Real Estate Archives - Lazy Man and Money

The Basics of REIT Investing for Passive Income

August 28, 2019 by Lazy Man 5 Comments

It’s been a little while between posts. I’ve been on a short family vacation/road trip. We brought the kids to New York City for a day before moving on to Hershey Park. We’re trying to squeeze every last drop of fun of summer before school starts. It’s been nice to put down the laptop and be blissfully ignorant of whatever is going on in the chicken sandwich wars. However, I’ve been fortunate enough to have a guest post from sureDividend on two of my favorite topics – REITs and passive income. I plan to be back next week with an article (and maybe one before that), before taking another break for the FINCON financial blogger conference.

Real estate is a highly popular method of investing for passive income, and for good reason. It has proven to be one of the most reliable long-term investments capable of delivering consistent, sustainable, and inflation-resistant cash flow.

However, it has the main drawback of potentially requiring extensive hands-on management and the hassles that come with being a landlord, which prevent it from being a truly passive investment. Additionally, real estate often requires considerable capital just to purchase your first investment, making it a cost-prohibitive investment for beginning investors.

However, for those looking for true passivity, a less cost-prohibitive, and/or a potentially even more lucrative and lower risk means of investing in real estate, publicly traded real estate investment trusts (or REITs for short) offer investors a compelling alternative. REITs are also attractive for their high dividend yields.

Why Real Estate?

Investopedia defines REITs as real estate portfolios that receive income from a variety of properties and then distribute at least 90% of that taxable income to investors in the form of dividends. Additionally, the REIT itself qualifies as a pass-through entity which means that it does not have to pay any corporate income taxes and most, if not all, of its dividends qualify for a 20% tax write-off after the latest tax reform bill.

Real estate is a tangible asset that provides clear value to its user. Additionally, the nature of its value is limited, necessary, and flexible – giving it remarkable durability and stability in value and making it extremely unlikely to become worthless over time unless it is grossly mismanaged and overleveraged.

Furthermore, real estate often generates cash flow through a variety of means. This means that it can be repurposed to fit whichever business is in demand at the time.

Finally, its finite supply makes it inflation-resistant. While the fiat currencies of the world continue their inevitable march towards zero, the amount of available land actually declines as the population increases. This has resulted in the value of real estate, on average, growing in a direct positive correlation to the rates of inflation and population growth over time.

This aspect of real estate is extremely valuable for early retirees as it leads to cash flow growing in line with consumer prices over time, making it a great way to ensure stable buying power to fund a retirement lifestyle.

These positive qualities are also supported by the data, as commercial real estate scores as the best possible risk-adjusted investment over long periods of time.

Why REITs?

As previously mentioned, while real estate investors enjoy many advantages that often lead to stellar long-term results, real estate still has some drawbacks as a passive income source. In fact, some would argue that it is not really passive income at all. Being a landlord necessitates going through the sometimes arduous and stressful process of finding good tenants, completing the necessary legal work, performing routine maintenance and occasional repairs or hiring contractors, and keeping your tenants accountable to paying their rent on time.

Furthermore, if you ever need to liquidate your investment, preparing, listing, and ultimately selling your property can be a costly, time-consuming, and stressful endeavor. If you have to liquidate it quickly, you will quite possibly have to settle for far less than market value to attract an immediate cash buyer.

Of course, you can always hire a property manager to mitigate many of these stresses, but the costs associated with that will eat heavily into your cash flow and total returns. Additionally, there is the personal liability of getting financing and making mortgage payments if you do not buy your property with all cash as well as the potential for a costly law suit from tenants. In all, these costs could make owning physical real estate a much less appealing long-term investment compared to alternatives.

Finally, there is substantial concentration risk. Unless you are a multimillionaire who can afford to purchase a large empire of rental properties, you will be focusing much of your wealth on a concentrated selection of assets. If that real estate market turns south, or a couple of your properties suffer from prolonged vacancies and/or bad tenants, your investment returns will be significantly harmed.

In contrast, REITs provide investors with all the benefits of traditional real estate investing without the aforementioned downsides. Instead of dealing with the dreaded “triple Ts” (tenants, toilets, and trash) of landlording, shareholders in a publicly traded REIT can kick back and relax, knowing that a professional management team is caring for their real estate portfolio 24/7. This makes REITs a truly passive investment.

Furthermore, publicly traded REITs are very liquid investments. With a simple click of a mouse (and without costly transaction fees), investors can buy and sell shares of a REIT at the current market price. This means that if an emergency strikes or some other reason arises that causes investors to want to liquidate their real estate investments quickly, REIT investors can get out immediately if they need to.

