I have a couple secrets to tell you today, so listen closely. Let’s get right to the first one:
You don’t have to be a genius to be successful.
A great brain is good for a lot of things, but it isn’t a requirement for building an awesome life.
I’m a smart guy, but I’m never going to solve nuclear fusion, create peace in the Middle East or have Buffett riches. Heck, on most days, it’s a struggle to find my wallet and sunglasses. However, my life has exceeded all of my expectations and a big reason for that is my second secret:
Identifying and listening to smart people is incredibly valuable and important.
The great news is that you don’t have to figure much out for yourself. Very smart people have written about how to invest successfully and almost anything else you care to learn. Many of these people share their knowledge for free on the Internet. Your job is to figure out who the good people are and learn from them.
So, most of my learning doesn’t revolve around figuring out new ideas; but finding great people and learning from them.
Earlier this year, I ran into one such person at a conference. His name was Chad Carson and he was being interviewed by the BiggerPockets crew onstage. I chatted with him later in the day and knew quickly that Chad was a person that I should listen to. Despite only being in his mid 30s, Chad owns 50+ properties. He went to college, but skipped the 9-5 job in favor of entrepreneurship. Chad has built an awesome life for himself.
I invited Chad to guest post and was blown away when I read the really great article he wrote. I know you’ll enjoy it as much as I did.
Early Retirement Using Real Estate (The Real Story)
I’m a big fan of 1500days.com. I regularly look to Mr. and Mrs. 1500 for a good laugh and valuable insights. So it’s an honor to be able to share with you today.
Over 13 years ago when I graduated from college I briefly considered conventional careers in medicine or with big Wall Street corporations. But in the end I chose to be an entrepreneur and start my own small business. My entrepreneurial path was in the world of real estate investing.
In this article I’d like to share some ideas about the benefits and challenges of using real estate investing to retire early.
Real estate is clearly not for everyone. But I’ve found many aspiring or current early retirees needlessly discount real estate as a viable strategy. I hope to show you that you can use real estate in a very small or a very big way to accelerate and smooth out your journey towards financial independence.
My Style of Real Estate Investing
I want to say up front that my bias is towards a small, simple, and hands on form of real estate investing. I have never invested in REITS, I don’t control a syndicated empire of real estate, and I run my entire business out of my basement (or from my laptop while traveling in South America).
My primary focus is on the life opportunities that the money from real estate provides. I like being a dad, traveling, creating social businesses and non-profits (the Green Crescent Trail), writing my blog, and teaching.
If you want to get big and take over the world, go for it. But if you just want a small amount of real estate that provides stable, safe, and passive income while you live your life, it’s definitely possible.
The Good – Real Estate is an I.D.E.A.L. Investment
The most common benefits of investing in rental real estate can be described with the acronym: I.D.E.A.L.
I = Income
The right real estate investment can produce consistent income in much better ratios than most other asset classes. An unleveraged return of 4-10% is typical for real estate that I see every day.
For an early retiree, consistent income is the holy grail. This is what you use to live, to play, and to explore. In my world, the 4% rule is a non-factor because there is enough investment income without depleting any of my equity.
D = Depreciation
Like other large capital asset purchases, the IRS requires real estate investors to depreciate the value of the building over time. Residential real estate, for example, has a life of 27.5 years. This paper expense (it’s not actually cash out of your pocket) can shelter your rental income. This means less of your rental profits are exposed to current taxes.
If this depreciation creates a loss for your rental, it can sometimes also be used to shelter other income from tax (with some limitations). In combination with other strategies like Jeremy explains over at GoCurryCracker, I’ve paid much less in income taxes even during my high-earning growth years.
E = Equity Build-up
Even conservative investors like Warren Buffett use smart leverage. Real estate investing gives you access to long-term, fixed, low interest, fully amortizing mortgages.
This leverage can be a powerful and safe growth tool because you build up equity by amortizing your loan. One of my favorite concepts in the real estate has been that my tenants go to work each month, pay me rent, and effectively pay off my mortgage for me. It’s beautiful!
