#mini case study

[This is an excerpt from an upcoming book I am working on called, Business Model Illustrations, Real Estate Investment and Personal Business for Life Mini Case Studies]

David Leigh (not his real name) is a rich dentist, age 44 when he first comes to Firestone for coaching. He is a lean, polite married person with five children who loves to travel overseas and wants to retire from active dentistry at age 59, 15 years from now.

Even though David came late to dentistry, in fact, maybe because of that, he is constantly integrating new technologies into his practices and is as much an entrepreneur as he is a dentist. He is an immigrant to his current country and, upon arrival, spoke only a few words of English.

He is now fluent with a light accent.

[It’s here! Now available! Business Model Illustrations]

How did he get into dentistry? Was it his love of perfect teeth? Desire to promote better dental healthcare and hygiene? No. He simply asked around and found out that dentists make more money than any other professionals including doctors, so he announced one afternoon to his amazed spouse he was applying to 11 dental schools despite his lack of facility with the local language, which he figured correctly he could learn in 100-days before any interviews took place. He also correctly and abundantly proved that dentists (at least ambitious ones) make a lot of dough.

 panoramic radiograph of historic dental implants, circa 1976/77, source: free media repository

He currently owns three dental practices in a million plus population city and makes about $1 million per store. Put simply, he has three million dollars per year of what my spouse likes to call, “Whole Foods money,” that is, money you can touch, feel and SPEND.

 He is risk averse but likes real estate.

What would you do?

***

David at first decided to buy townhomes, lots of them. His retirement goal was to have $900,000 a month in net operating income. That is not a misprint—that's equivalent to $10,800,000 per annum.

He hired two realtors referred to him by his coach who over the next five years worked pretty much exclusively on building his portfolio.

They also put together a portfolio management company that charged him 8% of rental revenues or 15% for any properties they managed on his behalf that were placed on platforms like Airbnb, which obviously represents more work for his property managers.

At the time he started, each town was costing him about $300k in Ottawa, $850,000 in Toronto and around $925,000 in Vancouver.

Cap rates were around 5% in Ottawa, 4% in Toronto and 3% in Vancouver, which means that after his mortgages are retired, his Ottawa places would produce about $15,000 in net operating income, Toronto would net him $38,000 and Vancity $27,750 per year per investment property. 

All of these cap rates are below the Firestone Institute target of 6% pa. Nevertheless, with rental vacancies hovering around 1% in all three cities, this is a very low risk investment strategy.

 Over time, Dr Leigh became more comfortable with animation strategies such as adding tech (multimedia) packages to his rental properties and buying doubles and single-family residences as well as towns where he could add legal in-home suites and later backyard coach houses.

As a result, he was able to boost his cap rates by about 1 to 2 points in each city, which does not sound like a lot, but look at it this way—it's like turning an aircraft carrier or very large passenger ship. Even a degree or two improvement in turning radius makes a big difference in terms of how much lead time you need to avoid an iceberg. Ask captain Edward John Smith[1] about that.

To make things easier, lets conjure up a hybrid property... a Vanto[2], which is an imaginary combination townhouse, double, single family home with legal in-home basement apartment, tech package and an occasional coach house that costs $675,000 and is situated in Vancouver, Toronto and Ottawa and produces a 6.75% cap rate.

How many “Vantos” do you need to buy to produce $900k a month in net operating income?

The answer is simple: It is $900,000/($675,000 x .0675/12) or 237.

So, the doctor needs to buy 237 Vantos to reach his goal of $10,800,000 in retirement income.

To be on the safe side, David and his coach set a goal of 300 properties purchase over a five-year period.

***

Now you would be forgiven of thinking, “That's all fine and good. He's a rich dentist, he can afford to put together a portfolio like that by just keeping on writing checks.”

Well, you would be wrong in this assumption.

Once, a real estate portfolio gets to a certain size (which it turns out isn't all that huge), it becomes self-supporting.

Huh?

Yes, real estate, when managed properly, is the only perpetual motion machine in the known universe.

How does that work?

Ok, first you have to learn something about amortization. Your banker, financial planner, (most) realtors, lawyer, mortgage broker, mom, dad, sister, brother, uncle and aunt will tell you to string out your amortization period as long as you can or, better yet, get your monthly payments down as low as possible by going with interest-only mortgages. 

How long does it take to pay off an interest-only mortgage?

Forever.

How long does it take to pay off a 30-year amortized mortgage?

Obviously, 30 years.

This is the worst advice ever.

Shorten your amortization period as much as you possibly can until you are squeaking with the pain of meeting your monthly payments.

If you have animated your property, written proper leases (an art in itself) and are managing it well (qualifying great tenants, providing them with top level service, and making sure there is no deferred maintenance), you should be able to get your amortization periods down to 20 or maybe even 15 years.

Now here's the tricky part. You want maximum leverage in your early years as you build up your portfolio; ie, borrow as much OPM (other people's money at the highest LTV, loan to value, ratios you can possibly get) but with the shortest amortization periods you can manage without going into a negative cash flow situation.

Let's illustrate this.

You buy a Vanto for $675,000 with an LTV ratio of 80% so your mortgage is $540,000. With a short enough amortization period (say 15-years), you could be (or actually it's your tenants) paying off, say, $29,200 a year in principal. Over five years, that's a whopping $146,000 of your mortgage principal retired—gonzo. 

Here’re some sample calculations:

And if you've bought in a great location in a city with at least five or six major economic engines (nice stable ones like government, healthcare, tourism, learning, finance, entertainment, tech (well maybe not all that stable but certainly a growth engine), real estate...), your place has gone up in value at 3, 5 or even 7% per annum. So now (assuming a 5% annual appreciation rate), your imaginary Vanto has gone up in value to a fantabulous $861,500 over 5-years.

