"Wall Street created the U.S. housing bubble and now it’s missing the real estate rebound." Begins William Pantalon's editorial for Money Morning/The Money Map Report. This well written view point of the cause, the effect and the recovery of the recent housing bubble makes for an excellent and educational read. Full Story
Kiplinger's Personal Finance Adviser reports in the April 2009 edition: "If your job prospects are good and you don't plan to sell for at least five years, now's a good time to snap up a bargain on a home. For a listing of foreclosed homes the Department of Housing and Urban Development is selling, visit HomeSales.gov. Or consider buying a "real estate owned" property-a house the bank buys back if bidders don't meet the minimum on a foreclosure - to avoid some of the hassles of a foreclosure. Go to your local multiple-listing service's Web site to search for REOs. If you're not facing a deadline and aren't easily discouraged, you could try to buy in a short sale, in which a home is sold for less than the outstanding mortgage balance with the approval of the lender. And if you want a new home, builders are offering a host of incentives, including price cuts, low mortgage interest rates and upgrades of cabinetry, flooring and other finishes."
Kiplinger's Personal Finance Adviser for April 2009 reports: "Vacation rentals generally offer better value than resort hotels, so tough times may mean you can squeeze more-not less- money from your second home. The average rental brings in about $30,000 a year, and high-end homes in popular destinations can rake in $150,000. Advertise on vacation rental Web sites, such as HomeAway.com, and in local newspapers and around the office (be sure to include high quality photos). Consider renting out your home during the peak season, when you can collect higher rents, and shifting your own use to less pricey times. If you rent out your home more than 14 days per year, you must report all the income to Uncle Sam, but you can write off expenses to hold down the tax bill."
Cases featured in this section are actual case histories of IRA/real estate plans structured by Uranga & Associates. Names have been changed to protect the privacy of our client(s).
Case outline: Mr. Collins is 39 years old, married, owns a primary residence and is an institutional trader. Believing real estate in Florida to be attractively priced he decided the time was right to purchase the vacation home he and his wife had dreamed of owning one day. Mr. Collins first heard of the OUTSIDE™ method of investing in real estate from searching the web. Having always believed an IRA could only invest in traded assets, (stocks, bonds, money market, and mutual fund shares), Mr. Collins was intrigued with the idea of being able to reallocate his IRA to support the purchase of real estate that he, his wife and family could enjoy now, during their active years, rather than having to wait until retirement before gaining any benefit from their hard earned savings. After completing the Compatibility form on the Uranga web site Mr. and Mrs. Collins had a telephone meeting with an Uranga consultant to more thoroughly understand how the OUTSIDE™ structure could apply to their scenario and determine if it was suited to their situation.
The Collins’ decided to allocate $100,000 of their IRA to the purchase of their $89,000 vacation home. Using $21,000 of non IRA monies for the down payment the Collins’ obtained a second home mortgage in the amount of $68,000 to finance the balance of the purchase price. To establish the structural foundation of the IRA real estate plan Uranga & Associates assisted Mr. Collins in transferring his allocated IRA monies to a SAFE HARBOR® IRA account. This SAFE HARBOR® IRA account, with a potential to earn 5% or greater as a ten-year average, also insures against loss of principal value due to investment exposure during the life time of the plan. Uranga & Associates then structured Mr. Collins’ SAFE HARBOR® IRA account to provide a reliable monthly income stream to be used to make the mortgage payments. Any tax liability generated by withdrawals from the IRA was calculated to be offset by allowable real estate tax deductions, resulting in a zero tax outcome.
Summary: The implementation of the OUTSIDE™ structure of IRA real estate has enabled the Collins’ to purchase a vacation home for their personal use within a secure financial framework. Believing to have bought their real estate in depressed market conditions the Collins’ anticipate to eventually benefit from an attractive rate of appreciation while at the same time earning interest on the principal value of their IRA, a financial strategy they believe will help support their eventual retirement. Additionally, the enjoyment they expect to experience from the use of their vacation home over the next many years is priceless.
An email we received from our client, Randy M. from Utah last week reflects the sentiments of many right now.
He wrote:“I have been reluctant (scared) to move forward since last Wednesday when I got my February IRA statement in the mail. It showed that my IRA balance had dropped to $309,000 and that every day last week the market continued to drop. This certainly would have been easier a year ago when my IRA balance was close to $450,000. Do you have any advice? I keep thinking that this market is going to turn around, and that I will recover some of these losses, but it only seems to be getting worse.”
