🏠 Friday Zoom Session — October 31

Topic: Analyze Real Estate Investment Efficiency & Explore Alternative Wealth Strategies

Key Takeaways

• Use a Schedule E for real estate analysis, not just rent vs. mortgage.

  Many investors unknowingly subsidize tenants by ignoring non-deductible costs (e.g., principal payments) and over-relying on depreciation.

• Sell inefficient properties to unlock trapped equity.

  Example: A 2.6% return on $500k equity was converted into a tax-free income stream with a 9.6% tax-adjusted equivalent return.

• The 1% Rule: Gross rent ≥ 1% of property value → indicates a strong deal.

  Failing this rule often means poor cash flow and risky dependence on appreciation.

• Use policy loans for down payments to make interest tax-deductible.

  This converts personal (non-deductible) interest into a business write-off, improving cash flow.

The Problem: Inefficient Real Estate

The Schedule E Reveals True Performance

• Principal payments are real expenses but not tax-deductible.

• Depreciation is a tax credit, not a real expense.

• Result: A property can show a tax loss on paper while the owner is still subsidizing tenants.

Two Rules of Thumb for Efficiency

1. 1% Rule: Gross monthly rent ≥ 1% of property value

   • Example: $200k property → $2,000/month rent minimum.

2. 4% Net Return Rule: Net annual cash flow ≥ 4% of equity

   • Rationale: If less, capital could earn more elsewhere (e.g., in a life insurance policy).

The Lending Impact

• Banks use 75% of net income + depreciation to assess lendability.

• A property showing a tax loss can hurt loan qualification.

The Solution: Convert Equity into a Policy

Case Study: Converting a “Lazy” Asset

Before:

• Couple (age 67) owned two mortgage-free properties — $500k equity.

• Net Income: $13,000/year (taxable).

• Return on Equity: 2.6% (taxable).

• Asset Profile: Illiquid, high-risk (tenants, market), inflexible.

After:

• Sold properties → funded high-cash-value policy.

• Income: $48,000/year for 15 years (tax-free).

• Return on Equity: 9.6% (tax-adjusted equivalent).

• Asset Profile: Liquid, guaranteed, flexible income.

Policy Benefits

• Tax-Free Income: Distributions do not raise taxable income → may lower overall tax bracket.

• Flexible Income: Owner controls amount, duration, and timing.

• Guaranteed Growth: Contractual guarantees protect principal and provide predictable returns.

Case Study: A Successful Real Estate Deal

The Deal — Adam Edwards (Michigan Triplex):

• Purchase Price: $90,000 (via HELOC)

• Repairs: ~$30,000 over 6 months (DIY)

• Total Cost: ~$120,000

The Strategy:

1. Cash-Out Refinance:

   • Appraised at $159,000 post-repair.

   • 70% LTV refi = $111,300 → recouped nearly all invested capital.

2. Cash Flow: ~$1,700/month post-refi.

The Exit:

• Sold after 2 years for $205,000.

• Total Profit: ~$127,000 (cash flow + sale proceeds).

Key Insight:

A “home run” deal — it met the 1% Rule and was purchased at a deep discount, creating built-in equity.

Next Steps

For Property Owners

• Analyze your rentals using Schedule E to determine true net return on equity.

• If a property fails the 1% Rule or yields <4% net return, consider selling or redeploying equity into more efficient, tax-advantaged vehicles.