The other day, I had a dentist call me and request assistance in converting his existing 401(k) retirement plan to a Self-Directed 401(k) retirement plan. He said he was tired of receiving the abysmal returns his retirement plan was generating and wanted to be able to retire early with sufficient passive income to support his lifestyle. After reviewing the past performance on his 401(k) plan, he concluded that he couldn’t get there if he continued investing as he had.
He basically discovered the simple truth many other professionals have come to know, i.e., investing in income-producing real estate provides the leverage you need to reach your retirement goals five times faster than investing in individual stocks or mutual funds. He said he didn’t want to end up at retirement with a sinking fund he had to liquidate to survive. He preferred having income-producing assets that appreciated in value during retirement that didn’t need to be liquidated over time. Here’s an example.
Recently, we put under contract a Family Dollar store located in North Salt Lake, Utah. The acquisition price is $1,307,000 and the equity capital being raised is $432,000. The amount being borrowed is $875,000 at 4.88% amortized over 25 years, which is a lower interest rate than the property can achieve with no debt, so we have positive leverage. With no debt we would have an average of just under 7% Cash-on-Cash Return.
Based on these numbers, the average annual projected return to the investors over the 5 years is as follows: 6.54% Cash-on-Cash Return, 10.77% Return on Equity, and 15.91% Internal Rate of Return. These are strong returns for a Triple Net Lease, Fortune 500 property in a great location.
These returns take all the stress out of investing in the stock market. There is virtually no volatility over the next several years. The lease payments are paid every month like clockwork and the checks for the distribution to your retirement plan are sent each month. You don’t have to worry about market timing, volatility or other conditions that typically affect stock prices.
The reason income-producing real estate is so good is that there are multiple streams of revenue that add to your overall return. For instance, each income-producing real estate investment has three sources of revenue: (1) Net Cash Flow; (2) Loan Principal Paydown; and (3) Appreciation in Value. These three revenue streams are measured by three types of return: (1) Cash-on-Cash Return; (2) Return on Equity; and (3) Internal Rate of Return. Each metric measures your annual Return on Investment based on the different revenue streams produced.
Cash-on-Cash Return is based on actual Net Cash Flow received from the operation of the property divided by the actual cash invested in the property.
Return on Equity is based on the actual Net Cash Flow received plus the annual principal paydown on the loan. As the loan is paid down each year from the lease payments received from the tenant, the equity increases.
Internal Rate of Return (IRR) is a comprehensive measurement that includes the total amount of equity invested plus the annual cash distributions received plus the equity received by paying down the principal on the loan plus an estimate of the appreciation in the value of the asset upon sale.
