The Power of Focused Intensity in Real Estate Investing

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As discussed in my last post, under certain circumstances, long term real estate investors can opt to take a temporary detour from growing their capital base and recycle their positive cashflow to fund more acquisitions instead. The operative word in that statement is “temporary”. If market conditions (i.e interest rates, price/rent ratios) make it especially attractive to acquire quality properties and the investor doesn’t have sufficient capital to pursue both and she has the luxury of abundant time – then it makes sense to press the pause button. But this temporary pause does not change the principle that in order for the cashflow at retirement to be adequate, the investor must always build a large enough capital base first. 

There are two ways to build a large capital base and they both involve paying off your portfolio’s debt. The difference is in the manner in which they go about achieving it.

Method One: Appreciation

The first method relies on the “A word” (appreciation) and it works like this: Investor acquires 15 cashflowing investment properties. After a number of years, she sells off five of the properties that have appreciated the most and uses the proceeds to pay off the remaining assets in the portfolio. The biggest pro of this method is that  when it works you don’t have to sacrifice your cashflow to pay off debt during the holding period. The biggest problem with it is that it relies on high appreciation which is about as predictable and reliable as Charlie Sheen. In my opinion the reliance on appreciation is a structural flaw because this method would not work in stable markets with slow and steady appreciation rates. So the end result leads the investor to put his hard earned capital in more volatile and temperamental markets (Hello California) and if long term investors wanted that they could just put their money in stocks. Last but not least, what happens if the appreciation does not materialize or worse, values drop right before you retire?

Method Two: Cashflow

The second method is based on the premise that while all long term investors want cashflow – the timing of that cashflow is the true determining factor. All investors want a great income stream at retirement but they aren’t looking to current cashflow to subsidize their current income. Put a different way, they aren’t waiting for the cashflow to come in to pay their light bill. Therefore, if we want cashflow at retirement and we don’t need it now, why don’t we put the current cashflow to work now to build a large capital base and in so doing, increase the cashflow at retirement. But having said that, what’s the best way to use the current cashflow to accomplish that goal? It’s called a Domino Strategy (see photo below) and it possesses the power of focused intensity that you should employ in your real estate investing strategy.

Domino

As an illustration, let’s take  the numbers on a property a client just closed on yesterday as they’re fresh in my mind. We purchased the property for $125k, 20% down, 4% interest rate for 30 years and it has monthly positive cashflow of $400. So let’s assume you purchased just this one property and wanted to use its cashflow to pay the debt off faster. If you applied the extra $400/mo towards the principle, it would take you 143 months (just short of 12 years) to pay off this property. So far so good.

Now let’s assume you purchased nine identical properties instead and you take the overall positive cashflow from your entire portfolio and apply it towards the principle on one of the properties while making regular payments on the others. The entire portfolio becomes free and clear in 145 months.That’s the power of focused intensity and discipline. In virtually the same amount of time it would take you to pay off one property, you could pay off nine. Instead of $125k in capital base generating $12k a year in income, you could have $1.1M and $108k a year. And that’s without a dime of appreciation.

Slow and steady adds up to some real money really quickly, doesn’t it?
Photo:taberandrew

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About Author

Erion Shehaj (G+) is Investing Architect. He helps people craft a Blueprint investing strategy that leads to accelerated capital growth, higher income and lower taxes. Side effects might include: Early retirement, wealth and piece of mind. Follow on Twitter if that's your thing.

14 Comments

  1. Erion, good article and I certainly don’t disagree with your message, but I think that your logic is a bit flawed at the end. If you purchase one property and can pay it off in 143 months, it stands to reason that you can pay off nine identical properties over the same time period with the same method, regardless of where you apply the payments. In fact, I’m not sure why it’s taking 145 months in your calculations instead of 143.

    • Erion Shehaj

      Probably, due to the rounding on mortgage balances.

      But while I agree that the manner of applying extra payments doesn’t affect the length of time it takes to get to a free and clear portfolio, it does affect the risk within your portfolio quite a bit. Because, if cashflow is applied to each property individually, all assets will be paid off in 12 years – but they will be mortgaged that whole time. Instead, when using a domino strategy as described, you get to a free and clear asset every 2 years or so, with the pace accelerating at the end.

  2. Great article. I wish I could get bank financing but at this time that is out of the question. Right now I am trying to get a new property and have it planned for a 5 year payoff. The kills cash flow…actually puts me in the negative. Fortunately, I have two others paid off and I intend to use that flow to help pay off number 3 and 4. I like this article because it shows how someone with determination AND a plan can achieve excellent results.

    Thank you!
    John Thedford
    Naples, Florida

  3. Good post, Erion! You wouldn’t know of a good place to grab a spreadsheet like that by any chance, would you? I’d love to play around with it a bit if it’s something you’ve built you w/ formulas and whatnot.

  4. jeffrey gordon on

    Well no sign of the Bawld Guy so I will share a comment I made on a post of his a while back and his response, which was enlightening for me about why pay one property off first vs paying them down equally in regards to Ethan’s question above.

    here is the original post, not sure if it will hyperlink.

    http://www.biggerpockets.com/renewsblog/2012/06/13/50-years-old-impressive-assets-potential-retirement-income-anything-but-impressive/

    and here is his answer to my question that all things being equal won’t the properties all pay off at the same date either approach?

    Jeff B. “If we take four small properties at random, with loans around $204K each, at 4.625% fixed, and NOI of roughly $18-19K/yr., the first year’s combined cash flow (spreadsheet) would allow the investor to add about $2K/mo to the monthly payment of one of the loans. This would pay off the first prop in just over six years (78 months). That’s a free ‘n clear prop that immediately opens up the options menu. Those options wouldn’t be available if you’d been paying all four of ‘em off simultaneously. What if in those 78 months a killer cool opportunity became available? You could either refi for the cash, in this case roughly $200K, tax free — OR — you could sell and/or exchange just that one prop. You wouldn’t be forced to decide to pass on the opportunity, or mess with all four props to make it happen. That’s just one of the benefits, as their are several more, depending upon the specific investor’s Plan.”

    So, Ethan to answer your question above, focusing all the cash flow on paying down the mortgage on one property at a time will open up options for sale and/or refinance to free up equity with much greater value than having to work with all the properties involved.

    Good old Balwld Guy common sense that usually is best learned from experience rather than books etc.

    jg

    • Jeff Brown

      Correcamundo Jeffrey. :)

      The timing of making the portfolio F/C remains virtually the same. However, there’s an axiom I’ve taught for years, that says: The real estate investor with the most options at any given time, wins.

      Knockin’ down one prop loan at a time, as Erion suggests, produces those options FAR more quickly.

  5. You must be a very busy guy Erion. Either that or your website is busted. Because I tried to contact you through your website well over a week ago and haven’t heard a peep.

    • Hey Robert

      Busy, yes. But never too busy to reply :-)

      I actually did reply to your email on the 19th. I was wondering why I didn’t hear back but did not want to be overbearing. Please check your spam folder as Yahoo emails are notorious for banishing emails there

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