It's a Landlord's Market

In any economic downturn, there are always opportunities. One such opportunity is the result of higher lending standards, which makes it more difficult for people to purchase homes, as well as a doubling in the number of home foreclosures in the 2nd quarter of this year: higher demand for good quality single family rental homes.

This was my hunch, but it was confirmed this week after receiving a signed lease agreement for a rental property being vacated today. The new lease includes a 5% increase in rent over the previous one and will be the first time I've had no lapse in vacancy upon a tenant's move-out, quite a relief. I've been considering the purchase of another rental property, and after this experience I plan to start researching prospective investment homes.

And watch this to see a disturbing encounter between Will Ferrell and his landlord:

See more funny videos at Funny or Die

Mid-year review

This entry is more for me than anyone who stumbles upon it, as I wanted to do a mid-year review of some life resolutions which will some day become habit. I'd give myself an arbitrary grade of B-, as good progress has been made in some areas while others are untouched. Below is each area with its respective grade:

- Pare down: F. I'm preparing for an October and November barrage of eBay activity, but that doesn't help in the interim.

- Make running a habit: A. The real evidence is that when I pack running gear on a business trip, it gets used; I now run at least twice a week and more if the schedule allows. I've shed over 15 pounds and moved from "Overweight" to "In Normal Range" according to the WHO and CDC, which defines overweight as having a body-mass-index/BMI of 25 or more. A good BMI calculator can be found here.

- Travel more for leisure: B. Gasoline over $4 a gallon doesn't help, but we've been on three trips so far this year with a big vacation scheduled in early December.

- Reduce exposure to media/news: B. I'm a political news junkie, but you won't find me at a methadone clinic as long as I can get my fix of The Daily Show with Jon Stewart and The Colbert Report.

- Invest more in community: D. It's not what I originally had in mind, but right now this investment in community is through time and money directed at helping to get Senator Obama elected President.

- Manage ADHD rather than having it manage me: A. Just after the first of the year I switched from Dexedrine to Vyvanse, and it's much more effective with zero side effects.

- Simplify investments: B. I'm down to just four individual stocks considered long-term holds (DIS, MRK, SHPGY, and MSFT). All other holdings are in the form of exchange-traded funds. Unfortunately I'm still down 14% since the first of the year compared to a 12.7% decline in the Dow Jones and a 13% decline in the S&P 500. Fortunately the rental properties are all occupied and throwing off good cash flow.

Life resolutions starting now

No New Year's resolutions for me. I'm not interested in being part of the majority who commits to a new way of life, only to fail. If I'm going to commit to change, I want it to stick. So below are several commitments I've made to myself that my friends and family are welcome to hold me accountable to. And perhaps it's just a symantics game, but I'm not calling these New Year's resolutions, they're life resolutions.

- Pare down. If 2007 was the year to de-clutter, it was just a start. I'm committed to eliminating physical clutter and unnecessary material items which only lead to mental clutter.

- Make running a habit. Since Thanksgiving I've added an extra 15 pounds, and that needs to go permanently.

- Travel more for leisure.

- Reduce my exposure to media/news, more mental clutter.

- Invest more in my community. I need to practice what I preach to my girls.

- Manage my ADHD rather than having it manage me. Two years ago I switched from Adderall to Dexedrine, and while effective, Dexedrine just isn't working as well as Adderall XR did.

- Simplify my investments. For me this means moving cash investments from individual stocks to index funds. This will help avoid mistakes like NovaStar, down 97% over the last 2 years, despite its hefty dividend (recently discontinued). I'd rather have base hits than strike out swinging for the home runs.

Is Atlanta real estate a buy?

The NY Times has an article today on Atlanta's increasing rate of foreclosures. What the article fails to highlight is the fact that borrowers in metro Atlanta use interest-only mortgages at a higher rate than the rest of the nation, which is a key contributor to the increased foreclosure rate. Those who took out a 6-month LIBOR +1% interest-only mortgage in June of 2003 when LIBOR was at 1.124% have had their mortgage payments more than triple in the last 4 years.

