Investing Architect

Category: Case Studies

True stories of investors from all walks of life applying our Blueprint strategy and winning

The Freedom Formula: How to turn $244,000 into $1.4M in 14 years

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.

Case Study

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.

Final Results

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.

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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.

September 10, 2016
Case Study: Small multifamily investments in growing Texas market

When market dynamics change, long term real estate investors have to adapt their approach to stay on track and accomplish their goals. Previously, I articulated the case for branching out into other growing markets and different property types when market conditions restrict supply to the extent that it threatens the investor’s acquisition needs. Today, we are going to get deeper into the nuts and bolts of purchasing new construction, luxury small multi family properties (duplexes) in a growing Texas market with a detailed case study.

Income and Expenses

Annual Rental Income: $31,800 ($1325/side/month)
Operating, Management, Vacancy and Leasing Costs: $11,534* (36%)
Net Operating Income: $20,266

Purchase Price: $279,000
Down Payment: $69,750 (25%)
Loan Amount: $209,265 (4.75% 30 Yr Fixed Conventional)

Debt Service: $13,099.50 ($1091.63/mo)

Positive Cashflow: $7,166.50 ($597.21/mo)

*Breakdown of Operating/Management/Leasing/Vacancy

Vacancy: $1590
Property Taxes: $5400
Insurance: $800
HOA: $200
Management : $2544
Leasing fees: $1000

Total: $11,534.00

Investment Scenarios

Let’s begin with a basic example and build from there. Suppose you acquire one duplex that performs as outlined above. Next, you follow our advice and decide to grow your capital base first so you can maximize cashflow at retirement. Therefore, you utilize current positive cashflow to aggressively pay off the debt on the property. If you just use the property’s own cashflow without any additional investment from your job income, the mortgage will be paid off in 170 months or (14.2 years) at which point, if rents haven’t risen a penny in that decade and a half (chances of August snow in Houston are higher), your property would produce a pre-tax income of just over $20,000 per year. That’s in addition to your capital base growing four fold from the $70k initially invested to $280,000 of paid off real estate (if we assume zero appreciation). Suppose you need to get this done in 10 years vs 14 – how much would you need to contribute monthly from your job income? Roughly $500 per month! That’s lower than most people’s monthly Starbucks “contribution”.

Now what if your income needs far exceed the $20k/year produced by one duplex. Let’s look at a scenario where you acquire 3 such small multi family properties. It’s commonsensical that if you are able to pay off one duplex using its own positive cashflow in 14.2 years, you will be able to pay off 3 in the same amount of time since you’d be working on all three simultaneously. But what may not be as self evident is that if instead of using each duplex’s own income to pay off its own mortgage, you use the combined income to pay them off one at a time, you will start seeing results sooner. More specifically, the first duplex would be paid off in roughly 7 years, the second in just over 4 years and the last in just under 3. So, while the total time to pay off all three is the exact same, the investor that has one duplex completely paid off after 7 years has a lot more options on her menu than the investor who has the same mortgage balance spread over three properties but none paid off. And more options lead to victory. Similarly, if you want to shorten the time in which they’re paid off, a small contribution from your monthly job income could shave about 30% of the time to get to retirement. In this scenario, the investor would end up with pre-tax income of $60,000 per year and a paid off portfolio of real estate worth just shy of $1M if rents and values don’t go up one penny.

Concluding thoughts

In these case studies, I intentionally omit to consider any rent or price appreciation as part of the analysis due to my conservative nature. But you don’t have to be a real estate expert to know that over long enough periods of time both prices and rents go up (excluding markets where prices are artificially inflated by bubble conditions and rents are controlled). Even under the most conservative of appreciation assumptions (I.e inflation rate), the investor that controls the highest asset value (3 duplex scenario above) reaps the largest benefits on both the income and net worth front.

