Are You Willing To Sacrifice Your Potential Retirement Income At The Altar Of ‘Local Control’?

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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 Fair enough, but I’ve also noticed how that accusation is withdrawn when empirical evidence of its existence is offered for review.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.

Related: Retirement Security: Invest In Texas NOT California

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?

Related: Investing In Real Estate Is Better For Retirement – PERIOD!

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.

Who knew?

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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.

34 Comments

  1. Mike McKinzie on

    Jeff Brown, we are “brothers from different mothers” as is our sister Ali Boone. Currently, I am in an RV park in Red Bluff, CA and will close on properties in Texas, Arizona and California before I leave. How? I sold one rental in Los Angeles county that I was getting $1,600 a month on and had no mortgage for properties totalling $7,700 a month and a total of $2,000 a month in mortgages. Oh yea, I will also have about $100,000 in cash left over to buy some more. When I am done, I will have traded a LOCAL rental making me $1,600 a month (no mortgage) for around $10,000 a month with around a $2,500 mortgage.

    I have posted this before but it bears repeating:
    1. If you own a local rental and drive by it more than once a month with the thought “I own that,” you are not a real estate investor, you are a real estate hobbyist.
    2. If you drive your family and friends by a rental you own, proclaiming to them I OWN THAT, you are not a real estate investor, you are a Tour Guide.
    3. If you collect your own rent, make all your repairs, invite your tenants over for dinner and give your tenants gifts, you are not a real estate investor, you bought real estate to create a job and business for yourself.
    4. If you only invest locally because you KNOW the market, then you are a lazy real estate investor who does not want to learn about other markets.

    Orange County is just a sister to San Diego County, real estate value wise. We have to,look elsewhere if we want a great retirement!

    • Very irresponsible post, Mike. If an investor has the know how to do repairs then they are increasing their return over the investor that doesn’t have the know how. Pretty smart if you ask me (ie – Brandon Turner). Also, if an investor takes the time to know their market to make better decisions that certainly doesn’t make them lazy. Not every investor WANTS to have properties scattered all over the country.

      • Jeff Brown

        Hey Glenn — I think what Mike is saying is that merely ‘knowing’ our local market doesn’t make it the best place in which to put our hard earned investment capital. I’ve been a professional and an insider in my own San Diego market since Nixon was in office. How does all that knowledge overcome inferior numbers and results? It doesn’t. Make sense?

        Knowledge of any particular market, in and of itself, has no value if that market is inferior to other accessible markets.

        • Jeff, I agree that in your market the numbers would never add up. I’m just saying that every investor that happens to make the numbers work in their local area wouldn’t have a need to invest elsewhere, that would be foolish and they certainly aren’t “lazy”.

        • Jeff Brown

          I agree with you on that point, Glenn, and I suspect Mike does too. I’m pretty sure I’m not going out on a limb by suggesting Mike didn’t go to other markets if his own was a buncha easy pickings.

      • Mike McKinzie on

        Glenn, you make my point very clearly. If an investor does his/her own repairs, then they have BOUGHT THEMSELVES A JOB! As for me, I want to buy myself a retirement, which I did. And by retirement, I don’t mean golf every Wednesday, I mean traveling the world. We went to Russia last year and saw the Hermitage, the Peter Hof, St. Catherines Cathedral, etc… A person needs to know many markets so they can make wise investment decisions.

        • Jeff Brown

          I often tell my clients, Mike, that their time spent managing their investments while retired shouldn’t be much more than goin’ online to ensure the deposits all hit the right accounts. :)

        • Congratulations on the retirement. However, a job is active income. Doing a repair to save on expenses doen’t make the passive income already being generated turn into active income. Only the small portion that was saved from hiring the handyman. Also, the investor has a choice to pick what level of involvement they want in the management, albeit at a cost.

        • Jeff Brown

          An excellent point, Glenn. But if the investor has retired well, and by that I mean $10-50,000 a month, those sort of savings are, to say the least, irrelevant.

