Here’s a scoop. At BiggerPockets we love talking about investing in real estate. Then there’s short and long term strategies. Some stay out of the real estate investment arena, preferring instead the role of banker — they like notes. They like dealing with paper, not people. However, what so often tends to get lost in the noise a bit are the underlying realities of our choices. Investors too often shuffle the various principles literally governing their financial future to the back of the room.
I speak often to groups about these principles. They should be front ‘n center at all times during the decision making process. Let’s lay them out first, then tackle ‘em one at a time.
The time value of money.
Increasing your options over time.
The time value of money.
Always loved the ways this principle is explained using analogies. “Would you rather have a fast nickel or a slow dime?” is an oldie but a goodie. I was recently reminded of that one while on a business trip. ‘Course value, in and of itself can be interesting when a single asset can be viewed over very long periods of time. My favorite example of that is gold. 150 years ago an ounce of it would buy a much better than average suit. That suit today costs a whole bunch more, yet the same ounce of gold will buy it. Real value.
Let’s not get caught up in all the catch words used for this topic, net present value, future value, internal rate of return (a lie, by the way), etc., etc. Instead, let’s understand what counts on the most basic of levels.
More is better than less.
Sooner is better than later.
More, sooner, is much mo betta.
When analyzing your options at any given time, don’t get caught up in the always/never trap. As one of my oldest mentors taught me, “The fast nickel is always better than the slow dime, ’til the day it’s not.” Fast and slow are relative terms. By attaching set meanings to them — set conclusions if you prefer — we’re likely to get ourselves into trouble. If the nickel ain’t fast enough, or the dime isn’t as slow as we thought at first glance, the analytical conclusion can change. Sometimes surprisingly. Here’s an example.
In a recent, stellar BP article, Ben Leybovich spoke of his preferred strategy of paying off multiple real estate loans one at a time. For decades I’ve referred to this as the BawldGuy Domino Strategy. (Yeah, I know, pure corn.) Frankly, all three of the aforementioned principles apply to the discussion of how the investor chooses to pay off loans. Or even IF they should. Every ‘extra’ dollar applied to debt reduction is a buck not spent or invested elsewhere. Our income/cash flow/net worth all have one thing in common. They’re finite.
Loan payoff velocity and the time value of money.
Timm has multiple properties, all of which have loans. He has a plan calling for retirement in X years, which requires the maximum cash flow generated by debt free properties. Since Timm knows the amount of cash flow he has from these properties, along with income from various other sources, he can do the simple arithmetic, engineering the elimination of all loans on or before retirement. Here’s just a few questions that predictably pop up.
1. Why not just pay ‘em all off at the same pace? The result is the same, and whether the Domino Strategy is used or not, generally won’t end up with the loans paid off more quickly. It’s about the same.
2. Given the various interest rates, why would he put precious capital towards debt reduction when he could easily generate a higher yield putting it elsewhere?
3. Once your primary goal is having a free ‘n clear real estate portfolio, aren’t you also puttin’ a ceiling on your ultimate retirement cash flow?
#1 Since Timm won’t be delaying his retirement by opting for the one at a time approach, he’s decided to increase his options over time with the Domino Strategy. Every time he free ‘n clears a property his options increase significantly. Not only is cash flow instantly turbo charged, but so is his options menu. He can separate that building from the herd. Let’s list a only a few options Timm might choose in order to increase his end game retirement cash flow.
A) He could refinance that property, using the tax free cash to acquire discounted notes at a yield 2-5 times higher than the interest rate he’d be paying. I’ve written often about Strategic Synergism. This is an excellent example of that concept’s rubber hittin’ the pavement.
B) He could sell that property, using the proceeds to generate more retirement income than the property would have. This begs the question of taxes on profits and depreciation recapture, right? He woulda planned to create a partial if not total offset to those taxes before ever contemplating that technique.
C) If his overall ability to speed up loan elimination has improved, he might opt to refi/exchange/sell, then buy more property. This of course would hinge on his ability to pay off newly acquire financing by his retirement date . . . or not . . .
D) What if he chooses to refi and buy notes? Since the very positive result of that arbitrage approach would easily exceed his cash flow from the refied property(s), he might very well decide it’s ok for those selected units to remain encumbered at retirement.
#2 This question is perhaps one of the most common posers for real estate investors. What do they do with the monthly dollars they have to advance their overall plan? Here are some factors to consider, as no formula, or one size fits all game plan will work.
A) How old is the investor? Relatively young? Middle aged? Over 50ish? At 39 time is their best buddy. At 59? Not so much. The younger guy has more options too, as certain long term strategies simply aren’t available or even workable for the older guy. I’ve found that impressive amounts of expendable monthly cash works wonders on the ravages of age. When you can accomplish the same thing in a decade as your much younger counterpart can in 20 years, you just proved that Father Time can be bribed.
B) If you do have enough time to keep more viable options on your menu, and you have decent/reliable monthly cash from whatever sources, be slow to decide where to direct that cash. I say slow only in the sense that these days there is no real ‘normal’. What will interest rates be next year? They’re hovering around the 5% mark now for investors.
Saving monthly cash flow so as to acquire another property in a year makes great sense for many, ’til it doesn’t, right? How trustworthy has your crystal ball been lately? I’ve seen interest rates nearly double in a year’s time. Would you do the same thing next year if the rates went to say, 8%?
C) There are times when one of our underlying assumptions is just plain wrong. What?! Huh?! Take the original assumption about putting your original capital into real estate. What if some of that seed capital — if enough exists — was redirected in the beginning to discounted notes? (another post altogether)
#3 This one is often a poser, when it needn’t be. Once your primary goal is having a free ‘n clear real estate portfolio, aren’t you also puttin’ a ceiling on your ultimate retirement cash flow?
Yep, pretty much. Unless you’re incorporating multiple investment strategies synergistically in order to arrive at retirement with more than your real estate cash flow as a source of income. Though notes are an obvious addition to the discussion, it also matters how those notes are held. When possible, having a self-directed retirement plan yielding its income tax free is the obvious choice. Yeah, I know, Captain Obvious rides again. Still, it often makes common sense to have a personally held note portfolio too.
A) If you begin with the premise that limiting yourself to income property isn’t always the Golden Highway in and of itself, it’s not only possible, but probable you’ll wind up with a far higher retirement income — and maybe a bit sooner than you originally planned.
B) Even when the initial investment capital available isn’t enough to buy more than a ‘starter’ income property, you can incorporate the concept of multiple income sources into your overall game plan. I’ll be talkin’ a lot more about this and the ‘how it’s done’ in coming weeks.
C) The thinkin’ that real estate investing can be the magic carpet ride to a robustly magnificent retirement income is outright truth. However, one of my favorite quotes from the original Rockefeller is the answer he gave to the following question:
“Mr. Rockefeller, how much money is enough for the average person?” His reply? “Just a little bit more.” Nail. Head.
Here’s the takeaway: When you have the wherewithal to safely make things happen sooner, rather than later? Do it. When you can concurrently and safely engineer the end game income to be more, rather than less? Do it.
Oh, and beware your assumptions.Your Ultimate Game Plan — Can It Be Tweaked? by Jeff Brown