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Primary Home – Investment or Liability

Pre-2007, I am not sure this topic would have even been controversial; people not only regularly utilized their home as their “primary investment”, but often, treated it as their personal piggy bank.  In hindsight we can all judge others as we secretly lick our own wounds from a vicious downturn no saw coming, but that experience left a visceral taste in many mouths.

Most experts would suggest that your primary residence is not an investment.  Why, you ask?  First, you purchase a home based on need.  Your buy and sell decisions rarely spring from analytical thinking around market timing.  Instead, most times, they are rooted in your changing life needs.  Second, investment strategy wages a secret war with your personal desires.  For example, I want a tricked out man cave equipped with a full wet bar, bathroom and other appropriate amenities.  Am I thinking about the return on my investment, or the endless joy my friends and I will have watching football on Sunday, Monday and Thursday?  Sure, I will likely increase the value of my home with these upgrades, but the anemic return on investment, if any, would never be worth the money.  Said differently, would you make the same upgrades to your rental property; probably not.

If it was that easy, I wouldn’t write the article.

I will start with a question.  Is it easier to invest in stock or buy a house?  Right now, Berkshire Hathaway Inc. (NYSE: BRK.A) trades at $128,175 per share.  Its five year performance has been strikingly similar to the performance of many real estate markets.  If you have a job making $50k and $7k in the bank, do you think you will ever in your lifetime own a share of Berkshire Hathaway A outside of a very lucky lotto ticket?  The answer is unequivocally no.  You don’t qualify for the right to buy on margin and even if you did, where would you get the 50% required to do a margin buy?  And how would you live on the prison food when the margin call comes?  All important questions to consider…

Now, let’s take that same fellow and put him / her into a working class neighborhood.  He sees a for-sale sign and the asking price is $130k.  He walks into his local bank branch gets a pre-approval letter and in 30 days, he is the proud owner of a similar $128k asset.  Interesting…  Are these two assets really that different?  Sure, the risk profile is different, but not as different as people would have thought 4 years ago.

The real difference is access.  Leaving aside the risk of foreclosure and the costs associated with credit repair, moving, etc., this person has $7,000 at risk and unlimited upside.  Additionally, there is no other investment available to them with a lower risk profile or higher upside.  This person probably could not even qualify for a real estate investment loan, but interestingly, they can get one chance to basically play with house money.

I would humbly submit that your primary residence is what you make of it.  You can treat it like an investment, moving to an up and coming neighborhood every 4 – 7 years, investing in only the Spartan renovations that meet a certain return threshold, or you can treat it like your home, “investing” in renovations that make you smile a little bit every time you walk in the door.  The choice is yours, but importantly, it is a choice.  If you treat yourself as you would a tenant and you make sound investment decisions, you very well could do well with your primary investment.  Given the easy access to financing, it may just be the biggest, safest investment in your portfolio.  Or not, its really up to you.

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  • 14 comments

    Revestor.com is live now. Revestor.com searches current listings by cash flow and capitalization rate.

    I received an email, from BHB Anaheim presenter Bill Lyons, that Revestor.com is live now and will be announced to the public tomorrow.  Bill knows that the Bloodhound way is to fly under the radar, sneak in the back door, and quietly win so I appreciate the chance to break the news.

    Revestor.com is a new property search site.  It’s unique proposition is that it allows users to search by either capitalization rate or cash flow.  Revestor believes it will become a useful tool for both investors and primary residence home buyers.  Bill Lyons suggested that its unique ranking display, offers data to a home buyer, which is currently unavailable.  Incorporating the income potential of a property offers another valuation model for home buyers to consider.

    I ran a search for an area with which I’m familiar; Oceanside, CA  zip code 92056.  I searched for properties listed from $150,000 to $250,000, by cash flow, and ten current listings were displayed.  The top two listings appealed to me:

    3906 Marvin -  a 3BR 2BA, 1064 s.f. SFD with $902 of free cash flow, with an 80% LTV loan, listed at $169, 767

    3132 Glenn -  a 4BR 2BA, 1302 s.f. SFD with $533 of free cash flow, with an 80% LTV loan, listed at 249,900

    Revestor offers a “launch” blog post and I’ll insert Bill’s comments from there (italicized), as I offer my ideas  here.

    Here is what I like about the site:  I like the map display of the listings and I love the fact that it ranks the listings by investment potential.  The financial data offered, on individual listings, is pretty comprehensive.  It drills down on expense data and allows the user to customize it.  The mortgage data is cool because it allows you to slide the down payment tool and see real-time figures.  The exit strategy information is unique but I’m unclear as to how they determine the potential resale value.

    Bill offered:  While San Diego is just a starting point we are still very much a “work in progress“. The site is not perfect (especially for a perfectionist that is striving for simplicity). We launched with about 75% of the functionality/capability that we wanted to, but hey, we were anxious to bring about change.

    Here is what I think needs improvement:  It’s only available for San Diego County right now.  That works fine for me but, as I’m sure the management of Revestor,com knows, that ain’t gonna fly if they intend to be a player.  I’m unclear as to the accuracy of the rental rates.  I thought the data look pretty high but I haven’t seen a property lease, in that zip code, for over a year now.  The individual property listing display page seems kind of boring with incomplete MLS listing data but the financial data exceeds my expectations.  Finally, the mortgage information is not “live” yet and a tad too ambitious.  That should improve as they secure live mortgage feeds.

