The battle cry sayin’ all real estate is local, has been bastardized of late to also mean the real estate investor is foolish to eschew their local market for superior markets far away.
It usually involves — strike that — virtually always involves the comfort zone of the individual investor. For the record, like you, nobody can make me violate my comfort zone either.
We must voluntarily decide what’s more important, maximum, stable retirement income, or our unalienable right to drive by the brick ‘n mortar responsible for our financial survival in retirement.
This false principle in my opinion, is the most common reason for disappointing retirement income results. I’ve seen it far too many times in real life. That’s why it’s such a joy to be able to diagnose this self inflicted malady when there’s time enough left to rid the portfolio of this malicious disease.
I’ve often been accused of becoming too dramatic when addressing this subject. Fair enough, but I’ve also noticed how that accusation is withdrawn when empirical evidence of its existence is offered for review.
Exhibit A — My Own Local Market
Before the bubble the examples I could cite would be comical. But, since we’re now very much post bubble, I’ll use real time examples of how San Diego properties for local investors is just wrong. There’s an old joke I’ll bastardize here to make the point.
Know how to create a disappointing retirement income? Start with the potential for an impressive retirement income, then invest in San Diego property.
I talked about leaving my own market, business wise in late 2002, then walked that talk beginning 11 years ago last month. The move turned my life upside down for about 18 months or so.
Some local investors and agents/brokers who’d heard of my move made their disapproval abundantly clear. Let’s just say I attended a lot fewer happy hours for awhile. They thought I was nuts, and said as much more than once.
Though I left my local market in 2003, when it was already beyond ridiculous, it got far worse. How bad did it finally get? How ’bout half century old duplexes with $30-32,000 GSIs selling for $580,000! That was the norm within a two mile radius of my firm’s office. Want property closer to the ocean? The rent/price ratios became fodder for Saturday Night Live skits.
A current Duplex Example, about Three Minutes from my Office.
It’s listed in the mid $580,000 range. It’s very well located, offering a couple 3/2 units, in a boxlike, two story building. Been on the market now for a month and a half. It was built a year after Pearl Harbor. Off street parking?
Two decrepit lookin’ carports. Those units will rent for roughly $1,800 apiece at most. That’s a monthly income of $3,600 for which you’ll pay $565-580,000. An exciting prospect, eh?
Once you apply what I’ve come to call Murphy’s Spreadsheet — dividing the GSI by two — you come up with an NOI of $21,600. Even that might prove a dubious number, given this duplex turned 72 years old this year.
Wonder how much functional obsolescence there is to cure, and what the repairs/maintenance is on a duplex older than Grandpa? But I digress. At the current investment property interest rate of around 4.75%, you’d be forced to put 40% down — wait for it — here it comes — to break even.
Can’t understand why this duplex has lasted a month and a half on the market. Can you? But wait, there’s more!
Fast Forward to the Good Stuff — Retirement Income.
If our ‘must be local’ investor has somehow managed to get this much desired duplex free ‘n clear just before retirement, what will they be spending?
We’ve already seen that number, at it’s a whopping $21,600 yearly, or $1,800 monthly. They must be bursting with pride. (Not sure of the emoticon for heavy sarcasm.) But what if they’d traded that net equity for income property in a far better performing market, far far away, in another state? Oh, the horror of it all.
Investors can do this while massively increasing their ultimate retirement income. I know, cuz I’ve seen me do it for dozens of investors since the bubble burst. It’s really not that hard to accomplish. What appears to be almost infinitely more difficult is abandoning the delusion that keeping your portfolio is a superior approach.
Let’s assume the investor owning the San Diego duplex free ‘n clear is 50 years old, and will retire at 67 when they can qualify for maximum Social Security benefits. (Yeah, I know, try to keep a straight face.) If they sold this duplex for say, $570,000 or so, they’d net around $525,000. I used sales/closing costs of 8%. Your mileage may vary.
But what if . . .
. . . the investor moved that equity to a superior market?
I’ll use a market for which I have intimate knowledge. I don’t want to name it, cuz there is more than one regional market in the country that is clearly superior to San Diego. Seems as if I’m pickin’ on SD, though I’m not. Facts are facts, and I didn’t turn my own life topsy turvy while leaving this market on a whim.
The results of moving the net equity to a better performing market — way better.
With about 17 years before retirement, they moved their net equity of $525,000 into six duplexes. Half were acquired with 25% down, and other half with 30%. They had a little leftover.
These duplexes had the same high quality as their San Diego property enjoyed. However these duplexes were brand new, not ancient. They had double car garages attached to each 3BR/2BA unit.
There was obviously no functional obsolescence either. The average price paid was around $290,00 or so. The GSI on ‘em averaged $32-34,000 apiece. Factoid: The cash flow of these six properties combined will be about the same, give or take, as the free ‘n clear disaster he left behind — even with 70-75% beginning debt.
Our investor will eliminate the debt from all six in the 17 years left before retiring. To be fair, we’ll use Murphy’s Spreadsheet on these duplexes too, though clearly their repair/maintenance figures will be significantly less than the prehistoric duplex he once owned in San Diego.
Remember, if he’d kept that old thing, at retirement it would be 89 years old. Think about it. You wanna do that to yourself on purpose? Really?
The Retirement Income
We’ll use the middle figure of GSI for this number. So here it is, very simply put. I’ll assume no increase whatsoever in rents or NOI. Baking in value and income increases is for novices.
6 X $33,000 = $198,000 combined GSI. $198,000/2 = $99,000 a year retirement income. Compared to . . .
the aforementioned $21,600 he woulda had if he’d insisted on being able to drive by his property.
Now this example is something I’ve seen and solved since abandoning San Diego over 11 years ago. But San Diego isn’t the Lone Ranger by any means. Most of the time the values aren’t nearly as high in the local market of the investor.
Most of the time it’s a combination of less than stellar location quality, plus very old, plus daunting functional obsolescence, plus ever rising operating costs and decreasing tenant demand and quality. Either way, the investor’s equity is being frittered away under the demonstrably false belief their subsequent retirement income will be the most they coulda generated.
In the example used here, one I’ve witnessed firsthand too many times, and all over the country, the investor’s ability to grasp reality and act on it resulted in an increase of just over 4.5 times the income to which he’d sentenced himself.
I’ve talked to countless investors who’ve put themselves into this unenviable position, who can’t extricate themselves now, cuz nobody wants their old, decrepit units. They finally admit they’d do it in a heartbeat if they could.
But in so many sad cases, it’s simply not possible, at least for the time being, for one reason or another. Experience has shown me the potential increase in ultimate retirement income is a factor of 2-6.
The value given for the ability of our San Diego investor to drive by his property in retirement was trumped by more than quadrupling his retirement income.
Furthermore, I’m bettin’ he won’t miss driving by, since he’ll be living on more income per quarter from another state than he would’ve ‘lived’ on yearly in San Diego.
How much is driving by gonna be worth to you? It was worth over $6,400 a month to him.
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