Today’s question comes in from Janice and she says, hi Marco. I’ve been educating myself on real estate investing. Congratulations. Your podcast is very informative and straightforward, which I love. Thank you for taking the time to educate. My question is specifically about age. At the time of investing, I listened to episodes 224 and 225 which had to do with using your principal’s home equity to invest, which is what I’m interested in. You briefly mentioned age in one of the episodes but didn’t go into detail. Hypothetically, I want to invest equity from my primary residence and rental properties. What recommendations would you give a 30 year old versus a 50 year old if each had $200,000 to invest in case you’re wondering, I’m 49 my husband 54 I was initially interested in flipping because of the faster turnaround, but have recently come to understand the long term value of buy and hold properties, but maybe that applies more to the younger generation?
Being 5 to 10 years from retirement makes my husband worry about the potential risk and he says, quote, it’s too late to start something this risky. Now, close quote, my goal with investing is to possibly retire earlier and be more comfortable plus have something to keep busy once I’m retired for reference, we have seven more years until our primary home is paid for.
Thank you for your input, Janice. Well, Janice, the answer to your question does age matter is yes and no. Yes, it matters in the sense that the earlier you get started in real estate investing or any investing for that matter, you have the advantage of time on your side, time to build, time to grow and compound your cashflows and compound your returns, compound the equity that you build in. Having that real estate earlier on which you can now leverage and take advantage of moving forward.
So yes, it does help the earlier you get started and that’s true with so many things when it comes to investing and even with your education, but at the same time, no, it doesn’t matter because as you get older you have certain things that you don’t have in your younger years. For example, you have greater wisdom and the ability to ask better and more intelligent questions, time to educate yourself, more investment capital, probably higher income as you get older because you just tend to find your way into better positions and through promotions or building a business where your income is higher resources available to you, your network of people and contacts may play a part in that. There are advantages but it’s not something that is or should hold you back. If you really want to look at the difference between a 30 and 50 year old at a high level, a 30 year old essentially has a longer runway and more time on their side to build that portfolio and to allow appreciation to take place or for returns to be utilized and compounded so there’s more time to grow equity and compound that equity, but as a 50 year old or whether that’s 45 or 55 it doesn’t matter.
As you get older, sometimes you find yourself using real estate investing or other forms of investing to supplement what you already have and I don’t know what you already have in place in terms of an existing business or any kind of passive income you have, but a lot of people might have social security and or a pension or other investments and annuities that are providing or will be providing a monthly or annual form of income. Call it cashflow, personal cashflow. But most of us, believe it or not, start late in life. A lot of our clients that contact us are actually in their forties and 50s we have clients that are as young as 18 some of them are in their twenties but the reality is that most people who work with us and contact us are in their forties and 50s and we’ve even had people in their sixties and seventies so let me give you a couple of examples.
It seems like whenever I do these short episodes of ask Marco, I tend to throw out some examples. So here’s an example, hypothetical, and we have to make some assumptions here, of course, but let’s just call it $1 million of investible capital. That could be liquid cash, could be in the form of equity. It could be a combination of the two. It could be equities that are converted into investment capital. But let’s just look at your options here. So if you had $1 million around the time of your retirement, the question becomes, what do you do with that million dollars in order to survive on your retirement or after you retire? It doesn’t mean you’re retired, but let’s just call it your retirement years. Well, one thing you could do is just take that as cash and draw down from it at let’s say 4% and I say 4% because a lot of financial advisors use this 4% quote- unquote magic number to use examples of what you should expect to pull from your investments in order to survive.
I think that number is kind of low because if you think about it, you would need several million dollars anywhere from two to $6 million depending on the lifestyle you’re accustomed to and the type of living standard that you want to have, but let’s just call it 4% if you’re drawing down 4% per year from $1 million and you have nothing to replenish it, it’s just simply your retirement fund and you’re drawing down from it, that’s $40,000 a year or $3,333 a month that you’re going to live off of. Now, if you live in a very inexpensive market and your cost of living is very, or you are willing to lower your standard of living, that’s fine. You could live off of that, but if you’re in an expensive market, a coastal market, let’s say New York, California or Washington DC, or a place where the cost of living is very high and even your rent would be $3,000 a month or more, that’s not going to be enough to live off.
Also, the other thing to consider with any kind of pool of investment capital or pool of retirement capital, I should say, is that unless it is replenishing itself or you are preserving that capital, it will deplete itself. So in this example, drawing 4% per year from $1 million would last you 25 years and then it would be completely gone. The other problem with this is that there’s no hedge against inflation. In other words, each and every year that goes by what you’re drawing from that million dollars is actually worth less and less every year because of inflation. So the purchasing power is going to be less every year. So you actually are not even keeping up with inflation by drawing down in this very simple example. The second example is investing that million dollars into something that will give you 4% per year as a minimum. Call it a 4% annuity, a 4% dividend, whatever it may be.