    Bill offered: We will be the first to admit our ‘estimated rent’ and our algorithm are not 100% accurate. Over time (as the algorithm recognizes patterns in our database and our users give feedback it WILL gain more intelligence and get very close!). At this point, Revestor is not an end all be all, but rather a pre-due diligence tool. You certainly aren’t going to call up your real estate agent and say “buy 1234 Main St – now!” without doing any additional research but it sure is going to give you a good place to start

    All in all, Revestor,com is a great tool with a limited reach.  Tomorrow, it works for San Diego County agents and home buyers,  If Revestor,com wants to last past their cash burn rate, it is going to have to add new markets…quickly.  I’ve know Bill for five years now and I’ve seen him build profitable businesses pretty quickly.  If I had to bet on on a horse race, I’d bet on the Lyon.  Give Bill your feedback and don’t be too kind. He’s a big boy who can handle constructive criticism.

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  • 13 comments

    Re-Entering the Real World of Real Estate Brokerage

    As many of you know, I stopped doin’ business in my local market, San Diego, at the end of 2003. Since then I’ve done two transactions here, both as listing agent — both gettin’ the sellers Outa Dodge, so to speak. I haven’t bothered to market here cuz, well cuz I thought the prices were gonna keep falling, which they did, big time. Since I avoid short sales and REO’s like the plague, that pretty much ensured I’d not be doin’ any San Diego business. How dumb is it to buy income property in San Diego even now? You can see an example — where I present my answer to those whose only reason for holding on to the crappola they call income property there, is “I gotta be able to drive by my investment properties”. For the record, that example uses the lowest priced duplex in the neighborhood, and I used high projected rents.

    My response to local real estate investors when they’ve called or emailed objecting to my stance, is to ask them, “Well now, how’s that whole ‘drivin’ by’ thing been workin’ our for ya lately?” The ongoing market correction, and there’s more to come IMHO, has reduced well located duplexes that sold in late 2005 in the neighborhood of $550-600,000 to hoping to find a buyer while now asking $300-400,000.

    And their numbers still suck like a turbo-charged Dyson.

    In spite of these empirical facts of life, I’m makin’ my official return to the San Diego investment market next week. Office is set up, except for the internet connection which will go hot by Wednesday. Yet it didn’t feel real ’till I picked up my new cards and letterhead this afternoon. Haven’t had either for many years. There’s literally been no need. Everything I’ve done since 2004 has been out of California, and everything sans referrals since July of 2006 has come from my 2.0 efforts.

    It’s a good thing, cuz I had no other choice, unless it was to return to selling local homes to owner users, something I’ve happily abstained from doing since Carter’s second year in office. Man, just writing that puts a smile on my face.

    Most have been surprised when I’ve told them my income should increase manifold almost immediately. This is especially true when they learn I will refuse to represent buyers in the acquisition of SD investment property — as in, get somebody else, I won’t be a party to it. Still, my income should rise by somewhere in the neighborhood of 5-10 times.

    The reason is simple, in that pretty much all my local clients will be selling for the expressed purpose of movin’ their equities out of California. This means I’m back in the saddle again doin’ normal type business. See, when real estate investors make a move to improve their status quo, it almost always means they’re selling and buying — and buying more than they sold — 2-5 times as much. I’ve been shut out of this by San Diego’s horrific numbers. Since those numbers are now merely shamefully inferior, it’s likely local agents will bring their buyers to the table. There are more than enough agents/brokers and local investors who think I’m all wet about investing there. That works — as those buyers won’t be callin’ me when reality hits the fan.

    The best part comes when the smoke clears on these transactions — the clients will be immensely better off. More cash flow, more tax shelter, and the ability to increase that superior cash flow 2-6 times in a surprisingly short time span. That doesn’t even account for the relatively rapid increase in their equity to value ratio. For me it’s like introducing filet mignon to someone who thinks a really top notch cheeseburger is the best they could hope for.

    It’s what makes my work fun — significantly improving someone’s retirement, and/or movin’ up their retirement date. You can’t put a price on that feeling.

    If you’re an agent/broker doin’ business in San Diego on the home sellin’ side, gimme a holler. I’ll show ya how to get listings you never knew were on your menu. No kiddin’.

    So I’m all giddy with anticipation, not to mention I’ll now be able to resurrect my ‘local agent’ card on Fridays at HappyHour. Just don’t tell them how I feel about the local investment market, OK? They get a little touchy for some reason.

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    Appreciation Is A Luxury – Invest Accordingly

    Here’s an example, using real properties recently purchased by real clients. I’m gonna modify some of the numbers, but the modifications will not in any way make the bottom line better by an inch. (Worse in fact.)

    What if you paid $245,000 apiece for four properties, each with an annual gross scheduled income of $28,800. The renters sign year long leases, and tend to stay a little longer than two years. We’ll set the operating expenses and vacancies at just under 40% — $10,950 a year. This results, when using currently available loans, in a negligible cash flow of less than $250 monthly — essentially a break even.

    The down payment used will be 20%, though I’ll use 22% for any return figures. In these transactions you’ll be credited up to 2% of the sales price for your closing costs. The first year’s cash flow will be just under $3,000 or so for each property. We’ll assume any increases in expenses will serve to cancel out any rent increases. The loans are fixed rate, amortizing over 30 years, with a 6.5% interest rate.

    If in five years the value is still $245,000 — what will you have gained? Of course, you didn’t invest to find yourself in a non-appreciating asset. Since your crystal ball is in the shop, we’ll just consider it your time in Murphy’s barrel. :)

    So, what will you have gained in this scenario?

