UNDERSTANDING FINANCIAL STATEMENTS

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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What is it and Why May it be Important?

A financial statement gives an accurate and current snapshot of your finances and investments. It let's you know where you are so that you can plan well for where you want to be. Financial statements allow a person to invest in both real estate and businesses knowing exactly what you are getting into by understanding the numbers. 

I'm including an example financial statement I created that is based on Robert Kiyosaki's teachings on these because I find it simple for teaching new investors how to begin looking at cash flow. 

I realize this may be difficult to see, especially if you are attempting to read this post on a phone, but I simply want to give you a general idea at this point.

When investors talk to me about risk I immediately refer to financial statements because they give such a clear picture of risk vs. strength of an individual investment or business as well as a person's overall financial picture.

How do I Learn How to Use it?

As you can see above, there are two major parts of the financial statement. The first is called an income statement and shows your income as well as your expenses (again, you can use this for investments/businesses as well as your personal financial picture). Below the income statement is a balance sheet which shows your assets as well as your liabilities. Both of these are extremely important to understand. 

Before going forward I want to quickly recommend that each and every person reading this post talks to you accountant about financial statements so that you have a professional opinion on this. I'm giving some very simple basics in order to start you off, but if you really want to move forward with this you will want to speak with an accountant. The problem with some accountants is that they may not understand the difference between a liability and an asset, so I'll go over these two concepts quickly right now

What is an Asset?

An asset, and my definition will be different than other people in your life at some points, is anything that puts money in your bank account. A liability is anything that takes money out of your account. I'll provide a few examples:
-Your home is not an asset, it is a liability because it costs money each and every month. Even when the mortgage is paid off it is still a liability because you are paying property taxes, maintenance, insurance, and utilities to keep the thing. Yes, your home can have equity in it, but that doesn't mean it is an asset. You bank will disagree with this definition. They will call it an asset. One reason, in my opinion they call your house an asset is because while you have a mortgage on the house it is an asset to the bank (it puts money into the bank's accounts each and every month)
-If you write a book and collect royalties for the rest of your life... the contract and book are assets.
-If you own a property that cash flows after ALL EXPENSES are accounted for it is an asset (please read my previous post on this for a definition of expenses. This will at least provide a brief explanation to get you started)
-If you own a property that you must manage yourself in order to make it cash flow... it is an incredibly sketchy asset. Why? Because as soon as you can't mange the place for a month it can instantly turn into a liability. If you get into an accident or die and your family doesn't know how to properly manage a property, it has become a liability for your family. Most "investors" in real estate do not own assets. They own liabilities.
-If you loan money to a family member with a contract that states they will pay you back the loan with interest on a monthly basis... this loan to them is an asset.

How do I Learn about Risk from a Financial Statement?

I will explain this very quickly using a few examples. You can judge who is taking bigger risks. Person A owns 5 rental properties (assets) that all cash flow and she has a full time job that pays $50,000 each year which is enough to get by on year to year. Person B has no assets, but has a job that pays her $200,000 each year and a pension that states it will pay her $60,000 each year until she dies in her retirement. Who has taken care of their risk of not having money in retirement better?

Person C invests in a single family home. It cash flows at $1,000 each month and the outstanding mortgage is $200,000. Person D invests in a multi-family property that has 10 units with each unit cash flowing at just $50 each month and an outstanding mortgage of $1,000,000. Both of these people have the same income each year from their job ($60,000). Who is in the best place to manage their risk with all other factors being equal?

Hint: Evaluate these scenarios by plugging information into a financial statement to see how things change. As a general rule, the more assets a person has and the more sources of income (income streams) a person has, the less risk that person is taking. Why? Because if one income stream disappears for any reason, there are others to rely on. If there is only one income stream it doesn't matter how big it is, if it disappears, there is no income left. Also, no matter how big debt looks, if it is consistently paid off the risk of this debt is mitigated. If a property has multiple income streams, it has less risk because if one income stream dries up, there are others that will still balance the books.

