Strategy

Forget the Nest Egg Approach: How to create retirement income, grow your net worth and leave a legacy

September 6, 2016 By Erion Shehaj Leave a Comment

Take a good hard look at the Net Worth Timeline Comparison graph below:

It’s a colorful, damning indictment of the Nest Egg approach to retirement that an overwhelming majority of investors in the developed world follow.

Let me set the scene for you so the meaning of the graph can come into better focus: A very disciplined high net worth individual (over $1MM) with a six figure job income maxes out contributions to tax advantaged retirement accounts (401k) and college savings accounts. Her family lives well below their means so even after those contributions there is surplus income that is invested regularly in a taxable stock/mutual fund account (dollar cost averaging).

The return assumptions are the same shade of conservative we use on real estate investment projections. We are assuming that all accounts will average a 6% linear return annually and that stock markets don’t shed 40-50% of their value every 8-10 years. In addition, we’re also assuming that the surplus is invested without fail (continued discipline) in brokerage accounts. Finally, on the real estate side, we assume that property values track inflation (3% per year) and base income and expense projections on actual figures.

The first graph at the top illustrates the investor’s net worth projection should she follow the current investing path (securities) projected out over the next 50 or so years.

The second graph at the bottom illustrates the investor’s net worth projection if she followed our Blueprint strategy. Under the Blueprint strategy, she would utilize current investable capital plus a portion of the income surplus (60%) over the years to acquire and pay off quality income-producing real estate assets. That leaves the remainder of the surplus to fund major purchases, travel etc. As she executes on her real estate investments she would continue to max out tax-advantaged accounts and invest those funds in securities for an all-of-the-above approach to investing.

Two critical junctures

Let’s take a look at two points in time – The first is the projected retirement date in 2033 (at the age of 55). On that date, the projected net worth under the Blueprint Plan is $1MM (22%) higher than under the current path ($6.2MM vs $5.1MM). But that’s where these paths only begin to go in two opposite directions.

During the retirement years until the end of the plan (life expectancy 90), under the current path the investor’s net worth drops by 60% (to $2MM) while on the Blueprint Plan the investor’s net worth increases by 70% (to $10.6MM).

What happened here? Why such vast difference in the two approaches in the years following retirement? The answer: The differences originate in the structure and basic concept of the two strategies.

The Nest Egg Approach

By definition, the Nest Egg approach retirement investing has two phases: Asset Accumulation and Asset Distribution. In other words, during your productive years you are to set aside and invest a portion of your disposable income so you can accumulate assets. Then following retirement, you will distribute (read: plunder) a sizable portion of those assets to fund your income needs during retirement. In fact, on tax advantaged accounts such distributions are mandatory.

Therefore it should come as no surprise that the investor’s net worth dropped by 60% during retirement years. That was the plan all along!

Now – you might ask – what’s wrong with a plan where you save for retirement, arrive there with $5MM in net worth and leave $2MM to your heirs when you are gone? It’s not that it’s wrong – it’s just that you could do so much better!

If the legacy you leave behind for your loved ones is important to you, why not explore a different path that leads to better income at retirement while allowing your net worth to rise instead of plummet?

The Blueprint Approach

The approach I’m suggesting is fundamentally different. I don’t believe that the optimal path to retirement is to accumulate assets so then you could live off of them in retirement. Instead, I would advise you to accumulate cash flowing real estate assets and pay them off over time so the income they create takes care of your retirement lifestyle while the principal (net worth) is untouched and rising. Live off the yield and don’t cannibalize the principal.

The results speak for themselves. If by using the same resources (capital, income, time) you can end up with a net worth that’s 20% higher at retirement and 5x higher at the end of your plan, why wouldn’t you?

How to compound real estate investing results with a little extra effort

September 23, 2015 By Erion Shehaj Leave a Comment

If I could show you a way to compound your real estate investing results by investing a little extra effort over time, would you be interested? I know it sounds too good to be true but lend me your mind for a short while and I’ll explain exactly what I mean.

