Friday, October 26, 2007

Did this Couple Do Everything Wrong or Everything Right?

Two Wise Acres wrote about an older couple who succeeded in the real estate investment rental business by doing "everything wrong" by violating these "rules":

  • 1. "Leverage Your Investments to Maximize Growth" (instead, they paid off a property before they bought another).
  • 2. "Always Make Sure You Have Well-Drafted Leases with Tenants" (instead, they rented month to month with no lease).
  • 3. "Maximize Rental Income" (instead, they charged 30% under conventionally-accepted "market rates").
  • 4. "In Your Lease, Make Sure that You Contain Appropriate Restrictions on Tenant Alterations to the Property" (instead, they allowed renters to paint even the exterior of the building).
However, the couple followed these rules instead:
  • 1.Minimize costs (debt)--and pass the savings to the customer without lowering your profit (low producer costs=low consumer prices).
  • 2.Serve the customer, find a niche, and build loyalty--the biggest cost/effort/risk is spending for the initial setup and then (tick-tock-tick-tock) eating your costs while waiting for a 1st-time customer to "walk in the door" (this why companies spend so much to advertise and to track and profile customers) so the holy grail for renting is "finding your market" (flexible leases) and no vacancies (less turnover, less frictional losses, maximum utilization of your infrastructure, on the edge of your economic "production possibilities curve"), provided by tenants' loyalty and tenant-provided free word-of-mouth advertising/recruiting.
  • 3.Undersell the competition--#1 leads to #2. Low price also increases the landlord's applicant pool so he/she can select and keep the cream of the renter crop.
  • 4.Build/allow customer identity/community with your product--customers will lower your costs by doing free maintenance (paint the rental house) or will create new content or products for you (free R&D). A recent book argued that most innovation comes from the bottom up, from users who invent something new for their own use first (necessity is the mother of invention, and the customer/user knows his/her own needs better than existing companies know his/her needs) and then the big companies mass-produce what the customers invented for them.
Real-life example: Another landlord (not Two Wise Acres' couple) offered low rent with no lease, let a renter nail/drill holes, and even added a major amenity without being asked or raising the rent. The renter returned the favors, paid to fix the apartment's (landlord's) refrigerator without bothering the landlord, and paid professional cleaners to clean the apartment when he moved out.

(I will write more about renter modifications in a future installment of my "Housing Myths" series.)

Did these Landlords Do Everything Wrong or Everything Right?

Personal Finance Carnival 123 Features Home Finance Freedom's "Homeownership Cost Cliches: Housing Myths Part 10"

Home Finance Freedom's "Homeownership Cost Cliches: Housing Myths Part 10" was featured by the 123rd Carnival of Personal Finance at The Dough Roller in a Halloween theme, along with a number of good articles from fellow PF bloggers. Thank you.

Monday, October 22, 2007

How Much Is Your Blog Worth?

Single Ma's Fabulous Financials posted these helpful links:

Someone added my blog to Blog Shares: The Fantasy Blog Stock Market. Apparently, I have 2 investors.

Have you valued your blog?

Friday, October 19, 2007

Homeownership Cost Cliches: Housing Myths Part 10

Previous: House Depreciation-Maintenance: Housing Myths Part 9

Housing Clichés Can Cost You Dearly

The last article mentioned that counting just 2 factors (inflation and maintenance/repairs) can cancel any supposed real-estate “investment” appreciation but there are many more costs that can turn home ownership into a loss: mortgage interest, taxes/insurance/fees, and opportunity costs of missed investments.

Your mortgage costs DO increase every year and these increases disprove the "payments never go up," "payback with cheaper money," and "good debt" cliches.

“Your rent goes up but my mortgage payment does not” is just another way of saying that the "fixed" mortgage payment starts too high, in real (inflation-adjusted) terms (plus, rents DO NOT always go up). The mortgage-holder tends to assume that the first mortgage payment is the “just right” size and everything later is discounted (by inflation) but rarely considers that the last payment might be the “just right” size and everything earlier is at a penalty rate.

