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A key to successful finances and a cornerstone to building wealth and creating financial security is Real Estate. There are several stages in life where making Smart decisions at those Pivot points will make the difference between success and something less.  Managing your cash flow and equity related to your home is based in the fundamental understanding and following “The Four Steps to Financial Freedom”.  1) Emergency Fund 2) Eliminate all consumer debt 3) Build massive Liquidity 4) Reach the freedom point – where income from passive investment exceeds expenses.  Having or Paying off a mortgage is not a step – that decision is a by-product of successful financial planning.

1) Smart Home Buying

Smart Home Buying – Most people aspire to own a home and believe it is very important to their financial success, however being able to articulate why is more difficult, other than a belief. There are key concepts to understand when buying a home:

  • A) Leverage – the reason real estate tends to create millionaires is due to leverage, leverage is using small amounts of money to control a larger asset – leverage amplifies the return on any asset.  With $50,000 you can buy a $800,000 home or invest in stocks and bonds for $50,000. If the $800,000 house goes up 10% you made $80,000, whereas the same 10% in stocks got you $5000.  You need both in the end, but leverage is why real estate works – if you had to pay cash for a home – the world would look very different!
  • B) Equity – is the amount of money you put into buying a home, the down payment, the principal payments, and the market appreciation are all equity.  Equity is the difference between the value of the asset and the debt on that asset.  Equity adds to your net worth and looks good on a balance sheet but fails in a few key areas.  Equity is not liquid and does not earn a rate of return. Once you understand that a big portion of your net worth (wealth) is not easily accessible and does not earn you anything, you may start to approach the equity decision differently.
  • C) Cash flow – your home tends to consume the largest portion of your income, somewhere between 30-50% for most families.  Living paycheck to paycheck is not the way to build financial security.  Looking for ways to improve your cash flow, should be a focus of much of your financial planning.  Reducing expenses is the obvious place to start, but also understand that income tends to increase over time.  The challenge is that our expenses and cash flow tend to follow our incomes up over time. The Holy Grail of cash flow management is to both reduce expense and increase income until you are in a position where your assets pay your expenses and working for money becomes optional!
  • D) Taxes – owning real estate carries with it tax implications from property taxes, capital gains taxes, inheritance taxes as well as the tax code that helps homeowners reduce income and other Federal and State taxes.  Since the tax code is constantly changing and being adapted to the government’s priorities, it is crucial to pay attention to both the expense and potential benefits of the tax laws. Hiring professionals to help manage and mitigate tax strategies is usually very worthwhile. The more tax you pay owning real estate, the less the real estate will build financial security for you and your family. 

2) Cash Flow and Tax Planning Strategies

Since homes tend to consume the largest percentage of our income and the taxes related to real estate ownership reduce our wealth, it makes a lot of sense to spend some time focusing on improving those outcomes.

  • A) Rates on mortgages – are a simple way to manage cash flow. It is obvious to refinance higher rate mortgages into lower rates, but also, looking closely at the product is important.  Many people focus on shorter term mortgages, in an effort to avoid interest expense. A noble reason but one that overlooks cash flow, doubling the payment on your mortgage to save interest will save money but what is the opportunity cost on that cash flow? Could you have earned more or created wealth or accomplished another important financial goal with the same cash flow. And since mortgage interest is usually tax deductible, it is critical to evaluate each cash flow decision. 
  • B) Right product at the right life stage – taking a 15 yr. fixed a few years before retirement may not make sense, especially if you end up moving and selling your home. Taking a 30 yr. fixed, when you may move in 5 years also may not be the right financial decision. Each time you get a mortgage a careful evaluation of your financial plan is in order. Interest Only and Reve
  • C) Home Equity is an non-taxable asset– using home equity to accomplish any number of financial goals can be smart. Cash out refinancing allows access to generally tax-free money for other purposes, ideally to produce more assets and improve income or build wealth in other areas. Selling a home often produces a large tax-free lump sum and this happens only a few times in life. This pivot point can be used to make up for deficiencies in your financial plan, such as education, retirement, health care or legacy planning. 
  • D) Interest only and Reverse mortgages – are simply cash flow tools to be integrated into financial planning in retirement, they allow management of cash flow and home equity to create sustainable plans and improve lifestyles for millions of homeowners.

