What to Know if You’re Beginning to Invest in Real Estate Later in Life

by | BiggerPockets.com

Crafting a long-term real estate investing strategy is like making an alloy. First, you take raw materials like investment capital, savings from job income, ability to obtain financing, risk profile, and most importantly, time. Then, you mix them in the right proportions to create a finished product that is stronger and more flexible than the individual parts that went into the process. Essentially, you are taking brittle iron ore, adding heat to melt impurities away, then finally adding carbon to produce mighty steel.

So when someone asked me whether age should factor in the decision of how you should invest in rentals later in life, the answer had to be yes. Age strongly impacts two of the most important raw materials of any real estate investing strategy: time and risk profile. But how exactly?

In Real Estate, Time is FAR More Valuable Than Money

If I gave you a choice between the following two scenarios, which one would you pick?

  • Scenario A: You are in your early 30s with $10,000 in savings and the ability to save another $10,000 per year from your income
  • Scenario B: You are in your early 60s with $500,000 in savings and the ability to save another $50,000 per year from your income

Let me tell you what option investors that fall in the Scenario B have told me they would pick: Scenario A, hands down. Why? Because, in real estate investing, time is far more valuable than money. It’s not even a close contest. Let me explain why.

Related: 5 Smart Ways to Start Investing in Rentals Later in Life

At its core, money has three basic functions:

  1. Means of exchange: We receive it for goods or services we provide to our employer or customers, and we spend it on goods and services we need.
  2. Security: We refrain from spending it and keep it as emergency savings to provide peace of mind in an uncertain world.
  3. Investment capital: We invest it and earn a reasonable return for the risk we are undertaking to stave off the effects of inflation.

So, you see, once we have taken care of day-to-day purchases and have saved up adequate reserves, the only thing that’s left to do with money is invest it. Or put differently, money will naturally flow to where it can earn a return. “Lenders lend,” as my mentor Jeff Brown has brilliantly said. If you can bring to the table opportunities for invested capital to earn good returns, you don’t even need to look for the money. It will find you. Also, if you can scale your opportunities, you can always find money to pull them off.

On the other hand, you can’t make more time. You can’t scale it. You can’t buy it. You get what you get, and you don’t throw a fit—like my five-year-old told his brother last week. Age inversely impacts the time horizon that you have available to make your strategy work, which in turn reduces the options at your disposal.

For instance, the more time an investor has available, the more compounding works in their favor. To begin with, the investor with more time needs to buy a smaller asset value because they can take better advantage of compounding appreciation rates multiplied by their leverage factor.

Moreover, the more time the investor has available, the more they can let cash flow and debt pay-down do more of the heavy lifting in creating the equity required to generate the cash flow they need at retirement. In contrast, the investor with less time has to rely on her capital and her savings rate to do most of the heavy lifting. In other words, if you have more time, you can execute a capital growth strategy. If you don’t, your strategy is limited to investing for immediate or short-term yield.

habits-hold-back-success

Risk Profile Naturally Shifts to Conservative Later in Life

As we age, our risk profiles naturally shift toward the conservative end of the spectrum. That’s not to say that someone who’s naturally risk-seeking becomes conservative but rather, they become more conservative. This shift is primarily initiated by the shrinking available time to accomplish your goals.  

If you have 30 years until retirement, you can make a bad investment move (or two), lose money, and land back on your feet. You have time to make it all back, to turn it around. That option just isn’t available to you if retirement is three to five years away.

Whatever move you make, you have to weigh it well and make sure that it will produce the results you need. There are no rehearsals, no do-overs. When you think about the limited time available, there’s an instinct to compensate for lost time by taking more risk in your investing. You’ve got to make up ground so you should throw caution to the wind and pursue high-yielding investments. That’s exactly the wrong thing to do in this moment. Don’t forget that risk and return are best friends: They go everywhere together. So when you’re considering a high-yielding investment, you’re also accepting a riskier investment. From a long-term investing standpoint, the only ways to get a higher return on your investment is to either get more cash flow for the same investment or pay less for a cash flow stream. Both of those scenarios lead to the same outcome: A higher-risk investment.

Some investors are successful at squeezing better cash flow through better management and renovations, but in the end, rents, like most things in life, tend to regress to the mean. Put simply, the market rent is the market rent.  

In order for a rational seller (who’s not in distress) to sell you the same stream of cash flow for a lower price, he must be selling you a lower grade property. If not, he’d be acting against his self interest.

