252: Running Out of Money – Part 1

SHOW NOTES FOR EPISODE 252: RUNNING OUT OF MONEY – PART 1

If you’re planning on living off the rental income from your investment properties during your retirement years, the biggest fear is usually running out of money.  However, buying right, managing your money right and buying for the long run can help insure that your cash flow stream never runs dry.  In this episode, Bill discusses tactics and practical strategies you can employ to help prevent you from running out of money both while you’re building your retirement rental portfolio and once you’re living off your rental income during your retirement.

In the past, pensions were a primary solution to this challenge.  People retired in their 60s, and, if they were lucky, a pension (typically from a former employer) comfortably paid their bills until they died. The former employer withdrew from its own pension reservoirs so that the retirees didn’t need to worry about generating income for survival in their retirement years.

But outside of the military and some other government worker plans, pensions are by and large a relic of the past.  Today, most people must create their own pension if they hope to get through their retirement years. The primary exception is social security income, which can begin at the earliest retirement age of  62 or 67 for those born after 1960.   But most people are living much longer than before, and social security income doesn’t usually cover all of their living expenses in retirement.  And we still aren’t sure just how long social security will even be around.  So, creating a personal reservoir of retirement savings or, better yet, a cash flowing retirement income stream is still a necessity. And for those leaving full-time work earlier in life, like in their 30s or 40s, social security income isn’t even a part of the solution until maybe much later.

A good real estate investor who does not have a pension or a big retirement reservoir knows that creating a retirement cash flow stream, that will create enough constant income to last a lifetime, is critical.  A properly designed rental property strategy should produce enough income to last well past the life of the investor and, hopefully, be part of a legacy that can one day be handed down to surviving family members and or loved ones.

However, if the income stream you’re creating gets hijacked while you are building it or, worse yet, can no longer support you during your retirement — while you are dependent upon it – that could be a disaster.

…can’t keep up with inflation or survive some other, unexpected large expenses occur (such as lawsuits, medical bills, natural disasters things not covered by your insurance, etc.) you might have to sell off properties (that are part of your retirement income stream) to cover those expenses and thus reduce your retirement income.

So what can you do to make sure you don’t run out of money

Your real estate investments, if purchased wisely, should create a continual and steady flowing stream of income for your lifetime.  If you are building your rental portfolio while you are still working or even after you have retired, the principals remain the same – you need to buy right, manage your money right and buy for the long term – those principles are key!

Before you buy your first property you need to be prepared:

• Get educated
• Find a mentor
• Write a Plan
• Take action

See podcast episode #006 – How to Get Started in Real Estate Investing

Next, you’ll need to develop critical skills for success.  You’ll need to be proficient in:

• Market analysis
• Finding good deals
• Analyzing and properly underwriting deals
• Negotiation
• Understanding and acquiring the right funding
• Understanding and conservatively utilizing leverage
• Growing NOI
• Generating and maintaining cash flow
• Asset management
• And Tax strategies

You also need to be prepared for the multiple roles you will be taking on.  Be aware that a successful real estate investor wears many hats:

• Investor
• Deal Maker
• Businessperson – CEO, COO, President
• Leader
• Landlord
• Motivator
• Visionary
• And more…

Now granted, you can always delegate or partner with someone who may be more skilled in areas where you are not particularly strong, but you still need to understand the broad overall basics of real estate investing so as to be able to oversee or at least know that the people who are on your team and with whom you delegating responsibilities are doing the right things and making the right decisions. And, as with any business, your need to be good at managing your financial resources.  This is key!

And this is the area where many real estate investors succeed or fail.

Where Does Your Starting Capital Come From?

In real estate investing, we all start differently.  In the beginning, there is always your first initial investment.  Keeping it simple, let’s talk specifically about buying a rental property.

When I first started, I received an inheritance check to purchase my first properties.  But for you, it may have come from a number of sources:

• Your savings
• An IRA/401K or loan against your IRA/401k or open a self-directed IRA/401K
• Maybe it is a 1031 Exchange that comes from the sale of another property
• Sale of stocks or bonds or other financial investments
• Or maybe you take out a loan:
  • Borrow from equity in your home
  • Get a 100% loan (VA loan or FHA loan)
  • Down payment grant
  • Hard money
  • Credit cards
  • Personal loan from a relative
  • Or even a loan in the form of seller financing – whereas the seller/owner takes on a loan to cover the down payment and you take on or assume the existing mortgage or agree to make payments on the mortgage out of rental income

Wherever it comes from, as an investor and businessperson, that amount is referred to as your “seed capital.”  It’s called seed capital because, like a seed, when you apply the proper amount of water and nourishment, it can and should grow into something bigger.

Your seed capital, if utilized in the right way, can also grow to into something much bigger.

Let’s look at the following example:  You buy a fixer-upper home that you buy for $100,000 in cash.  And let’s say you BUY SMART in a strong emerging market where similar sized homes are selling for $200,000.  Wow!  That would be a great deal but it’s feasible.

Let’s say you also spend an additional $20,000 in repairs and upgrades and, after your repairs and improvements are completed, the home is now worth $200,000 – like most of the other homes in that area.  If you decided to sell the home, you would have made a quick $80,000 (and, of course, that’s what flipping or fix ‘n flip is all about).  But instead, you decide, to hold on to the house FOR THE LONG TERM, as a rental property, to generate cash flow for your retirement.  And let’s say you begin renting it out at $800 a month.

Since it is a rental, and even though you paid cash and don’t have a mortgage, you will also have monthly expenses. Let’s say, your out-of-pocket expenses, which includes things like property taxes, insurance, repairs/maintenance, funds set aside for capital improvements and an allowance for vacancies, totals around $300 per month.  That leaves you with $500 a month net cash flow or $6,000 per year.

You also know that, because you bought in an emerging market, homes in that area are going up in value at the rate of 5% a year.

So, that $120,000 investment, at the end of year one, is now worth $206,000, because it’s in an appreciating area where the property value has increased 5% or another $6,000.  The property has also generated $4,500 of rental income for 9 months (your rehab took 3 months).  So that $120,000 has, in essence, increased in value to over $210,000

So, that home that you bought and rehabbed for $100,000 in cash, in ten years, will be worth $310,000, plus you earned $60,000 in net cash flow.  Giving you a 209% return-on-investment, and that’s without factoring depreciation and other tax savings.  Its roughly 20% return annually.  Where can you find that?

That’s not bad for one $100,000 investment.

But, if you are buying for cashflow, that $500 per month, although a nice return, isn’t enough to sustain you.  You’re going to need 10 or 20 times that amount (or more) to replace your current living expenses.  And this is where some of the biggest challenges come.  Especially, if you only had $120,000 to invest and now it’s all gone.  This is where the concept of leverage comes in.  This is also the place where wise money management is critical.

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