Though many real estate investors are primarily interested in short term profit, almost all of ‘em eventually turn their efforts towards ensuring a sizable and reliable retirement income. Yeah, classic Captain Obvious material to be sure. Still, experience consistently demonstrates how, more often than not, people get their eyes off the ball — and make no mistake about it — abundant high quality, steadily reliable retirement income is the ball. Net worth is fun yackin’ about at your buddy’s BBQ, but it won’t be of primary importance to you in retirement. Income will be. Does anyone doubt or dispute that?
I recently asked a caller whether or not they’d prefer a safe and reliable retirement income of $100,000 yearly, or twice the net worth with half the income. She thought I was playin’ with her, which of course, I was. Yet how many times have we read or heard somebody talking about net worth while not connecting it with income? There are folks I know personally who’re making or will make $10-30,000 a month in retirement. Yet many of ‘em don’t have the net worth of those now learning to live on WAY less than that cuz they chose, shall we say, a relatively inferior income strategy.
Imagine you walked away from your job last week, ready to sail into the sunset. You have a couple million — the nest egg you’ve built over lo these many years. Being exceptionally conservative while following Grandpa’s example, you’re invested in various bonds and treasuries. The 10 year government treasury closed this Monday night at roughly a 1.51% yield. Let’s do the math, alright? 1.51% X $2 million = $30,200 a year — wait for it — before tax. Oh happy day! But, you say, “I can do twice that in the bond market.” Go ahead. Would love to hear how the spin goes when you’re asked how your two mil is producin’ for ya. A bit over $60,000? Really? Before taxes? Hope your buddies have great poker faces.
If all that was done was paying cash for some super located rentals in an equally superb market, they’d screw up and make $110-135,000. Oh, and around 30-45% of that would be tax sheltered, maybe ’til they’re long gone. Put another way, and in plain ol’ regular folk English, the after tax income from just payin’ cash for high quality residential income properties would more than double that of the bond approach — literally.
It’s about income. It’s always about income. Grandma doesn’t take her net worth to the grocery store. She uses her after tax retirement income. All things being equal, if you told her she could double her annual after tax income by giving you all of her net worth, she’d do it in a New York minute — if she believed it would happen.
Some things it’s definitely NOT about
It’s not about how high the cap rate is on your income property purchases. There are literally thousands of investors who, as you read this are sorry they ever learned what a cap rate is. (Net Operating Income/Price) With scary rare exceptions, double digit cap rates are mirages. Let’s stop, take a couple cleansing breaths, and think for a minute. Everything our investor has checked out has sported single digit cap rates. Then, like a prayer answered, comes a rental showing a real life 13% cap rate. They immediately call for a moment of silence.
Pause: Another way to view cap rates is this. The price + closing costs on a cash purchase, divided into the NOI. Example — You pay $100 for something with an $8 NOI. Your cap rate would be 8% — same as your cash on cash yield. OK, where were we? Oh yeah. Our investor just found a very high cap rate property.
Let me ask you a very simple question. Why is that property’s cap rate so high? Don’t rush the answer. Take your time. (Jeopardy music softly playin’ in the background.)
Unless somehow our intrepid investor is the smartest in his area — and the other investors are all dumber ‘n stumps, there’s only one reason the property sports such a high cap rate.
Cuz nobody with the sense the Lord gave a goose would buy it otherwise. In fact, investors by the hundreds have successfully resisted buying this property at a lower cap rate. Again — why? Cuz it’s not worth it. Period. End of sentence. The reason the cap rate is so high are many, but heres three.
1. It’s in a neighborhood in which they wouldn’t live on a bet.
2. When it was for sale before they found it, the seller got tired of the laughter.
3. Regardless of our investor’s numbers, real life will show the cap rate to have been a fraud.
The next extraordinarily high cap rate I see on a 1-4 unit residential income property that actually produces that cap rate during the holding period, will be the first. So yes, even the high cap rate is a mirage. Which brings us full circle.
It’s not about net worth or cap rates, or any of the rest that investors so love to talk about. When the smoke clears, and your retirement party is under way, you and your other half are smilin’ ear to ear cuz of the income you’ve created. It’s all about reliable, stable, income when it comes to your retirement.
The ultimate agenda for any retirement strategy is high income, that’s reliable and stable. Keep your eye on that ball. The rest, as Grandpa was wont to say, is HappyTalk.
Photo: Frank Kovalchek