Today marks my 40th post for the BiggerPockets blog and yesterday I realized that up to this point I am yet to write a commentary. That changes today.
Pardon my rant, but I think the responses to this post will help a lot of people.
Ok, seriously? I can’t think of anything that has been more confusing as the Secure and Fair Enforcement Mortgage Licensing Act (aka SAFE Act) in the real estate investing community this year. The Act was first put in place in 2008, but recently there have been some updates made to the legislation (some of which won’t take effect until October 1). Depending on your strategy it may not mean anything at all to you, but as someone who leverages private money lenders and makes offers to homeowners that include owner/seller financing options, the SAFE Act has been a bit of a mind boggler.
I’ve spoken to real estate professionals and have also scoured the web for answers. A Google search on “S.A.F.E. Act and owner financing” or even a BiggerPockets forum search on “SAFE Act” will send your head spinning. So many different thoughts on the legislation.
I still have more questions than answers. For example,
1) How does it effect seller financing for properties my company wants to purchase? We make cash and terms offers all the time! If a homeowner wants to sell a property (one that is NOT his primary residence) to me and hold back a mortgage, does he need a license?
I believe that my fellow BiggerPockets blogger Clint Coons has addressed this in his recent post “Are You Safe to Sell Under the SAFE Act?” and my take from that post is that the sellers I’m making offers to do not need to have a mortgage license in order to provide seller financing to me as a buyer. I think we’re relatively clear on this issue. However, I’m much less certain about the following:
2) How does it impact how my company works with private money lenders? Do they now need to have a mortgage brokers license to lend my company funds to purchase properties for long term hold? If so, is there a reasonable workaround?
3) Does each state have its own separate version of how this works and how it will be regulated?
I’m also unsure of how the federal and state governments will enforce all of this. There seems to even be confusion among attorneys at the title companies regarding what’s ok and what’s not. Thanks in advance to anyone who can shed some light here on what may be very well be the most confusing legislation impacting real estate investors in 2010.
I bought my first investment property back in August 2008. I paid $63,500 for the house using my own cash. I spent the next two months rehabbing it with $34,000 of my own cash. It sat for about 5 months before I lease-optioned it for $1000/month in rent, starting May 2009. In August 2010, I refinanced and pulled out $66,320 in cash. It cost me about $2300 to do that refinance. I spent $1400 on property taxes in August 2009 and another $1200 in property taxes in August 2010. I'm expecting the tenants will be able to purchase the property for $120,000 in July 2011, and I'll end up netting about $50,000 after all fees, commissions and loan payoff.
If you don't know how to calculate the correct answer to that question " and as a real estate investor you SHOULD know " I highly recommend you keep reading"
Anyone who reads my BP blog posts or my blog probably knows that I'm a hard-core numbers guy. While I don't discount "gut feel" when it comes to investing, if the numbers don't work, it doesn't matter how excited my gut might be. I like to examine the financial aspects of a deal before I buy, while I'm holding and then after it's done. That way, I can mitigate the risk of financial surprises as much as possible.
Seeing as how I'm such a numbers guy, I find it very surprising when I speak to investors who don't seem to have clue how to analyze a deal or how to determine how profitable a deal was after it's completed. It's not that most investors are stupid (far from it!), but many investors have never spent any real time learning the basics of analyzing investment numbers.
I've spent many of previous BP blog posts discussing how to analyze a deal upfront to determine if " in theory " the deal is a good one; today I want to tackle the other end of the deal and discuss how to determine whether a specific deal was profitable after all is said and done.
First, let's clear up some common misconceptions. I'm sure most investors have heard terms like "cash-on-cash return," "total return," "return on investment," etc. These are all terms that indicate in some way, shape or form how successful a particular deal is. The most common I hear people referring to is Return on Investment, or ROI. For many investors, this is the one number that summarizes the entire success or failure of a particular investment.
For those not familiar, ROI is calculated as follows:
ROI = (V1 – V0) / (V0), where V1 is the ending balance and V0 is the starting balance.
A simple scenario for using ROI to calculate an investment return would be as follows: On January 1, you put $1000 into a bank account. On the following January 1, you cash out the account for $1100. Your ROI on the investment is:
ROI = (1100 – 1000) / (1000) = .1 (or 10%)
You start with $1000 and end up with $1100 after a year for a return of 10%. Seems pretty straightforward and even the most non-mathematical among us should be able to do that type of calculation.
