Posts Tagged ‘investment’

Transform with Gratitude

October 27th, 2009

By Logan Flatt, CFA

As Americans start the holiday season of an economically challenging 2009, we have much for which we can be thankful. After all, we live in America and we are a prosperous and generous people. For example, working hard in America today is Bill Phillips, the self-made multimillionaire and author of the bestselling book, Body for Life. Bill is thankful for his good fortune and has decided to make it his mission in life to help Americans of all colors and sizes make healthy changes in their lives so that they in turn can make a difference in the lives of other Americans. While his message may be schmaltzy at times, it is fundamentally sound: he advocates that each of us must “Be The Change” we want to see in our lives and that the best way to do that is by changing how we as Americans eat, exercise, and think. In short, Bill suggests that a healthy mind and spirit can only thrive in a healthy body for it is the body that hosts and feeds that mind and spirit.

To encourage Americans to be healthier, Bill puts up hundreds of thousands of dollars of his own money each year to challenge any and all comers to his Be the Change Challenge (It’s free. See www.transformation.com for more information). If you work hard over 18 weeks to transform your health and fitness, you could be crowned a Transformation Champion and win some of Bill’s money for yourself and for your favorite charity.

One such Champion is Denise Taylor, a married mother of five children from Sellersburg, Indiana. What made Denise’s championship unique was the venue in which she got fit: a hospital. Denise lived at the hospital while taking care of her 15-year old daughter Jonnae, who spent months there undergoing treatment for leukemia. While Jonnae slept, Denise would run up and down the hospital’s staircases for aerobic exercise. For resistance training, Denise would do push-ups and sit-ups on the floor of the hospital room while Jonnae watched and counted aloud the reps.

Denise and Jonnae were happy to support each other as each attempted to conquer her own personal adversity – Jonnae to defeat leukemia and Denise to transform her body, mind, and spirit through the Challenge. Denise likes to point out that she and Jonnae rallied together against adversity through gratitude. Both enjoyed using the gracious phrase “I get to” as a replacement for the more burdensome “I have to.” For example, Jonnae didn’t tell her friends, “I have to have a bone marrow transplant.” Instead, she told them, “I get to have a bone marrow transplant.” This simple change showed Jonnae’s gratitude for having a chance, a hope for a cure to her cancer that many other children in the world do not have.

As Americans facing economic adversity, we can all learn a powerful lesson from Jonnae and her mom. Many of us who suffered financial losses over the past year now have to work harder, save our earnings, and rebuild our investment portfolios. Many of us have to go out and try to find a new job in an economy with a 10% unemployment rate. Many of us have to move out of our cherished home and into a smaller house or an apartment to make ends meet. But, do we HAVE TO do these things? Or, do we GET TO do these things? Bad economy or not, we are still Americans living in America: we represent only 4.5% of the world population, yet we control over 20% of world economic output. Our disproportionately large control of economic power endows the average American family with many trappings of life that go far beyond those of the average non-U.S. family.

Take a look at India: it’s a country with 17.2% of the world population and its average income per person is only $2.78 a day. Could you live on only $2.78 a day, every day of the year? Probably not. You likely spend more than that on a Starbucks latte just to get your day started (the average U.S. income per person is $130 a day – before taxes). China is similar to India: it has 19.6% of the world population and its average income per person is only $8.93 a day. You likely spend at least that much on lunch. Do you think average people in India, China, and other places like Africa, Southeast Asia, South America, and Eastern Europe even have investment portfolios that they have to rebuild? Do they have good paying jobs they have to go out and find again? Do they have a comfortable family home that they have to sell? No, they don’t have to do any of these things because, for them, it is simply not economically feasible to do in the first place.

