All Forum Posts by: Spencer Brennon

 Hi, Jaysen. Thanks for the input. Due to the urban nature of the house, there's no landscaping/snow removal/shared utilities beyond nominal amounts (I'd have an LED porch light no matter where I lived). I'll manage the two units myself since I'll be living in the building, but if I hire a property manager I know that will eat pretty much all of the positive cash flow and then some. It's one of my points of hesitation, should I need to leave the house in a few years. Why do you want to include my unit in the vacancy expense? As long as I'm living there, I know I'll pay the rent.

With regard to the fourth unit, good questions. It is theoretically legal, once I make appropriate adjustments. I spoke with a representative of the zoning board and they clarified a few things with me. It luckily has two means of egress, two windows, a full bathroom, and several other requirements they have established for a self-contained unit. But it would require reconfiguring a few utilities, so it's not something I'm including de facto in the analysis. Just an added cherry on top if I decide to buy the building.

 All units are subbed out for water/gas/electric. As I mentioned to Bram above (and have added to the post, since I wasn't as clear in the beginning), I will be living in the biggest unit so I'm not charging myself a vacancy expense on that unit. But I'm also not including the potential $100/month income from the parking for that unit (a rate which people would kill to get in that neighborhood), so the $150/month vacancy expense is a bit of a wash if the space becomes available by my moving out. I'm happy to take the $50 out of the cash flow, but that still leaves a worryingly large amount at the end.

 Thanks, Bram. They're all helpful notes. One note about the rent: the unit is located in a city where it's customary to charge a parking fee for tenants. It's a high-demand area and I have yet to see a reasonably priced place stay vacant for more than a few weeks. The parking fees are the extra $200 a month (should have specified this in the post, one per unit) and the low vacancy rate seems about right. To my estimation, if I were renting out the big unit instead of renting it, the cash flow only decreases $50 because I'd be renting out the third parking space, too. But the $100/spot estimate on parking is exceptionally low, which is how I'm building in a bit more conservative results.

I put the somewhat low (though I still think they're conservative) capex/repair because the building was gut renovated in 2012, including a new roof. It doesn't have central AC. As it stands, they represent an annual ~2% of the purchase price, which I've been led to believe is reasonable. Do you have a better estimation method? (I don't use rent rates for determining captex/repairs because I don't believe they're as strongly correlated as a lot of people believe) This has always been the area I've been most concerned with.

Where are you getting the $1,100? You mean my out-of-pocket if I don't charge myself rent? In this scenario, the house hacking was only meant to explain the slightly lower vacancy expense than would be expected. I'd still be "paying" my 2,200 a month into the building's fund, in order to analyze it. I might need to move in the next few years, so I want to make sure it's still going to cash flow even if I'm not hacking.

So I've been looking into a multifamily deal in north New Jersey, where it can be hard to find anything worthwhile that doesn't require a host of renovations. But I've found a nearly-turn-key 3-family (with optionality to create a fourth unit in the basement after slight renovations to bring it up to code) that seems too good to be true. While I've lived here for a while, I haven't invested in the area because deals are so hard to find and I don't like how high property taxes are.

So I'd like your help in figuring out what expenses I'm missing here. I'd be househacking since this is nicer than where I'm living, so the biggest unit would have no vacancy expense. Other than that, I can't explain why the cash flow is so high and I just think I'm doing something wrong here. 

Unit 1: 3 bd/2ba with basement, rent 2200

Unit 2: 1 bd/1ba, rent 1500

Unit 3: 1 bd/1ba, rent 1200

Total Rent: 5100

Mortgage: 2250

Property Tax: 1100

Insurance: 175

Vacancy: 200

Repairs/Maintenance: 475

CapEx: 490

Total "Cash Flow": 418

 Parallels is a software application that lets you run Windows programs on a Mac. http://www.parallels.com/products/desktop/

I would encourage you to use Microsoft Excel. While replies from others who've used OpenOffice products are accurate (I used it for a year and no one was any the wiser) I don't think that's the best choice for you. It is the best choice for people in some other situations. 

Since you don't have a lot of familiarity with this type of product and you're self-admittedly not a numbers guy, Excel has a lot of resources online where you can quickly Google any questions you have about the software and have hundreds of answers at your fingertips. It also is a bit easier to use, I find. Excel can also scale up easily, so if you decide you want to do a few fancy things next year, you don't have to export your data and purchase Excel later. You can just add the functions to your spreadsheet from Excel. 