Now what if I give you the following scenario: On January 1, you put $1000 into a bank account. On February 1, you put another $500 in the same account. On September 1, you removed $250 from the account. And then on October 1, you removed another $250. On the following January 1, you cash out the account for $1100. Like the first example, you started with $1000 on the first day of the year, and you finished with $1100 on the first day of the following year.
So, is your return still 10%? At first glance, you might think so. In fact, using the ROI formula above, the ROI on this investment appears exactly the same as the previous investment. But, given that you had $1500 invested for several months of the investment period (from February through September), you'd think that a 10% return should have resulted in a higher ending balance. So, in actuality, your ROI is probably a good bit less.
As you can see, the ROI formula has two big limitations:
For any investments that involve sums of money going in and coming out through the life of the investment, ROI will pretty much ignore every in-come and out-flow other than the first and the last;
ROI doesn't take into account the amount of time an investment was held. For example, let's say in that first example, the $1100 was cashed out after 5 years instead of one " according to the ROI formula, the return is still calculated at 10%.
This is where Internal Rate of Return (IRR) comes in. IRR is the much more powerful cousin to ROI, and while also more complicated than ROI, it's an essential tool that all serious investors need to understand. I'm not going to go into the nitty-gritty of how IRR is used (and yes, there are some downsides to using IRR that I won't go into here), but I do want to review the basics"
First, you may hear IRR referred to by different names " on your mortgage truth-in-lending statements as annual percentage yield (APY), as the "effective interest rate" of a loan, as the discounted cash flow rate of return (DCFROR), or sometimes even as the generic rate-of-return (ROR). All of these things essentially mean the same thing, and serve to underscore how important and versatile the concept of IRR is when it comes to investing and finance.
(For the other hard-core finance geeks out there, IRR is most specifically defined as the discount rate that makes an investment's net present value (NPV) equal to 0.)
Second, and most importantly, I want to do a quick summary of how to calculate IRR for a given investment. Unlike ROI, you can't calculate IRR in your head. In fact, even doing it with pencil and paper is practically impossible. But, calculating IRR using Microsoft Excel (or any other financial software) is a piece of cake.
In Excel, list the monthly (or annual) dates of your investments in sequential order in one column. Next to each date (month or year), list the aggregate in-come or out-flow for that time period (in-comes are positive and out-flows are negative). Then use the XIRR function in Excel to calculate your IRR. Using the example above where we deposited $1000 into a bank account on Jan 1, deposited another $500 on Feb 1, removed $250 on Sept 1, removed another $250 on Oct 1, and then removed the remaining $1100 on following Jan 1, our Excel calculation would look as follows:
As we suspected above, our return was a good bit less than 10% (almost 25% less!), despite our ROI calculation of 10% return. As you can see, doing a quick ROI calculation in your head would left you feeling a lot better about your investment than it probably should have.
If there is enough interest, I'm happy to go into more complex uses of IRR in future posts, and am also happy to discuss some IRR nuances that sometimes affect the ability to accurately determine returns of some types of investments. In the meantime, if you're interested in learning more about IRR and how to calculate it using Excel, there are some good online tutorials.
“Even after careful research, not all ideas are good; sometimes your competitors have better ideas or they're faster than you. The modern entrepreneur takes failure in his or her stride and moves on.” ~ Richard Branson, Screw It, Let’s Do It
Sir Richard Branson made a cameo appearance on the HBO show Entourage this week and it got me thinking about him and the life he leads. I actually had the pleasure of listening to him speak last year in a room of only a few hundred other entrepreneurs and the thing that stuck with me the most is how simple he keeps things. With hundreds of companies to run, I don’t think you could live life any other way. And a few nights ago as I contemplated what to write today, I thought about the life lessons he shared in one of his books, and how those can be applied to real estate (and should be applied for successful – and simple - investing success!). I mean – think about it – every house you buy is essentially a small business with it’s own target market of customers to rent or buy from you, it’s own expenses and it’s own marketing needs. So if you have hundreds of houses then it’s, in a smaller way, like Richard Branson owning hundreds of companies.