“I get to pay back my mortgage later in cheaper money” is another common cliché that undermines the first cliche: If postponing repayment is so lucrative, then you would want to pay little at first and more later, so mortgage payments that do not increase over time would be bad. The “cheaper money” slogan argues for the ultimate balloon-payment plan of paying $0 for 29 years and paying everything (several times the purchase price) in the last year.

Both of these common quotes misread the mortgage situation:

All mortgages have annual cost increases built-in but people overlook the increases by looking at the nominal payment rather than the accrued cost. If your mortgage rate is 5%, each year your new, extra cost is an additional 5% of the year’s debt. The mistaken belief of no payment increases is an illusion simply because the bank has pre-calculated your 30 years of cost increases and front-loaded your money-up-in-smoke interest costs.

You are repaying your mortgage with more expensive money (not cheaper money) because the interest rate is almost certain to increase the debt cost at a rate faster than the official inflation rate. The repayment would be "cheaper" only if the mortgage had no interest rate (or one less than inflation), but I have not seen any mortgages like that, so I think the banks have figured out that loophole. Unless you find a bank that is so stupid that it lends for less than its costs decade after decade, you are losing more money each year that you keep a mortgage.

A $225k 5% fixed-rate mortgage is about the same as taking 30 years to pay off a $225k 5% credit card debt. Debt is debt. Compound interest compounds.

Pre-paying principal is so powerful at lowering your costs because it reduces the compound-interest increases.

The only escape from annual mortgage-cost increases is to end the mortgage.

Non-debt home-ownership costs increase too and these costs disprove the "but eventually I'll have free housing" cliche.

Owning has many costs such as taxes and insurance that can increase faster than the inflation rate and faster than rent increases. Experiences vary from person to person but consider these real-life examples: One person rented for 7 years without a penny increase in rent while another person during the same period bought a house and saw property taxes skyrocket 50% in 5 years. Even with no mortgage, a homeowner’s costs can increase faster than a renter’s costs.

Opportunity costs of missed investments disprove the "renters end up with nothing," "at least I have home equity," and "mortgages are forced savings" cliches.

Neither borrowing 100% nor paying 100% cash to buy a house necessarily beats renting:

Borrowing $225k at 5% costs $11,250 in interest in the first year ($937.50/mo), not counting loan origination “points,” closing costs, taxes, repairs, and other fees/costs--none of which creates a penny of equity.

Anyone who likes to pay principal on top of the consumption costs can just as well save/invest on top of paying rent, so "owning" and renting offer similar equity opportunities.

Building equity depends primarily on the individual. Spendthrifts can find a way to stay in debt whether they rent or "own."

0% downpayments, interest-only loans, HELOCs, reverse mortgages, and other house-as-ATM "equity harvesting" all prove that home-"owning" is no guarantee of "forced" savings. An automatic payroll deduction into a money-market account might be a cheaper "forced" savings plan. A renter's security deposit has more equity than some no-money-down homebuyers do.

Renters might beat homeowners in the equity-building race because renters are more likely to have lower early payments and therefore benefit from the renown compounding magic of saving early (contrary to "mortgage payments do not increase" and its backward logic of high costs/low equity-building now and low costs/high equity-building late in the game).

Paying $225k cash for a house will avoid paying interest but then you have nearly a quarter-million dollars tied up in an illiquid asset that might appreciate nominally at 5% but can have zero or negative real “appreciation” after all input/carrying costs are considered.

You instead could invest the $225k cash in stock or other investments to earn net 5% ($937.50/mo) and keep your $225k stock equity while the interest/dividends/appreciation income pays your rent, maybe in perpetuity (depending upon exact rent, inflation, etc.).

The Good Cliche: There Is No Such Thing as a Free Lunch in Housing

Housing is consumption when you own as well as when you rent so do not be surprised by the possibility that homeowner’s net costs might be similar to renter’s net costs.