  2. Jeff,

    Good timing on this post. I also live in a high COL area, and have been evaluating investment options for a while (turnkey, partner locally, etc). Right now I’m looking at syndicators, specifically commercial multifamily in TX. The steady 12-15% returns seem to be a pretty good fit for a long distance investors, and the market has very strong employment and demographics.

    Would love to hear your thoughts…

    Thanks!

    • Jeff Brown

      Hey Johnny — Though I’ve done large residential income properties myself and for clients, I tend to favor the 1-4 unit approach. This is for a few very important reasons.

      1) For every buyer lookin’ to acquire a 30 unit building, there are at least 10 wanting your duplex/fourplex.

      2) Financing for the smaller stuff is far more common.

      3) Owning several smaller 1-4 unit props allows you far more flexibility. For example, you can move one or two of ‘em when a stellar opportunity presents itself. Not so with one or two large properties. This has proven to be a huge benefit and advantage.

      4) Sometimes when we sell these smaller units, there are buyers interested in acquiring our duplex/fourplex as a place to live. This is very rare with big residential units.

      On the other hand, your approach using group investments has it’s own set of benefits, not the least of which is convenience and no need for you to do any of the really heavy lifting.

  3. Brown, you never cease to amaze me. Thank you for reinforcing the idea that a $40,000 house rented for $800 is pretty damn good. I thought that I was just lucky and that everybody is doing these deals.

    Not so. You, I and an elite few see the magic in the numbers. A 60 Gross Rent Multiplier is a pass. And these $40,000 houses come on the market every day here. I passed on a $30,000 deal that could bring $800 within sight of my primary. (Kick myself often)

    The bonus is: I do get to drive by these properties and all the while my own housing is cheap.

    Colleagues brag about $150,000 houses rented for $1,200, no mortgage, and the owner is STOKED. I just smile and nod my head.

    McKenzie: there are exceptions, man. I happen to live in an under-priced market and don’t have to go far to find 2% rule deals. I could walk to two right now.

    • Mike McKinzie on

      Joe, i paid $40,000 for a house that rents for $795 so I see those deals all the time. But it is 300 miles away. But I still stand my belief that anyone who constantly drives by their rentals, claiming “I’m just checking on them” is a hobbyist and not an investor. I have not seen the last 15 houses I have purchased, ever! I have owned houses for 25 years and NEVER saw it once. There are reasons to own $150,000 houses that rent for $1,500 as well as houses that cost $40,000 and rent for $800. The number one reason is appreciation. In my 35 years of investing, one of the things I have learned is that the lower the GM, the lower chance of appreciation. Therefore, a good balance of cash flow and appreciation is sought. Next is maintenance, a water heater cost the same for a $800 rental as it does for a $2,000 rental. The same goes for a garbage disposal, paint, etc… Next is turnover as experience shows the lower the rent, the higher the turnover. This means the “quality” of the tenant (yes, there are always anecdotal exceptions). I could write a book on the pros and cons of every price point, rental point, ROI, etc… to consider when buying investment property. And my number one rule would be the same when learning Poker, “Leave all emotions at the door,”

    • Jeff Brown

      Hey Joe — As the post said, there are indeed some lucky investors whose local market is a goldmine of exceptional options. One caveat though, and that’s the allure of low price/high rent while sacrificing both building and location quality. One of the costliest lessons I’ve learned — the hard way — is that valuing rent/price ratios over the quality of the building and location is one of the surest ways to investor heartache. When bad times hit the cost to me was 3 lost properties. Being a quick study, I haven’t made that mistake since. :)

      A building suffering from a combination of old age, functional obsolescence and subpar location quality will soon bear the disappointing fruit of inferior tenants, rising operating costs, and unacceptable vacancy/credit losses. Trust me, it is inevitable. If you’re currently able to enjoy the rent/price ratios you mentioned in your comment, and the properties are of high quality in ‘plus’ locations, you, my friend are kickin’ some major booty. :)

      • *cough* I never met a 100 year old termite ridden and flat roofed house I didn’t like.

