The terms return on investment and capitalization rate get thrown around a lot in fancy-shmancy real estate circles.  We’re going to demystify them.

Return on Investment (ROI) is a performance measure used to measure the efficiency of an investment.  In other words;

How much money is this house making me?

It is used in many forms of business, but we will focus on how it applies to real estate.

ROI measures the return on an investment compared to the investment’s cost.  To calculate this, the return on an investment is divided by its cost.  The result is expressed as a percentage.

For real estate, it’s the income from a property minus costs.

There are many things to keep in mind when you see an ROI from a property, such as whether you are paying cash or financing, will you include closing costs, interest, and loan paydown.  The ROI can look higher than it is when certain costs are being ignored.

When you see someone bragging about their ROI, take it with a grain of salt.  They may not be accounting for all their costs.

Today, we are going to focus on a specific type or measure of ROI called a capitalization rate.

Capitalization Rate (Cap Rate)

If you are calculating the ROI on a real estate deal as if it was being done in cash, you are calculating the capitalization rate, often abbreviated as cap rate.

The reason cap rate is one of the most popular measures used in real estate is it allows you to compare investment opportunities to each other.

Sometimes ROI’s are calculated by using the down payment as part of the formula.  This means the ROI can change based on the size of the down payment.  This isn’t the case with cap rates.  The formula for a cap rate has nothing to do with down payments or mortgages.

Read More

Being in the military presents unique challenges.  We are burdened with moving every one to three years throughout our careers.  While moving that often can be exciting, it can wreak havoc on our finances.

While I think most people make mistakes with real estate, those mistakes are magnified in the military because of frequent moves, especially when sent overseas.

Today I address the two biggest mistakes I see military members make with real estate.  First, buying in high cost of living areas.  Next, buying a home at each duty station.  Both bad ideas.

Let’s take them one at a time.

Buying in a High Cost of Living Area

I just ran into this issue a few days ago.  Somebody told me they were moving to Hawaii and everybody told them they have to buy because the prices of houses just keep going up!   They usually say things like, “you can’t lose!”

I told them, don’t buy!  Whatever you do, don’t buy in Hawaii!!

Why would I say that?  Don’t I want everyone to be Rich on Money?

They sighed and remarked that I was the first person to tell them they shouldn’t buy in Hawaii.

Clearly, I don’t know what I’m talking about.

There are two problems with buying in high cost of living (HCOL) areas.  One is the appreciation myth, and the next is cash flow.

The Appreciation Myth

There is a wide-spread belief if you buy in a HCOL area, you can’t lose because you’ll get massive appreciation, and even if your rent doesn’t cover the mortgage, (which is likely) you’ll still come out ahead.

Here’s the problem with that thinking.  Appreciation is a fickle thing.  In HCOL areas, it sometimes comes in spectacular fashion for a few years, and then disappears for several years.  Those spectacular years are what get people’s attention, but you never know what years that will happen, where it will happen, and how long it will last.

In the end, appreciation in HCOL cities usually ends up being only slightly better the appreciation in any other city in the U.S.  For instance, Honolulu may see a 4% appreciation per year on average over the long term compared to 3% for most cities.

I’ll give an example of the appreciation myth from my life.  I bought a townhouse in Washington D.C. for $280,000 in 2003.  Two years later it was worth $400,000.  I was ecstatic!  I could only imagine what it would be worth in ten more years!

I sold that house in 2016.  How much did I get for it?

$400,000.  All my growth (appreciation) happened the first two years, and then a net of no growth over the next eleven years.  This works out to less than 3% appreciation per year.

Not impressive.

You can’t count on appreciation when you buy in a HCOL area, especially in the military.  During the one to three years you are there, it could easily stay flat or even go down in value.  That would not be a good thing on a million dollar home!

Read my full article on The Appreciation Myth

Cash Flow

If you buy a property at an assignment and realize it didn’t appreciate much, you made need to rent it out instead of selling it.  Maybe your plan was keeping it as a rental anyway.

Rental properties in HCOL areas almost never work out!

Why?

Well, we know the first reason is because of the appreciation myth.  It’s also because the numbers don’t work!

Let’s talk about the 1% rule.  It’s the most basic and important rule in real estate investing.

