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Welcome back. In yesterday’s article, It’s All About The Benjamins, I went over a commonly overlooked, yet simple concept in real estate investing; and that is, investing for positive cash flow. Very important indeed. But I left the article unfinished; a lot of people don’t want the hassle of searching far and wide for a rental property that’s going to yield positive cash flow. Instead, they want a relatively stable (I can hear everyone in California laughing) investment vehicle that’s going to yield a descent return. They’ve heard real estate is just such an investment vehicle. They’re right, the problem is, a lot of people who take this type of investing do so the wrong way. I’m going to key you in on the right way.
OK, so you’ve got yourself a job, you’re out in the real world making money and you want to be smart and invest it. Good for you! A lot of people in your situation will buy a rental with the goal of sitting on it until they decide to retire, at which point they plan to sell the property and use the proceeds to help fund the golden years. You could do this too, if you’re a person who doesn’t want to maximize his/her return. But you’re not someone who doesn’t want to maximize his/her return, you’re someone who wants to make the biggest return on the least amount of capital, right? Of course you are. So, how can we tweak our invest-for-retirement plan to help us maximize our return without becoming full-time landlords?
Let’s compare the two options. Operation Sit-On-House will be the name of the plan described above; sitting on your one rental property until you retire, then selling it and reaping the rewards. Operation Cash-Money will be the name of my as-yet-to-be-described plan of action.
Operation Sit-On-House:
You purchase a $300,000 house and rent it out for 30 years, at which point you plan to retire. At the end of 30 years, you’ve paid a total of $665,000 and you own a house worth around $1,296,582.71 (based on annual appreciation of 5%). After you sell the place you make a profit of $632,000. Not too shabby.
Operation Cash-Money:
You purchase a $300,000 house and make interest only payments on the mortgage for five years, at which point the house is worth $383,000 (5% annual appreciation). You sell the house at that point and reap a profit of $83,000; after costs, it’s more like $73,000.
Now you use your $73,000 as a 20% down payment on a $365,000 house. Hang on to that for five years with interest only mortgage payments, at which point you sell it for $466,000 (again, 5% annual appreciation). This time you factor in your down-payment and you come out with $174,000 cash in your pocket. (Hopefully now you’ve found yourself a trusted mortgage advisor).
Now you use your $174,000 as a 20% down payment on a $870,000 house. See where I’m going with this? If not, you will soon; just hang in there. After five years, your house is worth $1,110,000; at which point you sell again. This time you come out with $414,000 cash in your pocket.
Guess what, let’s do it again. Put $414,000 as a 20% down payment on a $2.07 million house. After five years the house is worth $2.6 million. Time to sell again. This time you walk away with $944,000.
So where do we stand? We’re at the end of 20 years and we’re already well past our $632,000 gain from Operation Sit-On-House. But let’s keep going just to see how good it gets.
Now we take our $944,000 and put a 20% down payment on a $4.7 million house. After five years we sell for $6 million (wow, now we’re looking at some big numbers!). We’re left with $2.2 million in our pockets and we’ve still got five years left!!
So, one last time before the end of our glory days and we relegate ourselves to a life of waking up at 4am, early bird dinners, and retirement homes (OK, that was a joke). For one last hurrah we invest our $2.2 million as a 20% down payment on an - oh, you’re going to like this number- $11.2 million dollar house. Hang on for 5 years and this baby’s worth $14.3 million! Sell the place and you end up with $5.3 million in cold, hard cash to wipe the tears of joy from your wrinkly old face.
OK, so where are you going to find someone to rent an $11.2 million house? It’s probably not going to be that easy; and this is where Operation Cash-Money separates the men from the boys. Once you get into those larger figures you’re going to need to either find some kind of incredible vacation getaway and rent it out to rich people on their honeymoons, or spend the money on multi-unit properties like apartment buildings. Eww, there’s that landlord idea again, right? No, just hire a property management company to handle the details and pay them a percentage of the monthly rent.
If you’re still not convinced, let’s put it this way. Do you want to retire with $622,000 or do a little extra work for $5.3 million? Ultimately the choice is yours.
Thanks for reading.
John Crenshaw, TruthfulLending dot Com
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