Finally, any investment performance must be judged relative to other available alternatives. So in that sense, I want to end this with this question:

When we take up the case of investing $70k to purchase one small multifamily (or $210k to purchase three), can you think of any other investment alternatives that in 14 years would turn your capital into $280k (or $840k for 3) AND produce $20k (or $60k for 3) per year respectively?

Or let’s make it a bit more fair. Can you think of an alternative that can do HALF as well?

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In the next post, I will discuss the Top 5 qualities that make this property type and it’s growing market a solid investment for a long term real estate investor. So please stay tuned.

If you would like a detailed cashflow analysis of the numbers discussed above, please email me or if you’re reading this from your email just hit reply.

May 22, 2014
The number one rule of investing

As the Sage of Omaha eloquently put it, the number one rule of investing is Don’t Lose Money. At first sight it is a blatantly obvious piece of advice although I suspect most investors don’t realize just how sophisticated it really is.

The Case Study

Allow me to share a hypothetical case study with you. Suppose you invested $100,000 in the S&P 500 on January 1, 2006. For the purposes of this example, there are no management fees or costs. During 2006, this index grew 13.62% so at the end your investment would be worth $113,650. The following year it was up 3.53% so your investment grew to $117,661. So far so good. But as we all know, 2008 was not a very good year. The market dropped 38.49% so now your investment value dropped to $72,385. However, during 2009 the market came back with purpose closing the year with a 23.45% gain and lifting your investment’s value to $89,359. And the rise continued in 2010 when the market was up 12.78% lifting your portfolio to $100,780. During 2011 the S&P 500 was flat so your value was unchanged.

In summary, during a six year spell, your investment had a flat 2011, four positive years with cumulative gains of 53% and one losing year where your investment lost 38%. So we should be up 15% right? Actually we’ve made a life changing $780 over 5 years. That ads up to two lattes a month! That’s before we consider the facts that over the same period, inflation “ate” over 15% of our investment’s purchasing power and stock market investments usually aren’t free of management costs.

The Explanation

How could this be? Because in all kinds of investing every step back is worth about two steps forward. Every loss of capital takes almost twice the gain to get back even. It took until January 2013 for the S&P 500 to get back to the 2007 high again! Six years to get your head back above water with the leaches of inflation at work the whole time.

I told you this was a hypothetical scenario but unfortunately this is the bitter reality that many people face all over this country. It’s how hard working folks come to consider pulling their hard saved money out of their Roth IRA after it sits idle for an entire decade as those same fund managers draw billions in fees.

How real estate investments are different

But wait a second, you might ask – real estate isn’t immune to capital losses. In many parts of the country real estate prices plunged at least as much as the S&P 500 in 2008. But there’s a huge difference between a stock portfolio that relies primarily on value increases (appreciation) and a long term real estate portfolio. Say you invested the same $100,000 in real estate in 2006 and it followed the same path as the stock portfolio. In other words, the value dropped substantially in 2008 then recovered back to the same amount by 2011. If you held on to the property through the whipsaw, your capital would be intact.

But the big difference is that throughout, your portfolio gave you a return of 12%/year independently of the value of the capital. So in this case, a real estate portfolio acted more like a dividend paying stock but with 3-4 times the return. Let’s face it – it’s much easier to ride out a bad market while making 12% a year in the interim. Not to mention that there were fundamentally stable markets all across the country that didn’t experience the value roller-coaster as much (or, at all).

Next

What’s Buffett’s rule number two of investing? Don’t forget rule number one.

Kevin Dooley via Compfight

April 9, 2013
Does your real estate investing strategy offer flexibility?

In my last post, I discussed one of the most important advantages of our Blueprint real estate investing strategy: Built in performance benchmarks. Well, today I want to tell you about another unique advantage that’s just as important. Unlike other strategies that by their very nature are rigid and resistant to change, our Blueprint strategy allows real estate investors the flexibility to make adjustments midstream to account for potential changes in goals, personal finances, portfolio performance and the overall economic environment.

