Real estate investing has always been a hot topic in the doctor’s lounge. Naturally, real estate is a tangible asset that is more easily understood than stock certificates and market securities. Bragging about owning 50 doors (commercial real estate slang for 50 units) sounds a lot sexier
One of the most frequently discussed avenues for alternative revenue streams among physicians is owning real estate. Crowdfunding, syndications, private equity, or simply down and dirty rental property are hot topics to increase net worth and provide additional income. This fervor isn’t limited to doctors only—it seems like everyone including the average Jane has known someone with a great real estate investment story. The amount of interest among physicians in real estate, however, is fascinating. Decades ago, it was okay to just focus on one’s professional career. Doctors could get to retirement relatively easily given the amount of income in their primary profession. Today physician income is all but secure, and a surprising number of physicians even strive to become real estate professionals. Being able to find income outside of our profession is an asset—who knows what variables in our practice would make medical practice untenable in the future? Real estate certainly is a viable route to get to your end goal.
How do you get to Rome?
The name of the financial game is to achieve a means to survive when our primary income source is no longer viable. Some of us achieve this by simply saving a portion of our earnings during our working years for use during retirement. Others opt for more material income in the form of alternative businesses or real estate. Part of this end game involves allocating to charities that support our beliefs, and also leaving a part to subsequent generations to build upon.
Some of us aim to retire around Medicare age. Others choose to call it decades earlier.
What is important to realize is that each person’s definition of Rome is different, and everyone’s journey there will undoubtedly take a different course.
What this means is that real estate investing is a great option for only some of us.
In other words, some of us will not do well investing in real estate.
I remember a time in the recent past that everyone including those who never cooked wanted an Instant Pot. People spoke of it so highly that I almost bought one myself.
Or the several weeks where no store had any stock of toilet paper, even though there was no rational urgency to squirrel away a year’s supply of it.
It’s human nature not to want to miss out on a deal or opportunity, even if the thought had never crossed your mind prior to everyone else talking about it. Real estate investing has a similar allure for those who have never considered it, except that we all probably know someone who claims to be making “good money” on real estate. We all know that real estate can generate fabulous wealth, but it can also cause a lot of grief.
If you don’t do your homework or master it, it can cause a bit of financial damage.
Why do people love real estate?
The benefits of real estate are too lengthy to discuss in a brief overview, but one of the more commonly discussed reasons for real estate is that it generates cash flow. There is a real allure about having money coming into your bank account every month. Whether you are an employee or business owner, there is generally a consistent interval where money appears in your bank account. Real estate as an investment vehicle often provides reliable cash flow that can be used for living expenses. This is not necessarily the case for stock market investing or purchasing bond funds, where you have to sell the invested currency in order to obtain cash.
Additionally, the endpoint of real estate is that you actually end up owning a building. Something concrete. Something that you can physically leave to your heirs. It sounds more substantial to own a physical building rather than something non-material.
The case for financial success
As with any task we embark upon, nothing comes for free. In order for us to become physicians, we gave up lots of money and lots of time. If you choose to become a successful real estate investor, then you have to give up time and money. Even with syndications, the investor still has to spend time to do the homework. We all have a finite amount of time, energy, and health to devote towards our interests.
To answer the original question, it is certainly plausible to achieve financial success without real estate if you are focused on achieving financial success.
Remember, there are many roads to Rome, and Rome wasn’t built in a day.
What percentage of your total investments are in real estate?
The grass is always greener on the other side. Humans are like that. For reasons that we can never consistently define, any situation other than the one that we are in has potential to be better. I guess we just like to compare ourselves to others and assume that there is a better life over the horizon. That doctors wish to get themselves in a better situation is nothing new. This mentality involving our own financial situation is painstakingly prevalent in the hospital, especially for those feeling the squeeze of healthcare’s devolution.
