With the World Working from Home, How Can Real Estate Be a Good Investment?

With the World Working from Home, How Can Real Estate Be a Good Investment?

 

One of the most noted and real impacts of the coronavirus is that employees are working from home. While it has been a huge shift, four plus months in, the results have been positive for many, and headlines in business publications are examining whether a substantial fraction of these employees may never return to the office. There is solid debate about how big the impact will ultimately be, but there is no doubt that companies will be revisiting their spaces.

This trend might lead one to worry that real estate values will plummet as demand falls and supply stays constant. To this I would offer two counter points. First and foremost, commercial real estate encompasses a wide range of investments. The pie chart below shows the sub-sector breakdown of the holdings of our most widely recommended real estate investment, the Dimensional Global Real Estate Fund (DFGEX).

REITs that focus on office properties as of June 30th, 2020, made up just 12% of the fund’s allocation. Office REITs do not just own high-rise commercial office buildings in downtown cores. Much of the space they own is in suburban office parks and includes space leased by dentists, hairstylists, lawyers, and small research and engineering firms. While many more things can be done virtually, there are still many businesses, such as orthodontists and spas, that will always require an in-person experience.

While demand for some types of office space may be dropping, demand for other types of real estate in the fund is growing. As of June 30th, the top three holdings in the Dimensional fund were American Tower Corporation, Crown Castle International Corporation, and Prologis Inc. American Tower and Crown Castle are owners and providers of infrastructure for wireless communication and fall into the Specialized category. Prologis is in the logistics real estate business, leasing distribution facilities to support direct fulfillment to customers. All three of the companies are poised to see substantial growth from increasing demand. The fund owns many other businesses, from cold storage warehouses to multi-family apartments to medical facilities, where demand remains high.

The second point is that changes always follow any societal upheaval. There is no doubt that COVID will have an impact on our world. However, it is unclear that the shifts will be as radical as some are predicting or that COVID alone will cause the demise of industries or institutions. Large scale change rarely happens that quickly or dramatically.

For example, the idea that demand for office real estate will suddenly drop 60–70% seems overblown. IBM was an early proponent of telecommuting. In a 2009 report, they boasted that “40 percent of IBM’s some 386,000 employees in 173 countries have no office at all.” According to an Atlantic article from 2017, they unloaded 58 million square feet of office space at a gain of nearly $2 billion. By all accounts, it sounded like a winning strategy. Only, it did not work out, and in March of 2017, IBM decided to move thousands of its workers back to physical company offices.

The problem was likely a drop in what the Atlantic terms “collaborative efficiency”—or the speed at which a group successfully solves a problem. Physical distance still mattered when it came to team creativity, and remaining competitive in a rapidly changing landscape more and more requires novel solutions to complex problems. Offices may look different, but I believe that more than ever people and employees will need places to gather and connect.

The future trajectory is never clear even to the greatest minds. What is clear is that people will always need spaces to live, work, and conduct business. What those spaces look like will evolve, but companies are motivated to adapt. And historically, they have changed industrial warehouses and former malls into Amazon fulfillment centers and multi-family apartment complexes. Despite the recent drawdowns and changing landscape, we believe that investing in a diversified real estate portfolio continues to offer the potential for equity-like returns, current income, and solid inflation protection, all important elements of a well-balanced portfolio.

 

Inheriting an IRA? New Rules to Consider Under the SECURE Act

Inheriting an IRA? New Rules to Consider Under the SECURE Act

 

The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019, creating significant retirement and tax reforms with the goal of making retirement savings accessible to more Americans. We wrote a blog article detailing the major changes from this piece of legislation.

We’re going to dive deeper into some of the questions we’ve been receiving from our clients to shed more light on topics raised by the new legislation. We have divided these questions into six major themes; charitable giving, estate planning, Roth conversions, taxes, stretching IRA distributions, and trusts as beneficiaries.  Here is our sixth of six installments on inherited IRAs.

 

I’m about to inherit an IRA. Will these changes mean I pay more taxes?

Before the SECURE Act was signed into law, non-spouse IRA beneficiaries were able to stretch RMDs over their lifetime with annual RMD calculations based on their life expectancy. However, the implementation of the SECURE Act requires non-spouse beneficiaries to distribute an inherited IRA within 10 years following the death of the original owner. Inherited IRAs left to minor children must also be fully distributed within 10 years of the beneficiary reaching the age of majority.

