Sep142009

Real estate, cashflow investment and retirement

Now that the high-flying real estate market of the Great Housing Bubble has crashed, let’s look back to an investment style of yesteryear to provide for retirement. Cashflow investing is the idea that stable inflows of money can be captured and diverted to you for a price. If you accumulate enough cashflow, you can retire.small_investors

Stable Sources of Cashflow

In retirement, what determines the amount of money available to enjoy for lifestyle expenses? Is it your wealth? Is it the equity in your home? Not really. It is the stability of the sources of cashflow you control.

Many are obsessed with being rich when what they really want is unlimited spending power. People who have attained great wealth may have amazing spending power, but they seldom use it. If they did, they would not be rich.

Being rich is about forming a habit of saving and consistently spending less than you earn. It is about having the self-discipline to limit your spending voluntarily rather than being forced to by a lender’s credit limit.

You and I work because we need a large amount of stable cashflow to cover personal spending and provide a balance to save. We need to work until we acquire enough assets to provide a stable source of cashflow from another source — our investments.

The quality of our lifestyle and the quantity of our available spending money in retirement is directly related to the sources and stability of cashflow you control and direct. The quantity of money or total net worth is not as important as the ability to convert it to cash.

Cashflow Investments

The problem with asset appreciation as the primary method of funding retirement is that this appreciation must be converted to cash in order to be used. This cash can be obtained through sale or through borrowing. Sale is the cleanest, and it is simple with stocks or other securities that you can sell part of, but houses are different. It is difficult to sell part of your interest in a house. Usually, you will need to borrow the money to stay in your house. This means either a reverse mortgage, or HELOC dependency.

Borrowing money is a bad way to go because you have compound interest working against you. The longer you live, the more you borrow, and the more interest on interest you pay. It is an airplane in a nosedive picking up speed heading to certain doom.

Cashflow investments like (1) dividend stocks, (2) bonds and other debt and (3) real estate are all worthy components of a balanced portfolio. Realistically, few people actually hold stocks or bonds for their cashflow. Most will trade these instruments if only by proxy through a mutual fund.

Real estate is the one cashflow investment that people are more familiar with because we all have homes, even if we rent them. It is also a great cashflow investment. Everyone should consider strategies for owning real estate as part of their retirement savings.

What I am proposing is different than what most people think when they invest speculate in California real estate. It doesn’t matter what it it resells for; appreciation is not important. Buy to obtain maximum future cashflow.

Real Estate as Cashflow

Real estate provides cashflow either through (1) renting the property or (2) living in it and saving the cost of a comparable rental. If you assume most people are putting about one-third of their income toward their housing expense, you see the expense is quite significant. If you own the property with no debt, you can enjoy the benefit of that money for yourself in other ways.

When you look at cashflow rental properties, you want to get the largest possible cashflow for the least amount of money. Don’t focus on appreciation potential unless you want to overpay and dilute the cashflow returns.

If you owned three properties with no debt where each one represented a market rent equal to one-third of your yearly income, you would have a stable income without having a job — other than perhaps property manager… if you want…

The retirement hurdle: own three properties of equal quality to what you rent or own today with no debt.

Living in Retirement

If you look at the fate that awaits us all as seniors, you can see distinct boundaries between the styles of life of various people based on how they lived and how they saved.

There is one group that will save nothing. They will have to chose between working until they die or living on about one-third of their lifetime wage average through Social Security. This is the minimum entitlement in our society as granted in the Social Security Act of 1935.

According to Wikipedia, “… the Social Security program began as a measure to implement “social insurance” during the Great Depression of the 1930s, when poverty rates among senior citizens exceeded 50%.” Social Security is the collective price of societal compassion to its senior citizens. I am glad it’s there.

How well you live above and beyond this minimum entitlement depends on your stable future cashflow from your investment savings.

The conventional wisdom among financial planners is that you need about two-thirds of your work salary as monthly spending to live comfortably in retirement. Social security gets you one of those two-thirds. If you can pay off your primary residence, you get the remainder. Paying off a home and living on Social Security in retirement is still an option in the United States.

Paying off Your Home

Paying off a Home mortgage became passe during the Housing Bubble. People had better things to do with their money than retiring debt. Debt was cheap and abundant; why pay it off under those circumstances? Paying off a house as an investment strategy nearly died. Did anyone keep their conventional mortgages during the bubble?

If you retire debt, you no longer have to service it. For those that keep a revolving credit line at its limit, this is a strange concept, but retiring debt is fundamental to having a stable retirement. Do you want to work and service debt forever? Who is the slave and who is the master?

Paying off your home mortgage removes an enormous financial drain from the family’s balance sheet and greatly improves an income statement; it is an historic measure of success.

Paying off Your Investment Property

If you pay off your home plus one other investment property — like perhaps your starter home — you have more than enough stable cashflow to live comfortably in retirement. (1) Social Security plus (2) a primary residence with no debt and (3) a paid off starter home as an investment equals (=) a prosperous retirement.

It is an old investment strategy to keep a small condo or first-rung property, and it is a good idea if the property is financed with a conventional mortgage. Unfortunately, most people simply used these properties as sources of additional leverage in building their speculative empires.

When you purchase your first property, it should be near rental parity. Ten years later, that property should have a positive cashflow due to 10 years of escalating rents.

If you keep the property, you can take the excess rent and put it toward the mortgage paying off the debt more quickly. Remember, the goal is to have maximum free cashflow in retirement, so you want to pay off those debts.

Debt equals delayed retirement.

Success

If you (1) save money, (2) acquire assets with maximum cashflow and (3) pay off debts, you will be successful and enjoy a very comfortable retirement. Real estate should not be the only component of your retirement savings plan, but it will be an important one. I hope this provides a way of looking at real estate that benefits you.