Now – not to worry – I’m not going to relive each and every lesson in an effort to motivate you to get off your duff and start taking action towards your real estate investing goals. I did think I would share my favourite five lessons from the book and apply them to real estate investing … but guess what … lesson #1 is basically just that:
Lesson #1: Just Do It
I really can’t say it any better than Sir Richard does:
“If you really want to do something, just do it. Whatever your goal is you will never succeed unless you let go of your fears and fly.”
Lesson #2: Be Bold but Don’t Gamble
As a real estate investor you have to take some bold steps. There is always uncertainty as you can never really know exactly what will happen but there is a big difference between gambling and taking calculated risks. Calculated risks are things you’ve thought through and mitigated in whatever way possible. A gamble is just taking a leap of faith that it will all work out. If you aren’t sure what the difference is or how to mitigate risks there are some great posts kicking around BiggerPockets that can give you a good basis of real estate investing fundamentals like:
Lesson #3: Have Fun! Life is Too Short to Be Unhappy
I guess his passion for fun is why they featured Sir Richard Branson sandwiched between two beautiful blondes on Sunday night’s episode but I don’t think you have to find two beautiful people to go bowling with to make your life complete. I think that as a real estate investor you have to make sure you take time out for your family, your friends, and your fun time. This probably sounds a bit silly for people who are getting into real estate for the free time it gives you – but the reality is that many investors that are working to really get their business rolling also find themselves working all the time to keep up with everything they are trying to do.
Keep things simple. Focus on WHY you are doing what you are doing and remind yourself it’s not about owning more houses than the next guy or being the richest woman in your book club it’s about creating the life of your dreams and then living it!!
Lesson #4: Have Respect
I’m not going to tell you all the times we’ve been cheated by folks in the real estate business but it has been more than once. And it’s been by just about everyone you can think of from the property manager that robbed rent money from us to the tenant that worked the system so well she got three months free rent from us, and of course our joint venture partner that ditched out on a deal at the very last minute leaving us holding on to a pretty big potential problem.
There are people out there that don’t live by this rule but I believe that it’s one of the most important in all your dealings … treat others with respect. Just because a seller is in distress does not mean it’s open season to take advantage of them. Find a good solution for them and for you.
If you are doing something that will haunt you at night – stop – and don’t do it.
I believe what goes around comes around and karma is a big witch.
Lesson #5: Do things with POW/Shazam
To me, no entrepreneur embodies this more than Sir Richard himself – but you don’t have to rappel down the side of a sky scraper to do things a little differently. Real estate investors can take a page out of his book simply by trying to solve problems with a unique approach. Just because a deal has never been done the way you want to do it – does not mean it’s not possible. I can’t tell you how many times a real estate agent has told us “you can’t do that” only to learn that it’s possible and actually pretty easy with the right lawyer. Folks who’ve been in the business for decades aren’t always the best ones to listen to -many of them are pretty set in their ways as to how things are to be done. Come at things with a little pizzaz – try different angles to solve your problems.
“Sometimes when you start from scratch with a clean sheet of paper, with the principle of keeping things simple, you get results that wouldn't be possible by leaving it to the so-called experts.” ~ Richard Branson, Screw it, Let’s Do It.
Every property you buy can be considered it’s own small business – so maybe these little lessons from the worlds most interesting and inspirational entrepreneur (in my opinion) might help you enjoy your life, find more success and have a little more fun with every single deal. Image Credit: Ftvkun
There are a lot of things to consider when evaluating a deal. As real estate investors, we must find great deals. Not good deals, but great deals where we can minimize risk, maximize annual return and control our success.
Here are the 4 most important things to remember when evaluating deals:
Avoid Speculation as the only way to profit " Appreciation is great, but it absolutely cannot be the only way to profit. The fact is, the value of the market is out of our control. At no point in time should investors buy at market value and speculate for appreciation. Who wants to take a gamble and risk taking a loss when they can control their success by buying 30% below value? Appreciation is an extra bonus, follow the next 3 tips and never speculate as the only way to profit.
Max 70% LTV " The total cost of purchase, fees and any repairs must be a maximum of 70% of the value of the property. If not, pass and get 10 or more prospects like it and cherry pick the best deals.
