Real Estate Investing For Retirement– A Yugo Or A Mercedes?
Posted @ 10:49 pm - Filed under Real Estate Investing, Retirement
It’s been awhile since I’ve written about ’should I do this, or should I do that’, but today it cropped up for the 247th time this year — Rick wants to begin investing for retirement, and Allie wants to take the 2-3 years it’ll take to pay off the cars. Of course both cars represent a total of less than $500 a month. Go Figure.
So here’s the deal. A young couple, (25) owns a house, has kids, and is living the American Dream. He’s studying for his degree while working full time. She’s home with the kids. He contacts me wanting to find out what I’d tell him to do to get started. I’ll skip the preliminaries.
A company he found on the internet wants him to refi his house, invest the money with them so they (hard money lenders) can pay him 1.5% a month, or 18% a year. His wife is apparently all for it. I need to write this down somewhere — Wives tend to go for whatever choice appears to offer instant security.
They can refi their home, netting around $40,000 or so. They can buy a rental for around $25-27,000 including closing costs. (Price is $235-250,000) It would break even before taxes.
Principle in Play: You don’t know what you don’t know. Corollary: You can’t prepare for the consequences of what you don’t know that you don’t know.
Their choice is to invest in a vehicle yielding an after tax cash flow of less than $6,000 a year — with zero, nada, zilch appreciation — guaranteed. OR Invest in a new home in an excellent location, (growth region) that will pay for itself on a monthly basis. It is expected to appreciate 5% a year, sometimes more, over the foreseeable future. (Yeah, I know, crystal balls and all. Mine’s cracked too, but if this area doesn’t go up a least 5% a year, we’re all face down in the water. 
)
The results for each choice after five years are as follows:
The first choice will have yielded our young couple $30,000 in after tax cash flow, increased the debt on their home, and produced two free and clear, and by then, very used cars. (But the payments will be gone, right?)
The second choice will result in just under $70,000 in accrued appreciation. (5% a year on a purchase price of $250,000) He will have saved a little over $13,000 in fed/state income taxes due to the tax shelter provided by the depreciation. If he decided to make use of a tax deferred exchange (1031) he’d be trading into give or take $500,000 in new property.
As I explained this to him, he understood immediately. (After talking with him just a few minutes it’s obvious he’s very bright.) Just to make sure though, I offered one last thought to ponder. I asked him if he understood he was, in essence, trying to decide what to buy — with the same exact capital mind you – a Yugo or a Mercedes.
This is a perfect illustration, provided in real life, of what can happen when you don’t know what you don’t know. Reading this, you know that a Yugo is not worth what a single chrome Mercedes wheel costs. So you wouldn’t waste time ‘deciding’ what was best. But that’s only because you know, right? Right.
If he decides to go with my advice, he’ll have avoided the financial consequences of choosing a non-appreciating asset over an appreciating asset because the income, in the short run was alluring — though a dead end. “Investing for retirement goes a lot easier when the investments appreciate over time.” (Captain Obvious)
NOTE: His first choice is only a poor choice in this particular set of circumstances. There are instances when that choice would be much preferred — not many, but some.
I wonder if one day, when he’s older, wiser, and wealthier, and passing a broken down Yugo parked on the side of the road in his shiny Mercedes, he’ll remember our conversation?
Closing Principle: Those who don’t know what they don’t know cannot prepare for the consequences of their actions.
How much does a chrome Mercedes wheel cost? I don’t know for sure, but I know it’s more than a Yugo. And I bet it holds its value a lot better too.
This entry was posted on Wednesday, June 13th, 2007 at 10:49 pm and is filed under Real Estate Investing, Retirement. 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.