If you are in your 40s, 50s, 60s, or even 70s, and you have money in your retirement account, you should be asking yourself this question. Is what I'm doing in my retirement account going to allow me to retire when the time comes? In other words, is your retirement portfolio growing, and producing enough cashflow that you can pay yourself enough every month and not run out before you pass away? You're about to discover how to maximize your retirement investments by getting safety, growth, cash flow, tax breaks and complete control over your investments.
When you are in your 20s and 30s, it can make sense to invest some of your retirement money into stocks and mutual funds. But as you age, you're time horizon reduces, and those traditional investments become less and less effective. There is, however, a tried and true investment that works better than any other, especially when you have limited time to "catch up" on your retirement savings. Welcome to the powerful world of commercial real estate investing; where you can have your cake and eat it too!
We have a student, her name is Kathy and she has a substantial amount of money in a retirement account, but she has a problem. It's not growing, and she feels uncomfortable taking money out to spend on her bills because she doesn't believe that's going to last her entire life. She came to us and hired us as her mentors. We had her take out 15% of her retirement account and invest in commercial real estate. When we did this, I wanted to show her the benefits of commercial real estate and how in contrasts with investing with stocks and mutual funds.
Benefits of Commercial Investing
- She's getting cashflow that she can spend comfortably, continually and confidently for many years.
- There is growth in the value of her property, where she's not going to lose principle and she's not going to run out of money. We'll call her property her retirement account.
- Her commercial real estate purchase is going to be safe compared to stocks and mutual funds. Safe means predictability and in commercial real estate we have predictability. Therefore, when interest rates rise, or when something happens in the economy, we know what to do because we do nothing other than real estate and we've been in this business for so long.
- It's tax friendly. Every month Kathy is going to put money in her pocket that she can spend on bills and at the end of the year, that money she received should not be taxable. If done well, there should be no income tax to pay because of all the write offs she has and because of the legal tax loopholes that she has as a commercial real estate investor.
- Most importantly, Kathy will have control of her property. You don't have control over your stocks and mutual funds. Kathy has control over the property, where no bad news from the media, no political environment, and no corporate corruption can take away her value or her cashflow.
Five Pillars to Maximize Your Retirement Investment
In order to maximize your retirement investments, you need these five things:
- Growth in value
- Being tax friendly
Control of the Cashflow:
In commercial real estate, we can increase our rates, reduce our expenses, and produce more cashflow on the spot. Can you do that with the stock and mutual fund?
Growth in Value:
Did you know that in commercial real estate, as the net operating income goes up, so does the property value? We can force the property value upward, so much so that we can refinance that increased equity and pull out our down payment. Then do a cash out refinance, put it in our pocket tax free, and keep the cash flowing property. You can’t do that with stock and mutual funds, however you can if you have control over your investment.
Control Over the Safety of the Property:
What I mean by safety is predictability. With commercial real estate, you have control over when things happen. You also have control over the management; you can hire and fire any management you like. If you have stock in a mutual fund, you can't do that because it's up to the shareholders.
Did you know that if you have a commercial property, for example an eleven-unit apartment building, and it has 11 refrigerators or 11 air conditioners or 11 sets of new carpet, you can do what we call cost segregation? You can rapidly accelerate the depreciation of all those items. Over five years, you can write off all the refrigerators, all the air conditioners, all the carpets, and all the other fixtures. We call that hidden cashflow in your pocket during tax time at the end of the year. That is not possible with a stock and mutual fund, but this powerful strategy, cost segregation, or sometimes called chattel depreciation, exists when you control your real estate.
Using a commercial real estate agent, Kathy is buying a 16-unit apartment building. Her purchase price is $640,000 and she’s buying it in an 8% cap rate area. (For those of you that want to make the best decisions, wherever you buy, you need to know what the market cap rate is in your area.) She's putting down 25% of $640,000, which is $160,000. Her rents are under market, meaning that we can raise the rents. The property is in average condition and needs some work.
Can you find a deal like this? Of course, you can. However, Kathy created a great relationship with her agent, and it took her going through probably 40 deals with us to find this one. So, don't think you're going to just read this post and go on to a website and find a deal like this. It takes time and focused effort, but this is from an agent, so these deals are out there.
