Hunting Happiness

Borders has a decent credit card offer through VISA.  It includes a free $20 card and 1,000 free points.  Purchases of $1 at it and affiliated stores earns 3 points, gas and groceries earns 2, and everything else earns 1.  There is no limit on points earned.

It is hard to read or listen to any news without gloomy proclamations that prices are spiraling out of control on essential items like gas and groceries. Stories abound telling of families unable to buy sufficient groceries, or having to cut back hugely on driving.

Rather than look at prices for essentials, I thought it would be interesting to look at our monthly spend on such items. So I made a custom report in the ever-handy Quicken to compare our actual spend on gas and groceries for the past 30 days versus the previous twelve 30-day periods. I wasn’t sure what to expect but the results are telling. Our average over the past 12 months is $580.15. In the past 30 days it was $588.01, a virtual tie. I recently posted that SomeGal and I are not really feeling any effects of the possible recession we are in. The graph below backs this up. We have certainly not actively attempted to spend less on groceries or do less driving. So either prices have not really gone up that much, or we have subliminally cut back, or some other unrelated trend has caused us to drive and eat less. I originally was going to include the dining out category because it is conceivable that we have recently eaten out more and therefore bought fewer groceries. Unfortunately I could not include it because the dining category varies wildly from month to month due to normal activity and things like treating family for holidays or birthdays and rewarding employees. I also do not change the allocation of dining out when we are on vacation (where it tends to spike, obviously).

I have written a couple posts about our first foray into real estate investment. The first post details the reasons we did it and will continue to, and gives some hard numbers.  The second post details some of the gotchas and surprises.  Overall the results are very positive, increasing our net worth by $25-30K. For those considering doing the same, this is a step-by-step guide based on our research and real-life experience with Property #1.

Education & Preparation — Before you Buy

• Read “Buy Low, Rent Smart and Sell High” by Scott Frank and Andy Heller.
• Check out my posts on the positives and negatives of our first property. The positives post also contains more details of property #1.
• Spend several months watching the market in your proposed area. Watch the rental and the sale markets. When a new property comes on the market and you can read the MLS listing and immediately know if it is a good deal and what kind of rent it could fetch then you are ready. Also, find a good real estate agent if possible.
• Set up an LLC (or Corporation) including an Operating Agreement and separate bank accounts to provide some isolation of your personal assets. These are very important because if you are involved in a legal dispute the opposition will likely look to pierce the “corporate veil” to get at your personal assets. Doing these things will NOT prevent you from having to pledge personal liability on loans and other financial obligations, however.
• Prepare your lease application form.
• Prepare your lease contract and purchase option contract. I recommend making these two separate documents. This makes it easy if you decide to the go the rent/lease only route, and if you go the lease-option route it makes it clearer and easier for the tenants. Most folks will be very familiar with a lease/rental contract, but the option contract will be completely foreign. Having it separate makes it less intimidating and easier to digest. Also, have an attorney review or even write these documents! Housing laws vary (significantly sometimes) by state and if you ever need to go to court and you’ve pulled contracts that are written for another state you are going to have major problems. In the purchase option contract push as many duties and responsibilities onto the tenant as the state law allows. Again, an attorney will be invaluable here.
• Order professional yard signs. See more below but this is critical and it can take several weeks from starting the process to receiving your signs. We used Realty Sign Xpress and were pleased with the them.

Getting Started — Finding a Property

• I highly recommend starting out with single family homes in a nice working/middle-class neighborhood. We also found that in our area, if the fixed up value of the home is under $100K the profit margin becomes very thin and the ability to be cash flow positive diminishes. Obviously if you can pick up a home worth $90K for $40K you will still have no problem.
• Do NOT force the process. A really good deal will come up in time; do not settle for an mediocre deal because you feel rushed or impatient.
• Buying your first property will be nerve-wracking. You will have fears and doubts. If you have done your homework, you will be fine. At some point like Nike used to say “Just Do It“.
• Make sure you insure your property even while renovations are taking place.  See Item #1 in my gotchas post about this.  If the property is unoccupied your insurance will be 3-4 times the norm.

