Sunday, October 30, 2016

The Landlord Files: How do I know if this house will get a good return?

Landlording can be a very financially rewarding endeavor, but it can also suck the money and life right out of you.  How can you tell the difference before you buy an investment property?  If you already own a property that is not being used as a rental, would it make a good rental?  Here is how you can tell.

Calculate Income and "Cap Rate"
1.  Determine how much rent this property can earn in a year.

If it's rented already, you have that number.  Otherwise, research local rental values for similar homes to come up with an estimate.

2.  Determine the annual expenses created by this property.  This includes:

  • projected vacancy rate (5-10% of annual rent is typical)
  • utilities paid by you (water?  garbage?  Some localities require landlords to pay certain ones.)
  • repairs (new roof, new furnace, siding repair, emergency plummer?  These things will come up.  1-3% of the home's value is a good estimate.  I use 3% since I bought a foreclosure, and assume those numbers higher.  If your home is newer, you may use a lower percentage.)
  • property taxes
  • insurance
  • management fees (if you use a rental management company)
3.  Calculate "Annual Net Income"
  • Annual Rent minus Annual Expenses
  • Mine is:  17400-9800= 7600 (roughly)
4.  Calculate the "Cap" Rate
The capitalization rate is the expected annual rate of return.
  • Divide net income by cost of property.
  • Mine is:  7600/102500= 7.5% (approximately)
If you took out a mortgage on this home (or plan to), you still do NOT place that number in this calculation.  Once you have this calculation figured, do some number crunching to see if there is still a healthy enough return to account for your mortgage payment AND a few worst case scenarios.  One year you might have more vacancies or late rent payments than usual.  The year you replace a roof or something huge may look a little different.  You may have a series of expenses come up in the same year.   If you don't leave a significant cushion, you could quickly operate at a loss.

Personally, I won't invest in a rental property with less than a 5% cap rate, but that's just me!

Sunday, October 23, 2016

Budget Revisited: Avoiding the Trap of Two Incomes

Those of you who have read last week's blog post have probably been thinking about your own monthly spending habits, and the possibility of shoring them up.  For those of you who missed it, the concept is 50/30/20.  The jist of it is that you should budget your money so that your fixed expense necessities take up no more than 50% of your monthly budget (housing, transportation, heat/electric, or anything that cannot be trimmed or deleted), 30% for flexible, lifestyle expenses (these items maybe important, but could be trimmed or have payments altered if needed; think: minimum credit card or student loan payments, cable, cell phone, groceries, dining out, entertainment), and 20% for goals (paying down debt and saving for your future).

I want to revisit the 50/30/20 idea for a moment.  Hopefully this doesn't throw a wrench into your budgetary plans.  What number are you calculating your percentages based upon?  We have two incomes in my household for the first time in years.  My partner went back to school a number of years ago, and we lived off my income during that time.  Now that we are both working our income has literally doubled, but I didn't update our budget.  "BAD!  Bad personal finance writer!"  It's okay, I know you were thinking that.  Let me explain.  This move is totally on purpose.

I'm tempted to offer you a catchy anecdote that explains to you exactly WHY you should create a budget based on one incomes, but I think we should just let the numbers speak for themselves.

Let's say I take home $3000 per month after taxes.  According to the 50/30/20 guidelines, I have:

  • 50% Fixed-Cost Necessities:  $1500
  • 30%  Flexible Lifestyle Expenses:  $900
  • 20% Goals:  $600
Those numbers look familiar, right?  We used them last week.  Now, let's say we have two incomes of $3000 per month after taxes.  That makes $6000 per month incoming.  If we apply our formula (50/30/20) to it, it looks like this.
  • 50% Fixed-Cost Necessities:  $3000
  • 30%  Flexible Lifestyle Expenses:  $1800
  • 20%  Goals:  $1200
I know what you're thinking "WOOHOO!  THAT'S the lifestyle I'd really like!"

