It’s been happening more frequently lately. Seems more ‘n more folks are seeing the writing on their retirement wall. It says their retirement income is gonna be distressingly less than their plan initially indicated. Imagine being 52, having available cash, and/or cash convertible assets in the range of $500,000. Then picture the exact moment they envision the 13 years ’til retirement, and what must happen to even allow that retirement to become reality. That’s about when they began crunching numbers like an accountant on their second pot of coffee. Turns out they’ll need at least twice what they have now, and must make that happen in 13 short years.
Or else. It’s the ‘or else’ that sometimes makes my phone or inbox ring.
Here’s the outline of a Purposeful Plan for our 52 year old.
First thing is to turn any liquid assets into cash, and don’t take the slow bus doin’ it. He had around $300,000 and some stocks ‘n bonds. Our guy, let’s call him Josh, now has $500,000 in cash and the next 13 years at his disposal. Let’s take a look at what’s possible.
Before continuing, it’s important to understand that Josh has just over $90,000 in cash reserves. Sorry, you can take me outa the Old School, but ya can’t take the OldSchool outa me.
Let’s say he divides his capital into a couple baskets — one for income property — one for notes secured by real estate, bought at an attractive discount. We’ll split it up 60/40 respectively. That is, $300,000 for income property, and $200,000 for notes.
The use of Strategic Synergism will be used here. The following are some, probably not all of the strategies which will be put in play.
BawldGuy Domino Strategy — Yeah, I know, cornpone to the max. The essence is the systematic payoff of debt. The ‘dominoes’ are the properties in your portfolio. What most investors do, a mistake in my experience, is to attack all loans simultaneously. By attacking one loan at a time, using the combination of the cash flow of the entire portfolio + plus any other investment income + plus any available cash from the monthly family budget, will render the entire portfolio debt free sooner than attacking all the loans simultaneously. In this ‘case study’ it comes out to around 20 months sooner. In this case that means the investor will have 20 more months of a completely debt free real estate portfolio.
Multiple Income Stream Strategy — Whenever possible, I think it’s very important to establish a source of retirement income generated from more than one vehicle. If Josh was younger than his 52 years, I’d probably have incorporated the use of an EIUL, a topic about which I’ve written here often. With Josh though, I lean heavily towards note income, secured by real estate. There are a few reasons this makes sense, both as a significant enhancement of the process, and for the end game — retirement income.
Aside from the reality of Josh’s age, the EIUL will cost him money better allocated to his relatively narrow time window. Let’s face it, time ain’t Josh’s friend. Though the EIUL’s ultimate income stream will be tax free by definition, it’ll take more time than Josh can afford. Furthermore, it does more damage by sucking up the investment capital that will perform in the allotted time. In this case, the EIUL just isn’t the way to go.
The note(s) income will add meaningful velocity to the elimination of the income properties’ loans. In fact, I’ll go a bit farther. The income, and built-in profits of the discounted notes will allow Josh to possibly retire sooner than his 13 year deadline — and with more after tax income than opting for the EIUL approach. Going the EIUL route would literally add many years to Josh’s desired retirement date.
Josh’s family budget allows him to designate $1,000 a month to the cause. He’s comfortable with that amount, though he can afford more. Again, Comfort Zone trumps all. The immediate benefit of using $200,000 to acquire notes is the monthly income. Duh. Buying multiple notes totaling around $300,000 will get the job done. The notes will bring with ’em a 10% interest rate. Even if the note terms allow for interest only monthly payments, that’s $2,500 a month.
Acquisition of the income property.
Josh’ll be investing in four duplexes, with 25% down payments. His GSI (gross scheduled income) will total $127,200/yr. His NOI (net operating income) will approximate $76,320. However, for this case study, I’m invoking the so-called ‘50%’ rule. That is, instead of predicting cash flow based upon boots on the ground research, we’ll surrender to Murphy in advance. Since these properties are brand new, resorting to simply dividing the GSI by 2, allows a far more conservative approach. The loan interest rate used for these acquisitions is 4.625%, a number I confirmed hours before writing this.
The combined NOI (net operating income) for Josh’s real estate, having capitulated to Murphy, is $63,660/yr. Annual debt service will be $50,437. That results in yearly cash flow of a tad over $13,200.
