 6(&85(<285),1$1&,$/)8785(,19(67,1*,15($/(67$7( 3. Set the number of years you want for the overall plan. We’ll go through the same exercise as before, but this time it won’t be a dress rehearsal. Using this chart, move down the column on the far left ( Present Value ) to the amount nearest your available capital. Move across this row until you come to a value at least as large as your lump-sum gap or your future net-worth goal. The per- centage rate at the top of this column is the minimum rate of return you will have to maintain in order to meet your general plan goal in the time you have allotted to achieve it. Remember, you can com- bine two lines and add the totals to get a combination that equals your capital investment if it isn’t on the chart. 7+('(7$,/('3/$1 The detailed plan in Figure 6.2 is similar to a profit plan of a business. It establishes the year-by-year goals of the plan and will be the yardstick by which to measure how you are doing along the way. Make copies of the worksheet in Figure 6.2 and insert them in your planning binder. You should be adding data to it for as long as you’re building your nest egg through real estate. The horizontal lines represent the year by using year-by-year estimates of the performance of any property you acquire. The ver- tical columns are the financial parameters of the plan. The most important columns are the last two columns—the Return on Equity ( ROE ) and Average Return on Equity ( AROE ) . The numbers that are inserted into these columns are the ones that need to stay above the minimum percentage return required to meet your goals in your desired time frame. To illustrate how to do this and to make it really simple, we will use the $8,370 it took to buy the example Lawndale duplex as our starting capital. We’ll use that property as the beginning invest- <285:,11,1*/27727,&.(7  FIGURE 6.3 75$16$&7,21$/326,7,21:25.6+((7²  Starting Year 2002 Transactional Position for Real Estate Retirement Plan Yea r of Plan Market Value Total Equity Income Oper’g Exp’s Total Interest Amorti- zation Cash Flow Appre- ciation Tax Rebate Return on Equity (ROE) % Avg. Return on Equity % Actual Actual 3.5% × Yea rl y Increase 2.5% × Yea rl y Increase Actual Actual Actual 5% × Market Value Actual 21 279,000 8,370 27,000 5,400 18,948 2,664 12 13,950 1,106 212 212 12 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 13 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 14 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 15 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 16 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 17 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 18 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 19 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 10 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 11 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 12 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 13 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 14 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 15 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 16 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 17 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 18 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 19 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 20 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______  6(&85(<285),1$1&,$/)8785(,19(67,1*,15($/(67$7( ment of this example and the general investment plan that we just worked out to set our final net worth goal. Here’s the general plan: “We are going to invest $8,370 for 20 years in real estate investments at a sustained rate of return of 20 per- cent to be worth $320,886 at the end of the plan term.” Given that goal, the next step in building a true detailed plan is to establish accurate variables to be used to make the estimates for the future calculations of the plan. What you will need are:  Appreciation rate for your area  Interest rates for first and second loans  Loan-to-value ratios  Income and expense increase rates  Buy and sell costs  Gross multipliers for various size properties You will be able to establish these variables after you have con- ducted some diligent research. Also, don’t discount the help that the agent who sold you your property might be able to give. He or she should have access to the prior history of the market, appreci- ation rates, and all the other variables needed to help establish a detailed plan. We will start this detailed plan with the specifics of the example property at the end of the first year of ownership. To recap ( see Figure 6.3 ) , remember that in our example our return on investment the first year was: Cash Flow $22,212 Equity Growth ( loan reduction ) $22,664 Equity Growth ( appreciation ) $13,950 Tax Benefits $21,106 Total $17,732 <285:,11,1*/27727,&.(7  FIGURE 6.4 75$16$&7,21$/326,7,21:25.6+((7² 7+5((<($56 Starting Year 2002 Transactional Position for Real Estate Retirement Plan Yea r of Plan Market Value Total Equity Income Oper’g Exp’s Total Interest Amorti- zation Cash Flow Appre- ciation Tax Rebate Return on Equity (ROE) % Avg. Return on Equity % Actual Actual 3.5% × Yearly Increase 2.5% × Ye ar l y Increase Actual Actual Actual 5% × Market Value Actual 21 279,000 28,370 27,000 5,400 18,948 2,664 ,1112 13,950 1,106 212 212 12 292,950 22,320 27,945 5,535 18,757 2,855 ,1798 14,648 1,110 187 149 13 307,598 369,968 28,923 5,673 18,557 3,055 1,638 15,380 1,060 157 118 14 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 15 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 16 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 17 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 18 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 19 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 10 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 11 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 12 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 13 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 14 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 15 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 16 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 17 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 18 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 19 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ 20 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______  6(&85(<285),1$1&,$/)8785(,19(67,1*,15($/(67$7( To make the estimates for the second and succeeding years of the plan, we have used the assumption of a 3.5 percent yearly in- come increase and a 2.5 percent yearly increase in expenses. For the other components on the chart we have worked out the actual num- bers in longhand. This requires a bit of time and arithmetic but is necessary for you to be accurate. The next chart in Figure 6.4 takes us through the end of the third year of ownership on the Lawndale duplex. As they say, “The proof is in the pudding.” By penciling out your year-by-year transactional position