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Risk: Getting Your Money Back Guaranteed?

I have been reading Investing for the Future by Larry Burkett on investing principles. I was struck by the author’s clarity in defining risk.

Almost without exception the degree of risk is rated based on the guaranteed return of the principle, not how much earnings the investment might yield.

The key factor in evaluating an investment’s risk is: Will I get my money back?

An investment that could lose lots of money, should provide the investor with a greater reward for their willingness to take that risk.  Conversely, “safe” investments provide less reward to investors, because they have a greater certainty of getting their money back.

This explains why savings accounts are bearing such a low rate of return. The federal government has guaranteed that savings accounts up to $250,000 will be made whole, by the FDIC. Investors in savings accounts are taking almost no risk, so they get almost no reward or return.

If you are interested in earning a higher yield on your savings, please feel free to contact me at (925) 385-8798.

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First-Time Home Buyer or Real Estate Investor

Real estate investment has been very rewarding to many intelligent and strategic investors. Investors that have the patience to take the long view have been well rewarded for their patience and diligence.

Many people view the purchase of their personal residence as a “real estate investment”. Rich Dad, Poor Dad author Robert Kiyosaki has challenged this idea through the definition of the word asset. He defines an asset as something that pays you money during your ownership and a liability as something that costs you money while you own it. By this definition, a personal residence does not qualify as an asset as you are not paid for ownership.

As well, best selling author of I Will teach You To Be Rich, Ramit Sethi, has shared reasons for his personal views that buying a house is not always the best advice for a young working professional. Not the least of which is the “phantom costs” of insurance, taxes, and repairs associated with owning a home.

The analysis of both these men is sound. In general, a personal residence should not be purchased for investment purposes. There are certain circumstances where buying a personal residence can in fact work as a means of investment.

Buying a Residence with Investment as a Secondary Goal


For a young, working professional, buying a home and having other people help pay your mortgage can
be a way of investing. What do I mean? You buy a house with three bedrooms and rent the other two bedrooms out to two of your friends. Or buy a duplex live in one side and rent the other side out.

With most fixed-rate 15-year and 30-year mortgages, a portion of each payment is applied to the debt owed, the principal or principal balance. This increases your home  equity. Equity is the value of your residence minus the total debts against your residence.

Home equity is a form of “forced savings”. Home equity is not easily spendable. Thus making a monthly payment towards the principal balance forces you to save a portion of each loan payment.

Having additional people to make your mortgage payment can provide you with extra cash for investment, spending, or to pay down your mortgage.

Using FHA 203(b) for First-Time Home Buyers

For the working professional using an FHA insured loan makes sense. The FHA 203(b) program allows eligible borrowers to qualify for up to 96.5% of the purchase price to be financed. These loans often have a slightly higher rate than a traditional mortgage, but offer the flexibility of a smaller down payment.

Most traditional lenders will look for at least 20% of the purchase price to be paid by the borrower. In high priced areas, like the San Francisco Bay Area, this can be a big hurdle to overcome.

FHA has stricter guidelines for what types of homes qualify. Homes have to be in livable condition and have been owned by the previous owner for at least 90 days.

A Charted Course

To apply this strategy a charted course is needed to avoid trouble.

    • Make sure your credit is in order. Pay your bills on time. Don’t run up to much credit card debt. Spend less than you earn.
    • Collect adequate savings for a “rainy day”. This should be 6-8 months of reserves. One month of reserves would cover your proposed monthly mortgage, monthly utilities, any other debt payments, food, insurance, etc. Lenders like to see that you have funds available should you be unable to work or are laid off to continue to pay your monthly obligations. It will also help you avoid anxiety and worry.
  • Determine how much house you can afford based on your current income. A single professional earning $60,000 per year would bring home about $3,600 after taxes each month. When calculating the amount you can afford to pay you should exclude any payments from your proposed roommates. You want to be sure you can make the payments without the roommates, should they leave for any reason.Lenders usually require that housing costs  should be no more than 28% of your gross monthly income. (It may be wiser to limit yourself to 25% of your take home pay.) Using the lender ratio would provide for a monthly housing costs of about $1,400 including taxes and insurance.Assuming property taxes of approximately $275 per month and insurance of $85 per month leaves $1,040 per month for loan payments. Using an interest rate of 6.50% per year our young professional could afford a house worth $164,539 on a 30-year mortgage and $119,388 on a 15-year mortgage.
  • Save for a down payment and closing costs. Notice this is separate from reserves. Once you make the down payment, you won’t have it for reserves. Plan to save between 5% -10% of the purchase price of the home. Each housing transaction has additional costs relating to transfer tax, title insurance, and escrow. Our young professional should save between$8,227 and $16,454.
  • Find and purchase your home

The whole strategy will take a number of months to accomplish and building equity in your home will take years. This is not a get rich quick strategy. This is taking the long view, charting a course, and diligently following it till you get the desired results.

Alternative Strategy

The FHA 203(b) mortgage can be used to purchased up to a 4-unit property. Using the same principal you could attempt to purchase a building that will generate income from the other units.

A Note About Investing

The key to any investment strategy is not to risk more than you can afford to lose. If losing your down payment is more than you can afford to lose mentally, emotionally, or financially do not risk it by investing. Each investor has their own risk tolerance. For some investors, they can only tolerate the risk that a CD at the bank offers. Others are willing to take bigger risks. Find the level of risk that is suitable for you and invest accordingly.