Below I have her deal numbers broken down for you. First you will see the "today numbers;" the actual numbers related to her investment as they are now. As well, you will see the "predicted numbers," which represent the goals we intend to meet in about two years. I know two years is a long time, but I'll show you that it's worth it to reach these numbers.
Let's go over her today, or actual numbers. Her rental income per year is $90,000. Because she is not going to be 100% full for the full 12 months, I'm going to subtract a 5% vacancy factor of $4,500. That gives me an effective gross income of $85,500.
I'm going to subtract her operating expenses of $32,142. That includes taxes, insurance, property management, repairs, and supplies. Then it's going to leave me with an NOI (income minus expenses) of $53,358.
Then from there I'm going to subtract her annual mortgage amount of $30,912. That's based upon her putting down 25%, a 5% interest rate, and a 30 year amortization.
The NOI minus the mortgage equals the cashflow. Her cashflow is $22,446, or $1,870 per month. She ends up with a 16% cash on cash return and an 8.3% cap rate. Now, this 8.3% is slightly above the market cap rate, which means she's slightly overpaying for the property. However, in markets today it's okay, especially in this case, as you will see.
Our two-year plan is to raise her rents $125 per unit. As the tenants move out, we're going to go in and spend about $3,000 per unit in upgrades, and then we're going to raise the rent $125 more. That's going to give us a new income over the next two years of $114,000 per year. I'm going to take out my 5% vacancy factor of $5,700 and what's left over is $108,300.
We have the same expenses of $32,142. I'm going to subtract the expenses from my income. That gives me a new NOI of $76,158 and an increase of about $23,000. That's key because as the NOI goes up so does the property value, and it is one of the reasons why we slightly overpaid.
The NOI minus the same mortgage of $30,912, gives us a new cashflow of $45,246. Over two years, we raise the rents $125 on 16 units and it doubles our cashflow. Here you can see the importance of buying more units. That gives her a monthly cashflow of $3,770 per month, 32% cash on cash, and the cap rate comes out to 11.8%.
Does this property meet the five pillars to maximize your retirement investments?
Does Kathy have control over this property? She sure does. She bought it herself and no one forced her to do it. She hired the management and she's overlooking the numbers. She has full control over this asset.
She’s walking in with cashflow and then two years later she doubles her cashflow. Guess what? This is going to go up even more and it’s consistent. Every year she's going to make this until she raises the rent. Can you say the same with your stocks and mutual funds?
Growth in Value
Kathy came to us because she was not experiencing growth in value in her portfolio account. Instead, it was going down. So we had her buy this property to show her that it can grow. You may have to read some of my other blogs to fully understand this concept but let me explain it.
If you take your future NOI and you divide it by your market cap rate area, that's going to give you your new property value. Kathy’s projected NOI of $76,158, divided by 8% gives her a new property value of $951,975. She bought it for $640,000, but through the process of increasing the rents, maintain the expenses and boosting up the NOI, we increased the property value from $640,000 to $950,000. Then, one thing she can do that you can't do in a stock and mutual fund is she can do a cash out refinance. She can go back to the bank, show the banker her new numbers, pull out her original down payment and keep her cash flowing property.
Safety, Predictability and Management
Kathy hired the best management in the area. She has full control of hiring them and firing them and overseeing them. As a company, we show our students how to manage the management, which is extremely important.
To me something that's tax friendly simple means that at the end of the year there's no income taxes to be paid. Her cashflow is $22,000. She’s paying $30,000 a year in mortgage, $20,000 of that is interest she can write off. There's also around $10,000 of depreciation she can write off as well. With the legal tax loopholes and all the write offs, she can write off that $30, 000 against the $22,000, so she's paying no taxes on this first year.
Next Steps to Maximize Your Retirement Investments
Ask yourself this question: is my retirement portfolio performing in such a way that I can pull out money and still have the value in my retirement account grow?
If you can't, then you need to get educated because no one cares about your money more than you do. Your investment advisor who handles your retirement account is educated in what they do, but you need to decide if you want to put your investments in the hands of someone else or do you want to take control of it yourself?
The last step is to contact us. We're here to help, serve and listen. We'll be glad to talk to you about what you have going on with your retirement portfolio. Maybe we can help you add something to it and maximize your retirement investments.