Buying low and selling high are the keys to profitable investing, but knowing what is a high and/or low is often difficult. My barometer for knowing a good real estate investment opportunity is its ability to generate positive cash flow, but that doesn't apply to people who are in the business of flipping houses.

Profiting on Foreclosures

There was a great article in Saturday's print edition of The Wall Street Journal on making money in foreclosures, and I was glad to see this article make its way to Yahoo's Personal Finance section where you can read it for free!

Are you average and is your average mean?

When someone asks if I'm average, I immediately wonder if they're asking about mean, median, or mode? If math isn't your thing or you're intellectually lazy, skip to the bottom data elements. Since you're still reading, I'm going to take you back to junior high or high school math class and use Merriam-Webster to define these terms:

mean = a value that is computed by dividing the sum of a set of terms by the number of terms

median = a value in an ordered set of values below and above which there is an equal number of values or which is the arithmetic mean of the two middle values if there is no one middle number

mode = the most frequent value (or values) of a set of data

For those like me who read these definitions and go "huh?", here are the terms portrayed visually:
Practically speaking, let's compute each of these with a dataset of 5 numbers: 29,1,4,1,5.
Mean
29+1+4+1+5 = 40; 40÷5 = 8
Median
The numbers in value order --> 1 1 4 5 26 ... and the middle number (or the median) = 4
Mode
With the data set 29,1,4,1,5... the most frequently occurring or repetitive number = 1

When dealing with statistics about finances and income, the press is often sloppy in their use of the term "average". While most do not use mode, many identify both median and mean as average, which is too imprecise. If you add a few zeros along with a comma or two, the numbers in my dataset could be housing prices or household incomes, and not knowing whether a number is median or mean can have a big impact on how the numbers are interpreted . Because outliers, such as the number 29 in my dataset above, can skew the calculation of mean, many cost and income-based financial statistics are computed as median so that half of all such costs (or incomes, housing prices, etc.) fall above this value and half fall below.

While statistics may not lie, liars use statistics, so know the difference between mean, median, and mode. And with that lesson, here are a few facts about average in the U.S. of A.:

Median home value = $167,500

Mean travel time to work = 25.1 (minutes)

Median age = 36.4 years

Average* household size = 2.6
Average* family size = 3.18
* - assumed to be mean, but it's not clear

ALL
Median household income = $46,242
Mean household income = $62,556

Families
Median household income = $55,832
Mean household income = $72,585

Nonfamily household
Median household income = $28,050
Mean household income = $39,741

And if you're looking for a real-life example of an outlier, Bill Gates has more wealth than the bottom 45% of American households combined.

Note: All stats are from the economic profile of the 2005 American Community Survey from the U.S. Census Bureau unless otherwise noted. This survey breaks the data down further into these other profiles: demographic, social, and housing.

[update added March 13, 2007] For a fantastic essay described as "the wisest, most humane thing ever written about cancer and statistics" read The Median Isn't the Message by Stephen Jay Gould.

Dividends are my friend - update

Note: This is an update to my first note on this subject back in January.

If you were so trusting as to misinterpret my advice to buy dividend stocks and instead followed this amateur and actually purchased NovaStar Financial (NFI) back on January 13, you'd be a happy camper as the stock is up 14% since then. The stock should also throw off at least $5.60 in dividends this year (an 18% yield based upon the closing price on 1/13/06).

Of course you would have had to resist the temptation to dump the stock when it took its roller coaster ride from $30.36 down to $25.70 on February 15.

In my last note, I alluded to an issue of stock price manipulation and shorting (a practice where someone sells the stock without actually owning it). Shorting is legal as long as the entity selling the stock is able to find someone else's stock they can temporarily borrow. In the case of NovaStar and several other stocks, including Overstock.com and Krispy Kreme, however, there is proof that not everyone shorting the stock is actually able to find stock to borrow. When this happens it's called naked shorting, and it's against the law. Kudos to Forbes for giving some press to this subject. Perhaps this article will generate some interest from regulators who are not doing their job (companies should not be on the SHO list for months or years at a time).

