Here’re Dave’s questions, verbatim, with text before and after, edited out. You can still see his comment in its entirety by going to the link above.

Let’s assume one buys a $250,000 home in Austin. He puts down 20% and gets a 30 year loan at 4.62% for $200,000. He rents it out for $1375/month. He has plenty of cash stored away in case of an emergecny. Here is how my numbers would look:

mortgage=$1,025/month
insurance=$45/month
taxes=$100/month
maintenance=$100/month
property manager=$108/month (8% of 1 month’s rent)

TOTAL=$1378

Basically, it would be a breakeven. So, what you are really saying is that it is perfectly OK to not cash flow. As long as one buys in the right location and has the right time frame, then the plan would still work out over the long run. Is that correct? Are my numbers somehwat close to being correct for buying a nice home in a good area in Texas?

Where do I begin?

I’ll take most of the blame for this one. You’re foundational assumption is inaccurate — the property of which I was speaking wasn’t a house. It was a duplex. The rent wouldn’t be $1,375/mo. It’d be anywhere in the range of $1,225-1,3550/mo per side. So, if you used a recent, real life example, it’d look something like this.

Paid $255,000 — rented $1,350/side — $2,600/mo — $31,200/yr, gross rent. Expenses would run in the neighborhood of $11-12,000. This would include everything. My clients only pay 5% management fee.

Let’s say the Net Operating Income (NOI) is around $19,500 or so. At 5% interest your monthly/yearly debt service, at 75% LTV, would be $1,026.67/12,320. You can readily see there is some decent cash flow there. Again, I take responsibility for you thinkin’ it was a house, and not a duplex.

But you ask a great question, Dave. Is break even OK? Well, yes, and no.

In today’s investment climate, I’d be far less inclined to advise clients to accept a break even property. On the other hand, the key question would have to be — What would the specific circumstances be? In past eras I’ve literally begged a few, select clients to purposefully buy multiple properties with a combined negative cash flow that’d make your head spin. But those were way different times than we have today — and that’s an understatement if there ever was one.

BawldGuy Axiom: The real estate investment strategies applied for a particular investor must be selected with an intimate knowledge of the economic climate, IRS rules/regs, and the general/specific investment context of the times. A Purposeful Plan using multiple strategies synergistically, is only effective when they’re all applied in the correct context. For instance, a strategy with appreciation as a crucial factor in today’s investment reality would be, um, ill advised. (Captain Obvious alert!)

Back to our regularly scheduled program.

Investors in those days could depreciate property twice as quickly. There were NO limits on how much depreciation they could apply to their ordinary (job) income. There were NO limits to how much they could make in ordinary income in order to make use of depreciation. Those two factors aren’t in play today — period.

Combine those facts with the reality of the cartoonish appreciation of that time. (Mid-late 1980s.) Back when I was tellin’ a very few select clients to purposefully acquire relatively large negative cash flows, their properties were goin’ up in value 8-15% a year, year after year. Even applying the bottom of that range for five years on a half million dollars of property — roughly $1.5-2 Million in today’s San Diego values — they’d see their property values balloon by nearly 50%. At 10% a year, their $500K in property would rise to about $805K, a 61% increase in five short years.

But that didn’t tell the real story, at least not from the investor’s point of view.

What I didn’t tell you earlier, is that in those cases my clients were easily able to buy properties with just 10% down payments! That means that in five years, heck, just three years, at 8% annual appreciation, their $50K beginning equity position was improved to roughly $180K! Put another way, their invested capital, (I’ll use $60K to account for acquisition closing costs.) was literally tripled in just three years.

Their negative cash flow? Completely eliminated in two very concrete ways.

1. Their income taxes were drastically reduced, in many cases by nearly 90%. In essence, they had merely traded income tax dollars for short term negative cash flow dollars. Quoting one of those clients, “Where do I sign up?!”

2. In an inflationary economic environment, rents tend to float up with the rising prices at the grocery store. This tends to add velocity to the elimination of negative cash flow. Go figure. (See? Give Captain Obvious an inch, and he takes a mile.)

BawldGuy Takeaway: No real estate investment strategy can ever be implemented effectively sans the context of the current economic realties, IRS rules ‘n regs, and the investor’s specific financial status quo. Without knowing those factors in rich detail, you might as well blindfold yourself and throw darts at a list of investments, locations, and strategies.

Sadly, that’s almost what so many seem to be doing the last several years. Strategies don’t exist in a vacuum. Economic realities are ever changing. What was a great market in which to invest a decade ago, is now a graveyard for investment capital and retirement dreams.

Thanks again, Dave, for your kind words and excellent questions.

Call me with your questions! I need a fix, and I need it now. My number is 619 889-7100. Your other option is to click the Contact BawldGuy button up top, and write me. Have a good one.

Anywho, I wrote about an ongoing case study over there this morning. It’s about combining several strategies dynamically to improve your end game results, which is spelled — Retirement Income.

