Notes Bearing Interest

Volitility in the Market and Asset Allocation

2011-10-03T09:32:00.000-07:00

Since 1939 each decade in the stock market seems to get more and more volatile. This may mean that you will see your retirement funds go up or down in value more in a given year but does it mean that they may also be down longer? It is possible.

In 1990, Harry Markowitz won the Nobel Prize in Economic Sciences for a study that he had done on the behavior of the stock market. He called his study Modern Portfolio Theory. This study became the basis for the "Asset Allocation" that people have now applied for the past 20 years. The study found that the way you diversify made the most difference in your portfolio's return, not which individual stocks you chose, or when you got in our out of the market. I believe Markowitz’s study has some very good truths today but unfortunately it had been proven to be ineffective in the last two market crashes. The study's flaw: It assumed that asset classes would continue to be "uncorrelated." In reality, due to the way that our world has begun to be more instantaneous and the fact that we are more affected by other countries in our New World Economy, different asset classes began to be much more significantly correlated.

Today's investing may need to be more tactical, meaning that algorithms may now need to be applied that help to avoid some of this volatility. This may mean sitting on the sidelines in cash, moving to bonds at times, or even going "inverse, or shorting" the market. We still, of course, need to look at asset allocation and how your "pie graph" looks, but we have to truly look at the correlation of these assets and not just assume that large cap stocks, small cap stocks and international stocks will all perform differently. They very well may not.

If you are concerned about the volatility in your portfolio, please call us today to see how we may be able to help reduce or minimize it.

_____________________________________________________________________________________

Diversification and asset allocation do not guarantee a profit nor protect against loss in a declining market. They are methods used to help manage risk.

Troy Collins is a Financial Advisor offering securities through First Allied Securities, Inc. A Registered Broker/Dealer, member of FINRA/SIPC. Advisory Services offered through First Allied Advisory Services, Inc.

Gas Prices

2011-04-04T12:12:00.000-07:00

I don't know how the rest of you feel but Gas at $4.29 a gallon has changed the way I live. We as Americans are used to driving everywhere for anything and not thinking much about it. Lately I have done a lot more car pooling and definitely conserving trips. Instead of going to the grocery store 2x per week, I may now only go once and while I am there pick up my dry cleaning next door and hit my other nearby errands. Many of you know that my family is a big outdoor family and that I would rather take my kids and the camper and go into the mountains for a few days rather than flying down to (especially) Disneyland. I bought a Ford F250 Super Duty diesel a few years ago to tow my camper. With diesel historically cheaper than gasoline, and better mileage it simply made sense. Now diesel is more than premium. I saw $4.59 this morning in Belmont. It used to be that for $100 of gas we could go up towards Tahoe and camp for a few days and capture some great family memories. Now it costs me over $300. So with gas prices through the roof I thought I'd give a few tips. 1. Alternate shopping: (My wife came up with this one) We used to do a trip to Costco weekly, (with 3 boys and all). Now my wife goes every other week but she still gets stuff from Costco every week. How? Every time she goes, she calls our friend Wendy and finds out what she needs from Costco. Every time Wendy goes, she calls my wife to find out what she needs? Clever huh? We still get our weekly items from Costco but it saves both TIME and MONEY. 2. Lump errands together. Try not to just solve one need per trip. For example, time your dry cleaning to be dropped off when you are going to someplace nearby and don't pick it up until you need to go somewhere nearby. (Tip, you may need to find a new dry cleaner nearby lots of other things you need.) 3. CARPOOL! Really, at least to activities that you do... Have another mom pick up your son on the way to baseball practice. You can return the favor next week. 4. Most everybody would put here: "Drive slower," but I realize that some people just can't. (Sammy Hagar for example... you know "he can't drive 55, ) But for guys with heavy feet, they can try to have fun with another game. Try accelerating slowly and costing longer to a stop. For me, my car has a fuel consumption computer. I try to beat 25mpg on my way to work. The way I can accomplish this is to coast as much as possible and accelerate as slowly as possible. I can't do it pressing the gas and slamming the brakes on at each stop sign. This can be fun! I know that you'll have more but. I just think of it this way. I have a monthly meeting in San Jose and every darn time I drive down there it costs me over $25. Ouch!