  • Income tax savings of around $7,500 a year, or $37,600 over 5 years
  • After tax cash flow of almost $12,000 annually, or $59,800 over 5 years
  • Principal reduction of just over $50,000 over 5 year holding period
  • It took about $54,000 +/- to close each of the four purchases, meaning you’ve invested a total of $216,000. In 5 years without values increasing, here’s what happened.

    Add up your 5 year total for tax savings — $37,600. Your after tax cash flow for the same period is a couple hundred less than $60,000. What that means to you is simple. Your Levi’s garnered just under $20,000 ($19,520) annually in spendable cash. That’s an after tax cash on cash return of roughly 9%.

    You also owe about $50,000 less than the day you closed escrow. Let’s look at what you might’ve done, if the after tax income was expendable for you.

    If you’d taken most of that after tax cash flow, say $18,000 a year, and applied it monthly to your loans, your total loan balance for all four loans combined, would’ve been only about $77,500 at the end of the holding period. If you did it for just another 31 months, you’d own all four properties free & clear. The income would be, give or take, $18,000 a year apiece — before depreciation.

    Your after tax income would run around $62,000 a year. You would’ve created this without a dime of appreciation — or a dime outa your own pocket. Not bad for less than eight years, would you agree?

    This is only to illustrate what’s possible for those of you wondering about your retirement. If you now have that $216,000 in capital this illustration is to demonstrate something I was taught when I first made the transition from homes to investments.

    Appreciation is a luxury — period — end of sentence. If you go into every real estate investment with that axiom in mind, you’ll be changin’ the way you analyze and acquire property.

    For those of you who’ve been decimated via your 401K or similar plan, this is a potential lifeline. Could things go wrong down the line? Absitively. Could those numbers be affected negatively? Yep. But they’re fairly conservative as used. Even if we apply what I’ve called the Vanderwell Rule — cut it in half and see if it’s still attractive.

    If you could invest $216,000 today and end up with 36,000 in before AND after tax income, half of what would be the most likely scenario, would you be OK with that? Your original capital would’ve more than quadrupled — in less than eight years. The after tax income at that point would be over a 16% yield on the original capital — again, using only half the most likely scenario.

    And all without any appreciation whatsoever.

    Something to chew on while perusing your latest 401K statement.

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    Real Estate Investing For Retirement – 2 Schools of Thought

    There surely are more than just a couple schools of thought when it comes to using real estate as a vehicle to get them to an abundant retirement. The two that almost always garner most of the attention are Buy & Hold for cash flow from Day 1, and Capital Growth First THEN a transition to cash flow upon anticipation of imminent retirement.

    Will either one get you there? Yep.

    The real question is — do you want your Social Security check to be used for groceries, or spending money? And yeah, I know, what SS check? :)

    Proponents of the Buy & Hold school are from the Old Old School. Don’t try to talk them outa their strategy. Show their results side by side with the Capital Growthers though, and they really get loud.

    I urge you to check out a comparison I’ve done over at my place. Caveat: It’s over 1,600 words of reading. It goes into clear detail. So far, folks who’ve read it, have been pleasantly surprised at how much solid info they understood and can now apply.

    If you’re a real estate investor, or wanna be one, this ‘case study’ is for you.

    Merry Christmas!

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    Retirement Ain’t For Everyone

    Just because you’ve found yourself in a position to quit your day job, and sail into the sunset, should you?

    If we assume you’re financially set and your Purposeful Plan has found the cool end of the rainbow, what will you do? So many of us use artificial rest stops in our lives as an excuse to do one thing or another.

    My dad sat down one weekend and set a business goal for himself with a 10 year time period for its accomplishment. Big problem. He was one of those guys born with only one gear — overdrive. For nearly five straight years he worked with less than a total (not counting a few sick days here and there) of 30 days off.

    He was definitely a thinker, but once he believed he’d figured something out, either lead the way, follow, or get mowed down, ‘cuz he was gonna get to Point B. His motto was given to him by his sixth grade teacher when he pointed his finger at 11 year old Dad and said, “Don’t make excuses Brown, make good!” And he did. I’ve given this a lot of thought, and at least for Dad the problem was simple.

    He never seemed to ask himself about life after achieving a goal. Like so many investors who read books and buy videos to learn how to buy investment property, he never asked a crucial question, much less come up with the answer.

    Then what?

    Just like buying real estate investments — anyone can buy something. Is it the right something? If so, and it rises in value — then what? Uh oh. Planning for retirement begs the ‘then what?’ question like a puppy happily wagging his tail who won’t go away. Figure out what your ‘then what?’ is and you’ll be way ahead of the game.

    There was the story he told me about having some drinks after work one evening with some friends. They got to talking about business, as they all owned their own real estate firms. Before he knew what was happening, the conversation had veered sharply into the topic of goals. One by one they began to reveal their goals — both successes and failures.

    Dad was very much a close to the vest kinda guy, and that’s being kind. He made CIA agents look like town criers. Still, these were some of his best friends and they wanted him to take his turn. So he did. (I’m sure several Jacks helped.) After a few minutes he was finished, and nobody was really saying much. Finally one of them said, “Doyle, it’s great to have lofty goals, but that simply can’t be done — in only 10 years? No way.”

    Dad was the poster child in many ways for walking spherical void. Yet for his friends that night he just smiled and agreed the goal was indeed a lofty one. He didn’t want to tell them that it was just 5½ years since he wrote the goal down, and he’d already surpassed it six months earlier. True story.

