Real Estate 401kSomething has been weighing on my mind recently and I wanted to try to offer a solution.  The more agents I talk to, the fewer, it seems, have an exit strategy for when they are ready to “retire” from real estate.  I’m not talking about the traditional exit strategy discussed in many blogs that involve creating an asset that can be sold or passed down with ongoing income streams.  I’m talking about a retirement investment strategy.

If you look at the statistics, the average agent is 57 years old.  While there are many contributing factors to that, one of the concerns I have is that people aren’t leaving the industry because they don’t have a choice.  They are literally working until they die.  So, my question is, quite simply, why?  Here you have men and women with a world of investment data literally at their fingertips and nothing to show for it.  In fact, how many times have you posted something on social media about now being a great time to start investing in real estate?  But, have you taken your own advice?

Why don’t more Realtors walk the talk when it comes to securing their financial future?

Now, before we get into the details, let me preface this with a few disclaimers.  Although at one point I did have a couple of securities licenses, I am currently not a licensed financial advisor.  Also, I realize there are a multitude of financing options, market variations, etc.  And, yes, this is not exactly Dave Ramsey friendly.  This is overly simplified, I know.  So, before all of the comments, I am aware of all of these things.  This is just a simple illustration.

Why a “401k” example?

I am using the idea of the 401k in its simplest form.  The meaning is that this model is designed to create results at retirement or some point in the future.  This is not your traditional real estate investment plan where you are taking passive income today.  This is an investment plan that is designed to create assets and income in the future by using the income today to build equity.  If you choose to do otherwise, you can, but I am putting this out there for the folks who are disciplined enough to follow a plan and then reap the rewards 10-20 years from now.

Additionally, the “accumulation phase” of this plan is designed to hold the real estate.  That doesn’t mean, at some point, you couldn’t “sell your stocks” or “trade” for a new or better (hopefully) asset, but remember this is a plan where you can hold an asset and receive a dividend for well into the future.  We’ll discuss “trading” your “stock” in the Wealth Building Phase portion of this.

Finally, much like a real 401k, this is designed to own assets.  When I say own, I mean own.  I don’t mean finance and be leveraged.  This is where, I believe, the plan spits in the face of many traditional real estate investment plans.  It doesn’t happen overnight, but it happens and you will find yourself with an incredible asset and a whole lot of money coming in monthly.  So, let’s get to it.

The Accumulation Phase

So, the first step, like in everything, is always the hardest.  For the purposes of this illustration, we are going to create some constants.  First, every house we are going to buy is going to be priced at $150,000.  Second, every house we buy is going to rent for $1500.  Third, the houses we are buying need no repairs to make them “ready for move in”.  Finally, we are not going to take any price/value appreciation into effect until way later.  We are, for the sake of painting the picture, and for ease of math, going to assume that ten years from now the houses are still worth $150,000.  Trust me, just go with it.  We’ll do some appreciation illustrations later.

Ok, so let’s buy our first house.  To give us a jump-start on this, we are going to put down 20% (also to make financing easier and cheaper).  So, we need to save $30,000.  I’m not going to lecture you on how to do this.  If you want to save $30,000 you will save it.  Let’s shoot for no more than one year to save that amount and we are going to save that amount every year for the foreseeable future.

One year has passed and you now have $30,000.  So, you drop your 20% on the first house, hereafter referred to as House 1.  At a loan value of $120,000, your note is roughly going to be (assuming 3% taxes, $1500 insurance, and a 4.5% rate) $1150.  That leaves you with $350 each month in profit.  Instead of, like many investors, taking that profit, we are going to put every penny into the mortgage.  Based on that overpayment, we would pay off House 1 in 14 years and 9 months.  Not very sexy, but stay with me because it gets better.

In the meantime, we are saving another $30,000 in a year.  So, year two begins and we buy House 2.  Same numbers as before. Instead, however, of paying the additional $350 to House 2, we are going to pay it on House 1.  Now, our payoff of House 1, with a $700 overpayment each month, goes down to just over nine years. Still not showing up on MTV Cribs (yes, I’m old), but the light at the end of the tunnel is more realistic.

Third year, same story.  Our payoff on House 1, overpaying by $1050 each month, is less than four years away.  And so the story goes.  $30,000 a year.  One new home a year.  Every year.

Here’s where it gets better and why you have to see the long-term payoff on this.  Let’s say that year 6 we pay off house #1.  Now, we transfer all of our overpayment, and now an additional $1000 ($1500 less taxes and insurance) to house two.  So, for the record, that’s $1000 plus (5×350) $1750 for a grand total of a $2750 monthly overpayment.  House 2 gets paid off in less than 3 years.  House 3 comes next, nearly 9 years from buying house 1.  You now have 2 homes that you own and 7 financed, but not for long.  So, 2,000 (from House 1 and House 2) plus (7×350)$2450 for a total of a $4450 payment each month.  House 3 is paid off in a matter of months, not years.  And so the dominoes fall.  You can continue to purchase and payoff very quickly from this point forward.

The Wealth Building Phase

So, let’s say it is year 10 from our start.  We now own 3 homes outright and another 7 with notes remaining.  The great news is that we can literally pay off the remaining 7 within a couple of years, if not sooner.  So, let’s stop saving our $30,000 a year in year 12.  At this point, we will own (or be very close to it) 12 homes outright for a total value of $1,800,000 ($150,000×12).  As a bonus, that asset is paying us (after property taxes and insurance) $12,000 a month.  Do I have your attention now?

So, you can make some choices: either continue to buy, trade up on some of your “stock”, or sit back and enjoy the rewards of your hard work and discipline.  The awesome part is that you can do whatever the hell you want because you have the asset and the security.  For me, my choice would be to continue building wealth.  Even in “retirement” I would still do it.  Now we are getting into the legacy department, and that is for another day.

Picture this, though, at $12,000 a month, not saving an additional dime of your income outside of the 401k, you could buy a home a quarter and have them paid off in next to no time.  So, instead of having 15 homes in year 15, you could have 20.  In year 20, instead of having 20 homes, you could have 44.  Looking at that, using the same numbers, you would go from a $1.8 million asset in year 12 to a $6.6 million asset and cashflow monthly of $44,000 instead of $12,000.

Oh, and by the way, since we stopped saving our $30k a year in year 12, we just bought and paid for 32 houses without investing a single penny of money into the 401k.  That’s $32,000 a month and $4.8 million for free in an 8 year period.

Appreciation Models

So, using our illustration above, we have invested a grand total of $360,000 (12x$30,000) and have a $1.8 million return with a $144,000 a year dividend.  Not too shabby, right?  So, let’s look at what this might look like with some realistic appreciation models in place.

I live in Houston, TX, where we generally have conservative appreciation.  Since my other assumptions are using our market as a model, we’ll stay here.  We run a roughly 4% appreciation rate historically.  So let’s assume that our value and our rental rate appreciates 4% annually.  This will obviously affect our payoff in a positive way, but might also affect our taxes negatively.  Let’s focus on the end result though, because, after all, we are in a 401k mentality.  In year 15, House 1 is worth $270,000 and your rent is $2700.  I’ll let you take the math from there, but you get the picture.

So, there it is.  Yes, I know it isn’t perfect, but it makes the point.  Should you also invest in other things like stocks? Yes, you probably should.  Like Warren Buffett says, though, “Never invest in a business you can’t understand.”  You understand real estate.  Go get rich in it.

Here’s my challenge to you.  Tomorrow, I am going to go to my bank and open up a separate account.  I am going to start saving my first $30k tomorrow with the goal of buying my first rental property next year.  Will you join me?


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