For the past couple of weeks I have been reading Darren Hardy’s fantastic book “The Compound Effect”. Darren is a protege of the late Jim Rohn whose teachings have had a great influence on me. (I like to think of Jim as a great mentor I never got to meet). In the last chapter of the book called Acceleration, the author talks about a simple but powerful concept that I find fascinating:

Real growth and acceleration in results happens when you apply a little extra effort after you have done the best you can do.

Let that sink in for a minute and reflect on it – It’s true and relevant in all areas of life. But it’s especially powerful in long term real estate investing. Let us consider a couple of common scenarios where a little extra effort can compound your results.

Saving a little extra

Imagine you are Jackie – through hard work and determination you have managed to climb the career ladder and now you earn a great salary. You could switch cars every other year or spend it all on the latest tech toys. But you don’t. Instead you’ve chosen a path of living below your means and are able to save $3,000 per month after all expenses. With that savings capacity, you will be able to save just over 100k in three years and would acquire 3 investment properties in that time frame for an total portfolio value of $510,000. After applying our Blueprint, in 15 years time after your acquisitions you would have a paid off portfolio worth approximately $800,000 producing $40,000 a year in pre-tax income. Not too shabby.

But now let’s look at the effect of doing a little extra. Suppose you manage to save just an additional 10% on a monthly basis. Cut out Starbucks, eat out one less time per week, what have you. Over 10 years you will manage to accumulate $35,000 to make a fourth purchase increasing the portfolio value to $680,000. It might take you a couple of extra years to pay off this last asset but at that time you will own a free and clear portfolio worth just over $1M producing 52,000 a year in pre-tax income.

Therefore, saving an extra 10% on a monthly basis increased the value of your portfolio and your income by 28% and 30% respectively!

Investing a little extra

Now suppose you’re John – you’ve just completed the acquisition phase of your Blueprint strategy. Five properties, $170k a piece cash flowing $3,000 per year (to keep illustration simple). In keeping with the plan you apply the positive cashflow from all assets to one mortgage at a time and you pay them all off in 17 years. Excellent outcome by any standard.

But now imagine that you decide to invest a little extra to make everything go faster. Like Jackie above, you cut out some non-necessities and manage to scrape together $250 per month that you apply to the mortgages on top of the positive cashflow. Because of that little extra investment of $250 per month, your properties are now paid off in 13 years. That’s 4 years earlier!

What could you do in 4 years if your portfolio allowed you the financial independence to do whatever you wanted?

I guess there are two greater lessons in all of this: 1) There’s incredible power in doing a little extra after you’ve done “your best” and 2) The future cost of today’s little expenditures is incredibly high so act accordingly.

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Last week I didn’t publish an article because I visited the Dallas Fort Worth area to explore market conditions, investment opportunities and the possibility of expanding into that market. Thanks also to the invaluable assistance of some long term Investing Architect readers it was a very productive trip and I can’t wait to share my findings with you in next weeks article.

The fascinating paradox with long-term real estate investors

August 19, 2015 By Erion Shehaj 2 Comments

There is this fascinating paradox I encounter regularly in our real estate practice. The overwhelming majority of real estate investors I have the privilege to help, fall on the conservative end of the investing spectrum. They are driven by unbiased logic, need empirical evidence and have a long term focus. If you haven’t left this site yet after reading an article or two, you can probably relate.

But with all that focus on logic, numbers and the “long game” they still succumb to doubts that run counter to all those things. See, we like to think of ourselves as rational beings driven by unbiased logic but the truth is we are hard-wired to respond to certain impulses and fears.

Let’s look at two related misgivings I hear frequently from our clients:

1. “I wish I had met you in … (2008, 2010, 2012 – you name it) so property prices would have been more favorable.”

2. “Shouldn’t I wait to acquire investment properties since we’re in a Seller’s market and prices are high?”