Rents are 1.5-3% of Purchase – A property that rents for $750/month should be purchased for no more than $50,000 or rents are 1.5% of purchase. Some higher priced markets it is very tough to find this type of cash flow, you are lucky if rents are close to 1%. The best markets with the highest returns there are many deals with max 70% LTV and rents are 1.5-3% of purchase. These markets you not only minimize risk, but you maximize annual return which should be the goal of all investors. Sometimes, you can find really great cash flow deals where rents are $2400 and total cost in is only $80,000 or rents are 3% of purchase. Now that's some cash flow!
Strong & Multiple Exit Strategies – With equity and cash flow you end up with multiple exit strategies. You can sell at retail, sell to an investor, wholesale, seller finance a sale, lease option, rent and hold, refinance, sell the note, sell the entity holding title to the property, quick claim deed the property to transfer title, etc, etc. Having multiple exit strategies is a must and significantly mitigates risk. You must also evaluate and if possible test your exit strategies to ensure you have strong exit strategies.
I received an email from a client recently who was concerned about some information she received from an promoter of Wyoming and Nevada LLCs. She was told that a Wyoming LLC registered to conduct business in California will provide greater protection from charging orders than a California LLC. I hear this same argument time to time from Nevada or Wyoming ptichmen who’s only concern is selling you an entity and not in protecting your affairs. The information they provide is full of half-truths and misleading statements with one purpose in mind — to get you to buy an entity. I thought that I should share my response:
Dear Jane Doe,
In my opinion a WY LLC or a NV LLC registered to do business in California would not prevent the creditor of a member from enforcing a charging order against the LLC. – Why? — When it comes to asset protection and LLCs we are concerned with two forms of liability — inside liability and outside liability. With inside liability the primary concern is protecting ourselves as members from liabilities associated with the activities taking place in the LLC e.g., rental real estate. The protection for inside liability claims is derived from two places: state law and the LLC operating agreement that governs how the LLC is run and the protection it offers to its members. Most states are fairly uniform in their approach to inside protection. Liabilities that occur inside a LLC remain inside and will not attach to the owners of the LLC. Of course, this is contingent upon having a solid LLC operating agreement that has adequate protection and indemnification provisions for the member and managers. Unfortunately, when I review a client’s operating agreement it is not uncommon to find two or three critical defects that, if exposed in a lawsuit, could spell disaster. Nevertheless, with the protection provided by state law and a good operating agreement, the LLC offers excellent protection from the liabilities associated with owning real estate. Thus, if you created a California LLC or a Wyoming LLC registered in California to hold your rental real estate, both entities will protect you from claims arising out of liabilities associated with the LLC’s assets. If, on the other hand, you simply set up a Wyoming LLC to hold the property without registering it California, it would provide with you no protection whatsoever.
Outside liability protection is just the opposite. Rather than looking to the assets of the LLC for recovery, a creditor is seeking a judgment against a LLC member because it is the member that caused the harm and not the LLC. Most people I meet completely miss this point because so much attention is given to protecting you from your real estate that very little thought is given to your personal actions or, for that matter, those of your children who could also jeopardize your investments. You, by your everyday actions, are probably the greatest threat to your assets.
Nilse, an avid real estate investor, is traveling in his new BMW 7-series sedan on Interstate 5. Confused by the electronics, his focus is on the stereo and not the road! Because his attention is diverted, Nilse does not see the car in front of him suddenly brake. Nilse plows into the car, causing substantial damage to both vehicles and injuries to the occupants of the other vehicle. If Nilse owns his real estate investments in his personal name, he is at serious risk. Fortunately for Nilse, his attorney recommended he place his investments in LLCs. How does the LLC help Nilse? It has to do with state law and what the creditor of a LLC member can reach when he collects on his judgment.
Every state has, to some extent, given LLC members what the law refers to as “charging order” protections. Unlike the situation with “Inside Liability” where the creditor can only look to the assets of the LLC and not the members individually for recovery, with outside liability the creditor is looking to recover against the member’s assets. Your LLC membership interest, like the stock you own in a publicly traded company, is an asset that is considered personal property. One important feature of this asset is its unique characteristics that prevent creditors from levying on it if they have obtained a judgment against you personally. Approximately 23 states, Nevada and Wyoming included in this number, limit the judgment creditor to a charging order.