Surely we must be close to the bottom – is the view of many investors and understandable they are reluctant to sell their stock portfolio at the bottom. The investment manager for Yale’s endowment was quoted on NPR just the other day as saying “buying at the top and selling at the bottom is a tough way to make money”. There is a huge media drive at the moment, in large part politically driven, to persuade investors to not only NOT sell equities into the falling stock market, but to buy – claiming now to be a terrific time to get in at a bargain price. The incentive behind this media push is most likely an effort to try to stop the free fall and restore some confidence in Wall Street to the American public. But wait a minute…..where are the housing lobbyists? If it’s such a great time to buy into the stock market, would now not also be a good time to buy real estate? After all history demonstrates that stocks and real estate tend to rise and fall together.
Now, back to the email received from our client. The question I have for him is this. What was the value of the real estate a year ago that you would like to buy today? Has that real estate depreciated over the past twelve months, just as your IRA value has?
This particular gentleman has his eye on a home currently priced at $250,000. A year ago its market value would have been at least $330,000. He could buy it today for $80,000 less than he would have paid for it a year ago. So this is where there has to be some soul searching. Why does this client want the real estate? Will it be a home for him and his family, or will it generate rental income for additional cash flow? If he were able to remove the fear and regret of realizing stock market losses and look at the situation objectively he would have to admit that today is just as good a time to commit his IRA assets to supporting the purchase of real estate as it would have been one year ago, if not perhaps better. Why better today than a year ago? Because he can buy the real estate for substantially less and because of this he stands to benefit from a higher likelihood of future appreciation in the home’s value and he benefits from mortgage interest rates at an historic low.
OK, that all sounds good, so instead of waiting it out in the stock market, hoping the value of his IRA will recover at some point in the future, (read our Feb 6th post “How Many Years to Recover Your Diminished IRA Value?), he transfers his investment into real estate with the expectation that he will eventually recover his stock market losses with the appreciation gained from the real estate while at the same time benefiting from the intrinsic value of occupancy or from rental income – case closed.
Not entirely case closed! Those of you who have benefited from a consultation with Mr. Uranga will understand the OUTSIDE® method does not utilize the cash value of the IRA all at once for the real estate purchase. Instead, the IRA monies are placed in SAFE HARBOR® while they are supporting the purchase of the real estate over a period of time. So picture if you will, you now own two assets, the real estate and the IRA, independent from one another but at the same time mutually supporting.
Since the real estate is purchased with borrowed money, (a mortgage), supported by the SAFE HARBOR® IRA the potential return on investment is far greater than where the investment is purchased with 100% cash as is usually the case with equities. Not only can you benefit from the advantage of cash-on-cash returns, from the real estate but at the same time you are earning interest in your SAFE HARBOR® IRA account. For those of you who are reticent to realize your stock market losses take heart in understanding that one of the SAFE HARBOR® custodian choices offers several account strategies which allow you to earn interest credits that are linked to the performance of several different indexes allowing you to benefit from positive market performance while the principal balance of your IRA is protected from potential market losses. So, if you really want that real estate but at the same time are bullish on the market and having a hard time deciding which way to go, the OUTSIDE® program offers you the best of both worlds. Your IRA can have the opportunity for upside potential linked to a specific index or combination of indexes with built-in downside protection while at the same time you can benefit from owing real estate to either enjoy as a home or to generate income as well as have the potential for capital appreciation over the time you own it.
Comparative Appreciation
If a Wall Street index has an appreciation rate of 10% and real estate only 8%, Wall Street is two points better, right? Yes and no. When economists compare stock versus real estate they typically compare the dollar capital appreciation and ignore tax advantages in the event of profit. The profit on any stock sale begins with the first dollar made, but taxes on an owner occupied home begin at $250,000. In the case of income property, only after expenses are deducted.
If the house was bought for cash with no mortgage the return on the capital dollar is a fair comparison. If the stock and the house investment were bought and liquidated at the same time, (less cost of sale) the stock could yield a better return. But real estate is seldom bought for cash. The deposit (10 to 30%) is usually leveraged with a mortgage. Here is where the magic starts.
Cash-on-Cash Returns
This is a term that all but the most sophisticated investors do not seem to understand or talk much about.