Everyone likes to hear about the next great investment, especially the one that brings in foolproof cash flow. In the spirit of jesting our colleagues, conversations involving some amazing breakthrough are almost always initiated by anesthesia, both in the operating room and in the doctor’s lounge. We love blaming anesthesia for everything, especially if there is any inkling that they had the foresight to pick a more lucrative and lifestyle friendly career than everyone else. 😛
Many of these anecdotes involve real estate investments, whether involving secondary rental income, medical spas, pain centers, crowdfunded commercial properties, or even car dealerships. Frankly, it all sounds good. You wire over a chunk of cash somewhere, and every quarter your bank account enjoys a nice infusion of positive numbers.
Real estate can be a great investment modality
If real estate investing weren’t lucrative, the ultra-rich barons who pay 8% effective income tax wouldn’t exist. One of the advantages of property investments in general is that you can leverage some serious funds compared to your initial bankroll, sort of like buying Microsoft stock twenty years ago borrowing simultaneously from a loan shark and on margin. With adequate insight, homework, and a little luck, one can piece together some decent returns and cash flow from real estate to keep your living expenses afloat. @PassiveIncomeMD has done just that–he has the remarkable ability to leverage his interest and expertise in activities that generate income.
There is clearly a psychological appeal of owning a physical entity, whether it is a building or simply a parking lot. For some people, having this entity generate cash flow produces a meaningful association that rings income. If we are employed by a hospital, our income arrives as a paycheck at set intervals. We do the work during a time interval, and are compensated for our time. There is a clear relationship between work and compensation. Investments through the stock market, on the other hand, mostly generate potential income through appreciation. There are certainly dividends that are distributed, but the bulk of growth comes through appreciation of the stock. Unless you decide to sell the investment, all of your profits remain theoretical. Not so with owning something physical.
If you own a medical office, you can collect rent from your tenants in addition to appreciation of the property. If structured properly, you can truly have an income stream that can replace your day job and allow you to receive the big payout when you do decide sell the property or leave it to your heirs.
Real estate can be a great way to lose a lot of money
Remember that just because there are doctors who have struck pay dirt in the real estate world doesn’t mean that you will. The 280 score on your USMLE Step 1 only translates to a high level of clinical synthesis. You still have to put in the time to succeed. Sometimes success involves luck. I have known physicians who extensively researched and purchased land intended to be divided up into residential subdivisions, only to find that urban development decided to expand in the opposite direction. I have known physicians who haphazardly purchased run-down homes thirty years ago in the most undesirable neighborhoods in New York, contribute nothing to improve the properties, and still see the values more than double!
With the rising popularity of crowdfunding, we are now faced with opportunities to shine or to fall flat on our face. The good news is that many of the crowdfunding companies have distilled the data down to concise presentations and prospectuses—review the projections, decide if that is worth it for you, and wire the money over and relax!
Different strokes for different folks
If you compare the rate of real estate appreciation to the stock market using the rule of 72, the real estate investment will never win. For instance, one would expect a stock market investment to double in nine years if the market grew by 8% a year. Good luck finding a home that will double in value in the same amount of time! The value in real estate in this situation is that you can leverage a bigger investment than what you can likely pay for outright in cash, generate income flow, and potentially have certain tax advantages. Don’t forget that there is plenty of homework to do throughout the entire process.
The next time your anesthesia team brags about their next great extracurricular financial venture, don’t discount their success. Chances are that they have actually done their homework. You just have to decide whether taking the leap into their ancillary ventures will work for you.
Have you chosen to invest in real estate?
I love watching those home renovation shows where investors buy a run down crackhouse, bring in their demolition crew, and sell the property a three-times the original purchase price. Amazing eh? We know these situations are the exceptions, but how good is real estate for building wealth?
I’ve certainly zero experience in the rental or the buy-and-hold markets. The only real estate I deal with is my own home (which I sunk a foolish amount of money into fancy kitchen appliances) and a REIT fund that’s losing money in my IRA. Is real estate an investment vehicle that I hope to venture in one day? Sure. Everyone else including my mother-in-law dabbles in it and is convinced that it will be the savior for my retirement.