A = Appreciation
I don’t count on appreciation when I evaluate the purchase of a rental, but there is no doubt that in most areas the prices and the rents on real estate tend to keep up with inflation rates over time. This article does a pretty good job summarizing the real estate appreciation statistics.
What average appreciation models do not take into account is forced appreciation. Almost every property I buy has value added potential, like remodeling, increasing sub-market rents, improving cosmetics, adding storage, etc. This form of appreciation is very much within your control.
I also like to buy properties below their market value. A 10-30% discount creates built in appreciation right away. Unlike stocks, cash and patience can pay off with bargain prices on real estate.
L = Leverage:
As mentioned before, safe leverage is available in real estate. This can allow you to take $100,000 and invest in 3-4 properties instead of one. I have certainly used this strategy, but I am also leery of too much leverage. Unwise use of leverage kills more real estate portfolios than any other factor. Debt is like a loaded gun, which can be helpful if you’re an experienced hunter looking for food but extremely dangerous if you’re careless and reckless.
Even More Good Reasons to Invest in Real Estate
The I.D.E.A.L. benefits are the core reasons most people get into real estate investing, but for early retirees there are even more benefits that are not often discussed.
Your Home Can Become an Investment
Despite what I’ve read from smart people like jlcollinsnh who say your home is a terrible investment, I’d like to respectfully disagree for people with an entrepreneurial mindset and a desire to retire earlier.
Here are a couple of specific strategies that can turn that assertion on its head.
First, you can hunt for bargain purchases, move into the bargain, clean or fix it up, and then sell it after two years to receive a tax free gain of up to $250,000 for individuals or $500,000 for couples. This is the best deal in the entire U.S. tax code.
This technique is called a “live in flip,” and you could use it to own a home free and clear within 6 years. You could also just use it to pile up a bunch of cash for investing, and then start renting once you get out of your growth phase.
Second, you could do something called house hacking. This means you live in a house or a small multiunit that allows you to rent other apartments or bedrooms. This rental income allows you to cover some or all of your housing overhead.
I personally house hacked a quadraplex that allowed me to live not only for free but with a positive cash flow for several years. I have since moved two more times, and each time I keep the old residence as a rental property that transitions beautifully into a long-term rental for income and growth.
Timing of Early Retirement
Most early retirees have a target date for their financial independence. After that point they plan to live off their investment portfolio (or at least be able to).
I am personally very confident in the long-term returns of the stock market (especially with low expenses and Vanguard index funds), but sequence of returns, particularly in the first decade (awesome article by The Mad FIentist) would still be a concern for a 4% withdrawal strategy.
Real estate income properties can provide a diversity of income and growth that can smooth out the timing issues of your early retirement. Whereas stock market prices could fluctuate wildly over the short-term, real estate income and loan amortization is very steady and predictable. That is a very useful feature when you want to live off of your assets at a certain time.
Control Over Returns
Once again, I personally have confidence that over time the 3,797 managers of the companies owned by my VTI total stock market index fund will reinvest the retained earnings and grow my net worth. But there is also a part of me that likes more direct control over my returns. Real estate, particularly the hands on type, gives you that control.
Simple, Understandable, and Safe
One of the primary investing tenets of Warren Buffett is to purchase assets that are simple and understandable. I focus on residential real estate, particularly houses and small multi units, because they are the most simple and understandable investment I know.
Ordinary people live in these units. They want things like safety, convenience, comfort, affordability, style, and good school districts. When you shop for a residence, you probably look for the same things. Therefore, you intuitively understand the fundamentals of good real estate.
Real estate is also a “real” asset. It’s tangible. In the right locations, its value is buoyed by construction costs and salaries which keep getting higher over time. Housing doesn’t go out of style or get replaced by the latest technology. People will still be living in homes long after you and I are gone, and this makes it a safe long-term investment.
Debunking 3 Common Objections to Real Estate
Real estate rentals have a bad reputation in the early retirement community. But some of the biggest so-called negatives are actually positives in my book. Here are some objections I’ve seen.
Real Estate Is Illiquid
This just means it’s harder to be stupid and sell at the wrong time. With real estate you’re forced to do what Warren Buffett suggests you do – hold on long term.
