Importance of Economics: Creating Multiple Streams of Income
Recently, we were chatting with some friends in the U.S. who have been brainstorming ways to hedge their new real estate investments from possible declines in price while at the same time setting up future streams of income for themselves.
Don't underestimate the importance of economics...
Here’s what they came up with:
They are taking the Option Fees collected from Rent- To-Own Tenants and buying Strip Bonds with them.
A Strip Bond is a bond that is issued at a fairly large discount from its value at maturity, and pays no interest during the life of the bond and matures at face value.
To buy a bond that matures at $15,000 in 15 years may cost you $4,000 today. The length of time to maturity and the interest rate offered by the Strip Bond issuers are the key variables that determine maturity value.
As an example, if these investors that are very aware of the importance of economics receive $7,000 as an upfront option fee they’re taking that and buying a Strip Bond that mature to $25,000 in 15 years.
Now, if their tenant leaves or is evicted from the property they are left with the home and $25,000 worth of bonds. They then can clean and paint the house and then advertise for a new tenant and buy another $25,000 worth of bonds maturing in another 15 years.
This one property now has been used to purchase $50,000 worth of bonds maturing at different times.
This way they are using the upfront option fees to create multiple streams of income for themselves in the future. Talk about knowing the importance of economics and how it can only benefit you to know more!
Their plan is that over four or five years they’ll do this with multiple properties and have several hundred thousand dollars worth of bonds maturing at staggered intervals down the road. Their goal is to build a “bond ladder”… A series of bonds with increasing maturities often spaced one year apart.
Their idea is to supplement their retirement income by buying bonds that mature each and every year after you stop working. So if you’re 40 right now and you want to retire at 60 (this is where the importance of economics come in) you setup bonds that begin maturing 20 years from today:
$25,000 Face Value Bonds Maturing in 2030
$25,000 Face Value Bonds Maturing in 2031
$25,000 Face Value Bonds Maturing in 2032 etc.
When we first heard them discussing this we couldn’t believe how simple and powerful this strategy could be.
In 25 years you could have debt free income properties, cash flow from those properties and a series of bonds that are maturing. We jumped in and began our own research and uncovered some challenges to this approach in today’s environment in Canada...
1. 1. The rate of interest on top quality Federal Canadian
Strip Bonds right now is low, very low. 3% range. To get any good returns you’ll have to get very long maturities.
2. 2. You can get higher rates but you’ll have to go to Corporate Strip Bonds or in the U.S. Municipal Bonds… in that case you need to be certain the corporation or municipality is going to be around in 20 years to pay what it owes you.
3. 3. At low rates of return, say 3%, any inflation over 3% for an extended period of time would mean your money isn’t keeping up with the cost of living.
4. 4. Lastly, we learned that in Canada, on Federal Strip Bonds you pay interest on the gains annually even though you don’t claim the bond’s value until maturity … years and years later. So this really is like a form of insurance and you’ll need to plan for those taxes.
So obviously at the present moment, we’re not pursing this strategy ourselves but found it intriguing and creative enough that we thought we’d share it. It’s a great example of how some unconventional thinking can create future income. And it's also a good example of the importance of economics & knowledge of what is available to you.
In our own research of the importance of economics, we picked up an old book that you can find on Amazon.com via it’s resellers called, Secrets of Financial Success, by Richard C. Powelson, Ph.D. and Albert J. Lowry Ph.D.
The last few chapters are all about using bonds to hedge some of your real estate investments. Invest in your knowledge and learn about the importance of economics.
As always, we’re on the lookout for great insights and strategies and we’ll continue to share the very best ones with you! process themselves. After conquering your own fears and doubts about your decisions you’re a much stronger person, investor and business owner.
Undercapitalization Is A Problem
Overcapitalization is A Problem
We’ll often meet investors who have no capital and want to begin investing. They fall into two camps.
The first sees it as a major problem and decides they can’t achieve their goal of owning their first investment property.
What they really lack is enough drive and determination to push forward.
Recently we had two examples of investors overcoming this exact issue. There is an amazing couple, fairly new to Canada, who lacked capital and income to acquire property. They worked for six months to save up cash and find a partner to sign the mortgage and become a Joint Venture partner. They succeeded where so many others failed.
Another member acquired six properties in one year and was 4 short of her goal of 10 due to lack of capital for more down payments. She immediately asked for our help to create a business plan and then started shopping it around to prospective Joint Venture partners.
She quickly found a single partner that allowed her to acquire 3 more properties and recently acquired her tenth. The lesson? Undercapitalization in business is a common problem but can be overcome.
Having capital to invest doesn’t guarantee success either. Robert Herjavec explains in his book how he started three companies.
The first two were launched with the same amount of money you may have in your wallet right now. The third was started after he became a multi-millionaire.
It had huge amounts of seed capital and the luxury of top-tier management steering the ship.
Only one of the three companies lost money in its first year. Guess which? The one with all the money. It lost $650,000 in eight months.
Robert concludes that lack of money in business is a challenge but it creates the discipline that forces clarity of thought.
Here’s a direct quote from him, “With no cash in the bank, you don’t enjoy the luxury of casually choosing among a list of alternative strategies … you get out and hustle because, if you don’t, you starve”.
This mimics exactly what we see with potential investors with lots of capital who arrive at our offices. They debate strategies and tactics and property types for YEARS before dipping their toe in the water.
They’re so scared to lose their cash that it’s preventing them from taking any action at all. It’s almost as if their financial success up until that point in their lives is preventing them from growing further.
Europe vs. North America
Robert was born in Europe and immigrated with his family to Toronto, Canada as a young boy. He explains his thoughts on making money by comparing the two cultures. In summary, he believes that in Europe people think the rich were given their money by the corrupt government and that’s the only way to get really rich.
While In North America people think the super rich found the “one simple secret” to millions and they’re all out looking for the same secret. He concludes that a real dragon makes his fortune with hard work, self control, discipline and a passion for their niche that allows them to slay the doubts and fears that pop up along the way. We couldn't agree more!