Finally, REITs offer investors much less risk than physical real estate. A single REIT share in some cases can be purchased for a few dollars, providing a stark contrast to the thousands of dollars’ worth of equity typically needed to purchase a piece of physical real estate. This enables even small dollar investors to diversify broadly across a large number of different REITs. Additionally, each individual REIT typically holds dozens, hundreds, or even thousands of different individual properties, often across multiple cities, regions, and even countries. This gives REIT investors an enormous diversification advantage over their real estate landlord peers as their cash flow tends to be much more stable and secure against market, tenant, and vacancy risks.

A final advantage of investing in REITs is that over long periods of time they have proven to offer superior average returns than investing in individual properties by a score of 11% per year to 7% per year (source).

While this outcome may sound surprising at first, it’s very much expected and even normal. There are real economic reasons why REITs outperform and why this outperformance is expected to continue. First is because REITs generally experience faster growth rates than individual property investments. This is due to the fact that REITs have better access to low-cost capital and enjoy professional management and economies of scale. Second, private investors have a tendency to take on far too much leverage and are lulled into a false sense of security during prosperous times. REITs, meanwhile, take a longer-term, full-cycle approach to investing and typically maintain a responsible “happy medium” level of leverage. This enhances long-term returns without putting them at excessive risk of suffering permanent loss or even bankruptcy in an economic downturn.

Final Thoughts

Real estate has proven to be a great way to build long term wealth and a steady and growing stream of passive income. With access to publicly traded REITs, every investor can begin building wealth and an entirely passive income stream today. In fact, many investors would be better served over the long term by investing solely in REITs instead of physical real estate.

Despite this, many investors lack the proper mentality to invest in publicly traded securities as they will panic at the first sign of extreme market volatility and sell their REIT shares at a loss. Other investors prefer to have as much control as possible over their investments and therefore also prefer to invest in physical real estate. For those that can handle the volatility and prefer total passivity to their income-generating investments, however, REITs are the ideal passive income generating investment.

This article discussed REITs to fill out the top of your Passive Income Pyramid. To see our favorite dividend growth stocks today, start your free trial of The Sure Dividend Newsletter.

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One Solution to Planning College Expenses?

August 16, 2019 by Lazy Man 5 Comments

Nearly three years ago, I wrote, College Planning is Impossible (But Do It Anyway!). At the time My kids were just 2 and 3. The idea behind the article is that college costs vary so much, that there’s no easy way to plan for them.

If you want to be aggressive you could save a ton of money in a 529 Plan. That’s assuming you have a ton of money… which most people don’t. The downside to that (other than the lack of a ton of money) is that if you put too much in, you have to deal with penalties or other creative uses for 529 plans. Perhaps the best thing to do is just let the kids have the remainder for their kids… or maybe some schooling down the line.

Essentially, if you overshoot the 529 savings, your money is trapped. That’s not a terrible problem to have, but it’s less than optimal. You may even think that you are planning it well, but what if Jack/Jane gets a scholarship/grant or goes to a public school making the costs very different than what you planned?

College has just too many variables and you can’t plan for them…

… except we did. And I swear it was completely by accident.

Before I get to that I’d like to cover some ways to cover college expenses. Not all will be applicable to all families or students. There’s a lot of tools in the tool box and we hope utilize them all.

Covering College Costs

I focused on 529 plans above, because that’s the traditional savings vehicle for 529 plans. Sorry Mr. Coverdell… I have you, but you are mostly obsolete. Like Smelly Cat, it is not your fault. One of the reasons I got a Coverdell was that it could cover private school costs before college, but 529 Plans can do that now, thanks to the recent changes in the tax law.

How could one cover college expenses? Here are a few ideas:

529 Plans – That’s obvious one. It’s a great vehicle to saving money
Schoralships/Grants – It would be nice to get these. Some schools may give more than others, so our plan is probably to apply to a lot of schools?
Pay off adminssions – Just making sure you are paying attention. This certainly wouldn’t save you money. You might end up in the news… and not in a good way.
Student Loans – The old standby. It’s a big problem nowadays, so hopefully we can keep this down.
GI Bill – My wife’s military service gives benefits that we can split between the kids. I realize that not many people may have this option.
AP credit – If you can test out of a few classes, you can get some credit without having to pay for it.
Community College – Most community colleges are cheaper than traditional public and private universities. It may be possible to take some basic pre-requisits for cheaply and then transfer.

I feel that it is like having multiple income streams. The hope is that through some combination of the above (with minimal loans) paying for college won’t be impossible.

