This is getting old . . . Seriously . . . .

Real estate can be a fantastic asset for preserving and growing wealth over medium and long spans of time.  This is why many of the most prolific families in the history of our country and abroad have held portfolios of real estate.  Between the growth in value, the ability to use leverage to purchase, cashflow, tax advantages, and the ability to provide quality housing to others who in turn pay down your leverage . . . . it’s not hard to see how these levers work to grow financial momentum over time.

What is often less clear is how the aging of a home can become a walking-back of many of the advantages we’ve realized in the earlier stages of our asset.

Repairs can be a walking-back of revenue in previous years

We often think that we are somehow gamifying or “hacking the system” when we think of the way depreciation loss works [refresher:  depreciation loss is the paper loss (i.e. not an actual loss) that the IRS allows an owner of investment real estate to claim each year to spread out the loss of the full value of the structure over 27.5 years (residential) or 40 years (commercial)].    This is indeed the case, unless:

• You own the home for 27.5 years
• You own the home long enough that you incur the large cash-sucking capital improvements needed during the economic life-span of the systems of the home (HVAC, windows, foundation, appliances, roofing, plumbing, electrical, etc)

In these cases you actually are simply moving around the tax-benefit slightly at best.  In truth the IRS is not being “nice” to allow for depreciation loss; they are being honest.

Not nice . . . Honest

Houses die . . . or are dying . . . constantly.  We own buildings that are made of parts that will each, at slightly different times, need to be replaced.  Knowing this the IRS has shrewdly created a tax schedule that allows investors to be financially safeguarded in the good years so that we can be safeguarded in the cash-sink years.  Let us not be naïve of this!

Too often what we see is that owners of residential real estate fail to realize that once a home has been in the rental pool for around 15 years or more, OR the home is more than 50 years old and has not been deeply renovated (“down to the studs” kind of renovation) in the previous 25 years, then you are on borrowed time.  Each year that goes by holds the possibility that a sewer line will need to be replaced, a tree removed, windows replaced, electric panels updated, HVAC systems replaced, and on and on.  Each of these can “eat” months (even years) of cashflow in one fell swoop.

Whose fault is this?

Is this a failure of some sort?  Of management?  A tenant?  A vendor?  The wind, waves, or God himself?

No, these things can impact the life-span of the systems, but in the end when a system fails after its useful life-cycle they must be replaced, and when they must be replaced it is often the wrong time to think about how to optimize your investments.

Taking it home

Where do we go from here?

The best thing that you could possibly do with your investments is to regularly realign (or rebalance) them in whatever ways lead to the best momentum towards YOUR goals.

For instance . . . I started out my investing journey with the intention of creating “passive income” that exceeds my cost of living.  That, according to my awareness at the time, was freedom and that was my aim.  Fast forward seven years and my goals have changed and I do believe that cashflow is the ultimate aim, but right now it can be a distraction.  My aim these days is to find ways to afford the best real estate possible.  This allows me to combine the different benefits of real estate investing outlined in our intro in a way that compounds beautifully over time.  This flows out of my aim to build multi-generational wealth in all five of the capitals of life, including financial.  My aim is not for financial freedom tomorrow, but rather for the resources that will allow my family to walk in freedom for generations and to bless the communities they are in.  This will be most benefitted by better assets, not by cashflow today.

So, if total value is the aim and not cashflow today, then it often makes more sense to swap properties for ones that are better poised for value growth (usually newer properties, which also have the benefit of having lower repair costs and premium resident profiles).  For this reason I’ve traded a lot of cashflow for more premium properties.  Ironically this also reduces the complexity of my investments, which is a nice side-pot benefit.

Another investor, however, may be in a different season of life.  While I am in the summer, he finds himself in the late fall season of life and to them cashflow is the need of the hour.  But . . . not all cashflow was created equal and for this investor the more predictable the cashflow the better AND the more stabile his principal base the better.  So, for them my strategy of newer-and-better-and-swap-swap-swap doesn’t work so well.  Mine will cashflow in 7-10 years, his needs to cash-flow now.  So, we look at slightly older A- location properties with high down payments (usually 50% is where we see it work well.). We’ll want these to be renovated well upon purchase to stabilize the cashflow and we’ll look to recapitalize through a refinance or a sale-and-repurchase as needed if the properties value faster than expected.

Two investors, two different needs, so . . .

Two different investors with two vastly different needs.  It should not be surprising that the two portfolios look different and they should.  But, this is a nuance that gets glossed over in the watercooler chats about real estate investing.  Let’s end that.

What do you need?  What do you want?

Let’s make YOUR portfolio work for you!  If your properties have been rentals for more than 15 years or if they have not had a “down to the studs” renovation within the past 25 years then we recommend you:

• Set aside at least $40,000 per unit for renovation on the next turnover (use $50/sq ft of your home size as a short-hand for renovation cost)
• Look for an opportune time to trade the equity you have up to a property that works better for you (newer, more cash-flow efficient, prime for value growth, etc). Consider selling and using a 1031 exchange, seller financing, etc.