Here in America, life is different. Americans don’t have to do these things during tough economic times. Americans get to do these things – things that average people in the rest of the world would love to get the chance to do. In America, we are all privileged. We don’t have to do anything. We get to do everything – even those things we do not really want to do. It’s a valuable lesson that Denise and Jonnae knew well as they both battled to become champions. While her treatments, her mom’s love, and her own sense of gratitude kept leukemia at bay for many months, Jonnae succumbed to the disease on June 9, 2008. Her mom Denise is grateful it was a battle the two of them got to fight together.

Addendum:
Watch a video of Denise and Jonnae’s story of transformation at www.Transformation.com.

Watch a video of Denise talk about Jonnae and “I Get To” in July 2008 at www.YouTube.com.

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NOTE: This article first appeared in the Thanksgiving-themed Winter 2009 issue of The Swan, a publication of the Lake Forest Community Association, Inc., a nonprofit Texas corporation.

Copyright 2009 LoganFlatt.com. All rights reserved.

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Posted in Current Affairs, Personal Finance

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Don’t Fool Yourself – Your Home Is Not An Investment.

November 4th, 2007

By Logan Flatt, CFA

Recently, a respected blogger on the Web misquoted me on their blog in an entry referencing my essay, “You Don’t Own Real Estate. Real Estate Owns You.” The blogger made a couple of critical errors in quoting me but the errors have, for the most part, now been corrected based on three points I made privately to the blogger by email. Below, I present the text of my email (with some small edits) for all LoganFlatt.com readers who have an interest in real estate investing to review and consider.

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First, I never said on my LoganFlatt.com site that a “home mortgage is not an investment.” What I said was, “…your home is not an investment…” That’s a huge difference! I think your confusion arises out of your merging of two separate and distinct financial considerations from the homeowner/borrower perspective:

1.   The Asset, which is the real estate property we would call “home”; it is an asset because it has marketable value to you and others in the real estate marketplace;

AND

2.   The Liability, that loan or mortgage serving as a lien on the real estate property only because the buyer of the home did not have enough cash on hand to pay for the property outright and had to borrow the money from a bank or mortgage lender to complete the purchase of the real estate property.

From the borrower’s perspective, a “home mortgage” could never be viewed as an investment. It is a legal contract obligating the borrower to pay back the money borrowed, plus interest charges and other fees. In effect, the home mortgage slowly drains the borrower of cash through those interest charges and fees paid out over time. Being legally obligated to pay someone else cash over time is a liability. One “invests” in assets, not liabilities. A freedom loving person seeks to rid themselves of a liability – having no meaningful financial obligations such as liabilities is what “financial freedom” means. Consequently, an investment in a liability is a non sequitur.

It is important to note here that only the lender would view the “home mortgage” as an investment because that home mortgage is indeed an asset to the lender – in exchange for lending the money to the borrower, the lender gets the mortgage documents signed by the borrower agreeing to pay the money back plus interest charges and other fees. So, what is a liability to the borrower – the mortgage – is an asset to the lender. If you were writing about lenders, then your implication that a home mortgage is an investment would make more sense. Unfortunately, you were writing about borrowers in your post. So, contrary to what you posted, no, I do not agree with you.

Second, my quoted statement on your site [Editor's note: the quote used from my article was, "To make it your home, you must take cash out of your pocket each month to finance it, insure it, maintain it, fix it, furnish it, and pay property taxes on it. Unlike investment real estate, your home generates no income to offset these out-of-pocket expenses. So, while you likely derive much pleasure from owning your home, you lose money on it every month. Don’t fool yourself – your home is not an investment. It is simply a purchase."] would be true for a home that had no mortgage on it if only we were to delete two words: “finance it.” So, the home need not have a mortgage on it to fail my “investment test” – even if the homeowner owns the home free and clear, there are a litany of expenses associated with home ownership that make it difficult to call a home an investment (because the home generates no income itself to offset those expenses). This was the full point of the “Personal Real Estate is Simply a Purchase, Not an Investment” section in my article on LoganFlatt.com.

