investment income en-US Retirement: Not Just for People? <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/retirement-not-just-for-people" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="" alt="man by beach" title="man by beach" class="imagecache imagecache-250w" width="250" height="141" /></a> </div> </div> </div> <p>This has always been true &mdash; almost all the economic value of a typical household is the future value of its members' labor.</p> <p>With a little foresight, this will change over time. As your career progresses, you build up savings and investments, with the goal of replacing your income from labor with income from financial assets, preparing for some future time when you can no longer work. You accumulate other assets as well. Household goods, once purchased, continue to provide value for years or decades. If you pay off your mortgage (rather than doing a series of cash-out refinances), you eventually own a house you can live in. (See also:&nbsp;<a href="">What It Really&nbsp;Costs to Own a Home</a>)</p> <p>A lot of what I've written here at Wise Bread has been to advocate for this shift. To advocate for making it early. To advocate for making it consciously.</p> <p>One thing that I hadn't really thought about until recently, is that corporations have been making much the same shift.</p> <p>Until around 1980, the economic value of a corporation was almost entirely the value of its productive capacity. Over the next decade or two, that changed. Instead of investing in plant and equipment, corporations found it more profitable to set up financing arms, to lend their customers the money to buy their products. During the 1990s and early 2000s, companies like General Electric and General Motors found that their money-lending businesses made much more money than their manufacturing businesses.</p> <p>This had a lot of negative side effects. It led to the elimination of good manufacturing jobs, only partially offset by the creation of finance jobs. This shift, as much as off-shoring, was what eliminated six million manufacturing jobs over the past 20 years.</p> <p>It also made corporations much less answerable to their customers. Before, companies either produced what people wanted to buy, or else their profits suffered. After this shift, it scarcely mattered what corporations produced, because so much of their income was <a href="">investment income</a>.</p> <p>Basically, the corporations could retire.</p> <p>This shift only benefits the management &mdash; they can now report reliable profits without having to actually do any work.</p> <p>It might be nice if the harmful effects on workers would be enough to promote change, but I don't think that's going to happen. Fortunately, this whole thing is also a negative for shareholders &mdash; the corporate structure doesn't provide any value-add for the shareholders. (Really, it's of negative value &mdash; another layer of expense and another layer of taxation.) The shareholders would be much better off simply getting their money back and investing it themselves.</p> <p>So, although the negative side effects are large, I don't think they're permanent. I foresee an end to the days of retired corporations. If you own stock in such a corporation, you might consider whether your money would be better off in a <a href="">company that actually does or makes something</a>.</p> <a href="" class="sharethis-link" title="Retirement: Not Just for People?" rel="nofollow">ShareThis</a><br /><div id="custom_wisebread_footer"><div id="rss_tagline">Written by <a href="">Philip Brewer</a> and published on <a href="">Wise Bread</a>. Read more <a href=""> articles from Wise Bread</a>.</div></div> Financial News Investment Retirement corporations investment income Manufacturing Tue, 18 Sep 2012 10:00:43 +0000 Philip Brewer 954552 at So You Want to be a Landlord? Part II: How Do You Actually Make Money? <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/so-you-want-to-be-a-landlord-part-ii-how-do-you-actually-make-money" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="" alt="" title="" class="imagecache imagecache-250w" width="250" height="167" /></a> </div> </div> </div> <p>I know we're not completely done talking about risk in this series (see the first post <a href="/so-you-want-to-be-a-landlord-part-i">here</a> ), but Paid Twice, from <a href="">I've Paid Twice For This Already</a> asks an excellent question with regard to the rent vs. buy debate. Namely, if you can save more money by renting a house than buying, then what is your landlord doing?</p> <blockquote><p><em>So I ask my readers - how does this work? Anyone know how renting can be so much less expensive than buying, yet the home&rsquo;s actual owners don&rsquo;t lose piles of money?</em></p> <p>&nbsp;</p> <p>&nbsp;</p> <p>&nbsp;</p> <p>&nbsp;</p> </blockquote> <p>You can read the whole post over at <a href="">Someone Had to Buy the House You Rent</a>.</p> <p>The truth is that rents sometimes do not cover the monthly costs of owning the rental home, so how is it that these real estate gurus make their money? A lot of people think that it must involve unfair tactics, such as buying investment property at below-market rates from gullible elderly people, but there can't possibly be enough gullible elderly people to keep the whole industry going. Others think it must be because all of the property is fully paid for, or that it was financed for better terms than today's rates. <strong>However, economically speaking, rental rates in today's dollars have to somehow make sense with today's property values and interest rates.