Income as Protection – Are CD’s ‘Safe’?

2011-01-05T15:21:00.000-08:00

Income as Protection – Are CD’s ‘Safe’?

‘Show Me the Money’ – From the movie Jerry McGuire

Of all the different ways to protect your nest egg, perhaps one of the most interesting is to focus on the income that the egg produces rather than the egg itself.

Let’s Compare

A 5-year certificate of deposit (CD), as commonly offered by a bank, does a great job of protecting the egg and a lousy job of producing income. As an alternative, let’s consider a security where we know more about the income than the value: for simplicity, let’s assume a common stock with a regular steady annual dividend of 5.00% and we’ll ignore taxes and compounding.

As you can see from the chart, the stock pays 5 times more income but which security is safer?

This chart shows that the longer we hold the stock, the less risky it becomes to the point that the stock would have to decline more than 20% to only break even vs. the CD after 5 years.

Furthermore, in order to harvest a reasonable income from the CD, we’ll need to cash it in and purchase a smaller one a the end of 5 years, whereas with the stock, we may not care about the price so long as the dividend is steady and the income is reasonable for our needs.

Risk Cuts BOTH Ways

So if the stock is unlikely to underperform the CD, where is the real risk? One risk is that the stock will OUTPERFORM the CD. Risk measures the uncertainty of the future return not just to the downside, but also to the upside.

In summary, stocks are riskier than CD’s for investors who need certainty of principal while income producing investments may be safer than CD’s for investors who require income. Work with your financial planner to determine what mix of strategies might be appropriate for your personal situation.

Karl W. Steinbrecher, CFA, CFP

Financial Planner & Wealth Manager

(650) 551-8949

For questions please send e-mail to KSteinbrecher@mkfinancial.com

Disclosures:

Bank CDs are insured by the Federal Deposit Insurance Corporation and offer a fixed rate of return, whereas both the principal and yield of investment securities will fluctuate with changes in market conditions. Investments offering the potential for higher rates of return also involve a higher degree of risk. Rates of return will vary over time, particularly for long-term investments. Your actual results will vary.

The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Past performance does not guarantee future results.

Life Insurance for Families

2010-11-04T10:45:00.000-07:00

Life Insurance for Families

People die. Yup, they do, we all know it and as a Mom or Dad, we know our responsibilities don’t die when we do. If you’ve ever pumped a roll of quarters into a slot-machine and received a payout, you can appreciate the odds of dying during the time your family needs you. It’s about 3-4%1 (one quarter is 2.5% of a roll). That means for an average class of kindergartners, one kid’s Mommy or Daddy won’t be there for college graduation.

How much is enough? For families with young children, life insurance is usually about income replacement. I use a rule of thumb of 20 times your income based on the idea that that’s what it would take to replace your income2 if you earned 5%, plus inflation. For comparison, most companies offer between $50k and 3 times your income. A few companies, Cisco comes to mind, may offer up to 9 times your income. No matter where you work, you probably need to supplement it somehow.
I’m with the kids full-time, what’s my replacement value? Of course you are irreplaceable! This is actually a complicated calculation. I usually consider that the surviving spouse may cut back on their hours and their career goals in addition to the actual cost of full time care. E-Mail me for a list of questions to run through.

Is it expensive? If you are reasonably healthy and you can afford pay-TV, you can afford life insurance. Would you buy free life insurance (see below)? If you are a California resident I would be happy to run a quote for you.
I’m a smoker, what should I do? Quit. Life insurance for smokers costs more than for life insurance for non-smokers because smokers don’t live as long. If cigarettes cost $5 / pack and the extra cost of a month of life insurance is $100, you would save about $250 per month if you quit. That could fund a college plan, a vacation, or a weekend getaway.

