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You are here: Home / Archives for Accumulation Phase

June 2, 2011 by Peter Maclennan Leave a Comment

Why Young Professionals Should NOT Buy a House

If you are a young professional with a high paying job, you have many things working in your favor. Lots of disposable income. Lots of freedom. Lots of options.

Here are three reasons you should not buy a house/condo if you are in this stage of life:

Real Estate Ties You Down

You decide to buy a nice little home in Walnut Creek, CA. Your career starts to take off. A headhunter contacts you with your dream job in Boston. You would love to take it, but what do you do with your home? Do you sell it? Can you sell it? Do you rent it? Do you want to be a landlord on a home in California while you are in Boston?

As one radio host said, “Owning real estate is placing a stake in the ground.” It is a financial obligation that can limit your options and limits your freedom.

Your Spouse Won’t Like It

Let’s say you buy that little two bedroom house in Walnut Creek. One day while walking your dog in the Dog Park, you see the most beautiful creature on two legs. Your whirlwind romance leads to a proposal and wedding plans.

As you begin making plans for life after marriage, you are deciding on where to live. Your spouse begins to point out the deficiencies in your first house. It only has two bedrooms, where are you going to put Jack and Jill when they come along? The kitchen is too small. The bathroom only has one sink. Where are the in-laws going to stay when they visit? Why did you paint the kitchen that shade of blue?

Your options are to remodel or to sell your existing house and buy something new. Do you really want this hassle while planning a wedding?

Odds are that the person you marry won’t have the exact tastes that you do. The house you thought was ideal, is not their ideal. It is a much better decision to buy something together that you both enjoy.

It is Not the Wisest Financial Choice

Imagine a young farmer. He just bought his first plot of land. He needs to plant his fields for the harvest and he needs to build his first house. However, he only has enough capital (money) available to do one or the other. Should he buy seed for his fields or buy lumber to build the home? Which would you choose?

Hopefully, you chose the seed. Seed provides more income for the coming years. Seeds will allow the farmer to have a future in the farming business. Lumber may have provided shelter, but it didn’t produce any lasting return to the farmer.

In many ways buying a single family house is like a farmer buying lumber. It provides shelter, but the long-term benefit is mitigated.

There is another answer that makes sense for a young professional. If you would like to hear more about this solution call me at (925) 385-8798.

 

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Filed Under: Contra Costa Real Estate, Real Estate Investing Tagged With: Accumulation Phase, American Dream, Real Estate Investor, Young Professional

December 11, 2009 by Peter Maclennan Leave a Comment

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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Filed Under: CA Real Estate, Real Estate Investing Tagged With: Accumulation Phase, Investment Opportunities, Real Estate Investing, Real Estate Investors

July 17, 2009 by Peter Maclennan Leave a Comment

Accumulation and Income

As an investor makes plans for Retirement Freedom, they should keep in mind where they are in the wealth building process.

Investors, generally, can be put into one of two phases depending upon their financial needs and their employment status. I will call these the Accumulation and Income Phases.

Accumulation Phase

During the Accumulation Phase an investor is not trying to live off of their investments. Usually, the investor has a source of employment that generates their investing capital and supports their daily needs.

At this point it vital that the investor attempt to gather and grow assets. These assets need to be as large as possible to create as large an income as possible.

Appreciation is a key ingredient in a successful Accumulation Phase. Appreciation is the growth in value of real estate.

Imagine that you will earn a return of 7% on your assets once you retire. Would you rather retire with assets worth $500,000 or $5,000,000 ?

Income Phase

Once you have quit your day job, retirees need their investments to support their lifestyle. Consequently, income is more important than growth during this phase.

A transition to properties that will generate regular cash flow should be executed prior to your transition from 9-5 to retirement. Hopefully, much of this income is sheltered from the IRS through depreciation.

Why Accumulation and Income Matter

So what? Why should you care?

Your investing phase will determine the types of real estate investments you should consider.

An apartment building that will appreciate slowly over the next 5-10 years and throws off tons of cash flow may not be the best investment if you need to accumulate wealth. It may be the perfect investment for someone in the income phase of their wealth planning.

A four-plex that is break even on cash flow, but will appreciate by 15% in the next 5-10 years isn’t a great fit for someone who needs to survive off of their investment income. It may fit well into the accumulation plans of someone starting out on their journey to Retirement Freedom.

Do you need help evaluating which phase you are in? Do you need assistance making the transition from one phase of investing to the next? If so click the link below to give us a call, we would love to chat with you.

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Filed Under: Real Estate Investing, Retirement Freedom Tagged With: Accumulation Phase, Investment Income, Retirement, Retirement Freedom

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