Hold it right there.  Not so fast.  Let's have some fun with numbers for a second.  What if you had both of those incomes, and budgeted to ONE of them, placing the remainder of the money into "Goals"?  It would look like this:

  • 50% Fixed-Cost Necessities:  $1500
  • 30%  Flexible Lifestyle Expenses:  $900
  • 20%  Goals:  $3600
In one year's time, that goals category would amount to $43,200!  Can you imagine what you could do with an extra $43,200?  I sure can!  While I know these were made up numbers, and your situation is different, I just want you to let this sink in for a moment.  This is house down-payments, student loan payoffs, a fully funded emergency savings; the possibilities are nearly endless.

If you are single, you likely won't be forever.  Maybe you should consider THIS strategy when you start to become serious with that special someone.  If you are in a couple, can you squeak by on one income?  In my household, we have done so for years.  It was purely circumstantial, but one of the smartest moves we've ever accidentally made.  Since I've always been the bread-winner, we will continue to budget to my income, and add my partner's income directly into the "Goals" category.  One year from now, we will have more than $10,000 in debt paid off, have 2-3 months of our emergency fund funded, and paid for a new roof on our rental property in cash.  That feels amazing to me.

If you are in a couple that has already bought a house, and you budgeted to two incomes, maybe you can't live off one.  Review your budget.  Could you live off 1.5 incomes?  Try it for a 2-3 months.  You might surprise yourself.

If you are in a couple, and rent.  I want you to seriously consider buying a home (assuming you have that as a goal) that could be paid for on one income even with other bills.  If you are single,  you have not yet combined finances with another person.  when that comes down the pipeline for you, don't you dare budget to both incomes.  Regardless of your goals, you will meet them much more quickly if you avoid the trap of two incomes!

Note:  I started using this phrasing "two income trap" years ago.  I didn't even realize that the fabulous Elizabeth Warren has written a book using this same title.  I have not read it, but have added it to my list.  I just wanted to point this out for a couple of reasons.  1.  Some of you might want to read it.  2.  This post is in NO way meant to relate to that book in any way.  I am sure it is fabulous, and I would like to read it, but my thoughts and ideas are not intended to relate to it in particular.

Sunday, October 16, 2016

Creating a Budget: The 50/30/20 Budget System

50/30/20 Budgeting

                Now that you have an idea where your money is going, we can zoom in on this a little.  I want to introduce you to the 50/30/20 Budgeting Guideline (initially made popular by Elizabeth Warren).  If you type it into a search engine, you will get a zillion hits.  It is basically a guideline that helps you to determine how much of your income should be going where.  Different financial writers will describe them slightly differently, but here is my version:  50% of your take-home pay should go to fixed expenses, 30% goes to flexible (or lifestyle) expenses, and %20 should go toward goals.

50% Fixed Expenses
Let’s look at the first category.  This is the 50% category, and it is devoted to fixed expenses that are needs only.  There should not be any wants in this category.  These are the things that you literally must have to function, and they cost you the exact same thing every month.  Your rent/mortgage payment, the cost of your transportation to and from work, certain utilities, etc.  I put  only a handful of things in this category because there are very few things that are fixed cost needs.  Quite frankly, I even put groceries in another category, because while I need food, I can scale back on certain items to impact the dollar amount I spend.  I do not have that kind of choice where my mortgage, rent, car insurance, car payment, or public transit pass are concerned.  Those items cost me the same thing every month, I can do literally nothing (short of moving, selling a car, etc.) to alter the cost, and I absolutely must have this in order to function in my day to day life.  Once you have figured out which of your subcategories (mortgage/rent, car insurance, etc.) go into the 50% Fixed Expense category, you need to do a little math.  If you take home $3000 each month after taxes, then this category should take up no more than $1500 per month.   If you are spending more than 50% of your take-home income in this category, you may need to face some tough choices in order to get these numbers down.  You may need less expensive transportation or housing.  Alternately, you could consider a roommate or an extra job.  You maybe wondering why it matters whether or not you go above 50%, especially when these expenses are the most fundamental to your life.    It’s a fair question.  If you are spending so much money in this category that it goes above 50%, you won’t be able to pay down your debts or save for your future.  If you are unable to do those things, you will risk putting yourself in an unstable position when you are in your golden years.  If you are struggling to make ends meet now, when you are theoretically in the best health and with the most energy to work, how do you think you will get along when you are significantly older?