I believe that the financial freedom advocates are divided in their opinions of real estate. There are plenty of early retirees who are convincingly opposed to owning any home—I think several have written manifestos against property ownership. Whether or not their math is sound, the opponents to home ownership are typically the ones who basically spend their days traveling the world and country hopping.
Sure, but what if I wanted to stay put? Is it worth sinking in a chunk of change to own a piece of America? Let’s see:
Scenario 1: Upper East Side Manhattan Co-op
This unit is in a prime location on Park Avenue in the Upper East Side of Manhattan. You can run to Central Park and exercise every day if you’d like. I wished that I lived in a place like this. This is a 1000 sq. ft unit on the market for $1.1 million. This is more than twice the size of my apartment rental in NYC! This is actually a reasonable price per square foot. Let’s look into some statistics:
Prewar building with an HOA of $1,582 a month! If you owned this unit outright, you’d still be contributing about $2000 a month for HOA and utilities! The property tax on this unit will run about $90,000 a year. So all in, your annual upkeep on this co-op will be about $114,000! Oh yeah, don’t forget that it is also customary to tip the doorman during the Christmas holidays too. A look at the Zillow pricing history shows that the pricing for this unit has been relatively stagnant over the past few years. So much for appreciation of this property’s value:
In fact, a recent report by the Eliman Group shows that Co-Op sales in Manhattan for Q3 2016 has been declining:
Let’s suppose that you are looking at this property for investing in cash flow. I’d say that the unit could command perhaps $3000-$3500 in monthly rent as a one bedroom unit given its great location and building amenities (read: doorman).
How can one possibly get positive cash flow on this unit?
Answer: You can’t.
The rental income wouldn’t even be enough to pay for the taxes, let alone the doorman’s salary through the HOA fees. This is the sad truth of about the NYC real estate market. Many of the owners are either holding companies or longstanding owners who bought the units decades ago at the fraction of the price. Fortunately with the prime location of this co-op, the value of this property will not diminish significantly over time.
Lesson learned: If you have a huge chunk of change that needs to be parked somewhere, New York City isn’t a horrible place to put it
Scenario 2: Condominium near the University of Indiana Campus in Bloomington
I arbitrarily picked a college town in a relatively inexpensive city. Consider that you’re trying to find a unit near the university to rent to graduate students. A quick find shows that there is a condominium within walking distance of the campus:
This is a two-bedroom, two-bathroom unit for $105,900! Modest amenities, great location, and in a relatively good complex. I would be great for two graduate students or a small family. Further details show that the unit does have an HOA of $245, which I am not thrilled about in a small suburb, but not the end of the world:
How can I get cash flow out of this property?
With a downpayment of $20,000, one could probably negotiate a 30-year mortgage to cost a little less than $400 a month. If you include the HOA fees, you’d be paying about $600 a month at the minimum to maintain. I think that one could rent out each bedroom for $500, or the entire unit for $950 a month.
Let’s say that you rent out this unit for $950 a month, and your costs are $650 a month for mortgage, HOA…etc. Assume that you only get to rent this unit for 11 months of the year. With $300 of ‘net-profit’ per month for 11 months of rent, you get about $3,300 per year. With an initial downpayment of $20,000, you’re actually getting a 15% return annually. Not bad!
This amount is not going to fund your doctor lifestyle, at least it’s positive cash flow. Let’s say you buy five or ten of these units and rent them all out. You hire a maintenance person or even a property manager. You suddenly have $10-15k a year of extra cash flow for owning approximately $1 million worth of properties that you’ve leveraged with a little over $100,000 in parked costs.
Not bad, eh?
How have you used real estate to fund your cash flow? What suggestions to you have for me to get started with real estate?
I have an unused washer and dryer hookup in my bathroom. I currently use the space as storage for mops and other cleaning supplies. It’s been an eyesore, and I’ve been considering installing a washer and dryer for added convenience. These days, you can find relatively inexpensive washers, especially if you can find a used one. In my space, however, there seemed to be one problem.
The space seemed awfully small.
