Lazy Man and Money

Your Life or Your Home

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Quick House Keeping Note: It’s a busy time in our home. I refer to these two weeks as the “summer hole.” (I need to come up with a better name.) It’s the time when our kids are out of school and camps haven’t started yet. We’re in year two, so at least we were prepared this summer. We scheduled a little vacation and some other activities. In other words, expect the writing to be a little limited until the 18th or so.

I suspect that most of my readers are at least familiar with the title of a book called, Your Money or Your Life. It is widely considered the best personal finance book. (I haven’t finished reading it, but so far it hasn’t met my extremely high expectations. That’s not to say it is poor in any way.)

One of the main ideas of that book is that you trade your life for money. By limiting consumerism, your money goes further, you can retire early (if you choose) and get your life back. That’s really the core of the FIRE (Financial Independent/Retire Early) movement.

I’m going to piggyback on that to share a concept that I like to call, Your Home or Your Life. For most people, their home is their largest expense. So, by proxy, keeping housing expenses low will save you money to get you to FIRE quicker. In 2007, I called it Get Rich by Thinking Small. (I miss the days when a 350-word article and a well-placed George Carlin joke would get 26 comments.)

Today, there’s a lot more focus on tiny houses or even living in trailer. I get excited when I watch a tiny house television show because it seems like everything is amazingly efficient. I’m not sure how practical living in a tiny house would be. Sometimes things that sound great don’t pan out in real life and this may be one of those things.

Big Closet
Does anyone’s closet really look like this one from NEHomeLife.com?

Last month I picked up a free magazine, New England Home Life. The closet on the cover caught my attention. It is bigger than most best bedrooms and seems to have very few clothes. It was so ridiculously not like any normal closet that I had to pick it up. Surprisingly, there was an article in there that was the exact opposite of the cover, Tiny Home Living, by Mary Hullett. I wish I could share it with you, but it isn’t available online from what I can tell.

The article does a good job of painting a picture. In Japan the average apartment is 250-300 square feet, while the Americans move to bigger and bigger houses. It then explains that the tiny house movement began due to environmental and financial concerns. That’s where it gets interesting with this quote:

“For most Americans 1/3 to 1/2 of their income is dedicated to the roof over their heads; this translates to 15 years of working over your lifetime.

I was just about to start to go into all the math behind that, when I realized that it really isn’t that complicated. I think we can presume that a typical working career is typically 45 years (age 22 to 67). A lot of things vary, but that’s exiting college until retirement, which gets extended a couple of years as people live longer. So 1/3rd of your income is 15 years of working. If you spend half of your money on your home, it’s 22 years.

For me, that drove home the true cost of a home. Of course, the alternative of not having a home isn’t a good plan. That’s where a tiny house comes into the picture. I’ve seen them starting at around $40,000. That’s the kind of mortgage that many people could pay off in less than 10 years. It’s like getting a decade (or more) of financial freedom.

I ran some numbers on how much of our income our own regular-size house is. Because my income varies a lot from year to year, it’s impossible to get an exact number. It is around 20% and it would be less if we had a typical 30-year mortgage instead of a 15-year one. Look like we are in good shape.

There’s one more thing that I can’t help but think about. We have 3 rental properties (condos) that mostly pay for themselves. Two are them are very similar as they are in the same complex. They should be paid off by the time our kids are 15 years old. There’s a very real option that they’ll have the choice of a free home. (Or we may decide to keep it to support ourselves.) It’s hard to imagine the financial challenges more than 10 years from now, but I think that having that home will be the kindling for their own FIRE.

We have an affiliate relationship with one or more of the companies linked in this article.

Real Estate Roads Not Taken

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“Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.” – Robert Frost

I don’t have a lot of rules in life, but one of them is: If I can quote a famous Massachusetts person born on March 26, I will. Since half my life’s in books written pages, I’ll do what I want :-).*

This past weekend my mother brought me a postcard that she got in the mail. It was from real estate agent announcing the selling of this home. I’m sure you’ve gotten similar mail, right?

What makes this special is that I had seriously considered buying a condo in the same complex in 2004. I dug up an old spreadsheet that I had from that time. It’s hard to be 100% sure because I used MLS numbers instead of addresses, but it looks like the owners were asking $324K at the time. From this we can infer that condos that building have roughly appreciated 55K or 17%. (That’s assuming this isn’t an outlier.)

I decided against buying in that building. I don’t remember the exact reasons why, but it was very close to where I grew up, had no yard, and no pool. Instead, I opted to buy a place that was a little further with those things. It was closer to my job and a little further from Boston.

I paid $278K and now it is worth around $250K. In 13 years, it’s depreciated by 28K or around 10%.