BawldGuy Heads Up: Tomorrow (Wednesday) I’ll be out of touch with the world completely. Gettin’ some dental work done, and they wanna knock me out to do it. Works for me.

I’ll be available for calls beginning at noon Thursday. ‘Course by then I’ll be Jonesin’ for a fix. You can help me with that by callin’ me at 619 889-7100. Or you can, if you prefer, send me a note using the Contact BawldGuy button up top. Have a good one.

Why?

The answer is simple, but multi-faceted. I’ll be brief. (Hey! I heard that snicker in the back.)

1. The vast majority of property out west is relatively older. In San Diego, anything built in the 80′s is called newer. If it makes sense to keep a property for the duration numbers wise, but it’s 40-100 at your retirement, your cash flow will suffer noticeably.

2. San Diego’s strong point from the early 70′s till the latest bubble burst was appreciation — reliably so — more than most markets. That be gone, people. I’m too experienced to say forever, but appreciation that matters won’t be around SD for quite awhile. There was no other reason to own property there, even when times were good.

3. We’re now several years into the ‘correction’. San Diego (California in general.) was never a place to buy a home for investment, i.e. for tenants only. The price/rent ratios since 1972 ranged from just plain stoopid to insane. 2-4 units were better, but only relatively, and only when compared to props in SD.

Take a typical duplex here — please.

Before the correction, at the peak, duplexes within a mile or two from my office sold for $525-625,000. And no, not makin’ that up. The rents? Usually $11-1,300/side back then. Even using today’s much lower interest rates, say 5%, the investor had to put 45% down — wait for it — here it comes — to break even. ‘Course the interest was higher then, so figure a minimum of half down — with no cash flow. That was based on a $575,000 price.

Now?

The same duplex (literally) would now sell for roughly $375,000. The rent would be around $1,200/side. That means if you put 25% down you’ll break even at 5% interest. Whoopty Do!

It’s location is mediocre, maybe half a slice better.

It’s freakin’ 60 years old. Rhetorical question: Why do folks buy this crapola?

The majority of these museum pieces have floor plans that have zoomed right past functionally obsolescent to I Love Lucy comic relief. Try no garbage disposals or dishwashers. Kitchens so small, when two people are in ‘em at the same time they better be in love. Most modern one bedrooms sport more square footage than many of these two bedroom dinosaurs. Again, literally.

OK, enough already. I think you get the idea. Long term investment in San Diego and regions like it will deliver a retirement income far short of what’s easily possible in other areas. And with the same amount of capital. It matters not whether you’re using cash or equity — Get . . . Outa . . . Dodge. Preferably around 4:30 yesterday afternoon. Tick Tock.

Short Term

Let’s first establish what ‘short term’ means in clear, unambiguous terms. In the context in which I mean here, it’s less than six months. Usually way less. Invoking the 80/20 rule, I’d say 4-12 weeks is reasonable. Longer than six months? Something hasn’t gone according to plan. Murphy could be in the neighborhood.

Though my resumé includes rehabbing apartments, a medical office building, 2-4 unit properties, and, no kiddin’, a rooming house, I’m not the guy to call for the buy/rehab/sell for unconscionable profit strategy. Although I harbor great respect and admiration for those who pull that off consistently, with the exception of the examples above, I’ve always thought that segment of the real estate investment universe was/is sorely misunderstood in terms of risk.

Way misunderstood, as in, many went into it thinkin’ their risk was far below what it was in real life. That is until real life sucked the spirits from their souls. But the public doesn’t hear much about those folks.

I like SoCal for short term profit.

That said, I prefer (Read: Will at all costs.) to avoid properties in need of fixing. Since no plan for short term real estate profits ever works 100% of the time, assessing risk with professional accuracy is the linchpin to its success. (Notice I said short term. Long term is much more reliably subject to solid gold fundamentals — what I call the physics of economics. Short term stuff is more, “Buy low, sell high” in nature, and relies almost exclusively on the investor’s ability to accurately KNOW both the low and the high. Far more difficult than most suspect.)

Since even conservative short term real estate investing brings risk to the table (duh), compression of that intrinsic risk can be found in the details. Maybe the most common mistake made in short term agendas is sacrificing location quality standards. This is almost always due to the investor’s thinking that since they’re only gonna be there a very short time, location quality becomes less critical, or has less impact on their success. After all, “I’m not gonna be the one left holdin’ the bag, so why worry about it?” In my office we call that utterance, famous last words.

Insisting on no rehabbing required, at worst superficially light, cosmetic fixing, will also reduce your risk. Don’t play head games with yourself on this one. “Heck, it only needs a ‘quick’ kitchen remodel”. Believe me when I tell ya, that’s an oxymoronic sentence if there ever was one. Ever come across an anthill with two ants? Me neither. There’s ALWAYS more. Learn to say ‘Pass’, and go to the next one.

Having built-in buyers for market price is good if you can make it happen. Talk about compressing risk. That goes a long way. But even then, like the bumper sticker says, ‘Things Happen’, or something to that effect.

