Early FI Progress: Last Night’s Meet Up (April 03, 2014)

pieology

I met up with my local real estate agent on Thursday night to discuss future plans. As most everyone is well aware, the housing market has continued to recover, and prices (at least locally) are now sitting at all-time highs (for the most part).

Background

If you were trading stocks, and your initial investment appreciated from $80,000 to $230,000, what would you do? That’s a 188% return on your investment! I’ll be the first to admit that I’m no stock picking expert, and I’m probably even more of a novice when it comes to real estate investing. So, I would be absolutely delusional to think that I possessed the know how to replicate such results again in the future, time and time again.

I’m not so smart. And even if I was, I still wouldn’t see the point of sitting on so much equity. Even if the house I bought is now worth substantially more than what I paid for ($315,000 to ~$465,000), what good does it do me if I don’t find a way to tap into that equity? Do I see an increase in cash flow each month? No. Does it allow me to quit my day job anytime sooner? No.

Just like with paying down mortgage debt on a personal residence, that money sitting in there does me no real good and is just wasted opportunity…

So, it’s back to the drawing board! In order to get to early FI by 30, I will need to move one last piece. I call it “checkmate”. Granted, a lot of this future planning involves the market fully cooperating, so if it does decide to correct or crash again, all bets will be off. I do factor in a lot of “what if” scenarios (including Doomsday events) when I plan, so I’ve already accepted the consequences of another market crash. If a crash happens, my strategy will change entirely (I’ll want to keep working to load up on more houses!). For certain, I won’t be retiring early at 30! 🙁

The Meeting

We met at Pieology, which is a pretty happenin’ new pizza chain restaurant. I filled my agent in on my current situation, and asked him straight up, “If I want to invest my capital back into the Bay Area, what should I do?

I already knew that investing money back into residential real estate made no sense (the 188% gains on Rental Property #1 would be nullified by exchanging it for another asset that would have experienced the same meteoric rise in appreciation gains), so I wanted to talk about investing in commercial properties.

The following is just one man’s opinion, but I do trust my agent. He’s a straight-shooter and even agrees that looking at residential properties for cash flow is a dead end; it simply doesn’t exist in today’s market in the Bay Area.

Here are his thoughts:

  • For commercial real estate, apartment buildings are being overbought. Not just in the $1M space, but all the way up to $20M+. Too many players, and too much interest. As a result, don’t expect to find Cap Rates above 3% or 4%. If you’re lucky, you might be able to locate 5%. If you want 7% or better, be prepared to drop even more funds into an extensive rehab project. Since rents are scaling up so rapidly, he feels that a lot of big-time players are going with the strategy of forced appreciation (total gut jobs).
  • The “sweet spot” in the commercial space is around $4M to $10M. Here, you should be able to find office buildings with Cap Rates of about 7% to 10%. These are Class B buildings. If you want Class A, you probably won’t get more than 5%. Again, a lot of players in this space are looking for appreciation gains. Their buy-and-hold period is about 5-10 years.
  • Just like with residential real estate, the best deals are the ones that fly under the radar. My agent doesn’t believe in buying a commercial property that’s publicly listed. He only targets distressed sellers who need to sell FAST.
  • The learning curve for commercial real estate is very steep. Don’ go in expecting it to be much of a passive investment, especially at first. It’s important to get as educated as possible before jumping in and risking your neck.
  • When it comes down to it, bottom line, I’m just too small a fish to be playing in this giant ocean filled with sharks. Most of the clients my agent has are “very cash rich”. They don’t need to liquidate properties, or do 1031 exchanges to come up with the required capital necessary to get in on these deals. These folks have $1M+ in liquid funds at the ready.

My Thoughts

I’m not too surprised with the things I learned from this meeting. I expected just about as much, although I was somewhat disappointed to learn that $1M doesn’t go very far in the Bay Area, at all. I was hoping to find a $1M deal where I could put down 25%, or $250,000 (Rental Property #1 equity plus $20,000 of my own funds). Either that, or find a more expensive deal and partner up with someone…

So, what am I to do? At this point, I honestly feel like my best strategy is to perform a 1031 exchange, capture the appreciation gains from my Bay Area property, and deploy it elsewhere in the country. Buy low and sell high. Re-investing back in the Bay Area makes very little sense because EVERYTHING here has appreciated substantially. Why not take my buying power and maximize it elsewhere?

I believe I have two options:

  • Continue going the turnkey route. I can deploy the $250,000 and load up on 6 properties (Indianapolis, Dallas, Houston). This would maximize my loans to 10, and allow me to make significant progress in the cash flow department. In the Midwest, it shouldn’t be too difficult to locate 10%+ Cash-On-Cash deals, even in today’s market. That would be $25,000/year, or over $2000/month in cash flow. Combine those figures with my four other rental properties (I currently own five, but would have to liquidate one), and I should have enough passive income to declare early FI. The drawback? I would sacrifice long-term appreciation gains (since turnkey companies generally focus on Class B-/C neighborhoods)… But when it comes down to it, cash flow is what I’m ultimately going after. Cash flow will buy me my freedom. Appreciation would make me wealthy beyond my wildest dreams, but who says I can’t aim for that later in life? A large part of me just wants to keep things as SIMPLE as possible. Secure the cash flow now, buy my freedom, and then worry about the future later. The turnkey route would also be by far the most passive form of investment.
  • Invest the capital into acquiring an out-of-state commercial apartment building. $1M in the Bay Area doesn’t get me very far, but in places like Phoenix or Dallas, I might be able to get 20+ units. Getting into commercial real estate would be something EXCITING. I’m sure I would also have a ton of fun learning something new again… Although, I’m sure the devil is in the details, and it won’t be simple at all! For the right deal, though, I might be able to secure both cash flow and long-term appreciation. I know that Dallas is up and coming, and they are building up like mad out there. For the right deal, I might even just decide to quit my day job and move out there… I could live in one of the units while I learn the ropes. I would finally own my own “personal residence” too! A place where I could store all my minimal stuff while I tour the rest of the world. Through my initial cursory glance research, I’m seeing Cap Rates being advertised around 7% to 10%. That’s not so bad…

Most likely, I believe I will go the turnkey route. I’m not sure I want to be managing a commercial project while I’m thousands of miles away on a faraway island. That’s not exactly my idea of a fun, relaxing retirement. But I don’t want to close the door on that possibility either. For the right deal, it may very well be worthwhile.

