2008 marks the first year when 78 million baby-boomers born between
1946 to 1964 start retiring. This is the first time in the US history
that there is so many people who will be eligible for AARP membership.
So how will this affect you when it's your turn to retire? And what
should you do now? Since it has never happened before, you don't have
the benefits of learning from history. Let's look at the big picture
from 30,000 feet:
1- Uncle Sam is currently spending about $1.30 for every tax dollar he
collects. As of March 2008, the US national debt has skyrocketed to
over $9.38 trillion dollars or about $30,894 per citizen. The
majority or about 44% of total debt is owned by foreign or
international investors. The borrowing pace has also accelerated as
he added $2.38 trillion dollars more debt just less than 4 years. The
budget deficit for 2008 could widen to over $500B. The Government
Accountability Office (GAO) warned this kind of fiscal policy is
simply unsustainable!
2- Per Michael Astrue, Commissioner of Social Security Administration,
Uncle Sam will begin paying more benefits to retirees than he collects
from active workers starting in 2017! The situation for the Medicare
Trust fund which pays for hospital benefits is even worse. To many
retirees, Medicare is even more important than Social Security checks.
Per David Walker, the former US Comptroller Director, the Medicare
Trust Fund will pay out more than it collect starting in 2008. This
is because Americans are living longer while having fewer children.
The baby boom generation just compounds the problem. So there are
fewer young workers paying taxes to support the retirees. Government
spending on health care alone could double by 2017 to more than 2
trillion dollars a year as a result of baby boom generation retiring
and rising costs of drugs & medical expenses. As a consequence, the
reserves for the Medicare trust fund will be depleted by 2019!
3- On top of that, the US has a huge appetite for imports. The trade
deficit reached $708 Billion dollars in 2007. It has been rapidly
increasing since 1997 when the figure was only $108 Billion. So more
and more of our capital is sent to the Middle East and China to pay
for our addiction to oil and imports. Per the Wall Street Journal
(WSJ), the US has spent $10B since 2000 to expand railroad tracks,
freight yards and locomotives; and planned to invest another $12B.
It's not an accident the US is expanding its railroads the first time
in nearly a century. One of the primary reasons is to haul more cheap
Asian imports to heartland cities.
The aging of the baby boomers is probably the US most urgent issue of
the 21st century. The government will have to spend more and more
money that it does not have. To put it simply, the problems are so
big and a financial train wreck is inevitable. The question is not if
but rather when the tipping point triggering an unprecedented
financial crisis will happen. So to make sure you will be least
impacted by what is about to come, you will need plenty of cash when
you are retired.
If you work for Corporate America, you probably participate in the
401K plan which invests mostly in stocks/mutual funds and bonds.
While 401k is a convenient retirement plan for many as it allows
people to make a small monthly tax-deferred contribution, it may not
be the solution for everyone. Some people prefer to own more tangible
real estates with limited supplies that they have total control and
most likely will not reinstate financial results years later! Most if
not all financial experts agree that as you get older, you should
reduce your investment in the stock market due to its volatility. In
addition, the stock market is often promoted & considered as a best
investment in the long term. However, the WSJ summarizes it all on
its March 26, 2008 issue "By one broad measure, the stock market has
made no progress over the past nine years." So where should you move
your investment to? This article discusses about an alternative plan
to 401K and for a lack of better name the "equity-of-my-home-is-my-
retirement-investment-plan". It is intended to introduce a new
paradigm in retirement investment that is not promoted by Fidelity,
Smith Barney, eTrade or Charles Schwab.
There are several reasons why commercial real estate investment is a
strong candidate:
1- It is a fairly stable investment. This is an important factor as
investors want to make sure their equity is also preserved throughout
their retirement years. Unlike stocks, real estate investment is not
sensitive to market fluctuation. Commercial real estate investment
will shield people from going through the emotional roller coaster as
the stock value widely fluctuates sometimes within a very short time.
The stock of the Bear Stearns, the fifth biggest investment bank in
the US is an example. J.P. Morgan Chase & Co. initially offered $2 a
share for what was traded at $150/share in March 2007 with a book
value of $84/share and Lehman Brothers reiterated its $110 price
target just 3 days earlier! It sparked soul searching questions about
the true, not book, not market, value of stocks & mutual funds. You
don't see this kind of dramatic volatility in commercial real estate!