    So in the spring of 1970 he began preparing for retirement, though he’d never admit that’s what he was doing. He golfed daily — 12:15 tee off. His handicap sank like an anchor. He became bored. Went to law school, passed the bar, and opened shop.

    Got bored again.

    He was never satisfied with his retirement, never. In my opinion he was one of those guys who shoulda never turned in his office keys. He never found the rush when he stopped working. Ever met one of those people who simply couldn’t function without taking the contrary position? On every freakin’ thing? That’s how he decided what to do next. It had to be something he knew folks would poopoo.

    How ’bout you? I’ll speak for myself — I’ll stop working full time, but I’ll always be in the game. I think I have a diluted version of Dad’s gene. Seriously though, we must all plan for the part of retiring having nothing to do with finances.

    What will we do? Where will we live? And while we’re at it, how healthy will we be? Exactly what will we be able to have on our retirement menu? You gonna ski at 81? The last marathon I ran, there was an 80-something year old couple who crossed the finish line together cackling like teenagers. Will we be able to do things like that if we wanna? I plan to. That’s why I’m in the gym six days a week doin’ CrossFit workouts.

    Retiring isn’t just having more than enough stable income. It’s the other 99% of life.

    So when yer puttin’ together your Purposeful Plan, don’t forget the other side of the coin — the 99% side.

    Dad was never able to do that, and I think that’s a big part of why he was so bad at it. I can see myself umpiring Little League games when I’m older than Moses. Just the thought makes me smile. I envision myself at 80 callin’ balls and strikes on 12 year olds. How cool is that?

    What things in your retirement are gonna put a smile on your face? No matter what, always remember — it’s gonna come from the 99% side.

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    Halfway Through The Year (And Then Some) What Next?

    [[Crm notes: OK, I'm not gonna give a green light to Infusionsoft, not yet.  I HAAAATE the interface. But... there are triggers & action sequences that do a lot.  It might be the real deal.  This said, especially since they are ditching or have ditched most of their upfront fees.]]

    So we’re smack dab in the middle of july.  5.5 months left in this year.

    How’s it going?

    Making enough?   Was talking to Tim and Alexis McGee the other day.  They tell me that loads of Realtors are not chasing dreams and in are survival mode.  But, that they don’t wanna leave the business that’s not making enough anymore.

    Look, 5.5 months are left.  165 days.  120 workdays.  Tick Tock.

    Time is the enemy right now.  And not go go all Purcell and Brady on you, but is it gonna be EASIER, EVER to build wealth than it is today?  Tick Tock.

    How many closings have you had?  If you double it, is it enough?  If it’s not, what will you do differently to get more business in the door?   Tick Tock.

    Most of the industry, like it or not, makes it harder to do deals past Thanksgiving.  There are 137 days till then.  And only 106 work days, based on a 5.5 day workweek.   Tick Tock.

    Now, I’m saying this because we gotta be cognizant every day that it’s go time.  Time is finite.  It’s every one’s tendency to spend some time, “planning to get ready.” Tick Tock.

    Now is ready time.

    Every month has an excuse not to do jack in real estate sales:

    • January- “All my clients Just got over the holidays.”
    • February- “All my clients Waiting for the spring rush.”  (Deus ex machina).
    • March- “All my clients are getting their houses ready.  Mmm doggie, summer’s gonna RAWK!”
    • April- “All my clients are waiting for summer.”
    • May- “All my clients are priced too high.”
    • June- “All my clients are expecting a deal that just doesn’t exist.”
    • July= “All my clients are on vactation.”
    • August= “None of my clients want to take their kids out in the middle of a school year.”
    • September- “You can’t get ahold of anyone around labor day.”
    • October- “This fall is unseasonably cold.”
    • November- “My clients are getting ready for the holidays,”
    • December- “Who sells in December,”

    Get it?  Alec Baldwin’s moment of GLORY talks about this.  (Jump, Jeff Brown, to 5:55 for the punchline). We’re half way through.  Not time to rejigger your systems.  Not time to reinvent stuff.  If you’re not selling, bang the damn phones.  Bang on doors.  Network.  Give of yourself.

    One thing that I realize–as I went through the meat grinder of the IRS is this: I’m not yet wealthy because I haven’t rendered enough valuable stuff to other people.  Boom.  That’s it.  That’s the only reason why I was subject to the caprices of the IRS, that’s why I’m 33 and have a negative net worth.  Serve others, and they pay you.  Keep the money and it becomes a fortress against whatever.  My success this year (a trending right mixed bag) has been because of my dedication to help out, pitch in and give stuff to good people.  I ain’t perfect, we all know that.  Nobody is but the Nazarene makes that claim.

    That puts me at the punch line: you’re halfway through the year.  Have you given enough of your expertise? Have you given enough knowledge?  Have you locked the right rates, and told the full truth?   I am not yet there, but I’m closer than last year.  I’m getting somewhere.

    My numbers this year will have to improve second half by about 25% for me to be content.  That starts with being always cognizant of what kinda time we have.  We don’t want to be like Napoleon & get slaughtered by General Decmeber, January or February.  We don’t want to rationalize a bad finish with a ‘we’ll get ‘em next year.’

    Time to bang some phones and sell some blogs. Tick Tock.

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    Bar At The Raddison Phoenix?


    The Raddison In Phoenix is great so far. Everyone’s friendly. Coffee
    was tasty tasty.

    But hey, we’ve got like 5 hours to kill before the fun starts at
    Unchained. So where’s the Bartender?