(House Photo: james.thompson)

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Selling Tax Deferred Properties at a Loss Still Can Trigger a Taxable Gain

One of the benefits of holding real estate for investment is the ability to defer taxes on capital gains through what is known as a 1031 exchange. Section 1031 of the Internal Revenue Code provides for investors to delay capital gains on the sale of property as long as they invest the proceeds in a “like-kind” (same type) investment within 180 days.

Real estate investors have been using 1031 exchanges for decades to defer gains in properties and use the proceeds to invest in larger properties. With the recent decline in real estate values and the loss of some properties through foreclosure, 1031 exchanges may actually trigger capital gains tax for real estate investors.

The California Real Estate Journal detailed this dilemma in an article on September 14, 2009.

For the thousands of people who have invested in 1031 tax-deferred exchanges, the real estate downturn may be coming home to roost.

Section 1031 exchanges allow real estate investors to defer their capital gains taxes as long as they roll the gain from the sale of one property into the purchase of a like-kind replacement property. With today’s sharp decline in commercial real estate values, their current property likely is worth less than what they paid for it.

If they sell their property, even if they don’t make money on the sale, they are going to trigger the capital gains taxes that were due from their previous sales. Selling at a loss does not eliminate those deferred taxes, according to Daniel Oschin, managing director of BGK-Integrated Group and president of BGK-Integrated Investment Services.

“Your taxes are never wiped out,” Oschin said.

It’s a situation that is likely to hit home with people who have traded properties over three, four or even five different legs of a 1031 exchange, re-leveraging them over the years and rolling significant gains into the property they’re currently holding.

What appears to be a loss, may in fact trigger taxable income, because of a low tax basis. This unfortunate situation can leave a real estate investor caught trying to find cash to pay Uncle Sam. (Jeff Brown details how this catastrophe was avoided here.)

Competent tax professionals are necessary for every real estate investor. A CPA or tax attorney should be contacted when considering a real estate investment decision.

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Bay Area Real Estate News

Here are a couple of items from today’s Contra Costa Times.

First, in Circuits to seafood: New tenants plug into empty buildings the Contra Costa Times shares about the new uses for former Circuit City stores.

A Seafood City Asian market is due to a open in a shuttered Circuit City store in Concord, and another retailer is eyeing a closed Circuit City in Fremont, raising hopes that at least a few empty retail buildings in the East Bay could gain a fresh lease on life.

Second, in Bay Area rents decline, fueled by unemployment we learn:

Housing prices aren’t the only thing that’s falling in the Bay Area. So are apartment rents, but not nearly as much as the hard-hit housing market.

Still, the average asking rent in the nine-county Bay Area during the first quarter for apartment buildings with 50 or more units was $1,556, or a 1.4 percent drop from a year ago, said a report released Thursday by Novato-based RealFacts.

The occupancy rate fell 1.7 percent to 94.2 percent. The average rent applies to all rental units, ranging from studios to three-bedroom townhouses.

The loss of jobs – or the fear of losing jobs – is leading to lower occupancy rates that push down rents.

Deciphering the News

It is encouraging to know that some retailers are willing to expand in the current market. Seafood City is a supermarket for the Asian/Filipino communities.

As rents decline and vacancy increases multifamily values will decline as investors underwrite at lower income values.

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The Value of Strict Buying Criteria

For most small or beginning real estate investors, the purchase of a rental home is the only option. Investors that don’t have hundreds of thousands of dollars to invest, are likely going to start with a rental property or two until their capital accumulates to buy something larger.

Many new investors look to buy a foreclosed home based on the recommendation of many real estate gurus. Without knowing what they are getting into it is easy to overpay for a property and not reap the full rewards of being a property owner.

The likelihood of overpaying is even greater. The WSJ.com is reporting that Bidding Wars Are Emerging on Foreclosures in certain areas of the country, including California.

Falling home prices are starting to ignite bidding wars in a few parts of the U.S. as first-time buyers compete with investors for the same foreclosed properties.

In most of the nation, the supply of unsold homes continues to swamp demand. Home prices in many markets continue to fall, and foreclosures, which slowed in late 2008 as mortgage companies delayed taking action against delinquent borrowers, are picking up again.

But real-estate brokers say multiple offers on certain homes have recently become more common in parts of California and Arizona and the Washington, D.C., and Minneapolis-St. Paul metropolitan areas.

Strict Buying Criteria

It is important to establish buying criteria in advance of the purchase to meet your investment goals.

The easiest way to hit nothing, is to aim at it.

Buying criteria serve as the the yellow and white stripe along the road. As long as the yellow line is on the left and the white is on your right, you are going the right direction.

The same is true with buying guidlines for real estate investors. First, you need to know which way you are going. Second, you need the guidelines in place to keep you on track.

Setting price, income, and expense goals in advance will protect the early investor from venturing to far from their goals and jeopardizing their retirement plans.

If you would like help establishing your buying criteria, feel free to call Maclennan Investment Group at (925) 324-8626.

Company Profile

Welcome to Maclennan Investment Group, Inc., your East Bay Area real estate investment advisors. Maclennan Investment Group assists buyers and sellers of real estate maximize the investment potential of their real estate assets.

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Offering real estate services in the communities of: Walnut Creek, Concord, Pleasant Hill, Martinez, Alamo, Lafayette, and surrounding cities.

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925.385.8798

Maclennan Investment Group, Inc.
3380 Vincent Rd, Ste HUB
Pleasant Hill, CA 94523
p. (925) 385-8798
Licensed Broker in the State of California, DRE#01871809
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