30% Flexible or Lifestyle Expenses

                The next category is for Flexible or Lifestyle Expenses.  This should be no more than 30% of your after-tax monthly pay.  These could be one of two things:  a regular monthly bill that could be trimmed back if you needed to or has a changing payment amount, or things that you spend money on for recreation of some sort.  There are a few things that are in this category that appear to be REALLY important, so important in fact that you may wonder why they weren’t in your 50% category.  Let’s take a look at a few.  The first item is groceries.  You MUST have food to live, but this expense is flexible.  If you fall on hard times, you may qualify for the food stamp program which will alleviate you of some of these expenses.  You also have a huge range of choices regarding what to buy and how much it will cost you.  Perhaps dining out is a huge priority with regards to lifestyle.  That number also shows up in this category.  Another surprising item that is in this category is your cell phone bill.  You need telephone access now days, but let’s be honest.  You probably do not have the cheapest most basic plan available right?  Well neither do I, and that’s fine.  It is a lifestyle choice, and if push came to shove, and you could scale back that expense as needed.  Another expense that is very important, but flexible is your student loan debt.  It is very important that you pay on these debts, but the payments are flexible.  If you became ill or unemployed and your student loans are federal, you can have your payments reduced or deferred.  A credit card payment is also a flexible expense.  As your balance goes  up or down, your payment amount will change.  If you became ill or unemployed, these debts could be discharged in a bankruptcy (not ideal, but possible).  Other items that are flexible, lifestyle expenses are entertainment, dining out, clothing, and many others.  The basic rule of thumb is that if you could reduce the payment or eliminate some or all of the expense, then it is in this category.  Note about student loans and credit cards.  Only the minimum payment amount belongs in this category.  Once you have determined how much money you are spending in this category, compare it to 30% of your take-home income.  If you are spending too much in this category, you can easily fix it.  Decide where you can scale back so that you are comfortable within that limit.  If you are already below 30% in that category, even better.  You have more funds to allot to goals.

20% Goals

                That brings us to the final 20%.  This is for goals.  This is the category that makes me feel excited because I feel like this category is directly related to my own financial freedom and future.  If you earn $3000 per month after taxes are taken out, then 20% is $600.  That is the amount you can spend on goals.  Goals should be a combination of savings and paying down your debt.  These are both super important, and you should be doing both.  If you have money left over from another category, I recommend that you give it a home in the “goals” category.   Paying down your debt will free up some of your income for other things.  In terms of savings, you should have at least two different types:  retirement savings and emergency savings.

If you are using some kind of software to help you with this budgeting, it will easily figure these numbers for you.  If you are using pen and paper, just calculate how much is 20%, 30%, and 50% of your income, and track it.  Each month you will be able to see whether you are within the parameters you have set for yourself and adjust your spending as needed so that you can make progress toward your goals.

Sunday, October 9, 2016

Financial Freedom: Finding a Starting Point

Financial Freedom:  Finding a Starting Point

Being poor as a child taught me the value of hard work and determination.  I am not sure what having money teaches a child.  I imagine that it gives them the freedom to just be a child.  Hard work and determination were not gifts bestowed upon me.  The fact is that I earned them both.  That being said, I will also have to earn my freedom.

When people say that they want to be rich, I am not sure if that is what they really mean.  I suspect, they really mean that they want to be free.  Don’t we all want that?   It’s the freedom to do what we love regardless of what it pays.  It’s also the freedom to have control over our own time.  It’s also about opportunities.  Have you ever missed out on opportunities because you couldn’t afford them?  I have, and enough is enough. 

But where do I begin?  If my finances are a journey, and I am plotting along on a road to financial freedom, it seems vital to know where I am starting from. 

Step 1:  Track your expenses

Most of us don’t actually know what we are spending or what we are spending it on.  Spend at least 1 month doing this.  I spent several months on this activity.  In this first month, try to spend as you would normally.  Not more, not less.  The point in this activity is to find out where you are starting from.  Honesty is key.  Collect every receipt.  If you don’t get a receipt for something, keep a pad of sticky notes or something with you and immediately jot down the dollar number and what it is that you purchased.  Then stash the receipts somewhere.  I use a cigar box.  At the end of the month, make a date with yourself.  Pour yourself a glass of wine (you’ll need it), and dig in.