More Misleading Housing Cliches (Parts 1-9, in reverse order):
"Renting doesn't build equity like my house payments do!"
"I'm debt-free! . . . with a $500,000 mortgage."
"My mortgage rate is really 1/3 less and I want to get as big a tax deduction as possible!"
"Buy as much house as you can afford!"
"My mortgage is free because I'm renting to myself!"
"My mortgage doesn't count as an expense because you have to live somewhere!"
"I really increased my ROI by leveraging as much as possible with no-money-down!"
"Never prepay your mortgage!"
"I borrow against my house to invest in the stock market!"

Next: Home Decorating Costs: Housing Myths Part 11

Thursday, October 18, 2007

Personal Finance Carnival 122 Features Home Finance Freedom's "House Depreciation-Maintenance: Housing Myths Part 9"

Home Finance Freedom's "House Depreciation-Maintenance: Housing Myths Part 9" was featured by the 122nd Carnival of Personal Finance at Mighty Bargain Hunter in a fanciful Dr. Seuss theme, along with a number of good articles from fellow PF bloggers. Thank you.

Tuesday, October 16, 2007

Birthdays without Presents?

Birthdays without Pressure claims,

"If you think children’s birthday parties are getting out of control, you’ve come to the right place."
What do you think?

See also: Is Your Baby Cost-Free?

Sunday, October 14, 2007

House Depreciation-Maintenance: Housing Myths Part 9

Previous: The "Debt-Free" Deception: Housing Myths Part 8

The Accidental Money Pit:

Do you have a few hundred thousand dollars lying around to sink into a 0% investment?

Real Estate marketing hype is that you sit back and smoke a cigar while your home value goes up, up, up--but the reality often is that you drag yourself home from work to find that you have to bail water out of your basement before black mold takes root.

The repair problem is not limited to the current housing-bubble price crash. Even “normal” maintenance and repairs of 1-2% of home value total $2k-$5 for a $225k median-price home and thousands more for more expensive homes.


Consider these 2 real-life examples:

  • A condo buyer in the first year suffered water damage costs (a problem that damaged a neighbor’s unit), re-roofing costs, and fencing costs to add on top of the regular condo fees, mortgages, and taxes (regular condo fees cover frequent, small expenses such as lawn-mowing but large repairs often require extra “assessments”).
  • A home buyer suffered a single structural problem that cost $9,000—an entire year’s rent for many people—to add on top of all the normal maintenance, mortgage, and taxes.

No Escape from Housing Consumption (not Investment)

You can see the false assumptions:

  • A condo buyer thought that he/she would escape surprise maintenance bills by paying regular condo fees but then finds that he/she must pay the condo fees and then still pay big maintenance bills too.
  • A home buyer thought that he/she would escape paying thousands of dollars of consumption housing expenditures that do not build equity but then finds that he/she must pay hundreds of thousands for the house “sticker price,” plus taxes and fees, plus (usually) mortgage interest, and then still pay more thousands in housing consumption to counter depreciation.

Imagine if people used real finance rules to calculate their housing “investment”?

Repair=Input: Repairs Increase Your “Cost Basis.”

Repairs are input costs, similar to a delayed addition to the purchase price. People like to stop counting their costs after “closing day” and pretend that years of additional costs never happened.

Tax rules recognize that repairs lower return on investment (ROI), i.e. eat away your "profits," which is why people keep repair records for tax returns, to prove that they did not make that much money after subtracting expenses.

I suppose that theoretically you could prevent your car from depreciating if you poured enough extra cash into it but those infusions would lower your return on investment (ROI), not increase it.

Houses Are a Depreciating Asset?

Try this: Buy a house and then abandon it completely for 30-50 years (no heat, no lawn-mowing, no re-roofing, no sump pump, no security, no insurance, etc.). Go find it when you are ready to claim/sell your nest egg to retire. Is that a winning investment?