Distributing your inherited IRA balance over 10 years instead of over your lifetime will accelerate your receipt of income. If you inherit a large Traditional IRA, income from your inherited IRA could push you into a higher tax bracket and increase your tax rate. We can help you plan the best way to distribute income from your inherited IRA within 10 years relative to your income and tax situation each year to minimize additional taxes.

For example, an individual who is earning a gross income of $150k per year would fall in the 24% marginal tax bracket after claiming the standard deduction. However, adding annual $100k+ distributions from a $1.0 million inherited IRA balance that must be distributed over 10 years will push that person into the 35% tax bracket. If income fluctuates over that period, there may be opportunities to take additional distributions in lower income years to minimize overall taxes on the inherited IRA.

We can help you avoid running afoul of the new SECURE Act requirements by evaluating your income and taxes to develop the best strategy for adhering to the latest rules for your inherited IRA.

As with all new legislation, we will continue to track the changes as they unfold and notify you of any pertinent developments that may affect your financial plan. If you have further questions, please reach out to us.

 

 

 

First Installment: I’m Planning to Leave Assets to Charity – How Does the SECURE Act Change That?

Second Installment: How to Optimize Your Accounts After the SECURE Act

Third Installment: Must-Know Changes for Your Estate Plan After the SECURE Act

Fourth Installment: How to Circumvent the Demise of the Stretch: Strategies to Provide for Beneficiaries Beyond the 10-year Rule

Fifth Installment: The SECURE Act: Important Estate Planning Considerations

 

 

Disclosure: The material provided is current as of the date presented, and is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor. Any information is for illustrative purposes only, and is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances.  Investors should consult with a financial professional to discuss the appropriateness of the strategies discussed.

 

Top Financial Tips for Property Investors

Top Financial Tips for Property Investors

 

For people who are just starting as property investors, investing in real estate can feel like a maze. They know where to enter as well as their desired exit point, but everything else is a puzzle.

Newbie investors can see that there is a lot of money to be made by investing in properties. They also know that all they need to get started as a property investor is to go out and buy an investment property. But as Windermere Management warns, the problem lies between buying the property and making it profitable.

Are there secrets to profitable real estate investing that new investors need to know? Yes, there are, and this post will help you get started on some of the most important ones. Here are the top tips for property investors.

 

1. Clarify your investment goal

Before you set out to look for a property to invest in, you should ask yourself what you want from the property. There are many options for what your investment goal for a property can be, and the particular goal you choose will define the best real estate investment strategy to pursue.

Your goal can be to save money on rent by investing in a property that you can live in and rent out at the same time. It can be a regular income and long-term value appreciation. It could also be that you want to make small to medium profits in a very short period. Clarifying your goal is the first step to defining your investment strategy.

 

2. Define your investment strategy and niche

There are several real estate investment strategies, and each one has its pros and cons. The best strategy for you depends on your particular circumstances and needs. Examples of real estate strategies include buy-and-hold, fix-and-flip, long-term rental property or vacation rental, and long-term rental property.

Apart from choosing your strategy, you should also decide your niche. This is the specific property type to which you want to apply your strategy. Examples of property niches include single-family houses, small apartment buildings, commercial retail, etc.

 

3. Understand what makes a location good

What factors make an area good or bad as a potential location for your investment properties? These are referred to as the area’s fundamentals. They include population demographics (age, income, education, etc.), good neighborhoods, a surplus of local shops and entertainment centers, good road networks and multiple modes of transportation, schools, hospitals, amenities, security, and employment opportunities. Gaining an understanding of the fundamentals will help you make a good decision about the best locations for your investments.

 

4. Find a mortgage broker who specializes in investment properties

Most mortgage brokers are familiar with residential mortgages, but the process for obtaining a buy-to-let mortgage is completely different from that of a residential mortgage. Using a broker who is familiar with investment property mortgages will help you get the best terms from lenders.

Who your broker is can mean the difference between an application that is rejected and one that is approved. And when buying houses below market value, the speed with which mortgage processes are completed can make or break a deal. This will depend on the experience and connections of your broker.

 

5. Use interest-only mortgage

When getting a mortgage for an investment property, you usually have a choice between interest-only payments or paying both the principal and interest. Choosing a mortgage that allows you to pay interest only is better.

It allows you to maximize cash flow and equity growth on the property while saving thousands in the mortgage payment. The money saved can be redirected into paying off the mortgage principal on your primary residence. Using interest-only mortgage also lets you take advantage of tax deductions for the interest payments on the investment property.