The 1% Rule – A house should be able to rent for at least 1% of the acquisition price.  This is purchase price plus fixing it up.

Read More

There are four ways to make money in real estate.  Cash flow, taxes, mortgage principle paydown, and appreciation.

Three of these four are often misunderstood in how effective they are.  Appreciation is one of those, and I’m focusing on that today.

Before I bash appreciation too much, here’s what the leverage lovers want me to explain first.

If you buy a house for $100,000 cash, and that house goes up by 4% in a year, the house is now worth $104,000 and you’ve made 4% on your money.  Not amazing.

However, if you buy a house with $20,000 down on a $100,000 house and it goes up 4% in a year, it is now worth $104,000.  You’ve made $4,000 on a $20,000 investment.  You’ve made 20% on your $20,000 investment. The mortgage magnifies the benefits of the appreciation.

That’s a benefit of appreciation with a mortgage.

Of course, if you mortgage a property and it goes down in value, remember, you still owe that monthly amount to the bank no matter how low the price of the house goes.  If the market crashes, you still got to pay that mortgage back at whatever price you originally borrowed for.

This was the big problem with the last real estate crash.  It’s called being upside down on a mortgage.

Borrower beware!

Here is something I hear people say a lot about appreciation that makes me cringe.

It goes something like this:

“Well, I know I’m not making any cash flow on this house, maybe even losing some money, but that’s ok, because I’m in this for the appreciation.”

WHOA!!!!

This attitude is especially common in high cost of living (HCOL) cities.  Why?

It’s really hard to get good cash flow in a HCOL city.  The price to rent ratios are way off.  There is also this belief that these cities are great for appreciation, and you can’t go wrong buying because they will go up enough in value to make it worth it, even without the cash flow.

I’m here to tell you, this is not always the case.

Read More

“So you want to payoff your mortgage faster?”

I wish I had read this before paying off my mortgage!

 

Some banks or other financial institutions offer a mortgage accelerator program.  It’s usually some type of program that helps you payoff your mortgage faster.  The deal is, they charge you for this.  It could be anywhere from a few hundred bucks to several thousands dollars.

Do not use these programs.  They are a total rip-off.  You can use any of the methods below to payoff your mortgage faster without spending a penny.

Paying off your mortgage faster is something most homeowners consider at some point.  There are practical and psychological reasons for doing so.  We’ll hit the pros and cons after discussing the 5 top strategies to payoff your mortgage fast.

Make sure that your loan doesn’t have a prepayment penalty built in.  They are uncommon, but out there.  Be sure you understand how much it will cost and if it makes sense to pay this fee.

By the way, when you get a loan, make sure there isn’t a prepayment penalty!

In my case, I bought a townhouse in 2003 in Alexandria, Virginia for $280,000.  I put 10% down, financed 10% of the loan at a 7% interest rate, and then rest was a mortgage at 5.5% on a 30-year fixed rate loan.

While reading Dave Ramsey’s Total Money Makeover book one day, I saw the section in there where he suggests paying off your mortgage after paying off debt and funding retirement accounts.

I thought, wow! That’s a crazy idea!

But the idea of paying if off intrigued me.  I liked the idea of having no debt!

I threw everything I could at that loan over the next six years and paid it off.

And I LOVE the feeling of it being gone.

Read More

 

I will give you my 5 secrets to finding the perfect rental property management company.

Maybe you think you can manage the property yourself?

Perhaps.

But if you use my tips to find an outstanding management company, they’ll save you more money than the fee you’re paying them.

Think about that.  You’ll do less work, but save more money.

The perfect rental property management company earns their management fee and more. They do things better than you could if you did it yourself.

They have more experience:

• Finding tenants
• Dealing with dead-beat tenants
• Collecting late rent
• Doing evictions
• Finding fair prices and getting discounts from contractors
• Knowing what repairs are necessary (and unnecessary) for rentals
• Knowing which locations are best for rentals
• Pricing rentals
• And much, much more…

To reiterate, these companies end up being worth far more than their fees just through their contacts, expertise, and understanding of the rental market.

Again, this is only true if you find the right management company.  There are also plenty of bad ones that will cost more money and be as much work as doing it yourself.

That’s where following these tips come in!

Read More