when a downturn occurs, its magnitude is likely to be lesser than the last time.

 

One of the riskiest things, ironically, is that people delay buying solid investment homes, especially with today’s fantastic interest rates. I have met people from my past who never got started because there was always a recession around the corner, or a boom, or some other news item. Some of these people can be quite regretful 14 years later, realizing they could have changed their financial future but didn’t.

 

We will discuss this and many other issues at our 1-Day Expo on May 18th. I will also address this topic during our first webinar tomorrow–our official launch of the Members area on our website! Learn all about it and get on board at icgre.com/MEMBERS. Join us and stay informed!

 

 

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