(Anyone can be a Monday-morning quarterback and name past performance of a particular location, like saying, "If you bought Stock X in 1930 . . .," but it is harder to predict which markets will be hot a half-century in the future.)

The long-term US residential real estate nominal appreciation has averaged 3-6% per year but inflation plus regular, boring maintenance/repairs means that your house might return 0% real growth after 30 years—and that is before considering mortgage interest cost.

Next: All costs combined can make homeownership a negative investment and possibly worse than renting: Homeownership Cost Cliches: Housing Myths Part 10

Friday, October 12, 2007

Personal Finance Carnival 121 Features Home Finance Freedom's "The "Debt-Free" Deception: Housing Myths Part 8"

Home Finance Freedom's "The "Debt-Free" Deception: Housing Myths Part 8" was featured by the 121st Carnival of Personal Finance at Mr. Credit Card in a fanciful presidential debate theme, along with a number of good articles from fellow PF bloggers. Thank you.

Sunday, October 7, 2007

The "Debt-Free" Deception: Housing Myths Part 8

Previous: Home Mortgage Tax Deduction Snake Oil: Housing Myths Part 7

The entire rent/own/mortgage debate is thoroughly confused, misguided, and backwards.

You are NOT debt-free if you have a mortgage. Mortgage is debt.

The love of mortgage debt is so bizarre that some people try to deny that mortgage is debt--and then accuse debt-free people of being in debt.

Have you ever had anyone tell you that they are "debt-free" only to learn that he/she carries tens or even hundreds of thousands of dollars of mortgage debt? The person might be justly proud of reaching some milestone in debt reduction but it is quite a feat of denial to pretend that the largest debt of his/her life does not count as debt.

RENT is debt-free for the tenant.

Someone once doubled the "up is down" mistake by asserting not only that mortgages did not count as debt but that rent did count as debt.

The person confused houses with housing, confused consumption with debt, and confused purchasing with financing.

  • Housing is consumption, an ongoing necessity like food, but recognition of a future necessary consumption is not "debt" unless you want to tell everyone that you are heavily in debt to the grocery store because you will need to eat lunch 50 years from now.
  • Debt is when you consume/take-title before you pay (becoming a debtor to the seller/provider), as opposed to pay-as-you-go (provider and consumer walk away even), or paying in advance (becoming a creditor to the provider).
The rent v. own debate is a false "opposite" and crippled by a logical flaw.

Renting and buying housing with cash are 2 forms of paying in advance. The question is if it is cheaper to pre-pay for 30 days or 30 years.

Renting and buying with cash are similar to each other and it is the mortgage that is the complete opposite. Too many people make a leap of logic of confusing paying-in-advance with spending money that they do not have, which is an entirely different kettle of fish.

The landlord is debtor to the tenant.

The tenant pays in advance by paying on the first of the month for housing in the coming month, which puts the landlord in debt to the tenant. The tenant is the creditor and the landlord owes a month of housing.


A lease is a mutual obligation on both parties. Technically, you might argue that you are in debt to the electric company because the company does not bill you until after you consumed the electricity, but by that logic you are in debt when you are eating at a restaurant before the waitress brings the bill. The distinction with restaurants, electric bills, and credit cards is that they provide a grace period with no interest charge (treating the transaction as pay-as-you-go).

The practical test for "debt-free": You are in debt if you are paying interest. You are debt-free if you do not pay interest.

Next: The Accidental Money Pit - House Depreciation-Maintenance: Housing Myths Part 9

Friday, October 5, 2007

Personal Finance Carnival 120 Features Home Finance Freedom's "Home Mortgage Tax Deduction Snake Oil: Housing Myths Part 7"

Home Finance Freedom's "Home Mortgage Tax Deduction Snake Oil: Housing Myths Part 7" was featured by the 120th Carnival of Personal Finance at My Retirement Blog, along with a number of good articles from fellow PF bloggers. Thank you.