 

6. Avoid cross-securitization

This is when your investment loan is secured using more than one property. A common example is when an investor uses their home and the investment property as security for the investment loan.

The problem with this kind of loan structure is that it gives the bank control over properties that should normally not be connected to the investment loan. In the event that you default on the loan, the bank can sell your home. The better way to structure your loans is to split them up by using different banks for your investment property and your home. It costs more, but it is safer.

 

7. Understand the relevant tax laws

Getting a handle on the various tax laws as they relate to investment properties can be very difficult. Unless you are an accountant, it is highly unlikely that you will know all the small loopholes you can exploit to cut down on your tax expenses.

This is why you should not view the money spent on a good accountant as an expense. It is an investment that can help you make more money from your real estate business.

 

Written for Merriman.com by:
Tom Flanigan who is the owner of Windermere Property Management in Spokane, WA.
They manage rental properties in Spokane, Airway Heights, Liberty Valley, and Spokane Valley areas.

 

 

How to Circumvent the Demise of the Stretch: Strategies to Provide for Beneficiaries Beyond the 10-year Rule

How to Circumvent the Demise of the Stretch: Strategies to Provide for Beneficiaries Beyond the 10-year Rule

 

The Setting Every Community Up for Retirement Enhancement (SECURE) Act passed in late 2019, creating significant retirement and tax reforms with the goal of making retirement savings accessible to more Americans. We wrote a blog article detailing some of the high-level changes from this piece of legislation.

We’re going to dive deeper into some of the questions we’ve been receiving from our clients to shed more light on topics raised by the new legislation. We have divided these questions into six major themes; charitable giving, estate planning, Roth conversions, taxes, stretching IRA distributions, and trusts as beneficiaries.  Here is our fourth of six installments on stretching IRA distributions.

One of the major changes from the SECURE Act was the elimination of the ‘stretch’ IRA, which allowed beneficiaries to take retirement account distribution over their lifetime to spread out the income.  While a limited number of beneficiaries still have this option (see blog article referenced above), the act has replaced this option for the vast majority of beneficiaries with a new 10-year payout rule, requiring the retirement account to be emptied by the end of the 10th year following the year of death.  This will significantly shortening the distribution period on those retirement accounts and require the beneficiaries to recognize income more quickly than they would have had to do before.

Now that the stretch has been eliminated for IRAs, are there other options for my beneficiary to receive the income over a period longer than 10 years?

Since the law is only a few months old, new strategies are still being considered to address the compressed distribution schedule for non-spouse beneficiaries. A few strategies have gained traction, but they require intentional actions by the account owner before a death occurs. They include:

  • Designating a charitable remainder trust as the beneficiary on the IRA. The CRT can pay a lifetime income stream to a person (or persons) of the IRA owner’s choice, but any residual balance will be retained by the charity. This option works best for owners who are already charitably inclined.
  • Consider tactical bequests. For example, leave Traditional IRAs to spouses (since they still have the stretch distribution options) or to charity (since they don’t pay taxes, so the compressed distribution won’t matter to them) but leave Roth IRAs, after-tax accounts, or real estate assets to non-spouse beneficiaries.
  • Take larger IRA distributions during your lifetime to purchase life insurance which can be paid to a trust. Since the life insurance proceeds are post-tax assets, there would be no time requirement on the trust distribution. The trust can even be set up as an Irrevocable Life Insurance Trust to keep the insurance proceeds out of the decedent’s estate if federal or state estate taxes are a concern.

Each of these strategies require careful consideration but can potentially provide your beneficiaries with income beyond the next decade.  We recommend speaking with your financial advisor or estate planner if you think any of these strategies may be appropriate for you.

 

First Installment: I’m Planning to Leave Assets to Charity – How Does the SECURE Act Change That?

Second Installment: How to Optimize Your Accounts After the SECURE Act

Third Installment: Must-Know Changes for Your Estate Plan After the SECURE Act

Fifth Installment: The SECURE ACT: Important Estate Planning Considerations

Sixth Installment: Inheriting an IRA? New Rules to Consider

 

Disclosure: The material provided is current as of the date presented, and is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor. Any information is for illustrative purposes only, and is not intended to serve as personalized tax and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances.  Investors should consult with a financial professional to discuss the appropriateness of the strategies discussed.

