The Un-Sexiest Word in Real Estate
Issue #2228
- WEALTHY: How to pocket over a quarter-million dollars a year… regardless of the market (Justin Ford)
- HEALTHY: An inexpensive tool to help you reach your weight-loss goals (Craig Ballantyne)
- WISE: Abraham Lincoln on becoming rich
ALSO IN THIS ISSUE:
- 3 ways to make your holiday road trip better (Bonnie Caton)
- 10 little things Rick loves about the holidays
- It’s Fun to Know… why we hang up Christmas stockings
- Add "euphemism" to your vocabulary
Are You Ready for a Thrilling, Positive Change In Your Life?
This may be the life-changing opportunity you’ve been waiting for. If you continue doing everything the same way, you’re going to get the same results. You must make a change TODAY to see a change in 2008.
I’d like to show you how to dramatically increase the chances of making all your dreams - whatever they may be - come true in 2008.
-Charlie Byrne
"That some should be rich, shows that others may become rich, and, hence, is just encouragement to industry and enterprise."
Abraham Lincoln
Amortization: How the Un-Sexiest Word in Real Estate Can Make You Rich
By Justin Ford
There are a lot of high-energy terms in real estate: flip, leverage, cash out, cash in, boom, bubble, and bust. Then there’s the sensible sister: amortization. Very few investors talk about it. Most don’t understand it. Yet it is the one aspect of property investment that can guarantee to make you substantial money over time.
In the short term, amortization won’t make you rich. Yet it can help ensure discipline in your investing. And that means it can help you avoid the costly, short-term mistakes that are so often caused by greed and impatience.
But its greatest value lies in the long term. In 10 to 15 years,it can make you a multimillionaire and create a six-figure passive income - even in a flat market! Let me show you how this overlooked wealth-building phenomenon works - and how even a single deal can help create a comfortable retirement.
Amortization: Kill That Debt
"Amortization" comes from the Latin mors, or "death." It literally means "kill off the debt." You do that by paying down the amount you owe on a loan (the principal). If more people had taken amortization into account during the bubble a few years ago, they would not have paid peak prices for cash-flow-negative properties. And now they could be killing off their debt… instead of being killed by it.
The reason amortization gets so little respect is that it works very slowly in traditional residential real estate loans. Take a 6 percent, 30-year, fixed-rate loan, for instance. On a $100,000 mortgage, your payment will be $600 a month. Yet only about $100 of your first payment goes to principal. A full $500 - or 83 percent of it - goes to interest.
So you accrue equity very slowly through amortization. In fact, in the first five years of this loan, you’d reduce your loan balance on average by only about $1,400 a year. It’s only after about 18 years that half your mortgage payment would be going to principal. And toward the end of the loan, say in years 26 and 27, over 80 percent of each payment would be going toward paying off the little principal that remained.
The debt is being paid off, however slowly. And every dollar reduction in debt is a dollar in equity creation for you. Over time, this can create substantial wealth.
How to Pocket Over a Quarter-Million Dollars a Year Through Amortization, Regardless of the Market
Take, for instance, the case of an investor who has amassed an $8 million property portfolio, with half comprised of equity and half comprised of mortgage debt. Let’s also assume that, on average, the mortgages are 10 years old, with an average interest rate of 7 percent and an average amortization period of 20 years.
This investor will now accrue $287,425 in the coming year just from amortization. And he’ll go on to gain over a quarter of a million dollars in equity every year for the next 10 years… regardless of whether the market is flat, falling, or rising. It all happens from the systematic and progressive reduction of his loan balance.
Here’s another example. This one shows how, thanks to amortization, you could retire a multimillionaire with a six-figure passive income from a single commercial property.
Let’s say you buy a $2 million income property with a 9 percent cap rate. The cap rate is the net operating income (NOI) of the property as a percentage of the purchase price. It is a figure that is calculated before and apart from any debt service or mortgage payments. In this case, the 9 percent cap rate means the property produces $180,000 in NOI.
It’s important to remember that NOI is defined as the income left over after paying all expenses and budgeting for vacancy and maintenance. So if you bought the property for all cash, that $180,000 would be mostly spendable income.
Of course, you don’t have $2 million in cash. In fact, let’s say you don’t have any money at all. So you bring in equity investors to fund the cash portion of the investment.
