Why at 33, I’m saving for a rental property instead of retirement

1:59 PM James 0 Comments

Conventional financial advice says to invest for retirement as early and as much as possible. As for the first, that’s what I did - I started saving in a Roth IRA when I was still in undergrad at 20, and started investing 10% in a 401k when I started my post-college engineering career at 22. For the second, I started off maxing out everything, because I didn’t know what else to do, but in my mid-twenties lowered it to guarantee the full company match (my employer matched up to 6%, which is a great deal).

When Life Priorities Change, So Do Financial Priorities

When I got engaged, I prioritized saving for the wedding. When I realized I wanted to go to grad school, my wife and I made the tough decision to pause retirement savings and cashflow an MBA (for me) and a JD (for her) to the maximum extent possible. That went against my instincts, but it saved us from taking out $100k in student loan debt at 6% APR. (We still took out a ton of money in student loans, but not as much as we would have.) Weighing the risk of student debt and the interest rate, I feel like we did the right thing.  

Once we graduated, we attacked the remaining student debt mercilessly. We had a $900/month payment on various 10-year loans from Nelnet, but we routinely threw $3-6k/month at them to obliterate the principal as fast as possible. We also refinanced to a 5-year APR from SoFi, which knocked the interest down from 6% to a measly 3%. We continued to sacrifice a little 401k growth, but to us, managing our student debt made sense from a numbers and from a risk perspective.

During my first year of grad school, we made another huge financial commitment by buying a 2-bedroom condo in a working-class neighborhood. We’d been living in a cool part of Downtown LA in a 1-bedroom for $1750/month, but this condo dropped our monthly payment to $1300/month. We were able to do that because I HADN’T put all my savings into retirement. I knew at some level that I’d want some spending money before I turned 60, and I’m really happy I’ve made that decision, because it’s given me a lot of flexibility.

Riding The Market Up

We got the condo in 2012, not the bottom of the California housing market, but close enough that the purchase made a lot of sense. It was a Real Estate Owned property, and we got it for $252k after closing costs with a down payment of around $50k. Two years later, we sold it for $320k ($304k after transaction costs), which turned our initial $50k investment into $102k, essentially doubling our money. Doing the math on this, that’s an IRR of 42%. While retirement savings isn’t a bad investment, you don’t get anywhere close to 42% on $50k even when you factor in incentives like matching contributions and tax savings. Our stats:
Purchase price: $252k
Down payment: 20%, or $50k
Holding period: 2 years
Sales price: $320k ($304k after sales fees)
Gain: $52k on $50k
IRR over holding period: 42%

After we sold the 2-bedroom condo, we bought a 3-bedroom detached townhome in another working-class neighborhood. This was a new construction in a planned gated community, by a builder with a good reputation, in a practical location close to freeways, a Target shopping center, and several aerospace and tech companies. Since the home wasn’t built yet, there were pros and cons to this deal. The obvious con is that you’re not 100% certain the community will be finished the way you hope it will. However, there are buyer protections in case this happens (which you should read VERY CAREFULLY before you decide to buy new construction!). There are also great positives about this situation, which I’ll get into next.

First, buying new construction means you get to watch your house get built. If you know what you want, and you have good people helping you, you can make smart design choices and conduct quality control to know you’re getting a top-rate residence. In our example, we had an excellent home inspector who caught issues along the way, so the builder fixed them before things got too far. My wife also has an amazing aesthetic sense, so she picked out the flooring, tile, colors, and fixtures to make the place really pop. I figure this added about $30k in property value, just by making smart choices along the way.