    It’s noon in Phoenix, but it’s about time for happy hour for those of
    us still on the (ET)!

    -Ryan Hartman
    (Sent From My Fancy Phone…)

    Latest Videos From Youtube.Com/BloodhoundUnchained!

    [tubepress]

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    Silver Lining of Real Estate Market Correction Hiding In Plain Sight

    Gonna be down and dirty today with a strategy real estate investors aren’t using nearly as much as they should. I wrote a post on the subject on my own turf, but thought it important and valuable enough to give it some visibility here. The results this strategy can potentially produce are, in my experience, sometimes pivotal in getting retirement goals back on track, or even more dramatically, raising them from the dead.

    So many real estate investors own many properties. They’re located in different areas. sometimes different parts of the country. Some were acquired long ago, some, not so long ago. Some in areas blessed with ungodly appreciation — some that dropped like the anchor on the USS Ronald Reagan 20 minutes after escrow closed.

    Earlier this week I spoke to an investor wanting to know how to get out from under some losing income properties. They were worth less than he paid for them, but there was still some equity there if he were to sell them. Further questioning revealed his portfolio also had some long term winners that had increased in value impressively over the years, even after nearly four years of the current brutal market correction.

    This is one of those silver lining strategies that should really be looked at as the perfect silver lining storm.

    Told this investor he should sell ‘em all this year, and to get started around 4:30 yesterday afternoon. Now, of course that doesn’t mean everyone should take that route, but the strategy is as follows.

    Long term capital losses (held more than a year) offset long term capital gains. Simple as that. If, for example, you own a couple props bought with bad timing, that will produce losses, those losses will offset the gains on your gold medal props. This approach will yield many different very positive results — the escape from capital gains taxes being just one — and sans the use of a tax deferred exchange. How cool is that? The various perks are listed in the linked post. Not all of the cool potential results are listed, as some will accrue only to certain taxpayers. But the best rewards — especially the avoidance of capital gains taxes virtually universal.

    Anyway, hope this helps. Have a good one.

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    Joe Strummer: My thoughts on the looming crisis

    “Joe Strummer” is the pseudonym of a frequent commenter on BloodhoundBlog. He runs a weblog of his own — under a different pseudonym — and leads a life of joy, contemplation and undisturbed privacy under his real name. But no matter how he is denominated, Strummer is an expert in the Austrian School of Economics, a colloquium of great minds who are, alas, the eternally unheeded Cassandras of the decline of Western Capitalism. In this essay, penned yesterday, Strummer shares with us his reflections upon the burgeoning economic crisis:

     
    My thoughts on the looming crisis

    by Joe Strummer

    This is a graph of the nominal value of the assets that the Fed has “owned” over time. Notice the fairly flat, slightly rising line until September/October of 2008.

    Two points about this graph. First, the Fed did not get value for the $1.2 trillion it has purchased in “assets” since October. The $1.2 trillion in nominal value is actually nearly worthless. That’s because these “assets” are the mortgage backed securities backed by now- or soon-to-be-broken promises to pay by individual homeowners.

    Second, the Fed has merely pumped about 1.2 trillion of dollars into the market place free. In other words, it has taken nothing out of the economy of value. When the government adds currency – what Jim Cramer calls, dropping wads of cash from helicopters – without getting anything in return, it’s called inflation.

    Now, $1.2 trillion in new currency is bad, but not nearly as bad as when the Fed loans money to banks at a .5 interest rate. The Fed simply is printing money for any bank that wants to borrow it at .5 percent. Consequently, banks are now borrowing to 1) cover the losses they incurred to make themselves solvent, and 2) to have cash reserves that they can then use when the economy picks up to lend at future, higher interest rates.

    All of this inflation hasn’t hit the real economy because banks are hoarding that money to wait for better borrowers or because borrowers simply are hunkered down right now trying to wait out the storm.

    When the economy starts to improve a bit, and borrowers start coming out of the woodwork to borrow money for homes, or to build or expand businesses, banks are going to start lending again. And when they do, every bank will have a ton of cash to lend. That excess in currency is the inflation that will very rapidly hit the real economy as each bank seeks to push more and more of its cash into the economy. The inflationary-lending cycle will feed on itself.

    At the first sign of inflation, the Fed is going to clamp down. Inflation is harmful because it erodes the real wages & purchasing power in the economy. People on fixed incomes are obviously the hardest hit by inflation. Rapid inflation is even worse because it creates price instability and uncertainty. Think, for a particularly extreme example, of Weimar Germany with the semi-apocryphal stories of people pushing wheelbarrows full of devalued German Marks to buy loaves of bread.

    The Fed’s major tool for clamping down on inflation is to restrict the money supply, which means making the price of borrowing money from the Fed expensive. Up goes the prime rate. In the past 20 years, prime rates have moved on the order of .25 to .5 points per Fed meeting. Expect the Fed to engage in rapid adjustments of 1.5 to 2.5 percentage points per meeting.

    Very quickly the lending rate will move from 4.75 (which is what Wells Fargo is offering today for a 30 year fixed) to 7, 9, 12, 15, 20. I think it’s heading north of 20 within 36 months. That is historically high, but in 1979/80, for a brief period, the interest rate was over 20 percent. People my parents age can remember home mortgages that cost 14 percent in 1979 or so. Expect much higher this time around as this economic downturn is a genuine crisis.

