You Can’t Eat Equity

Posted on Posted in Buying a Home, Real Estate Investment, San Diego

Which is better – to own an $800,000 house free and clear or to own a $500,000 house free and clear and 2 rental properties? That depends – your answer will vary according to your age and your goals, so let’s step back and take a “big picture” look of how real estate works. With some planning, it can work financial wonders in your life.

Real estate prices have gone back up to pre-2008 levels in some markets like the Bay Area, Orange County, and parts of San Diego. These areas are where the jobs are. In the Inland Empire, prices have gone up from the bottom, but not nearly as much as the coast. This difference gives us some lessons about real estate and sets up some interesting possibilities.

If you’re young and your goal is to increase your net worth, then buy where there is always the best appreciation, and that is near the coast in the best school districts. There the price of your home will increase over time, providing a nice nest egg when you want to retire. It makes perfect sense to borrow money from a bank to own such a property – yes you pay them interest, but you get to keep the appreciation and don’t have to give them a dime of it even though they are the partner who provided the funds for the investment.

Then when you are older, it’s time to use that equity to provide passive income for you. But you can’t live off the equity in your house, so how exactly is that done? There is the possibility of a reverse mortgage, but I’m assuming you want to maintain or increase your net worth, not draw it down every month.

Since the goal has changed at that point from one of appreciation to one of income, the thinking must change to support the goal. Instead of now living in an expensive house and working to pay the bank every month it’s time to have our money work for us. You have to ask the question “To what end?” when writing that mortgage check. Is the end to keep working until you pass away and the banks, the government and your heirs get the benefit of all your labor? Or is the end to now use what you’ve worked for to partially or fully fund your retirement?

Imagine a different life, one where you are living comfortably in your own home that is paid off and having a few rental properties providing the cash flow to do what you want in retirement. This is not only possible, it’s actually easy to do. If you buy a house in an appreciating area when you’re young enough, say 30, it will be paid off when you’re 60. Sell it and have up to $500,000 tax free gains if you’re married. Then buy a smaller home, or a home in a less expensive area for yourself and use the remaining money to buy rental properties. That’s a life plan in a nutshell.

So at some point in your life the thinking must switch to “how can I make my house work for me rather than me working for it?” We learned earlier that there are areas where appreciation is better (the coast), and there are areas where cash flow is better (the Inland Empire). When we are older and the goal is cash flow, then buying property in high cash flow areas makes perfect sense. The way to live wealthy is to ultimately get rid of the banks – you will become the bank and have people paying you. This is what I’ve learned from working with well over 100 seniors who have made this switch in their minds and live life by their own design.

When you’re younger you are working to build up some equity and when you’re older you realize you can’t eat equity. But you can change your situation to free up that dead equity and put it to work for you. The fact that appreciation has not returned as vigorously in the Inland Empire has made it possible to invest locally and not have to go out of state. There are places right here in Southern California where you can buy property for $150,000 that generates $2000 a month in rents. After expenses, the net would be around $1500.

It is the right time to make your equity work for you? This is a personal question and depends very much where you are in life. But my phone is always on, so feel free to call me and we can discuss your situation.