Why does flexibility matter? Well, because real estate investing doesn’t happen in the vacuum assumed by cash flow analyses and multi year projections. The circumstances surrounding the portfolio and the investor herself don’t remain static – they are always changing. And unless your investing plan can change with them, it might be “providing answers to old questions” and leading you down the wrong path.

So let’s take a look at some specific case studies where flexibility in your real estate investing strategy can make the difference.

First, a case where a change in investor goals can require a course correction. Suppose that when you started investing, you were aiming for a second source of income to subsidize your job income or to allow your spouse to stay home with the kids. You thought all you wanted was an extra $35k a year. Until you saw the plan in action and realized its true potential. Until you realized that you don’t really like your job after all and if you could replace that income you’d quit without batting an eye. So now the goal has changed substantially: Now we need $100k a year and we need it in 10 years. This change of pace would throw most other strategies in a tailspin of confusion. With our Blueprint real estate investing strategy, we can figure out how many additional assets you need to acquire and figure out a plan to get you to that income in a decade.

Next, let’s say that Murphy moves into your guest bedroom as you’re executing your capital growth phase. Your company downsizes and you’re unemployed for some time. You were working the plan and making measurable progress – in fact you were aggressively attacking your mortgages at a rate of $2800 per month – when it all came to an abrupt stop. We can press pause on the capital growth phase so you can draw cashflow as income during this period until you steady the ship and find other employment with similar salary. Then resume your flexible Blueprint plan.

Or say that you’ve completed your acquisition phase and are now in the fifth year of the capital growth phase. All your properties are doing great except for one – what once was a good neighborhood has now taken a bad turn and the location no longer meets your high quality standards. It’s even become more difficult to find good tenants and you find yourself tempted to lower your standards to keep vacancy rates low. To be honest, if given the chance for a do-over today, your wouldn’t purchase the property again (litmus test). No problem. Our Blueprint strategy calls for a recurring re-assessment of your holdings every so often to identify situations like this and it offers the flexibility of a course correction. We exit the problematic property and acquire a replacement asset in a location that does meet our high standards. If the market at the time won’t allow for an advantageous exit, we bide our time and wait till the conditions are in our favor.

Further, if you are a regular Investing Architect reader, you know that (with rare exceptions) a well executed Blueprint strategy works best when the properties within your portfolio are recently built (new or less than 6-7 years old). The primary reason for this is that, over time, older assets consume a higher percentage of incoming rent as operating expenses (due to major repairs required) resulting in lower cash flow and return on investment. In addition, you probably also know that the road to retirement can sometimes take 10-15 years. If you purchase a 5 year old home today, it will be 15-20 years old by the time you reach retirement. So how do we reconcile the fact that right around the time you need to draw maximum income is when the property will need capital expenditures? Our Blueprint strategy provides the investor with the flexibility to trade into newer assets. This process of “freshening up” your portfolio can be accomplished by either exiting your current investments and acquiring newer properties or by doing a like kind 1031 exchange to defer taxes. Or depending on asset performance during the holding period, it may make more sense to incur one time capital expenditures and keep holding on to some properties as you trade others. For instance, if you’ve got a great property that’s been well maintained by long term tenants in a location that seems to get better every day, it make make more sense to make the capital expenditures (i.e. change the roof or A/C system) so you can keep holding it hassle free for another decade or two. If instead we’re talking about a property that’s progressively requiring more and more repairs each year, that might not be the best way to go. Again, flexibility rules.

Last, suppose that due to changes in the economic environment, investments that were once not feasible are now attractive. For instance, commercial real estate might offer some opportunities to consolidate your capital base into larger properties with established business tenants at a good capitalization rate. Or changes to income and capital gain tax rates might offer a window to take a gain under more favorable terms. Or a high interest rate environment may offer opportunities in profitable deals where you finance the property for a Buyer and collect note payments at a good rate of return. Regardless of the scenario that life might throw at you, our Blueprint strategy can adapt to it and get you back on track to your ultimate investment goals.