Wall Street talks about a ten or 15 percent return with a certain reverence. This is the effective return on the actual amount of money invested. Take the same definition of “the actual money invested” by an investor in real estate. Then determine the value of the amount of property that can be controlled using the power of borrowed money (a mortgage), and the actual cash invested is leverage massively. For example if $10,000 is the deposit required as the down payment to buy a $100,000 property, a 10% rise in the value delivers a 100% return on the 10% invested:
The cash (return) on (the) cash (employed) equals 100%. This example is conservative. The appreciation reported by US Census for the Pacific Region for the year ending March 31st 2005, translates into a 212.5 percent return assuming 90% loan to value loans were used. In 2008 appreciation has moderated and in many cases is reported to have gone backwards by up to 10 to 25 percent but is still ahead on 2005 valuations. Where can you get this type of return on Wall Street especially given the 33% retrenchment in 2008? Now add the security of real estate that can never go to zero value? Historic appreciation through good years and bad is averages about 5 percent.
The competition for investment dollars.
In the battle for investment dollars, Wall Street advisors are competing with real estate with both hands tied behind their back.
Wall Street was on full “bubble watch” during the real estate value run up from the late ‘90s to 2006 as they were increasingly concerned by the amount of money that had left their care and management for the security and the superior returns of real estate.
When the market started to moderate and slip backward, indexes like S&P Case/Shiller diligently reported precipitous losses by averaging samples in 20 of the most dynamic markets. This immediately raised doubt in consumers and other market interests about the viability of housing as an asset. The ratings agencies like Moodys, Fitch and S&P did not break stride and reaped huge revenues from rating the mortgaged backed security funds and the bond insurers that covered risks on these.
Having been associate publisher of Technology Investor Magazine (a NASDAQ focused magazine) we have a slightly “dark” attitude toward the Wall Street marketing machine. A savvy self-directed investor is not an ideal Wall Street customer. They ask tough questions that are not satisfied with simple answers.
For example why can S&P Case/Shiller only look at 20 markets and average homes in good neighborhoods where values have remained steady and not fallen? Then there are new build neighborhoods in remote areas that have dropped 30 to 50% as they became nearly undesirable and uneconomic destinations for the folks they were meant to house. Wise real estate investors understand this. Wall Street and their cheerleaders do not. Most homes are considered “castles” that defy convenient and misleading commoditization. Behavior maybe, but not the housing stock that ranges from inexpensive tract home to luxury homes is perennially stable and desirable neighborhoods. To the fundamental and technical analysis of a stock, any home analysis must also add messy cultural and personal value considerations driven by a location.
INDEX CHALLENGE
The S&P 500 is a basket of five hundred companies; however 206 of the companies that were on the list in 2000 were replaced by January 1st 2006. That means the data making up the baseline index is subject to a “best of breed” adjustment!
Take the top 500 zip codes in the United States and map appreciation. First the base line data cannot be adjusted as these exist as long as the USPS says so or near in perpetuity. We have not done this calculation but we suspect it will result in a very favorable real estate story.
Having suffered such great losses in the stock market over the past 12 months many are reluctant to sell their portfolio at such a low point. Professionals in the equities industry encourage clients to hold on to their stock market investments with the anticipation of a market rebound which will enable them to recoup their portfolio values.
We decided to examine just how long it might take a portfolio loss of 38% to come back to full value.
Assuming an optimistic scenario of a 12% annual return each year over ten years, with a 1% maintenance fee, the Variable Assumption Calculator software showed a recovery to full value after 5 years. However, this calculation does not take into account the effect of any negative years. In fact in the last 25 years there has not been one 10-year period with consecutive increases in value for the Dow Jones Industrial Average. In the most recent 10-year period the Dow has experienced 5 negative years.
So just as an exercise for educational purposes only we ran the Variable Assumption Calculator software with two more hypothetical scenarios:
Also, let’s not forget the lost opportunity cost effect which has not been taken into consideration in these hypothetical assumptions.
For those of you truly wishing to purchase real estate it would be helpful to take a look at the bigger picture of what the ultimate result might be for the same duration of years if your monies were structured to include a combination of SAFE HARBOR earnings and real estate ownership. The SAFE HARBOR part of your plan would provide downside protection with the opportunity for upside earnings potential. While the real estate portion of your plan gives you the possibility of appreciation in value of the real estate, beneficial tax offsets for either occupied real estate or investment property, intrinsic value or rental income as well as the benefit of a step-up in cost basis upon inheritance for your heirs. If you intend to purchase this real estate for your home, second home or vacation rental, it is hard to arrive at a hard return on investment figure for the intrinsic value the use and enjoyment of the real estate purchase would bring you.