But again, you’re going to need more than that because of the effects of inflation. So you need to not only keep up with inflation, but you need to have the inflation hedge in addition to the draw down so that way you now are receiving a monthly or an annual income from that draw down. But again, in this example is you’re still making $40,000 a year or $3,333 a month from that million dollars that you’ve put away, and hopefully you’ve got that hedged against inflation. Now, here’s a third example, and that’s not to say that there aren’t other examples, but I’m going to give you a third example with real estate as the investment vehicle. Now with real estate. I’m just going to simplify this example just for the sake of illustration, but this is not far from reality here. I always like to use the a hundred thousand dollars three bedroom, single family home in middle America in a B class neighborhood because the numbers are just so simple and it’s typically a hundred thousand dollar home that rents for $1,000 a month.
That’s the assumption I’m making here. So what do you do with the million dollars? And this is $1 million in cash or $1 million from your home equity or $1 million from your business or whatever it may be, and I don’t know how much equity you have. In your example, you mentioned $200,000 but I’m just going to use this as a goal because the million dollars just rounds things out very nicely here. So let’s just say you purchased 10 rental properties, 10 $100,000 rentals, and there’s no loans, no financing. You just buy them all outright and we’re going to assume about a 35% expense ratio, which that at the end of the month, that thousand dollars will be $650 net income to you per property. While you’ve got 10 properties, 650 a month per property times 10 is $6,500 per month in passive income. That is real spendable money that goes into your pocket. You could live off of that.
You can spend it, you can go on vacation, you could do whatever you want, but 10 rentals, 10 $100,000 rentals without any financing should kick off around $6,500 a month from a cash on cash perspective. If you do the math, very simple, you just take your annual income divided by the million dollars and you get 7.8% so that means your return is 7.8% keep. One thing in mind too here is that this forms an inflation hedge because real estate is one of the best hedges against inflation because it sticks bricks, concrete and copper that’s sitting on dirt and so it is a natural hedge against inflation. Now, let’s make this more exciting. Let’s say you take that million dollars, and again, you could use other examples here, you just play with the math, but let’s just say you take that million dollars and you decide to put 25% down as a down payment and finance the other 75% of those purchases.
Well, that million dollars will allow you to acquire 40 not 10 but 40 $100,000 properties because you’re putting 25% down. You just do the math, you’re dividing $1 million by $25,000 now what you have is the same examples before, but now you have debt service on those properties. So when you deduct the mortgage, and I’m just rounding these numbers here, I’m just doing this on paper. Let’s just say you have $350 per month per property net cashflow. This is factoring in all your expenses, carry costs and your debt service. Well, let’s do the math. 40 units or 40 houses times $350 per month is now $14,000 per month in passive income. Your cash on cash return in this example is 16.8% much better than before. Why? Because you’re leveraging your investment capital. You’re using 25% as a down payment and you’re borrowing the other 75% and you’re letting your tenant pay that mortgage down for you each and every month, which of course naturally increases your equity in all 40 of those properties each and every month, and keep in mind what we’re not talking about here is the depreciation that you’re getting across all 10 or all 25 or 40 properties.
The equity growth through two things, the amortization of the loan in the case where you’re leveraging the investment and the appreciation on those 10 or 40 properties each and every year. Some years are going to be up, some years are going to be flat. Some years might be a little negative. If we go through a real estate cycle or a recession, but over time those tend to go up because again of the effects of inflation. Plus you’ve got local market drivers that push demand such as population growth, job growth and all that kind of stuff. So just to keep this example simple, you can just see how you can create a passive income of 6,000 to $14,000 a month by using that million dollars to invest in real estate. Now let’s keep going forward. Your husband mentioned the word risky and I’m saying risk in quotes here, air quotes, so let’s talk about that for just a second here.
If you were to take your $200,000 or the million dollars or whatever it is that you have in terms of retirement capital, retirement funds, even if it’s equity in your home, your two most common examples are something that’s related to the stock market, some sort of paper asset. The other is income-producing real estate. Now there are other options out there of course, but the two most common and the two most thought about is the stock market. And real estate. Let’s quickly compare and contrast those and then you can determine what you think is more risky quote-unquote. In the stock market you have high liquidity, which is a good thing typically because you can be in and out literally in minutes. It’s push button investing. With the stock market you can just set up an online account and way you go, but as we know specially recently there is high to very high volatility.