Risk can be reduced incrementally in many ways when investing for short term profits. I’ll be puttin’ groups together to spread that risk around pretty soon. One of my motivations is to provide a vehicle for long term investment clients who would like to increase the velocity of their Purposeful Plans for long term retirement, but don’t like going down that road alone, without an expert at the helm.

The San Diego market, and those like it, are indeed a paradox. Long term investment do not and will not go well there, while short term investment attached to reduced risk is doing well, and should continue to for the next 2-5 years.

Next up: How to combine long term real estate investing for retirement synergistically with short term strategies. This adds a page to your options menu that can serve to not only hasten your final day at work, but increase your ultimate retirement income too.

Stay tuned.

Meanwhile, back at BawldGuy Ranch, operators are waitin’ with bated breath for your call. 619 889-7100 will get us talkin’ about how to get your retirement headed in the right direction. Or you can send me a note by clickin’ on the Contact BawldGuy button up top. Have a good one.

It talks about a couple guys who came into my office quite some time ago. Real folks, in the flesh, with real agendas and money to back ‘em. A father and his son — from different schools. I learned much about human nature from those two.

Anywho, here’s what I really think of cash flow vs capital growth — read and enjoy. I hope ya like it. Better yet, I hope it helps in some small way.

I’d love to talk with you about your retirement goals. Call me at 619 889-7100 — let’s put our heads together. Or, if you’d rather write me first, click on Contact BawldGuy up top, and we’ll start that way. Either way, do it quickly, cuz I need a fix. Have a good one.

There are multiple schools of thought related to investing in real estate for retirement. Two dominate.

One says you buy property, holding it forever. When you’ve saved sufficient capital to buy additional property, you do — then hold IT for evermore too. The idea is you allow rental income to pay off debt as quickly as possible, arriving at the point of a debt free cash flow machine. Do this a buncha times and you’ve built the foundation for a nice retirement income stream.

Or so the doctrine goes.

The other school’s doctrine teaches cash flow comes from the yield on capital or equity in an asset. The bigger the capital amount or equity in the asset, the greater the income, measured in dollars. The ‘yield’ itself is expressed in terms of a percentage. For example, 7.5%. This commandment says that since the yield is equal, more or less, for a more substantial or less generous figure, why not arrive at retirement with the largest amount of capital and/or equity possible?

The million dollar questions?

The ‘Buy & Hold’ school (BHS) gets you there. But in what condition? Furthermore, how much cash flow relative to the ‘Capital Growth First’ school (CGF)?

Buy and Hold

Limited to how fast investor can save capital for down/closing on each purchase

Properties are old, having high maintenance/expenses when investor retires

100% of income is devoid of any tax shelter — right when they need it most

Properties more likely than not to exhibit functional obsolescence upon retirement

Older properties generally don’t compete well for highest quality tenants

Props are old when you retire, & only get older each year — not a good trend

Rents will be less likely to keep up with the competition — or inflation

That’s the short list, but you get the idea. Buy and Hold should be called Buy and Mold.

First — Capital Growth

By ensuring a more or less superior capital growth rate — net worth increases

Capital growth is maintained by exchanging equities when the market dictates

Exchanging keeps the power of prudent leverage working

This results in significantly larger capital/equity base

Larger capital/equity base = larger income in terms of dollars using same yield % at retirement

Arrive at retirement with higher income, mostly tax sheltered

Able to execute strategies completely unavailable to Buy & Hold

Again, that’s a short list. You can readily see the advantages.

Here’s an example with some real life numbers for illustration. Sadly, the investor used in the example chose to stay his buy ‘n hold mold course. Here’s what coulda happened if he’d switched strategies.

Considering Real World Examples

“Wayne”, 71, came into my office many years ago — a genuine born again buy ‘n hold guy. His pride ‘n joy was a fourplex, purchased in his 30′s, now free & clear, spinning off a net income of roughly $2,900 monthly. This is in addition to two other income sources — Social Security and a taxable annuity.

Wayne’s paying a lotta taxes on the annuity income and the fourplex — neither of which is keepin’ pace with his cost of living. He retired in 2005. He bought the fourplex in 1975. We both live in San Diego, so I’ll be using that market to illustrate. The principle works for most any market — especially over the long haul.

He paid just about $80,000 back then. Upon retirement the value was nearly 10 times that. Where would he be today had he gone the capital growth route? So happy you asked.

The market would’ve signaled him to exchange his increased equity position in the first quarter of 1979, give or take. Having put 20% down, his equity at that point would’ve been around $100,000 — more than five times his originally invested capital. His cash flow for the period won’t be added into that, except for the paying of closing costs on his newly acquired exchange property(s).

He now owns about $400,000 in multifamily properties. He’s conservative, so due to interest rates at that time, he puts 25% down. He then waits for the next time the market signals him to make a move. It’ll be longer than four years this time, as the recession exacted its toll. Meanwhile, his units are rented, with slightly increased rents over the long term. The recovery arrives around the end of 1983. He waits, wanting to be sure. Values again start rising. Still, he waits. In roughly July of 1988 he triggers another tax deferred exchange with the following results.

