Richard H., Real Estate Investor

During the recent Chick-Fil-A grand opening event that I went to, I met a handful of interesting people.  There was one in particular who I found fascinating and was able to talk to for a great length of time.  It was a gentleman named Richard, who eventually revealed to me that he was financially independent and had done so at a relatively young age (mid-40s).  After hearing what he had to say and asking him lots of questions about him and his story, I couldn’t help but think that he would make a great case study.

Although I have yet to do any biographical case studies, it is something I think I am going to make a greater effort towards.  You never know the kind of interesting people that you will meet as you walk through life, or the amazing stories you will encounter of people through books or other means.  Allow me to introduce Richard as the introductory case study toward a hopefully ongoing series.

Richard H. Net Worth and Biographical Overview

Full Name: Richard H. (real name redacted for privacy)

Born: c. 1970

Gender: Male

Nationality: United States

Family: Married, with children

Education: College

Estimated Net Worth: 1,000,000 – 2,000,000 USD

Source: residential real estate – single family homes, multi-unit homes

Richard H. Business Model

  • Work hard to achieve academic excellence, if you know it is going to take you to a well-paying career eventually.  Richard started out poor, graduated in top 5 of his high school.  Most students didn’t go to college because gang violence caught up with them.
  • Keep trying until something sticks.  Richard went to local college on a scholarship and then eventually transferred to another university.  He didn’t know what to pursue professionally – tried engineering, then accounting, then computer science/IT.
  • Continually seek to earn more, especially early in life.  OK grades in college but nothing spectacular; needed time to work.  He worked five jobs at one point during college (computer lab, furniture store, etc.).
  • Eliminate debt as quickly as possible.  The reason for working so much was to graduate with little debt as possible; graduated with $10,000 in debt, but paid it off the first year out of school
  • Go into a field that pays well and has room for growth.  He started working in IT (really loves technical challenges) with a decent salary.  As far as career goes, he stated that it is important to work in a field/environment where there is a high ceiling on income.  otherwise it is hard to progress quickly toward financial goals (i.e. you cannot save as much quickly).
  • Constantly expand your circle of competence.  Richard is always expanding his circle of competence in his field.  He figured out which type of developer positions paid the best, and set out to learn all necessary skills and certifications, always making himself more marketable.
  • Seek higher paying positions when the increase in pay and lifestyle change justifies it.  He switched jobs a few times but did not do so unless it was for a justifiably higher salary ($20k – $30k increases).
    • Advice on salary negotiation: figure out your desired salary, and then tell them you are making a reasonable amount less.  Ex. “I am making $80k looking to make $90k”.  Of course, be sure that the position you are applying for has value at the level of the desired salary.
  • Be well-liked and high achieving so people naturally help you reach higher positions of responsibility.  He eventually worked his way up to lead developer (technical role), then was good enough with people that he was encouraged to accept a manager role, making $100k+.
  • Take advantage of special situations.  The most recent company he worked for got bought out; he knew he was very valuable to the new company in order to help transition their old systems over to the new company.  He was thinking of leaving because he knew the role they would transition him to made less than he did at the time.  Instead the new company made him an offer to double his salary ($200k+)
  • When the time is right, buy back your most precious resource – time.  Once the transition was complete, he decided he was prepared enough to be self-employed/do something different.
  • Savings lots of money consistently provides greater flexibility as life progresses.  Throughout IT career he saved close to 15% of earnings in 401(k) plans, as well as money in regular savings.  He left IT job and created two companies: one for [redacted] and one for real estate investment.
  • Use the structural nature of the tax-code to your advantage to build wealth.  He consulted necessary professionals and rolled 401(k) into Solo 401(k); used Solo 401(k) money plus other cash to do first real estate deal.
  • When venturing into a new field, find a mentor to accelerate the process.  Richard had a friend that had been doing real estate investing for a decade that mentored him through the first deal as well as several more.
  • Build passive income by buying cash-generating assets.  Over the past 2.5 years, he has focused almost exclusively on real estate; now up to 9 rental units.
  • Building the right team is critical for real estate investment success.  Some homes are locally owned, while some are out of state; he stated that property management company was worth the cost for the out of state rentals.
  • Understand your niche and stick to your strategy.  He only buys distressed properties, usually at auction, and fixes them up (he has construction skills and his brother has equipment).  Richard’s  target rents for each property is $800-$1200/month.
    • if value of property is too low, you risk tenants messing up the property, more hassle
    • if value of property is too high, you risk higher tenant turnover because people can/will buy houses
    • targets 10-12% cash-on-cash rate of return
    • uses rents received only for maintenance and re-investment in more properties
  • State clear goals from the outset so that you know when you have achieved them.  The initial goal was to replace old manager’s salary of $100,000 with passive income; now almost there at around $90,000.  Ever since college he wanted to be financially independent by 45 years old; recently turned 45 and feels he has finally achieved that goal.
  • Avoid debt for investing – it requires more patience but reduces risk.  He never uses debt to buy rental properties – an rarity in the real estate investing world.  He only has a mortgage on his personal residence; all nine rental units he owns are paid for.
  • Allow your lifestyle goals to change as you age.  He will continue to invest in single family homes but will shift more time to help with his and his brother’s family business.
  • Think like a business owner when it comes to investment.  He thinks that many real estate investors simply “play games” with weird and shady deals – not true property owners.
  • Never stop giving back and enjoying life with people you love.  Richard enjoys playing golf, so he volunteers at a local golf course and gets to play for free; brought down his golf game from a 95 to a 75 handicap.  Also, he is now able to spend more time with his daughter and play tennis.  He ran his first half marathon this year and is going to run in a full marathon this fall.
  • Commit to a plan and follow it consistently – over time it will not feel like much of a sacrifice.  He said that he and his wife, over the years have not really had to sacrifice much to have what they have (nice home, cars).

