Thinking about retirement

(Not me – don’t get excited.)

Over the past few days, I attended a conference for wealth managers. I won’t lie: My intention was to meet the people tasked with managing assets for affluent investors, with the idea of convincing some of them to steer their clients my way. Turned out to be the wrong decision; these guys can get sued to kingdom-come for putting clients into private deals that go bad, so they’re very reluctant referrers.

But just because the conference wasn’t right for me doesn’t mean it wasn’t interesting. One of the things that kept coming up was the fear that many investors have of outliving their assets in retirement. This got me thinking about how income producing real estate fits into a retirement plan.

The cool thing about income producing real estate purchased with a mortgage is that it is effectively a tax-efficient vehicle for forced retirement savings. What do I mean? Consider the situation of someone who buys a small apartment building in her thirties:

  • Say she puts down $200k on an $800k property with rents of $73k and net operating income of $45k (a 5.6% CAP)
  • To finance the deal, she takes out a $600k mortgage with a standard 30 year amortization and a fixed interest rate
  • Say further than she does a reasonable, but not spectacular job managing the building
  • Each month, before she pays out any cashflow to herself, she makes the mortgage payment, reducing what she owes the bank
  • The interest on the payment is tax deductible
  • And the principal portion of the payment, which is taxable, is more than offset by the depreciation
  • In addition to retiring the mortgage little by little, the building spits out some cash each year

Here’s what happens to our investor as she is hitting retirement age in her 60s:

  • The building pays off its own mortgage 30 years after the acquisition
  • The investor now owns an asset which is worth whatever 2044’s equivalent of $800k is (assuming it increases in value along with inflation; she should do better if the property is well-chosen) – whatever else she did with her money during her life, she has a big asset free and clear
  • Assuming rent and expenses grew at the same rate as inflation, once the mortgage is repaid, she’ll have an income of 2044’s equivalent of $45k / year

Whatever else our investor did with her finances during her life, she’s going into retirement with an income of $45k / year and an asset worth $800k. That doesn’t make her rich, by any means, but it does make her self-sufficient, particularly coupled with her government-provided healthcare (Medicare) and income support (Social Security).

Can you rely on just one apartment building to see you through retirement? That’s probably a bad idea. But, if you manage to get 1-2 of these deals done in your thirties plus behave reasonably responsibly over-all, you’re going to end up just fine.