2- It generates strong cash flow after paying all expenses and
mortgage. To those who invest for retirement purposes, this is
another important criteria. In order to retire with dignity you need
cold hard cash. Your social security check which was never intended to
be your only source of retirement income will most likely not
sufficient. The maximum benefit for a 65 years old person in 2008 is
only $2185/month provided you have maximized your contribution every
year after you turned 21 (you can estimate your social security
benefit check on www.ssa.gov/OACT/quickcalc). For those who are still
working for Corporate America, this cash flow gives you a second
source of income just in case. The simple truth is you are the
company's most important asset until you get the pink slip. Besides,
your gray hair is often a liability! To achieve strong cash flow,
investors often look for properties where "cap rate" is higher than
the interest of the loan. This means you also make a profit on the
money you borrow! Texas is an area where many commercial properties
offer 8-9% cap rate and it is a good place to invest for strong
income. Commercial properties are like a golden goose that keeps
laying eggs. You can just eat the eggs, i.e. cash flow, without
slaughtering the goose, i.e. your equity, for meat.
3- It is an excellent hedge against inflation. As gas approaches 4
dollars per gallon, you will have to pay more on almost everything.
In addition, the US dollar is falling against most foreign currencies
so imports will cost more (is there anything made in the US any more?)
All these things cause inflation to go up at least in the foreseeable
future. Commercial properties tend to hold values very well for two
reasons: strong cash flow and limited supplies. Besides, the leases
often have an annual rent increase so you should have a raise every
year. As the rent increases, the property value is more likely to
remain the same or to go up.
4- It gives you a wide range of landlord responsibilities options from
purely passive to active. Some single-tenant properties, e.g.
restaurants or pharmacies offer 20 years absolute triple-net lease
with no landlord responsibilities whatsoever. This means you don't
have to worry about looking for a new tenant for a long time. The
tenants maintain your property in first-class condition & pay for all
property taxes while all you have to do is cash the rent check and pay
the mortgage. This kind of property is ideal when you don't want to
do anything.
5- It also offers potential for appreciation while allows you to
depreciate for income tax purposes. This may increase dramatically the
overall return of the investment. It is a more prudent investment than
residential real estate investment. Due to strong cash flow, you
don't have to gamble on appreciation to make money and thus are less
likely to invest on pure speculation. If the property appreciates in
value then your investment return is much better. However, if it does
not appreciate rapidly and thus you don't get rich quick, your rental
income is more than enough to cover the loan payment & expenses. As a
result, your property is less likely to be foreclosed. So it's not an
accident that the default rate for commercial properties is only 4/10
of 1%, at least five to ten times lower than that of residential
rental properties. Of course real estate properties are more
difficult to sell compared to 401k shares. This actually encourages
you to hold the properties for long term investment and discourages
you to sell prematurely.
Below is a case to illustrate these principles:
The Smiths (name changed to protect privacy) had their own business
and lived in a very expensive neighborhood in the San Francisco Bay
Area. They planned to sell their business and retired in the next 2-3
years. They still wanted to maintain current life style. Over the
years, they had invested in real estate and had quite a bit of
equities in several residential properties. However, they figured out
these residential properties would not generate enough cash flow for
them to retire comfortably. They decided to exchange these properties
for ones with more income. They sold one of the properties and netted
about $1M. While the Smiths were looking for properties with high
rental income, they wanted to make sure the investment also preserved
their equity. This meant they would need to invest in a stable and
growing area. They chose to do a 1031 tax-deferred exchange for a
$2.825M Italian restaurant located in front of a mall in the fast
growing Atlanta metro. The financial information showed the tenant
was doing very well and expected to do well in the future due to its
highly-visible and irreplaceable location. They applied for $1.8M 5-
year fixed-rate 30-year amortization loan at 6.95% interest rate. The
property generated $19,000 of net rental income a month after expenses
(8% cap) while the mortgage payment was $11,915. So each month, the
Smiths net over $7000 of cash flow --several times more than the
expected amount of their social security check. The tenant signs a 20
years absolute triple-net lease in which there are no landlord
responsibilities. Since the lease had a 2% annual rent increase, the
Smiths could expect to get even more cash flow in the future.
<b>Conclusion</b>: The turbulent stock market in 2008 and the subprime
crisis are a belated wake up call to reevaluate the emphasis on
investment for growth & appreciation to investment for income.
Investing in commercial real estate is a good alternative solution to
generate a strong & stable stream of retirement income for baby
boomers while preserving your equity. However, it is not a plan for
everyone as it requires a large sum of down payment. It's time to
take action is now before everyone jumps into the bandwagon.
You are welcome to share this report, unedited and in its entirety,
with anyone you like. You may not remove this text. (c) 2008 eFunding,
Inc.
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