as demonstrated, the idea is that you will be able to stay on track and retire on schedule. )2//2: 83$1'*2$/5(9,(: This is the section of your planning binder that you will revisit on a regular basis. Here you should insert predetermined dates to periodically monitor your progress. Certainly more important than assembling a successful plan on paper will be managing that plan to its successful completion. This section of your plan will force you to review and adjust your thinking at each step along the way. This review of your plan starts with objectively looking at your personal situation and then examining how changes in your life may affect your investments. As things change personally, you will see that you might need to adjust your long-term goals. For example, an unexpected promotion at work may allow you to buy another build- ing sooner than expected. This could get you to your goal sooner, or raise the amount of your final net worth when it comes time to re- tire. On the other hand, a job change may take away some of the time you had dedicated to the properties and could slow things down. Furthermore, the market and the economy may be changing for better or worse, which would, no doubt, affect what you buy and sell in the coming year. <285:,11,1*/27727,&.(7  We recommend you keep a blank copy of the transactional pro- jection worksheet shown earlier in this chapter. At the times when you do this follow-up and goal review, make it a point to meet with your investment real estate agent and do an estimate of value based on the current market conditions. Compare what really happened in that year with the plan you laid out a year earlier. See how you did. If there are any significant changes, go back and revise your plan and get ready for next year. Ask your agent’s opinion on how the market is doing and where it looks like it is going in the next 12 months. Use the new value and the actual performance figures from the year’s operation of your property to complete the next line of your transactional position worksheet. No doubt many changes will occur over the life of a long-term real estate investment plan. Some changes will be positive and some will be negative. The secret is to take full advantage of the positives and take the necessary steps to minimize the negatives. This re- quires keeping informed at all times about what’s really happening with you—and the market. [...]... the real estate investor’s single most important technique available By using the 1031 exchange, you can pyramid your equity and continue to defer your taxes for years into the future In effect, the IRS becomes your business partner by letting you use the taxes you owe on your capital gains as a down payment on the buildings you trade into The government figures that when you trade into larger properties,... to take Andrew’s triplex in trade for his six-unit Result: At the close, Charlie got started investing and now owns the triplex he wanted, Andrew traded up into the six-unit building he desired, and Barry is relaxing just as planned: in retirement, sipping drinks with little umbrellas in them along the Gulf of Mexico In case you were wondering, Barr y doesn’t pay any tax by taking the title to the triplex... but rather plan to invest it in some passive cash-f low generating vehicle to help with retirement, then the installment sale is for you As mentioned, with an installment sale, instead of selling the property, getting all cash and walking, you become one of the lenders on the property You find a qualified buyer and instead of getting new financing, the buyer takes over your existing loan and you carry... capital gain in this scenario would be $101,510 Thankfully, a number of options are available to the real estate investor to help defer paying these taxes What follows are the methods that help distinguish real estate investing from all other investment vehicles 7+(  7$;  '()(55(' (;&+$1*( When it comes to deferring capital gains taxes, the IRS 1031 tax-deferred exchange is probably the real estate... will, in turn, 7$ ; 3 / $ 1 1 , 1 *  make more profit By making more profit, you will eventually owe more tax As far as the IRS is concerned, everyone wins Who said Uncle Sam can’t be your friend Three rules must be adhered to when qualif ying for a 1031 exchange: 1 You must trade for like-kind property In this instance, likekind would mean the property you are trading into would be for investment... paying some or most of your capital gains taxes Here’s how: Until you actually receive the profit from the sale of your property, you don’t owe the IRS a penny Instead, with an installment sale you would be carrying the note (and your profit from the sale) long term and receiving interest-only payments from the buyer The idea is to keep earning a high interest on the taxes due for many years By doing... 7$7 ( $101,150 capital gain we calculated earlier We’ll estimate the tax rate at 28 percent To find your after-tax net equity, use the following formula: Capital Gain Tax Rate Tax Due $101,510 × 28 $128,423 Once you know the tax due, subtract it from your capital gain to determine your net: Capital Gain Less Tax Remaining Profit $101,510 – 28,423 $173,087 This $73,087 is all your money to do with as... purposes For example, you can’t trade an income-producing duplex for a getaway beach cottage In contrast, you could trade that duplex for a strip mall or another apartment building The idea is to trade income producing property for other income-producing property 2 The new property should be of equal or greater value than the existing property This means that you can’t trade a duplex that you sold for... the installment note, as opposed to putting your net cash in the bank Let’s assume you can get 6 percent interest on your savings from a certificate of deposit or a similar investment Because you can often earn greater yields by carrying the paper on loans, we’ll assume that you can carry this financing at 9 percent interest For starters, let’s illustrate what the profit on a CD or on a similar investment... –$10,360 $26,640 Finally, to determine the balance of the equity from the installment note, subtract the down payment from the capital gain: Capital Gain Less Down Payment Installment Note $101,510 –$137,000 $164,510 In this example, we have a net cash profit of $26,640 and an installment note on the property of $64,510 In the following illustrations you will see how the real advantage of an installment . insert them in your planning binder. You should be adding data to it for as long as you’re building your nest egg through real estate. The horizontal lines represent the year by using year-by-year estimates. options are available to the real estate inves- tor to help defer paying these taxes. What follows are the methods that help distinguish real estate investing from all other investment vehicles. 7+(7$;. objectively looking at your personal situation and then examining how changes in your life may affect your investments. As things change personally, you will see that you might need to adjust your long-term