Note: From roughly 1985 to the beginning of 1990 appreciation rates in SoCal were double digit, more or less depending what specific market. San Diego did, um, well.

His exchangeable net equity at that point was approximately $275,000. Again, he chose to put 25% down on his exchange uplegs. (newly acquired properties)

Let’s pause at this juncture to figure his capital growth rate.

It’s been 13 years since he began with about $18,000 to close his first investment back in 1975. He now has $275,000. That’s an annual capital growth rate, exclusive of tax benefits and cash flow of about 23% — a figure nobody with a three digit IQ would predict in public, but historically accurate nonetheless.

Anywho, he now owns about $1.1Mil dollars of multifamily properties. They not only pay for themselves, but cash flow — not heavily, but enough to make him happy. For the record, he does two things consistently along the way — one I recommend sometimes, and one on which I insist. He has way more than adequate cash reserves. I call it a Sominex Account, as when Murphy visits, you can still sleep at night.

The recommendation at this point is to apply a portion of the cash flow to the loan balance. Back then it was almost a built in practice for my clients, due to interest rates 2-4 points higher than today’s. It just made sense. It’s called keepin’ your eye on the ball, which in this case is growing the guy’s capital/equity safely over the long haul with retirement always #1 on the hit list.

Around this time the S & L Crisis hits San Diego like boulder hits a bug. It was beyond horrible. Not only did we experience what everyone everywhere else did, we had the added thrill of losing two huge employers overnight. Talk about both barrels of the shotgun goin’ off point blank. Vacancy rates went from virtually zero to 10-15%, oft times more depending upon location. Rents plummeted even more in some cases. Bottom line? Wayne’s cash flow went from cool to break even faster than Rubio’s makes fish tacos.

This forced a holding period of about 10, no, more like 12 years. What’s an investor to do? Life happens. It certainly did back then. It seemed Murphy squatted in San Diego the whole time. Ever heard of O’Toole’s corollary to Murphy’s Law?

“Murphy was an optimist.”

Wayne executed another trade, tax deferred, in the early spring of 2000. His portfolio by then had risen at a more modest rate than in previous times. Real life. It’s now worth a total of $1.6Mil — give or take. His net tradeable equity is roughly $645,000. Relatively speaking, interest rates are a bit less, but he insists on a 30% down payment, overruling my advice to try 20% this time. It’s his money, so guess how much he put down? He’d been made nervous by his experience of the early 1990′s. Um, me too.

When the smoke cleared he ended up with $2.15Mil in multifamily property. It wasn’t cash flowing much, give or take $25,000 a year. His retirement was, according to him, a long way off. He changed his mind about that later.

In fact, he decided in early 2004 to call me about setting in motion his transition from capital growth to cash flow — he wanted to retire no later than spring of 2005, about 30 years after buying his first investment property. After much analysis and a few meetings of the mind, we agreed — he needed a property outside of California. The prices were simply outa whack in the Golden State, a fact of which we were both painfully aware. The search began.

First we had to ascertain how much equity we had to trade — cue the HappyFeet music.

Seems his luck had turned around again. From his latest acquisitions in 2000 his portfolio had grown in value from $2.15Mil to the neighborhood of $4Mil. His net tradable equity was about $2.2Mil. Let’s take a pause for the cause here, alright?

Is that a white flag I see being waved by the buy & hold crowd? Just askin’ . . .

We didn’t care much about growth now, as we wanted stable markets, not much prone to big swings either way, historically. Idaho, Texas and Kansas/Missouri ended up on the short list. We really liked Texas though, which is where we landed. We ended up with about $5.5-5.7Mil in cash flow properties. (Larger properties this time.) The cash on cash return averaged around 7-10% conservatively. This resulted in a yearly cash flow, the majority of which was tax sheltered by the way, of $140-200,000 yearly.

For discussion sake, discount the low part of that range by half. You still end up with $70,000 a year at retirement — mostly sheltered — not in ancient properties with ever rising operating costs. Even discounting the low end of the income range by half, he still finds himself with just short of double the retirement income he did applying the buy and mold, um, hold school of thought.

Of course, he won’t hafta discount all that mostly sheltered cash flow. A retirement income of five figures monthly. Sweet.

Here’s the real plot twist. Just as he did on the way there, Wayne can still apply a prudent amount of cash flow to the premature reduction of debt. Each multifamily property he pays off will increase it’s cash flow to him by a factor of 2-4. Nothing like getting a $500-1,500 a month boost in income on a regular schedule.

Real life for Wayne

Back to Wayne’s current reality. He’s now retired on just under $36,000 a year from his fourplex. His SS income and annuity supplement this. However, as pointed out earlier, every single dollar of the annuity and the real estate is taxable. Ouch. Furthermore, he’s now discovered, much to his chagrin, that he didn’t retire — he started serving a life sentence.

