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SHOW NOTES FOR EPISODE 220: EFFECTIVE REAL ESTATE STRATEGIES FOR YOUR RETIREMENT
The goal for most retirement growth strategies is to turn a smaller nest egg into a much bigger one. Knowing your niche and strategies is key to achieving this goal. As a beginner, it’s even more important to avoid wasting time chasing shiny objects and running after rabbit trails. In this podcast episode, Bill zeros in on some effective real estate strategies that will help you get a bigger investment return in a shorter period of time.
Real Estate Growth Strategies
The goal for growth strategies is to turn a smaller nest egg into a much bigger one. This objective is one part offense, as in making good returns. But the second part is defense, which means avoiding risky moves that will send you sliding back down the wealth building mountain.
Here are a few real estate strategies that I think will meet both of those criteria.
Live-in Flips
With live-in flips, you purchase a house that needs work or that has the potential to add value in some other way. For example, you could remodel the kitchen, open up the floor plan, improve curb appeal, or upgrade the baths, flooring, paint, light fixtures, plumbing fixtures, and other cosmetics of the house.
I’ve also known people who look for smaller houses in popular neighborhoods that can be added onto. If you can add a master bedroom suite for $125 per square foot and the addition adds $200 per square foot of value to the home, it’s a profitable project.
The bonus for live-in flips is their tax advantages. As of this writing in the U.S., gains up to $250,000 for an individual and $500,000 for a couple filing jointly can be earned tax-free. I’m not as familiar with Canadian tax laws, but Canadians seem to enjoy a similar benefit.
You probably already know the power of tax-free compounding of growth. It’s the reason so many people invest in 401ks and IRAs. This is a real estate strategy that benefits from the same principle.
House Hacking
House hacking is a great way to get into the rental property game. It just means that you live in a property that allows you to rent part of it to others.
For example, you could live in one apartment of a duplex, triplex, or quadruplex and rent out the other units. Or you could get more creative and rent your garage apartment to a grad student, use AirBnB to rent out your basement, or install a Yurt in your backyard for vacationers (yeah, that’s a thing).
See my friend Brandon Turner’s popular article on Bigger Pockets, How to Hack Your Housing and Get Paid to Live for Free.
Of course, this strategy requires some sacrifice. You’ll have to live next to other people, and those tenants will know you’re the landlord. But I actually made wonderful friendships with some of the tenants who were also my neighbors. And the elimination of a housing expense makes up for any potential headaches.
Once you’re ready to stop house hacking, the property transitions perfectly into a long-term rental. Your owner occupant financing can be kept in place, and the building should cash flow even better now that you can rent the extra space.
Rapid Mortgage Paydown
Now this strategy is for those that have a job and can afford to wait 7-15 years before they need the cash flow to live on.
A basic rental strategy is to buy a rental, hold it, amortize your loan, and let rents and prices appreciate over time. This is not a bad strategy. In the right locations, it will work very well over 20-30 years.
But there is a better way for those seeking early retirement. The approach is called a rapid mortgage paydown. I’ll explain it briefly…
Essentially, you buy a certain number of rental properties that will meet your goals. As an example, let’s say you buy three. I’ll assume each rental has positive cash flow of $200/month ($600/month total) and that you use long-term, 30-year mortgages with $500 payments to buy the properties.
The benefit comes into play when you reinvest all of the extra cash flow (plus any other cash you can spare) to attack one debt at a time. The extra principle payments quickly pay off the first loan, which then frees up another $500/month to add to the next loan. Like a growing snowball, each loan gets paid off faster than the one before until all properties are owned free and clear of debt.
The beauty of this strategy is steady and then accelerating progress towards a goal. It’s not uncommon to complete paying off your properties within 7-15 years instead of the typical 15-30 year real estate plan. In this way, rentals basically become a vehicle for you to invest and grow your upfront and ongoing savings. The end result is a portfolio of low-risk, high cash flow properties.
All-Cash Plan
Are you a debt-averse investor? Has all of this talk about mortgages made your palms sweaty? If so, real estate can still work just fine to grow your wealth. You’ll just need to use an all-cash plan where you pay cash for properties, save up all of your net earnings, and reinvest them into more properties.
I have personally used debt to grow my non-retirement account portfolio of rentals. But Dave Ramsey and many other wealthy real estate investors have done incredibly well by simply paying cash for properties. This article I wrote shows how well this simple, all-cash plan can work over time.
Investing with all cash may limit the size, location, and timing of the properties you can buy because your cash funds are limited. This may work fine if you’re patient and don’t mind building up your cash before buying. But you can also consider getting more creative by using partners. If you have $75,000 and a partner has $75,000, you could buy a $150,000 property together and start much sooner.
Loaning Money from a Self-Directed IRA
Most people invest their 401k and IRA retirement accounts in traditional assets like stocks, bonds, and mutual funds. But you can also be self-directed to invest in alternative assets like private loans, tax liens, limited partnerships, and real estate. Smaller, more specialized custodians offer these options, so it’s not as widely known.
If you do choose to invest your self-directed IRA in real estate, you might want to consider focusing on loans. Being a lender is more passive and exposes your retirement account to fewer risks and hassles associated with actual ownership. This works by finding other real estate entrepreneurs who need loans to fund their own deals.
The private investor enjoys the completely passive returns, and he also sleeps well at night knowing his investment has good collateral in the form of real estate at a low loan to value ratio.
This strategy works well for growth because 100% of the earnings stay inside of your IRA account and grow tax-free. If the interest was earned outside of your IRA account, you’d be subject to ordinary income tax rates without any of the typical shelter provided by depreciation from rental properties.