These statements indicate valid concerns but they’re paradoxical in that they run counter to the very core of the conservative long term investor.

Silly Rabbit … Market Timing is for traders

Real estate prices in most markets (Texas included) were substantially lower in 2008-2013 than they are now. Furthermore, most investors that purchased during that time were able to lock in quite a bit of equity and very favorable price/rent ratios. That’s especially true if you consider the increase in rents during the same amount of time. Those are facts that no one can dispute. But our investor clients forget a couple of critical issues when they express the wish to have invested earlier.

First, investing in 2008-2013 seems like a given now that we know “how the movie turned out”. However, at the time, it didn’t seem as such a no-brainer to most investors. I know because I was on the phone with them trying to get them to see it. When the whole nation was curled up in a fetal position waiting for financial Armageddon, it was hard to think about investing for even the most visionary of investors. When you drove into a neighborhood and saw 15-20 foreclosure signs back to back on the same street, it was hard to imagine the time when they would be worth so much more.

But most importantly, that wish disregards a critical truth: The long term investor is fundamentally not an opportunist.

A long-term investor invests to achieve financial independence regardless of the market he’s dealt. That doesn’t mean that a long-term investor cannot or should not take advantage of an especially advantageous real estate market. They absolutely should. However, they should NOT invest only when there’s “blood on the streets” and “going out of business” banners are aplenty. So ask yourself this essential question: Are you a long-term investor or an opportunist and then act accordingly.

Seller markets come with the territory

The average Blueprint plan we devise for our clients entails an investment timeframe of 7-20 years (depending on the resources and goals). Take any 7-20 year period and look at the market conditions over time. It’s not only highly likely that market conditions will change over time – it’s to be expected! As a matter of fact, a scenario in which market conditions remain the same over a decade is almost implausible.

But there’s another fear at work here – no one wants to be the sucker that invests at the top of the market only to ride it downward. That’s understandable. But did you know that the Houston area has been in a “Seller’s market” since the Spring of 2012? What if the investors that purchased properties during that time had succumbed to the same fear and waited for a price drop? They would find themselves wishing they had invested in 2013 when prices were lower. Sometime in the future, investors will speak of 2015 as the ideal time to have purchased because conditions may be less favorable then (read: interest rate hikes).

As long as property valuations are supported by economic fundamentals and we are not in a real estate bubble, the long-term real estate investor keeps her focus on the main goal (financial independence) and executes her Blueprint plan regardless of the market. Sometimes the market is extra favorable, other times it is not. Over the long term, the market will do what the market will do and our goals are still there for us to accomplish. So accomplish them we will.

How to increase velocity of money to turbocharge your investment returns

September 18, 2014 By Erion Shehaj Leave a Comment

Fact: Every investor I’ve had the privilege to help has worked extremely hard to earn and save the capital required to make long term real estate investments. So it’s no wonder that as an investor you want to put in practice strategies that maximize your return on that capital. But I have a slightly different take on this matter. Because I’ve seen first hand how hard many of you work to create that capital, we have a duty to make that capital work as hard as possible to help achieve your financial goals.

So in that vein, today I want to introduce the concept of velocity of money and show you a strategy to increase the velocity of money your real estate investments produce and turbocharge your returns in the process. First of all, the concept of velocity of money can mean very different things depending on the context (i.e macro economic or field specific). For the purposes of this article we are looking at velocity of money strictly as it applies to long term real estate investments.

In simple terms, consider the following analogy to illustrate velocity of money at work. Imagine that an investment property is an actual vehicle and the initial capital to acquire that property is the fuel for that vehicle. When you put your capital to work in a long term investment property, it produces positive cashflow that represents a return on that capital. In our illustration, when you put “fuel” in your “vehicle” and engage the first gear, it will reach a certain speed or velocity. But now that you receive the return on your initial investment you come to an important fork in the road. You could spend the positive cashflow on regular expenses or leisure (as it’s your right) or you could put the cashflow back to work to earn even more. In our analogy, this would be the equivalent of “staying on first” or engaging the second gear and making the vehicle go even faster. That’s velocity of money in a nutshell: When you re-invest the earnings of your capital to earn even more, the overall return on your original capital increases significantly. Compound interest – a much more familiar concept – is essentially velocity of money at work.