Finding a Tenant

• As soon as you own the property, get a yard sign out. We advertised via many channels but over 90% of our calls came from drive by callers who saw the yard sign. We also believe the professional yard sign deterred “vultures” — agents pestering investors to help sell or lease properties.
• Get a dedicated phone number for the LLC, if not for each property. Even if you just forward it to your personal cell phone, this presents a more professional face. It also provides some protection from an unsavory potential tenant having your personal cell phone. There are many services out there but we ended up going with Vonage. We like the ability to receive voicemail messages as WAV files attached to emails.
• Do not overprice the rent. Most of your profit comes from selling the house so do not be overly concerned about making a huge positive cash flow. If the property sits for two months because the rent is too high, that is equivalent to a 15% lower rent price on a 12-month term! If you factor in other hold costs the real percentage is more like 30%.
• Keep a list of names and phone numbers of prospects.  Make notes of any info you can.  At first, I was hesitant to ask some questions but later found it was generally not an issue.  Ask the caller what their comfort range for rent is and record it in your list.  Ask about kids.    Ask if they are currently renting and when they are able to leave.  Ask for their email address and send them a brochure and pictures of the home.  Even if your current home is out of the running for one reason or another, another property you acquire in the near future may meet their needs.
• Remember that many of the tenants will be primarily drawn in by your flexible lease-option program, even more than the home itself.
• Don’t put too much time into chasing bad prospects.  This was a mistake we made earlier on and it cost us time and hassle.  If someone is wishy-washy, or won’t return calls, we found it’s better to just let them go.  If someone is really interested, they will generally answer your calls or return them promptly.

Sealing the Deal & Being a Landlord

• Make sure both sides understand expectations.  Trust me, it is much better to have it out over some term or stipulation now than later on.
• Get the contract(s) signed.  Get a check.  We required the first month’s rent and one month’s rent as a security deposit up front.  Until the tenant actually moves in, keep up advertising efforts and returning calls.  If they back out you don’t want to have to start all over.
• We have decided not to use a property management company.  Their cost was 6-10% of the monthly rent and we think lease-option tenants will be fairly low maintenance.  If that turns out to be a mistake, we can always bring the PM company in later.

I will add more to this or add new posts as we progress. We are quite pleased at this point and looking for properties #2 and #3 now.

CNN Money has a story about America and the potential recession we’re in. A recent poll shows 79% of Americans believe we’re in a recession now. It goes on to given the correct correct definition of recession as determined by the National Bureau of Economic Research (NBER) which I highlighted in my post more than a week ago here. Hint: it is NOT two or more consecutive quarters of economic decline as commonly stated.

I wish they had asked their respondents to state the definition of a recession and compiled how many knew it. I bet it would be less than 5%.

Does it feel like a recession or just a “correction” to you? To SomeGal and me it’s the latter.

I posted many details of our first investment property and getting a lease-option tenant placed in a generally positive article here. But it wasn’t all fun and games; there were some negative issues that had to be dealt with as well. Some of them are probably obvious and others not. Some were listed in the book “Buy Low, Rent Smart and Sell High”.

1. Hazard Insurance. You’re probably thinking this guy is an idiot, of course one has to pay hazard insurance on an investment property just like a primary residence. And indeed, I was expecting that and had even included that in my detailed analysis spreadsheet. What I did not know was this. If the property is going to be unoccupied (i.e. repair and improvement work is being done before it goes “on the market”), that puts it into a special class of insurance that all the standard home insurance companies won’t touch. In fact, it is specialty insurance and only a handful of companies write policies. Because of this there is little competition and prices are insane.  As in primary residence purchases they usually require prepaying the first year. In our case, this meant $2,000 up front (about $700 was expected), and a higher mortgage payment than anticipated (about +$100/mo) during the renovations. Now on the bright side most of these policies will issue refunds for the last 75% of the policy if you get it rented out quickly. This was not mentioned in the book and was definitely a shocker.
2. Crazy Prospective Tenants. This one may be more obvious but the extent and range of folks we dealt with shocked even us — both SomeGal and I have had a wide range of life experiences including dealing with all types of people in different environments. One family seemed normal until they submitted their application. They wanted a total of 14 people including 4 adults and 11 children to live in this very modestly sized home. We declined their application. Another prospective “family” involved a husband trying to win his estranged wife back. He was convinced that they would move in as “roommates” and eventually become romantic again. He was so sure that he kept me on the phone for more than an hour during the initial call and he kept SomeGal at the showing for nearly as long.  We declined their application.  Actually, we tried to convince them not to bother applying but they insisted.
3. Buyer agents. While we didn’t receive a lot of calls from agents looking to represent us, we did receive a handful of calls from agents representing buyers that were interested in our property. While this was not our ideal situation, we were willing to pay one side of a commission (3%) for a quick sale at market value. The shocker was how unprofessional agents were when it came to returning calls and/or responding to emails.  If they wanted or needed something, they were always available and returned emails or calls quickly.  If they didn’t need something, multiple calls or emails would go unanswered.
4. Water pressure. The water was off on the house when we inspected it and after we bought it we discovered insufficient water pressure on the second floor and had to install new water lines. We bought the property as-is but enough below market that we could afford the hit.  Even though we had a “who knows what” repair budget, having to spend it cut into our cash and our potential future profit margin.  Obviously in the future we will be on the lookout for this specific item.

