Real Estate Investors: A Simple Way To Increase Your Capital Growth

Posted @ 9:54 pm - Filed under BawldGuy Axiom, Buying Income Property, Capital Growth, Financing, Investment Lessons, Purposeful Planning, Retirement

Before we start today, allow me an observation. Over the years, I’ve noticed when confronted with simple concepts, some folks act as if they’ve always known about them, and have applied the concepts in question often. Bull Pucky. (Excuse my French) There are any number of these simple and reliable realities we use when analyzing properties or scenarios. Financing is one of the obviously more important factors in any real estate investment. So let’s go over how an itty bitty modification here and there can mean literally six figures in less time than you might imagine.

Let’s look at what would happen if a real estate investor, whose Purposeful Plan calls for capital growth, makes one simple tweak in their loan terms. And yeah, I know it’s so simple it’s basic, but when was the last time you applied it? Yeah, thought so.

There was a time back in the 80’s when tweakin’ loan terms for a client’s transaction made the difference on a couple levels. First, it made the deal possible, as the lender wasn’t gonna do it ’till I came up with terms that worked for everyone. Second, the terms themselves put more money into my client’s hands during his holding period.

The bonus? Dad finally realized I knew which way was north on the real estate investment map. He was never an investment guy, so after that transaction came together against all odds, he finally became a believer. So did his friends, who also happened to be buddies of the bank president whose mind was changed by my numbers. Who knew?

Let’s talk about how some of today’s realities can be turned into a wheelbarrow full of equity for ya.

Let’s say you’re lookin’ at a small income property with a Net Operating Income of $18,500. (NOI = Gross Scheduled Income, (GSI) minus Vacancies and Operating Expenses. It should always be expressed as an annual figure.) Note: Loan payments are not operating expenses.

The property in question will cost you $250,000 and you’ll be puttin’ 20% down to a new 80% fixed rate loan. The interest rate is 7%. The problem? The underwriters won’t lend to you ‘cuz you already own a few investment properties. Now what? You go to what’s known as a portfolio lender, one who isn’t beholden to Fannie Mae or Freddie Mac guidelines. Why? Simple — they’re not gonna sell the loans to either of those government entities. Since it’s their money, it’s their rules, their loan terms.

What happens when they say the loan must have a 20 year amortization rate? No way!! you say with all the righteous indignation you can muster. That eliminates all my cash flow. Let’s pause for a moment. You aren’t investing in this property for cash flow. Your Purposeful Plan has called for many years of capital growth before transitioning into a cash flow stance. Cash flow? Yer gonna torpedo a perfectly solid capital growth vehicle ‘cus the new loan terms eliminate a couple hundred a month? Really? Let’s take a look.

These new terms eliminate about $2,500 cash flow yearly, $12,600 over a 5 year holding period.

The 20 year schedule leaves you with a loan balance of roughly $15,700 less than the 30 year approach. Use whatever analysis you wish, but you ain’t gonna invest your paltry $200 a month for an annual return of almost 11%. You simply are not. And, since your cash flow is now going toward principal pay down, it’s not subject to taxation. Even if you did manage to earn 11%+ on your annual cash flow, it’ll be taxed big time.

($2,500 per year at a little over 11% over 5 years will get ya about $15,700 or so.)

Let’s say, like so many of our clients, you’re gonna buy four small income properties. No matter what they sell for at the end of the 5 year holding period, you’ve now found yourself with about $63,000 additional exchangeable equity. But, you ask, how does that compare to the 30 year loan with the cash flow? So glad you asked.

$2,500 annual cash flow invested at an after tax rate of 4% each year for the entire holding period comes out to approximately $13,700. But wait, you bought four properties, right? So that would be around $55,000, rounding up. Yer still down $8,000 over the holding period if you went for the cash flow. Also, keep in mind your primary purpose for investing in these properties in the first place.

Capital Growth.

BawldGuy Axiom: More is better than less. Sooner is better than later. And more sooner is much mo betta.

The Takeaway: This exercise isn’t to point out that you’ve made a whopping $8,000 extra during the holding period. That’s hardly worth the effort. The point here is that most folks woulda walked away, cursing under their breath about the dang lender forcing them to miss out on a great opportunity. Wanna see the person who cost you that opportunity? Gotta be a mirror some place, right?

Taking the modified loan terms not only got you a boatload of capital growth, it allowed you to make the investment — period. Where would you have been if you’d waited for the terms you wanted? In 5 years you’d a been $1-200,000 poorer than you coulda, woulda, shoulda been.

And for the record? My experience with clients and small amounts of monthly cash flow, says that money had a shelf life of a super-sized #4 at Carl’s Jr. People promise themselves they’ll do what they know is the right thing, but sadly, the reality isn’t always a match. Just sayin’. Again, Bull Pucky. Over time, so many investors lower their own bar when it comes to spending cash flow. After all, they’ve earned it, right? I’ve heard all the perfectly reasonable sounding explanations for mysteriously missing cash flow. Bottom line? It was miraculously converted into steam. It’s long gone.

Go with the new loan and its modified terms. Your retirement will thank you in so many ways, and for a long, long time. I’ll thank you for the chance to chat. Let’s get together and figure out what makes sense for your Purposefully Planned retirement. You know how much I like talkin’ to folks about their retirement plans. I need a fix. Have a good one.

This entry was posted on Tuesday, November 18th, 2008 at 9:54 pm and is filed under BawldGuy Axiom, Buying Income Property, Capital Growth, Financing, Investment Lessons, Purposeful Planning, 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.