Renting Vs Buying, And When To Invest... The 1% Rule And #NYC Real Estate

Deciding whether to rent or buy is an age old question, and one that leaves many people confused and misguided.  Many people are ill prepared to deal with their emotions about the subject and make decisions with clarity. Financially, it is one of the biggest decisions you can possibly make, so making a purchase decision without some key bedrock financial understanding is akin to going into a gunfight with a water pistol.

When do I rent and when do I buy?

Many people hinge their success in life on owning a home. They are convinced that renting is just "flushing away money" and that home ownership is a right and a privilege that every American deserves. They leverage themselves to the limit, and end up with a 30 year mortgage that, even at today's low interest rates, will have them paying for that house twice over by the end of the term. In NYC, with its high property values, an average middle of the road home can easily go for a cool $1,000,000. By the end of the loan, at 5% interest (if you can even get a loan for that low a rate) you will end up having paid $1,932,588 for said home.

"But I'm building equity, right?" Actually, not as much as you think... Sure, you have the initial 20% down payment that you put into the property to secure the loan, in this case $200,000 (as banks typically want at least 20% plus excellent credit to consider a loan right now) but what happens if you need to sell and the market is down? You have effectively lost equity. Many people who bought at the top of the market in 2007 are now underwater on their loans, they effectively have negative equity. Even if they sell, they will still owe the bank, which leads many of them to be foreclosed upon, walking away from their homes and forfeiting not only their sunk capital but their credit rating. In fact, if you look at and play around with the amortization chart/schedule calculator here, a few things become clear. Firstly, most of the interest is paid in the first half of the loan schedule, in fact, you pay more interest than principle for each payment in the first 193 months of the life of the loan. That means that after paying diligently for more than 16 years you have only paid down about a third of the actual principle balance of the loan. The first year, your payments are comprised of about 83% interest, toward the last year they get as low as 3%.

Now lets look at a rental scenario for a comparable property. Since property values are so high in Manhattan, you can typically rent for about half of what a property would go for should you decide to buy... Using nice round numbers, a $1,000,000 carries a $5000/Month price tag (its actually usually more when you factor in maintenance, insurance, taxes, upkeep etc) when a similar apartment can usually be rented for about $2500 a month, where the landlord pays for maintenance, insurance and taxes. If your dishwasher breaks and you own the place, guess who foots the bill... exactly, it's you. Again, these are rough numbers, you can figure out a more precise scenario for your given situation, this is just to illustrate a point.

Now lets look at two people, Renter Randy and Buyer Betty. They have the same amount of cash and the same income, lets say they are equally qualified to purchase or rent the same properties. Buyer Betty puts down her $200,000 down payment on her $1MM property and pays $5000 a month plus all of the aforementioned extras for her 'owned' apartment, but builds very little equity in 15 years. In that same time, Renter Randy decides to take that $200,000, plus the extra $2500 a month ($30,000 a year) he saves and wait for dips in the market to buy index funds. Even passively purchasing equities at regular intervals, based on the performance history of the S&P 500 and adjusting for inflation, Renter Randy can expect an 8% per year return on his investment over time. We use a savings calculator to and an amortization schedule to figure out where each is at the end of this first 15 years.

Buyer Betty, who started out with a $200K down payment and paid diligently for 15 years, only has built about up to about $456,929 in equity, including her initial down payment, and still has another 180 months (15 years) of payments to go before she pays the remaining balance of the loan ($543,071). During this time, she has paid to maintain and fix up her home, as well as insurance and other extras that come with being a diligent homeowner. Not to mention that she is glued to one place... A renter can pick up and change scenery whenever they feel like. A home can take months if not years to sell, and you lose on commissions, lawyers, and all the hidden extras that come with a home sale.

Renter Randy, however, despite "flushing" his money away on rent, has diligently been investing his initial $200,000, plus the $30,000 per year he has saved by not buying, and spending the extra monies left over-- which were not spent on dishwashers, maintenance, insurance, taxes etc-- on vacations. His annual rate of return has been at least 8% after inflation, and he now has turned his initial $200,000 into a cool $1.3 Million. He can now use this money to buy a place outright, or if he is now in love with renting, as he should be, continue to rent and live off the interest. He now has options, which are much better than obligations.

