Recently someone on a forum asked me a great question. Can you lay out in simple terms your long term plan for real estate investing? Basically, they are asking, What’s your big picture when it comes to real estate?
It’s something that many people have asked in various ways. But never so succinctly. And I found that it was a fun exercise to distill down our whole real estate investing plan to its simple component parts.
Again, I am a simplifier rather than a complexifier. So this appealed to my nature.
I also remember when Selenid and I were just learning about real estate investing. It can be really hard to see the long term plan at first.
You hear everyone (including myself) talking about how great real estate investing is. But then you realize that your first property will cash flow $10,000 annually. And you start to say, Well, this is way less than my clinical salary. What’s the point?
Let me assure you, there is a point! And a great point at that. Real estate investing is a wealth accelerator. It has done just that for me and Selenid.
I can prove it here:
But one property will not make you wealthy. And that is an important but often glossed over point!
That is why it is necessary to be able to step back and visualize the big picture of real estate investing. To look years down the road and see what you will be able to grow. Then it makes all the sense in the world.
As an analogy, compare this to becoming a doctor. When you decide to become a doctor and take your MCATs and get into medical school, you don’t think that one class is going to make you a doctor. But you plan out and see the big picture and persist in your efforts.
It’s the same thing (But with less burnout!)
So let’s start visualizing the big picture!
Before we start, if you are looking for a quick primer on the topic of real estate investing for physicians or of my current real estate properties, check out these posts:
- A Physician’s Guide to Real Estate Investing
- Insider Look: Deal Analysis of Investment Property #3
- Insider Look: Deal Analysis of Investment Property #2
- Insider Look: Deal Analysis of My First Investment Property
Laying out our long term, big picture real estate investing plan
I’m going to go step by step, explaining each one along the way…
1. Buy small multifamily properties that cash flow > or = 10%
This is the crux of our whole plan. We evaluate and seek out properties that cash flow greater than or equal to 10% cash-on-cash. Usually, the properties we select cash flow way more than this. But we like to be conservative.
It’s important to note here that we invest largely in long term rentals rather than short term rentals. But short term rentals are a very viable option as well. More info on that here.
Here is an in depth guide detailing our strategy for screening and analyzing prospective rental properties:
2. Use forced appreciation to increase value
Once we buy the property, we look to force appreciation.
Remember, there are 2 types of appreciation: market appreciation and forced appreciation.
Market appreciation is a gamble. It is dependent on the whim of the real estate market which is volatile in the short term but trends upward in the long term. Any market appreciation that we experience on our properties is a cherry on top. But we do not rely or count on it at all in our plan.
4 Reasons That Cash Flow Is King in Real Estate
Instead, we take advantage of forced appreciation, which is in our control. The value of a rental property is different from your residential property. Your rental property is a business. It has income. The value of the property increases as the income increases. You can figure this value out using the NOI and cap rate. (Read this post if you are unclear on these terms or how this works)
Forced appreciation happens when you make rehabs or renovations to the property to increase the income (rents) that you can collect or otherwise optimize your property to reduce costs and increase income. Doing any of this will increase the value of the property.
We have increased the value of each of our properties by 5 or 6 figures by doing exactly this.
3. Claim REPS to shelter rental income and partial W2 income
Depreciation is something that all real estate investors have to know and understand.
Basically, depreciation says that your real estate property decreases in value every year by a factor of 1/27.5. This happens even if your property is actually bringing in money…like our rental properties are. There is also a thing called accelerated depreciation in which you can claim more of these paper losses in your first years of owning the property.
Depreciation is a paper loss for your property. And you can use this paper loss to offset the income that your property makes. Every investor can do this.
But, if you obtain Real Estate Professional Tax Status, you can use any paper losses above your rental income to offset W2 income. Your can obtains REPS by working at least 750 hours on your property which must be greater than the amount of hours you spend on any other job that year.
Selenid plans to obtain REPS status and we plan to use accelerate depreciation to offset a portion of our W2 income taxes.