Sort the receipts into piles of “like purchases.”  You can take a little creative liberty here in choosing your categories.  Remember this is just a rough sort.  Now, very quickly pick up each pile and leaf through it.  Does everything you see truly belong in the same category?  My realization was that my “food” category really needed to be three categories, so it became “food”, “date night,” and “liquor”.  Now, don’t judge yourself, just be honest.  If you find that you have seven receipts for coffee, maybe you ought ask yourself “Is that a major category for me?”  Or at the very least, is it deserving of its own pile? 
Once you are happy with your categories, either grab a notebook that is designated for this purpose only, or open a spreadsheet (for those technological types).  Start writing down all of your spending categories.  This is a combination of the categories you created when you sorted your receipts, and your monthly bills.  Next to these categories, make a column for your estimated spending.  Now, do NOT calculate anything yet.  Just write down how much money you THINK you are spending in any given category per month.  After you are done, gather all of your monthly bills, and you get to start totaling.   Next to your estimated total, you will enter your actual spending amount for the month.  Then total both columns and compare them to your after-tax income.  Did you think you had a surplus?  Deficit?  What was the reality?  Do you have a surplus at the end of the month or are you in the red?  This is where the wine comes in.  Stop judging yourself and study your numbers.  Are you uncomfortable with what you see?  I was, but that’s okay.  All great journeys start with a roadmap, but a roadmap is no good to us if we don’t know where we are starting from.  Where our finances are concerned, the roadmap is our budget.  Now, of you might be thinking “Lacy, didn’t we just create a budget?”  The short answer is “no.”  We did not create a budget, we found our starting point.  We are being honest with ourselves, and have begun our journey.  We will look at budgets next.

What interesting thing did you learn when you tried doing this activity for yourself?

Tuesday, October 4, 2016

Freedom House

Freedom House

Real Estate is a personal passion of mine.  I currently rent a one-bedroom apartment in Inwood, a neighborhood in northern Manhattan.  I am also a landlord.  I own a rental property in Portland, OR. 
When I bought my house in Oregon, it was with the intention that I would live there, and I did for a few years.  It was also a move that I made not only to build equity, but also to lower my cost of living.  “But Lacy,” you might ask “How does buying a house decrease your cost of living?”
It’s simple.  Buy your freedom house.  Your freedom house and your dream house are NOT the same thing.  Your dream house is the one that has the perfect number of bedrooms, and the perfect number of bathrooms so that your twice per year guests won’t ever have to use the same toilet that you do.  All joking aside, your dream house is the one that you aspire toward, and has all of the amenities that you want.   Your freedom house has all of the amenities that you need.

For instance, I had been renting a 2 bedroom, 1 bath house in a trendy, walkable neighborhood, near buses, for nearly $1300 per month.  I asked myself “Can I get what I need for less than what I am paying now?”  Not as a rental, unless I moved to a different neighborhood, which I was willing to do, but I don’t drive, and need to be on a busline.  So, I started researching houses for sale.  I was making $25,000 per year, and because of that, I could only get approved for $120,000 of a mortgage loan.  In Portland, Oregon, housing prices are typically double that (or more) unless you strike a killer deal, but that didn’t stop me.

A few months later, I bought a Fannie Mae foreclosure for $102,500, and put about $5000 down.   The transaction was really pretty smooth, although foreclosures can be difficult for people, as can short sales.  The one thing to remember, if the bank owns the property, they really don’t plan to do any repairs.  They also don’t want to be a landlord.  Their only mission is to get the house off their books.  That means they need to sell it so that it doesn’t show as a loss that they are taking, or at the very least, they need to minimize the losses that they will end up taking.  Where a human being that owns the house may be moved by you writing them a letter about how you want your children to grown up climbing the beautiful oak tree that is in the back yard, the bank isn’t interested in this plea (to view Fannie Mae foreclosure listings in your area go to

The Fannie Mae house was my freedom home, not my dream home.  It had horrible wood paneling in the living room and faux tiles in the bedroom that matched the ones in the kitchen.  It was a real eye sore, but, it was structurally sound, and had great bones.  It had 2 legal bedrooms, 2 bathrooms, and unfinished basement with 2 bonus rooms, hard wood floors, a garage (also in rough shape) and a decent sized back yard.  It was also in an up and coming, walkable neighborhood, and near several bus lines.  This could more than meet my needs.  It also saved me $500 per month in housing costs.  Yes, I had to make the down payment and move, but that was fine since I wasn’t going to try to sell it. (If you plan to sell within a few years, you may not recover the costs associated with the down payment and moving.  So, crunch your numbers carefully.)