His option from Day 1 was to end up with so much sheltered retirement income that his SS check would simply be spending money.

So I restate the principle: Worshiping cash flow when capital growth is the appropriate approach will not have the happy ending you envision.

What school of thought do you favor? Let’s talk about your specific status quo and figure out what might be on your menu. Gimme a buzz at 619 889-7100. Or, if you’d rather, click on the ‘Contact BawldGuy’ button up top. Have a good one.

Let’s construct an example to illustrate the principle.

At 42, you own your own home, but will be buying your first income property. Your plans are to retire at 62, if possible — giving you 20 years to get the job done. You have no problem going to 65 if it makes sense. You have a total of $200,000 for down payment(s) and closing costs to get you started. If you opt for bigger down payments and higher cash flow, using accumulated cash flow for future purchases, you’ll begin with two initial acquisitions.

Two properties at roughly 260,000 apiece, using 35% down plus closing costs will take about $190,000 or so. The cash flow generated will total approximately $14,300 annually. It’ll take ya 6 years 8 months to accumulate enough for your next purchase. That’s IF interest rates haven’t risen too much, and IF there’s been no real increase in values. If either one of those is true, much less both, your plan hits a significant roadblock.

Let’s pause here and see how the capital growth approach plays out, using the same initial capital.

Using 20% down on one, and 25% on two more, he’ll begin with three properties. His cash flow will exceed $15,000 a year, but we’ll use that figure here. Each month he’ll be applying $1,250 in cash flow directly to the principal pay down of one of the property loans — not all three. I’ve dubbed it the BawldGuy Domino Strategy. You knock ‘em down one at a time.

In 8.75 years, (105 months) the first property is debt free and now cash flowing at just over $1,500 monthly. We’ll round down to $1,500.

With the vastly increased cash flow the second property is completely paid of in the next 4.67 years, (56 months). Elapsed time: 13 years, 5 months. Let’s finish it off now.

The third and last property is then paid off in 3 years, 1 month. Total elapsed time: 16.5 years.

In the 3.5 years he has left before retirement, if he chooses to wait, his cash flow would add up to, give or take, a tad under $193,000. ($55,080/yr) Think he might be able to find a use for that cash about then, don’t you?

OR . . .

He opts for borrowing enough to buy a couple more duplexes at 25% down. That option leaves him with an annual cash flow of $50,500 AND 5 properties. He pays off the newly refinanced property in 33 months. This leaves him just 9 months short of his planned retirement. What to do?

I have a suggestion: Delay retirement if necessary by 20 months. At that point all 5 properties are now completely debt free and producing annual retirement income of a couple steak dinners short of $92,000 — a 67% increase.

What he did there, was decide it was worth 20 more months of working to increase his ultimate retirement income by over $3,000 a month. If he decides against that, his income would be $55,000 yearly, but he’d retire on the date planned.

Let’s revisit the alternative strategy of using cash flow to buy more property.

Though a silly, and frankly, a dangerous assumption, prices remaining static for nearly 7 years — this strategy does just that. It’s no less silly than assuming prices will do anything, as his crystal ball is as cracked as the rest of ours, right? Right.

Anywho . . .

He buys his third property, which closes at the end of his seventh year. His first 2 properties now sport loan balances of about $149,400 apiece — almost $300,000 PLUS the new property’s loan of $165,000. Cash flow remains static. He owes $465,000.

He buys another property about 5 years later. Elapsed time: 12 years. He buys his 5th property at about the 16 year point. Let’s review where he’d find himself at 20 years, his intended retirement date.

He’d own 5 properties, though each one would be relatively heavily encumbered. Let’s me specific, shall we?

The initial two purchases are still sportin’ loans with balances of roughly $87,000 each.

The third property’s loan has a remaining balance of just under $123,000 at the targeted retirement date.

The fourth property’s loan still has about $146,000 left.

The fifth one has barely been dented, with a remaining balance of $155,000 or so.

Income at his scheduled retirement date using this strategy would be $37,000 annually, give or take a weekend getaway. I’m underwhelmed. You?

He’d still owe almost $600,000 before he’d have the same income had he used the more efficient capital growth strategy.

Go over these numbers a few times. Get comfortable with ‘em. Make your own charts or columns for comparisons in order to really get a clear picture of what they mean in real life.

BawldGuy Takeaway

In order to increase cash flow initially the real estate investor is forced to put more capital into each investment. The more down he puts, the less property he, or she, can buy. Over time this results in a somewhat nasty surprise — a sorta good news/bad news joke — only not funny.

The good news? Ha! Ha! You bought the same 5 properties as you would’ve doing it my way.

The bad news? When retirement time arrives, your choices are not too cool no matter how ya spin ‘em. Either retire at just over $3,000 a month till ya pay off another $600,000 in debt — which will take a truly long time.

OR

Delay your retirement by about the extra decade or so it’ll take to finish payin’ all that debt off. In simple terms, you can wait till your 70-72 to retire, or exist on $3,000 monthly till the $600,000 pays itself off — and that will be MUCH longer than a decade.