Third, both you and [a financial services professional who made, in my view, an erroneous comment to the blogger's post] appear confused on the notion that the use of “leverage” to buy a home somehow instantly transforms the purchase of a home into an investment. No, it does not. While “leverage” is a sexy term used by professionals in the trade to romanticize real estate investing and make it sound exciting conceptually, it is a red herring. It masks the truth: to use “leverage” is to legally obligate yourself to a lender. In other words, what you are doing when you “lever a deal” is voluntarily take on a liability and the risk of losing your home to the lender due to your failure to pay back that liability according to the lender’s terms. The addition of a liability to your home purchase does not – poof! – make your home an investment.

To clarify, when you use “leverage” to buy your home, you are essentially completing two separate and distinct transactions at the same time:

1.   purchasing a piece of real estate that will generate no income for you to help you offset all the expense associated with owning said real estate,

AND

2.   entering into a legal agreement to borrow money from a lender whereby you agree to repay the money borrowed plus interest charges and fees according to the lender’s terms specified in the agreement.

Note that the addition of “leverage” to the deal did nothing to change your home’s ability to generate income for you one bit. In fact, by borrowing the money to buy your home, you simply increase your home ownership expenses by adding interest charges and fees. Clearly, “leverage” is sexy in concept only; in the harsh light of reality, it is anything but sexy.

[Blogger], I hope that you and your readers will consider reading again my article, “You Don’t Own Real Estate. Real Estate Owns You.“ to recall and reinforce its key takeaways:

1.   to invest in real estate means to own and operate income-producing real estate;

2.   to speculate in real estate means to buy real estate at the prevailing market price and hope to sell later at a higher market price;

3.   your home is neither an investment nor a speculation – it is simply a purchase of a piece of real estate to enjoy and call “home”, not to make money from it;

4.   you really don’t own real estate if a government can swoop in and take it away from you because that government thinks your real estate stands between it and a just cause – a cause apparently less important than your personal property rights.

Thank you,

Logan Flatt, CFA

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Copyright 2007 LoganFlatt.com. All rights reserved.

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You Don’t Own Real Estate. Real Estate Owns You.

July 22nd, 2007

By Logan Flatt, CFA

Many Americans believe that real estate can do no wrong as an asset class upon which they can build wealth. I disagree. Building wealth through real estate depends on your ability to distinguish among the three types of real estate ownership – investment, speculative, and personal. If you don’t know the differences, you may soon discover that you don’t own real estate, real estate owns you.

Investment Real Estate Puts More Cash in Your Pocket Than It Takes Out

Investment real estate refers to the ownership and operation of income-producing real estate whereby the income generated by the property – usually, rent payments from tenants – more than covers all the costs of owning and operating the property. If the income is high enough to cover all the costs of ownership and operation plus leave cash left over for the property owner, the property is said to be cash flow positive. If the income fails to cover all the costs of ownership and operation, the property is said to be cash flow negative, whereby the property owner must dig into his or her pockets to come up with the cash to pay for the remaining, uncovered costs.

A bona fide real estate investment puts more cash in your pocket than it takes out, on a repeatable, consistent basis. As such, a cash flow negative investment property is really not much of an investment at all. If you continue to hold on to a cash flow negative investment property out of pride or any other emotional attachment to the property, you are not maintaining an investment; you are maintaining a hobby. A rational real estate investor would put a stop to the repeated, consistent cash drain ASAP. In many cases, it is simply best to swallow your pride and sell a cash flow negative investment property. That way, you can let a new owner cope with the income shortfall each month while you put your sale proceeds to work in a cash flow positive investment property you can find elsewhere.

Speculative Real Estate Is a Bet Against the Odds

When buying real estate at or near the prevailing market price, many people firmly believe they will make a profit upon the future sale of their real estate. Unfortunately, there is wishful thinking and there is reality. Wishful thinking plays a prominent, defining role in speculative real estate. A new property owner may hope to sell his property at a higher market price in the future, but in reality, he has no idea what the future market price will be. Nobody does – all future market prices are unknown to everyone. That is, until the future arrives.

