Today’s post is exciting for me to write primarily because of what it can do for investors that actually heed the advice.
Since the beginning of Investing Architect, I’ve argued that quality real estate purchased in the context of and according to a sound overarching long term strategy can alter an investor’s life in fundamental ways. Surely, it can have an impact in that investors financial life – namely her passive income and net worth. But that’s only part of the magic. Most importantly, through their financial impact they can offer what I believe most of us are truly after: The freedom and independence to craft a life well lived.
I have a Freedom Formula that I’d like to share with you:
(Quality real estate + Strategy+ Discipline + Execution)^ Time = Freedom
The case study I’ll go over with you today is the “proof” of the validity of this formula. Let’s dive in the numbers.
Suppose you were presented with an opportunity to invest in brand new small multifamily (4 units) properties in a new development in an established Texas market with impressive population growth and solid tenant demand with strong median household incomes to support your rents.
Annual Income: $55,200 (4 units leased at $1,150 per month)
Total Operating Expenses: $22,563 (property taxes, insurance, management and repair reserves, vacancy provision)
Net Operating Income: $32,638 per year
Debt Service and Leasing Fees: $23,485 per year
Positive Cashflow: $9,152.64
Purchase price: $460,000
Cash to close: $122,000 (25% down payment plus closing costs)
Why Strategy matters
This is usually the point where first time readers get a puzzled look on their faces. “Wait a minute – how do we go from a potential investment property that throws off $9,200 a year in positive cashflow to turning $244,000 into 1.4 Million?”.
In one word: Strategy.
There’s a reason why strategy is the second ingredient of the formula. Quality real estate comes first because in it’s absence none of the remaining factors matter. You could have the most sophisticated strategy in the world, the discipline of a buddhist monk, and Jason Bourne’s execution skills and none of it matters. But once you’ve purchased quality real estate your strategy makes the difference between magic and meh. Every month I meet with investors that through sheer gut feel have acquired a couple of quality properties. But only minutes into our conversation it becomes abundantly clear that their investing efforts lack a general direction, an overarching strategy. Therefore, they do okay with their investment but they leave massive potential on the table.
Let’s get back to the numbers to illustrate the opportunity cost of a solid strategy. If you were to purchase this same exact property but lacked a long term strategy, what would happen? Well, you would be earning 7-8% on your money (conservatively) and would take advantage of leverage as the property appreciated over time. That’s not a bad investment but it doesn’t exactly change your life.
Here’s a better option. For the investor with available capital resources, I’d recommend the purchase of two fourplexes (8 rental units in total). The completion of these two transactions requires $244k in capital (+- 1%). Upon the completion of acquisition, I would have this investor utilize the positive cashflow from both properties to aggressively pay off the mortgage on the first property while making regular payments on the second. To add more “wood to the fire”, I would recommend that the investor contribute an additional $500 from her income to accelerate debt retirement even faster. Think of this as a 401(K) contribution that actually works.
What’s the effect of this strategy? The mortgage on the first property is completely paid off in 112 months (just over 9 years). After the first property is free and clear, the positive cashflow from that property is no longer $9200 but rather the entire Net Operating Income of $32.6k since there no more debt to service. Now I’d recommend that the investor continue the same process with the second property. The only difference is now we’re attacking that mortgage with a LOT more money every month. Therefore the mortgage on the second property is paid off in 57 months (just under 5 years.
Let’s look at the only thing that ultimately matters: Results. If you heed my advice, you invest $244,000 of your hard earned capital and after applying a Domino Strategy you end up with two free and clear properties in 14 years that assuming an appreciation rate of 3% (inflation) would be worth $1.395M at that time. Also at that time, these two properties would produce $65,000/year in investment income. That’s the difference between just buying a couple of good properties and buying a couple of good properties according to a solid strategy mixed with discipline and laser focused execution raised to the power of time.
Important Note: A project with 11 new construction 4plex and 4 new construction 6plex multi family properties in a growing Texas market is about to break ground in 2-3 weeks. We have partnered with the Developer to offer first shot on these properties to our clients during the construction phase. Over the next few weeks, we will be holding one-on-one conference calls with our clients to discuss the opportunity. Typically we sell out projects of this magnitude in 2-4 weeks.
If you are interested and would like to receive an information packet containing detailed cashflow analyses, location map, site map, demographic and psychographic data about the location, contact us or if you’re reading this from your email, just hit reply.