I Just LOVE Passive Income!

I got home yesterday and found a nice surprise waiting for me in my mailbox – a check for just over $1,000! This was a semi-annual disbursement from a private, closely held company I have invested with. The company buys foreclosures in the San Francisco area, fixes them up, and resells them. The principles raise a couple million dollars from private investors then form an LLC. The LLC exists for a period of three years, after which it is disbanded and the investment capital is returned to the investors (assuming there haven’t been losses). Disbursements of profits are made every six months. This was the fourth disbursement for this particular venture and with it, they have just topped the one million dollar total profit mark in this LLC. I have received a total return of 33.9% so far, which works out to an annualized return of 16.95%. Not bad for a completely passive investment!

I’m currently invested in two LLCs with this group. Each distributes profits every six months, so I receive a check approximately every three months. I hope to be able to increase the number of LLCs I’m in to six and that the disbursements remain staggered (something I have no control over), so that eventually I’ll be receiving a check each month.

What is there to learn from this? Network! I never would have found out about this investment group had it not been for someone on the richdad.com message boards. Of course, I did my own due diligence before deciding to invest with them and the investment is not without risk – I have a half-inch thick prospectus that details those risks in exquisite detail. However, so far it has turned out quite well for me. The returns are less that what I would get flipping properties on my own, or even renting a property on my own, but given that the total time I have invested in this is the time it took to read the prospectus and write a check (a couple hours, tops), I think this a good return.

Step by step guide to buying preforeclosures

Many people just starting out in real estate investing work at buying preforeclosures (meaning they contact people whose house has had a notice of foreclosure filed against it and attempt to buy the house and pay off the mortgage before it goes to foreclosure auction). This is mainly due to the fact that large amounts of capital are not needed - you just find a good deal, get it under contract, then sell your contract to an investor who does have the money to buy the place. People who do this are called birddogs, since they find the deals and bring them to the investor, who pays them for their work (usually a couple hundred to a couple thousand dollars, depending on the deal). Since the birddog never buys the house, he or she doesn't need any cash. Easy though it sounds, people still have questions about exactly what they need to do.

Some time ago, on the discussion boards at richdad.com, a poster named UtahInvestor gave instructions on how to do this. Unfortunately, his posts often contained lots of typos, grammar errors, and tended to jump around. Often, all the pieces needed were scattered over several different posts. I went through and gathered these posts and distilled them down to a series of steps the birddog needs to follow. I wrote out the steps for two scenarios: buying the preforeclosure yourself and selling your contract to an investor.

This information is powerful! This is all you need to take your first steps towards getting out of the rat race of your 9 to 5 job. You can thank me later :-)

For buying a preforeclosure and reselling it yourself

1. Check Recorder’s office for Notice of Trustee Sales filings. Find properties where first deed amount divided by the fair market value <= 75%. Don’t worry about second mortgages.
2. Send out postcards or call owners found in step 1.
3. For those people that are receptive, set up a face to face meeting.
4. Before the meeting, search court records for the owners – find out about divorces, criminal charges, etc. Anything that might create a need for them to sell. Use this information to stop you from offering too much.
5. Before the meeting, get a preliminary title report on the property from a title company to verify your findings of step 1.
6. At meeting, find out their pain – listen to them, determine what they need, and offer solution. Also check out condition of house and verify that your FMV appraisal in step 1 is appropriate.
7. Get quit claim signed by people on title. This should be notarized. Do not provide payment to owners at this time. They should move out immediately. Do not record the quit claim.
8. If there is a second mortgage, negotiate with mortgage holder to buy it.
9. When they have moved out, pay them. Meet them outside with their moving van. They give you the keys, you give them their money (or whatever they needed).
10. Get place cleaned, carpet shampooed, etc.
11. Place for sale ad in paper, post signs, get lockbox on door. (Or list with Realtor.)
12. Make sale. Fill out sale contract. Sign and notarize contract.
13. Take quit claim and sales contract to title company. Let them do their thing.

All above should take place in 30 days, more or less, to avoid getting more negative items on the owner’s credit report. If you need to do major repairs, you should insert step 5A where you find out the costs to bring the loan current, then make it current and keep it current until sold. In this case, you should not drag this out as the owners will not be able to get a new loan until their old one has been paid off.