        You are too right, I have rolled with the punches and spent far too much cash for repairs of inferior product. Among ten, the $40k and $800 monthly is the average per property. I could have bought three others for the same money if it weren’t for the exorbitant rehabs in year three. I am indeed lucky that I learned the importance of six months liquid no matter what.

        Fortunately the economy in Florida continues to favor investors and this state is still number one in short sales (May 2014 data).

        I always enjoy learning from you.

    • Mike McKinzie on

      Joe, there are definitely exceptions. If you live in a market that has good returns, then invest away. Maybe your market is ripe for a fantastic return. But I also believe that diversity is a good thing. Las Vegas is full of investors who had all their money in the local market, pre 2008, who wished they had diversified. Thousands of Enron employees had 100% of their 401K in Enron stock, Woops! Like Jeff said, San Diego County, Orange County, much of Los Angeles county, and on up the coast, Santa Barbara, Ventura, San Jose, the Bay Area, you would spend a minimum of $500,000 to get $2,000 rent. Therefore, I went over to the Fresno/Visalia area and paid $40,000 for $795 rent. Uh oh, the Sheriffs just called and said my $40,000 tenants are growing marijuana in the back yard! Just one of the unforeseen risks with low income tenants!

      Jeff has 45 years and I have 35 years experience. We both make between $10,000 and $50,000 a month in rental income (I think). Therefore, we must be doing something right. There are many ways to succeed in Real Estate Investing. At BP, we are all about sharing HOW we did it. Maybe you will do it different than Jeff or me, but we are successful and love to see others succeed. If you own $1,000,000 worth of real estate but are only bringing in $5,000 a month rent, maybe you might enjoy $10,000, $15,000 or even $20,000 a month rent with $1,000,000 worth of real estate. Of course there are many other factors involved, which is why we research. But always be ready to learn!

  4. Corey Schneider,CCIM on

    Like I always said: “If you can’t get the benfits by playing where you are, you have to leave to get the benifits that you want or need”……

  5. Jeff Brown, do you really expect me to give up my annual 9-11% compounded appreciation and my 6-7% annual rent increases for say 10 $50,000 places that rent for $800 dollars? You sure left them out of your figgering. Dang it would cost me $30,000 + just to liquidate. Then I’d have to pay 10 property managers, 10 realtor fees, ( are you doing the 1031’s for free?) Then 10 of them, how much do you charge?. Now I’m dealing with 9 more tenants and 9 more roofs and 10 more air conditioners. How much more space am I painting and carpeting? Doesn’t sound like much of a retirement, I’ve become an employer! Now I gotta wait 2 hours to get on a plane each time to check on my tenants and staff. How much of that fake NOI is vacancy and collection? I like my 0%.

    You would be more credible if you would name your “superior” market. 70 is the age for maximum amount for social security. I bought two properties since you bailed for Texas that have doubled in value and a third is almost there but I haven’t owned it for 10 years yet. That’s more than $500,000 in equity that I could spend today and have the increased rents pretty much cover the mortgage.

    But to each his own. I just advocate running ALL the numbers. You’d also be more credible if,
    1. you would name your “superior” market. Hell, I’ve named specific buildings I invest in.
    2. you knew that 70 was the age for maximum social security benefits.

    Best of luck!

    • Jeff Brown

      Hey Bob — Boy, I’m feelin’ lucky this morning that you’re not the one who decides if I’m credible or not. I’ll let my 45 years of experience do that. ;)

      Please show everyone specifically where in this post I said to get rid of your properties doing so well? You don’t give details on location quality, lack of functional obsolescence, tenant quality, or prop age. Without knowing those facts, how on earth would I even be able to advise you to sell or exchange?

      I didn’t name the superior market cuz it’s not the only one in the country. I was merely writing of fundamental principles, which work universally when followed. Frankly, I think you likely know a whole lot more than guys like me, and should keep doing what’s been so successful for ya. Sounds as if you have everything wired for phenomenal success, and I salute you.