Two strategies to increase velocity of money

In long term real estate investing there are two principal methods to turbocharge investment returns by increasing the velocity of money.

The first method involves using the positive cashflow produced from your initial capital to pay off existing debt. In this scenario, the added return on your positive cashflow is the interest cost saved by paying down the principal on the mortgage. Let’s take a look at a concrete example.

Suppose you acquire an investment property for $160,000 with a down payment of $32,000 (20%) and closing costs of $3,000 for a total initial investment of $35,000. For the remaining balance you take a 30 year fixed rate mortgage at 4.75%. At the end of the year, the property produces $4,500 in positive cashflow after all expenses and mortgage payments, which represents a 12.9% cash on cash return. If you take the positive cashflow and re-employ it to accelerate the payoff on the mortgage on your investment property, that results in interest cost savings of $214 per year bringing your total return on your initial $35,000 to $4,714 which represents a 13.5% cash on cash return.

The above example is the reason why I burst out laughing when critics of the Domino strategy brand it as “paying off low interest debt with high return dollars”. You see, when you accelerate the payoff on debt, you’re not substituting high return dollars for paid off low interest debt. You are increasing the return of those high return dollars even further instead of stashing them away in a bank account paying 0.00017% interest or worse, spending it.

The second method to increase the velocity of money in your real estate investments is to recycle the positive cashflow produced by your properties into acquisition capital (down payment) for additional properties to acquire according to your Blueprint.

Let’s resume the example where we left off. Suppose that a year after you acquired the first investment property above, you want to acquire another, identical property that requires $35,000 in initial capital. But this time, instead of coming up with the entire amount from your savings, you use the $4500 in positive cashflow from your first acquisition and make up the difference from your savings. In this scenario, the $4,500 cashflow that produced a 12.9% return on your original $35,000 capital is earning 12.9% when invested in the second property. That’s another $581 return on the original capital which increases the cash on cash return to 14.5%.

Here’s the real kicker: So far, we’ve spoken only about increasing cash on cash returns. What happens when the property increases in value and you are leveraging your positive cashflow further to earn additional double digit returns? Don’t answer that.

Which method should you choose?

By now you must be thinking to yourself: Recycling cashflow into acquisition capital seems to be the no-brainer method of choice among the two. But there’s one crucial ingredient missing in that “stew” of thought: Risk. I know it’s not as much fun to discuss risk as it is returns. But this pesky socialite attends every party real estate investments attend. So we must account for risk at the outset or pay for it from our checkbook. The first method of increasing returns by paying off debt seems understated in its added return but what it does offer in addition is risk reduction. Everytime you get a step closer to a paid off investment property, you are shaving off a chunk of risk from your porfolio. That’s why the increase in returns is smaller. When you recycle the cashflow into acquisition capital, it will earn a higher added return but it involves the acquisition of another asset. In addition to the return it produces, it increases risk as well.

So what should you do – which method should you pick? As with all good questions, the answer is “it depends”.

One factor to determine which method is the best for you is whether or not the investor has the savings capacity from her income to save all the capital required to make all the acquisitions per her Blueprint. If the answer is yes, then the investor is better off working both sides in parallel. In other words, she can use the cashflow to accelerate the payoff on her debt and use her savings capacity to complete her acquisitions. If the answer is no, then you’d be better off putting aside debt acceleration for a short while and employ all cashflow and savings to complete your acquisitions – then resume the Domino strategy once your portfolio is complete.

But – you might say – that may seem counterintuitive. Even if you have the money to complete acquisitions from your savings, why wouldn’t you use the cashflow since that yields the highest added return? The reason is simple: Our ultimate goal as long term real estate investors, isn’t to get the highest return on investment but rather to reach our income stream goal through a paid off real estate portfolio within the allotted investment timeframe.