Real Estate Investing - Buy Low

The key to any investment, real estate or otherwise, is to buy low (and I would also argue that this same principle should be applied to the purchase of your primary dwelling, whether you consider it an investment or not). With real estate, there are innumerable ways of doing this, but few are easy. My philosophy is to find properties that no one else wants, such as those with mold in the basement, a cracked foundation, a roof that is caving in, or other serious structural problem. Not interested in such a home? Good! These flaws scare away many potential buyers and investors, resulting in much less demand which gives me more leverage to negotiate a favorable price.

When I'm evaluating a property, I get a good look inside the home. I look for cracks in the drywall between the wall and ceiling, water stains on the ceiling and on walls, tiny black spots on drywall, signs of rot on the eaves & facia, and cracks in the flooring/foundation. As I identify problems, I note them and begin a mental tally of what each item will cost to repair. Estimate high. If you're not sure how much something will cost, make friends with a contractor and take them with you to view a potential investment.

With the house I'm currently working on, I made an offer immediately after seeing the property. I knew the fair market value (FMV) of the home if it were in "normal" condition. How? I know the market. I've researched and studied my micro-market and know the selling price of nearby homes. Online sites such as HomeRadar and the Atlanta-specific AJC homefinder provide a list of somewhat-recent home sales. Two great sites that show comps on a map are ShackPrices (only for Seattle) and HomePriceMaps. One site that may some day provide the ultimate solution is Zillow.com, which can give you a "Zestimate", but today it's only available in certain markets as the site is in "beta" now (so be patient!). And remember that a Zestimate is just a start--the key to knowing the fair market value of a home is to know the details of the comparable recent sales used to derive the Zestimate. If their data is bad, your Zestimate is wrong. Finally, if you're unable to determine recent sales in a market, it's time to make friends with a local realtor and take them out for lunch. Realtors have access to a database of recent home sales through their local MLS. When you do finally determine the FMV, be conservative.

At this point, you now have two numbers:

1. Fair Market Value (FMV) of the improved home
   
2. Repair cost (now abbreviated as RC)
   

I need to calculate yet another number before determining my offer price, and I call it the PITA factor. PITA is my acronym for Pain In The Ass. If the house only needs new carpet and a coat of paint, my PITA factor is a low $ amount. If I need to tear down and haul away 1/3 of the house, gut it, and install a new roof, the PITA factor is high. It's different for each house and each investor, but it's real, and I include it in my calculations.

Lastly, there has to be some profit (which actually results in equity) in the deal, or it's not worth your time. And if you've errored in calculating any of the other three numbers, you're going to eat into your profit. Again, this number is different with every investor, but if there is less than $20k profit in the deal, I don't pursue it.

Finally it's time to calculate the offer price. I derive this by using the following formula:

FMV - RC - PITA - Profit = Offer price

So if the Fair Market Value = $195k, the repair costs are $20k, the PITA factor is $5k, and the desired profit is $20k, the formula to determine an offer price would look like this:

195,000 - 20,000 - 5,000 - 20,000 = $150,000

One last point: this calculation helps determine what you're willing to offer. This should go without saying, but if the house is listed for $140k, don't be a fool and offer $150k.

Likewise, if the home is listed for sale at $150k, I wouldn't immediately submit an offer with a seller's asking price. If the house has been on the market longer than a couple of weeks, I'd make a low-ball offer, knowing the seller is already cognizant of the fact they're selling a defective house and are probably afraid no one is interested. If the house is newly listed, I'd probably make an offer around $140k, as there may be something I didn't factor into the repair costs. And regardless of what is on the Seller's Disclosure Statement, once the house has closed, it's yours--problems and all.

Best financial advice

Monday night in Community Group we were asked to share advice we'd give to a newly engaged and a newlywed couple. One piece of advice I'd offer is fortunately one I learned early in my marriage.

I've since figured out that people who teach real estate investment classes and sell tapes, CDs, and books about real estate investing normally make more money teaching about real estate investing than they actually do investing in real estate. Years ago my wife and I attended a real estate investment class from John Adams here in Atlanta where we learned very little about the topic at hand but took away some completely unexpected wisdom. Mr. Adams offered the following advice that we apply to this day: finance things that appreciate and pay cash for things that depreciate.