I’m going to make a huge oversimplification here. I’m going to ignore that the former property would have stretched my finances. I’ve rented the later property a lot longer than I lived in it with the rent covering most of those expenses. Viewed through that lens the cost of the property is minimized. With all that pushed to the side, the road not taken would have netted $85,000 in equity (turning a 28K loss into a 57K gain).

Flash forward a couple of years to 2006…

My wife and I are living in Silicon Valley. A coworker and I have an interesting conversation. He makes the point that buying a home in Silicon Valley is always a good investment.

That sounds crazy to me. At the time a 1000 sq. foot home that should be torn down was going around $650,000. We were able to rent for a fraction of what it cost to buy. It was one of the few places in the world where the buy vs. rent equation was far in favor of renting. It wasn’t even worth thinking about.

In hindsight the prices in Silicon Valley just kept going up. I haven’t looked up the pricing in the last few years, but I’m sure that $650,000 house is around a million now.

It’s no use crying over spilled milk, but I found it interesting. There’s a lot of truth to the big purchases making a huge difference in your financial life. For every negative, there’s a positive though. We did buy two properties in 2011 and 2012 near the bottom of the market. We’ve been able to build a lot of equity that way.

Do you ever stop to reflect on financial decisions you have made (or didn’t make)?

* I’m quoting Steven Tyler who was born on March 26th for those who didn’t catch that reference.

Calculating the Cash Flow Value of Cash Flowless Real Estate

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Every month I write about my Alternative Income, which is a measure of “passive-ish” cash flow. For a long time, I was completely confused about how to value our real estate accidental “empire”. The three properties don’t make money each month, which is to say that make any cash flow. Usually real estate investors are looking to make money each month (have positive cash flow).

Housing prices were up and so was he.

We’re not typical, because our real estate was mostly accidental. My wife and I bought independently near the market highs and then we moved across the country for different career opportunities. Selling at a loss wasn’t a good option, so we became landlords and refinanced them with a double HARP refinance opting for 15-year fixed mortgages (better rates – yay!) at market lows in 2012. We added another property around 2011. These aren’t big expensive properties… they are condos worth around $500,000 in total.

It seems fairly easy to say, “zero cash flow property is worth $0.” However, my goal is to measure progress in growing cash flow. It doesn’t feel very good to say that they are $0, but then magically become worth $3000 a month when the mortgages are paid off. That’s too Boolean even for the computer scientist in me. It’s really a perception problem:

“It’s all about the exposure, the lens I told her. The angles were all wrong now.”

Paramore – Brick By Brick which is great financial advice!

We could do either of the following and get cash flow out of them:

  • Refinance the remaining principle into 30 year fixed mortgages. This lowers the monthly costs and we could pocket several hundred dollars a month.
  • Sell the property with the most equity and payoff 1.5 properties. We aren’t going to sell a property just to make the math work better when I calculate cash flow. Also, paying off half a property doesn’t lead to better cash flow number.

The angles were all wrong because neither of them is a very realistic scenario. In fact, they are very unrealistic. Neither of them really assessed the progress we were making to owning them outright.

The “Right” Formula to Calculate the Cash Flow Value of Cash Flowless Real Estate

I don’t know if there’s a “right” formula, but I created what I feel is right for our situation. I’d love your thoughts on this, especially if you are into real estate investing.

The formula is:

(EquityInAllProperties/TotalValueOfProperties) * ((MonthlyEstimatedZillowRent + MonthlyActualRent)/2)

Let’s make that a little prettier:

Cash Flow Rent Equation

(This is my first time trying to format a formula for the web, so I apologize if it isn’t as good as it could be. I only promised it would be a little prettier.)

The left side of the equation is meant to calculate the percentage of equity you own. When you first buy, you might put down 20%. Over time the hope is that this grows to 100% and you own the property completely. I calculate the value of the properties using Zillow, but use whatever you feel comfortable with. That’s the denominator. You can subtract the amount you have outstanding from your mortgage statement from that total value calculation to get the equity you have in the properties (the numerator.)

The right side of the equation is meant to calculate the monthly rent that you’ll be getting from all the properties. I average the Zillow expected rent because we give some great tenants a bit of a discount. It makes me feel a little better about the numbers to know that we can and will likely raise the rent to market levels eventually. You could, of course, skip this. For us the numbers are close to the same anyway, so it isn’t a big difference.

As a real life example, we own 43.1% of the total value in our properties. It’s up 36.4% from earlier this year. This is due to the value of the properties increasing as well as the mortgages getting paid down. Our expected rents from all the properties (factoring Zillow) is $3225.

Essentially, the left side tells you how much of the pie you own. The right side tells you the size of the pie. Multiply them together and you get a number representing the amount of virtual cash flow you own. Over time both numbers will grow. That makes tracking the progress of this number.