Therefore, the true question isn’t whether you pay off debt to increase velocity of money but rather when to pay off debt. Depending on your level of risk aversion, available time to reach your goals and your overall preference you may decide to start the debt payoff right away or once your acquisitions are complete. But start it you must if you are to achieve the level of income you seek at retirement.

In conclusion, your money has to work at the very least as hard as you do and ideally multiple times harder. The way to achieve the highest possible return from your investment capital without adding reckless levels of risk is to increase the velocity of money by re-employing positive cashflow to earn at its maximum potential.

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For more on velocity of money and how to think and invest like a banker, I strongly recommend the book “The Bankers Code” by George Antone. It was recommended to me by a good friend and it’s a very powerful book.

Branching out to solve the Biggest Challenge: Small multifamily properties

May 16, 2014 By Erion Shehaj 2 Comments Tags: small multifamily, texas duplexes

In an article I wrote at the beginning of the year, I summarized the biggest challenge of 2014 for long term real estate investors in a single word: Supply. Now that the second quarter of the year is almost coming to a close, that prediction has become reality. And as we go into the summer months, supply historically shrinks even further as demand rises. In the meantime, your financial goals are still there, calling for acquisitions to be made to build income streams that lead to financial freedom. On one side of the coin, you don’t want to acquire assets that don’t make sense from an investment standpoint simply for the sake of acquiring them. But on the other, you don’t have the luxury of simply taking a year or two off in an environment where prices and (eventually) interest rates are expected to rise further. So how should you navigate under these circumstances?

Market “gravity”

In life and investing alike, there are issues that are rightfully up for debate and then there’s “gravity” – a law that applies equally across the board regardless of our beliefs about it. In long term real estate investing, a gravity-type law says that you take what the market gives you and build your strategy around it. Many a fortune have been squandered by investors on a mission to disprove that simple law. While in midair, many such investors actually think they have outsmarted the law – on the way to the eventual pavement.

However, one major distinction is that, unlike physics gravity, which is constant and applies to all equally, the real estate investing market is an ever changing landscape. Today’s market “gives” investors a much different set of circumstances than say it’s 2008 counterpart. So while the law always applies, there’s a variable dimension to it and you must be able to adapt your investing strategies to reach your goals. That’s not to say that you switch strategies as the wind blows – the principles must remain the same. But you shift your investing approach while abiding by those principles.

Principles to assets

Investing principles come first and assets follow. I know it sounds like a Captain Obvious proclamation but you would be surprised to know that the majority of long term investors get that important order completely backwards. Without first devising an overarching strategy and distilling from it investing principles to live by, they make an arbitrary decision on the type of real estate assets they will pursue. They buy “cheap single families and rent them out” or “small apartment complexes at $X per door” or “small condos with a max price of $X”. And all the while there’s no rhyme or reason to it. And most crucially, there’s zero consideration of the fact that the market “gravity” may have changed the landscape to extinguish the opportunities in the asset type they’ve arbitrarily chosen.

The alternative approach: Start with the end in mind (goals), devise a plan to achieve them (Blueprint), come up with clear criteria the asset must fulfill (principles) then look at the market and the asset types it offers that are the best suited vehicles to get you across that finish line.

Asset principles of the Blueprint Strategy

Our Blueprint strategy’s approach to determine investing principles for the type of asset to acquire is very simple. Our investors reach their goals when they own the right size portfolio of real estate leased to great tenants. Great tenants lead to low vacancies, low turnover and profit maximization. In our experience, great tenants look for properties located in good school districts in great, safe neighborhoods with easy access to employment centers through highways and great amenities and low hassle. Constant repairs in a property represent a great hassle to a great tenant (and the corresponding investor which has to foot the bill to boot) and they’re a direct result of the age of the property. It’s better to purchase an older property in a great location than a new one in a bad location but it’s so much better to purchase a newer property in a great location. Real estate investors should be concerned with two types of returns: returns on investment and returns of investment. The way to protect your invested capital and make it grow through appreciation over time is to purchase a property that can be sold for top dollar should the investor decide to exit. No one pays top dollar for average, run of the mill properties so investors should be looking for a property that will have appeal to the eventual buyer to whom they will sell the property eventually. And last but not least, the property has to have a good price to rent ratio as to provide an adequate return on investment.