Second, new construction is purchased differently than already-built homes, and this allows you to buy at below market price. Demand for this community was extremely high, but purchase prices were set by the builder. They didn’t want to deal with vetting multiple offers, even at higher prices - they just wanted to sell their units and finish the project. In a sense, the builder left money on the table, because they chose to sell their units rather than maximizing their unit price. As a result, the homes all quickly sold out, and once owners were allowed to sell their homes, they started going for much higher than the initial purchase price. We’re closing next week, and these will be our stats:
Purchase price: $436k
Down payment: 20%, or $89k
Holding period: 2 years
Sales price: $603k ($576k after sales fees)
Gain: $149k on $89k
IRR over holding period: 63%


You may be reading that and saying “it’s great that you made such high returns, but you just got lucky!” That’s partly true - anyone who bought a home at a low point in the market got lucky. If I’d bought my first home in 2006, I probably wouldn’t be so bullish on real estate. However, bias can occur from both positive and negative experiences! I think the more productive conclusion is that I got in early on a trend, by analyzing the information available to me. I’m not a genius, but we saw that a condo that was priced at $360k in 2007 was now priced at $252k. That looked like a good deal to us, and we jumped on it like a Black Friday special.

You may also say “you can’t expect consistently high positive returns because buying individual homes is inherently risky, and volatility will bite you eventually.” I’d say that’s a pretty long sentence, but I’d agree for the most part. My wife and I were gifted another property that didn’t do nearly as well. The stats for that one:
Purchase price: $440k
Down payment: 40%, or $176k
Holding period: 2 years
Sales price: $508k ($483k after sales fees)
Gain: $43k on $176k (I forget how much principal we paid off)
IRR over holding period: 11.5% (not bad, but not great either)

You may still be reading this and saying “real estate isn’t a very passive investment, unlike stocks,” to which I’d absolutely agree. Real estate isn’t what investors call efficient. It’s not liquid, transactions take weeks and require multiple humans who need to get paid, and it’s not easy to know everything about what you’re buying. However, it also means that Wall Street won’t buy all the good deals in microseconds and leave you with the bad end of the deal. There are plenty of good articles about why real estate is a good (or bad) investment asset class, so I leave the research and the final judgment to you. But for us, it’s been the best financial investment in a sellable asset we’ve made so far.

There Are Better Investments In Your Future Besides Retirement

My top investment decision has been marrying my lovely and amazing wife. She makes me better in an infinite number of ways, and I can’t possibly reduce her awesomeness to a simple financial decision (nor do I want to). But the one relevant to this post is that her wisdom and vision have given me the courage to invest in other things that matter in our lives, including these real estate deals.

My second top investment decision has been going back to grad school. It cost about $110k over 3 years ($60k after the $30k tax savings and $20k tuition reimbursement, that’s for another post - yes, you can deduct your MBA), but it paid for its entire sticker price in less than a year after I graduated. I estimate that about 4 years after I made my first tuition payment, it’s had an IRR of roughly 44% over that period based on allowing me to get my current job, and it’ll continue to serve me well for the next 40 years of my working life.

After we close, we’re going to have around $333k to invest. I’m not going to plow it into a 401k (Roth or otherwise). Instead, I’m going to look for better returns, most likely in real estate. Prices have gone up considerably since 2012, but LA is a hot real estate market, and demand here is still quite strong. We have a rental property that’s cashflowing, but we hope to move there later and take advantage of the excellent neighborhood and school system. After all our costs and tax effects, I figure we’re getting around a 25% annual return on our initial down payment investment. In that case, if we can find another good rental property that cashflows, it’ll give us a lot of flexibility in the future. Early retirement, career switching, part-time work, sabbaticals, entrepreneurial ventures, and passion projects would be much easier with a cushion of extra rental income.

What will we invest >$300k in? Not sure yet. We might find a fixer and buy it really cheap, then renovate it. We like watching HGTV and talking like we have our own version of the show Flip Or Flop. We’re trying to assemble the right team that will give us high confidence in that type of undertaking, because they can be risky (or as my former real estate professor likes to say, “there’s a lot of hair on those deals.”) Or we might invest in a multi-family unit in an up-and-coming neighborhood that we know pretty well. One thing we’ve learned is that despite the stress and work involved, we think real estate is fun, and it can be a darn good investment as well.