I’m uninsurable, what can I do? Finding out that you are uninsurable can be a wake-up call to a family bread-winner. Working with a professional financial planner to develop and maintain a financial plan should be a top priority.
Can I get it for free? Funny thing about that, it depends on your definition of free. You could purchase term life insurance that will return all of the premiums paid, tax free, at the end of the term if you don’t die. If you were going to buy insurance anyway, this could be construed as free insurance.

Karl W. Steinbrecher, CFA, CFP
Phone: (650) 551-8949
CA Insurance Lic. No. 0F37292
www.mkfinancial.com

Karl is a financial advisor offering securities through First Allied Securities, Inc. A Registered Broker/Dealer member of FINRA/SIPC For any questions or information on Financial Planning and insurance strategies you can contact Karl at ksteinbrecher@mkfinancial.com or by phone at 650-551-8949.

Disclaimer: This information should be considered incomplete outside the context of a completed financial plan. This material has been prepared for informational purposes only; it is not intended to provide and should not be relied upon for financial, legal, or tax advice.
1 Source IRS.gov Table 2000CM
2 I prefer the more conservative ‘pre-tax’ figure amount but you can use the ‘after tax’ figure, or the ‘pre-tax’ amount to be more conservative.

Social Security, Is There More to it Than Meets the Eye?

2010-10-04T10:53:00.000-07:00

I was in a review meeting with my long standing client “John Smith” last week. John is turning 63 and wanted to discuss his retirement next year. In the conversation we discussed his income options, not only with his investments, but also with his pensions, and Social Security.

It seems that people look at Social Security in a terribly over-simplistic way. “Well, I could take it now and it will be $500 per month or I can take it at age 70 and it will be $930 per month. I need it now, so I will take the $500” is usually how the conversation goes. Mr. Smith told me that he was likely to take his starting in a few months. I asked a question. “How much is your wife, “Jane’s” benefit?”

“She paid into it much longer than I did and hers should be around $1,400 per month,” John said.

“Why don’t you file and take ½ of hers next year and let yours grow until age 70, then take yours at age 70,” I asked? “That would mean that you would get $700 per month right now, ($200 per month more than yours) then you could take your full benefit at 70 which would be $930 per month.”

“You can do that?” he said.

“Yep,” I acknowledged.

Besides making the best financial decision with regards to taking Social Security and maximizing a client’s benefits, there may be other strategies that people are not considering. This can be one of the most disastrous decisions a client makes in retirement. It is very important to look at all of the options and determine the best for you.

For more information on planning for your Social Security benefit and your retirement income plan, please call us today.

Troy V. Collins, RFC.
President, McKinley Financial Group
Phone: (650) 551-8900
CA Insurance Lic. No. 0B96613
www.mkfinancial.com

Registered Representative offering securities through First Allied Securities, Inc., a Registered Broker/Dealer Member FINRA/SIPC.
Investment Advisor Representative offering services through First Allied Advisory Services.

To Buy or Not to Buy? That is the Question

2010-09-16T17:25:00.000-07:00

To Buy or Not to Buy? That is the Question

I have been asked many times over whether one should buy a home because it is a good investment. The answer is “maybe.”

Let’s look at the benefits of home ownership first.
1. Forced savings, building equity
2. Appreciation on the home value
3. Tax Deductions/Tax savings*
4. Pride of ownership

While it is true that you build equity by buying a home versus renting, where you do not, it could also be a financial blunder. If buying a home means that all of your discretionary income, (that is, income that you would have to invest for your financial goals) is now going into a somewhat illiquid asset, (the home), then buying a home could lead you down the path to become “real estate rich and cash poor.” But if done correctly and a payment is affordable, buying a home could be a great investment. One word of caution… don’t buy a home “just” for the investment. Buy a home because you want to buy a home, enjoy living there, perhaps raise a family, and so on. Purely financially speaking, buying a home does not always provide the BEST financial result. See below.

