Wednesday, December 30, 2015

Happy New Year 2016!

No post this week in celebration of the New Year!

Photo: Daniel Lee

Wednesday, December 23, 2015

An Introduction To Hard Money Lending

Last time, I mentioned how I like to receive cash flow from my investments, which is why I am a dividend investor. There is one other type of investment I like and have used for years to generate cash flow and that is hard money lending.

What Is Hard Money Lending?

Hard money lending is the process of making a loan based solely on the value of some item put up as collateral by a borrower. Hard money lenders are usually private investors who lend people money using a piece of real estate as collateral. Most lenders will only loan up to a certain percentage of the value of the property. For example, my partner and I don't loan more than 73% of the value of a property. This is referred to as 73% LTV, or loan to value ratio. So if a property if worth $100,000, we would loan a maximum of $73,000 based on that property. This is because if the borrower defaults and doesn't pay the loan back, we need to foreclose on the property and then sell it to get our money back. That process takes time and costs money, so the 27% cushion in the loan gives us some room to cover those expenses, should they occur.

When investing, my primary concern is that my principal is safe. I don't want to lose money (who does?), but no investment is without risk. So hard money lenders secure their investment by writing a mortgage on the property. This is just like a mortgage a bank would create when you buy a house, only in this case the hard money lender is the bank. The mortgage states how much is borrowed, what property is being used as collateral, and how long the borrower has to pay it back. This is a publicly recorded document and the house cannot be sold until the loan has been paid off. When this happens, another document is recorded stating the loan has been paid off and the hard money lender's claim on the property has been released. If you've ever bought or sold a house or refinanced a mortgage, you've gone through all this paperwork.

Hard money lenders usually charge borrowers higher interest rates than a bank would. This is because the whole process moves much faster, which is advantageous to the borrower. There is no credit check or income verification because the loan is based completely on the value of the property.

Who Uses Hard Money Loans?
So who would use a loan like this? People who need a big chunk of money quickly. The borrowers my partner and I lend to are people who buy houses at foreclosure auctions. When you buy a property this way, the entire purchase price is due in full by the end of the day of the auction. Obviously, there is no time to go through a loan process with a traditional bank. Enter the hard money lender. We loan the borrower money to buy the property. The whole process is handled through an escrow company, just like a regular house purchase. The escrow company handles the paperwork of writing and recording the mortgage and distributing the money to buy the house. The borrower then either keeps the house to rent out as an investment (and does a refinance to a standard bank loan later to pay the hard money lenders off and get a loan with a lower interest rate) or fixes up the property to sell it for a profit. The profits from that sale pay the hard money loan off and the rest goes to the borrower.

Who Are Hard Money Lenders?

I don't have enough money to make hard money loans for houses myself, so I have to pool my money with other people to make loans. This is where my partner comes in. He has several investors whose money he pools and lends out to borrowers. When a loan is made, each investor is listed on the mortgage so we are all fully protected. Altogether, our group of investors has a pool of about $6 million that we loan out.

There's much more to hard money lending than this and, if you are interested, I suggest you read about the 30+ loans I've made and written about on my real estate blog.

Why Do This?

So why switch from dividend stocks to hard money loans? Because I can get a better rate of return. My dividend paying stock is right now returning about 4.5%. With hard money lending, I can make between 7% and 8%. When I started years ago, before interest rates dropped, I was making 12%. Now yes, if the share price of my stock goes up, I could end up with a higher overall rate of return when you factor in stock price increases, but that's not a sure thing. Also, a stock price increase is not money I can spend until I sell the stock. Once again, I like cash flow and asset appreciation isn't cash flow.

There are other options for hard money lending besides real estate. and Lending Tree are large peer-to-peer lending sites that basically allow anyone to become a hard money lender. I lent money through eight years ago and I didn't enjoy the experience. I'm sure much has changed since then, but there is still one basic fact about their business model that I don't like: when you make a loan through them, it is an unsecured loan. If the borrower doesn't pay you back, you have almost no recourse. There is nothing you can sell to get your principal back. Recall when I said my primary concern was the safety of my principal? An unsecured loan is not safe. But if you've got $50 you're willing to gamble with and want to experience what hard money lending is like, go ahead and make a peer-to-peer loan. See if you like it.