    The high interest rates will make borrowing unaffordable for homeowners and businesses who want to do capital expansion. Housing prices will stay low with weak demand in the face of high mortgage rates. Economic growth will stagnate as businesses fail to create new jobs owing to the high cost of credit. More people will lose jobs, more defaults, more uncertainty.

    In addition, there is a second housing bubble waiting to burst in 2010 and 2011 stemming from credit worthy borrowers who are in ARMs but who will have trouble refinancing because they have very little equity or negative equity in their homes and from non-credit worthy borrowers who have gotten loan workouts that are going to fail because they just don’t have the money to pay the mortgage. Greg recently wrote that 60 percent of the loan workouts done in the Spring 2008 have ended up in default already.

    This second financial crisis will not just affect the people who made bad choices. It will affect a lot of people who were otherwise operating as if we were living in a normal economy the last five years.

    The period of rapid inflation coming in the next year or two, followed by rapid interest rate hikes, will be catastrophic to people like my parents. For instance, someone on a $80,000 a year pension – many public service workers – have by today’s standards a pretty comfortable life style. But imagine just two years of 10 percent inflation, a not unreasonable rate given what happened in the late seventies. Two years of 10 percent inflation – 20 percent in aggregate – erodes the value of a $80,000/year pension (assuming no cost-of-living-adjustment) to the equivalent of about $64,000. That loss in value is unrecoverable, because the Fed never permits genuine deflation.

    Consequently, retirees will be living on the equivalent of something like $64,000 a year, still not bad. But recall that normal inflation that’s considered normal/low over 10 years is still at 4 percent annually. That makes $64,000 the equivalent of $30,000 in fairly short order. Prudent investments now to simply maintain the value of money are difficult, so the key will be to reduce expenses and exposure that in 10 years, a retiree’s expenses are low enough that that person can get by on $30,000.

    People on public pensions are in better position than most assuming they also have some money in a 401k. But you can imagine how people can go from very decent lifestyles, to ones that are not so awesome. Add to that the looming crisis in Social Security and Medicare. The tax rates to simply keep those programs afloat are going to be dramatically high.

    The problem is sort of compounded in this sense by the fact that we got few of the benefits of socialism (say what you will about Sweden, but on a lot of measures for various reasons, the people there are fairly content), but by socializing the very wealthiest in society by bailing out the financial industry, and automakers, we are going to have all the costs of socialism.

    The United States is not going to claim a unique position in 15 years of being the powerhouse economy. Now, to the extent that the United States can claim not to be Argentina, that will be because of two things: first, we have much more built up wealth thanks to the preceding 150 years, and second, the rest of the world may suffer worse.

    But the fact of the matter is that in 1900, Argentina was the wealthiest country in the western hemisphere. It went from that point, to being eclipsed by the United States within 40 years because of the kind of economic policies that have kept Argentina much poorer (and which the United States has been engaged in for the past 15 years that have led to this crisis).

    There are two possible, and linked benefits of this economic depression: the United States will no longer have the economic power to operate as the world’s policeman. Now, it’s entirely possible that, in the slide, the United States starts to use its residual military power as a way to extract from perceived enemies economic rents. Imagine threatening the Chinese over some semi-real or perceived dispute in order to get promises from the Chinese government to buy more of our debt or subsidize more imports into the U.S. That would be bad.

    But it’s possible that, like the British, we start to unwind our commitments (which will involve some bloodshed as happened to the British in places like Rhodesia/Zimbabwe and so forth in the 1950s and 60s.)

    The second benefit is that as our country ages, the government recognizes the value of immigrants in coming to the country (as has happened in Germany) to pay for the cost of the retired baby boomers, many of whom have not in fact earned their retirement. Now immigration has a downside. First, for racial and ethnic reasons, many Americans don’t like Hispanics. That’s unfortunate as Hispanics have powered segments of our economy without a lot of the legal or economic benefits going to them. Those benefits have been extracted by the middle class who have had them build their homes at low cost, and then turned around and complained complained about “illegals”.

    The good news is that it could be marginally better than I describe.

    The bad news is that it could be much, much worse.

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    The Verdict Is In

    Last year on these pages I wrote posts extolling the benefits of EIUL’s. Back then I called them FIUL’s. The common usage for awhile has been the former, which we’ll stick to here. What’s an EIUL? It’s permanent insurance, designed, in essence, to deliver tax free retirement income. Some have called it investment grade insurance. It also has many other benefits, including the ability to pass the entire value of the policy tax free to heirs upon the insured’s death.

    My point in the previous posts was that if folks would just be objective, they’d realize 401k’s are a trap, baited by government with paltry annual tax savings to lure us in. What folks don’t know, I wrote, is that upon retirement, a disciplined saver finds out that in 4-6 years they’ve already paid back 30 years of ‘tax savings’. Such a deal.

    Why would anyone do that on purpose?

    It created a barrage of comments, some seemingly personal, but most disbelieving the information imparted. What’s so ironic, is whenever we guide our clients into these vehicles, it’s at a loss to us. We make not a penny on anything done by the EIUL experts to which we refer our people.

    Then why do we advise many of them to separate some of the real estate investment capital from their pile in order to acquire an EIUL? Simple — it’s the right thing to do. Yesterday I posted what happened to those who refused to believe me last year.

    Those who manage their company’s qualified retirement plans? Please, pretty please, at least check into this? If you’d at least done your own objective research, you would’ve discovered I was simply tellin’ you the way it was, and was gonna be. And now, the way it is.