For buying at preforeclosure and assigning contract to buyer

1. Same as steps 1-6 above.

7. Get sales contract with people on title. Buyer should be “your name or assigns”.
8. Notarize document.
9. Contact investor and negotiate price for contract.
10. Write assignment contract assigning your rights of the sale contract to the investor. Contract does not list amount you are being paid. Notarize.
11. Take both contracts to the title company.
12. Investor pays you either when the assignment contract is signed or when escrow closes.

This method assumes you trust the investor, as there is no document forcing him to pay you. If you do not get paid, you can file a Notice of Interest or Notice of Lien against property. If you do not trust the investor, you can have a non-circumvent agreement stating you get paid x dollars at the close of escrow. In this case, give that document to the title company as well and they will pay you directly. But keep in mind, there is usually no reason not to trust the investor - he's in it to make money and the more deals you bring him, the more he makes. Thus, it is in his best interest to treat you well.

The most important step is step 6!!!! You must establish a rapport with the home owner. Be a great listener. Find out their pain, what they need from you. These people are being deluged with offers from other people like you. Make them feel comfortable with you and you will beat out all the other people trying to get their home.

Slow week

It's been a slow week. Well, slow in terms of real estate matters. Otherwise, it seems I'm going non-stop. My daughter has an ear infection, as does my wife. Been trying to keep up with cleaning, cooking, going to the doctor, taking care of them, etc. Not getting much sleep since my daughter isn't sleeping well due to her ear... Is it Friday yet?

How REITs are helping me reach my IRA goal

As mentioned before, my goal is to accumulate enough shares of REITs in my Roth IRA so that the dividends they pay equal the amount the IRS allows me to contribute to it. For example, for 2004, the IRS allows me to contribute $3,000 to my Roth IRA, so I want to own enough stock to receive $3,000 in dividends. That, combined with my own $3,000 creates $6,000 flowing into my tax-free retirement account, double the amount the IRS allows me to contribute directly.

Let me first say, this is a purely arbitrary goal. I picked the 2X factor out of thin air. However, it presents a satisfying mental image to me. It’s like other companies are matching my contributions dollar for dollar.

This is also not an easy goal to reach. Obtaining $3,000 of dividends requires $30,000 of stock, assuming a 10% ROI, or yield, as it’s called in reference to stock dividends. Furthermore, the Roth IRA contribution limit changes each year. In 2005 through 2007, the limit will be $4,000. In 2008, it rises to $5,000. This means my goal is constantly moving upwards. Also, since I am limited to how much money I can put in each year, I am limited as to how much I can increase my dividend each year and thus, how fast I can reach my goal. Luckily, my REITs have dividend reinvestment plans, so I can harness the power of compounding.

Currently, I am almost 65% of the way to my goal: my Roth IRA is receiving a total of $1,900 in dividends a year from my REITs.

Here are my top three REITs:

SFI (iStar Financial) – This is the financially strongest REIT I have in my portfolio and the one I have held the longest. They currently are paying out $2.79 per share a year in dividends. The stock price, as of this writing, is $42.66, giving a yield of 6.5% - somewhat low by my standards. However, I started buying this stock back in 2001, when it was priced around $22, giving a yield that was closer to 11.5%. Since then, the CEO has been striving to get this stock rated “investment grade”, thus bringing it to the attention of the large mutual funds. He succeeded and the higher stock price reflects it. This company has increased its dividend every year since 1998, the first year it was a publicly traded company. iStar is a finance company focusing on commercial real estate loans. My annualized return is 27%. My total return on this stock, (change in share price plus dividends for the entire time I have held it) is 60%.

ANH (Anworth Mortgage Asset) – They are paying out a $1.32 dividend and their share price is currently $11.35, giving a yield of 11.6%. The company buys single family, adjustable and fixed rate mortgages on the secondary market that are guaranteed by the government or agencies such as Fannie Mae and Freddie Mac. Their dividend history is a bit more erratic than SFI’s, ranging from $2.00 a share to $1.32 a share over the last two years. This stock bears watching, as the company will be affected by changes in the Fed’s interest rate and possibly any problems that might turn up in the Fannie Mae and Freddie Mac investigations. My annualized return is -9.9% and my total return is -11.8%. The loss is mainly due to the drop in stock price – it has fallen a couple of bucks from where I first bought it. However, I am holding this stock for the dividends and they have so far cut my actual losses in half – I’ve lost about $2,000 via the drop in stock price but gained $1,000 in dividends. Since this is in my retirement account, I am comfortable holding on to it for a while and letting the cash income from the dividends help offset the share price drop. (That the price appears to have stabilized makes this a bit easier.)