Now I know what you are thinking, Betty not only built equity, but her property has probably appreciated some too in that same time frame. Perhaps, but as we have seen in the housing crash in 2008, you can't count on appreciation. Its a lazy and dangerous way to invest. A seasoned investor knows that cash flow is king... the only good investment, or true asset, is one that puts money in your pocket. Betting on appreciation is akin to gambling. The debt she secured is also a huge liability.

There are some scenarios when it does make sense to buy instead of rent, but typically home prices in major cities such as New York preclude this from happening. Luckily, after many years of keeping my ear to the ground on real estate as an agent and also an investor, I have learned a very easy rule to quickly determine not only whether it is better to rent or buy in a particular area or market, but whether or not an investment will potentially be cashflow positive, which is what a sophisticated investor should be interested in.

The 1% Rule... A home that you can rent monthly for at least 1% of the purchase price (at current interest rates) will typically be cash flow positive, assuming the maintenance is not extensive.

Now if you apply this to your $1MM home, there is nothing on the market that you can purchase for $1MM and rent for $10,000 per month. A $100,000 home going for $1,000 a month in rent is not unheard of, and in fact is a more common scenario around the country. If you would have to pay $1500 a month to rent a place that costs $100,000 to buy, you are actually saving money by purchasing the home, even when you take interest into account. If you are renting it out, the cash flow would typically be positive. This gives you options.

REO's (Real Estate Owned) are typically very cheap compared to the open market, and hard negotiations coupled with motivated sellers can produce amazingly cheap deals. REO's are simply homes that the bank owns but cannot collect on. They have foreclosed, put it up for auction, but still have no buyers. These homes are essentially toxic assets, they still have to pay for the taxes and other lawful obligations, but are usually not allowed to collect rent, as most places have laws that preclude banks from making money any other way than from lending. A bank does not want to be a landlord anyway, they want to make money by borrowing cheaply and lending money at higher interest rates.  What this means for an investor is that you can usually come in with a lowball offer and pick up these toxic assets cheaply, then fix them up and rent or sell them. 

If you choose to build a rental portfolio, which in my personal experience is more headache than its worth, you should always be sure that in almost every scenario that you are cash flow positive. You should be consistently clearing at least 8% cash on cash return, and building equity at a favorable rate. There is still a lot of friction in this business model, and high overhead. Bad tenants, bad property managers, maintenance, taxes, insurance, and lawsuits (some are just unavoidable, no matter how good a landlord you are) will all eat into your profit and cause undue stress. Buying established blue chip dividend stocks when they are on sale is my personal preference for excess cash. They are reasonably liquid, and if your timing is good, go on sale much more often than homes. Also, no maintenance, no headaches, and long term capital gains taxes are very low when compared to earned income. You simply have to have an eye for a bargain and keep tabs on your companies performance. Index funds are even less maintenance, you get inflation protection, dividends, and liquidity benefits. Or you can simply build low friction high yield cash flow businesses. Ask me for more info on this. 

I understand this is grossly simplified, but I hope this helps at least see the bigger picture. If you have any specific questions please feel free to drop me a note, or better yet, do some of the math and see for yourself. I used the Mortgage Calculator App from SVT software and CreditKarma.com for the mortgage calculations and amortization schedules respectively, and the SaveCalc App (pictured above) for the compound interest calculations.

Passive Income-- Breaking Ground On, or Breaking Up With, Your Next Big Idea

Its easy to fall in love with an idea, but as but any serial entrepreneur will tell you, its all about the execution.

I had correspondence with a doctor from the Midwest this morning, who was asking for a few ideas to kick start his goal, to make income off of low maintenance business ideas. My response read like a blog post, so here goes.