Buying: Lets say you buy an $800,000 home with a down payment of $200,000. This is $200,000 that you have just put into a somewhat illiquid investment and lost use of for other purposes. With a 5% 30 year fixed principle and interest payment you would pay $3,220 per month whereas renting a place might only cost $2,000 per month. In addition, in California, you would have property taxes of about 1.1% or $8,800 per year and other miscellaneous expenses that you may not have as a renter of let’s say $2,000. Thus renting you might have $1,920 more per month to invest.

If the home were to appreciate at 5% per year over 30 years, your $800,000 house would now be worth $3,457,553. But in order to use any of this equity, however, for your retirement, you must either sell it or take out a Reverse Mortgage. So it may be that this value is useless to you should you just plan to live in your home indefinitely. The tax savings due to the fact that your mortgage may likely be tax deductible*, invested at 7% over time would total between $243,000 to $430,000 of additional capital, giving you a total equity and investment in the neighborhood of $3,800,000.

Renting: Investing $200,000 instead of putting a down payment on a house, plus investing $1,920 per month at let’s say 7% over 30 years, (accomplished even in the stock market over every 30 year period historically), you would have $3,965,643 of “liquid assets” with which you could retire.

Some benefits of renting may be:
1. More liquidity
2. Flexibility
3. Lower cost
4. More money (potentially) for retirement.

As you can see, the ending values of each are very similar so there may not be one distinct advantage of one over the other, AND, these assumptions will not work for everyone. Growth rates of both real estate and other investments will differ, tax brackets will change and many other factors can play a huge part. So, I guess the question, “To Buy or Not to Buy” will continue to go unanswered. My absolute answer is, “It Depends.”

*Depending on your individual tax bracket. Consult your Tax Advisor for deductibility information.

Troy V. Collins, RFC.
President, McKinley Financial Group
Phone: (650) 551-8900
CA Insurance Lic. No. 0B96613
www.mkfinancial.com

Registered Representative offering securities through First Allied Securities, Inc., a Registered Broker/Dealer Member FINRA/SIPC.
Investment Advisor Representative offering services through First Allied Advisory Services.

I've just inherited a loved one's estate. How can a financial adviser help me?

2010-08-18T16:09:00.000-07:00

When one inherits money from a loved one, the emotions are often mixed. When the need to deal with the inheritance arises, many people are still dealing with extreme grief. This makes it difficult to determine how to deal with the transfer of funds and/or property, especially when there are usually different parties—often with very different perspectives and financial goals—involved in the decision. This can be a very emotionally draining time for all.

Moving away from the emotional issues, let’s talk about the financial considerations in terms of the inherited investments.

When a parent or other family member dies, one of the biggest mistakes that the beneficiaries make is leaving the investments as they are, without doing any research into how they are allocated or considering alternative options. Why could this be a mistake? Because the portfolio was set up for someone typically 20 to 30 years older than the individuals who inherit the funds, and it may not fit well with their own financial goals. Also, the beneficiaries may not realize that there is a real opportunity with many investments for them to receive a “step up in basis” if they decide to sell, which means they can sell them at the value upon death with NO TAXES. This provides a good opportunity to reposition the assets to be in line with their investment goals and risk tolerance. If the original investments are held for too long, the fear of capital gains could once more be an issue and repositioning to the “appropriate” positions may never be done.

Furthermore, it is absolutely critical to establish one’s own financial plan prior to deciding how to invest the inheritance because some companies offer different settlement options. And if you get talked into a settlement option that is not in your best interest, it may be impossible to change.

One of the biggest mistakes people make with investment inheritances is that they accept the death benefits without planning. Why is this a problem?

