Case Study: The Strategy That’ll Help You Reach Your Retirement Goals Faster & More Easily

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First, let’s define what I view to be Strategic Synergism.

Most simply put, it’s the purposeful combining of two or more investment strategies in order to produce results superior to that generated by the employment of just one strategy at a time. 

The test applied to the results of this approach is equally simple. Either you ended up with more net worth, more cash flow, or achieved a goal sooner. Many have learned more than one of these happens most of the time, with all three results anything but rare. 

So many of the people I meet around the country seem to fall into the following overall profile range.

  1. Household pre-tax income in the range of $75-200,000.
  2. A relatively frugal lifestyle.
  3. The ability to save decent money on a monthly basis, say $500-3,000.
  4. Available savings/capital of $50-200,000, some of which may be in the form of personally held stocks.
  5. Maybe a quarter of ’em either have a side business, are already self-employed, or could start a side business.
  6. They have IRAs and 401k plans and are often contributing the most they can afford to the 401k at work.
  7. Most of ’em own a home with debt.
  8. Roughly one in five already own at least one residential rental property.
  9. Around two-thirds of ’em are 33-48 years old with at least one kid at home.
  10. All of ’em either suspect or know in their heart of hearts they’re not headed for the retirement set out in their goals.

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An Example of Strategic Synergism

This late 30’s Colorado couple makes more than $150,000 yearly between ’em. Furthermore, they’re huge savers. After state/fed taxes, they net around $108,000. Their cost of living is around $60,000. This puts them over the threshold when it comes to using “leftover” depreciation on the rental you own against their “ordinary” (work) income. This results in their ability to shelter the rental’s cash flow, but bars them from applying any surplus depreciation to their ordinary income. It’s shunted off to the sideline to gather dust. Most aren’t aware of this, especially those who do their own tax returns.

Let’s use that to our favor. I call this the Cost Seg Strategy, as it makes use of what’s known as cost segregation. All CS is is depreciation turbocharged. CS will double the depreciation amount in dollars for most 1-4 unit properties. For more complex commercial buildings, it can multiply the depreciation dollar 3-5 times. How is that possible? The buildings components are depreciated separately and given FAR shorter lifespans. Nothing mysterious about it.

This now has us using the Buy ‘n Hold Strategy in concert with the Cost Seg Strategy. But wait, there’s more! 🙂

You may not have the knowhow, or for that matter the simple access to buy discounted notes secured by real estate, and you’re not an accredited investor; you’ve invested in a group that does. They not only buy discounted notes in first position, all of which come with warranties, they also buy non-performing notes in order to foreclose and sell the securing property for much greater profits. Your money is earning an average double digit yield, roughly 12-15% annually. We’ll use 12% here. But where’d this investment capital come from in the first place?

They refinanced their home.

In this case the couple had been paying down their home’s mortgage religiously. The home’s worth was around $300,000, and the balance had dropped to about $50,000. It then dawned on them that the money applied to principal pay down was making less than 4%. They learned about the Arbitrage Strategy, wherein they’d borrow against their home’s equity at under 4% in order to earn a far higher yield, in this instance at least triple. They pulled out $150,000, which resulted in a loan payment still a little less than they’d been paying, since they’d been adding to their payment all that time.

They’re now incorporating four separate strategies, but using them in collaboration with each other.

  • Buy ‘n Hold
  • Cost Segregation
  • Arbitrage
  • Investing in Various Forms of Notes Secured by Real Estate

But where’s the dang synergy?!

Here it is.

The eight year old rental was bought a few months ago for $250,000, a duplex. The beginning loan balance was $187,500, at 4.75% for 30 years. The loan payment amounted to $978.09 monthly. The monthly cash flow is $350. Employing cost segregation as their depreciation strategy increased the annual depreciation from about $7,500 to $16,000. This amount will only last for about five years, at which point it will drop off big time. Just so ya know. 🙂

The CS Strategy, in order to produce the best results, requires the property’s loan to be paid in full, or close enough for horseshoes in five years. What this means is that our couple must somehow find ways to add roughly $2,540/mo to the duplex’s loan payment. How is that doable?

Related: Why Combining Investment Strategies is Vital to Retirement Income & Net Worth

The duplex cash flow gives them an average of $350 monthly, not a big dent. The distributions from their note investment group averages around $18,000 a year or more. That $1,500 monthly will quickly turn into a whole buncha $1,000 after taxes. They now have $1,350 a month to add to each month’s loan payment, though that still leaves them roughly $1,190 short. That’s not a problem since they have and still do save around $4,000 every month.

Fast forward five years down the road.