Wednesday, December 16, 2015

A Guide To Dividend Investing

When it comes to investing in stocks, there are all sorts of different strategies people use. Growth investing is the strategy of buying the stock of small companies that you think will get bigger. A growth investor might have bought stock in Microsoft in the 1990s, believing it would grow into the huge company it now is. Value investing is buying stock of established companies when their stock price is less than what the company is actually worth. For example, if a value investor thinks a company is worth $10 a share and the stock is currently trading at $8 a share, this would be a buying opportunity. Warren Buffet is the most famous value investor. Dividend investing is the strategy of buying stocks that pay dividends. And, of course, investors can use a mix of strategies.

There are a couple hurdles with the first two types of investing. Growth investing requires you to be able to predict which companies will succeed and which will fail. Value investing requires you to be able to read financial statements and determine what a company is truly worth. This is not to say it is impossible to be successful with these strategies. It just takes a good amount of specialized knowledge (or good luck).

They also depend on one other thing - the rest of the market eventually coming around to your point of view. These strategies depend on stock price increases in order to generate a profit. If the stock price increases, that means the general public has finally acknowledged what you discovered earlier and those companies' stocks will be in demand. To put it in real estate terms, this is like buying a house as an investment and waiting for it to appreciate in price.

Why I Like Dividend Investing

Dividend investing, on the other hand, doesn't rely on share price increases to generate a profit. Instead, dividend investors are looking for the income stream the stocks provide. So obviously, a long term dividend investor should be worried about two things: how reliable is that dividend and how stable is the company?

A good dividend investment would be the stock of a company that has a long history of paying (and preferably, raising) dividends. They should also be a stable company with a reliable income,which will enable the company to continue paying dividends in the future.

Choose Your Own Adventure

A cool fact about dividend investing comes from the definition of a stock's dividend yield. As I mentioned last time, this is calculated with this formula:

Using this, if we know the stock's dividend, we can choose our purchase price to get the return we want. It's just like those Choose Your Own Adventure books, but you get to choose what return you want. Well, within reason.

Let's look at this using my favorite stock, Realty Income (O). At the time I am writing this, the company is paying a monthly dividend of $0.1905 per share. That works out to $2.286 per year. The stock is currently trading at $50.11, giving a yield of 4.56%. But suppose I want to earn 4.75% instead. Using the above formula and solving for Current Share Price, we can see a stock price of $48.13 will result in a yield of 4.75%. I just have to wait until the stock price drops to that point and buy it to get that return rate.

Now whether or not this is achievable, is another matter. You'd have to wait until the stock price drops to that level and it may not. But if you just have to have that 4.75% instead of the 4.56% and you have patience, you could reach your goal.

The nice thing about this is that, as long as those two requirements are met - the company continues to pay the dividend (or increases it) and the company stays in business - the dividend investor really doesn't care about the share price after the stock has been purchased. As long as the dividend doesn't fall, the money spent on that stock will always be earning the same percentage rate.

Suppose I buy $10,000 worth of Realty Income stock today at $50.11 per share. As long as the dividend remains at $2.286 per share per year, that money is always earning me a 4.56% return, no matter what the stock price does in the future. I've already bought that stock at that price, so that rate is locked in, even if the stock price falls to $30 or rises to $60.  As long as I don't sell the stock, I'll be earning 4.56% on my $10,000 investment.

Why I Like Realty Income

My previous experience as a real estate investor has taught me that cash is king. It's all about the cash flow. I want passive income and that is the ultimate goal that this blog is documenting - my quest to buy a Tesla with passive income. Hence my preference for dividend investing.

As mentioned earlier, the two most important things a long term dividend investor cares about are the stability of the dividend and the stability of the company. This is why I like Realty Income. The company is a real estate investment trust (REIT), which means they own property and rent it out to others and collect rent. They market themselves to investors as "The Monthly Dividend Company," in part because they pay dividends monthly while most stocks pay them quarterly and also because their dividend is what they are known for.

The company has been paying monthly dividends for 543 consecutive months. That's over 45 years! I'd say that's a pretty darn consistent dividend history.

They have increased their dividend 82 times since they were first listed on the NYSE in 1994 and they have increased it for 72 consecutive quarters. Look at this chart of their dividend history:

Constantly increasing. Very nice. And it's even more impressive when you realize that they were able to continue increasing their dividends even when the real estate bubble collapsed a couple years ago. They have never, in their entire 45+ year history, decreased their dividend.

