We are living through boom times in our local real estate market. Houses are selling quickly, at the equivalent of 50-100x annual rent.
Everything, other than debt pricing, looks expensive to me. So… I’m looking to move, borrow and increase the assets in my portfolio that generate cash flow.
A simple way to view this… (a) split the equity in your existing house in two parts; (b) borrow 30-year fixed and buy a new place with one part of the equity; and (c) place the other part into a rental property.
The explanation follows, with a 25-year overview at the end.
In 2010, I purchased two rental properties as a hedge. Specifically, I wanted to hedge against the risk of my family being priced out of our home market. I thought I was protecting my kids. Turns out I was protecting myself.
The idea was to get paid (via rental income) to hold: 3 units, 10 bedrooms and 20,000 sf of Boulder land. The locations were excellent, the properties dated.
The 2010 purchases worked out well, not just because they performed. The purchases put significant cash pressure on me. The pressure improved my spending choices and motivated me to sort a business which was hemorrhaging cash. In a sense, having tight cash was a form of forced savings.
In 2013, we downsized, borrowed and moved across town. By staying in the same type of neighborhood, and borrowing modestly, our equity appreciation in the smaller house ended up the same as what we would have earned in the larger, unleveraged house.
My ego likes headline numbers and struggles to accept this reality. Something about real estate => the gross, headline numbers are more emotionally salient than the net cash flow reality.
Once again, I’d like to free up time, and reduce admin, by moving. The price I’m going to pay is time/hassle from the move, bringing some deferred taxes forward and agent’s fees.
With the run up in asset values (2015-2021), my family has a much larger allocation to “dead assets.” Dead assets are assets that cost money to hold => for many readers, this is the house they live in. Given recent capital appreciation, the cash cost to hold has been ignored by many.
Downsizing, and locking in 30-year fixed debt for a portion of the new purchase, enables me to keep the amount of “dead assets” modest within the family portfolio.
My ego is tempted to size up, and add a ski place. The better financial move is to improve the quality of our rental portfolio, while reducing my housework and driving.
30-year fixed debt on the family home is one of the best deals going. Given the borrower’s option to repay, it’s a one-way option that could be worth big $$$ in the future.
A word to the leveraged.
Now, like 2005-2007, is a great time to be heavily indebted. You will take comfort in your ability to unwind any financial difficulties.
You are correct.
However, if you truly “need” to unwind financial positions then we are likely in a market like 2009, unpleasant.
So be cautious with opting-in to risks that don’t add to your long-term strategy. Most particularly, any arrangement where an outside party has the power to force a sale. While I am seeking to borrow, total debt will remain modest relative to assets and cash flow.
Breaking it down, building wealth across decades.
- Resist the urge to up-size your life, particularly by adding negative yielding assets.
- Rather, seek to build up 2-4 rental units. Pay attention to location, lot size and bedrooms.
- Unless you want to get into the hotel management business, rent unfurnished to long term tenants. Inverting I have learned… furnished, short-term rentals bleed expenses, emotion and time.
- For your long-term rentals, use a local property manager – their cost as a %age of capital value will be tiny compared to the value they add, and the hassle you avoid. This frees time to make money in a field where you have an edge => whatever you were doing when you built up the $$$ to purchase rental properties. Side Note on taxes: tax bill as a %age of net assets is a number you should track.
- Use your personal home for shelter, as an entry in the best public schools in your state, as a cheap source of fixed rate debt and a tax-favored investment. If this asset appreciates to the point where you have “too much” invested in non-yielding real estate then downsize, get a new mortgage and repeat the cycle.
- Aside from the roof and HVAC… spend no material capital on any of your properties. Instead, spend time with the people you love (and buy more assets that generate cash flow).
If you start the above when you get married then you’ll have 1-3 moves by the time you are empty nesters. At that point, you’ll have built yourself an inflation-proof, tax-effective retirement annuity. You can constrain your spending and pass it to your grown kids OR run down the assets as you see fit.
That’s the financial overlay. You also have the ability to use trust structures within this strategy. I’ll get to those in a future post. Put simply, when I say “you” it’s possible to put a trust in “your” place. That can protect your assets from the unexpected which, over a 25 year time horizon, is nearly certain to happen.
Ideally, you graduated debt-free from college and made a habit of maximizing your retirement contributions in the first 10 years of your career. Don’t be in a rush to get into real estate, I’d been working/saving for a decade before I had the capital, and geographic stability, for a purchase to make sense. While a favorite form of security for lenders, real estate is chunky, a pain to manage and expensive to sell.
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