An excerpt from the email I received:

"...Anyway, I came across your blog after looking up stuff about lifestyle design, which I became more interested in during my medical training while working 60-80 hours/week. I have been on a break for a few weeks between finishing my training and starting my practice, but still will probably end up working in the 50-60+ hours/week range as a practicing physician. All of this has recently inspired me to start a blog of my own and to make contact with some people that seem to have a good plan in terms of lifestyle design, and to learn what I can.

I was looking at your post 'Anatomy of a Perfect Week', and without being too nosy, I wanted to ask you what kind projects you work on in terms of 'passive income'? How much time per week do you think you currently spend on them, and how long did you spend setting them up?

Other than the books you mentioned in your most recent post (4 Hour Work Week--which I've read, and One Simple Idea--which I'll add to my eventually to read list), do you have anything else you have found to be a good guide (books, blogs, people, etc.)...."

My Response:

Greetings ,

Thank you for taking the time to reach out. I appreciate that you took the time to read my blog and am encouraged that you are looking for ways to work smarter and increase your passive income.

I have toyed with a lot of investing/cash flow business models over the years and I have found the most simple approach is two pronged. Ideas typically come cheap and easy, its really the execution that is key. Most people have an idea, which could even be a great idea, but without a hand-in-glove plan to implement it, they will never see a dollar from it.

I have extensive knowledge of the ins and outs of New York Real Estate, which is a muddy, convoluted system that intimidates people and costs them a lot of unnecessary money. While there are many who would like to rework the entire system, the issue is that a few massive landlords control much of the rental real estate, and thereby can skew business practices in their own favor. Most of my products, consulting DVD's, websites and the like, stem from this narrowly held body of knowledge that I have acquired over years of being an insider in the industry. I prefer to keep these sites and products separate from my personal blog, so that I can control my message--- my music, musings and life lessons are the priority on AnonymousExploits.com

Essentially it boils down to what you know. Once you have a product, which in your case could be medically related, like a book, a DVD, a widget, or perhaps a supplementation, exercise or diet program, that you know everything about, and people want to learn about, it's easy to implement a low friction framework to distribute that paid content via the internet or as a "muse" type business as outlined in Tim's book.

For other types of ideas, which are either too complicated, you don't have expertise in, hard to compete with, or simply improvements on a current product or service, this is where Stephen's book will come in handy.

Let another, more established company run with it and send you a check.

I basically go through these steps when evaluating a product or service:

Does it solve a problem that needs a solution?

Would I buy it? More importantly, is there a verifiable (see testing methods in 4HWW) market?

Does it fit into a pricing structure that makes sense, can I make my margins?

Is it shippable, outsource-able, and (most importantly) scalable?

Will it take up a lot of my time and energy?

Is there repeat business/cross selling opportunity?

Obviously, this isn't all that I look at when evaluating a venture, but if you can get positive outcomes from looking at all of this beforehand, then you can dive in headfirst. I think of ideas all day long. I just don't implement most of them. I can spend a couple of months to a year setting up a venture, but I plan for it to generate income for at least 5-10 years. By setting up, I mean getting it to the point where all the kinks are worked out with the structure and I can focus on marketing or just sit back and collect revenue. All of the excess cash I generate gets invested in other ventures, or put into low risk dividend heavy portfolios, with index funds and a few promising small caps. I choose not to invest in real estate myself, because despite the fact that I know quite a bit about it, it does not fit into the uber low maintenance lifestyle that I fight to maintain. The point is not to be lazy, I work very hard, but the less fires I have to put out, the better. I am writing posts on various ways to invest, more to come.

I hope this helps get your creative juices flowing. It gets easier with practice. Just remember, execution is key. The Winkelvii might have had the idea that eventually became Facebook, but without proper execution, it would never have become what it is today.

I could mention a number of other blogs and books, but I wouldn't want you to fall into paralysis by analysis. Get started. If implemented properly, your plan shouldn't cost much, and you can correct course along the way. As long as you pay attention to materials we already discussed, you are well on your way. Plus, Paul McCartney once told me that I shouldn't drop names. ***

*** (Joking, though I'm sure he's lovely)

Yoga and the end of the world

I think Yoga saved my life today. This isn't some melodramatic cry for help.

