Retirement Security: Invest In Texas NOT California

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A real estate investor from California has several small rental properties (8), all local.

Location quality is suspect, as they’re in… you know… California.

Related: Southern California Housing Markets Increasingly Overvalued

Opinions vary on that topic. ;) 8% sales/closing costs generates a net equity of  around $435,000, give or take. That includes one rental in which he used to live that’s now under water.

He’s a couple years from 40 years old, so time is one of his A-List buddies. Household income is below $100,000 so they (married) can take any and all depreciation available, up to $25,000 yearly.

The End Game Agenda.

As in virtually all plans, maximum spendable retirement income is the ultimate goal.

One of the tenets upon which I build a Purposeful Plan is multiple sources of income, if possible. Furthermore, I very much prefer those sources to be independent of each other. By that I mean in the sense of no reliance on one source in order to make another successful.

Still, using what I’ve come to call Strategic Synergism, the investor definitely wants each source to be able to contribute one and/or both of the following benefits to the overall plan.

1) Speeding up the timeline, enabling the investor to retire earlier than originally planned.

2) Arriving at the end game goal with more spendable retirement income.

‘Course, Captain Obvious mutters under his breath that they all should do both. Well, sure, I get that.

But it doesn’t always work out that way. Since this couple is still relatively young, and not huge wage earners, their great start in real estate will act as their initial foundation.

I’ll not be able to provide in-depth numbers here, as time hasn’t been my friend this week. However, their $435,000 net equity will be exchanged, tax deferred, into five small income properties (duplexes) in another state.

**cough**Texas**cough**.

Related: California Dreamin” – Real Estate Investing In High Dollar Areas

The cash flow will be roughly $5,000 a year less than what he has now. The reason for that is that he’s significantly improving the location quality with his new acquisitions. Also, they’re brand new, which will benefit his bottom line for the first 5-10 years, depending on his relationship with Uncle Murphy.

Ironically this trade will increase total property value and debt a modest amount. He’s improving his status quo in the following ways:

1. Going from California to Texas is akin to trading your beat up Yugo for a new Beemer. Texas loves business, investment capital, and investors to death. The state has no personal income tax, and it was just declared the best state in the country to do business. (I can personally attest to that fact.) There’re many more reasons to love the move there, but those are the major points.

2. The repair ‘n maintenance costs will be far lower as the acquired properties are very well built, and brand new.

3. The quality of tenant will measurably improve. High quality location + state of the art brand new works virtually every time it’s tried. Higher quality tenants generally bring with them lower repair ‘n maintenance costs, all else being equal.

4. Down the road, when debt is eliminated, the net operating income of the Texas real estate will be appreciably higher than what he left. In fact, experience tells us that it will be impressively so.

5. Given that people and businesses are leaving California, while the opposite is happening in Texas, the potential for both increased value, NOI, and buyer demand are laughably higher in the latter.

The Next Step.

That’s phase one which will take much effort to execute, but will also be well worth it.

Phase two will involve a couple half steps. First, he’ll pay off one of the duplexes completely. This will then allow him to pull out cash in a refi. The tax free cash from the refi will then be used, in full or in part to establish a second income source, discounted notes, secured by real estate, in first position.

My initial estimate is that it’ll take ‘em roughly 6-8 years or so to pay off that first property. When note investing begins is when the real party starts as it relates to his plan.

We’ll get into the weeds on that phase next week.

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About Author

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.

20 Comments

  1. Sharon Tzib on

    Yep, the secret is out on Texas :) Seriously, it does have a lot going for it. The only negatives are the escalating property taxes and the expensive flood zone insurance that seems so prevalent, specifically in Houston, where I’m looking. This makes finding a property that cash flows very well from the start and is in an area where you can easily raise rents very important.

    • Jeff Brown

      Hey Sharon — I’ve heard the property tax complaint since I arrived in Texas about 7 years ago. My voice among ‘em. However, I’ve since learned that in the big picture it’s just not a big deal. All the macro economic factors make investing their an easy decision. Furthermore, the difference between TX and CA when income taxes are inserted into the equation, more than offsets any problem investors might initially have.

      The typical TX tenant has $100-200/mo more spendable income in their Levis than CA tenants have. That’s exacerbated by simple rent comparisons. For example, in my SoCal city, an exceptionally well located duplex sporting 3 bedrooms 2 full baths a side plus a full sized attached 2 car garage, a state of the art kitchen, laundry hookups, with central heat and air conditioning would rent for $1,800 a month apiece minimum. The same property in the Austin, DFW, and San Antonio/New Braunfels markets are just now approaching the $1,400 mark.

      The duplex in my city is virtually guaranteed to have been built no later than the 1970s, though most before that. The example I used is, in reality, non-existent in my hometown market. Yet decades old, functionally obsolescent 2-4 unit properties in stellar locations here BEGIN at around $400,000 for a duplex and go up from there. And they STILL get the absurd rents I used for a new duplex above.