You arrange for 80 percent financing (a $1.6 million mortgage loan), and you get $500,000 from your equity investors. That’s $400,000 for the down payment and $100,000 for closing costs, reserves, and some minor fix-up work. In exchange for their investment, your equity investors will get half the profits from the deal.
So what happens?
Well, let’s say nothing happens. The market doesn’t go up in value by a single dollar. The property simply generates its income, pays its expenses, and pays the debt service and a little more. Well, in this case, you’d still become a millionaire and end up with a six-figure passive net income in 15 years… all from this one investment… and thanks in good part to amortization. Here’s how it could happen…
Making Millions in a Flat Market
Let’s say you get a 6.5 percent loan that amortizes in 15 years. Your annual debt service on $1.6 million for this kind of loan will be $167,277. That’s covered by your $180,000 in NOI. You don’t have a lot of cash flow, but you already budgeted for reserves, you have a little extra income, and net rents tend to rise over time. You’re not flush, but you’re okay.
And remember, in this example, the market is flat. Yet, after 15 years, you will have paid off the $1.6 million loan. So the equity is equal to the original $2 million purchase price. At this point, you could also easily have $100,000 in the property bank account from accumulated net rents, which tend to grow over time. So the total equity for the partnership is $2.1 million: $2 million in the property and $100,000 in cash.
That represents a $1.6 million equity gain. Half belongs to your partners. You have an $800,000 equity gain and your partners have their original $500,000 in equity plus an $800,000 gain. Not bad, considering this investment didn’t work out.(The market was flat.) Nonetheless, you each gained $800,000.
And now, you no longer have debt service to pay. So you can split the NOI.
The NOI was $180,000 when you started. If we assume it hasn’t risen at all, it’s still $90,000 apiece. If it’s gone up by just a 3 percent average inflation rate, the NOI is now just over $272,000, or more than $136,000 to each of you in passive income.
And if market values went up just by the long-term average of 5 percent a year, your $2 million property is now worth almost $4.2 million. Add in cash in the bank from accumulated net rents, and you could easily be at $4.3 million. Subtract the $500,000 original equity investment, and your gain is $3.8 million. That’s $1.9 million for your partners and $1.9 million for you. And that’s on top of the six figures in free cash flow each year.
Amortization plays a big part in making this possible, taking a long-term ho-hum investment and creating equity by using the rents to pay off the loan. And while its benefits are most apparent over the long term and with larger properties and larger portfolios… it can serve you well even in the short term and even with a single-family home or a triplex. Especially in a hot market.
If you insist on buying only cash-flow properties with fixed-rate amortizing loans, you’ll avoid the time-bomb, interest-only, adjustable, and often even negative-amortization loans that can create huge negative cash flows. By insisting on using amortizing loans for your long-term holds, you will automatically rule out a lot of speculatively priced properties that are affordable only temporarily by using the "creative financing" that is now exploding in so many investors’ faces.
Even on your flips - where you may be using higher-interest, short-term credit lines or private money - make sure the numbers work out so that, if you had to hold the property, it would cash flow if you put competitive-rate amortizing financing in place. That will help you be more selective, take less risk, and ultimately make more money with less worry.
Amortization: It’s not sexy. But with the right income-producing properties, it can become a sure and even significant source of wealth creation in an uncertain world.
[Ed. Note: Justin Ford is an active real estate investor, the author of Main Street Millionaire, and the editor of the recently updated Secret Value & Growth Cities: How to Make 6- and 7-Figure Profits From the Flood of Money Away From Overvalued Bubble Markets and Into America’s Best Priced Growth Cities. To learn more about the best real estate markets in the country, click here.]
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Read this special report to find out how YOU can become a “Merger-Mercenary.”
Hitting the Road for the Holidays
By Bonnie Caton
Websites and blogs are filled with advice on how to travel by air. Rarely, though, do you read anything about road travel. Yet, according to the Department of Transportation’s Bureau of Transportation Statistics, at least 91 percent of holiday long-distance travel in the U.S. this year will be by car.
Before you pack up and hit the road, keep a few things in mind:
- You can easily steer clear of traffic and accidents with up-to-date traffic reports for anywhere in the U.S., free, on traffic.com. You can also call the website’s toll-free number, 1-866-MY-TRAFC. I tried it yesterday. A computer voice prompted me to answer questions, and then computed the traffic for the road I asked for.