The benefit of the charging order is it limits your judgment creditor to a lien on any distributions you decide to make from your LLC. If you do not make distributions, then your creditor does not collect on the judgment. It sounds great and it is, but unfortunately all states do not adhere to the charging order as the sole remedy. Some states, like California, go so far as to allow a judgment creditor to foreclose on the member’s interest if the LLC is not making distributions. For many investors this is disconcerting given that the state requires the investor to have a LLC registered in the state if it is to hold real estate (the statute actually refers to conducting business and renting property falls within this definition). To trump a state like California and its creditor-friendly approach to asset protection, many investors will establish a LLC in a state like Nevada or Wyoming then register their LLC to conduct business in California as a foreign LLC. These investors believe that California must apply the law of the entity’s home jurisdiction when it comes to matters of charging order protections. For example, if I created a Nevada LLC (remember Nevada does not allow any remedy other than a charging order) then register it in California as a foreign LLC, I will be immune from California’s approach to the charging order should someone attempt to collect on my LLC interest. Unfortunately, California and every other state that I have researched does not take this approach.
Under California Corporation Code 17450 the laws of the state … under which a foreign limited liability company is organized shall govern its organization and internal affairs and the liability and authority of its managers and members. In other words, the laws of the state of organization will govern any claims arising between the members or managers with respect to the inner workings of the company or between the company and its members or managers. The enforcement of a charging order on a member’s LLC interest does not fall within the statute’s definition. A charging order is the application of a judgment against personal property held by a California resident. Thus, if I am creditor and I obtain a charging order against a California’s resident’s interest in their Nevada LLC registered to conduct business in California, I can, under California Corporation Code 17402, foreclose on the member’s interest. This is not considered part of the affairs or internal workings of the company.
In layman’s terms this means I can foreclose on your out-of-state LLC because it has availed itself of California’s (see my previous post on Florida LLC Protections) laws when it registered to conduct business in California. To obtain the protections offered by Wyoming or the other strong asset protection states you can create a LLC in one of these states and have it own your California LLCs. In this way the out of state LLC does not fall within the jurisdiction of California, nor is it subject to its enforcement actions.
Have you ever wondered why some businesses fail? It’s more than just a business plan or lack thereof. I think its something much deeper than that. You see, in the mist of all this “doom & gloom” in the economy that we keep hearing about, there are businesses out there that are failing but there are also businesses out there that are prevailing! Then we have business, who are sort of stuck in the middle? A few years ago, one of my mentors told me that there are 3 types of people in this world and that they’ll be identified by their actions.
People Who Make It Happen!
People Who Watch Things Happen!
People Who Ask…What Happened?
Behind each business is an individual or team that fits into one of the categories above. Therefore this would mean that the individual/team are a direct reflection of their business because the business will only go in the direction they tell it to.
Obviously the category you should be shooting for is #1.
What does it take to be in category #1?
Determination
It can be defined as the act of coming to some type of a decision or settling a purpose. The key word I want you to grab from that definition is “decision”. Anyone can say that want to have a successful real estate business. They could even go as far as saying that they WILL have a successful real estate business. However, talk is cheap and action speaks louder than words. Once you make a decision to actually take action on what it is you want, you’ll be leaps ahead of those who are sitting on the sidelines and closer to your goals.
Education
We all know that education can be defined as acquiring particular knowledge or skills, as for a profession. It’s important that you constantly educate yourself on whatever niche or area of real estate you’re specializing in. As the world evolves, there will be things that used to work well in the past that simply don’t work as well today. By continuing to increase your knowledge and applying what is working today in your business, you’ll continue to see the growth you seek.
Surrounding yourself with like minded individuals
I mention this often in some of my posts because it is so important. One quote you often here is “If you hang around 9 broke people and sooner a later, you’ll be # 10.” Many people think about just money when they read that quote. However I tend to think it digs even deeper than that. This kind of goes back to the talkers versus the doers. I don’t know anyone on the planet who doesn’t want to be successful at something. However, I don’t have enough fingers and toes to count the amount of people who won’t do anything about it. On top of that, some people just don’t think as BIG as you do and therefore they try to tell you that your dream is nothing more than a dream and can never be a reality. By surrounding yourself with people that see your dream as a reality and people that are already living your dream, you’ll be well on your way to seeing your dream become a reality and living it yourself.