For example, let’s look at a four million dollar estate that was left by generation 1 after already paying estate taxes (which could be as high as 48 percent on everything inherited over $2,000,000). Let’s say that the beneficiary (generation 2) is 62 years old and has planned and invested well enough to not need the inheritance for financial security, but takes it anyway (that’s what over 90 percent of Americans do). If the beneficiary takes it, and then dies a year later, for example, the 48 percent estate tax will again deplete the inheritance for the beneficiaries (generation 3). Estate taxes could deplete the original inheritance by another $2,000,000! However, with the proper planning in place, all $4,000,000 could have remained, avoiding both the first and second taxation.*

Troy V. Collins, RFC.
President, McKinley Financial Group
Phone: (650) 551-8900
CA Insurance Lic. No. 0B96613
www.mkfinancial.com

Troy is a financial advisor offering securities through First Allied Securities, Inc. A Registered Broker/Dealer member of FINRA/SIPC For any questions or information on Financial Planning you can contact troy at tcollins@mkfinancial.com or by phone at 650-551-8900.

* This material has been prepared for informational purposes only; it is not intended to provide and should not be relied upon for financial, legal, or tax advice.

When should I think about discussing my finances with a financial planner ?

2010-08-12T21:48:00.000-07:00

You should consider talking to a financial advisor when you are making a life change such as getting married, having children, changing jobs or have some financial questions outside of your personal expertise. Don’t assume that you can find financial answers on the internet. You are about as likely to become an expert in financial planning over the internet as you are to become a brain surgeon.

Financial planning takes into account many different aspects of the current marketplace and a strategic financial plan helps those aspects to work together for the greatest reward. This is not something that a novice to the financial world can understand fully and create for themselves after doing a little internet research. So, don’t do it yourself! It is rather important to plan for your financial future properly the first time because you don’t always get a second chance. Rather than searching the web for good investments, most people should start by searching for a good financial planner.

Here are a few tips to find a good financial planner:

- You should find a financial planner who listens to your concerns and desires. This is your financial plan and he or she should focus on what you want to accomplish.

- You should expect a series of appointments, often 2 to 4, before doing any investing. (Anyone giving investment recommendations at the first meeting is not a true financial planner.)

- You should expect a written financial plan that covers the areas of:
Investments
Retirement Planning
Education Funding
Risk Management/Insurance
Estate Planning/Trusts
Tax Strategies

Note:
It is as important to find a good financial advisor who listens to your concerns and desires as it is to decide on a financial plan and stick to it. Most people start with a strategy and the minute it starts to work imperfectly, they give up on it and change to another strategy or another advisor. Even though a few changes may be needed, “don’t throw the baby out with the bath water!”

*Troy is a financial advisor offering securities through First Allied Securities, Inc., a registered Broker/Dealer member of FINRA/SIPC. Advisory services offered through First Allied Advisory Services, Inc., an Advanced Equities Company.

Creating Liquidity for Real Estate

2010-08-09T22:27:00.000-07:00

Part 4
Real Estate: What is it for?

One of the things that I have found over the years in working with clients that own real estate portfolios is that people love buying real estate, but they constantly make fundamental mistakes when doing so. The starting point in deciding what to buy and how to buy it should begin with the answer to this question: What is it for?

This may seem like a silly question, but as a financial advisor I need to know the time frame, expectations, and, most importantly, whether the property will be used to create income, for growth, or for growth and income (both).

This is the fourth and final piece in our discussions on the appropriate investment strategy for buying real estate.*

Liquidity for Real Estate Opportunities

So, we have established that one of the biggest mistakes that investors make when buying real estate is leveraging incorrectly, or not at all. But often times, people are somewhat reserved about having a mortgage payment to make. Let me remind you of a couple of basic premises.

A $1M property that appreciates by 5 percent has a 5 percent rate of return (ROR).
A $1M property that appreciates by 5 percent that is half leveraged has a 10 percent ROR.
A $1M property that appreciates by 5 percent that is 75 percent leveraged has a 20 percent ROR.

