Be Your Own Bank: The Case for Real Estate
A couple years ago, a friend and I were chatting about a pretty well known Chinese restaurant chain, Panda Express. Now, for those who don’t know, while the restaurant chain claims to serve “Mandarin Cuisine” or be a “Chinese Kitchen”, for us Chinese Americans, it would be as close to authentic Chinese food as Taco Bell is to authentic Mexican food. That hasn’t stopped its business from booming of course, but in an attempt to hold a bit more pride in our heritage, we tend to lambast this restaurant chain for its poor imitation food.
But this time, my friend began telling me about Panda’s business practices, and how the company which created this restaurant chain actually purchases large commercial real estate properties. They then build the properties as plazas with many different shopping locales and restaurants. Only after the property successfully makes a decent profit does the company then step in to build a Panda Express restaurant. In other words, while they fronted as a standard restaurant business, the company was actually in the real estate business.
The same can be said of McDonalds, and a myriad of other restaurant, fast food chains, or other businesses that exist around the world. Many companies that do well are actually in the real estate business as well as the business known by the general population.
The same can actually be said for banks. After all, whenever someone mortgages their home, the bank basically owns the home until that loan is paid off. If the customer doesn’t make the mortgage payments, then the bank actually comes and seizes control of it.
The reason real estate is such a desirable asset is that it can be used for so many different things. The business and commercial potential for a good piece of land is almost limitless, from shelter, to religious or community centers, to the aforementioned restaurants and other kinds of businesses. Its role in the modern economy really cannot be overstated. This multiplicity of use can be taken advantage of by the average person who desires to be their own bank, provided they have access to a bit of capital and are driven enough to make the investment property work.
For the purposes of this blog post, I’m going to be singling out using homes as an asset for being our own bank. However, everything I talk about can be done for almost any kind of prime real estate that is available for private ownership.
Liability versus Asset
It’s important to know that, for the vast majority of people, a house is not actually an asset. Instead, it's a liability. This is because our personal residence is costing us more money than it is giving us in appreciation and income. Even if we say a house is paid off in cash, we still owe money on it in taxes, insurance, and especially in upkeep. The land the house is built on almost always appreciates over time, but the cost to have and maintain it is pulling more money out of our pockets than putting in. Thus, in order for a house to become part of our bank system as an asset, that property must not only (or at all) be our primary place of residency. It must function in other ways as well.
A Source of Income
A privately owned house can be a primary source of income through a variety of ways. The two most popular are long-term rentals (usually about a year or more) and short-term rentals (a usual maximum of a month). To choose between these two options, we can think of them as managing a motel or bed-and-breakfast versus managing an apartment complex.
Renting out a house long-term is generally a safer and less risky bet as a source of income. Having one or more residents in a house paying for their tenure for a longer period of time tends to alleviate certain costs of maintaining a home. Good tenants tend to maintain a certain standard of living when renting long-term, since they consider it their home. And as the private property owner, as long as we lay out our terms by contract, we can say who gets to live in the home we purchased and who doesn’t.
Short-term rental is potentially more lucrative, as we can charge more per stay than with a long-term customer. However, the maintenance for short-term rentals is quite high. Because more guests are staying in shorter intervals, they tend to not take any responsibility for the quality of the house. Instead, we have to be the ones cleaning and managing it, which means buying more and more cleaning supplies or toiletries or other things to maintain a quality place to stay. However, even things like hiring a managing company to do these things is often worth it for short-term rentals, as the income from guests can potentially outweigh the long-term rental income by a significant amount.
For both, the quality of our care for our property often goes a long way towards gaining and keeping tenants. And by doing so, we create a sustainable income, and thus an asset, from owning a home.
Collateralizing the Home
Additionally, we can also collateralize our home in a similar fashion to gold or other precious metals. This subject is a bit tepid or taboo nowadays due to the 2008 financial crisis, which was largely caused by this kind of loaning. Despite that, through home equity loans or refinancing, we can free up capital sitting on the house we own and use it to finance other things in our lives (or perhaps other assets we want to purchase). The process to do this, however, is a bit more complicated.
First, at least presently, we do need to go through an intermediary such as a traditional bank or loan officer in order to get this kind of financing. Because of this, other things such as our income, credit scores and debt considerations, and even things like residential status come into play.
Secondly, we need to consider the interest rate on the loan. When we want to refinance a home, there are all kinds of different interest rates that will be pitched to us by banks or loan officers. There are generally two options: an adjustable interest rate and a fixed interest rate. Quite simply, the adjustable interest rate has the potential to change annually, while the fixed interest rate does not. Generally, while adjustable interest rates may seem attractive since they almost always start lower, almost everyone is better off getting a fixed rate, so as to avoid the interest going way too high as a result of some unforeseen or uncontrollable circumstances. If you want to avoid the disaster that befell many home owners during the 2008 financial crisis, stay away from adjustable rates at all costs.
Before we go on, here are the previous posts I’ve made in this series, in case you missed some or want a refresher:
Be Your Own Bank: An Introduction
Be Your Own Bank: Putting Money to Work
Be Your Own Bank: The Case for Gold and Precious Metals
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