There were also some issues many real estate investors have to deal with that we didn’t:

1. Seller Agents. I’ve heard horror stories of realtors circling like vultures, with some landlords receiving dozens of calls a week claiming to be able to rent out or sell a property. We did very professional looking signs and advertising, so I think that cut down on a lot of it.
2. Contractor issues. We thankfully have an outstanding construction manager/general contractor who has a great team and who we trust and is extremely experienced. So although property #1 needed some fairly serious work, this was not a big head ache for us.
3. Section 8 housing. Out of dozens and dozens of calls from prospective tenants, only one mentioned Section 8 vouchers and even then the lease payment was above their budget.

As I mentioned in the first post, the experience was positive overall, fun, and increased our net worth. We are actively looking for more properties.

We have our first investment property now officially done. A family moved in on a three year lease-option program. We took a lot of cues from Scott Frank and Andy Heller’s “Buy Low, Rent Smart, Sell High”.

The family is pretty much the ideal tenant both from the book and in common sense. They have two young children and have roots in the community. They got into some financial trouble a few years back but have been fine since. They also are in a situation where their income is artificially low while one of the parents finds a job in his or her long-term career path. Due to those two factors, combined with the increased tightening of credit, they are not able to obtain a loan on our home, even though even on one income the payment is within normal limits. I expect a year down the road their credit will have improved and they will be back to dual income status and will be able to qualify. I place the odds at 75% that they exercise the option.

Monthly cashflow on the property is approximately $250/mo positive. If they exercise the option, we expect to net a total of around $25K, including cash opportunity cost.

The high-level concept behind the method is to invest in single family homes that can be had *modestly* below market value and lease-option them to a family who due to transient financial circumstances is currently unable to buy directly. The option price is set at the higher end of current fair market value (FMV) and held there for the duration of the term. The term is usually between 24 and 36 months. Typically they will pay an up-front option fee of 1% of the option price. This 1% is refunded if they buy; otherwise it belongs to the owner. Another standard part of the program is applied rent, although in this case the tenant requested other improvements in lieu of this. A landlord would offer back a percentage of rent paid (often 10%) in the event the tenants exercise their purchase option. All of this is designed to incent the tenants to treat the property like their own, since they may very well end up owning it.

Here is an example using our actual Property #1. I have adjusted the numbers off a little to keep things anonymous.

Option Price $150,000. Monthly lease payment is $1000. Tenant therefore supplied $3,500 up front, composed of $1,500 option fee, $1,000 security deposit, and $1,000 first month’s rent. They can purchase the home at any time for $150,000 and will receive the option fee back in the event they do. If they do not exercise, they get the security deposit back but we keep the option fee.

This is a good deal for the tenant because it holds the price fixed. If they rented for three years then entered the purchase market, the same house would be worth about $15K more. So for 1% up front, they can save up to 10% later. They are also guaranteed that we wont’ sell the house during the 36 month term. We will also allow a little more latitude to the tenants because of the option money.

It is a good deal for us because it allows us to lock in the option price at the higher end of the FMV. It also allows us to avoid paying 6-7% of the purchase price to a realtor. If the tenants do not end up buying the home, we have the option to sell it at approx. $165K, or to find another lease-option tenant, but with the option price and rent adjusted upward to FMV.

I believe this is a legitimate way to build long-term wealth with a manageable amount of risk. We are actively searching for more properties with a goal to acquire two in 2008 for a total of three. There is no better time to be giving this concept a shot because it involves buying now (with soft market and low prices, including high foreclosure rates) and delaying selling for several years when the market will presumably have recovered. The tightening credit standards are also setting the rent-buy dividing bar down toward rent further benefitting the model.

I will write another post with some things that surprised us and things to watch out for.