    Those who saw the information for what it was, did not get hurt in the stock market crash of the last couple weeks. It’s been significantly hurtful to most, and absolutely devastating to a majority of American taxpayers heavily invested in mutual funds through their 401k’s.

    Those who chose EIUL’s? They not only didn’t lose a penny, they’ll have made about 2% this year. For those who belittled the info I put out last year, some of whom were in a position to make a difference for employees — how is your approach workin’ for ya now?

    This recent downturn hasn’t just caused severe financial losses to hard working Americans. What brings insult to injury is that it didn’t have to be that way. Toward that end, I’m on my knees begging you, no, BEGGING YOU — please talk to this expert in EIUL’s. What’s the worst that could happen? Garnering new information?

    If folks took the advice offered on last year’s posts, their retirement nest eggs would now be 15-30% larger. Not only that, but when they retire, their income will be tax free. When they die, their heirs will receive the EIUL’s complete value untouched by the death tax.

    I’ll stop here, as I’m about to get wound up. :) I’m sick to death of those for whom change is anathema, and to be besmirched at any cost, merely because it’s not what they’ve been doing. That cost in the last year has been devastating to thousands of American families who never knew they had another choice.

    What’s worse than that? Many of them were advised by those who knew about EIUL’s, but decided to keep it to themselves. Shame on them.

    What do you now say to a family who this month alone lost upwards of 30% of their retirement nest egg? It will take that family years to simply catch up to where they were. Some will be forced to postpone their planned retirements. Think about that. What’s worse than retiring with less income than should’ve been there?

    How about not being able to retire as scheduled?

    Had a call the other day from a client who’d started their EIUL last year. He and his wife aren’t 40 yet. You could hear his smile as he talked. Wonder what kind of phone calls some of the in house ‘advisors’ have been getting this month?

    Please, click the link and at least hear what an expert has to say. Yeah, I’m begging one more time. Imagine if this happens again, and you’re ambushed again. Working into your 80′s isn’t all it’s cracked up to be.

    To those who dismissed what I had to say, out of hand last year?

    Read my mind.

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    Planning to retire at 50? Good on ya! Have you made plans for living a hundred years beyond that? In a world that changes like dreams?

    Unless you come down with a fatal disease or find yourself in a gun battle, you’re probably going to live a lot longer than you ever imagined. This week’s news is interesting, but life-extension is a secondary consequence of everything associated with free markets. That trend is centuries old by now — better food and water, personal hygiene, continuous improvements in medicine, the widespread availability of something as mundane as fresh cow’s milk.

    And just think how much longer and richer your life could be if you weren’t carrying 50% or more in parasitic government weight on your back. The interesting thing is that the rate of change is increasing far faster than governments and other misanthropes can drag it down. My own personal dictum has always been, “They can’t enslave us if they can’t catch us.” The literate third of the globe is at that point now. The other two thirds are just a few years away. If we can navigate the next few years without blowing ourselves up, we will reach a point where the average middle class household in the United States will control more real wealth than entire countries would have owned just a few centuries ago.

    I’m sure I’ve cited this before, and this version of the film is an antique by now — it’s almost a year old — but this is a very compelling presentation:

    Of course you cannot make any detailed plans about living decades longer than you expected with everything changing constantly — and at an ever-accelerating rate of change. The truth of the matter is, if you live to be 150 years old, you have a decent chance of living forever. The even more startling truth is that the ever-accelerating rate of change in all branches of technology is racing us toward a singularity, a point where all of our models of understanding break down and we have no rational means of predicting what will happen.

    No one can predict the future more than a few years out, but what you can do is reprogram your mind. In omnia paratus — prepared for everything. If you are going to live a very long life — happily — I think you are going to have to train yourself to think like you did when you were twenty-five — serious about work, serious about the future, open to change, undismayed by frustration, eager to learn new things.

    It took you twenty-five years to get there, and I’ll grant you twenty-five years of senescence on the back end. That gives you a solid century — maybe more — to live and work with a young, supple, avidly-interested mind. If you’re not there now, you might start moving in that direction. There’s no rush, though. You’ll have a lot more time that you thought you would.

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    Who Should Use EIUL’s — 401(k)’s Aren’t Cutting It For Most

    Equity Indexed Universal Life is, when simplified, investment grade insurance. It’s a tool, a vehicle used by folks to create retirement income. I’ve written of this before, much to the chagrin of Mr. Swann. I’ve since put many clients into them using industry experts. Why? ‘Cuz it’s the right thing to do. Every dollar a client spends on this vehicle is a buck they’re not spending with me. I make zip, nada, zilch. They understand this, and appreciate it. They’ve come to rely on our consistent congruency when it comes to keeping their agenda #1. And their agenda is a magnificently abundant retirement. We make use of what i’ve called a Purposeful Plan. Sometimes that Plan includes investment vehicles other than real estate. We do what works.

    EIUL’s work.

    As a favor to Greg, though he didn’t ask, I’ve moved this party over to my place. Last time I think his head almost exploded when this subject came up here. People tend to get upset when it’s their ox being gored. Heck, I’m goring my own ox with this one. But again, it’s the right thing to do much of the time.

    David Shafer is the guy who will answer your technical questions for this post. He recently wrote a guest post on BawldGuy Talking explaining why and when taxpayers would opt for an EIUL over their qualified retirement plan.

    Soon, I’ll be writing a piece referencing a recent 20 year study showing mutual fund returns inside 401(k)’s have been less than 5% annually. And this study is used as a marketing tool. Go figure. I’ll make the study available, probably in dual form with David’s site. This study sheds light on the dirty little truth about mutual funds and their performance inside taxpayers’ qualified retirement plans.