Of course, you can invest in things like index funds and ETFs and whatnot that have less volatility, but they are still being drawn up and down by the whim of the market. So there is volatility and some people just can’t put up with that or deal with it well or can’t sleep well at night. Knowing that one day they might be up 5% and then the next week they’re down 15% in their portfolio. So you have to understand that paper assets, particularly the equities markets have high volatility. We have unpredictable returns. It is very difficult to predict your returns month after month or year after year in the stock market. All you could do is look at examples and draw out averages and make assumptions. Thirdly, for the most part, it’s not an inflation hedge. You’re looking at nominal returns, not real returns. You can calculate the real rate of return from your stock market performance, but when you do that you will see that the numbers are lower than what most people talk about as being the quote-unquote average rate of return of investing in the stock market historically meaning you’re looking at over a long period of time.
Also you have little to no tax benefits investing in the stock market. It is a capital investment, meaning that you have capital gains, capital losses, those are treated as capital gains from a tax perspective and there’s no depreciation or tax with few exceptions of course, but generally speaking, when you’re buying stock or shares in a company, there are no tax benefits there and you have virtually no control and if you are handing your money over to a fund manager or financial advisor or someone who is essentially managing your wealth, some sort of wealth manager, they have no control over it. They are controlling your money in terms of where they’re placing it, but they have no control on where they’ve placed your money. So there’s really no control for you nor your financial advisor. Quickly comparing that to real estate, real estate has low liquidity.
It is relatively easy to buy, a relatively hard to sell unless you’ve, you know, of course you’re in a seller’s market and or in a good location, relatively speaking, low liquidity versus high liquidity. But what real estate does offer you is low volatility, predictable returns, very predictable returns, great inflation hedge, one of the best if not the best tax benefits in any investment class or asset class today. And this is especially true ever since Trump has put in the new tax plan, I believe was last year and you have complete and full control over your real estate portfolio. So the control, the tax benefits, the inflation hedge, the predictable returns in the low volatility. To me, I’m sure a lot of people will agree with me on this, your quote unquote risk is lower in real estate than it is in a paper asset, like the stock market.
Some final comments about home equity and I’m trying to keep these episodes short, but they seem to keep getting longer and longer. I’ve wanted to do these in seven minutes and now we’re on 18 anyway. Final comments about home equity. Think logically. It certainly feels great to own your home free and clear, but what you end up with is this big chunk of equity that I call dormant dead or just a, it’s untapped, but along with no mortgage payment on a free and clear property, you have this equity that’s like I said, trapped in your property doing nothing for you other than providing that feeling of security and is it really security or is it a false sense of security? Because for me, if I had a bunch of equity in my principle residence versus having some of that equity working for me and generating monthly passive income, I would feel more secure and knowing that each and every month I’ve got a check in the mail or what some people call mailbox money.
I would much rather have the mailbox money than sitting at home and sleeping at night knowing that I’ve got $1 million of equity in my property that’s not doing anything for me other than making me feel good at night. And for some people they can’t get over that and that’s fine. My last comment about that is what if you turned some of that equity into passive income? Well, that really means two things. One, it means that you’re earning more from the use of that equity versus the cost of it, and we call this positive cashflow. Second, you’ve simply moved that equity elsewhere. It didn’t disappear. You didn’t spend it. It’s not gone. What you’re doing is you’re just taking it out of your principle residence or your rental property or whatever other piece of real estate you have and you’re moving it and sometimes you need to move this in the form of a loan where you pull it out of your equity in exchange for financing and you have some sort of monthly mortgage payment, but now you’re putting it to work and what you’re benefiting from what you’re getting out of it is more than the cost a lot more.
And so that’s just arbitrage and you’re ahead of the game. That’s called passive income. It’s positive cashflow. My final thought here is this, if you’re in your 30s or your forties or your 50s and you want to invest in real estate, but you haven’t started or you just started, but if you haven’t started, ask yourself why not? What is holding you back and are you thinking about this emotionally or are you thinking about this logically? If you need help with that, talk to your friends, investment advisors and also talk to someone like my team of investment counselors. That way you have different people’s opinions. And perspectives on the same thing, but you’re looking at the same thing from different sides and angles and then you can make up your own mind, but again, think about it logically, not emotionally. Okay, Janice, I hope that helps and if it doesn’t, just contact me or my team.
All right, well if you have a question about real estate investing or finance and you’d like me to try and cover it on the show, I’m getting a lot of them lately just to go to passiverealestateinvesting.com and click on the Ask Marco button. You can also go to AskMarco.com and if you haven’t already, please remember to subscribe. Hit that little subscribe button on your phone or your computer. Help us share the show with other likeminded people. We love the ratings and reviews that you leave us on iTunes or wherever that may be. Again, thank you for listening and we will see you on our next episode.
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