The monthly cash flow of $1,100 + $1,000/mo from family budget + $2,500/mo from notes = $4,600. Applied to one of the duplexes for just 40 months, and the first domino hits the dust . . . debt free. Of course, this increases the monthly amount available to retire the next ‘domino’s’ loan. The second loan is paid of far more quickly than the first. Rinse, repeat, etc.
This strategically applied procedure will render all four duplexes free ‘n clear in 120 months. The subsequent cash flow will either be $63,660/yr or $76,320/yr. The deciding factor will be if Murphy’s 50% rule is applied, or the spreadsheet’s numbers prevail in real life. Make note of the fact that I’ve not allowed for any increase whatsoever for Josh’s NOI, even though a decade will have passed. For the most part, I think baking increases into NOIs or appreciation to value is irresponsible at best, and potentially ruinous at worst. Again, OldSchool.
Let’s circle back around to the notes. But first, a word on purchasing notes secured by real estate.
BawldGuy Axiom: When analyzing a note as you consider its acquisition, consider this. If you’re not excited at the prospect of a potential default in the future, don’t buy the note. If merely the thought of having to foreclose on the note makes you financially nervous, don’t buy the note. Most of the time foreclosing on a discounted note should result in making as much if not more profit than if the note had simply played itself out re: it’s terms.
My personal and professional experience with notes tells me Josh will probably be able to pay his duplexes off sooner than 10 years. Here’s why.
1. It’s far more likely than not that his entire initial note portfolio will be paid off in full, per the note terms, sold off for a handsome profit, or paid off early by the payor.
2. Every time one of Josh’s notes is paid off, he makes the difference between the face amount on the note, and what he actually paid for it. That assumes the note’s payments are interest only. If they’re not, it means he has more each month to apply to debt elimination.
3. Every time a note pays off, he then buys another note. However, each newly acquired note will be bigger than the last, including its monthly income.
You can see how the note approach works out. Josh will start on Day 1 buying about $300,000 in notes which will in turn generate about $2,500/month income. Over a 10 year period it’s highly likely every single one of those notes will pay off, most of ’em in full, some for a profitable discount. The subsequently increased income would allow Josh to apply more and more to his loans each month. This will clearly result in his ability to pay off the duplex loans faster than 10 years — possibly WAY faster.
But wait! There’s more!
Remembering Josh’s plan to retire in 13 years, he has a new page of options on his menu the day after he pays off the last duplex. Even though I know in my bones he’ll retire those four duplex loans in eight to nine years, not 10, I’ll hold myself to 10. By then he’ll own at least, literally ‘no less than’, about $500,000 in notes. They’ll be generating, give or take, roughly $50,000 yearly.
NOTE: It’s important to be mindful of the reality of the taxes Josh will be paying, both on the note income and the profits as they’re paid in full. Josh understands this, and has accounted for the cost of the tax on interest each year as an expense. He can afford it, as it never comes to all that much. The taxes on the larger payoff amounts are obviously funded by the payoffs themselves. OK, back to Josh.
In the three years, (more likely four or five, but I digress) Josh will benefit from both the duplexes’ cash flow and all his notes. Each year, before taxes, and invoking Murphy, this will total around $113,600. Arbitrarily subtract a third of that for taxes, and over three years he’s accumulated roughly $225,000 — after tax.
If Josh uses that cash to buy more notes, probably 2-4 times annually, for the 3-5 years he has that income, he’ll have acquired an additional $325,000 in notes, give or take. (Much more if he gets the four or five years of income I suspect he will.) In other words, the few years between rendering the duplexes debt free, and retirement, he’ll have built a note portfolio of at least $800,000. Even at an 8% payment rate, that’s an annual note income of $64,000 — over $5,000 monthly. Add that to his real estate cash flow of $5,200-6,300 monthly, and you can see how Josh will be doing a lot better than his initial status quo indicated. Furthermore, that note portfolio will only grow, even into retirement. Each time a note pays off, Josh buys a bigger one, immediately increasing his month retirement income. And the beat goes on.
The question most of those in Josh’s shoes must ask themselves:
Given the investment capital I now have, or can make available, do I have the skill set to produce a five figure monthly income in the years between now and retirement?
Go ahead, take your time. No rush.