Purposeful Planning & Cash Flow Management — Your Million Dollar Steak

Posted @ 8:59 pm - Filed under Capital Growth, Cash Flow, Financial Planning, Investment Lessons, Purposeful Planning, RE Investment Practice, Real Estate Investing, Retirement, Retirement Income, Tax Shelter, Texas

In a recent post, I promised I’d get David Shafer over here to give you some ideas about what a real estate investor might do with cash flow, both before and after taxes. Dave not only stepped up to the plate, he’s knocked another one outa da park. It’s always driven me nuts the folks view their cash flow as ‘date night’ money, or vacation spending dough, etc. When I used to teach seminars on cash flow analysis, one of the crucial factors was dealing with cash flows during holding periods. Think big picture.

The next time temptation pulls at you to grab yer cash flow and go out on the town, think about this post. That juicy, perfectly broiled steak yer about to enjoy? Hope is was good, ‘cuz it coulda cost you a million bucks. ‘Course, it is your money, right? It’s your retirement too. Know what an extra Mil is worth in retirement income? $50-80,000 a year, easy. And that doesn’t take into account the extra properties that woulda been added to the portfolio along the way. Oops, there’s another million. The treatment of cash flow over the long haul can either be beneficial to your retirement, or medium rare. Your choice. The results of wisely reinvesting cash flows over time can be like world class cheesecake for dessert.

Again, that steak better be sent from Heaven. OK, enough. Here’s David Shafer, someone I respect and admire. This is good stuff people.

Thanks Jeff for allowing me to post again! First, a little introduction. My name is David Shafer and I am an investor and run a business called the Shafer Wealth Academy. I do not sell stocks or bonds or am I a Registered Investment Advisor. I do invest for myself in a full range of investments. My business is simply about helping folks
create the environment for their successfull wealth creation. The techniques and strategies we use in the SWA are based on the available data on what has worked for others to create wealth. I am a big believer in real estate investments because the data demonstrates its wealth creating abilities. One of the advantages of using investment real estate as a foundation for your investment portfolio is the additional cash flow from rents received and taxes not paid. BawldGuy has offered me, as an example, the numbers from recently closed investment properties in Texas bought with 20% down. The decision on how much to put down is a individual one, best left to you and BawldGuy to hash out. The purpose of this post is to show you how to take advantage of the cash flow a 20% down payment would afford you. These duplexes offer up $4,000/year in positive cash flow after all expenses are accounted for. In addition there is $8,500 is depreciation offered up to reduce taxes.

In my mind it is best to diversify away from the foundational investment that produces the cash flow, but not too far. However, I like real estate because it is hard assets, not paper assets, a limited amount of dirt exists, and believe real estate is the foundation for all economic activity. In addition I believe that one should specialize in their investment education. In other words, investors that have as their foundation, duplexes, should learn everything they can about all aspects of real estate including commercial, industrial, and real estate development.

Having laid out my philosophy, I will offer up a strategy. I do not advise people on buying particular investments, only use the ones I like as an example. Before purchasing any investment, educate yourself, don’t listen to anyone, make your own decisions!

The cash flow is $4,000. I assume a marginal tax rate of 25%, although if you live in a state with a state income tax yours might be higher. The additional cash flow from the tax reduction is $2,125. The total is $6,125.

What I would do generally, is to invest $4,500 in Berkshire Hathaway, and the remaining $1,625 in HCN a REIT that specializes in health care properties. Why those two investments? Berkshire Hathaway has a history of over 21% rate of return for over 40 years. Run by Warren Buffett, the world’s richest man last year, it has demonstrated the ability to deliver superior returns over the long run in a variety of economic conditions. He also does not pay dividends, so there is no taxable events to its owners
until the stock is sold. Current price of the “B” shares is around $3,900. I believe demographics will push the need for more health care institutions of all kinds over the next 40 years. We are an aging society. We are also a society that creates many health care products. Simply, I believe it is a growth industry. Since real estate development is the basis for all economic activity, all these health care practitioners will need specialized buildings to ply their trade. HCN also leverages on about a 1 to 1 basis. Current dividend is around 6%.****Remember, this is my thinking, you should not invest on mine or anyone elses thinking, only yours!*****

So here is the plan. Each year buy one Berkshire Hathaway “B” share of stock. With the left over cash buy HCN. Now comes the tricky part. Speculating on the worth of this strategy after 10 years. There are three moving parts. 1. Cash flow, which should increase over time. 2. Appreciation of BRKB 3. Appreciation of HCN plus dividend reinvestment. To simplify I am going to say each year you can afford to buy 1 share of BRKB and 31 shares of HCN. I assume your rent appreciation will help you do this in the later years. Note that in the first few years you are not using all of your cash flow, so there is a built in margin. After 10 years you have 10 shares of BRKB and 310 shares of HCN (I am accounting for the dividend reinvestment in the total rate of return). If you receive a 15% rate of return from Berkshire (Remember it has a 21% return for the last 40+ years, but I don’t think that will continue going forward) your 10 shares are worth $157,770. HCN has a returned 19% over the last 5 years and 17% over the last 10. I will be conservative and use 15% as a rate of return. Your 310 shares would be worth $66,469. Total $224,239. How about that, from your loose change (cash flow from one duplex) you have created a quarter of a million dollars in ten years using conservative figures! Now, there is a little additional taxes from the dividends on HCN, but by now you should have a good tax accountant which should be able to deal with that! Note, this strategy is completely liquid, so if at any time the @#$% hits the fan, you can access your cash flow. Also note that this strategy is a diversification strategy allowing you to diversify within and outside the real estate world.

Now, here is the best part. This client has 4 duplexes, so this could be a million dollar strategy in 10 years.

And even better, as you continue to learn about real estate investing, you could return some of this cash flow to real estate investing down the road. Perhaps, purchase a commerical project or invest in a real estate development. So get with your tax accountant to determine how best for you to structure this investment strategy with the idea of possibly accessing it down the road.

Here’s to creating tax problems for your accountant to figure out .

This entry was posted on Tuesday, August 12th, 2008 at 8:59 pm and is filed under Capital Growth, Cash Flow, Financial Planning, Investment Lessons, Purposeful Planning, RE Investment Practice, Real Estate Investing, Retirement, Retirement Income, Tax Shelter, Texas. 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.