But we have one secret weapon that’s not listed above. We have rental properties. The mortgages will be paid off around the time the kids start college.

This means that we’ll likely have some $35,000 or so (after expenses) each year. Is it enough to cover college costs in 11-12 years? Who knows, but it will certainly help. The benefit of this accidental plan is that we don’t have to think about whether we are saving enough or too much in a 529 plan. If there’s extra money left over, that’s just living expenses.

So how might you be able to plan this more intentionally? Unfortunately, you’d need have the money for a good downpayment around when the children are born. Then with a 15-year mortgage, the timing should be right. Of course, it’s not great being a landlord while raising newborns. OF course if you have the money for a downpayment, you put it in a 529 plan and mabye expect it to quadruple (assuming 8% annual returns) by the time the child is in college. I think prefer the real estate plan, because it is more flexible.

I’m not saying you can do it too. Like my 6 year old’s new catchphrase, “Nope, not at all.” However, it is something that you may want to explore.

Your First Home Comes With Your First Mortgage – Here’s What You Should Know

June 30, 2019 by Guest Poster 2 Comments

Recently, I had a Twitter interaction that has had me thinking of going back to the basics in an attempt to reach some readers who may be towards the beginning of their personal finance journey. Around the same time, I had a guest post hit my inbox covering a topic that I had long forgotten – buying my first home. Enjoy this post from Lazy Man and Money reader, Ivana.

If you’re anything like me, you consider the purchase of your first home a milestone in your adult life. After all, nothing quite says “I’ve made it” better than owning a home of your own, and it signals a kind of stability that wasn’t really there in your younger years.

Of course, to get that far, you’ve got to get approved for a mortgage (unless you’re independently wealthy, and if so, I congratulate you). When I first went through the process, I hadn’t the faintest clue what I was getting myself into – and that’s a scary thought because my mortgage represents the largest single debt on my personal ledger.

As it turned out, I learned a great deal from the process. I just wish someone had sat me down and given me the lowdown on what to expect before I jumped in head first. If you expect to be in a similar position soon, you’re in luck. Here are some of the important things you need to know about getting your first mortgage, but didn’t even know to ask.

Lay the Groundwork, or Suffer the Consequences

The first bit of wisdom that I’ll impart here may seem obvious to some, but it never occurred to me before I applied for my mortgage: check your credit reports (all three, I’ll explain why later). The reason I say this is that your credit report may be hiding some surprises that you’d rather not encounter while sitting in front of a loan officer. In my case, I found out from my mortgage specialist that Experian was under the impression that I owed Verizon Wireless about $550 from an account I had closed in 2001. Interestingly, Equifax and TransUnion had no record of the balance.

It turned out that Verizon had not closed my account when I requested it, and instead let the balance continue to build until they sent it off to a collections agency. That agency had never contacted me and only reported the “debt” to Experian. The good news is that I was able to get it worked out and it didn’t impact my ability to qualify for a mortgage, but the lesson is clear: don’t let the fact that you’ve never paid a bill late fool you into thinking your credit reports are accurate. Make sure everything’s right in advance, and also do everything you can to lower your debt-to-credit ratio. Be aware that lenders extend the best offers to applicants with FICO scores of 720 or higher, so that’s where you’ll want to be before applying.

Choose a Mortgage, Don’t Let One Choose You

Another thing that I hadn’t considered when looking for a mortgage was just how many options there are. Seriously, if you’ve never shopped for a mortgage, you’ll likely be astounded by how many lenders there are out there. What’s even more shocking is that you’ll feel like you need an advanced degree to tell the difference between all of the mortgage products you encounter.

So first things first – learn all of the lingo and as much as you can about the various available mortgage types before you try to tackle a mortgage comparison on your own. You’ll need to understand not only the way interest rates work, but also what kinds of fees may be part of the loan (origination, title search, insurance), and any other closing costs that might (or might not) get rolled into your loan. Be aware that it’s going to seem like lenders go out of their way to make it difficult to compare these products, with opaque documentation and the like. Don’t be afraid to admit that you’re in over your head. Use a mortgage broker if you must. Whatever you do, make sure you understand your mortgage before you sign it – you’re going to have to live with it for a while.

Look Out For Gotchas

The last major thing I wish I’d been counseled on before getting my mortgage was all of the various little considerations that go into the mortgage package you’re offered. I call them “gotchas”, only because if you don’t understand what they are before you take out your mortgage, you don’t get a do-over. First, you’re going to want to make sure that your lender has approved you for a mortgage you can actually afford. That means informing them about your real monthly expenses as opposed to just what’s on your credit report. For example, if you have financial obligations like supporting an ailing parent, child support, or any other ongoing monetary responsibility, speak up! Remember that it’s the lender’s job to look out for their own interests – not yours.