You can get Excel to run on Parallels on a Mac (which is what I do) and it's 100% the same as using it on a Windows computer. The native version of Excel for Mac is terrible and I would strongly recommend you avoid it. 

The nature of the tax deductions for these activities is fairly straightforward. You are generally obligated to do several things, but the three most important are: (1) Establish the business purpose of the trip and maintain clear and contemporaneous records of the business purpose; (2) Log the miles for each business trip; (3) Subtract from the deduction the proportion of the trip that was used for purely personal purposes.

So, if you are going to the grocery store and you stop and look at a house on the way, you can generally deduct the proportion of the trip that you would not have taken without looking at the house. (If you drive 12 miles along Main Street to get to the grocery store and the house is 3 miles off of Main Street, you can deduct 6 miles, not 30.) 

If you drive to Walmart and you buy household goods but also spend some time looking at paint chips, you will need to catalog both purposes of the trip and then deduct only the proportion that relates to business. (If you spent 25% of your time looking at paint chips, deduct 25% of the miles.)

I encourage you to contact a CPA about this, because I am not an accounting or tax professional and the above is not tax advice. I have not used the standard mileage deduction in several years, as I get a better deal using actual expenses, so things could have changed from the above. (But I doubt it.) I also encourage you to read the publications of the IRS on this matter, copies of which should be available at irs.gov. 

 Welcome, Simon. I lived in Sydney for all of last year. What a beautiful city, especially the old and beautiful terrace houses around Potts Point. (I also happily admit that the view from rooftop Glenmore Hotel in the Rocks is one of my favourite vistas in the world.)

As someone who was trying to remotely manage a few things from Sydney while I lived there, I do encourage you to be cautious. The timezone difference alone is enough to make you want to crack skulls, but when something is developing quickly on the ground in Ohio and you're stuck in New South Wales, there's a particular type of frustration reserved for that sort of uselessness. 

Thanks to the miracles of technology and the internet, I was able to make things work. But it cost me a lot of time and sleep, as I'd have to wake up at 4AM in Sydney to make a working-hours call to Ohio or focus on finding people who could do things for me without the benefit of a face-to-face vetting. Plus, as a non-resident of the U.S., you will be at a competitive disadvantage when it comes to many major forms of financing, especially given the currency headwinds you're facing in Oz. (It might be a great asset, actually, to have a dollar-denominated investment because it will provide an inherent hedge against further drops in the Aussie against the greenback. I encourage you to speak to qualified investment advisor about that sort of thing if it piques your interest.)

Others will dissuade you because they don't believe it's feasible to do in-person inspections of property before you buy them, but while the flights do take up a bunch of time, I was able to make that aspect of things work. The key is to group visits and inspections into a condensed timeframe and to see as much as possible in such a consolidated agenda. Depending on the time of year, return flights from Sydney to the Midwestern US can run from USD $1500 (right before Christmas last year) all the way through USD $4000 for a peak season last-minute purchase.

In the end, I guess I would simply say don't underestimate the amount of time it would take or the amount of frustration an investment from such a distance can (and inevitably will) cause. 

 I'm sorry that I wasn't clear in my post -- I was lumping together your proposal (investing the cash in CDs) with others' proposals, because all of them incur additional exogenous risks. I understand that you were proposing the idea that CDs would be safer than the mortgage paydown. I reiterate that this is not necessarily the case, because CDs incur risks not inherent to a principal paydown strategy. I dispute your characterization of the properties as highly illiquid: while true liquidation is difficult in a downturn, there are products that offer synthetic liquidity, such as cash-out refinancing and HELOCs, as well as collateralized loans against the portfolio, once it reaches a certain size. (We're not sure whether the 14 properties are $50,000 houses or $500,000 houses, so I can't be sure whether CLOs apply.)

Liquidity is a risk because there might be a need for cash or cash equivalent assets that the author won't be able to meet through extant cash reserves and gross cash flow from the properties. A standing HELOC or other revolving account is perfect for such situations. As time progresses, in fact, the additional cash flows from the properties (each year an additional one will no longer be paying the mortgage/Wichita Bank shareholders) will decrease liquidity risks and provide greater opportunities in the long run. If the author stashes the cash in a CD earning an inflation-adjusted 0% each year, then the reserves will be exhausted at some point well before year 30, which is fine because cash flow from the properties is meant to supplement the reserves in the long-run. But in this long-run, the additional cash flows from the properties (due to no mortgage payments) will enhance the liquidity position, by supplementing the amortization of these reserves more completely. In this way, I dispute the idea that in the long-run, liquidity risk is lower through a CD investment.