Practical Lessons from Richard’s Core Economic Engines

Career in Information Technology

Richard’s career in IT proved successful, even right out of college.  The constant learning of new information and what was valuable to the organizations he worked for enabled Richard to command higher salaries for his services.  He knew that most of his peers would not take the time to get extra certifications and take extra technical classes that were particularly challenging.  By setting himself up to be a learning machine, he paved the way for quick and steady career growth throughout his 20s and 30s.

His high income and avoidance of debt allowed him to maintain a solid savings rate over the period of a few decades.  For most, this simply would not be possible because of either a moderate/low income, or simply not enough time to let money stack up and compound.

Transition to Real Estate

One of the things that inspired me most about Richard’s story was that he found a way to invest in real estate without going into debt, a true rarity in today’s world of low interest rates, especially.  The wisdom is that yes, a higher cash-on-cash return could be made through leverage, but the quality of an investment is not measured by rate of return alone.  The quality of the cash flows an asset provides, as well as the risks inherently associated with an asset, need to be considered.

Note the gradual progression of Richard’s finances.  Him and his wife saved tens of thousands of dollars each year for a decade, consistently living on less than they made.  It was only with a big pile of cash in his various accounts that Richard felt comfortable enough diving into a completely new field.  With the help of his mentor he was able to purchase nine rental units in less than a three year time period.  That would not have been possible without a combination of factors occurring at the same time:

  1. Lots of liquidity available to make deals happen quickly.
  2. The advice of a mentor to avoid major pitfalls and provide specialized education.
  3. The power of paying for properties completely in cash, thereby lowering the overall cost of investment (buying distressed properties at auction).

Once the first deal was done, it was simply wash, rinse, and repeat.  Upon reaching the 9th rental unit, enough passive income was coming in that he declared himself financially independent.  The transition to working on his family’s business and spending more time with family and volunteering became possible once the primary economic engine of the real estate portfolio was firmly in place.  This portfolio, in turn, would not have been possible  to build so quickly if not for the years of savings that had been consistently set aside.

How to Be a 401k Decamillionaire (A ConocoPhillips Case Study)

Bloomberg recently did an analysis of the best 401k plans offered by the list of S&P 500 companies.  They created a scoring system based on: matching contributions, additional automatic contributions, fund availability, vesting requirements, and automatic enrollment.  They also looked at special restrictions such as requiring matching contributions to only be in company stock (this subtracted from the overall score).  Overall, it looks like they have a pretty good methodology.

I was amazed at some of the very best 401k plans at the top of the list – check out ConocoPhillips right at the top.  There’s some major opportunities for saving up a big chunk of cash for retirement without a lot of sacrifice.  It’s almost as if these companies simply shifted their pension obligations over to profit-sharing via 401k matches and contributions.  Check out the list of the top ten:

best401ksTo the astute investor out there it should be no surprise that a lot of the companies at the top of this list pay hefty dividends out to their shareholders.  ConocoPhillips, Boeing, McDonald’s, Altria, and Phillip Morris International stand out in particular.  However, there are others like Google, who don’t pay a dividend, but have a lot of free cash flow they can give back to their employees.  Citigroup barely pays a dividend as of this writing, but that’s likely to increase in the future, especially if interest rates rise.

One thing that came to mind when I looked at this list was thinking about an average employee who had a goal of stashing away a lot of retirement cash – how could they maximize their 401(k) plan?  What do you get when you couple significant sums of retirement savings on both the employee’s side and the company’s side?  The answer: a lot of money 🙂  But how much is possible?  What is the potential here?