AIGYX (Alpine Realty Income and Growth) – This is a mutual fund from Alpine that invests in dividend paying equities and securities which are principally engaged in the real estate industry. (While not technically a REIT, this mutual fund invests in them and pays dividends like them, so that’s how I think of it.) It has a 5 star Morningstar rating and has a “low” risk rating with a “high” return rating. Year to date (through August, the latest figures available), it has earned 12.4%. In both 2000 and 2003, it returned over 30%. In 2001, it returned 12.6%. Since this mutual fund can buy REITs, there is some overlap here with the individual stocks I own. For instance, this fund’s top holding, accounting for 4.35% of the fund’s assets, is SFI, which I also own outside of this fund. This bears watching because a serious problem with SFI can hurt me doubly bad. I just got into this fund a couple months ago. My annualized return is 11.6% and my total return so far is 6.3%. If you buy this fund through Schwab, there are no fees for buying or selling it.

Note: I am not a registered investment advisor. These are not recommendations to buy or sell any security. Do your own due diligence.

Real Estate In Your IRA

I’m not going to talk about buying property using your IRA. This is possible and legal using a self-directed IRA and there are many companies on the web that will help you do it. The only problem with this strategy is that all funds used must come from the IRA. So you can flip property, buy rental property, buy vacant land, or whatever using your IRA funds, but ALL costs – property costs, taxes, maintenance, insurance, etc. must be paid for from the IRA. In my area, costs for property are higher than the amount I have in my IRA, so this isn’t an option for me (unless I want to invest outside my area and I do not have the comfort level to do that yet).

But I can get a similar investment using the stock market and buying shares of publicly traded REITs. A Real Estate Investment Trust is a company that is required to pay out 95% of it’s taxable income as dividends to shareholders. Typically, a REIT will specialize in one type of real estate - shopping malls, hotels, residential units, etc. - and may also specialize further by geographic region. These companies own buildings and collect rent from the tenants, or they make real estate-backed loans and collect interest on the loan. These profits are then distributed to the shareholders. It’s not unusual to find REITs that have a 12% or higher dividend yield. Compared to the dividend of other blue chip stocks, usually in the 1% to 3% range, this is quite an improvement. (Dividend yield is the yearly amount paid in dividends divided by the stock price. It is basically your return on investment, ignoring fluctuations in the price of the stock itself.)

Unfortunately, the recently passed repeal of taxes on dividends does not apply to dividends paid by a REIT. This is because REITs themselves pay no tax and hence, the dividend does not incur the “double taxation” the law was written to eliminate. One way around this is to do what I have done – buy REITs inside of a Roth IRA. That way, all the dividends are tax-free.

By buying a REIT, you are basically investing in whatever type of real estate the REIT invests in, wherever it invests. You can thus tailor your IRA to your favorite real estate segment.

Next time, I’ll detail three of my holdings, my reasons for buying them, and the returns I have gotten. I’ll also discuss my goal: obtaining dividends equal to the amount I can put into a Roth IRA and thereby doubling my Roth growth.

Wiped out

What a week. My daughter got pink eye. We got that cleared up, then I got a sore throat. That turned into bronchitis. Then I got pink eye. Now my wife has pink eye and her throat is getting sore. I'm finally to the point where I can go about 15 minutes without coughing and last night was the first night in a long time that I got some decent sleep. As you can imagine, not much is happening in my real estate world right now...

Slow week

It's been a slow week. It seems like I've come down with a sore throat - probably something a bit worse, since it's sapped most of my strength. So I've been trying to take it easy and avoid passing whatever this is on to my wife and daughter.

My next LLC for flipping properties should be underway soon. My investors just listed a property and once that sells, they'll use the funds for my project. Average time to sell in their area is 16 days and figure a 30 day escrow on top of that, so it looks like right around Thanksgiving I'll be rolling again.

In addition to that, my savings are almost up to the point were it will be feasible for me to look into getting another rental soon.

Stay tuned!