3 Things I Did To Reduce My Taxes This Year
4. 1031 properties to larger multifamily properties with greater absolute value of cash flow
As we accrue properties and force appreciation, the equity that we hold in the properties will increase. We can then use that equity by selling the old properties to buy new, large, more profitable rental properties.
And, using a 1031 exchange in which we sell one property and buy another of equal or greater value, we can defer the taxes that we would normally have to pay on the sold property.
Let’s use an example to show how powerful this is
Many people getting started learning about real estate ask me how it’s possible to buy bigger rental properties without sitting on a huge stack of cash as a down payment.
This is how. (Note: I am using crude numbers in the way of an example)
- Buy a $150,000 property with 25% down payment
- Force appreciation so it is now worth $250,000 two years later
- Sell that property to get back your equity equal to your initial down payment, any equity from the tenants paying off your mortgage via rent, and forced appreciation (~$145,000)
- This equity is not taxed when used as part of a 1031 exchange
- Use that equity as a down payment to buy a $700,000+ rental property with 10% or greater cash-on-cash return
Powerful stuff! Talk about visualizing real estate investing in the big picture!
Addressing a counter argument:
By taking advantage of accelerate depreciation, you have less depreciation to help shelter cash flow and taxes in the future. That is why many people advocate for selling your property via 1031 exchange after using accelerated depreciation.
However, as I described above, that is not the main determining factor in us selling a property. If we do sell the property after accelerating depreciation for other reasons so be it. But if we don’t, we will just pay the taxes we need to while accepting that we essentially got a 0% interest loan from the government on our previously sheltered taxes.
We would likely use this “loan” to pay off student debt and/or buy another cash-flowing property.
To me, that is well worth it.
5. Continue to buy & hold more properties to increase cash flow to goal desired for retirement
Now, I know I just talked a bunch about 1031 exchanges, selling old properties and buying new properties.
But, overall, we are strong Buy & Hold real estate investors. We are not looking to flip the houses frequently. Obviously, selling properties does have a big role in the long term plan. But the foundation is buying and improving long term rental properties based on steps 1 & 2.
As I mentioned above, the real estate market, like the stock market, is fickle and volatile in the short term. But over the long term, the trend is always up.
That is why a Buy & Hold strategy works.
Further, you only collect cash flow via rent so long as your hold onto these properties. This cash flow is going to be a big part of our retirement. So, we hold.
6. Stop buying properties
This is a deceiving tricky step. I am not there yet but I can already tell.
Investing in real estate is a bit addicting. But there has to be an end point. So, Selenid and I have already talked about and established an end point.
And it’s a simple one. We will stop buying new properties once we reach our cash flow goal desired to retirement.
And if you need help determining how much money you need to retire, read this post:
7. Pass to heirs
When we pass away, we plan to leave our properties to our kids. They can then do what they want with them.
(A) Keep the properties and their associated cash flow, or
(B) Sell them for the lump sum and use it for something else. When they inherit the properties, they will receive the step-up in basis, meaning that the current value of the property will now be their basis. Thus, the taxes they would pay on the lump sum are much reduced.
This is how generational wealth is grown. However, the kids can certainly squander all of this. They are 2 and 3 years old right now. It’s up to Selenid and me to teach ’em right.
Real estate investing is a big picture game
That’s out long term, big picture real estate investing plan.
I truly believe that to be successful as a real estate investor, this is the type of thinking and planning that you must do.
I see too many potential investors get caught up thinking small and not taking advantage of the wealth available via real estate. Even worse, I see people get started without any plan at all and get burned.
Real estate investing is not hard. I am no smarter or better an investor than you. But it does take preparation, persistence, and planning!
Start your real estate journey today!
- A Physician’s Guide to Real Estate Investing
- Are We Headed for Another Housing Crash?
- Insider Real Estate Update: Ups and Downs But 22% CoC!
- Financial Freedom Through Passive Income: Year 1 Update
What do you think? Do you have a big picture real estate investing plan? What is it? Let us know in the comments below!