So, I’m going to start doing my research! I’m going to reach out and see what’s available out there. In regards to Rental Property #1, I’m still not sure if I’m going to try and sell this year, or wait until Summer 2015. These days, I’m getting a little more impatient and wanting to execute sooner rather than later. That, and I fear a major market correction which could potentially wipe out ALL my appreciation gains. Most of all, I want early FI ASAP! 😉

If I were to sell this year, I would start by actively listing Rental Property #1 on the MLS in June. July is typically the peak of the buying season out here. I’m also guessing all the pieces wouldn’t be in place (completed) until the end of the year.

Retired by the end of 2014? That’s very possible… and it’s starting to sound pretty good. 🙂

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kb
kb
6 years ago

Very impressive man. I think avoiding commercial is the right move for you as well. I met with a big time real estate investment broker and basically got a similar story anout commerical properties. it’s definitely much more geared towards people with some real liquid $mm.

Either way, I wish you the best and continued success.

writing2reality
6 years ago

FI, I can honestly say I felt that your drive to leverage the equity gains in your first rental would absolutely bring you to FI sooner than anticipated. Given the amount of potential capital for you to invest, the draw of earlier freedom and additional cash flow I think is the right move. Like your initial gut feeling, I would also move towards investing through the turnkey companies and add to your geographic diversification and spread the risk among six properties. Like you are considering now, I think taking advantage of the opportunity you have this year is a good… Read more »

Thegoblinchief
Thegoblinchief
6 years ago

Commercial sounds way too hands on.

The only way I would own a commercial building in retirement is if we decided to operate a small store with 2-4 units on top, living in one.

No Nonsense Landlord
6 years ago

Think big, but plan for risk. Continue to evaluate options that you can continue to grow cash flow, and lessen risk, not increase it.

Leigh
6 years ago

Commercial sounds pretty crazy to me. Retired by the end of 2014 is starting to look pretty real for you – can’t wait to see it happen! Retired at 29! Sometimes I debate selling my condo and renting again to cash out on the appreciation (my estimate is $50,000), but I don’t think that’s worth it because to rent a comparable place would be $1,000/month more than what I’m paying to own my place (including the required monthly principal). Plus, I like my place. It does mean though that if life convinces me it no longer makes sense to live… Read more »

Marvin
6 years ago

Wow, I didn’t even consider the commercial property side, but you’re right I’d imagine there are ALOT of sharks out there.

The Wallet Doctor
6 years ago

Commercial sounds really intense! You’ve got a good strategy here. Thanks for sharing everything you learned here!

Dave @ The New York Budget

Nice work. The part that stood out to me was the part about appreciation making you wealthy beyond your wildest dreams. I often fantasize about strategies that will lead to that outcome, but then I ask myself “why do I want to be wealthy beyond my wildest dreams?” – I have thought long and hard about my goals in life and my plan to get there. When I get to that level, everything else is just gravy – just a number I am chasing for status, or whatever. Which is why, like you, I would choose the turnkey route if… Read more »

The First Million is the Hardest

Commercial real estate sounds riskier but could possibly be more rewarding. I’ll be interested to see what you decide to do & how it works out!

Done by Forty
6 years ago

I agree with your take on the turnkey route. Tapping into the equity of our paid off home is phase two of our plan. But right now we have some cash to play with, so we’ll leave the equity alone.

I’d love to hear more about how to use a 1031, what costs are involved, etc.

Paul
Paul
6 years ago

Fi fighter. I’ve been reading your blog for a while now and I have the upmost respect for you, your on a similar path to myself, so I totally buy into your thought process and in trying to achieve Financial freedom, what it will give you in life (not having to work!) and the investment path you have taken – mainly property investment, I myself think this is primarily the most effective route and greatest ROI? I don’t mean to be disrespectful, however some of your numbers, I.e positive cash flow (yield), equity release from property no 1 seem almost… Read more »

Paul
Paul
6 years ago

Well glad you got in at the right time in the Bay Area. I’ve just bought my 1st in London so hopefully prices will keep rising!
Keep up the good work and useful information you print on here, I’m sure lots of readers are taking valuable points from your posts.

All the best for now..

Evan
6 years ago

Why isn’t it all relative? If there has been that much appreciation why isn’t your rental yield (cap rate) that much better?

Roz
Roz
6 years ago

Hi FI. We r definitely in similar paths. I’m fighting for FI and I too have properties in Calif that have appreciated and now thinking of the next move. My thought is the same, I need to do a 1031 since I’d hate to lose so much to tax. Then I have to find a place with better returns. I researched the turn keys. Indianapolis which doesn’t go up much have seen a bit of appreciation this past few yrs. doesn’t matter much if u r into cash flow but if something goes wrong and u want or need to… Read more »

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[…] it’s been a few months since I sat down and had a discussion with my real estate agent, and I’ve had a lot to think about… On paper, I must admit, it still looks so appealing […]