Most people who start investing in real estate know this and start out their investment strategy using this concept to their advantage. However, as the years roll on and people get comfortable, they start to make the mistake of paying it off. Doing this may be the right thing to do, but often it done by accident. By paying a property off, you may lose many of the great things about real estate: the tax benefits. You may have depreciated a building down all the way which takes away a deduction. By having expenses such as a mortgage, you have a way to offset income. These should not be overlooked.

Using up one’s liquidity to invest in real estate can be tremendously detrimental. Look at everyone you know who fell into the trap of buying multiple properties in Arizona, Las Vegas, and Texas over the past 10 years. Many of them are underwater; that is, they owe more to the bank than what the properties are worth. If there is no cash left behind and all properties are leveraged to the hilt, then there is significant risk.

In instances like this, paying cash for properties can really be a savior. If properties such as these were owned outright, though the value may be down, the likelihood of losing them is small. In fact, they would likely be cash flow positive. However, it may be argued that if there were a time to buy in Arizona it is NOW! With prices deflated like a porcupine’s balloon, there may be some great opportunities. For those who paid cash for properties, those opportunities may not exist. Getting cash out of a building is far more difficult than never having put it in. So, perhaps there is a middle ground.

I believe that having the cash to pay them off is a GOOD thing, but to actually do it is the last thing to do, (or last resort). For that reason, we have helped many clients use an insurance based program to create liquidity for opportunities in real estate.** In this program, your capital cannot lose value due to market fluctuations, but can obtain growth type returns and cause a positive “arbitrage” opportunity if used correctly (that is, it can keep pace with or beat the “cost of capital” ). This capital may be accessed tax free under current tax law. What is the advantage of this program? For one, all of your eggs are not in one basket. On top of that, consider the idea that you will have cash available at any time for any reason at all! And while it sits there, growing tax free, you could pay off the property that you choose to leverage instead, and it could grow at 7 percent or more while you are borrowing money at 5.5 percent or so, on a tax-deductible basis. You do the math!

* Investing in real estate and real estate investment trust (REITS) may not be suitable for all investors and involves special risks, such as limited liquidity and demand for real property, changes in supply and demand for real property, changes in law, tenant turnover or defaults, loss of investment, competition, casualty losses, and use of leverage. Real estate values may fluctuate based on economic, environmental, and other factors. There is no assurance that the investment objectives of any real estate program will be obtained.

** Most people do not know that one of the most tax efficient investments in our country is an insurance contract issued by Life Insurance Companies. There are risk factors other than market volatility that could cause loss of principle. Not everyone will qualify for insurance through this strategy. Consult your tax advisor for any tax related strategies.

Troy V. Collins, RFC.
President, McKinley Financial Group
Phone: (650) 551-8900
CA Insurance Lic. No. 0B96613
www.mkfinancial.com

Registered Representative offering securities through First Allied Securities, Inc., a registered Broker/Dealer Member FINRA/SIPC.
Investment Advisor Representative offering services through First Allied Advisory Services.

Real Estate For Growth AND Income

2010-08-09T22:18:00.000-07:00

Part 3

Real Estate: What is it for?

One of the things that I have found over the years in working with clients that own real estate portfolios is that people love buying real estate, but they constantly make fundamental mistakes when doing so. The starting point in deciding what to buy and how to buy it should begin with the answer to this question: What is it for?

This may seem like a silly question, but as a financial advisor I need to know the time frame, expectations, and, most importantly, whether the property will be used to create income, for growth, or for growth and income (both).

This is the third in a series of four discussions on the appropriate investment strategy for each.

Real Estate for Growth and Income

In Parts 1 and 2, we separated out the distinctly different reasons for investing in real estate: growth or Income. In this article, my purpose is to try and make sense in blending the two. How can you do both? It may be that you need two different properties? It may be that one can do it.

