“BUY NOW, LIVE IN LATER” OR “GET ON THE ESCALATOR”
Beach Condo Last evening, I met a charming couple from Scotland. They were interested in investing in a condominium in Florida. Rod, the husband, told me that he would like to buy a condominium or a home here in Southwest Florida that he could rent out and eventually move into in twenty years. This is a common request that I have from investors. They would like to buy an income property that will pay for itself, not need any management, need little maintenance, and be in wonderful shape when they are ready to retire to.
This is just not practical. For one reason, it is very difficult to predict what type of home or condominium would best suit you twenty years from now. It would be difficult to pick the location, or even the lifestyle. Secondly, this market is seasonal and to expect the rental income to carry the mortgage and expenses will require quite a large down payment. I call this the “BUY NOW, LIVE IN LATER” approach.
I suggested an alternative. I suggested that he “GET ON THE ESCALATOR”
This approach entails purchasing the property that is strategically selected to appreciate and serve as a vehicle to ride the escalator of appreciating prices so that when he is ready to buy the home of his choice he will have a saleable property from which to springboard into his ideal retirement home. I also suggested that he decide how much of an annual cash investment he is willing to make annually into this property.
(“annual cash investment” is my euphemism for negative cash flow) The way I look at things, the cash investment is comprised of two parts. The first part is the cash down payment to acquire the home. The second part is the annual cash required to optimize appreciation of the home while you own it. Keep in mind that while you own this investment property the mortgage is being paid down, increasing your equity plus the home is appreciating. There are tax benefits while you own a home as an investment. And these factors combine to make investing in income property very beneficial.
Let us say that you purchase a home for $300,000.00. The initial cash requirement is $65,000.00. The cost of owning the home is $45,000.00 per year. If the rental income is only $30,000.00 per year, this means that you have an additional annual cash investment of $15,000.00 into this home. The home will appreciate at least ten percent per year ($30,000.00). While you have a tenant occupying the property the mortgage will be paid down and your equity will increase. You will be able to deduct the annual cash investment as a loss against other passive income. Very simply, for a ten year program:
Cash Invested is $65,000 plus 10 times $150,000 = $215,000
In ten years the home will be worth (At ten percent per year appreciation) = $707,000
You still owe a mortgage or $137,000. (approximately) Even ignoring the tax benefits while you own, your investment (over ten years, mind you) of $215,000 is now worth, ten years from now, = $570,000. ($707,000 -$137,000)
This is the “GET ON THE ESCALATOR” approach that I prefer for preparing for retirement in Southwest Florida. The interest rates I use here are for illustrations only and not a predictor of future values.