Related: Inspirational Success Stories Are Great—Unless They Lead to Goals You Never Wanted

In Conclusion

Age impacts how you invest in real estate later in life because it impacts two critical elements of any investing strategy: time and risk profile. Time is a far more valuable resource than money because you can’t make or buy more of it. The time you have available to invest is directly proportional to the options you have available. Appreciation, leverage, and debt pay-down lose some of their magic when given insufficient time, as more of the heavy lifting must be done by your capital and savings.

Our risk profile naturally shifts to the conservative end of the spectrum later in life, as our opportunities to make mistakes and recover decline. There’s a natural impulse to make up for lost time by seeking high return assets that can produce results in a short amount of time. Don’t heed that call—it will lead you to riskier investments.

So how do you proceed from here with limited time? Since real estate strategies are like making alloys, your goal is to produce the best results with the ingredients available. Time can be limited, and there’s no way to get more. But you can play to your strengths by leveraging other ingredients that favor you. For instance, you might have more capital to start with than someone 30 years your junior, so you don’t have to wait to save capital and can complete your acquisitions quickly. In the same vein, your savings rate might be higher every month than someone who still has to save for college or pays exorbitant childcare costs.

Like the old Chinese proverb says: The best time to plant a tree was 20 years ago. The second best time is today.

Buy quality properties, play to your strengths, and you can put together a real estate investing strategy that works for you.

Are you beginning your real estate investing journey later in life? What strategies are you using?

Weigh in below!

About Author

Erion Shehaj

Erion Shehaj is the founder of Investing Architect. I help successful professionals design and execute a custom Blueprint Real Estate Investing™ strategy so they can achieve financial independence, retire early and gain the freedom to live the life they always wanted. Side effects might include: Early retirement, wealth and piece of mind. Follow on Twitter if that’s your thing.

2 Comments

  1. Jerry W.

    Erion,
    Excellent article. I am a little bit in both categories. I only dabbled a tiny bit in real estate in my early years, then began investing slowly building some assets up, but not until the last 5 years have I really ramped up my investing. I so wish I had done so earlier. While I had less money then to invest with, the banks were easier to get loans from and appreciation was very kind for a few years. Still it provided the base for me to be able to acquire more properties through stored up equity. With retirement checks set to begin in as little as 2 years having a decent rental portfolio gives me a sense of security I would have never had. I have the ability to not live comfortable, but to make sure if any of my grand kids want to go to college or trade school I can see that it happens. Even part time investing in real estate early on can produce nice results. The properties I did invest in have not only paid down their principal, but have appreciated, as have rent payments. While my local area is being hard hit by the energy bust, they are able to weather it well due to having been bought many years ago and either having high equity. or even if bought recently having built in equity from buying and fixing up distressed properties. Thank you for sharing.

  2. Cindy Larsen

    Erion,

    Great article. You are right. Everything in an individual investor’s situation should impact their investment strategy.

    For example, someone with credit card debt should have a strategy of getting out of debt before investing in RE. It doesn’t make sense to save up money for a downpayment at zero to 2% in a savings account, while paying 18% interest on credit card debt. Better to increase your net worth by not paying all that high interest.

    My situation: Currently 8 years from retirement, and over 55. Two years ago, my life changed significantly (divorce, new career investing in real estate, moving to a differnt state) and I had to devise a strategy that would work for someone in my situation. I had a house in CA, assets in 401k’s, and the prospect of ten years worth of alimony that would last just until retirement: then I would need to live on social security and whatever retirement income and assets I had.

    I dont know how anyone manages to live just on social security, and the social securitynwebsite advertises that I am unlikely to get more than 2/3 of what they ought to pay me. I also determined that depending just on the 401k assets for retirement was a BAD plan. Required Minimum Distributions (RMDs) would force me, over 20 years, to withdraw all of my assets, whether I need to make withdrawals or not, and will ensure that the withdrawals are taxed at high marginal tax rates. Reinvesting the withdrawals after taking that hit would reduce my net worth. Not what I expected when I put all that money in the 401ks. Not good at all.