Second, scour the details of your mortgage offer to look for things that may come back to bite you later on. The biggest one I encountered is known as a prepayment penalty. This common little trap is the lender’s way of extracting their pound of flesh from the borrower, come what may. The idea is, you’re bound by contract to only pay back a certain amount of your mortgage within specific timeframes. It exists so you won’t be able to save on interest by paying down your principal when you’re flush with cash. The thing many don’t realize, of course, is that such an arrangement doesn’t only apply to unexpected financial windfalls.

It also means (depending on the language in your agreement) that you’ll get hit with the penalty if you sell your home (since you’d be paying down the mortgage with the proceeds). It could also mean you can’t refinance if interest rates improve without paying the penalty, too. And if you’re thinking it’s no big deal, consider that the typical prepayment penalty is equal to 80% of six months’ worth of interest, which can be a hefty sum. The good news (if there is any) is that prepayment penalties typically phase out after one to three years, but if you’re subject to one, it may mean you’re trapped in your mortgage for that amount of time even if you have an emergency and need to sell your home.

Welcome to Homeownership

If you’ve made it this far, that should mean you’re at least twice as prepared to go out and get a mortgage than I was the first time out. Don’t rest on your laurels, though. What I’ve covered here is by no means encyclopedic – far from it. On the contrary, getting a mortgage is one of the most complex and consequential financial decisions anyone can make, and they come in all shapes and sizes.

That’s why the best bit of advice I could ever give to anyone who’s about to look for their first mortgage is to take their time. Do as much research as you can beforehand because the more you understand in advance, the less daunting the process will be. The results will be better, too. After all, the last thing in the world that anyone should want is to have the home of their dreams come with the mortgage of their nightmares. With any luck, I’ve done a bit to spare you that fate – the rest is up to you.

Editor’s View

My own experience was helped quite a bit by the support system I had. My mother was right there with me. My older brother was buying a house around the same time. One of my best friends, who I had lived with previously had recently bought his first house. My real estate agent was the spouse of a good friend. My closing agent was a groomsman at my wedding. It was almost impossible to imagine a better “Dream Team” of support.

Despite all that, I was still very nervous. So if you feel nervous, that’s to be expected. I hope you can surround yourself with at least a few people who have a lot of experience.

Starting Your Kids on a Financial Independence Path

May 16, 2019 by Lazy Man 9 Comments

Everyone is a product of where they focus their time and energy, right? As you can tell from this blog, much of my focus is on personal finance, especially financial independence. In my personal life, much of my focus is parenting two boys, ages 5 and 6.

Getting them started on a path of financial independence is inevitable. Given their age, we are working with simple things like chore charts and saving money for special toys.

One of my biggest concerns is the changes in the world. When I growing up in the 80s, I knew programing a computer was the future. Nowadays, retail stores and newspapers are closing. The automotive industry may nearly disappear as robot, on-demand cars may mean car ownership and driver jobs are a thing of the past. Artificial intelligence promises to disrupt more markets.

I know that most people think new jobs will be created. That’s probably true, but who knows if enough good jobs will be created. It seems that the current trend is replacing journalist jobs with influencer jobs. That should concern us all.

We can’t change where the world is going, but we can help prepare my kids. Here are a few things that we’re doing:

Teach Core Life Skills

This is a no-brainer. Some skills never grow old and can directly influence your bottom line. Here are the first two skills that came to mind. If you can think of more, I’d appreciate it if you could please drop me a line in the comments.

1. Cooking

Food is often one of people’s largest expenses. It doesn’t have to be. Eating out at restaurants is expensive. If you know the basics of cooking, going out to eat is less appealing.

We’ve got the kids enrolled in an after-school cooking class. They might not be learning much. (I’m still waiting to be served breakfast in bed.) However, they are learning and enjoying it. Those are the important things at this age.

In conjunction with learning cooking, I hope to teach the boys how to shop to save money. This will include updated versions of the following articles:

Being able to manage and limit one of their largest expenses can only help their financial bottom line in the future.

2. Handyman

I’m not handy at all. I can’t fix anything. I can barely work a screwdriver. If something breaks, I have to write a check.

That’s not good, especially for landlords like us. If you are good at fixing things and home improvement in general, you can create a lot of real estate opportunities with just sweat equity. You can fix up the house and move repeating the process over and over. You may even be able to keep the money tax-free when you sell. It may be a long time before artificial intelligence replaces carpenters and plumbers.