  • Folks aren’t starting with realistic numbers. Mutual fund returns in 401(k)’s not good.
  • Front loading EIUL is best — drives down the cost of the insurance.
  • Your combined income tax rate is over 15%? Then numbers skew toward EIUL.
  • The higher the combined retirement income tax bracket, the more the numbers favor EIUL
  • EIUL never tells you when you can access your money or force you to pull it out.
  • Insurance component: 50% die before 84 — 25% before 75 years old.
  • Average return rate reported my mutual funds don’t allow for ‘down’ (negative) years
  • Negative years hurt more than positive years help — EIUL’s don’t have negative years.
  • It’s been my contention since I learned about the EIUL that 401(k)’s are Uncle Sam’s own retirement plan. It begins by saddling Boomers with bigger tax bills than they ever paid while working. Those who believe their tax bite in retirement will be less are either ill informed, or not candidates for an EIUL. Why? ‘Cuz their retirement plan was so bereft of any real planning, their income will in fact not be high enough to put them into a higher tax bracket. They won’t be entering retirement as much as they’ll be beginning their life sentence.

    OK — Let the games begin. Go see what David has to say, and give him your best shot.

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    Warning: It May Not Be a Good Idea to Drive Agents Out of the Business

    To anyone who even suggests that Realtors (and ex-Realtors) can’t organize sequences and work out all the details for a long range plan, I invite you to read this story.

    Olga and Helen - Killers

    Helen Golay, 77, a former real estate agent in Santa Monica has been convicted of murder. I now recommend avoiding all unnecessary contact with ex-agents, just to be safe.

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    Are You Still Waiting For Her To Come Back?

    So much of the country hasn’t experienced the 15-40% annual appreciation rates places like San Diego have experienced several times. Regardless of the down times, we’ve learned she always comes back smiling. The market? In the end, she would always love us. She always has. Though at times she could lash out, she always made up for it with lavish gifts of abundant appreciation. That may still be the case in regions like SoCal, but it’s my belief it won’t include the vast majority of residential income property.

    There are several reasons allowing investors to conclude this. I wrote about many of those reasons in over at my place, adding a video for fun.

    First and foremost, developers paid attention in eighth grade math class. They can make $X building duplexes or fourplexes and the like OR $X+ building condos/townhomes OR $X+++ building single family residences — and all on the same piece of dirt. Go figure, they chose to build where they found the most profit. This has been happening in places like San Diego since the ’80′s.

    The only residential income product built since then has been recently. It’s been concentrated on the coast and upper income locations with rents that are incredibly high. These newish projects are not competition, nor do they have any positive affect on the values, rents, or vacancy rates of 35 year old duplexes. Duh.

    An example is a new place offering 1 bedroom apartments for twice the rent of competition half a mile away. Twice as much. They also offer their tenants everything but a Friday night date — something I’m sure they’ll correct upon reading this.

    The point is that the market? She’s left you. And she ain’t coming back no matter how much you turn on the old charm. When investors have the choice of putting less than 35-50% down just to break even, they’ll do it. The party’s over. Capital flows to the best returns. Duh. So why do folks in places like uh, the west coast for instance, insist things will revert to the status quo they’ve relied upon for so many decades?

    They’re spoiled. I speak as one of them, who admittedly came late to this fundamental reality. I’ve been shouting from the mountain top ever since. (around late ’03)

    Their true love has never let them down. She’s never made them actually work for the profits from which they’ve benefitted. In San Diego, buy something in ’76, exchange it in ’78 for a substantial profit and more magic property. Recession. She turns her back on you, miffed. Buy again in ’83-84 and exchange all your stuff in ’87 and again in ’89. S & L Crisis — she’s really upset at you this time. But she’ll get over it, she always does.

    It takes her longer that time, but she comes around just as you knew she would. Lord she’s gorgeous. You tax defer everything again in 2000, and find yourself feeling pretty special. Then you do it again in ’02 and once more in ’04. In the the five years 2000-2004 you’ve literally made gains requiring two commas, and all in San Diego.

    You’re thinking she still loves you.

    Then she decides it’s over in ’05. Without warning, (at least that’s your story) she’s been seeing others. Turns out she’s been planning this for quite some time. While you’ve been making all this money, she’s cut you off — and you may not realize it’s permanent. She doesn’t care anymore, yet you insist on sending flowers.

    Counting on her loyalty isn’t a bet I’d make, considering your retirement is what’s at stake.

    Forget her, and realize what’s she’s done with you. She’s allowed you to keep thinking she was your true love, when in fact she’s allowed your properties to become very unattractive to investors. They’re old, require much maintenance, are many times functionally obsolete, and frankly are becoming the default for those with poor credit, and the inability to live anywhere else.

    Sure, you retort, but that last bit describes rental property almost everywhere. True enough. But would you rather have a well employed tenant on their way up, who has chosen to live in your unit and in that neighborhood? Or deal with your tenants, lifetime renters who hate living in your units because they now realize the dream of home ownership is probably not gonna happen, at least not in San Diego. They’ll either join the folks leaving places like SoCal for Arizona, Idaho, Colorado, Texas, and Kansas City, or remain in San Diego until the choice simply isn’t theirs any longer.

    She’s not coming back. There are some pretty sexy markets out there doing there best to get your attention. Go where you’re wanted.

    Wow, look at her, is she hot, or what?!

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