Knowledge is Power. This article demonstrates how I accumulated 1.2 million dollars worth of  real estate without taking one penny from my savings account. I call this Commingling of  Asset Classes whereby I used my knowledge of the Stock Market and Real Estate Market to accumulate this wealth.

My story begins in 1999 when my son Craig was entering his first year at Brooklyn Law School. Looking to rent a studio apartment for him within walking distance to the Law School, I realized that it would cost the same to buy an apartment as it would  to rent one. The only difference would be the down payment. Well, this was a time when I was honing my skills of selling covered call options. I had generated $35,000 profit at that point in time. That cash was utilized as a downpayment on a $90,000 co-op. Well six years, one law degree, and one business degree later, that unit was valued at $350,000! During that time frame, I paid off the mortgage using the cash I generated from the sale of stock options.

Now I had all this capital gains cash with Uncle Sam hovering over my shoulders with a large empty sack. Would I fill it for him? The answer is NOT YET! I used my knowledge of real estate investing to defer the capital gains tax.

A 1031 Exchange: Under Section 1031 of the Internal Revenue Code (26 U.S.C. § 1031), the exchange of certain types of property may defer the recognition of capital gains or losses due upon sale, and hence defer any capital gains taxes otherwise due. If the equity is exchanged into another property of similiar or greater value I could avoid paying these taxes. I did my due-diligence in much the same way as I do locating stocks and decided on three office condominiums in Austin Texas. The real estate market in this city was smoking hot at that time and still isn’t bad considering these economic times.

At this point, I owned 3 properties and still haven’t spent down one cent from my savings account. But I still wasn’t satisfied. I had too much cash in these properties. As a real estate investor, I normally try to put only 20% into each asset. I feel that if I did adequate due-diligence, each property should cash-flow with a 20% investment. So how was I going to get my hands on the extra cash while still deferring taxes? The answer was to refinance. Refinancing is a loan. You don’t pay tax on a loan. Out of these properties came $100,000. I put $50,000 down on a single family home and on a residential condo. Now I own 5 properties in Austin, 3 cash flowing positive and 2 breaking even but appreciating in value.

Here is a flow chart showing how these deals transpired:

Commingling of Asset Classes

The current market value of these 5 units is 1.2 million dollars with several hundred thousand in real equity. Checking my savings account I see that I still haven’t taken out one penny to make these deals happen. Once the real esate market turns around, and it will, I will look to do more 1031 Exchanges and refinances. It will be interesting to see where this leads to 5-10 years down the road.
Knowledge is Power because it allows you to do things like commingling of asset classes which can lead you to become CEO of your own money and ultimately to financial independence. 

History Tells Us Not to Worry:

For those of us who have been through dramatic downturns in the economy and the stock market, recent events have not been as traumatic than it has been to newer investors. It would be wrong to give up on investing in the stock market or the real estate market for that matter. If we had an initial investment of $100,000 and lost 50% in a severe market downturn, we would now have $50,000. In order to restore our investment back to it’s original amount, that $50,000 would have to increase by 100%. What chance do we have of accomplishing that with a 3% CD or treasury note?

Admittedly, this past year has been challenging and difficult. It is an aberration brought upon us by a legion of people who are both greedy and incompetent. The recent approval of the “Rescue Package” is a step in correcting the problem. It’s hard to believe that history is telling us that the market appreciates 11% per year when we look at the 1-year chart of the S&P 500:

S&P 500 1-year- 2008

 
How many of you remember the “Crash of 1987”? Doom and gloom overwhelmed the market. Investors were swearing they’d never again invest in the market. Well, let’s see what would have happened had they never again invested in the Stock Market: 

S&P 500 Long Term showing 1987

Take a look at the big dip that occured on the chart in 1987. Had an investor thrown in the towel after the “crash” he would have missed out on a 5-fold increase in his portfolio as of today even after the recent decline. History tells us that the market will increase in value 11% per year in the long run. Our economy is resilient and seems to recover even when the picture appears to be hopeless. We, as investors, have to make a decision. Are we able and willing to withstand the risk of the short term volatility of the market? If the answer is yes, then decades of the stock market performance bodes well for the long term success of our portfolios. The decision is a personal one. If you are losing sleep and have developed a personality disorder from the current crisis, money markets and treasuries are probably best for you. Otherwise, stay the course because history is telling us not to worry.

Last Week’s Economic News:

Yet another roller-coaster ride is how I would describe the financial markets last week. Monday, the S&P 500 declined -8.8%, the largest single-day drop since 1987 ( the crash alluded to earlier in this article). The unemployment rate held steady @ 6.1% for September despite the fact that employers made larger than expected job cuts.. Manufacturing and factory orders were well below analysts’ expectations. For the week, the S&P 500 dropped 9.4% for a year-to-date return of -25.2%. Friday’s approval of the “Rescue Plan” gives us hope (along with the change in the administration) that the economy will start turning around.

Stocks Recently Added to my Watchlist:

EZPW

PSYS

*PRGO

CHTT

FLO

*GIS

* Also on this week’s CANSLIM LIST
 

My best to all,

Alan