Let's take a specific example: a tornado runs through Wichita and every house needs a new roof after year 9, for a total cost of $100,000. The author under my scenario dedicates $100k of the $110k cash flow for the year to the roofs. Net impact: profit of $10k for the year. Under your scenario, the author uses all of the cash flow ($25k) and dedicates $75k of CD cash reserves to the roofs, meaning that for the past two years all of the interest on that $75k will be sacrificed (ironically, this also means the author can't claim the interest tax deduction because he has no taxable income, further hurting his cash flow! So I hope you realize there IS a way to negate the interest deduction). There's not a lot of time value of money on zero dollars! Net impact: the author loses out on all profit for this year and still has to take $75k out of the CD cash reserves, meaning lower returns in perpetuity. (What's the time value of money on a negative dollar?)

But here's the important distinction: under my scenario, the author in year 10 would make $110k in cash flow and cash reserves would be higher than in year 9 by $10k. In your scenario, the author in year 10 would make $25k (plus nominal inflation-adjusted interest) and the cash reserves would be lower than in year 9 by $75k. Liquidity risk under my scenario decreased and under your scenario increased. 

With regard to the time value of money, your assumptions are leading you down the wrong path. The returns of "plowing after tax money" (and I will say again that the author never specified it was after tax money) into principal pay down are denominated in the discounted interest savings from the disappearing mortgages. Time value of money is only relevant with regard to when you receive the returns/money. Under your scenario, CD payments are quarterly. Under my scenario, discounted interest savings are monthly. I'd rather receive my savings on October 1st than on December 31st. In other words, every dollar I pay in principal in year one provides me with 4.5*$1 (4.5 cents) of extra cash flow in that year, never mind the discounted future interest savings. That interest savings alone is higher than the CD payment of 1.5/2 cents I would have gotten. All of this is an interesting paragraph, but it's not entirely relevant because it doesn't impact how conservative either investment is.

As I said in my previous post, the interest rate discussion does not belong here. So while you are still incorrect in your assumptions about it, I will not be commenting further on the fallacies.

I'm not sure why you wrote the response you did and I'm doubly not sure how in the world your refined strategy is more conservative. There are significantly more risks associated with what you described, which makes it inherently less conservative. Conservative strategies are designed to conserve and protect capital, not garner the greatest returns. I have no objection to (and in fact already did) indicate that the strategy the author proposes will not garner the greatest returns. Which is why I'm confused about your post that focuses exclusively on returns.

The simple matter of fact is that investing in CDs or other properties or the stock market or any other investment incurs risk that is not undertaken by paying off the mortgages. The risks of owning ten fully paid-off houses consist of lawsuits, natural disasters, vacancies, etc. If these risks are x, then having ten houses creates a risk of 10x. But by purchasing 10 more houses, you are increasing the risk. If there is a cash flow risk on 20 levered properties, then every property is affected, and therefore there is contagion risk as well. But if there are 10 properties and only one still has a mortgage, there is no contagion risk to the author's ability to pay off houses 1-9. Under your proposed scenario, there are also interest rate risks, timing risks, tax policy risks, market risks, and macroeconomic risks, as well as inflation risks, that are unaccounted for. So much risk demands a less conservative designation. 

Now, in totality, this means that the strategy the author proposes will probably make less money in the long run. But the probability of making that money is much higher, and the conservation of capital is much more strongly assured. It is therefore more conservative to pay off the mortgages.

With regard to interest deductions, I also stand by my statements. Between depreciation, repairs, and twenty thousand other deductions that are possible for landlords, it is possible to supplant the interest deduction with necessary spending instead of passing money on to Wichita Bank. But the author specifically mentioned that this is for retirement, which would indicate that the easiest solution would be to host it in a 401(k) or IRA. This is the more efficient solution, providing greater returns and a lower risk profile, eliminating the lawsuit risk you first mentioned. So it is more conservative than your proposal and provides greater returns than CD arbitrage. If you'd like to continue talking about interest rate deductions, I'm happy to do so on a separate thread, but let's let the author continue to focus on his strategy and topic instead of scrolling through our separate side-bar.