That’s right. There are several problems with this picture. Based on the arrangement, it’s clear that the space was designed for stackable units only. The width of the space is only 27.5”, which means that you’d have to stack the units if you wanted a dryer in this picture. Okay, no problem. There are plenty of stackable washer/dryer combinations.
Not so fast buddy.
I should have know that the previous owners of my house had a strange obsession with expensive appliances. I noticed several other problems in the process of washer hunting:
- There was no dryer exhaust!
- The only power outlet in the corner was a 220v hookup!
- There are hardly any washing machines that can fit into a 27.5” space. Like maybe two brands.
Enter ultra-compact washing machines and dryers. This is a new category of appliances that I previously had absolutely no idea existed. These appliances are geared towards regions where space is an absolute premium. Think New York City, San Francisco, the 8th Arrondissement of Paris, or Hong Kong. These are places where you can expect to pay at least $1000 a square foot and still consider it a steal.
The only problem is that I don’t live in any of these cities.
Asko and Electrolux make compact washers and dryers. They are expensive. Think $2000 per unit. You can get a really nice LG washer that has more than twice the capacity of a compact washer for less than $1000.
Guess what? You have to buy the matching dryer too. As you can see in the picture, there is only a 220v power hookup in my wall. This is intended for a dryer hookups only. The Asko compact washer connects into the compact dryer for its power. The dryer also has a ventless hookup in case you live on the 30th floor of a 60-floor high rise.
At this point, I’ll just keep using this area to store the world’s most expensive Swiffer.
Lesson learned: you can end up spending a lot of money on appliances.
Would you buy a compact washer and dryer?
This post is the third part in the series on mortgages and my experiences:
Today I will continue where we left off previously with online mortgage lenders, considerations, and what I learned in the process.
To summarize, online mortgage lenders may actually have storefronts in other states, but are licensed to lend in your state. You can poll the top lenders online through Costco’s website or through BankRate.com. I did both in my search. Having multiple offers allows you to have more flexibility and knowledge in the process.
Most of these lenders offer very generic information such as the rate, term, fees, and credits. I would say that the majority of online lenders had very low or NO lenders fees. Many of these lenders even offered lender credit! Let’s go through these in detail:
This is the black box in most lending statements. These fees are always convoluted and often masked by terms like origination fees, application fees, processing fees, and underwriting fees. My local lender had all of the above terms. Many of the online lenders had NONE of the fees. This is quite bizarre to see such a wide range of costs. These numbers can run in the hundreds of dollars each, and total in the thousands!
That’s right. Straight out the gate, you can end up spending a few extra thousand dollars depending on which lender you are going through. I asked the online lenders why they can still give borrowers a relatively low rate and have almost no fees, but most of the answers did not seem too convincing:
“We run a very lean operation, and pass on the savings to the consumers.”
“We have a small physical footprint, so our costs are low.”
I also asked for a “Truth in Lending Statement”, which typically outlines various closing costs and fees. One online lender provided a rudimentary form with most of the blanks empty, while the others told me that they no longer provide these statements, given that all loans signed after October 2015 are not mandated to provide one. Instead, there are “Loan Estimate” statements that are provided. However, most of the online lenders were very vague—they all only provided an interest rate plus a certain lender credit given the type of loan requested.
My local lenders were, for some reason, more forthcoming with their expenses. All of them provided me with a “Loan Estimate”. There was some variability in some of the numbers, but certainly gave me a better idea of the closing costs that a mortgage incurred.
The following is a list of common closing fees and my comments:
- Appraisal fee. This is mandatory, and is a means for your lender to determine whether the property you are purchasing is worth their risk in lending you money. This price is not negotiable as the lender typically chooses the appraiser. There is variability among lenders but I would estimate that it should cost around $500 or less.
- Title fees. These fees are dependent upon which title company you choose. You can choose which title company to help close the sale. However, depending on how your realtor arranged the sale, the escrow company that handles earnest money may actually be the title company as well. When I placed a deposit of earnest money, the escrow company was the same as the title company. This meant that it would have been very difficult to make other arrangements outside of the predetermined company.