This illiquidity also creates opportunities to make even more money in illiquid/down markets when you buy new deals. During hot or liquid real estate periods, I’ve found it fairly easy to sell my bad or less than ideal investments and to restructure my portfolio as needed.
Real Estate Requires Time and Effort
I’m also a fan of passive, index-style investing, but I don’t see a problem mixing in a little elbow grease in order to receive all the benefits I’ve laid out here. To me and others who value more control over investment returns, it sure beats waiting on the broader market to make money.
I have found that most of the time and effort in real estate is on the front end of a purchase. After it’s rented and stable, feel free to travel around the world like I have. The RIGHT real estate can be very passive, and there are plenty of decent management companies to handle it if you don’t want to.
Less Appreciation Than the Stock Market
Really?? Most people spouting this objection ignore overall returns, which include income, tax benefits, amortization of loans, and appreciation. Residential real estate appreciation may average 3%, but if you buy at a discount that number is even higher.
And unleveraged rental income yields can be anywhere from 4% – 10%. In a worst case, income and appreciation from real estate is actually very comparable to stock returns. In the cases I’ve experienced, it’s much better and compensates you very well for your time.
The True Challenges of Real Estate Investing
Real estate, like anything else, has its downsides. I’m not trying to sell you something. You need to be aware of the whole story.
Unlike passive investments like index funds, beginning to invest in real estate is more like a start-up. This means you need to learn the fundamentals of your business and act like the CEO.
In one of my articles at real estate website BiggerPockets.com, I shared the 7 best books for beginner real estate investors. This is a good place to start your education.
Overcoming the inertia and overwhelm of this early stage is often the hardest challenge. It does take some time to learn and to get the momentum going. A lot of would-be investors get stuck in this stage.
This is the reason free websites like BiggerPockets are so helpful for new investors. You can learn as much as you want for free, and then you can ask questions and get support from more experienced investors in the forums or comments.
Feel free to look me up at BiggerPockets and ask questions anytime.
Buying good deals in high-priced markets can be a challenge. The rental income of real estate in these areas is not as strong, and that makes it more difficult to justify the extra investment of time and effort.
I have a few suggestions in these cases.
First, don’t just accept defeat without a fight. Research all of your area for yourself. Every town has more expensive areas and less expensive areas. Don’t start in the most expensive. Look for the neighborhoods making positive transitions. This is where the best deals can be found.
Second, look for income properties near single family areas. 2-4 unit buildings in nice areas will typically be easier to cash flow than single family houses. You can still get attractive mortgage financing on these buildings, and they often sell as easily as single family houses when you’re ready to liquidate.
Third, you can still flip houses, do live in flips, or house hack in more expensive markets where income for rentals is not as strong.
Fourth, invest further from home. This is my least favorite because you lose some of the intuitive advantages of your home market. But many people have done it successfully.
Managing People and Systems
Real estate is a people business. Even in its most passive form, you still have a property manager who you’ll want to macro-manage from above.
If you’re completely opposed to any form of people interaction, real estate is probably not for you. This is a reasonable objection that you’ll just need to judge for yourself.
But on the flip side, learning to manage people is not as difficult as it seems. Despite horror stories you might have heard, tenants are MUCH easier to manage than employees. I have been gone for months at a time without huge issues from my tenants. The issues I did have could be handled with a call to a good local contractor.
Rentals in nice locations attract quality, self-sufficient people who can manage their own lives. When you build a few communication and operational systems on the front-end, most of the potential problems can be handled very easily with little stress. A good third party property manager should already have these systems and a good team, so look for those if you’re hiring someone to manage your property.
Is Real Estate Investing For You?
The journey towards early retirement is exciting and worthwhile. The fundamentals of the journey, like a high savings rate, rarely change. But I hope I’ve given you some alternative ideas with real estate that could make your journey smoother and more likely to succeed.
Real estate is certainly not for everyone, but it might be right for you, either as a small or larger part of your early retirement plan.
This post is collected from http://www.1500days.com/early-retirement-using-real-estate-the-real-story/