</strong> And remember that not all rental property is residential. There are a lot of investors out there buying office and industrial space to rent out. How does it all work?</p> <p>What we need here is a calculator and the back of an envelope. The first thing we need to do is identify the two different sources of income from investment property. The first is equity appreciation. This is a primary strategy for some real estate investors, who target undervalued real estate, or real estate in areas likely to increase in value, and then buy and hold until they decide to sell. There are many types of rental property, and even in a down market like today's (or especially in a down market) you can make money this way.</p> <p>The second income stream is rents. A lot of landlords buy up properties and hold onto them indefinitely, living off the rents, which will increase proportionate to the finance expenses of the property the longer you hold it. Although some landlords may focus on one strategy or the other, the truth is that both are in play for any given property.</p> <p>Getting out the envelope, let's make some assumptions (and remember the back of our envelope is small, so we are not going to to be excessively detailed about this).</p> <p>We are buying an investment property today for $200,000, with a $60,000 down payment (30%) and financing it for 6.75% for thirty years. The going rate for a mortgage on your primary residence today is 6.13%, so 6.75% should be about right for an investment property.</p> <p>First, the monthly expenses.</p> <ul> <li>Monthly mortgage payment (principle and interest): $908.04</li> <li>Taxes and insurance (50 mills): $483.33</li> <li>Water utilities (typically renters don't pay for this themselves): $50</li> <li>Maintenance (sinking fund*): $166</li> <li>Total: $1607.37</li> </ul> <p>The rent you can charge is determined both by market demand and costs. This particular house is a two bedroom, one bathroom starter home, and $1100/month is all you can get for it.</p> <p><strong>Your monthly cash flow for the house is -$507.37. Ouch!</strong></p> <p>Why would anyone do this? Well, let's look at things a different way, by checking out your profits.</p> <p>First, there's your equity appreciation. Let's go with the doomsayers for now and assume you can barely keep up with inflation on your investment, so it's going to appreciate at a modest 5% per year. (Feel free to play around with different numbers on your own time.)</p> <ul> <li>Market value up 5%: $10,000</li> <li>Rent collected: $13,200</li> <li>Interest Payments: -$9450</li> <li>Property taxes and insurance: -$5800</li> <li>Maintenance: -$2000</li> <li>Net profit: $5950</li> </ul> <p><strong>That's a 9.9% annual return on your investment of a $60,000 down payment. Not bad!</strong></p> <p>Now, this doesn't &quot;feel&quot; like a profit to the landlord because much of it is tied up in unrealized capital gain, and the monthly payment includes principle, so some of the monthly &quot;cost&quot; is money he's paying toward his debt liability. In other words, the small principle payment ($1492.05 the first year) is not really &quot;cost.&quot; That is money paid back to himself.</p> <p>There are also income taxes on the $13,200 in rents to be considered. However, the IRS gives you a lot of deductions for owning rental property, including the ability to depreciate the entire property (the structure of the building, that is, not the land) and appliances or equipment you use for your rental business. For that reason, the effect on your bottom line at tax time could actually be to reduce your tax liability. (I am deliberately avoiding a full discussion of taxes here. That's another post.)</p> <p>Although we could decrease that 9.9% annual return further by taking into account income tax, when looking at comparable investments, such as the stock market, it is customary not to deduct what you expect to pay in income or capital gains tax and so we won't do that here, but simply note that a 9.9% annual return compares quite nicely to what you can expect from stock market investments and mutual funds. Most people should be glad to get around 10% per year on any investment, before taxes, brokerage fees, and inflation.</p> <p>And this is why landlords lord lands. It doesn't require dishonesty, just a healthy tolerance for risk (which we'll talk about next time) and occasional conflict. Oh, and about $60,000 cash.</p> <p>*This assumes you are replacing your roof, furnace, and exterior paint or siding and windows every thirty years, and you are doing some miscellaneous repairs each year.</p> <a href="" class="sharethis-link" title="So You Want to be a Landlord? Part II: How Do You Actually Make Money?" rel="nofollow">ShareThis</a><br /><div id="custom_wisebread_footer"><div id="rss_tagline">Written by <a href="">Catherine Shaffer</a> and published on <a href="">Wise Bread</a>. Read more <a href=""> articles from Wise Bread</a>.</div></div> Real Estate and Housing investment income investment property Making Extra Cash real estate renting Thu, 13 Mar 2008 23:31:35 +0000 Catherine Shaffer 1915 at