I remember many years ago, back in my college days, when I was struggling to figure out what elective looked like the most fun, but also would be co-ed. I had played Lacrosse and Football in High School (not spectacularly well I might add) and I was looking for a sport that didn't have all the BS male hierarchy, where I could focus on my main goals at the time: finding a reprieve from the voices in my head, and getting more comfortable around women. Yoga classes fit the bill nicely.

As for the voices, you know, the annoying ones that tell you that you aren't good enough or you don't deserve the best in life, I, and all the honest people I meet, battle them daily. The most successful people I have met don't seem to have less voices to contend with, just much better coping mechanisms. It all comes down to how well you treat yourself and what your core beliefs are. People will flock to you if you have a strong center, but without one you may as well be a homeless leper. Everyone will sense your gaping hole-- your validation seeking behavior-- and run away screaming.

As for women... I grew up an only child, raised by my dad, in a neighborhood full of skinhead idiots. Not a lot of girls found their way into my social group. My mother was in effect the head of the family and main breadwinner, because my dad was disabled, so she never got to act as a motherly influence. She had left my father and found someone new, so I didn't get to see her very often. She was also weary, the oldest of seven, and had spent her entire life raising kids. Hindsight being as clear as it is, it seems logical now that a lack of socialization with women at a young age had left me utterly lacking in skills that everyone else seemed to possess. Some of the neighborhood guys, like myself, ended up eventually having more than our fair share of success with women, and some of them are still girlfriend-less to this day. The funny part about it is, despite being a grown adult with tons of experience with the opposite sex, its not a given that on a particular day that I will be comfortable approaching a girl I like. Other times I am unstoppable. Its tough to talk about, most people don't really get it, and I don't blame them. It's not easy to rationalize. It's also extremely frustrating. It messes with your feeling of self worth and drains your energy. You feel like a failure every time you walk by a girl you fancy and don't talk to her. In NY, this happens every 5 seconds.

I have read that a man's fear of approaching an attractive woman harkens back to an evolutionary mechanism that has long ago outlived its usefulness. Seems likely enough, but has been covered to death elsewhere, so I will not rehash it here. Alcohol is most people's crutch and social lubricant of choice, but I don't want to use crutches anymore. This throws another spanner into the works, because now the voices, especially the "What if" scenarios which seem to never play out, are in full force. It's really easy to get in your own way.

What I am realizing is that being outgoing, gregarious, and comfortable in social situations, traits which I fought hard to attain my whole life and pride myself upon, aren't learned and then retained. Like high school Spanish, if you don't use it, you lose it. There is no magic formula. You could be the best guitar player in the world--- and I was damn good at one time--- but if you don't continue to practice diligently, you will not maintain your edge.

So back to the point of this post. I have resolved to get back to where I am comfortable in my own skin, as the past year has been one of loss, loneliness and hard lessons. My social comfort level had damn near bottomed out. My biggest fan, and the one person I could call anytime for advice or to vent, a man who raised me, who loved me and was proud of me unconditionally, was gone... and now I have to be my own biggest fan and learn to love myself first again. To treat myself like my own best friend. To be comfortable in my own skin and sharpen the skill sets to be a master of any situation that I find myself in. I will accept no less. I know this is an arduous, but worthwhile, pursuit. I know that the payoff is huge but will cost dearly-- many years of time and dedication to being the best version of myself possible.

I have had many successes that would make me seem invincible, but there are still cracks in the foundation. Instead of hastily patching them, I'm gutting and starting from scratch by laying a new one. Now, after a few less than successful attempts at getting out of my own way, I decided to check out of my mental spiral and get back to basics. That's where Yoga brought me back from the brink. It may be the only practice that completely silences the chatter for any extended period. It is something that I plan to master and keep as part of my routine. It may just put off the end of the world, at least for me. Thank you Yoga to the People on St. Marks. Namaste.

Do something physical, every single day.