    So here is the strategy I came up with:
    1) move to a state that does not have state income tax (CA tax income is 9% to 13%, WA is ZERO). This means the RMDs will not get taxed by the state, just the IRS. My alimony, and my real estate income, will also not get taxed by the state. This will allow me to build wealth faster. It’s like getting a 10% raise that is not taxable.
    2) sell the property in CA (two units) and use that and my savings to buy multifamily properties in WA where the prices are lower, so I can buy more units, and the lack state income tax results in higher ROI.
    3) buy properties that are good deals, using a predetermined definition of a good deal:
    A) below market rents
    B) mostly only cosmetic remodeling needed ( found great home inspector to help ensure this)
    C) B class neighborhoods with good schools, and desireable rental locations
    D) positive cash flow when calculated by the BP rental property calculator (assuming current below market rents, real numbers for inputs when possible, and conservative assumptions otherwise)
    4) Buy as many good deals as possible in late 2017 and early 2018 with available capital as downpayment and rehab money, before interest rates increase too much. Get 30 year loans, lowest interest rate possible, to fit a buy and hold strategy.
    5) Increase cash flow by fixing up properties and rerent at higher rents, and with tenants paying all utilities. Also reduce future expenses by managing maintenance and cosmetic improvements to reduce future maintenance costs.
    6) manage properties myself: my time is an asset I can use to increase cash flow, while also lowering risk of bad property management.
    7) Invest some of the cash flow from all properties into value add property improvements as needed
    8) Invest all remaining cash flow into paying off the mortgage on the highest interest rate property: use this “debt snowball” to create debt free properties with rents as future retirement income
    9) Engage my sons in my real estate endevors to enable them to take over property management when I retire
    10) Withdraw a small amount of 401k funds each year, up to the top of my tax bracket. This will minimize tax rate on withdrawals, and enable use of that money for more investments. This will also lower the future RMDs, meaning lower future marginal tax rates on RMDs

    I was lucky enough to find, in my research, a loophole in the IRS tax code that allowed me to withdraw a sizeable amount of 401k funds this year, with minimal tax impact. The loophole is called Net Unrealized Appreciation, NUA, and has very specific requirements, which I was lucky enough to be able to meet. So, I was able to buy even more properties. If you are reading this, and you have a 401k with an employee stock purchase plan for company stock: learn about NUA. It can be great, but you can disqualify yourself from using it unless you know what not to do: dont take ANY distribution without learning about NUA.

    A year ago, I had 4 units (2 used by my family). I sold the two in CA. Now I have 18 units (still 2 used by my family) and have fixed up and rerented 8 of the 16 rentals. Of the rest, 5 are waiting on leases to expire, and the rest will be fixed up this winter and rerented. My biggest challenges have been:
    1) finding competent contractors in a state that does not require contractors to be competent: this has resulted in a lot of DIY, which has resulted in a high vacancy rate. I am slow at DIY. The good news is I am likely to have a tax loss this yeat on my properties, and they are all at positive cash flow for the year, except for money preallocated for rehab. I bought good deals.
    2) buying properties with tenants in place: this has resulted in some undesireable tenants, and some marginally profitable leases. Next year will be better, and less of my time will be spent on property management once everything has been rerented.

    I have increased rents by at least 25% on each of the units that I have fixed up and rerented, and have greatly improved both the tenants and the leases at the same time (better credit scores and/or cosignors, higher monthly incomes, better educated tenants in terms of taking care of a property, better lease terms). I have also taken the time: to personally inspect each unit quarterly, to carefully screen tenants, to educate tenants, to set tenant expectations, and to engage tenants in notifying me of any problems with the property.

    In my situation, for the next 8 years, I can reinvest all of my cash flow in my properties, and do not have to work (alimony) so I can manage my properties myself. The value I have added to the properties, by decreasing expenses and increasing rents, will allow me to either sell or refinance any of them in the future, depending on interest rates and on the market. I should have the flexibility to pull equity out when future opportunities arise. Meanwhile, I am building equity, and creating future retirement income that I will need 8 years from now.

    Paying mortgages down, or paying them off, is not a popular strategy on Bigger Pockets. But in my situation, I think it makes sense. Stockbrokers recommend that clients nearing retirement put some of their assets into bonds, which have a lower ROI, and lower risk than stocks. Instead of bonds I am putting my non 401k money into real estate equity. Each dollar that I invest in paying down my highest rate loan earns the 5% interest rate that I am no longer paying on my highest interest rate loan. That is a better rate of return than bonds, low risk like bonds, under my direct control, and fairly liquid.

    If that highest rate loan is paid off 8 years from now, the rents from that property are retirement income. Or, if the situation warrants it in the future (real estate downturn) I can always leverage that equity in one or more properties via HELOCs or refinances, to buy more units. Right now, with 16 rentals, I have enough on my plate to keep me busy 🙂 I have flexibility. In a year or two, I may be buying again, or not.

    Next year: move 401k assets into a SDIRA, and invest in real estate instead of the stock market. Or in notes, since interest rates are going up. Or maybe in a syndication of some kind. Its going to be fun researching the options. 🙂

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