Inspiration
This kind of piggy backs off of what I said earlier, but I have to mention it because life can really throw some curve balls at you. I’m not naive to the fact that there will be days or even weeks where things just don’t seem to come together like they should. Unexpected situations come up that interrupt the flow of positivity that you have going on. With that said, it doesn’t have to always be like that. This is why you always need to surround yourself with like minded individuals that see the light at the end of the tunnel because they can inspire you on days where you feel like giving up. You can do the same for them in return. Professional development is very important to you and your business and the more you immerse yourself in it, the more clearly you will see that the negative crap in life can be conquered.
Relationships
Let’s face it, real estate is a people business. If you’re not a people person then you are going to have a tough time, in my opinion. Understanding your client is key in building a successful business because without them your business is guaranteed to fail. Positioning your business as a business of value to the client will definitely give your business the boost it needs. Help them make easier decisions to do business with you by educating them on things they might not know about. Address their immediate concerns and see what resources you have or know about that can assist them. Customer satisfaction should always be at the top of the list.
Endurance
Again, this kind of piggy backs off of what I said earlier. However, you really need to have the ability to fight through hard times and come up with new & creative ideas to keep moving forward. Businesses that are close minded and stuck in tradition are failing big time in this economy. If you’re not a step ahead of your competition, then unfortunately your business will likely fail because they’ll be ethically stealing customers with their new and innovative strategies and you’ll get left in the dust. Analyze what is going on in the marketplace and CAPITALIZE on the opportunities by always moving forward.
Overall it is your D-E-S-I-R-E that will determine your overall Identity for you and your business!
The Desire to be Determined
The Desire To Keep Educating Yourself
The Desire To Surround yourself with like minded individuals
The Desire To Be Inspire yourself and othersby having a positive mind frame and keep pushing forward, no matter what.
The Desire To Build Relationships that stick
The Desire To Endure The Pain & Hardship that life throws your way and open yourself up to new and creative ways of doing business that allow you to move in the direction you want.
With that said, get out there and find your true DESIRES and take action upon it today! You can do this.
Sunday morning found me havin’ breakfast with my newlywed daughter and her wicked cool hubby. They’re both anomalies in this economy. Within a reasonable time both of them found jobs completely congruent with their degrees. In a year or so they went from starving students to, “I think we’re gettin’ outa hand with the whole sushi thing, Honey”. For 27/26 year olds, they’ve adjusted well. They both abhor debt. I’m the poster child for OldSchool and I was counseling them some of their debt could wait to be paid off in favor of more pressing issues.
I’ve been subtly and not so subtly pressin’ for a meeting with ‘em to talk about their own Purposeful Plan. So when they called out of the blue, Sunday, I knew it was my turn at bat.
So, what’d I tell ‘em?
Note: I’m gonna change some their personal numbers/data to protect their privacy.
Jim is as smart as he is cool. An engineer now, he worked his way through college as a Costco butcher. He was head of the department shortly after graduation. His new engineering job? Took a pay cut. He had a 5-figure 401k when he left Cosco, which was very recent.
Told him to gut it. Pay the taxes/penalty and shake the dust off his sandals. He’s opted to take the after tax net and pay off his student loans, along with a very small amount of plastic. This will immediately eliminate roughly $500/mo in outgo. Sweet.
Nicole will now be able to save her entire after tax paycheck each month. Jim will add the $500 a month in payments he’s not payin’ now. This will get them enough to buy a duplex or 2 on 1 with an FHA loan. It’ll take roughly ’till spring to save the money.
They’ll get the new property, which will cost them roughly $1,800/mo before tax benefits. The immediate tax deductions will amount to about $18,000 a year, resulting in a tax savings of, give or take $5-6,000 a year. This means their monthly nut for the duplex will hover around $1,300/mo +/-. The duplex will run them in the neighborhood of $375-425,000.