Beginning to see what I mean, Verne?

Look, this is nothing compared to what I could come up with, given enough time to get more deeply into the analysis. In fact, I’m fairly certain I could come up with a scenario with better results on the capital growth side of the comparison. But not so much on the cash flow approach. The whole “Save the cash flow and buy more property” comes from Grandpa.

Didn’t work real well for him, either. Just sayin’.

Whatever your plans for retirement, gimme a call, will ya? I need a fix, big time. 619 889-7100 will get it done. Or, go up top and click on ‘Contact BawldGuy’ and send me a note. Have a good one.

Let’s don’t talk in terms of age, but instead, years before retirement. If you have more than 10, surely 15 or more years till that day, puttin’ cash flow at the top of your priority list will be the kiss of death — to your retirement income. Of course, that doesn’t matter much if your agenda isn’t to maximize cash flow at the point of retirement. I’ll assume your #1 goal is maximum reliable income at the point of retirement.

BawldGuy Axiom: To the extent the real estate investor goes for cash flow, capital growth suffers — and vice versa. You’ll only get the best of both in the movies.

There’s no gettin’ around that truth. There are types of properties more appropriate for capital growth, just as the same is true for cash flow. Also, the structure/strategy used to acquire a real estate investment property will dictate whether or not it will be more productive for growth or income.

But again, the elephant in the room is timing.

If you’re 43 years old with plans to call it quits at 65, and makin’ plenty of money at work, why on earth would you sacrifice capital growth for current cash flow for which you have no need? Putting cash flow at the front of your chronological line guarantees the inhibition of your invested capital’s growth. But, you might ask, why is that such a big deal? Excellent question, grasshopper.

What is cash flow anyway, but a yield on capital, right?

Retirement income is nothing if not the yield on your accumulated capital, set aside for that purpose. The bigger the pile of capital you amassed, the larger the yield will be in terms of, you know, actual dollars. To put it more simply, a 6% yield on $3 Million is more than the same 6% on $1 Million.

OR

$180,000 is more than $60,000.

BawldGuy Takeaway: Those who opt for capital growth first, then switching gears to cash flow as retirement looms, will be living on the former. Those who insist on emphasizing cash flow now, will be settling for the latter.

There is no third alternative people. Make time your friend, cuz it’s a merciless enemy.

Let’s talk, OK? Gimme a call at 619 889-7100, and together we’ll figure out how to make time your best friend ever. Have a good one.

We’re now ready to get serious about painting their overall financial picture in more detail. This entails all kinds of questions, follow-up, forks in the road, and the like. Knowing your complete financial picture is crucial to the ultimate execution of a well designed Plan. Here are a few of the questions that’ll launch that discussion.

How old are they?

What do they do for a living?

Do they like their job, or hate every minute of it?

How much do they make?

Do they have an IRA/401K/ or company pension at work?

Have they bought an annuity of some sort?

Are their retirement goals, including timing, realistic? Specifically, are they too ambitious or are they underestimating what’s reasonably possible?

Then, of course, there’s everything else that popped up during this conversation.

At this point comes a critical decision, based upon my analysis of their fully understood status quo. Should their strategy be designed to produce Capital Growth or Cash Flow?

If enough time is available, a bifurcated strategy will be designed. Capital growth on the front end, followed by an ordered transition to cash flow as retirement nears.

If cash flow is the immediate goal, the tactics change. Remember, to the extent the real estate investor goes for either cash flow or capital growth as their primary goal, the other will suffer. Those who insist both can happily coexist are either dreaming, or buying property where you and I would never put Mom to live alone.

BawldGuy Axiom: Whether we opt for capital growth or cash flow, the other will suffer. There’s no way out. In baseball parlance, you can’t throw a fastball and a curveball on the same pitch. Pick one.

Bottom line? 95% of the people with whom I talk need to growth their capital first.

Let’s not gloss over the key factor of time when designing your Purposeful Plan. It’s pretty simple: Is there enough time to attain the stated goals? If so, it’s time to pull the trigger. Don’t delay.

The #1 lesson most people should understand with crystal clarity is that whether you have 25 years till retirement, or less than a decade, there’s one factor both timelines have in common . . .

Time is never your friend.

Next up, we’ll talk about a factor in your Purposeful Plan so important, I won’t work with anyone who doesn’t agree to it. I’ve made less than 10 exceptions to that rule in the last quarter century. Yeah, that important.

If you’ve gotten to the point your retirement is beginning to look different than you originally planned, gimme a call. 619 889-7100 will find me. Have a good one.

One says you buy property, holding it forever. When you’ve saved sufficient capital to buy additional property, you do — then hold IT for evermore too. The idea is you allow rental income to pay off debt as quickly as possible, arriving at the point of a debt free cash flow machine. Do this a buncha times and you’ve built the foundation for a nice retirement income stream.

Or so the doctrine goes.