This company has everything a dividend investor looks for in a company. That's why I love them.

Next Steps

As I have mentioned a couple times here, I'm not going to stay in dividend stocks forever. I plan to move into the hard money lending area once I have $20,000 saved up. Tune in next week to find out why.

Note that I am not an investment advisor and I am not recommending any specific investment. Consult your own advisor for advice specific to your situation.

Wednesday, December 9, 2015

Risk And Investing For Income

Last time, I talked about calculating yields for stocks and how that figure can be used to compare differing investments. If you recall, we looked at three different investments:
  • A typical savings account paying 1% or less
  • Realty Income stock (O) paying 4.58%
  • Microsoft stock (MSFT) paying 2.95%

If we just look at the yields, it looks like the obvious choice is Realty Income. But this overlooks one important factor: risk.

How Safe Do You Want To Be

Investing in stocks always involves risk. Stock prices change each second the market is open. Because a stock's dividend yield is determined by the stock price, this means their yield is also changing by the second. The calculation of a stock's dividend yield is:

As you can see, two factors can cause the yield to change. If the dividend paid out is increased or decreased, the yield will increase or decrease. However, because the share price is the divisor of the yield calculation, it has an inverse relationship with the yield. If the share price goes up, the yield goes down. If the price goes down, the yield goes up. Both the price and dividend can change at any time. A company can reduce or even completely eliminate its dividend. The company can also go bankrupt, reducing it's stock price to zero. This is why stocks have risk.

A savings account however, is pretty much risk free. Assuming you are banking at an institution that has some sort of government insurance, your principle is guaranteed to never lose value by either the FDIC (for banks) or the NCUSIF (for credit unions). Obviously, this safety comes at a price - a lower yield.

Don't Chase High Yielding Stocks

It may be tempting to search for stocks that have a high dividend yield. If that is all you are looking at, you can get in trouble. For example, I used Yahoo's stock screener to look for stocks that have a dividend yield of at least 20%. The top result returned was Atlas Resource Partners, with a dividend yield of 43.5%!
Click to embiggen

But before you put all your funds into this stock, look a little closer. The yield is so high because the yearly dividend is $1.30 and the share price is only $2.99. And see that EPS number? That stands for Earnings Per Share. That number is negative, which means the company is losing money - it's losing $6.53 per share. Basic common sense should tell you that the dividend is likely going to be reduced or cancelled altogether very soon. If the company is losing $6.53 per share, how long can it afford to pay out $1.30 in cash to investors each year? In fact, the company itself could go under.

When you screen for stocks based solely on dividend yield, you may end up with a bunch of penny stocks that no serious investor should buy.

Next week, I'll go over what I look for when buying a stock for dividends.

Wednesday, December 2, 2015

Goal Update: End of November 2015

At the end of each month, I post an update of my goals, including a brief discussion of any notable events that might have occurred during the month. The latest month's figures can always be found under the Featured menu in the menu bar at the top of the blog.

Last updated: End of November, 2015
Current value: $18,701
Change from last month: +$559
Percent of Goal:  17.20%

click to embiggerate

Note that the funds in this account are invested in stock, so there will be fluctuations in value that are outside my control. I never withdraw money from this account, so any dips are purely due to stock price changes.

Events Of Note Last Month:

Income this month from my online courses sales was $365, about the same as last month. Sales for the next two or three months will be relatively lower, based on past experience. I guess people aren't interested in learning about SQL Server during the holidays. Go figure.

I received $6 in ebook royalties. Woo-hoo!

My account didn't have the big jump in value like it did in October, but it held on to its gains, which surprised me. I expected the stock price of Realty Income (O) to pull back a bit.

Once again, I'll take a moment to point out I have added a contact page here so you can send me an email or questions, if you so desire. Just click "Contact" in the menu bar. I'd love to get some Q&A posts going.

Realty Income stock is getting up there in price again and I am tempted to sell some covered calls to get some extra income. I think everyone is counting on the Fed raising interest rates before the end of the year, and a move like that typically causes REIT prices to fall. That would mean my covered calls would be unlikely to get exercised and I'd get to keep my shares (and the money from selling the calls), but I'm having a hard time pulling the trigger on this one.  I don't want to sell my shares. Actually, I just thought of what I might do.. Since I plan on selling when I hit $20,000 anyway, I might sell some covered calls at a price that would net me that much if the options were exercised. I'll have to look into this...