- Scope out your potty breaks before you leave the house. thebathroomdiaries.com is a fun site that reviews public bathrooms in the U.S. and in over 120 countries. (Some of them look a little scary.) It will help you find bathrooms on your route that meet your standards.
- A good way to stay awake and keep everyone in the car entertained is to listen to audio books. You can download them for free at librivox.org - and there are about 1,000 titles to choose from. Download them to your computer and then burn them to CD or copy to an MP3 player that you can hook up to your car stereo.
[Ed. Note: Bonnie Caton is AWAI Travel’s Member Liaison. For 93 more time-saving, money-making travel tips, click here. Find deals, ensure a smoother trip, and even find out how to get paid for your travels.]
A $19.95 Cure for Obesity?
You want to lose weight and you want to lose weight NOW. So it’s no surprise that you may be tempted by the "quick fix" of weight-loss drugs.
Here’s one reason to avoid them: They’re expensive! A month’s worth of Xenical, for example, could run you over $300. Fortunately, there is a much cheaper way to fight obesity.
According to an article published in the Journal of the American Medical Association, the simple pedometer is fast becoming a popular tool for motivating physical activity. In a review of studies that used a pedometer to increase activity, researchers found that it increased activity by an extra 2,491 steps per day. That was a 25 percent increase in activity - which, in turn, led to weight loss and a decrease in systolic blood pressure of 3.8 mmHg.
The researchers recommend aiming for 10,000 steps per day. And all you need is a cheap pedometer to spur you into action. (You can find an accurate, high-quality pedometer online for only $19.95.) This will help you increase your fitness and get you ready for more intense exercise for greater results in the future.
[Ed. Note: Fitness expert Craig Ballantyne is the creator of the Turbulence Training for Fat Loss system. If you want a free online source of information, motivation, and social support to help you improve your health, lose weight, and get fit, sign up for ETR’s free natural health e-letter.]
10 Little Things I Love About the Holidays
By Rick Pendergraft, Financial Editor
1. 24 hours of A Christmas Story on TNT
2. My neighbors and their insane Christmas light display (Think Griswalds.)
3. Mr. Hankey
4. Thinking back to high school and the tradition my mom and I started for high school students to "adopt" Head Start children and buy them presents. It still goes on 22 years later, and has spread to numerous towns throughout Indiana. It always makes me smile when I think about it.
5. All I Want for Christmas Is a Real Good Tan by Kenny Chesney
6. Taking my boys to the beach on Christmas Eve so my wife can wrap the presents
7. My former neighbor’s homemade peanut brittle (Man, I miss getting it fresh! Can you FedEx it, Terri?)
8. Watching my boys tear into their packages (The sheer excitement can’t be matched.)
9. Gift cards = no more ugly sweaters under the tree
10. College football bowl games
It’s Fun to Know: Why We Hang Up Christmas Stockings
Why do we hang oversized socks on the mantle during Christmas? One theory is that the tradition comes from a story about the original Saint Nicholas, the inspiration for Santa Claus. St. Nicholas left gold coins in the stockings of three poor girls who needed money for their dowries. The stockings had been hung next to the fire to dry.
(Source: the HowStuffWorks website)
The Internet Money-Making Secret of a Desperate Housewife.
More bills than money. Dave, bless his heart, was trying, but he just couldn’t keep their heads above water.
Vicky and her husband Dave were caught between a rock and a hard place.
Vicky couldn’t stand to see the pain on Dave’s face.
That night fate intervened… Vicky got her hands on something very special.
What she saw changed her life… forever!
- Patrick Coffey
Word to the Wise: Euphemism
A "euphemism" (YOO-fuh-miz-um) is a nice way of saying something that is not nice. The word is from the Greek for "to use auspicious words."
Example (as used by Jeff Giles in a New York Times review of Legends of the Chelsea Hotel by Ed Hamilton): "The Chelsea Hotel describes itself as ‘a rest stop for rare individuals,’ a euphemism that still manages to pass the truth-in-advertising test if you take ‘rare individuals’ to mean artists and addicts, and ‘rest stop’ to mean possible death."
[Ed. Note: Become a more persuasive writer and speaker … build your self-confidence and intellect … increase your attractiveness to others … just by spending 10 VERY enjoyable minutes a day with ETR’s new Words to the Wise CD Library.]
Michael Masterson
Copyright ETR, LLC, 2007