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Author: FoolMeOnce Big red star, 1000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 5069  
Subject: A Strategy for Retiring Early Date: 8/7/2003 6:45 PM
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For those that are inclined to favor or consider real estate as a vehicle for building net worth, I offer the following.

I'm currently looking at a duplex about 3 miles from where I live. It is an older building but has been very well maintained. I have known the owner for years. The asking price is $140K but I think it can be had for $135K. Each side rents for $600/month. I am in the process of evaluating the place now. I am using the following assumptions which I believe to be reasonable for my area and situation.

Inflation (Rents and Expenses): 3%
Appreciation: 4%
Federal Income Tax: 25%
State Income Tax: 5.75%
30 Year Fixed-Rate Note @ 7.25%
Property Taxes: .75%/Annum
Insurance: .5%/Annum
Maint./Repairs/Reserve: 1.25%/Annum
Improvement Ratio: 80%
Purchase Costs: 3%
Sale Costs: 7%
Capital Gain Rate: 15%
Vacancy: 5%
Down Payment: 20%
Depreciation Recapture: 25%

My 10 year proforma shows a projected after-tax internal rate of return of about 14.75%. I can live with that.

Another analysis I like to perform is to see how long, using the above assumptions, it would take for the property to pay for itself. I allocate all after-tax cash flows to the note to accelerate the date at which the property would be owned free-and-clear and generating income to be used for living expenses. It turns out the property would be owned free-and-clear after only 16 years. In the 17th year, the net operating income (gross rents less vacancies and expenses) would exceed $16,500/Annum. The duplex itself is now worth over a quarter million dollars.

By comparison let's assume that the amount of the down payment ($27K) could be invested in the stock market for a compounded total return of 10%/Annum. After 16 years the stocks would be worth about $124K. Withdrawing at a rate of 4% would yield about $5000/Annum. The duplex in all likelihood will throw off more than 3 times as much income to a prospective early retiree. Just how bad would my assumptions have to be for the duplex to become an inferior approach? Imagine what owning just 2 or 3 buildings such as this would do for your early retirement aspirations.

This is just an example to get you thinking about the possibilities and about different ways of looking at small income properties and how they might fit in with your plans. Every location is different. I am fortunate to live in a rural area with low taxes, but with a very strong rental market and dependable appreciation.


Standard caveats:

> The expenses and all assumptions are for my area. Your mileage may vary.

> Yes, investing in an index fund requires less effort than owning and managing real estate. You may also achieve results commensurate with the effort required.



Also, those of you in the Roanoke, VA area might be interested in the following auction:
http://www.woltz.com/469/home.cfm

Regards,
FMO
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