Let’s say that a client came to me with a rental property that was worth one million dollars and had net rents (before tax) of $25,000 per year. His property was paid up, and Bob is content with his increase in income each year of about 4 percent (based on rent increases, if not rent controlled). I might look at this rental property and identify a few weaknesses. The first would be that the rents give Bob a 2.5 percent yield, which is not great for income. The second would be that he has virtually NO TAX BENEFITS. A third would be that he is not using his capital wisely to use what I would consider THE major reason for buying real estate, LEVERAGE!

If this is for income only, I could find individual bonds that might pay 4 to 5 percent, which would give more income than the property.* If it is for growth, then leverage might be a key. Bob wants both Income and growth. What do we do?

I might suggest that Bob look for replacement properties, two or more of them. It may be possible to find a property that has a 6 percent cap rate. If so, he could invest $500,000 into this property (all cash) and create $30,000 of income from just half as much money. Then he could find another property for growth in which he could put down, say, $500,000 on a $1M property (or four for $250,000 each).

What is the outcome of doing this? We still have $30,000 in cash flow. But now we have $1.5M of real estate appreciating for us instead of $1M. At a 5 percent growth rate, this is $25,000 more in year one alone. What is the risk? If you owned a $1M property outright and the tenant vacated, you would have no income. If that happens in our scenario, you have no income and you have a mortgage payment. So what you could gain on the top end can be at some risk. This is why for the income producing properties we often look to nonpublicly traded real estate investment trusts (REITs) or something with LONG term leases.** Having a company such as Home Depot or Walmart as a tenant with a signed 20-year lease can often eliminate much of the vacancy concerns. Thus, if the other property were vacant, you would still be able to cover the debt putting you in a similar situation as if you owned just one building outright.

It is important to consider all options when investing in any kind of real estate, but the more you know, the better.***

Troy Collins

* Bonds are subject to a variety of risk, the most visible of which is interest rate risk. If a bond is sold prior to maturity, the investor may receive back more or less than the original amount invested.

** Investing in real estate and real estate investment trust (REITS) may not be suitable for all investors and involves special risks, such as limited liquidity and demand for real property, changes in supply and demand for real property, changes in law, tenant turnover or defaults, loss of investment, competition, casualty losses, and use of leverage. Real estate values may fluctuate based on economic, environmental, and other factors. There is no assurance that the investment objectives of any real estate program will be obtained.

***Note/disclaimer: this article is over-simplified in many ways and is for illustrative purposes only. McKinley Financial is not recommending any specific product, nor are we recommending that you purchase real estate.

Troy V. Collins, RFC.

President, McKinley Financial Group

Phone: (650) 551-8900

CA Insurance Lic. No. 0B96613

www.mkfinancial.com

Registered Representative offering securities through First Allied Securities, Inc., a registered Broker/Dealer Member FINRA/SIPC.
Investment Advisor Representative offering services through First Allied Advisory Services.

Real Estate for Growth*

2010-05-25T16:27:00.000-07:00

Many people think that buying an apartment building is a great way to increase their cash flow and their retirement portfolio. While it may work for some, I want to explain a more realistic strategy using the following example:

Gus, Age 50, is a doctor and earns $450,000 per year. He wants to build his real estate portfolio to help him gather assets for retirement and considers buying an apartment complex. The building will cost one million dollars and he has the cash to buy it outright. Great! (But that doesn’t mean he should buy it outright.) After buying this building, he will have an additional $70,000 of income each year. Sounds good right? Not to me. Based on his tax rate, he will likely owe 45 percent of this to the IRS. To avoid this, wouldn’t he be better off by buying properties that would “appreciate” rather than produce “cash-flow?” I think so. Gus does not need “income” - he needs “growth.”