The other school’s doctrine teaches cash flow comes from the yield on capital or equity in an asset. The bigger the capital amount or equity in the asset, the greater the income, measured in dollars. The ‘yield’ itself is expressed in terms of a percentage. For example, 7.5%. This commandment says that since the yield is equal, more or less, for a more substantial or less generous figure, why not arrive at retirement with the largest amount of capital and/or equity possible?

The million dollar questions?

The ‘Buy & Hold’ school (BHS) gets you there. But in what condition? Furthermore, how much cash flow relative to the ‘Capital Growth First’ school (CGF)?

Buy and Hold

That’s the short list, but you get the idea. Buy and Hold should be called Buy and Mold.

First — Capital Growth

By ensuring a more or less superior capital growth rate — net worth increases

Capital growth is maintained by exchanging equities when the market dictates

Exchanging keeps the power of prudent leverage working

This results in significantly larger capital/equity base

Larger capital/equity base = larger income in terms of dollars using same yield % at retirement

Arrive at retirement with higher income, mostly tax sheltered

Able to execute strategies completely unavailable to Buy & Hold

Again, that’s a short list. You can readily see the advantages.

Here’s an example with some real life numbers for illustration. Sadly, the investor used in the example chose to stay his buy ‘n hold mold course. Here’s what coulda happened if he’d switched strategies.

Considering Real World Examples

“Wayne”, 71, came into my office many years ago — a genuine born again buy ‘n hold guy. His pride ‘n joy was a fourplex, purchased in his 30′s, now free & clear, spinning off a net income of roughly $2,900 monthly. This is in addition to two other income sources — Social Security and a taxable annuity.

Wayne’s paying a lotta taxes on the annuity income and the fourplex — neither of which is keepin’ pace with his cost of living. He retired in 2005. He bought the fourplex in 1975. We both live in San Diego, so I’ll be using that market to illustrate. The principle works for most any market — especially over the long haul.

He paid just about $80,000 back then. Upon retirement the value was nearly 10 times that. Where would he be today had he gone the capital growth route? So happy you asked.

The market would’ve signaled him to exchange his increased equity position in the first quarter of 1979, give or take. Having put 20% down, his equity at that point would’ve been around $100,000 — more than five times his originally invested capital. His cash flow for the period won’t be added into that, except for the paying of closing costs on his newly acquired exchange property(s).

He now owns about $400,000 in multifamily properties. He’s conservative, so due to interest rates at that time, he puts 25% down. He then waits for the next time the market signals him to make a move. It’ll be longer than four years this time, as the recession exacted its toll. Meanwhile, his units are rented, with slightly increased rents over the long term. The recovery arrives around the end of 1983. He waits, wanting to be sure. Values again start rising. Still, he waits. In roughly July of 1988 he triggers another tax deferred exchange with the following results.

Note: From roughly 1985 to the beginning of 1990 appreciation rates in SoCal were double digit, more or less depending what specific market. San Diego did, um, well.

His exchangeable net equity at that point was approximately $275,000. Again, he chose to put 25% down on his exchange uplegs. (newly acquired properties)

Let’s pause at this juncture to figure his capital growth rate.

It’s been 13 years since he began with about $18,000 to close his first investment back in 1975. He now has $275,000. That’s an annual capital growth rate, exclusive of tax benefits and cash flow of about 23% — a figure nobody with a three digit IQ would predict in public, but historically accurate nonetheless.

Anywho, he now owns about $1.1Mil dollars of multifamily properties. They not only pay for themselves, but cash flow — not heavily, but enough to make him happy. For the record, he does two things consistently along the way — one I recommend sometimes, and one on which I insist. He has way more than adequate cash reserves. I call it a Sominex Account, as when Murphy visits, you can still sleep at night.

The recommendation at this point is to apply a portion of the cash flow to the loan balance. Back then it was almost a built in practice for my clients, due to interest rates 2-4 points higher than today’s. It just made sense. It’s called keepin’ your eye on the ball, which in this case is growing the guy’s capital/equity safely over the long haul with retirement always #1 on the hit list.

Around this time the S & L Crisis hits San Diego like boulder hits a bug. It was beyond horrible. Not only did we experience what everyone everywhere else did, we had the added thrill of losing two huge employers overnight. Talk about both barrels of the shotgun goin’ off point blank. Vacancy rates went from virtually zero to 10-15%, oft times more depending upon location. Rents plummeted even more in some cases. Bottom line? Wayne’s cash flow went from cool to break even faster than Rubio’s makes fish tacos.

This forced a holding period of about 10, no, more like 12 years. What’s an investor to do? Life happens. It certainly did back then. It seemed Murphy squatted in San Diego the whole time. Ever heard of O’Toole’s corollary to Murphy’s Law?

“Murphy was an optimist.”

