Last week’s post talked about various strategies that didn’t work as advertised when it comes to real estate investing.
Now, to be clear, the “tried and true” strategy of acquiring rental homes ’til one has 10 homes, then eliminating all debt by retirement, will defeat most-non real estate approaches, hands down. That’s true and has been for quite some time.
Let’s talk about the side-by-side comparison of the above-mentioned strategy B&H (Buy ‘n Hold) versus selling/exchanging or refinancing to acquire more property, while also takin’ advantage of other related vehicles. In others words, we’ll just add flexibility to the mix.
Sometimes analyses tells us it’s better to refinance to buy more than selling/exchanging. It’s different virtually every time, especially considering all the surrounding factors existing for each individual investor.
We’re gonna use a 35 year period from history — 1975-2010. This allows everyone to check the numbers in their particular market to see how it woulda turned out where they live. I’ll be using San Diego’s market cuz that’s where I’ve lived since I was 15.
Related: 10 Real Estate Markets Where The “Buy and Hold” Strategy Actually Made Sense
Here’s how the comparison will go:
1. I’ll assume the B&H and “never ever sell” approach will benefit by the overall rise in values/rents of the time, just as everyone else’s properties did.
2. Ultimate retirement cash flow for the two approaches won’t be computed equally. The 10 homes will calculate cash flow by taking the GSI (gross scheduled income) and taking 100% of it as before tax cash flow. Yep, we’re gonna make these rental homes magical to make the point crystal clear.
3. The ultimate retirement cash flow for my “client” will be computed on two levels: a) Real estate, which will be subject to Murphy’s Spreadsheet math. That is, we’ll simply take the total GSI and divide it by 2 to arrive at before-tax retirement cash flow, and b) Since my clients will be movin’ n’ grovin’ whenever opportunity and the market allows, they’ll have more income sources than will their buy ‘n hold forever competition. Two of those sources will not be real estate.
4. However, fear not, as their ultimate before tax cash flow from real estate will annihilate the other investor’s strategy.
5. Both investors begin with the same household income, get the same raises/bonuses, and have the same lifestyle expenses. The only thing different will be the investment strategy(s) used to generate retirement income.
1975-2010 — Buy ‘n Hold
B&H sets their plan in motion by acquiring a rental property sometime in 1975.
It took ‘em five years to save the down payment. By today’s standards, it’s laughably cheap, under $30,000. As was their plan, they continued buyin’ home after home. The acquisition period ended some time in the mid to late 1980s. At that point, they’d acquired the 10 houses set out in their plan. The next part was to pay ‘em all off by retirement, which they did.
Both of these investors were born in 1945, so planned on retiring at 65, which is 2010.
They benefitted by three incredible periods of appreciation, 1976-’80; 1986-’90; and 2001-’06. ‘Course, their strategy dictated they both remain calm through the downturns and also not alter their strategy during the wild upturns. They remained admirably disciplined. B&H’s 10 homes in 2010 on the day they retired were worth roughly $3-3.5 million. Today, they’re likely worth $4-4.5 million.
What Was Their Before-Tax Cash Flow at Retirement?
The average rent is about $2,000. That’s GSI of $240,000 a year.
When we apply the aforementioned expense factor… um, wait, never mind. We said they’d retire with 10 magical rental homes with no vacancies or expenses. Therefore, their gross rents would be their before-tax cash flow. Voila! They retired at age 65 with $20,000 of monthly before tax cash flow.
Great job, guys!!
How Did Our More Flexible Investor Do With Their Strategies?
They began with the same exact house their buddies bought, for the same price/terms, on the same day in 1975, with the same exact floor plan, across the street. That start equal enough?
By sometime in ’77, nearly three years later, that home was worth roughly $50,000. Their equity at that point was around $26k, net of loan/sales costs. Those doing the math will come up with a slightly lower net equity figure. This investor, following my advice, added an extra $100 a month to the loan payment, which goosed the net equity. Pretty boring stuff.
NOTE: We’re definitely NOT gonna go through the painful minutia of numbers details for every transaction over 30 years. I’m doin’ it for the first property to show how I arrived at net equity, which was to apply sales costs of 8%. From here on out, it’s nothin’ but broad brushstrokes. Those who prefer all the numbers ad nauseum? I suggest an HP 12C.
They were advised at the time of sale to examine whether or not it was better to sell and pay the taxes or to defer taxes in an exchange. They chose to pay the taxes, which amounted to around $4,000, some of which came outta their Levi’s, but well worth it. They then took the after tax cash, approximately $25,000 and acquired a local fourplex for $110,000.
Update: They now own four doors instead of one, and it’s barely three years.
They make another move in the spring of ’79. They acquire a couple duplexes and a triplex on separate but contiguous lots from one owner. They got rid of the fourplex to do so.
Update: It’s now summer of 1979, and they own seven doors broken up into three properties.
As it happens, Grandma passes away during the early winter of late ’79. She didn’t have much to pass on, but both our investors received around a $20,000 inheritance. Our B&H investor put a huge smile on his wife’s face by giving their kitchen a complete makeover.
Our more flexible investor spent all $20,000 on a 2nd position note sportin’ a loan balance of $29,000. …read more