The duplex is free ‘n clear, or about to be at any minute. It was put up for sale a couple months ago in anticipation of the loan disappearing. It sold for a price barely high enough for them to come out, net, with the price they paid, $250,000. (I virtually never bake in appreciation to any plan. It happens or it doesn’t.) They’d been forced to put an accumulated $59,000 of unused depreciation on the sidelines. The year of sale, their combined total income was approximately $190,000.

The straight line depreciation used to shelter the annual cash flow PLUS the unused straight-line depreciation left at sale decreased their adjusted cost basis to about $212,500. Their costs of sale ended up being just under $22,000, which then increased their adjusted cost basis to around $234,500. Since they sold at $271,000, that means they realized a capital gain of approximately $36,500. At 15% that results in a tax liability a hair under $5,500.

There’s another tax liability, which is called depreciation recapture. All depreciation taken over and above what’s known as straight-line is taxed at 25%. There’s no way to get outta that of which I’m aware. In this case that would amount to around $10,625. Cap gains tax of $5,500 + recapture tax of $10,625 = total tax liability of $16,125, give or take.

Let’s get rid of that, ok?

Our couple had $42,500 in total unused, leftover CS depreciation. We must understand that even the depreciation dollars unused that were straight-line were subtracted at time of sale from the couple’s cost basis. It’s the leftover CS depreciation that they can now use against their ordinary (work) income. The reason is simple, they don’t own the duplex anymore. (Couple now doin’ HappyDance in the corner.)

The tax savings on their ordinary income total roughly $13,900.

The tax liabilities total roughly $16,125.

In other words, they put the $250,000 into their bank account minus just $2,225. That amounts to a net/net tax liability of less than 1% of the actual escrow proceeds check. Where do I sign up to do that over ‘n over?!

They paid off the duplex loan in five years. Fifty-three percent of the money used to accomplish that came from other people.

Related: Why Investors Should Create Multiple Streams of Income Within Real Estate

What Have They Accomplished?

  • First, and just for fun, what was their return given their down payment/closing ($65,000) costs plus the $1,190/mo of their own money for 60 months? 15.55%. I’m only counting the money they put out of their family budget because the other is strictly from their investments from other people.
  • Second, They now have almost $248,000 in after-tax investment capital in the bank.
  • Third, They’ve had $150,000 earning them 12%-plus for five years. They can choose to reinvest the distributions back into the group any time they choose. I strongly suspect they won’t choose that option any time soon, as they may very well rinse ‘n repeat the CS Strategy. On the other hand, if the capital invested would’ve been from a tax-free retirement plan as in an IRA or 401(k), I probably would’ve given the advice to let the distributions stay inside the investment and rollover, increasing the compounding effect.
  • Fourth, Even while puttin’ out almost $1,200/mo of their own money for five years, they’ve managed to save another $150,000. Much of that will be used in the next segment of their purposeful plan. Duh, ya think?
  • Fifth, They’re still just into their early 40’s, so cash flow isn’t the #1 end all, be all. They still need capital growth in all the forms in which it comes or can be created. They now have just under $350,000 in investment capital, including their savings. Note: I’d advise them to take $50,000 of that to be set aside as cash reserves. Furthermore, I’d tell ’em it makes sense to build that up monthly ’til they have around $75,000 in that “untouchable” account. 

Though this is a small and relatively simple example of Strategic Synergism, you can readily see how it positively impacted the results, shortened the time, and enhanced the ultimate return on their investment.

Do you use multiple investment strategies to build your retirement portfolio?

Let us know your comments, questions and tips in the comments section below!

About Author

Jeff Brown

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

15 Comments

  1. Stacy E.

    I don’t know if it’s possible but I also think it would be helpful if this was broken down even more. It sounds like a great idea. It could be that I only understand two of these strategies. I will look more into the other two (arbitrage and notes). It would be awesome if I could pull this off…

  2. Hey Jeff,
    Thought provoking and great style as always! As an engineer and an old one at that, I’ve been trained by time, teachers and testing to look for the risks. Engineers are rarely the “me too” touchie-feelie “great article” type when there are questions. Please accept my engineering mind as inquisitive not, to use the language de jour, “troll”.

    Arbitrage is always a nice thought, the safety of the higher performing investment is the risk. For example, I have a very simple arbitrage, one silly bank provided a nice HELOC at 1.9% just because I’m all that, give them my business an like you folically impaired! So, years ago, found another bank giving good CD rates at 4.x%. Not much of a spread, but free money, interest on the HELOC is tax deductible so that too helps the spread. With this arbitrage, I make a couple of bucks and it is incredibly safe.

    My lack of understanding with the approach suggested in the blog is the risk. Taking out a loan to purchase notes/paper on the discounted market is slightly 😉 more risky than a CD. I believe that ya may be gettin the notes from DV and his company, which, from the deal of the weeks that I see, some of these, the FMV is lower than the primary/first loan balance and many the higher rate loans to purchase can be seconds that are many times underwater. If the note does stop paying, DV will give ya a new note, I don’t know the exchange rate, aka risk.