So, to sum up, long term investors following the Blueprint strategy look for newer, quality properties in top locations with good price/rent ratios to provide an adequate return on investment.

Asset types

Notice how in the above summary, there’s no mention of specific property types. No “single family homes”, “small multi-family”, “condos” etc. That’s an omission of crucial significance because different markets “give” investors different asset types that can accomplish the goal. For example, in North Carolina, new (or new-ish) attached townhomes offer everything the asset principles above call for at a more favorable price/rent ratio than single families. In Texas, single families substantially outperform townhomes. In some cities, there are newer small multi-family opportunities in great locations while in Houston they’re virtually non-existent – they’re either older properties in good locations or newer ones in bad locations.

That’s the reason most of my case study articles that discuss investing in the Houston market involve single family homes. It is not because, that’s the type of asset we favor but because in this particular market, that’s the best asset type the market gives us to help investors accomplish their goals.

Solving the Biggest Challenge

Let’s come full circle to the initial premise of the article: Rising prices and increased competition for single family homes in the Houston market have reduced the supply of opportunities for long term investors. But if your Blueprint still calls for further acquisitions in a climate of reduced options, what are we to do? We need to look for additional options elsewhere – in markets that have most of the same strengths that perhaps “give” investors access to property types that just aren’t available here at this moment. That’s what we’ve been diligently working on since the second half of last year and I’m excited to say that what we’ve found abides by the asset principles above and gives us some additional benefits to boot.

I plan to present a specific case study with hard numbers in a subsequent article but I’d like to end today’s post with a summary of strengths that this new opportunity offers:

New construction, luxury small multi-family (duplexes) zoned to great schools
A growing Texas market with a population growth rate 9 times the national average
Quality property management company in place providing a true turnkey investment
Maximization of asset value per conventional loan
Low property taxes, hazard insurance, HOA dues
Attractive price/rent ratio and low days on market/vacancy rate
Luxury low maintenance finishes (brick exterior, granite counters, 11-12ft ceilings, oil rubbed bronze fixtures, no carpet anywhere)
Builder warranties (1 year wall to wall, 2 year HVAC/electrical/plumbing, 10 year structural)

Next time, I will present the hard numbers and show you how you can weave these small multi-family properties in your Blueprint strategy and utilize some of the strengths above to propel you towards your goals. Until then, take good care of yourselves for me.

To Domino or Not to Domino? That is the question

March 24, 2014 By Erion Shehaj 2 Comments

A very interesting debate has sprung up in a BiggerPockets Forum about my article on how to build a six figure income using real estate investing. In that discussion, the participants make different pro and con arguments over the use of the Domino Method to accelerate the payoff of debt in your portfolio. I think it would be beneficial for our readers here as well as the participants of that discussion if I addressed each argument in greater detail.

Not sure if I like this method… takes 149 months over 12 years to start seeing your income. If you’re looking for a retirement plan, well that’s a different story.

When we first sit down with an investor to discuss what strategy they should pursue, I first ask you about your investment goals. Inevitably, you tell me that you’re looking to build an income stream or create positive cashflow . Then comes the crucial timing question: When do you need this income/cashflow? If you are looking for income now, I’ll be the first to say that the Domino Method won’t do much for you. The strategies and methods I write about are suited for long term investors that are looking to build large income streams in the future (read: retirement) and in so doing are willing to give up small income streams in the present. If you are looking for income now and don’t have a scary amount of capital at your disposal to start, I would argue that real estate as an asset class is not a good vehicle to accomplish that goal. To create current income, you would do much better if you deployed limited capital into starting and operating a business.

