Growth Oriented Real Estate Investors Ask — What Is Laying A Foundation?

Posted @ 1:04 am - Filed under 1031 Exchanges, Real Estate Investing, Purposeful Planning, Retirement Income

When I speak to a client who is a first time investor, they often ask (pretty quickly) how much property should they invest in to start?

Let’s look at a relatively new client (a week old) who is in the process of obtaining about $310K in original investment capital. They’re a couple in their early 50’s, make $140K +/- between them, and will retire in 12 years. They have other assets, which we’ll deal with another time. The first thing on their plate — how much property should they initially acquire?

I’ll first have them pay off a couple small loans ($10-15K), then establish a fairly generous Sominex account (cash reserves). I’m recommending they set aside around $40-50K for this purpose. This will leave them about $250K for down payments and all closing costs.

They’ll end up with, give or take $2Mil in property. Now, when I mentioned this to Mrs. ‘Smith’ she almost fell out of her chair. Her husband Randy had no problem, though I did see him swallow kinda hard. Sheila asked if they wouldn’t do just as well with say $1.5Mil.

No, she wouldn’t.

Would I please explain how just a 25% difference in initial investments will make such a significant impact on their retirement? No problem.

I used the following analogy.

I have two vacant lots of equal size, next door to each other. One is theirs, one mine. We both plan to build office buildings, the size/heighth of which depends upon the size and therefore strength of the foundation on which they’re built. I lay a 20K square foot foundation with monster footings and steel pillars driven all the way down to bedrock, and anchored to it. The Smiths lay a 15K foot foundation with large footings, and steel not nearly as deep nor anchored to bedrock.

Which foundation will ultimately allow the largest office building to be constructed? Obviously, mine. It’s not only much larger in area, but it’s footings are more secure, and its steel is physically anchored to bedrock. Whatever the difference is, you can bet it will be easily discerned when they’re both built. Again — this is pretty simple stuff. The larger and stronger the foundation — the larger building it will ultimately support.

Now if we make total initial investment property acquired, the foundation of the Smiths’ retirement building, you can see how this plays out. The more they initially purchase, the bigger their ultimate estate will become. Let’s just take the first five years using what I’m recommending and what Sheila suggested as a starting figure. Don’t blow this off. Though admittedly a simple concept, the results are more far reaching than most investors surmise at the beginning stage.

I said $2Mil — Sheila wondered, why not $1.5Mil.

This means there will be $60K left in the bank if Sheila executes her Plan. What effect will a relatively small amount of money have on their retirement?

Factoring in closing costs along with down payments, the extra $60K will easily be able to acquire the extra $500K I’m recommending. Here’s what happens over the 12 years of their plan.

At the halfway point, six years, the extra property would (at 5%/yr appreciation average) be worth about $670K. A sale/exchange would produce net proceeds of +/- $166K. That would allow them to trade up into +/- $1.35Mil of property. (Including 10% down, and 2% closing costs. My clients don’t pay loan points 95% of the time.)

Let’s see what the final result is after 12 years. Here are the numbers.

This extra investment is now worth (again, 5%/yr appreciation average) $1.81Mil. The equity at retirement is roughly $600K. If this equity was yielding an after tax yield of say, 8% — the monthly income would be approximately $4,000 — almost $50,000 yearly.

Now, if you wish to blow off an extra $50,000 a year in retirement income, go ahead. Who knows if they’ll get 5%/yr appreciation. It might be 3% — or maybe 7%. Your guess is as good as mine. Also, some of my retired clients are making more than 8% on their equity, some less. The majority have found ways to make that much or a little more.

I think Sheila and Randy will probably follow my Plan. Why? Not only because the above numbers clearly fall in their favor, but because they’ll also have, ultimately a Sominex account totaling six figures. That will make Sheila feel much safer, which is as it should be.

Now think about the Smiths in a different light by changing just one factor. What if they were in their early 40’s instead of 50’s?

What would another decade mean doing it my way?

The extra annual income would now move into $100,000 territory.

You, as an investor, have one chance to lay
the strongest foundation your circumstances allow — I prefer steel into bedrock if at all possible. Don’t find yourself 10-30 years down the road kicking yourself because you made it to small — unnecessarily. Once you start building upon that initial foundation — you can never go back.

Most folks retire, including all sources of income, with much less than $50,000 a year. Most folks would kill for that much.

We’re talking about much more than that — plus an extra $50-100,000 a year.

Decide not to be most folks. Lay your foundation soon — the right size — and with a Purposeful Plan.

This entry was posted on Friday, August 3rd, 2007 at 1:04 am and is filed under 1031 Exchanges, Real Estate Investing, Purposeful Planning, Retirement Income. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.