Then they’ll redirect Nicole’s entire take-home pay to the monthly duplex loan payment. Assuming they’ll pay the top of the price range, $425,000 — and that FHA interest will still be about 4.5% (A silly assumption, I know, but my crystal ball is still in the shop. So using current rates will hafta do.) Within five short years this will result in a loan balance of around $273,000 — not bad considering it will have started at just over $410,000.
Also, this strategy will very quickly eliminate FHA’s mutual mortgage insurance, a .55% add-on. FHA experts may wanna chime in on this, but I’m pretty sure once they get the loan balance demonstrably below 80% of market value, they can lose the mortgage insurance.
In just five years this results in a loan balance of about $273,000. If they chose to sell at that point, their net check would be somewhere in the neighborhood of $110-115,000. That number assumes they enjoyed an annual appreciation rate of from 0% to 0% for the holding period.
More on that later.
Once the smoke clears on the duplex purchase, they’ll be budgeting for their own EIUL. I’ve advised them to acquire a premium of $1,000/mo — they’re to keep that payment level for the next 30 years, when they’ll be 56/57 years old. The income from that point, if they choose to pull the trigger at that point, their annual income would easily be in excess of $100,00 — tax free, by the way — from the EIUL alone.
If indeed they sell the duplex after five years (a totally arbitrary holding period), they’ll have created two baskets for the price of one. Half the proceeds will be tax free. That’d be from the ‘primary residence’ half. ‘Course who knows what the dang law will be by then? The other half of their net equity will be considered long term capital gain, as per the internal revenue code. (Section 1231)
They can take the residence half and buy a new place — NOT a duplex — or not — their choice. The investment half of the proceeds can be sent outa state using a tax deferred exchange per Section 1031 of the IRC. It’ll buy a Texas duplex with cash flow from the get go.
See what they’ve done? In five years they will have turned $15-20,000 into over five times that amount — and without any help from appreciation whatsoever. Furthermore, they’ve now established the foundation for building a real estate investment portfolio that will have the potential to generate another six figures in retirement income in the next 15-30 years. Why the rather large range? Simple — there’s no tellin’ how slowly or quickly Jim’s paycheck will increase as the years go by. If we go by his track record, he’ll rise faster than most. Of course, the economy is the ultimate arbiter, isn’t it?
Here’s what I see for them, conservatively, 30 years from today.
They’ll have the option to retire with over $200,000 a year. Over $100,000 of that will be tax free forever. Give or take 35-45% of the real estate cash flow will be tax sheltered. For how long will be anyone’s guess — but it’s reasonable to predict the first decade or so of their retirement would produce tax shelter.
Frankly? I think they’ll do markedly better than that on the real estate side. But I said I was being conservative. Either way, you can clearly see they have an excellent chance for a magnificently abundant retirement. Remember, they have some connections in the real estate investment world.
Haven’t talked about kids here, but if they do have kids, we’ll get them their own EIULs immediately. Why? How ’bout 18 years of guaranteed no losses? They’ll be ready for college at that age, and will have the option to trigger income or tuition money. Either way there will be no taxes whatsoever. When they graduate college they can then take out more cash, if it’s available, opt to continue the income, or simply take over paying the premiums themselves. All the options are on their side of the table. Sweet.
This Purposeful Plan is for my own daughter. Wanna know if an advisor believes what he says? Find out what he’s havin’ his own immediate family doing. What I told my daughter is not one inch different than what I’ve told dozens of couples this year alone.
Though some have opined gutting a 401k is extreme, I respectfully disagree — extremely. As I was tellin’ them over breakfast Sunday, “If you generate tax savings of $3,000 a year through your annual contributions to the 401k, you’ll have saved a total of $90,000 in 30 years. If you’re a world class stock picker and end up with $2 million 30 years hence, and get a 6% yield (don’t laugh), that $120,000/yr will quickly turn into a whole lotta $80,000 after state/fed income taxes. Furthermore, are you willing to wager you’ll not have some bad years on the way to retirement — or worse yet, after retirement? That’s $40,000 a year in taxes. In other words, in five years you’ll have paid over twice in income taxes in five short years than you saved in 30 years.”
I then asked the question I’ve often asked clients — “Why would you do that to yourself on purpose?”
Um, they wouldn’t.
Would love to hear your thoughts. Have a good one.