SomeGal recently became eligible to participate in her employer’s 401(k) program.  Unfortunately they do not offer a match at this time, but we are big believers in automatic savings so she is contributing.  They also unfortunately limit the contribution as a percentage of salary, so she will only be able to contribute about $11K per year instead of the IRS max of $15.5K.   The asset allocation is pretty much 100% stocks, with a mixture of big and small cap, and NYSE and overseas.

As mentioned in the most recent net worth update, I will max out my 2008 contribution at $15.5K as I did my 2007.  My employer does offer a match so I except total deposits for the year to be ~$20K.  My asset mix is similar to SomeGal’s.   I am currently contributing approximately $2000 a month to my 401(k) and so will hit the limit about 75% of the way through the year.  At that point, I will either go ahead and keep up the contributions (post-tax), or set it to zero and see a huge take home increase.  About that time I will also fulfill the FICA max of $97,500 and see another substantial bump in take home for the rest of 2008.   This works out nicely for the holiday season, and because the ‘Gal and I tend to travel to the beach in the winter.

I also hope to continue last year’s trend of putting around $15K post-tax into our mutual fund account, although that may be more subject to change, particularly if we buy additional investment properties.

So, SomeGal is planning a trip to the big apple this summer.   She and her mother are going and I will likely be staying home.  This is due primarily to wanting to give her some quality mom-daughter time, but secondarily to saving some money.  Plus, she’ll owe me a boys-only trip some time!

Most of our friends only travel with their significant other.  The unsurprising exception to that rule is bachelor/bachelorette parties.  However, two couples we know completely break that norm and regularly travel separately.  And we’re talking about major travel, often overseas.  They do also travel together on a major trip once or twice a year.

Speaking of NYC, Madame X at My Open Wallet was kind enough to link to and make mention of this blog.  Thanks a million, Madame!  If any of her NYC-area followers are reading this, do you have any Manhattan restaurant recommendations?  We’re talking more of the hole-in-the-wall “secret” places, not the boku-bucks type places where you’re paying for name and reputation more than food or service.

What do you do for travel — how often does one of you with a significant other travel alone for pleasure?  Business doesn’t count.

We have submitted articles to several carnivals this week and will track the results below.

Sound Money Matters is hosting the Carnival of Frugality this week. Aryn pretty wells sums up frugality: “being frugal sometimes means spending more to get a better value for a better product or to achieve the kind of world you want to live in.”

DodgeBlogium is hosting the Best of Me Symphony this week. They were kind enough to link to my article giving the true definition of recession.

Kimberly over at Alpha Consumer is hosting the Carnival of Personal Finance.  She’s a writer by profession so it makes her blog a little unusual and interesting.

We have finally gotten serious about looking at and obtaining life insurance. We are planning on going with AIG because of their A++ rating and generally good reviews online. At this point I have had several conversations with a representative and answered a fair number of detailed questions. He indicates that he is extremely confident in his categorization of me at “Preferred Plus” (the highest) and SomeGal at “Preferred” (second highest). Of course I am still suspicious since they have a huge incentive to initially quote low to get the full application and then come back with “well you missed this one thing” type excuse.

I will post more as the process progresses but for now here are the numbers rounded to the dollar. We’re looking at $1.5 million on each of us.

SomeGuy: 10 year: $37; 20 year: $56; 30 year: $88

SomeGal: 10 year: $39; 20 year: $62; 30 year: $95

I went in expecting to be in the “standard” class with substantially higher rates and was thinking 10 year terms. If we end up as quoted above, I am tempted to jump to the 30 for our base policies. I have also confirmed that there is no issue with having multiple policies, even from the same carrier. Why the heck would someone want to do that? My thinking is to do a laddered life insurance policy similar to a CD ladder. Perhaps a “base” 30-year for $500K, then a month or two later a second step for $500K on a 20-year and a third step for $500K on a 10-year. There would be three main advantages in this case.

1. Flexibility. If at some point we decide less coverage is needed, we can let one of the steps lapse without touching the others. That way we don’t have to qualify and pay rates at whatever age we are then, with higher to much higher rates. We also would have flexibility in the event we had a long-term or permanent financial issue and couldn’t afford the quarterly premiums on all three steps.
2. Protection. Having three policies and thus three payment due dates means that if we accidentally miss a payment (or have a major problem — eg hospitalization) we don’t lose all coverage.

There doesn’t seem to be any “base” in the price of life insurance, so the only disadvantage I see to laddering is the (somewhat minor) hassle of maintaining a couple different policies.