By: ERION SHEHAJ
Crafting a long-term real estate investing strategy is like making an alloy. First, you take raw materials like investment capital, savings from job income, ability to obtain financing, risk profile, and most importantly, time. Then, you mix them in the right proportions to create a finished product that is stronger and more flexible than the individual parts that went into the process. Essentially, you are taking brittle iron ore, adding heat to melt impurities away, then finally adding carbon to produce mighty steel.
So when someone asked me whether age should factor in the decision of how you should invest in rentals later in life, the answer had to be yes. Age strongly impacts two of the most important raw materials of any real estate investing strategy: time and risk profile. But how exactly?
In Real Estate, Time is FAR More Valuable Than Money
If I gave you a choice between the following two scenarios, which one would you pick?
- Scenario A: You are in your early 30s with $10,000 in savings and the ability to save another $10,000 per year from your income
- Scenario B: You are in your early 60s with $500,000 in savings and the ability to save another $50,000 per year from your income
Let me tell you what option investors that fall in the Scenario B have told me they would pick: Scenario A, hands down. Why? Because, in real estate investing, time is far more valuable than money. It’s not even a close contest. Let me explain why.
At its core, money has three basic functions:
- Means of exchange: We receive it for goods or services we provide to our employer or customers, and we spend it on goods and services we need.
- Security: We refrain from spending it and keep it as emergency savings to provide peace of mind in an uncertain world.
- Investment capital: We invest it and earn a reasonable return for the risk we are undertaking to stave off the effects of inflation.
So, you see, once we have taken care of day-to-day purchases and have saved up adequate reserves, the only thing that’s left to do with money is invest it. Or put differently, money will naturally flow to where it can earn a return. “Lenders lend,” as my mentor Jeff Brown has brilliantly said. If you can bring to the table opportunities for invested capital to earn good returns, you don’t even need to look for the money. It will find you. Also, if you can scale your opportunities, you can always find money to pull them off.
On the other hand, you can’t make more time. You can’t scale it. You can’t buy it. You get what you get, and you don’t throw a fit—like my five-year-old told his brother last week. Age inversely impacts the time horizon that you have available to make your strategy work, which in turn reduces the options at your disposal.
For instance, the more time an investor has available, the more compounding works in their favor. To begin with, the investor with more time needs to buy a smaller asset value because they can take better advantage of compounding appreciation rates multiplied by their leverage factor.
Moreover, the more time the investor has available, the more they can let cash flow and debt pay-down do more of the heavy lifting in creating the equity required to generate the cash flow they need at retirement. In contrast, the investor with less time has to rely on her capital and her savings rate to do most of the heavy lifting. In other words, if you have more time, you can execute a capital growth strategy. If you don’t, your strategy is limited to investing for immediate or short-term yield.
Risk Profile Naturally Shifts to Conservative Later in Life
As we age, our risk profiles naturally shift toward the conservative end of the spectrum. That’s not to say that someone who’s naturally risk-seeking becomes conservative but rather, they become more conservative. This shift is primarily initiated by the shrinking available time to accomplish your goals.
If you have 30 years until retirement, you can make a bad investment move (or two), lose money, and land back on your feet. You have time to make it all back, to turn it around. That option just isn’t available to you if retirement is three to five years away.
Whatever move you make, you have to weigh it well and make sure that it will produce the results you need. There are no rehearsals, no do-overs. When you think about the limited time available, there’s an instinct to compensate for lost time by taking more risk in your investing. You’ve got to make up ground so you should throw caution to the wind and pursue high-yielding investments. That’s exactly the wrong thing to do in this moment. Don’t forget that risk and return are best friends: They go everywhere together. So when you’re considering a high-yielding investment, you’re also accepting a riskier investment. From a long-term investing standpoint, the only ways to get a higher return on your investment is to either get more cash flow for the same investment or pay less for a cash flow stream. Both of those scenarios lead to the same outcome: A higher-risk investment.
Some investors are successful at squeezing better cash flow through better management and renovations, but in the end, rents, like most things in life, tend to regress to the mean. Put simply, the market rent is the market rent.
In order for a rational seller (who’s not in distress) to sell you the same stream of cash flow for a lower price, he must be selling you a lower grade property. If not, he’d be acting against his self interest.
Age impacts how you invest in real estate later in life because it impacts two critical elements of any investing strategy: time and risk profile. Time is a far more valuable resource than money because you can’t make or buy more of it. The time you have available to invest is directly proportional to the options you have available. Appreciation, leverage, and debt pay-down lose some of their magic when given insufficient time, as more of the heavy lifting must be done by your capital and savings.
Our risk profile naturally shifts to the conservative end of the spectrum later in life, as our opportunities to make mistakes and recover decline. There’s a natural impulse to make up for lost time by seeking high return assets that can produce results in a short amount of time. Don’t heed that call—it will lead you to riskier investments.
So how do you proceed from here with limited time? Since real estate strategies are like making alloys, your goal is to produce the best results with the ingredients available. Time can be limited, and there’s no way to get more. But you can play to your strengths by leveraging other ingredients that favor you. For instance, you might have more capital to start with than someone 30 years your junior, so you don’t have to wait to save capital and can complete your acquisitions quickly. In the same vein, your savings rate might be higher every month than someone who still has to save for college or pays exorbitant childcare costs.
Like the old Chinese proverb says: The best time to plant a tree was 20 years ago. The second best time is today.
Buy quality properties, play to your strengths, and you can put together a real estate investing strategy that works for you.