Summary

Financial statements are not extremely difficult to understand, but they will take some practice and potentially some help from someone who knows more about them than you do in order to make sure you are taking everything into account. Having said this, they are extremely valuable tools for evaluating your financial picture or an individual investment.  If you don't understand the basics of financial statements I would recommend you don't invest in anything because you are taking on a lot of risk no matter what you invest in without understanding the risk. Overall what I recommend is that you being to understand financial statements and then begin investing for your future!

Here's to your future of risk-averse investing!

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html

3 REASONS YOU SHOULD ATTEMPT TO OWN PROPERTY AS LONG AS POSSIBLE

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

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Long And Boring Wins The Race

If you listen to most radio shows, watch most TV broadcasts, or read most papers on investing you probably, like me, get it in your head that the entire world invests for the short term. There are a ton of shows out that promote quick and easy profits from flipping houses. It seems that the quicker, the return the more people desire that return. My post today is attempting to argue that the best money to be made in real estate is really very long term in focus. While many people live and die with the excitement of stocks or ups and downs of flipping strategies, look at the following paragraphs with an open mind for the boring.

3 Reasons Boring Does Win The Race

1. The first reason holding properties for a long time is that a property owner's highest interest rates are paid first. This is actually true no matter what strategy you use or even if you simply own your own home. The banks make a ton of money from you when you sell a property within the first 5-10 years of its mortgage. Why? Because mortgages are front end loaded. Take a look at your mortgage payments the next chance you get and you will see I speak the truth. If you have a $300,000 mortgage amortized for 25 years at an interest rate of 3%, you will pay almost $8,900 just in interest in the first year of that mortgage, or almost $42,000 in the first 5 years. In the last five years of the mortgage the interest payments will equal almost $7,000, and in the last year you will pay a grand total of almost $300 in interest.

Again, mortgage interest is front loaded in order to give the bank a major portion of their money up front and allow them to take advantage of people who move constantly. You pay off little principal in the first 5-10 years, but pay off a ton of principal later on in the mortgage

2. I have covered this second reason in a previous post. Click on this link if you want to read more about how it works. Did you know that the longer you own a mortgage, the less each dollar of the mortgage is worth? Inflation eats away at our money constantly. If you believe that inflation is at 3%, then you $1 today will be worth $.50 in 21 years. In other words $100,000 today will be worth $50,000! What this means is that the longer you hold that mortgage, the faster it becomes easy to pay off. A different way to explain this is that if you make $7,000 each month right now and continue to make the equivalent of what $7,000 can purchase today you will be making $14,000 in just over 21 years, but your mortgage payments will remain the same... If they are $2,000 each month right now, they will still be at $2,000 each month if interest rates stay the same.

Again, it becomes easier to pay down the mortgage because it is quickly worth less as time goes by. Owning a house long term is to your benefit. If you don't believe me, ask your parents or grandparents how difficult it was to make their payments in the first few years of their mortgage and how easy it is now (This only works if they have kept one property for a long time without refinancing it).

3. You save an extreme amount in taxes if you hold properties long term. I discuss this in detail in this post if you want to know more, but I will summarize that post quickly here. You pay taxes on the increase of a property's worth when you sell that property. If you never sell the property, you never have to pay taxes on it's gain in equity/value (your estate may not have to pay either if you set things up properly for your children when you die). You can even pull most of the equity out of the property without paying taxes on it. You do this by taking our a home equity line of credit. This actually decreases your taxes even more because you will be paying interest on that line of credit and the interest is a tax write off in itself!

Summary

I recently read the book "The Millionaire Next Door" and was reminded that North Americans who are wealth consistently build their wealth by holding onto their investments long term. The book was written by a couple of men who give detailed statistics for most of what they explain in the book and I highly recommend the read. Owning real estate for long periods of time is how many of the boomer generation became millionaires. Those who didn't, yet invested quite a bit of money in various investment classes typically bought and sold investments more frequently.



Here's to your future of risk-averse investing!

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html

Can my mortgage be an asset?