- Origination fees and Lender fees. This number is negotiable. A portion (or all) of these fees will go to your loan originator as “commission”. Some lenders will be more willing to budge than others on this number depending on how they are paid.
What other fees have you seen on your closing cost sheets?
Photo courtesy of Flickr.
In my previous post, we discussed some of the first steps in getting a mortgage loan. This post will focus on online lenders.
Frankly, the loan process was confusing as hell, especially to a first-time home buyer. Hopefully my series of posts will help reduce some of your anxiety and point out some mistakes not to make.
The Process of Online Loan Applications
I submitted my loan reapplication criteria through Costco’s website. This collates basic data such as the amount that you plan to borrow, the type of loan, the cost of the property, and your estimated credit score. A list of vendors approved by Costco will be available with basic estimates on the rate that they typically offer for the life of your loan. You can then choose which lenders to contact, and you will eventually be contacted by these lenders both by e-mail and by phone.
Bankrate.com also has sponsors who offer very competitive rates. I submitted a few test requests as well. Note: submission of this generic information does not constitute an application.
The centralized process to receive bids through online lenders makes it easy to compare quotes. At first glance, the online rates were significantly better than what my local lenders offered. For instance, one of my local lenders offered a rate of 3.125% on a conventional 15 year loan while most of the online lenders offered rates around 3% or less. Obviously this is a relatively small difference, but it is clear that online lenders are more willing to offer lower interest rates even without any negotiation. This is an important point, as there is no free lunch. Realizing this was the first step in figuring out who was actually giving you a better deal long term.
The unfortunate result of having so many bids is that you will be swamped with calls. I believe I submitted my contact information to about 5 lenders, and ultimately received over 15 calls in one day. This was during business hours on a weekday—I obviously had no time to return most of the calls.
Even though borrowers often focus on interest rates, there are a number of other factors that are critical in making a loan decision. Unfortunately, there is little standardization among lenders. After preliminary discussions with many of the lenders, including my local ones, the terminology used by each of them was confusing in that it was not easy comparing the details.
Understand the terminology.
It is challenging to learn the terminology on short notice, especially if you have already found a house that you are interested in buying. There are plenty of real estate books available in the library that you can peruse before you delve into the home buying process, but here are a few critical terms that I found helpful in understanding:
- Interest rate. Realize that the interest rates quoted may not necessarily be the same as the annual percentage rate (APR). As your interest accumulates in your loan, the amounts compound. Hence, the APR is what you will actually pay over the long term.
- Points. As someone who is rarely involved in debt accumulation, I was ignorant about what points were. As with stock market points, each point typically represents a certain percentage of the entire sum. In real estate, one point represents 1% of your loan amount. These “points” are often used to settle on a lower interest rate. For instance, a lender may offer you a loan at 3.5%, but if you “buy” a point, they may be able to knock down the rate to 3.1%. In essence, points are means to “buy into a lower” interest rate. Obviously you’d have to do the math to determine whether the points are worth it, but the first time I learned about this concept I was fascinated.
- Origination fees. Closing fees. Lender fees. Very confusing. Some lenders have “no fees”. Otherwise will have various fees tacked onto the closing statement. Make sure you understand where the charges are coming from. This portion of your loan will likely have the most variability among lenders.
- Closing costs. Some costs such as appraisal fees, title fees, and various escrow amounts are unavoidable. Some of these fees are mandated by the loan company. What I didn’t know initially was that you can still bargain for better deals. One example are the title fees. You can shop around for title companies and negotiate for the lowest bidder. Is it worth your time? I don’t know. My real estate agent worked with a title company who handled escrow accounts to hold onto earnest money for potential buyers. It turned out that I was also deep into contract with the seller and title company before I realized that I could actually shop around for a title company. Would I have saved more if I had looked? Most likely. Would it have been worth the hassle? It might not.
Stay tuned for the next installment where I discuss online vs local lenders in more detail.
(Photo courtesy of Flickr)