Let’s imagine a fictional guy named Treyvon.  He’s a smart dude, and he’s 22 years old.  He just graduated from engineering school and snagged a job at ConocoPhillips as an entry level reservoir engineer.  His starting base salary is around $100,000.  Man, look at this guy.  Already so young and he’s raking it in.

reservoirengineer

Being a wise young man, Treyvon decides not only to contribute the 1% needed to get the 401k match from the company, but to max it out entirely.  He just got out of college so, what the heck, he’s been living in poverty anyway, what’s $18,000 of unseen money?

At this point let’s look at the breakdown of ConocoPhillips’ retirement package.  It looks like they offer:

  • 9% match on the first 1% contributed to the 401k
  • 6-9% of employee compensation, based on age, placed in a cash account
  • a wide collection of stock and bond index funds
  • immediate, 100% vesting of all contributions

Let’s assume average 3% raises throughout Treyvon’s career.  Let’s also assume that even though the cash account contributions are credited with interest based on the U.S. 30-year Treasury rate, they earned no interest whatsoever so that it is truly a “cash” account.  Also, I assume that the full $18,000 contributed each year never increases.

His money compounds at an average rate of 10% annually over a 40 year period, net of fees.  I also assumed that all 401k contributions are using the Roth 401k option, which ConocoPhillips offers.  Although all company match contributions will be pre-tax, there is still a lot of money that is going to be saved in future taxes, as I demonstrated in this post where I talked about my wife and I’s decision to switch our 401k contributions from pre-tax to Roth.

Here’s what happens after 40 years of consistent contributions and compound interest:

ConocoPhillips401k_1
This is possible because of consistent contributions made from both Treyvon and ConocoPhillips over a long period of time.  Getting an average of 10% returns helps too, of course, but even if the returns were 5% annually, we’re still looking at over $4,000,000 in 401k wealth.  At the end of 40 years, our faithful petroleum engineer will be a decamillionaire.

This doesn’t account for stellar performance on the job, which would mean even higher raises than the 3% assumed.  This doesn’t take into account raised limits on 401k contributions over the years.  This doesn’t account for interest earned on the cash account.

Treyvon could have never saved another penny.  He could have taken the rest of his earnings and, after taxes and basic expenses were accounted for, gone out every weekend for beers with the boys.  He could travel to Europe every year.  Give large donation checks to his church.  Buy a house and comfortably support a family of five.

Ok, ok, you get it.  If you’re reading this, you’ve likely heard some version of it before.  Save lots of money and do it as early as possible and eventually you’ll wake up with boatloads of cash.  But what about an extreme case?  What if we pushed the limits of our assumptions even further?  What if our fictional engineer, at the age of 21, looked at his life and decided to tweak all of the variables he could in order to ensure the highest amount of wealth in his 401k account at 60 years old?

Let’s adjust our assumptions.  Let’s say there are 5% raises because of hard work and recognition among our guy’s management.  This will directly affect the company match as well as the amount contributed to the cash account over time.  Let’s also assume that the 401k contribution limits rise $500 every year.  This is typically in line with what has happened historically.  Here’s what happens to the numbers:

ConocoPhillips401k_2

That’s almost an extra $4,000,000.  Those increased IRS contribution limits make a difference.  Higher salaries over time make a difference.  Sometimes people complain because of seemingly small 2% or 3% raises at work, or maybe even shrug at the thought of the IRS increasing annual contribution limits by a whopping $500 per year.

I get it, I’ve been there.  But there are many worse things in life.  That seemingly small increase in income and seemingly small increase in tax-sheltered contributions means real wealth over long periods of time.  That extra $4,000,000, given an average dividend yield of 3%, could be pumping out an extra $120,000 per year in passive income.  Just as in the lesson of compound interest we cannot despise the day of small beginnings, neither can we be ungrateful for the days of small pay or savings increases.  Over time, they really do make a difference.

Let’s summarize the list of advantages that made this $18.6 million 401(k) account possible:

  1. To start, make as much money as possible, maybe even six figures, right out of college in order to  provide investment capital.
  2. Work for a company that has a generous matching program, and maximize it’s benefits.
  3. Maximize the IRS guidelines for contribution limits.
  4. Utilize a Roth 401(k) if it is available to significantly cut future tax liability (matching contributions will still be taxed under current rules).
  5. Invest every year without fail, and without taking loans out of the account and ignoring market fluctuations.
  6. Utilize low-cost index funds in the 401(k) in order to reduce fees.

By stacking advantage on top of advantage, before long a lollapalooza effect occurs, where you have multiple various reinforcing each other, which results in exponential returns over time.  Although this is great in an ideal world, the first example proves that you don’t have to get everything right to have outstanding results.  Just putting together a few key variables can make things work out just fine.  Here, the most important variables are the high starting salary, the generous matching program, and the passage of time.  The other variables simply amplify the results further.

I was excited to write about this case study because it helps psychologically reinforce decisions my wife and I are making in our own lives.  Over time, habitually making small good decisions can yield fruitful results, and it’s one of the reasons I’ve grown to love the process of investing.