In the face of such uncertainty at the time of purchase, all the new property owner  can know is that there are three outcomes for a future market price: significantly lower than, similar to, or significantly higher than the current market price. In other words, unable to know at the time of purchase what future market prices will be, the new property owner has only 1 in 3 outcomes where he can sell his property at a future market price significantly higher than the current market price. If each outcome is equally likely, the new property owner’s odds of selling his property at a highly inflated market price are low.

Unfortunately, the odds of making a profit on a property purchased at the prevailing market price are made even worse by the high transaction costs of buying and selling real estate. Even if a new owner sells his property at the similar future market price, he still loses money thanks to brokers’ commissions, legal fees, and other closing costs incurred to sell the property. He also loses money selling the property at a significantly higher future market price if that future market price is not quite high enough to cover the high transaction costs. Clearly, the odds of making a profit are against those who buy real estate at the prevailing market price and hope to sell later at a higher market price. Such is the nature of speculation and the wishful thinking that leads to it.

Personal Real Estate is Simply a Purchase, Not an Investment

Personal real estate is real estate you buy primarily because you believe you and your family will enjoy living there. Making money, if at all possible, is secondary. In fact, it is hard to make money with personal real estate. To make it your home, you must take cash out of your pocket each month to finance it, insure it, maintain it, fix it, furnish it, and pay property taxes on it. Unlike investment real estate, your home generates no income to offset these out-of-pocket expenses. So, while you likely derive much pleasure from owning your home, you lose money on it every month. Don’t fool yourself – your home is not an investment. It is simply a purchase.

Nevertheless, despite draining you of cash every month, owning personal real estate generally beats renting a house, condo, or apartment for an extended period of time. Owning personal real estate gives you at least two options that renting does not. These options provide you with real value.

First, unlike renting, ownership of personal real estate gives you the option to keep more of your income out of the hands of career federal politicians in Washington, D.C. Current U.S. federal tax laws allow you the opportunity to deduct mortgage interest and local property taxes from your taxable income. This helps reduce your U.S. federal income taxes. So, when you own personal real estate, more of your outgoing cash ends up helping your surrounding community, its schools, and its hospitals instead of largely going to waste in Washington, D.C. This is especially true if the investors in your mortgage are also local and in your community; such investors are more likely to reinvest your interest payments locally as well.

Second, if you ever have to move due to a job change or relocation, personal real estate ownership gives you the option to hold on to your personal real estate and rent it to tenants after you move out. Exercising this option gives you the opportunity to turn your personal real estate into investment real estate. Of course, exercising this option might not make sense given your personal interests or financial situation at the time of your move, but it is an option you would not have had if you were simply renting the roof over your head. When moving out of a rental unit, despite all the monthly payments you made to your landlord, you walk away with no ownership in any real estate asset whatsoever. The advantage goes to personal real estate ownership.

You Don’t Really Own Real Estate If It Can Be Taken Away From You

The differences among investment, speculative, and personal real estate ownership are clear. However, you don’t really own real estate. You only think you own it. Even if you have paid off your mortgage in full, a county, city, or local public school district can still take your property away from you. Just stop paying the tax bills these governments send you each year and you will quickly discover who really owns your real estate.

Paying property taxes is all you need to do to keep your real estate out of government hands, right? Sorry, but no. You could pay property tax bills in full year in, year out for decades and still lose your property to eminent domain, whereby a government expropriates your real estate to use it for what it claims to be society’s “greater good” – your personal property rights be damned.

Clearly, while many Americans believe that real estate can do no wrong as a way to build wealth, it sure is hard to build wealth with real estate when, in so many different ways, you don’t own real estate, real estate owns you.

Copyright 2007 LoganFlatt.com. All rights reserved.

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Posted in Personal Finance

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