Now that I am living in New York, I want to buy a property to live in here.  How do I replicate the things I did right the first time, now that my circumstances have changed?

  1. Avoid the 2 income trap.
  2. Buy only what I need.
  3. Consider the “what ifs”.

Avoiding the 2 income trap

Budgeting your life to two incomes will keep you from getting ahead.  It offers very little flexibility, and is likely to keep you in a situation where you will always NEED two incomes.  This is not ideal.  When I bought my freedom house, my income was the only one being considered.  My significant other had stopped working in order to go back to school.  So, at the time, I was the only one with a steady income.  I had avoided the two income trap based on shear circumstance, rather than intention.   In order to replicate this strategy in the future, I will need to buy only as much house as can be sustained on one paycheck.

Two incomes are the norm nowadays, right?  Not if you are single.  Fully using two incomes can also prevent one or both people in a partnership from being able to take an opportunity.  For example, we came to New York because I had received an opportunity to get a Master’s Degree that would be funded by an organization.  The organization would also help me to find a job that would more than double my salary once I was finished.  I took it.  My partner and I lived one year apart (the length of time it took us each to get our degrees).  When I had secured a position and apartment, we moved our household across the country.  I would have had to decline the offer had we made different choices regarding our housing purchase.  If we had both been working, and qualified for closer to $240,000 of a mortgage, the payments would have required that we both continue to work in order to keep the house.  Since we had only used one income to buy the house, the payment was low enough not to be a burden.  I was able to take the offer in New York.  While my partner was still on the west coast, I rented a room from a friend in New York.  The rent plus my mortgage in Oregon still cost us less than the mortgage would have cost us had we used two incomes for the original purchase.  That year was certainly difficult financially, but we were able to make it work.  Once we moved, we turned it over to a management company, and have a lovely family living there.  Our monthly net profit is close to $500 per month.  This is another thing that wouldn’t have been possible if we had purchased with two incomes in mind.  If we had purchased with two incomes in mind, we would likely operate at a loss if we rented it out.  In the future, there are things that I would like to accomplish which would require me to either quit working, or scale back immensely.  I know that in order to keep those goals attainable, I must avoid the two income trap.

Buying only what I need

I made two lists.  One list was my bare essentials, my needs.  The other list was my wants.  Considering my current circumstance, my needs include two bedrooms, close to public transit, elevator (or ability for wheelchair access).  My wants include two bathrooms, extra storage, laundry in the building, outdoor space, and a dishwasher.  Getting everything from the want list is not likely, but creating it is good.  If a few items from the want list appear in a property I see, that is wonderful!  It could put the place in the running quickly.

Considering “what ifs”

I’d like to review an item on my list.  I said that I need two bedrooms.  That seems unnecessary for a couple with no children.  I have a sibling with a severe disability that lives with my mother.  If anything unfortunate should come of my mother, I will immediately become my sister’s guardian.  This may or may not happen, but I cannot afford to be ill prepared.  I need a second bedroom, and the ability to get a wheelchair into my home.  Another “what if” to consider is employment?  What if both of us become unemployed or underemployed at the same time?  A second bedroom could be rented out to help minimize costs.  It is important to consider “what ifs” that are plausible, but don’t go overboard.  Consider a few “worst case scenarios” that seem entirely possible, such as job loss or illness perhaps.  Then see how these scenarios impact your housing and budgetary concerns, and factor them into your planning.

Many people that purchased houses in the early 2000’s found themselves buying their dream home, and quickly found the house becoming a nightmare.   Your house should offer you the security of knowing that you will eventually pay it off and not owe anyone.  It should allow you the freedom to pursue your dreams within it.  If you focus on what you need and avoid the two income trap, you can buy your freedom house.