What Pandemics Can Teach Us About Personal Finance

What Pandemics Can Teach Us About Personal Finance

Because economic markets are intrinsically linked across the globe, the impact of a global pandemic can be widely felt. Disturbances in supply chains can impact inflation rates, and an increase in unemployment is a viable risk. Due to this, low inflation rates can impact forex trading and force central banks to reduce country-wide interest rates, resulting in a weaker currency. Despite these changes, it’s vital to take an informed approach when it comes to managing your finances. Here are some ways you can re-strategize in the time of a pandemic:

How to rebalance your portfolio

During epidemics over the last 20 years, the S&P 500 Index tends to exhibit a pattern of dramatically falling then powerfully recovering over a period of approximately six months. A generally prudent strategy to follow is to seek expert advice in redistributing your investment portfolio. In general, selling US growth stocks and buying bonds is suitable for many clients. Selling partial or full positions in order to boost your tax savings is also good advice to follow in the long run. Keeping an eye on your portfolio and avoiding making panicked decisions is crucial in the event of a pandemic.

How to invest according to your current situation

Something else to keep in mind is to invest according to your age group and particular situation. This advice applies whether you’re experiencing the effects of a pandemic or not. If you’re a young investor, it is recommended to hold on to your existing investments and patiently waiting for your returns. If you’re nearing retirement age, you should consider delaying your retirement if possible and focus on building up your funds. Lastly, if you’re already retired, you should hang on to your investments if you can afford it, or attempt to reduce your expenses.

How to re-categorize your budget

During a pandemic, individuals and families are likely to juggle new financial challenges. At this time, it’s a good idea to rethink your priorities. For instance, figure out your new baseline income based on potential pay cuts or unemployment, as well as any benefits you may receive. After this, work on calculating how much you need to pay for the essentials, such as rent, utilities, and food. Finally, you should try eliminating or reducing unnecessary expenses where you can. Dining out, entertainment, clothing, and travel are some areas where you can cut costs during this time.

How to get refunds where you can

In order to limit the spread of illness, it’s common practice that major events, flights, and services like gym memberships will be canceled. Because of this, you’re usually entitled to some form of compensation. If a travel ban has been put into place, airlines are likely to give you a refund or some form of credit if your travel plans were made in advance. Concerts and sports events should have similar policies put into place, so check your spam folder for any emails and updates regarding your refund. If you haven’t received any communication from the relevant organization, reach out and contact them to see what can be done.

In the event of a pandemic, it might be tempting to give in to your emotions and worry about your finances. To prevent this, building up an emergency fund beforehand with approximately three to six months’ worth of expenses and maintaining a strict budget plan will help you maintain peace of mind.

Prepared exclusively for merriman.com
by Danielle Houston

Important Disclosure:
This article is for informational purposes only, and does not intend to address the financial objectives, situation, or specific needs of any individual investor.  The general suggestions provided are not intended to serve as personalized financial and/or investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances.  Investors are highly encouraged to work with a financial services professional to discuss their financial situation and suitable solutions.

Psychology of Investing

Psychology of Investing

 

 

“The world makes much less sense than you think. The coherence comes mostly from the way your mind works.”
– Daniel Kahneman, Thinking, Fast and Slow

“It’s not supposed to be easy. Anyone who finds it easy is stupid.”
– Charlie Munger, Berkshire Hathaway

 

In its most basic form, investing involves allocating money with the expectation of some benefit, or return, in the future that compensates us for the risk taken by investing in the first place. Investing is a decision: buy or sell, stock A or stock B, equities or bonds, invest now or later. But as the great Charlie Munger reminds us above, investing is far from easy. Prior to making an investment decision, we create statistical models, build spreadsheets, use fundamental and technical analysis, gather economic data, and analyze company financial statements. We compile historical information to project future return and risk measures. But no matter how much information we gather or the complexity of our investment process, there isn’t one rule that works all the time. Investing involves so much more than models and spreadsheets. It is an art rather than a science that involves humans interacting with each other—for every buyer, there is a seller. At its core, investing is a study of how we behave.

Daniel Kahneman and Amos Tversky are famous for their work on human behavior, particularly around judgment and decision making. Judgment is about estimating and thinking in probabilities. Decision making is about how we make choices under uncertainty (which is most of the time). Kahneman won the Nobel Prize in Economics for their work in 2002, an honor that would have certainly been shared with Tversky had he not passed away in 1996. Their findings challenged the basic premise under modern economic theory that human beings are rational when making judgments and decisions. Instead, they established that human errors are common, predictable, and typically arise from cognitive and emotional biases based on how our brains are designed.