There is no universal strategy that works the same for every investor because every investors’ goals and situations are different. It’s a sure bet that things will change – Change is indeed the only constant. But it pays to have a real estate investing strategy that provides flexibility to allow you to ride out the wrinkles and resume your path to retirement.

February 4, 2013
Getting an early start

Martin came to us referred from a personal friend and previous client of ours in the fall of 2009. He was in his late twenties, had graduated from college with an engineering degree about five years back and started working for a national consulting firm in the East Coast. He was a saver who had heard about the benefits of real estate investing in Texas, had a well defined set of goals, as most engineers do 🙂 but was looking for a pathway to achieve them. What follows is a case study of the Blueprint investing strategy I crafted for him, the execution of that strategy and most importantly the results it produced. If you identify some of yourself in these lines, it is my hope that this story can shed some light into what’s possible with a well structured, long term investment strategy and flawless execution.

Recalibrating his aim

On our first phone call, all he could talk about was cash flow. “I want to buy four investment homes in the next two years, rent them out for positive cash flow. I want to build enough cash flow, so I can do whatever I want and live off the cash flow”. You get the gist. So, we had to have a come-to-Jesus meeting. We started focusing on the “Why and When” rather than the “How”. It was immediately evident that Martin wanted to put together a solid portfolio of real estate investments that would produce enough cash flow at some point in the future to make him financially free. Just like it became painfully obvious that he didn’t need the positive cash flow right now to subsidize his income or pay his bills. He was right to want cash flow. It was the timing that was misconstrued.

The Eureka! moment came when I proceeded to explain what his beloved cash flow truly was: the return on capital. For instance, if you have $100K in available capital (a.k.a cash) and you invest it in a real estate portfolio that has a return on investment of 15%, your cash flow will be $15,000/year. While it does give you the ability to thump your chest that you’re out earning your friends’ 401Ks and CDs, $15K isn’t exactly financial freedom. So how do we achieve retirement or financial independence through real estate investing? We have to grow the capital first, to increase the amount of cashflow we draw on it later. If we managed to grow our capital from $100K to $400K, that same portfolio would return $60K/year. Sounds like we’re getting closer, doesn’t it?

Laying out the Blueprint

How do you grow your investing capital from $100K to $400k in 10 years? You execute the Blueprint. Over the next 24 months, Martin was to acquire four investment properties strategically located in specific areas with excellent schools, location and access to attract a good tenants. Two of the properties closed in 2010, the other two in the first quarter of this year. They were all leased out within four weeks of being placed on the market. Average price of the properties was $100K. Below is the actual breakdown on one of the properties:

Looks pretty good, doesn’t it? Funny thing is, the true magic lies into what comes next. If you put together a portfolio of four properties that have more or less the same numbers as the above breakdown, you have created $1600/mo in positive cash flow. Since our goal is to grow the capital now so we can draw a greater return (cash flow) on it later, we will put the current positive cash flow stream to work. The goal is to accelerate the payoff of the debt on the portfolio by executing a laser focused domino strategy. That is, we apply the positive cash flow as additional principal payment to pay off the mortgages on the properties one at a time. To use the example above, an $82K mortgage would be paid off in 44 months (little over 3.5 years) if we paid an additional $1600/mo toward the principal. This is when the dominoes start falling even faster. Now that the mortgage is paid off on that property, your available cashflow to “attack” the second property increases to $2,038/mo. At that rate of principal payments, the second property is completely paid off in 35 months. And so forth.

When Martin is done executing this Blueprint, his entire portfolio is projected to be debt free in 11.2 years. If we don’t account for any property appreciation, his real estate investment portfolio would be worth 4 times what he started with at a cool $400k+. If rents don’t increase one penny in 11 years (highly unlikely), Martin would collect over $40K in annual cash flow. All of that before his 40th birthday.

Are you ready to get an early start on your real estate investing? Let’s talk. Call me at 713.922.2702

Photo Credit: RonanCantwell

September 14, 2011