Now, I’d like to address the point that this simply takes too long. I come into contact with plenty of people that have been investing for 12 years or longer without a particular plan. Just buying a property here and another one there as the opportunities came around. I’m yet to meet someone in that group whose performance during the last 12 odd years can even come close to the results they would get if they applied our Blueprint strategy over the next 12. The fact of the matter is time will pass for us all one way or another. But what we can control is how we spend that time and the results we reap are dependent on the soundness of our plan.

I don’t think that 100k (six figure income created by strategy) is net. The true net of that is probably more like 50k after vacancy, repairs, taxes and insurance.

The cashflow figures we are using to pay off the mortgages as well as the cashflow figures used to calculate the income at retirement are net of all operating costs (property taxes, insurance, homeowners association dues, maintenance and repairs), vacancy provisions and leasing fees but before taxes. The reason why I used before tax figures (especially in the case of income at retirement) is because the tax rate, tax deductions, tax shelter can vary wildly from investor to investor. Since we’re trying to present a case study that applies to the majority of investors, I thought that was the most prudent course.

Many investors have little capital to start. So they are looking for maximum yield and forced appreciation. Their jobs in many cases do not allow for much savings. Example if you make 75k a year a lot of that is used for living expenses. Even if you save 1,000 a month that is 12,000 in a year.

So it takes much longer to get going this way with slow build up.

This versus someone who has a business they own or a job with very high income can regenerate capital much faster to take advantage of market cycles where someone with limited capital might buy one property and be tapped out for awhile.

I would like to offer a different perspective this issue. I would agree that many people have little capital to start and struggle to accumulate large amounts of capital because their incomes won’t allow for such accumulation. But I think that by definition if you are going to be an investor you have to have capital to invest. That may sound a bit harsh but it’s a concept that’s well founded and proven. I believe that the sacrifices you make in saving that initial seed money (and it is very hard in the beginning, especially if the income isn’t very high) “temper” you and make you a stronger investor. On the opposite side of that spectrum, you have people that try to create their capital through inherently risky strategies (read: flipping through hard money loans) and unfortunately, the wide majority of them don’t make it. Yes, it’s going to be a slow grind saving the money for that first property. It will be easier to save it for the second. And easier still for the third. But you don’t let that difficulty keep you from getting started or even worse, going in a much riskier path of least resistance.

I’m not a big fan of the article for a few reasons. The first being that you need ~$180K in cash to be able to pull this off. He’s suggesting buying 9 ~100K properties which will require 20% down each.

He’s then suggesting taking 0 cashflow on that for 12+ years. Over that time, you’ll be paying taxes on ~$40K of income that goes directly to the bank to pay down your debt while only capturing about 30-35K of depreciation.

If you’ve got $180K laying around there are surely worse ways to put it to work…but this definitely isn’t the best way

As I mentioned above, if you want to do it right, you will need capital. I make no apologies for that. But sometimes a sense of chronology can get lost in a simplified, linear case study. For instance, in reading the strategy, you’d get the impression that you would need to have the money in the bank this very moment. In reality, most investors I work with build up to that level of acquisition. They acquire 2-3 properties per year and recycle the positive cashflow from properties they own in addition to savings from job income to create the capital for the next 2-3 acquisitions.

The next point made is that the Domino strategy I suggested asks you to forego the cashflow for 12 years, pay taxes on the interim income to pay down debt since depreciation doesn’t cover all the income. All these points are correct, but I’m not sure they make much of a case against the strategy. First of all, when you invest your capital in a property to create a present stream of positive cashflow, you’ve made your money make some money. When you invest the “dividends” to grow your capital base, you’re essentially applying compound interest principles. If you spend the “dividends” in the present, you miss out on the magic they can do over time. So, if you don’t need the income from your properties to subsidize any other income you may have, but you opt to spend the cashflow created by your properties, you are essentially killing the goose that lays the golden eggs. You don’t play by the bank rules when you aggressively pay off your debt. You play by their rules when you pay off your properties in the schedule your bank set in the first place. Do you think they set a 30 year payoff schedule because it was in your interest or theirs?