Real Estate Income Strategies
In the last section, all of the strategies were about growth. But what is the goal of this growth? Is it just to get a big net worth to brag about?
At least in my case, the goal is to live more, enjoy family, serve others and enjoy more of what really matters! And for that, I need time and flexibility. And to get time and flexibility using real estate, I need income.
This shift is sometimes harder than it sounds. Slowing down the chase after growth and switching to a focus on income and stability is not natural. It’s easy to rationalize the status quo and just keep growing for years.
Luckily, real estate transitions well between the two stages. During the growth phase, that income was reinvested to pay off debt or to buy more properties. But during the Income phase, you can optimize your real estate portfolio to produce income to cover your personal overhead.
Here are a few strategies to do that.
Free and Clear Goal
More than a strategy, this is a goal that helps guide you in the growth strategies above. It also gives you a quantifiable target that helps you to say “enough” once you reach it.
The free and clear goal begins by figuring out how much money you need to live. Then you figure out how many rental properties, free and clear of all debt, you need in order to pay for those living expenses.
For example, if you need $3,000 per month to live, how many rentals will you need? Let’s assume you have rentals with $1,000 per month rent and 50% goes out the door to expenses, vacancy, management, etc. So, each property gives you $500 per month.
Your free and clear goal would be 6 rental properties free and clear of all debt ($500 x 6 = $3,000 per month). I’ve ignored income taxes in this case because I assume you’re in a lower tax bracket and also benefit from depreciation shelter of some of that rental income. But you can bump your goal up if you need more cushion.
Some people will also not like the idea of zero debt. They want the benefit of some leverage to hedge potential inflation or to continue growing. You can still use the same principle and adjust your goals using more properties with some leverage.
But the point is that you work all of your real estate activity backward from an income goal. And you arrive at a place that has much lower risk and a much higher income.
That clarity, focus, and practicality serves your early retirement plans very well.
Rapid Mortgage Paydown
Using a rapid mortgage paydown strategy was first and foremost about growing your wealth. But it actually served another purpose because the end result was income and equity from free and clear rental properties.
So, the snowball plan would also transition nicely into the Income stage. You would just need to finish the debt snowball and make sure it meets your free and clear goal above.
Buy 3, Sell 2, Keep 1
Some of you won’t or can’t do the rapid mortgage paydown. Maybe your rental properties don’t cash flow enough because the prices are too high. Or maybe the loans are just too big to get them paid off before your target date to start using the income for early retirement.
In those cases, you could adjust your strategy to the Buy 3, Sell 2, Keep 1 plan. With this plan you buy 3 properties, sell 2 in order to generate profits, and reinvest the gains to pay off the loan on the remaining property.
Instead of rental income, this plan focuses more on the built-in equity from buying properties below their full value. It also benefits from amortization of loans and from any passive appreciation in the overall real estate market.
There is risk in this strategy because it typically involves more leverage during the acquisition of the larger number of properties. You also face a tax liability on the final sale which eats into your profits. But both challenges can be minimized with careful planning.
Seller Finance to Your Tenants
This strategy works well if you are transitioning to early retirement or even at an earlier stage when you want to take a break (which was our situation).
For example, let’s say you have a house that rents for $1,000 per month. Your tenants have paid you well for 5 years, and they would like to buy the home from you. But their self-employed income and lack of 20% down payment limit their options in the traditional financing market.
So, you agree to sell to them under the following terms:
- $150,000 price (the full value)
- $15,000 down payment
- $135,000 seller financing
- 6% interest
- $967/month
- 20-year amortization
Your tenants get to buy a house they love and lock in long-term financing with only a 10% down payment.
You convert a rental that probably produced $500 per month (assuming no debt and 50% rule on $1,000 rent) into a 20-year income stream of $967 per month. That’s basically doubled the monthly income!
You now own a promissory note secured by a mortgage on your old property. And you also get $15,000 cash up front to use for current needs or for reserves (definitely a good idea in case of non-payment) and you are no longer responsible for the maintenance and repairs.
If you owned three properties like this, you could build a $3,000/month income stream to support you for a long time.
Not bad income for a relatively small nest egg!
Loan Money to Others
Just like the growth strategy of loaning money from your self-directed IRA, you could choose to loan money outside of your retirement accounts in order to produce income.
I already described how the loans work above, but in this case, you get to use the interest income before the traditional withdrawal age of 59 and a half years old in retirement accounts. Remember, the whole point is to free you from the need to produce income at a job.
Look up Lending Club. There are also many real estate focused crowd funding companies that allow you to make loans or invest as equity partners.
I don’t have any experience yet with online lending, so definitely do your homework. And with direct loans or crowd funding, make sure you get expert advice before beginning. Despite its potential benefits, it’s not a strategy to take on lightly.
What’s the Best Strategy For YOU?
Presenting this information in a podcast id relatively easy compared to real life. Because in the real world, you have to match these strategies to the unique constellation of factors called your life.
So, to help you find the best retirement real estate strategy for you, I’ll close with a few final thoughts:
- Choose a wealth stage to help you focus.
- Choose a strategy that gets you excited. If it’s not fun, you probably won’t stick with it.
- Learn more about that strategy using the links I provided or other online real estate resources.
- Write a shortbusiness plan (like 1 page) with the likely next projects and next actions.
- Get started!
This form of investing in real estate is very entrepreneurial. That means it’s not for everyone. But for others, it’s been a central tool in our journey to early retirement.
I wish you must success in your real estate and early retirement adventures!
Is real estate the right tool to help you reach early retirement? If so, what strategy is best for you? Have you had experience with any of the strategies I’ve shared?
I’d love to get your thoughts or questions in the comments section below.
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