      • Um…did I read this wrong?

        “But what if . . .

        . . . the investor moved that equity to a superior market?”

        • Jeff Brown

          You read it perfectly, Bob. ‘Superior market’ is a phrase bringing with it the implication of the existence of inferior market. So what’s the problem? I assume an experienced investor knows the difference.

        • Jeff, you are way off track. That was in response to you challenge, “Please show everyone specifically where in this post I said to get rid of your properties doing so well?”

        • Jeff Brown

          I never said get rid of props performing very well, in and of itself. I said to leave inferior markets for superior markets. In the end, high quality locations with high functioning buildings on them, will end up being much better in retirement for the investor. What has gone unaddressed here, is that properties with rents around 2% of the price are virtually always the punchline of a bad joke when it comes to location quality. If they were available everywhere as the rule, the need for BiggerPockets wouldn’t exist.

          But, to each their own. And again, I NEVER addressed anything but the relative merits of regional markets. Oh, and thanks for the correction re: SS max payments at 70. That’s a valuable piece of info for Boomers. Much appreciated, Bob.

        • Oh, and thanks for the correction re: SS max payments at 70. That’s a valuable piece of info for Boomers. Much appreciated, Bob.

          You’re welcome. That’s what I’m here for. to learn, help where I can, and the free beer.

    • Hey, am I the only one that gets the first Happy Hour draft free upon presentation of my valid Bigger Pockets membership card to my Applebee’s bartender?

      And Joshua, when I’m in Honolulu since there are no Applebee’s could you hook us up at Duke’s or at least the Chilli’s?

  6. Jeff, I think the issue Bob and others like myself have with your post is that you paint a very one sided picture of the San Diego duplex at $580k. Those are common here in the Bay Area too. Let’s say those run down 3/2’s renting at $1800. But most investors would buy that bldg to update and modernize those flats/layouts. They’d spend $60-80k for a nice rehab. Then those units in the Bay Area would rent for $3000-3600 each! And as for NOI, here’s the way it works for me with my San Francisco rentals: I subtract property taxes and insurance. That’s pretty much it. So NOI is safely 90% of gross rents (leaves a bit extra for maintenance.) That’s been accurate for over 10 years. Why? Vacancy- zero! (literally.) Repairs- almost nil (units rehabbed, professional tenants/low wear and tear, plus few rental units owned in total.) So the real NOI in this example is 3-3.5x the income you present. And the big whammy- future appreciation of prime costal locations. Plus, your rents will be more reliable, and increase at a much faster clip than fly over states, when you invest in prime, blue chip locations.

    • Conclusion: So right off the bat you added equity by renovating, plus you will have good, stable and reliable income which will grow at a nice rate, as the property appreciates. Fast forward after owning the above renovated duplex for a few years (and riding out any market downturns): you could easily add a couple hundred thousand in equity, plus have substantially higher income. A win-win in my book :)

      • Jeff Brown

        Hey Amit — You guys keep wanting to confuse markets, what the post was about, and specific properties, what the post wasn’t about. Yeah, I had to use an example property, but the takeaway was that the San Diego market specifically, and in my view the CA market in general is a seriously lousy place to invest.

        Your example has many experienced investors shakin’ their heads in wonder. Calling 90% of GSI a legit and predictable NOI is, to be kind, not recommended. But, as you likely already know, BP has all kinds with different experiences and takes. Your approach calls for paying a very high price considering income at the point of sale. It then relies on the investor’s ability to rehab with the immediately result of massively rent increases. It then relies on equally impressive appreciation in value.

        That’s why I left CA, at least in part, as to make most investment properties worth it, one had to overcome the originally silly rent/price ratios. Then there’s the macro analysis of Ca which clearly indicates the state hates investors, their capital, their profits, and business in general. San Francisco is #1 on that hit parade when it comes to CA cities.

        In the end though, it remains ‘to each their own’, which I always respect.

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