In practice, this means financing your home since it is an appreciating asset. For most Americans, that's not a problem--I don't know of anyone sitting on a big pile of cash who is considering using this cash to buy a home. The second part of Mr. Adams' sage advice, however, means saving enough money to purchase a new or used vehicle rather than financing it. I had done this most of my life, but then again, I drove a crappy 1988 Volkswagen Fox station wagon when I met my wife. I remember the time my wife and I purchased our first vehicle together. We decided to apply this principle, so we saved. I never thought I'd be able to pay cash for a nice car, but we started with an older vehicle and bought a used Ford Explorer with cash. Through the years we've continued to upgrade to newer and newer vehicles as we've saved more and more until last year when we were finally able to buy a new car (minivan, actually).

Why does this principle make so much sense? The answer has to do with the "cost" of money. If you're financing a $30,000 vehicle over 5 years at 5% which depreciates 20% a year, your real cost of the vehicle is actually $7,500 for the first year. Here is the calculation: $1,500 interest ($30k cost x 5% simple interest) + $6,000 in depreciation ($30,000 cost x 20% depreciation per year) on the vehicle. In paying cash for the vehicle, your real cost is only the $6,000 depreciation on the vehicle, which is 21% less than the cost had you financed it.

But Dorkydad, I want a brand new BMW 650i convertible! Tough--so do I, but at $78,800, the only way I'm going to get one is by starting to save now. If you want to do this (pay cash for things that depreciate), make some sacrifices with your first vehicle. Maybe it's not the newest, maybe it has a standard transmission, maybe it has 100,000 miles, and maybe it's not the color you had in mind, but trust me--the peace of mind in not having a car payment as well as the extra cash you'll have each month will more than make up for any buyer's remorse.

I've also discovered that this advice marries up well with some biblical wisdom. Proverbs 22:7
establishes that borrowers become slaves/servants to a lender, so I see Paul's statement, "You were bought at a price; do not become slaves of men" found in 1 Corinthians 7:23 as encouraging us to stay out of debt.

Dividends are my friend

In the last 4 years I've put most of my investment dollars into residential (rental) real estate, shifting it away from stocks & mutual funds. Of course I'm always looking for a good return and have always liked dividend stocks, especially those that have a company-sponsored DRIP.

One such stock is NovaStar Financial (NFI), which I've been purchasing for the last 3 years and in whose DRIP I participate. I'm reminded of NovaStar because they just paid out another dividend and issued their November production numbers today.

NovaStar is a mortgage real estate investment (mREIT) company offering nonconforming loans. Because of their mREIT status, they must pay out 90% of taxable income to remain a REIT and 100% of taxable income to avoid income tax. It's odd, but tax accounting is totally different than "real" or "GAAP" accounting, which is why the company can pay out 100% of its taxable income and still continue to operate. In the 3 years I've been buying NovaStar, this payout has consistently resulted in a 20~25% dividend. 2005 dividends were $5.60 per share, which equates to a 19% dividend based upon NFI's current stock price of ~ $30. Despite higher interest rates and an earlier Thanksgiving than normal, their November non-conforming production was up from $690 million in November of last year to $714 this year along with WAC (weighted average coupon = the average interest rate customers pay NFI) rising from 7.65% in 11/04 to 7.9% in 11/05, and the average FICO (credit score) going from 623 in 11/04 to 636 in 11/05.

The stock is trading about 40% off its 52-week high, and if you read the Yahoo message board for NFI, you'll find a lot of discussion about naked short sellers bearing the blame for this. While I think their arguments have merit given the stock is consistently on the failure-to-deliver or SHO list, I also think that the complexities of understanding the difference between GAAP vs. taxable income spook many investors, including those who do so professionally.

The purpose of discussing NFI isn't to promote the stock, though--it's to promote DRIP investing. In fact, being a DRIP participant, I prefer the stock to remain depressed as long as the company continues to crank out dividends. One good resources for finding other companies that sponsor DRIPs is at Computershare.

LOST about finances?

I'm not a fan of the small group curriculum from Crown Financial Ministeries, so I'm really looking forward to hearing this series!