Wayne executed another trade, tax deferred, in the early spring of 2000. His portfolio by then had risen at a more modest rate than in previous times. Real life. It’s now worth a total of $1.6Mil — give or take. His net tradeable equity is roughly $645,000. Relatively speaking, interest rates are a bit less, but he insists on a 30% down payment, overruling my advice to try 20% this time. It’s his money, so guess how much he put down? He’d been made nervous by his experience of the early 1990′s. Um, me too.

When the smoke cleared he ended up with $2.15Mil in multifamily property. It wasn’t cash flowing much, give or take $25,000 a year. His retirement was, according to him, a long way off. He changed his mind about that later.

In fact, he decided in early 2004 to call me about setting in motion his transition from capital growth to cash flow — he wanted to retire no later than spring of 2005, about 30 years after buying his first investment property. After much analysis and a few meetings of the mind, we agreed — he needed a property outside of California. The prices were simply outa whack in the Golden State, a fact of which we were both painfully aware. The search began.

First we had to ascertain how much equity we had to trade — cue the HappyFeet music.

Seems his luck had turned around again. From his latest acquisitions in 2000 his portfolio had grown in value from $2.15Mil to the neighborhood of $4Mil. His net tradable equity was about $2.2Mil. Let’s take a pause for the cause here, alright?

Is that a white flag I see being waved by the buy & hold crowd? Just askin’ . . .

We didn’t care much about growth now, as we wanted stable markets, not much prone to big swings either way, historically. Idaho, Texas and Kansas/Missouri ended up on the short list. We really liked Texas though, which is where we landed. We ended up with about $5.5-5.7Mil in cash flow properties. (Larger properties this time.) The cash on cash return averaged around 7-10% conservatively. This resulted in a yearly cash flow, the majority of which was tax sheltered by the way, of $140-200,000 yearly.

For discussion sake, discount the low part of that range by half. You still end up with $70,000 a year at retirement — mostly sheltered — not in ancient properties with ever rising operating costs. Even discounting the low end of the income range by half, he still finds himself with just short of double the retirement income he did applying the buy and mold, um, hold school of thought.

Of course, he won’t hafta discount all that mostly sheltered cash flow. A retirement income of five figures monthly. Sweet.

Here’s the real plot twist. Just as he did on the way there, Wayne can still apply a prudent amount of cash flow to the premature reduction of debt. Each multifamily property he pays off will increase it’s cash flow to him by a factor of 2-4. Nothing like getting a $500-1,500 a month boost in income on a regular schedule.

Real life for Wayne

Back to Wayne’s current reality. He’s now retired on just under $36,000 a year from his fourplex. His SS income and annuity supplement this. However, as pointed out earlier, every single dollar of the annuity and the real estate is taxable. Ouch. Furthermore, he’s now discovered, much to his chagrin, that he didn’t retire — he started serving a life sentence.

His option from Day 1 was to end up with so much sheltered retirement income that his SS check would simply be spending money.

So I restate the principle: Worshiping cash flow when capital growth is the appropriate approach will not have the happy ending you envision.

What school of thought do you favor? I’ll bet it’s not even a doctrine, but an agenda resulting in a magnificently abundant retirement. Let’s talk about your specific status quo and figure out what might be on your menu. Gimme a buzz at 619 889-7100. Have a good one.

First, for those that don’t know Berkshire is run by Warren Buffett one of the world’s richest people and generally considered the best investor of the last generation. His 47-year annual rate of return for Berkshire is over 21%. People like to think that Buffett has lost his way. Back in 2000 there was much chatter about this and again a couple of years ago. Its true the last 10 years he has not gotten anywhere near that return but remember no one else has either.

For fun let’s look at the total return for Berkshire over the last 10 years compared to a low expense highly diversified index fund from Vanguard and the S&P 500 Index before expenses are taken out.

The last 10 years BRK has returned 78.4%. The S&P 500 has returned -2.86% in that same time period. The Vanguard Total Stock Market Index Fund has returned 9.89%. Not bad for a person whom critics think has lost his edge!

The other criticism of my thinking is that I am not diversified enough. I find this laughable as I am in real estate, equities and in an EIUL tied to a stock index. But where it gets funny is when they tell me I need to own more than just Berkshire. Berkshire is a holding company that currently owns outright 52 separate companies that does everything from insurance to fractional airplanes to a railroad. Then there are 36 separate equities owned in its portfolio. The math behind diversification of a stock portfolio tells us that 95% of the benefit is achieved by owning 30 stocks. You see Berkshire owns much more than that so in itself it is well diversified. By the way, 66% of the benefit of diversification is achieved by owning just 4 stocks! Move up to 10 and you have achieved 84% of the benefit. By the way, this math works for real estate too, although Bawld Guy might have some comments about this.

So here is my thinking. Who do I want managing money for me and what will it cost me? Well, I figure I might as well have the greatest investor of the last generation. And the fact it costs me lest than a penny per year to have him do it is gravy [Buffett only pays himself a $100K salary]. Berkshire doesn’t pay dividends so that means no taxation until I sell shares.

Frankly, my only regrets at leaving behind the common investing wisdom is that I should have done it sooner!