You’ll want to take out HOAs, taxes, insurance, and some reasonable amount for maintenance, etc. As commenter Jaime below mentions, it could be more or less than 25% of your cash flow. I think I’ve estimated it to be closer to 20% of what I project, but 25% is a good safe number. I like to take it out of the right side of the equation, but the order of operations doesn’t matter mathematically.

MLM Corner

I thought I’d test out something a little different today and cover multi-level marketing in a section called MLM Corner. The goal is raise visibility of how such companies operate. I’m getting a lot of feedback from you that MLMs are crowding your Facebook and you are sick of it. I’ve covered quite a few such as Youngevity, It Works, and Le-Vel. Typically MLM Corner will highlight other perspectives of MLM from around the web.

I’d like to kick it off with MLMs and Me from Oakes’ of Righteousness. Rachel walks the reader through the cold recruitment (not sales) pitch from a friend who hadn’t talked to her in two years. She covers a lot of MLM in a fairly brief personal story. If you are interested in this kind of thing, it is worth reading (and sharing.)

Is it Time to Refinance your Mortgage?

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We are in the process of refinancing our mortgage – again.  We bought our first home in 2005.  Due mostly to the expense and uncertainly of kids, we took out a thirty year mortgage.  In 2014, we moved to a different, larger house with a different, larger mortgage.  My mom’s estate was recently settled, and we decided to pay down the principal refi the 30 year mortgage (which has 27 years remaining) into a fifteen year mortgage at roughly the same cost (about $15/month more).

[Editor’s Note: I wanted to emphasize that again… he reduced 27 years of paying a mortgage to 15 years!]

While the optimal choice for us would have been to start with a 15 year mortgage, this really wasn’t feasible at the time.  We wanted to be able to fund retirement plans, 529 plans for the kids, pay for day care (a big cost, especially before the kids reached school age), have a sufficient emergency fund, and have the flexibility to deal with other costs that popped up along the way.

Mortgage Refinance Calculator

One thing we did do over the years is refinance.  In the nine years that we owned the first home, we refinanced it twice.  In each case, the break-even point was between eighteen and twenty-two months.  After each refi, we continued to pay the amount of the original mortgage, but with additional money going to principal (shortening the length of the loan).  A key part of understanding the break-even is understanding what portion of closing costs are actual incremental costs and which are not.

Pre-paying the escrow is money that you pay to ensure that there is a enough money in your escrow account to pay for homeowner’s insurance and property taxes.  Why is this not an additional cost?  Because you’re spending money up front to fund the escrow on the new mortgage, but you’ll be getting a check for the amount that is in the escrow account for your old mortgage (this may take a month or two, depending on your state and your lender).  Regardless of whether you kept the old mortgage or refinanced, you would have had to had sufficient funds in the escrow account to cover the taxes and insurance when they are due.  Once the escrow on the old mortgage is refunded, it’s a wash.

You’ll also have some pre-paid interest.  This accounts for the interest in the partial month between your closing date and the first of the month.  If you close on the 30th, this cost will be minimal.  If you close on the second, it would be almost an entire month’s worth of interest.  But this is interest you would have paid regardless if you refinanced or not.  It’s important to note, though, that if you close on the 2nd, you’re skipping an entire month’s worth of principal payments, pushing your payoff date nearly a month past what it would be if you had closed on the 30th.

What remains are the actual incremental costs to refinance.  In my specific case, these come to around $1500.  To illustrate the break-even calculation, let’s assuming you are saving 3/4 of a percent and have a mortgage balance of $150,000.

  • The monthly interest savings would be (180,00/12)*0.0075 = $112.50
  • Here’s the tricky part.  While mortgage interest is tax deductible, the closing costs generally aren’t.  Let’s assume your combined federal and state income tax rate is 25% (note: you’ll want to use your marginal rates, rather than your effective rates, since you’re calculating an incremental effect).  This means the actual cash savings from the reduced interest is ($112.50 * 0.75) = $84.375.
  • $1500 / 84.375 = 17.77 months

While this is a reasonably accurate quick calculation, it will be slightly off, because you’re saving slightly less in interest every month.  You’ll save $112.50 ($84.375 after adjusting for impact of taxes), in month one, but you’ll save a dollar or two less in each additional months.  So to be safe, just round-up and add another month to the break-even length, bringing the break-even to 19 months.