      Let’s go a step further. A guy in a mediocre to subpar area in CA who owns a duplex with roughly $250,000 net equity, sporting a $400,000 dollar market value, can turn that into 3 brand new TX duplexes with a better bed/bath mix, in much better locations, upside, tenant quality, etc. Sure, they could keep ‘em and buy more old CA refuse, but in the end, retirement, they’re almost infinitely better off in TX in just about every way that matters.

      That’s why the relatively higher prop taxes in TX is pretty much a non-issue, at least in my experience, Sharon. Make sense?

      • Sharon Tzib on

        Yes, it definitely makes sense, and I’m very bullish on Texas, so don’t take my comments as outright criticism. But when you see people on the forums all the time talking about their 10-20% tax increases, it makes you realize that you either need to purchase property that can easily absorb that increase and still cash flow or is in an area that allows you to increase rents without suffering vacancies by doing so. To ignore those realities would be foolish, is all I’m saying.

        I also hope to see more developers building more small single family in Texas. In Houston anyway, that would be very welcome. Thanks, Jeff!

  2. Hi Jeff!
    From everything I’ve heard about the business friendly climate in Texas, I would be MORE than happy to base a real estate investing strategy within the state. Makes life so much easier investing in landlord/business friendly states.

    • Jeff Brown

      Hey Lisa — The difference between the courts in CA and TX is measured in light years. ;) In CA, the judges pretty much act as the lead attorney for tenants. In TX the judges couldn’t care less about the tenant OR the landlord. They focus on the rental contract, period. Violate that contract in TX and in a short time period you’ll be moving out with the assistance of a burly guy in aviator sun glasses, a badge, a gun, and a smile. :)

      In CA? True story. I once was taken to court by a deadbeat tenant who was fighting eviction. Their claim was that the unit was ‘uninhabitable’. The judge quickly went into action. She ruled that since the thermostat on the heater needed to be replaced, it was indeed uninhabitable. Ya can’t make up something that stoopid. The takeaway from that story is that it wasn’t in any way out of the ordinary.

      And folks wonder why I left the CA market? ;)

  3. So Jeff, where are you living now, and where are you investing? I’ve gotten confused in the dialog here. I lived in Houston for many years and agree it is very business-friendly.

    • Jeff Brown

      Hey Allison — I got rid of all of my CA holdings long ago. I’ve lived in San Diego since ’67. The only place I’ve put any real estate investment capital the last several years is Texas. Period. In fact, a couple of investors buddies and I recently funded a start up construction firm specializing in spec land development along with higher priced homes.

  4. You mention the thiing about income tax a few times.
    If you live in CA do you not have to pay CA income tax on your income from your TX properties?

    • Jeff Brown

      A good question, Shaun, and one with an answer of which I’m unsure. CA tries to tax anything that moves if they can connect fantasy dots for income. I’ll double check and get back with ya.

      • Here in MA anything that would be on your personal tax return would get the state tax treatment as well. Be it W2/1099 income, rental income in or out of state, or income from a business entity that is flow though (LPs, S-Corp and LLC).

        Hard for me to believe that CA wouldn’t do that as well.

        I mean they have the brace ones to say that you have to register an LLC in CA and pay those outlandish fees even if the LLC is in another state and only owns properties in that state, but the owner is a CA resident that happens to call and email the people doing the work in that other state while the owner is physically in CA, hence it is “doing business” in the state.

        Thankfully MA hasn’t tried that BS yet, since I’d guess that at $500/year we would be the most expensive one after CA.

        • Jeff Brown

          I’m just short of positive you’re correct, Shaun, but until I’m positive I’m reluctant to say. I do know that there have been cases in the last 10 years or so that have somewhat slapped CA down for their overreach on income. The CPA will have an answer in concrete for me on Monday. ;)

      • Hi Jeff, did you ever get the answer to that question about CA taxes from your CPA? Just curious as I have found that it is very hard for a CA resident to avoid paying CA taxes on ANY income and I would love to hear that you have found a way out of it.

  5. Hi Jeff, I’m curious about the income tax question, too. I live in San Diego but am just beginning to learn about REI. I’m personally interested in Washington State (no state income tax as well) but my husband is from Texas, so you’ve piqued my interest… :) Thanks!

  6. Jeff Brown

    Hey Ashely — Give or take, a 2-4 unit investment property in WA will cost roughly 50-100% more than the identical unit in TX. At least that’s what my WA peeps tell me. The outlook in jobs, and the overall economic future appears to me to be far better in TX than WA. I far prefer TX. Though they both have no income tax, WA doesn’t behave well with regulation of business, and investment capital in general. Bottom line is, I just don’t trust WA the way I trust TX.

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