3) Diversification and Growing your Assets

Will protect you – keeping “all your eggs in one basket” has never been a wise idea and yet a vast majority of Americans have more wealth inside their homes that all their other assets combined. We feel safe with lots of home equity, but we cannot send our kids to school or buy food with shutters. We need liquidity to be safe!  You may have heard to idea of taking some “winnings off the table” when it comes to the stock market or even gambling.  We do not want to gamble with our homes but successfully using home equity over time, as the value of our home increases, is simply a way of diversifying our assets and building wealth.  When you sell or refinance a mortgage is the time to evaluate the opportunity to diversify the funds locked in your home.

  • A) Home improvement – add to the value of your asset
  • B) Education funding – prefund education for high school or college
  • C) Retirement funding – most of us will not make it with Social Security and our 401k – using equity to fund a non-qualified retirement plan can bridge that gap
  • D) Second home or investment properties – build your wealth
  • E) Health Care funding – long term care is a critical gap for many – self funding Long Term care through Single premium plans or cash value plans can be a huge safety net
  • F) Legacy Planning – pass on wealth while it can help the beneficiary, with estate and gift planning, home equity can protect the next generation now

4) Retirement and Education Planning 

Over the years I have heard of various strategies to pay for later retirement or education.  I am going to pay off this mortgage quickly so I can borrow again to pay for college, or I am buying this rental property and will sell it to pay for school or it will become my income later in life.  There is nothing wrong with these ideas other than they burn today’s cash flow to pay for a later need and it may not the most efficient way to build the assets needed to pay for retirement or education.

  • A) Paying off a mortgage more rapidly to only borrow later makes little sense.  Understanding the cost of money and possible rates of return over time, are likely to lead to a plan to grow the money more efficiently and with a lower cost.
  • B) Buying and selling real estate carries with it significant costs and tax implications, there is nothing wrong with rental real estate, but the costs and taxes do not make it suitable to pay for education or even retirement (the only exception being owing rentals for cash flow in retirement)
  • C) Reduce your cash flow today and invest in college funding plans like 529’s etc. 
  • D) Set up a Home Equity Line of Credit to have access to short term funding needs
  • E) Retirement income planning should include an integration of home equity, your mortgage, cash flow and other assets to create a sustainable lifestyle. Carrying a mortgage in retirement is not a sign of failure of earlier planning.  The cash flow related to the mortgage is simply part of the plan, whether that is a forward or reverse mortgage.  A reverse mortgage provides access to idle equity that can be used to achieve retirement goals and takes careful evaluation alongside your financial plan.

5) Grow your Real Estate Portfolio

Making money in Real Estate seems simple from the outside, we have all heard the stories of building a mini-empire with multiple properties.  However, for every successful investor there are hundreds that failed and lost money. Benefiting from Market appreciation is not making money in real estate and takes no skill.  Finding, acquiring, and managing property is a learned skill – it takes time, funds, significant effort and a bit of luck! The decision process around a Primary or Vacation home are very different from Investment property.

  • A) You make your money going in with investment real estate
  • B) Property type directs your Strategy – SFR, units, Multi-family, TIC; s Commercial
  • C) Strategy must be developed – Fix and Flip, long term hold, Passive or Active, Cash flow or appreciation
  • D) How is leverage going to be used – will properties be sold to increase to larger or more diverse properties or will equity be accessed via mortgage refinancing over time
  • E) Management – self managing or outsource management
  • F) Holding Structures – partners, LLC, TIC
  • G) Markets – once you start investing in Real estate you will discover that each market has unique characteristics and needs research and analysis before investing 
  • H) Success – how will you measure success? Cash flow, equity, income ROI
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