Perhaps someday, one of their jobs could be a managing our real estate “empire” and we could pass money and equity to them over time. I haven’t figured out exactly how this arrangement would work, but in theory there’s an opportunity there.

For now, I just want my kids to be better than I am with any handyman stuff. Home Depot has “kid workshops” once a month, but we haven’t had a chance to get to one yet. They also have workshops for adults, so maybe it’s not too late for me to learn a thing or two to pass on.

Personal Finance

I don’t think I’ll have to focus on teaching them too much about personal finance. I half suspect that they’ll learn it from osmosis perhaps like I did from my mother. However, I can give them a couple of boosts.

If they don’t master personal finance from osmosis, they can fill in the gaps with my Ultimate Guide to Financial Freedom. I’m hopeful that when they are older they’ll give their old man 10-15 minutes to read the Cliff’s Notes to financial success.

As a practical matter, I recently wrote about their kid Roth IRAs which will give them a head start in saving for retirement.

Education

Education is one of the foundations for a high-earning career. We’re investing a lot in private school now in hopes that it will set them on a great path for the future.

I’m still not sure that’s an optimal investment. For example, an episode of Teen Titans Go! (one of my favorite kid shows) brings up the idea that investing in a rental property is better than college. I don’t agree, but it’s an interesting topic. Of course, the Teen Titans teach a lot of personal finance.

Finally, it’s helpful that the the best financial independence book is actually a kids book.

Final Thoughts

One of things that I’m hoping to balance is giving an opportunity versus handing them too much. That’s why they are earning their kid Roth IRAs by picking up dog poop. That’s also why I think they would have to be property managers before they reap the benefits of the rental properties.

Buying a Home? You May Need a $100,000 Salary.

January 29, 2019 by Lazy Man 2 Comments

Today, I’m picking some low-lying fruit of the “newsy” variety. It comes straight from the top of my email inbox courtesy of Zillow’s Media Room.

I know the title gave it away. (I’m terrible with clickbait.) Zillow’s research found More Than a Third of Home Buyers Now Make More Than $100,000.

Before we break apart that title, let’s do a little commonsense math check. That means that nearly two thirds of home buyers make less than $100,000. You still have a better than average chance of buying a home if you make less than $100,000.

When I first read the article, I was thinking that it was a comparison of haves (home owners) and have-nots (renters). However, it’s really three groups: The getting (home buyers), the haves (already home owners, and the have-nots (renters). Usually the home buyers and home owners make similar household incomes, but lately it’s changed so that home buyers actually make a little more… an average of ~$80,000 vs. an average of $75,000.

The press release does a little analysis, but it’s a little confusing. It seems that maybe first time home buyers need to make a little more a year so that they can save a little more for a down payment. In other words, there’s nothing too surprising.

The renter income numbers were a little more interesting to look at. The average household income there was $38,300 or about half of the home buyers/home owners. Zillow points out that young and single people are more likely to rent (makes complete sense). Who would have guessed that a single person with one income might choose to rent, but change his/her mind if they pair up with a partner creating a second income? (That’s sarcasm.)

I think I takeaway two things from the article:

A rule of thumb to buying a home might be to have a household income of around $75K-80K.
As with all rules of thumb, the individual situation matters greatly. In this case, Zillow breaks down the numbers for some of the largest metros.

That second point is most likely the most useful information in this report. In Pittsburgh and Tampa, buyers are getting in ~$65,000. In New York or Boston, buyers are getting in at ~$120K. You can use the chart to see what your area average is. Of course few people buy an exactly average home, but at least it’s at least a number you use.

If you are an investor, you can even crunch the numbers a different way. It didn’t take me long to notice that Tampa’s earners are one of the lowest, but it’s renter earns nearly the national average. The renter makes 57% as much of the buyer. Maybe it makes to buy a property in Tampa and rent it out? They’ll likely be able to pay their bills since it supports a higher rent.

On the other end of the spectrum, Philadelphia’s first time buyers earn $98,000 (well above average) and the renters earn a below average $35,300. Their renters are making as much money as even Tampa and it looks like a tougher market to buy into in the first place. Spending more on an investment property if renters aren’t likely to pay as much doesn’t seem like a smart plan.

Zillow’s chart made it extremely to put in a spreadsheet and pull out these numbers. It was literally almost a full 60 seconds. Since it was so easy, I’ll leave it as an exercise for the reader (it’ll take me longer to upload it).

So what do you think? Did you find anything useful or interesting in this data? Let me know in the comments.

The Basics of REIT Investing for Passive Income