Finally, I would be happy to listen to any alternatives to invest $180k in capital and most importantly to compare results.

paying down and not using interest for your tax deductions is dumb in my opinion. But many people on here would disagree. So u own a fully paid off pile of bricks in a shape of a house… what’s so great about it? If u want to take money out.. u have to pay 4k to refi. Just dumb

Ah yes! Let’s spend a dollar to get back thirty cents. This deduction argument is so weak and without merit when used paying off your own home but it really reaches silly levels when we’re talking about investment properties. When you own a leveraged investment property, the interest you pay on the mortgage is deducted against your gross income to calculate your taxable income. But the reason it’s deducted is because you spent it and didn’t receive it as cashflow. When a property is paid off, you don’t have the deduction of mortgage interest from your income but you don’t have the expense either.

If you own “a paid off pile of bricks in the shape of a house” you own an income producing asset that in alliance with other income producing assets can set you financially free. That’s what’s so great about it!

LOL, this “system” was bounced around in the 80s!

In financing this is a distribution of debt reduction and use of funds issue.

You’re paying off debt with expensive current dollars while reducing the after tax interest expense of cheaper money. In other words your real economic cost is greater with accelerating the payoff. The benefit is receiving future dollars with less value due to inflation. Keep in mind that raising rents does not effect the funds necessary to retire debt, increased rents are above amounts for debt service.

No one mentioned buying 9 properties with 25% down buys 2 properties free an clear and a third with 25% down. Property 1 could buy property 4 and property 2 can payoff property 3 or buy property 5. I’d say this could be quicker to the same end off hand.

In some cases this does have benefits depending on your age and retirement goals, wiping out any debt. Suffer now and enjoy later. 🙂

Actually this system has been around ever since mortgages and debt first appeared. The cashflow dollars you use to pay off the debt on your investment portfolio are (by and large) tax sheltered due to depreciation so I’m not sure how they’re “expensive dollars”. Again, you get to deduct the interest expense from your rental income because you’ve given those interest dollars to the bank. Interest expense is not some “paper expense” along the lines of depreciation expense. Yes, you will pay more taxes on positive cashflow from free and clear real estate but that’s because you’re receiving more cashflow than you would if the property was still leveraged. No matter how you split it, saving the expense is always better than deducting the expense for tax purposes. The future dollars you receive are subject to inflation (like everything else) but real estate is an asset class that is inflation resistant. The reason is that inflation makes 100k/year 10 years from now have less purchasing power than 100k/year today but it also raises property values and property rents. Generally speaking, you can’t built the same property 10 years from now for the same cost you can today because all the components that make up a property (bricks, roof materials, concrete etc) are subject to inflation as well. In the illustration of the Domino strategy, I eliminate value appreciation completely to keep numbers conservative and keep things simple. But if we were to account for likely appreciation, the discussion is over.

If you have $180k in capital and the properties we’re using for the sake of the discussion are $140k each, you could buy one property free and clear and have enough capital to purchase another with 20% down. The combined income of these two properties would be about 16,500 a year. Which means, you would need to wait 2.5-3 years till you could purchase the third. So, taking that alternative route would take you much longer than 12 years to just accumulate 9 properties – forget about having them all paid off in 12 years!

I’d like to end my take on the merits of the Domino strategy with this point: The factor that’s almost always missing from the arguments against this method is risk. I’ve said it before and I’ll say it again: Risk and return are best friends – they go everywhere together. A portfolio with 25 leveraged properties is inherently and substantially riskier that one with 9 paid off properties. So when discussing best use of funds and opportunity costs, it’s fine to consider the return but disregard its best friend at your peril.