In his book, Thinking, Fast and Slow, Kahneman describes our brains as having two different, though interconnected, systems. System 1 is emotional and instinctive. It lies in the brain’s amygdala and uses heuristics or “rules of thumb” to simplify information and allow for quick gut decisions. In contrast, System 2 is associated with the brain’s prefrontal cortex. It is slow, deliberate, and calculating. As an example, if I write “2 + 2 =”, your mind without any effort will come up with the answer. That is System 1 at work. If I write “23 x 41=”, your mind most likely switches over to the slower moving System 2. While Systems 1 and 2 are essential to our survival as humans, Kahneman found that both systems, and how they interact with each other, can often lead to poor (and sometimes irrational) decisions. We can apply much of what Kahneman and Tversky discovered to investor behavior. Let’s focus on some of the most common biases and how they impact our decision making.

Loss Aversion

Kahneman and Tversky summarized loss aversion bias with the expression “losses loom larger than gains.” The key idea behind loss aversion is that humans react differently to gains and losses. Through various studies and experiments, Kahneman and Tversky concluded that the pain we experience from investing losses is twice as powerful as the pleasure we get from an equivalent gain. This can lead to several mistakes, such as selling winners too early for a small profit or selling during severe market downturns to avoid further losses. Loss aversion, if left unchecked, can lead to impulse decision making driven by the emotions of System 1.

Confirmation Bias

Confirmation bias leads people to validate incoming information that supports their preexisting beliefs and reject or ignore any contradictory information. In other words, it is seeing what you want to see and hearing what you want to hear. As investors, we are prone to spending more time looking for information that confirms our investment idea or philosophy. This can lead to holding on to poor investments when there is clear contradictory information available.

Hindsight Bias

Hindsight bias is very common with investor behavior. We convince ourselves that we made an accurate investment decision in the past which led to excellent future results. This can lead to overconfidence that our investment philosophy or process works all the time. On the flip side, hindsight can lead to regret if we missed an opportunity. Why didn’t I buy Amazon in 2001? Why didn’t I sell before this bear market? As I always say, I would put the results of my “Hindsight Portfolio” up against Warren Buffet’s any day!

Overconfidence

As mentioned above, investors can become overconfident if they have some success. This can lead to ignoring data or models because we think we know better. As Mike Tyson said, “Everyone has a plan until they get punched in the mouth.” Overconfidence can lead to a knockout, and investors must be flexible and open with their process.

Recency Bias

Recency bias is when investors emphasize or give too much weight to recent events when making decisions and give less weight to the past. This causes short-term thinking and allows us to lose focus on our long-term investment plan. It essentially explains why investors tend to be more confident during bull markets and fearful during bear markets.

 

I could write an entire book on investor psychology. The bottom line is that we cannot eliminate these biases. After all, we are all human. Even Kahneman, who made the study of human behavior his life work, admits he is constantly impacted by his own biases. However, there are certain actions or “nudges” that can help address such biases and avoid making costly mistakes. At Merriman, we have built the firm in such a way to use our knowledge about human behavior in the work we perform for our clients. Below are some of the main examples:

Evidence-Based

We build and design our investment strategies based on academic data going back hundreds of years. We are evidence-based rather than emotionally-driven investors. We think long term and do not let short term noise or recent events impact the process. We build globally diversified portfolios across different asset classes to produce the best risk-adjusted returns. That said, we are consistently researching and studying to find data that might contradict our investment philosophy and will make changes if the evidence supports it.

Financial Planning

A well-built financial plan is at the core of our client’s long-term success. It is a living document that requires frequent updates based on changes in our lives—retirement, education funding, taxes, change in job, business sale, and estate planning. This forces us to make investment decisions based on the relevant factors of that plan and not on emotions—because at the end of the day, investing is meant to help reach our goals.

Education

At Merriman, we do our best to help educate our clients on our investment philosophy. Blogs, quarterly letters, seminars, client events, and video content are all examples of tools we use to educate our firm and clients. Knowledge and awareness are powerful tools to help us make sound decisions.

 

We are all going through an extremely stressful situation right now—both personally and professionally. Now, more than ever, we need to lean on each other and show empathy and support through this unprecedented time. Remember, investing is a study of how humans behave. At Merriman, we want to be your resource to guide you through both calm and turbulent markets, helping you reach your financial goals. Please don’t hesitate to contact us if you’d like to discuss how we can help.