    That’s the background and what many people consider “trolling” these days, I call it attempting to understand the investments and risks. How do we limit the exposure and risk in the notes? After all, the payment from the notes have to cover the HELOC payment and pay down the principle. I would not want to be placed in a position that because the mortgagee of the note was not able to pay makin and flowing the bad brown stuff down hill so that I cannot pay my HELOC payment and then my HELOC/mortgage becomes part of the secondary market as well and I’m a 53 year old dud back livin’ with his momie.

    Thanks Jeff, I like the entertaining, light-hearted writing style it opens up great new ideas to folks. I want to be certain that I understand the risks.

    BTW as a side note, how do ya collect the cash-o-la from the mortgagee and then at the end of the year give him his interest statement? I’m sure our mutual greedy uncle Sam is interested in this part.

    • Jeff Brown

      Hey Joe — If asking hard, thoughtful questions makes one a troll, a lot of us are in deep trouble. 🙂

      The short answer to your arbitrage vs risk question, is that we’re on the same page.

      The use of arbitrage on paper always sounds good, with often very sexy yields, right? The problem can almost always be found in the execution. Far too many underestimate one or both of two crucial factors. First, the real life risk, as you so accurately point out, is woefully miscalculated. Second, the ability they may have to mitigate that risk is almost always over valued, sometimes tragically so.

      The first position discounted notes I have my clients acquire, always come from my own fund, managed by PPR Note Co., Dave Van Horn, CEO and founding principle. All of ’em come with an ironclad warranty basically saying the investor can’t lose his original capital used to purchase the note. When buying a note on the street, something I will have been doing for 40 years this coming May, LTV is a virtual ‘warranty’. As you rightly pointed out, buying a note with the home’s value being less than the loan balance, is a sure way, as my mentor loved to say, to turn a large fortune into a small one. 🙂

      However, Joe, the warranty you get from the note fund is not only respected industry wide, it’s rarely used. Only around 5-6% of the performing notes bought in the various funds end up invoking the warranty. In my experience, that’s a pretty solid record. But that begs the question. Would I buy a note like from the street? No, no, a thousand times no!! But with a warranty with a stellar track record? Yep, without hesitation.

      As to your last question, I’ve always employed a ‘servicing’ company for all the note accounting. The prices differ, but using my note fund as an example, that fee is just $15 a month per note. They get the payment, take their fee, then electronically deposit the balance into the bank account you designated. At the end of the year you have all the statements you need.

      Let’s get back to arbitrage and risk, and various note investment strategies in general.

      In my opinion, the 95-5 rule applies. That is, just about 5% of investors have the knowledge, expertise, and experience to mess with note investing by themselves. The rest need a pro whispering into their ear. It’s the seasoned pro who has the real life, real time ability to empirically mitigate some of the inherent risk.

      That’s precisely why I’ve reversed myself when it comes to forming groups for investing. I swore ’em off 30 years ago as too time consuming. But in the last year or two I’ve concluded that far too many are putting the hook in their own lips, trying to do far too much with notes. The whole DIY movement is great for hobbies, but unless one thinks their retirement income should derive from a hobby, I recommend against it.

      Amateurs don’t always see risk, or at least all of it. That’s not only true with vanilla discounted performing notes, but more so when buying non-performing notes for the purpose of foreclosing/fixing and selling for much higher profits. I see people around the country thinkin’ they can do that hundreds, even thousands of miles from home. They typically lose their shirts. I’ve always and with one lone exception refused to be a part to my clients’ entry into the non-performing note arena. That’s why I now have note investment groups. Four clients went out on their own, AFTER I pleaded with ’em not to, and bough non-performing notes. All four lost their capital.

      • Jeff,

        Great article. When it comes to DIY, I have a new version. I read, read, and read to understand the fundamentals of how stuff like real estate, arbitrage, and notes work. But that is so I can better shop around to DIY find the right professionals to help me. There is no way I could have learned enough to put together an EIUL, real estate, and note package combined with 401K early withdrawals without risking personal injury. But all the reading I’ve done has helped me at least speak on the same wavelength with you, Dr. Dave, and John Parks. That, I think, it what’s key.

        And considering the nearest real estate “club” in Nashville was charging $20/meeting to just attend, well, that’s just absurd. Heh.

        • David Hutson

          Greg, and everyone else,

          Jeff has the team put together to handle this complete process. I have talked to Jeff about this in the past and I am at one of Jeff’s events right now, with his team. We completed the step by step discussion on how to complete this from the initial funds to the use of their processor to handle the funds.
          I think it can be a great process for those who have some knowledge of investing and some cash to put towards retirement. I definitely intend to purchase notes as I increase my wealth.

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