So let’s look at two issues:
1. Most real estate experts would agree that buying single-family homes in up and coming areas or well-established desirable neighborhoods would appreciate far greater than multifamily properties or commercial ones. That being said, perhaps Gus is looking at the wrong type of property.
2. Even with this property, instead of using all cash to purchase the property, perhaps leveraging it would work better. With 30 percent down, Gus could buy the property with $300,000. His loan would be $700,000, which at 6 percent would have a payment of $4,196. With other expenses and taxes, let’s say his total monthly expenses are $6,000. Perfect! His income and his expenses are roughly equal meaning that he likely has no taxable income. Thus he is using the property more effectively by having the tenants pay for the property with no creation of additional taxable income, and by leveraging it effectively a 5 percent increase in value on the property ($50,000) is equivalent to a 16 percent return on your money ($300,000).

Obviously more potential can be identified with this breakdown. How about the idea that Gus can now buy three properties for the same one million dollars with which he was going to buy only one? Now, a little caution needs to be exercised here as we can all identify with those who overextended and bought as many properties as possible and sacrificed liquidity. There definitely is a balance. (See part four of this series of discussion to see how life insurance can act as a tax free holding tank for funds with which to buy future properties and provide liquidity.)

** Investing in real estate and real estate investment trust (REITS) may not be suitable for all investors and involves special risks, such as limited liquidity and demand for real property, changes in supply and demand for real property, changes in law, tenant turnover or defaults, loss of investment, competition, casualty losses, and use of leverage. Real estate values may fluctuate based on economic, environmental, and other factors. There is no assurance that the investment objectives of any real estate program will be obtained.

Real Estate: What is it for?

2010-05-18T12:39:00.000-07:00

Part 1

This is the first in a series of three discussions on the appropriate investment strategy for each.

Real Estate for Income

When buying real estate for income it is necessary look at the type of income that you purchase. Although for appreciation, single family homes in the San Francisco Bay Area may be a great investment, for income typically they are not. Let me give you an example: A two bedroom home in Burlingame, California that would sell for one million dollars rents for $3,300 per month. Subtracting out the annual expenses of about 8 percent plus the property taxes, it would not be uncommon for this property to net $25,000 after expenses (but before taxes).* So for income, $25,000 on a $1M investment equals 2.5 percent, which is little better than a CD with substantially more risk and work to maintain. Don’t get me wrong; this investment may be far greater than 2.5 percent due to possible appreciation; however, my point here is to demonstrate that for income, this is not a great investment.

So what might work better? For income, multiunit properties, apartments, or commercial properties may be far superior in terms of income than single family homes. In today’s market, you may be able to find a 6 unit property for $1M. You could rent for approximately $1,200 per month, giving you a total $7,200 per month or $86,400 per year in rental income. After expenses, you may still have $70,000 net income after expenses (but before taxes). On a $1M investment, this is 7 percent net income. Now this, as far as income is concerned, is a very decent investment. As for appreciation, however, multiunit properties and apartments do not typically keep up with single family homes in terms of value.

Other options may include using Real Estate Investment Trusts (REITs)** for income. Generally, non-publicly traded REITS have a more stable valuation than publicly traded REITs and their goal is to pass along high income: 5 to 7 percent income is not uncommon in today’s marketplace. Using REITs instead of owning the property individually allows for the owner to have less of the management headaches that a landlord may experience.

Using leverage may also allow for additional income on a property. If, by using leverage, you are able to buy a larger building with more income, and the income outweighs the expenses of the loan, then this too can be of benefit.

Bottom line: You need to do some planning prior to purchasing a building. You should consider the types of properties, how to fund the property, whether to use leverage, who will manage the property, what improvements it may need, and what annual expenses it might have, among other issues. The list of considerations is long, but the end result well worth the hard work if done correctly.

Troy Collins

* If this property were bought 10 years ago it would fare a little better because property taxes would be reasonable for today’s standards. However, if it is a property that you are looking at today, property taxes would cost more than $10,000 per year.