2008 was a challenging year for many. Uranga & Associates was fortunate to close out the year with an increase in business from the prior year despite the disheartening state of the economy. This last year showed a dramatic increase in clients structuring their IRA to apply to an existing mortgage - a sad statement of today's economic environment. Fortunately for our clients we could structure their IRA to be of benefit them now, when they badly need the assistance, while still allowing for the great majority of it to be there for them tomorrow - in their retirement years. The sector that showed the second largest increase from the year before was in second home purchases. Many of our clients took advantage of attractive real estate prices to purchase the vacation home they have always wanted. The OUTSIDE method can be structured for people of all ages. Fifty five percent of our clients last year were in their 50's with 20% in their 60's, 18% were in their 40's and the balance of our clients last year were in their 30's.
Cases featured in this section are actual case histories of IRA/real estate plans structured by Uranga & Associates. Names have been changed to protect the privacy of our client(s).
Case Outline: Mr. & Mrs. Anderson responded to an advertisement in Delta’s Sky Magazine. The Andersons have been hit hard by the recent down turn in the economy. Mr. Anderson who is in his late fifties had heard he was to be laid off from his executive level position in the technology industry and his wife’s hours in her retail position had already been cut back. Faced with a dramatically reduced income and no immediate job prospect in site, the Andersons were concerned with being able to make their mortgage payment. After viewing Uranga & Associates advertisement the Andersons were intrigued with the idea of applying their IRA to save them from potential financial distress with their primary home mortgage so they scheduled a telephone appointment with an Uranga consultant to explore how the OUTSIDE® structure could help them out.
Structure: A total IRA transfer of $320,000 established a SAFE HARBOR® IRA account as the foundation for the Andersons IRA real estate plan. Uranga & Associates then structured the IRA to make regular monthly payments in the amount of $1,700 to be applied to the Anderson's home mortgage payment. After five years, by which time, hopefully, the economy will be back on track and the Anderson's employment situation will have improved, they can choose to discontinue the cash flow stream from the IRA to allow it to revert to building equity for their future retirement.
Summary: For the Andersons Uranga & Associates structured the SAFE HARBOR® directed IRA real estate plan to provide cash flow assistance as a short term solution to their financial needs. The Anderson's customized plan allows the flexibility for them to discontinue the cash flow stream from the IRA after five years or continue it for as long as they choose. If they do decide to discontinue the transfer of IRA money into their primary residence after 5 years, they can expect, with a worst case scenario, a minimum value of $259,000 to still remain in their SAFE HARBOR® IRA account even after $102,000 of its original value has been transferred into their primary residence. This financial plan gives the Andersons the security and peace of mind they need to weather the economic storm and come out of it unscathed.
Other estate planning benefits are derived from the OUTSIDE® structure. Please visit our website for further information.
Q: I’m not old enough to qualify to start withdrawing my retirement money yet, so how can it help me now?
A: There are two different ways in which your retirement monies could help you through this transition time. Both options are available to you at any age.
Q: What is the difference between the two strategies?
A: The OUTSIDE® structure is similar to estate planning. Your current financial situation is evaluated, your long term goals are assessed and then with these elements in mind your retirement funds are structured for immediate support of your existing mortgage or for a new real estate purchase while at the same time ensuring security and longevity of principal balance of your retirement fund.
The Mortgage Relief Strategy offers a short term bridge solution intended to assist your cash flow needs until you are able to secure gainful employment. This strategy can assist individuals with low value retirement funds and would only be suggested for consideration if the OUTSIDE® structure was incompatible with your circumstances.
Q: Will I incur penalties for accessing my retirement monies prior to retirement age?
A: Not when your IRA or 401k rollover is structured by the OUTSIDE® method. The Mortgage Relief Strategy will incur a penalty. However this strategy is calculated to take effect on an as needed basis, substantially minimizing the penalty to a level where the benefits outweigh the cost.
Q: How do I find out if either of these programs can help me?
A: Fill out the compatibility form on our website. The information you provide us in this form will help us determine if you could benefit from our services. We will then invite you to a complementary telephone consultation where our consultant will discuss with you how a plan would be structured to benefit your particular case.
Q: Once I speak with a consultant at your office am I committed to signing up for your services?
A: No. Our business code of ethics ensures you will receive no sales pressure to move forward with our program.
Q: If I decide to move forward with the OUTSIDE® structure, what is my cost for your service?
A: Most of our clients incur no cost at all. It will depend upon which custodian you decide to move your retirement monies to for the foundation of your OUTSIDE® plan.