Some other notes about mortgages and refinancing:

  • Some people have a rule to not refi within X years of taking out the mortgage or doing a previous refi.  This is not a good determiner of whether the time is right to do a refi.  If you close on a mortgage today and rates drop a full point tomorrow, you absolutely should refi.  You can’t change the fact that you had bad luck in the past – but you can change your future rate.  The key thing to look at is how many months it will take to break even on the refi costs.
  • When buying a house, some people will approach the lender and ask what amount they can be pre-approved for.  My advice is instead to settle on a price point and get pre-approved for that amount, plus a small cushion.  If you ask the lender to set the amount, odds are good that it will be higher than the price point you would have chosen, and you may end up purchasing a more expensive house than you really need.
  • A lender will often allow – or even encourage – you to roll the closing costs into the mortgage amount.  If you have the ability to pay these amounts up front, it can save you quite a bit of money in interest.  We’ve never rolled the closing costs into a mortgage or refi.
  • Shop around.  You may be able to find slight differences in rates between lenders.
  • Watch for coupons.  We routinely get coupons in the mail for $100 off closing costs.  When we knew the a refi would be imminent, I made sure to save one of the coupons.  In comparison to the mortgage, $100 is a very small amount – but it’s still $100.

Getting that Real Estate Buying Itch Again

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A few months ago, I had this weird little “thing” happen. I thought, “Hmmm, that’s odd”, bookmarked what I was reading and moved on. About 6 weeks ago, I had another “thing” happen, and after some discussion with my wife we kind of moved on. About 3 weeks ago, I was on the verge of a life event that made me think of finances in a new way. About 10 days ago, I published my alternative income update and I started to notice a pattern.

And recently, a cartoon sealed the deal. Let’s enjoy that cartoon before I clarify all that boring stuff in the last paragraph:

I used to think Teen Titans Go! was just really weird. Now I realize it is awesomely weird. In around 90 seconds, someone could learn more about real estate investing than 90% of the population.

If you didn’t get it from the title or from the cartoon: I’m starting to get excited about real estate investing again.

What I was Reading

I’ve been following Rental Mindset from its very first post. As you can tell from the website, Brian thinks a little differently than many people about their path to financial freedom. Most seem to take the path of acquiring stocks and mutual funds to build a nest egg over time. Brian may be doing that as well, but Rental Mindset shows that much greater returns are possible.

Many people don’t like the idea of being a landlord (including me). However, he shows that with turnkey properties and property managers, it doesn’t have to be a ton of work. Specifically, he’s been writing about how we finds a turnkey rental property and how he recently bought another one.

The following thought crept into my mind… what if I streamline the management of these rental properties? If, and this is a big if, that were true, adding another rental property would be much more feasible.

The Discussion with the Wife

I get the feeling that my wife is getting frustrated with work. Well, it’s more than “getting the feeling”, but I’m trying to be diplomatic. All careers have their ups and downs, right? About 6 weeks ago, my wife had a down around the same time that we were taking a vacation at a beach.

It’s not to hard to figure out which way the work/life scale tipped. It’s natural for people to plan their escape from their cubical in such situations. It’s probably 10x more natural when your spouse has more or less done that.

It is worth exploring whether adding to our rental properties would speed that escape along. My initial thought is that it would not. While we might have a a lot of passive income in 10 years, I can’t see how adding more properties now would speed that up. I’m not giving up on the idea though.

Before you think I’m evil for not taking the corporate job, I’d love to switch places. However, my wife is 90% of the way to a sizable military pension. The golden handcuffs don’t get looser for a couple of years.

I Thought I Might Get a Windfall

There were some rustlings that a windfall might be headed our way. That fell through almost as quickly as it came. For a few days though, it was fun to imagine how I might invest the money. Adding a rental property wouldn’t be the worst plan. However, since this hypothetical thing didn’t happen, I have to move on. I feel like I had already “mentally” acquired the money, so to a degree, it is difficult to imagine it never happened.

The Pattern of My Alternative Income

Each month, I look at how much income my investments should give me. If you are looking to get $25,000 a year from dividend stocks paying 2.5%, you are going to need to have one million in that brokerage account. My wife and I have been diligently saving in our Roths/401Ks/TSPs for nearly a decade now. We usually max out our contributions. The markets have been doing quite well. We aren’t at a million and we really aren’t all that close.

That’s not to say it is “a million or bust.” I’m just picking nice round numbers. I can see the amount of money we’d make from those hypothetical 2.5% dividend stocks grow each month the market grows. However, it only grows a relatively small amount.

I also calculate the percentage of profit we’d get based on the equity we have in our properties. The mathematical explanation is too long here, but the link a couple of paragraphs up, explains it well. I’ve been seeing this number jump a lot more throughout the year. It feels like real estate is actually beating stocks. My guess for why this is happening is that our properties are getting more valuable while the tenants are paying down the debt. We also have the benefit of leverage.

I think our investment in rental properties has been quite a bit lower than what we’ve poured into our retirement accounts. That small fraction of an investment has slightly surpassed what I expect to make from stock investing. Again, it’s not nearly as passive, but it definitely seems to be a plus

Conclusion

While I’m getting excited about buying another rental property, it won’t likely happen. If that windfall did come through (again, it didn’t), we’d think about investing it in a way that got my wife to retirement faster. Adding another 15 year mortgage is probably not going to get it done.

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