Some End Of The Year Thoughts For Current and Future Real Estate Investors

First off let’s agree 2008, spun in Grandma-speak, will forever be a ‘learning’ year. You’ll probably not argue when I posit the the belief 2008 might turn out to be as historically relevant as 1929. Probably not ‘cuz it will have turned out that badly, ‘cuz it hasn’t and won’t come close. But ‘cuz it was such a rare perfect storm, much as was documented in ’29.

The two most egregious mistakes made by the Federal Reserve back then was A) Raising interest rates B) Decreasing the money supply. Together they had the same effect on the economy as would treating a hemophiliac with leaches and razor blades. The resulting decade plus of massive human suffering was predictable — and a direct result of incredibly poor logic.

Surely, credible cases can and have been made against Fed Chairman Bernanke, but he obviously learned from the experience of 80 years ago — Don’t constrict the money supply while raising rates when deflation is upon you. Duh. While this has caused widespread wringing of hands and gnashing of teeth, it’s also kept us from catastrophic deflation, which is just another way of saying Great Depression II. The Fed can only do so much, and frankly I’m not ecstatic about some of the timing lately. But much of the crappola goin’ on in D.C. this year has been clearly out of Bernanke’s control.

Those afraid of hyper-inflation (and afraid they should be) say the massive employment of our printing presses presage that very same inevitable economic infection. Maybe, maybe not. What most people gloss over is that inflation is indeed the over production of money, but it’s a relative concept. It doesn’t exist in a vacuum.

Let’s use a hole in the backyard as an analogy. The hole is a ‘down economy’ in need of much dirt, which is ‘money’. Adding dirt to the hole to fill it up is a good thing. It’s not ‘overfilled’ until the dirt reaches higher than ground level. Bernanke has a pretty big hole to fill, and he’s shovelin’ dirt in as fast as he can. Will he overfill? I think that’s more likely than not. The real question is: Is he gonna build his own mountain of dirt? Not likely. He realizes the rock and hard place in which he is in between.

He’s got three major goals that I can discern. 1) Avoid depression. 2) Avoid the complete collapse of real estate markets. (And no, that still hasn’t happened, regardless of how it may look.) 3) Avoid creating untenably high inflation as a result of defeating deflation.

No matter how ya look at it, would you wanna be Bernanke? Yeah, me neither. But to be fair to him, mistakes and all, he’s been successful in all three pursuits. I know, I know, ‘successful’ is a pretty relative term in this context. I don’t know about you, but I’ve heard first hand from folks who were there in real time in the ’30′s. Current circumstances don’t have us all dancin’ in the streets, but we’re not in bread lines either. See? It’s all relative.

Segue coming, so hold on.

Let’s look at where you might be five years from today — December of 2013. If you invested in the stock market, it’s anyone’s guess what your return might be. I won’t even hazard a number here. You go ahead and fill in that blank. ‘Course that’s kinda tough since you’ve no doubt lost 25-40% of your portfolio’s value in the last 12-18 months. The most credible, long term (20 years) study of 401k returns, shows an embarrassing bottom line — about 4.5% annually.

If you closed today on an income property requiring $110,000 (down & closing), and it cash flowed 5% cash on cash ($5,500), plus saved you an additional $5,000 in state and federal taxes through depreciation, your return would be just over 9.5% AFTER TAX. Those numbers will remain more or less static or drift up the next five years.

Oh, did I forget to mention you get that return with 0% annual appreciation? Also, and I feel like a real Technical Tommy here, but in five years at today’s interest rates, you’d also have gained just under $28,000 ($27,826 to be exact) through principal reduction. Somewhere, there’s a real estate investment agent in Kansas City getting chills all over.

So to recap, let’s look at the real return resulting from your investment in a real estate income property which is assumed from Day 1 to have the same value five years from purchase. Most folks would run from such an ‘opportunity’. ‘Course if you thought the property was indeed going to experience 0% appreciation, AND you were going for capital growth, you wouldn’t have bought the dang thing, right? Not so fast Wall Street breath.

In five years your initial $110,000 would have yielded $47,500 in what I’ve called ‘Cash in Levi’s’, and an additional $28,000 in the principal reduction of your loan. That’s $75,500 — not bad for a non-appreciating asset. Incredibly simplified, that’s an 11% annual return — 9.5 of which is, (I love this part) after tax.

Tell me about your Wall Street adventures again, please please please?

I jest, but the numbers are no joke. They’re real as can be. The next time you read how a company you own is busting their vest buttons with pride ‘cuz they announced a 29¢ dividend per $100 share (Uhm, that’s 29¢ BEFORE TAX, by the way), remember these numbers. Then think of your retirement. Yeah, now we’re serious as a heart attack, aren’t we?

Still have significant money left in your 401k or IRA? Convert it to ‘Self-Directed’ and begin your recovery by acquiring real estate in high demand markets where jobs are searching for employees. And for the record? In the last 12 months our Texas recommendations have either held their value or appreciated — both in value AND rent. Don’t become jaded ‘cuz your market sucks like a turbo-charged Dyson. All real estate markets are definitely not created equal.

Finally, I ask those for whom 2008 has resulted in the loss of equity to take a step back and be fastidiously objective: If you sold now, took your losses and moved our capital to real estate in a growth region, would you be better or worse off five years from now? This is especially crucial for those real estate investors owning San Diego income property. Ya didn’t sell in ’05, ’06, ’07, or this year — and I literally begged you to. I’ve been advising San Diegans to bail out since late ’04, early ’05. I’m still bangin’ that drum as loudly as I can.

Make the move — your retirement may be getting farther away even though you’re getting older. And that’s the saddest result of all, isn’t it? Yes, it is.

OK fine. I said at the top Grandma would say our take on 2008 should be spun as a learning experience. The loss of equity in ’08 doesn’t mean you can’t begin to make up for it in ’09 and beyond. All real estate is indeed local — but that doesn’t mean you’re compelled to remain a hostage of your crappy local market.

Make sense? Cool.

Now have the bestest New Year ever! Then watch all the football you can take before the chip/dip/beer coma strikes. THEN let’s get together and figure things out. Let’s start the new year in the Purposeful Planning Lane, OK? Have a great New Year.

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