By: Mark Frentz
www.akerahomes.com
mfrentz@akerahomes.com

Remember: Please share this article if you find it enjoyable

Words Give Us Clues

Did you know that 'mort' comes from Latin and means 'dead' and that 'gage' comes from a French word meaning 'pledge'? In other words the origin of a mortgage means something like 'dead pledge'. Basically, if a bank lends money for a house and payments aren't made on time, their pledge to continue to give money is dead (they can take back the property to pay the debt). And if the house is paid off completely, the pledge to pay for the loan with the house is dead (there is no longer any debt owed). Either way, somebody's pledge/commitment dies when the situation plays itself out.

Why is this important for understanding mortgages? Because originally mortgages were never meant to allow somebody to take advantage of banks or other lenders. Instead they were a way that banks/lenders could take back something of value if the borrower didn't pay. That has changed a lot in the last 70-80 years. Many years ago a family could only borrow a small amount of the cost of the house (under 50%) and would have to pay off that debt within 3-5 years. Now a family, in Canada at least, can borrow up to 95% of the money needed for the house being purchased and can take 25 years or more to pay off that debt! With the big five banks (TD, RBC, Scotia, CIBC, and Bank of Montreal) they will typically lend, at the most, for 25 years at the time of this post. Other lenders (credit unions and insurance companies) will at times lend longer than that.

How Can A Mortgage Be An Asset?

First, it is important to understand that if you are investing in real estate that doesn't cash flow the argument I am about to make isn't as valid. I always recommend purchasing real estate that cash flows in order to cover risk. Having said that... What a mortgage allows a person to do now is borrow money at a certain price and pay that money back at a different, lower, price. I will give you an example to help make my point:

If inflation increases at 3% per year for the next 21 years we will pay $2 for something that costs $1 today. Have your parents ever told you about the time when they could buy a bottle of coke and a chocolate bar for 15 cents? The reason it costs more now is due to inflation. The reason inflation takes place is that our government makes money out of thin air (the more they make, the less valuable each dollar is because of supply and demand). Over time inflation DEVALUES our currency. So, those people who are keeping their money in a sock drawer or in the bank for long periods of time are actually losing money because their money is worth a little less each and every year that inflation takes place.

The way this effects a mortgage is that if you borrow $200,000 in year one and you have $100,000 left to pay in 21 years, that $100,000 that you owe is worth about half of what it is now worth. Another way to say this is that the you will still owe $100,000, but you will now be paying it back with money worth about $50,000.

I wish there were a really easy way to explain this, but I haven't thought of one that works really well. There are two key aspects to what I am attempting to explain. The first is that if you borrow money for a very long period of time, you will be paying it back when it is worth less than it is now which means it will be easier to pay back (it will be easier to earn $100,000 in 20 years because your wage will probably have about doubled). The second key is that all along the process of paying back loans you won't be paying it yourself, it will be the tenant who pays back this money. Because you will be making higher rent by that time, you will be putting more money into your pocket (if rent is costing your tenant $1,000 each month now, it's fair to assume it will have about doubled in 21 years and they will be paying you $2,000). So, if my mortgage payment is $600 each month now it will still be around $600 in 21 years, but I will be making an extra $1,000 from rent which goes straight into my pocket (the increase in maintenance costs won't be extreme enough to change this equation significantly).

Summary

This basic explanation of how mortgages work to our favor is that we can borrow at today's dollars and pay that debt back with future, devalued, dollars. When purchasing an income property it is sometimes wise to stretch the payment out as long as possible... that way you will be delaying the payment until you have more money to pay it back with. The only caution in all of this is that interest rates are at the lowest they have every been at in all of recorded history as far as I know. It is likely that at some point in time interest rates will rise significantly (it was only 35 years ago that interest rates for mortgages were over 20%). Always research what you want to do and how you want to invest and always connect with professionals in the industry in order to get an educated opinion before you invest, but then invest wisely and grow your wealth in so many ways because real estate is the most advantaged asset class on the planet!

Note: The main point of my argument above also applies to our family home, but only if we live in it for a long period of time. The average family is purchasing a new home every 5 years or so.... I'll cover why that's a terrible idea in a future post.

 

Here's to your future of risk-averse investing!

If you would like to learn more about investing in real estate please contact me at the email address listed at the beginning of this article or go to my website at: www.akerahomes.com/investing-in-real-estate.html