Here's the magic formula—by nearly killing yourself with really high monthly mortgage payments, you have opened up a ton of room for refinancing your Vantos. Your mortgage has dropped from $540,000 to $394,000 whilst your borrowing capacity has increased to $689,000 so now you can refi each Vanto you own and put (after 5-years of tough sledding) $295,000 in tax-free cash in your designer jeans[3]. That's for each Vanto you own, every five years. Wowza.

Now, of course, you could always decide to buy a nice top of the line Mercedes like Ray Donovan drives (in the first four seasons of a Showtime series of the same name) or, if you are like Dr Leigh, you can buy more property WITHOUT HAVING TO WRITE ANOTHER CHECK.

That's perpetual motion, folks.

perpetual motion anyone[4]?

It's something that Warren Buffett discovered in the 1950s. Only he applied this thinking a bit differently—he purchased stakes in great companies with decent dividends. Dividends acted as “rents,” stock prices as property values and buying on margin was equivalent to using OPM[5], aka property mortgages. Mr Buffett likes to say, “Our favorite hold period is forever.” He also understood that as stock prices rose, and his debt dropped, he'd be able to refinance and pull out tax-free money then rinse and repeat the process. Sound familiar?

By the end of 2017, the doctor owned 307 properties and his coach had to suggest to him, "This might be a good time to stop buying property, David!"

“But I like it,” he replied plaintively. 

“Yeah, but you had a goal when we started and now you've gone past it. I think you should stop buying, and because you have the cash flow to support it, I suggest you shorten all your amortization periods even more… to 11 years as they mature so you can pay off all your financing by the time you turn 59 or 60.”

He (reluctantly) agreed.

Then his coach added: “Oh, one more thing. Once you are debt free, never, ever pledge this portfolio again. Keep it debt free or close to debt free. It's your iron reserve as my dad liked to call it, and certainly never pledge it so you can buy an NHL team[6].”

Last thing—the doctor plans to pass his portfolio onto his five kids. As they each turn 18, he'll add them for “love and affection” (an actual legal term and practically costless to do) as joint tenants so on his passing, he is simply deleted from land titles leaving his kids as sole owners. All that to say, no probate, no probate taxes, no bankers, lawyers, accountants, executors, IRS or CRA agents or other hangers-on can steal those properties from his heirs. No one can sell them, pledge them, refinance them, without everyone on title agreeing.

What's the fastest growing form of abuse today? It's probably not what you think it is—it’s elder abuse.

As a realtor, a mentor, a teacher and a coach, you could get some seniors to sign practically anything. They'd sell their homes for half price just on their realtor’s say-so (something of course you must never do). But if their sons and daughters, granddaughters and grandsons are on title, not so fast, buddy.

***

REAL ESTATE IS GET RICH, SLOW, BUT IT'S PROBABLY THE SUREST WAY TO WEALTH EVER INVENTED.

[1] Captain of the RMS Titanic on its maiden and only voyage.

[2] This horrible acronym stands for VANCOUVER—TORONTO—OTTAWA, a Vanto.

[3] Here’s an insane real estate model for you: Somehow you are able to purchase 15 Vantos, one a year for 15 years and pay off all your mortgages during that same 15-year period. In year 16, you put a mortgage on one of your Vantos, but this mortgage has a 1-year amortization period with payments exactly equal to or slightly less than your NOI from your entire portfolio. If your Vantos are worth say $861,500 each, and have a cap rate of 6.75% pa, you’ll see a total NOI from your 15-property portfolio of $872,268.75 per year. You could put a 95% LTV ratio mortgage on one of your Vantos (or 47.5% on two of them), which yields $775,350 in tax-free cash that you can touch, feel and spend. At 4.99% interest with a 1-year amortization period, your P+I (principal and interest) will be -$814,039.97 for the year. You’ll also be able to add $58,228.79 in cash to your iron reserve. Plus, adios your mortgage debt at year’s end. Then you can do it again, once a year, forever. You’ll live like a prince or princess and NEVER PAY INCOME TAXES AGAIN in this lifetime or any hereafter 😊 which means (if you are in the 50% income tax bracket), you are better off by nearly half of your NOI of $872,268.75 with this model. #Bonkers For many clients, their exit strategy is to die—that is, they’ll pass on their PB4Ls and real estate investment portfolios to their kids and grandchildren. In places where British common law applies, they can do this via joint titles—adding kids and grandchildren to any title for what is legally known as “love and affection and a dollar.” After the principal owner passes away, he or she is simply deleted from land titles (land registry) without any legal, executor, bank, accounting, IRS/CRA, probate fuss or muss… And for some principals, they always have the option to do a variant on this “insane” model by putting some debt in place if they need cash for their personal care or just to take a great holiday or finish off their bucket list of lifetime wishes. Any debt left to their heirs will, like earlier tranches, be paid off by their tenants. A nice gig if you can get it, n’est-ce pas?

[4] Source: Public Domain, https://commons.wikimedia.org/w/index.php?curid=95851.

[5] OPM = other people’s money.

[6] Which turned out to be the NHL’s Ottawa Senators, purchased by the author in 1990/91 for $50 million USD. The Sens went bankrupt by the mid-2000s ☹ because the Canadian looney went from about 90 cents to the USD in 1990 to 62 cents a dozen or so years later and payroll went from $6.5 million CAD in their expansion year 1992/93 to approximately $85 million in the mid-2000s.

Bruce M Firestone, PhD

Real Estate Investment and Business coach

Century 21 Explorer Realty Inc broker

Ottawa Senators founder

1-613-762-8884

[email protected]

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