When we consider investing, the first thing we usually consider is profits. How much do I have to invest, and what is my expected return?
And this makes sense, because, after all, what’s the point of investing if not to profit and grow our wealth?
But there are other, hidden factors that we often fail to consider.
I learned this the hard way.
After I sold my company, I was faced with an immediate, pressing decision: now that my primary source of cash flow was gone, how would I deploy my capital in order to replace the lost income?
One of the investment opportunities that seemed like a logical choice was real estate. Of all of the asset classes out there, we tend to view real estate as critical to building long-term wealth.
While historic returns of the stock market outperform real estate as an asset class, there are other benefits. Real estate tends to be less volatile, and as opposed to the stock market, there is underlying tangible value. Of course, I would be remiss if I didn’t include the immediate tax benefits that a properly executed real estate investment can provide.
It was these tax benefits that eventually drove my business partners and me to decide to invest in a commercial property in downtown Golden, CO. We decided to acquire the property via 1031 exchange, allowing us to avoid paying tax immediately and shifting the burden down the road.
With another partner, we purchased this commercial building that included office and retail space for $2.7MM, and we funded another $700,000 in renovations to add modern office space in the unused basement of the building. We financed 50% of the acquisition and construction, meaning that my personal cash contribution was $550,000.
The building was in a prime location on the historic main street. Occupancy rates for the area were 97%, meaning there was high demand for additional space. With the renovation, we could immediately add significant value to the existing asset.
So far, so good.
And our plan worked. We completed the renovation, leased the new space, and increased the rents while locking in current tenants for the long term.
After 3 years, we sold the building for $5.56 million. This meant that my personal net proceeds from the sale were $985,000.
By any standard measure, this is a fantastic return on investment. In three years, the project yielded an 79% cash-on-cash and 21.4% annualized return. For context, the S&P 500 returned 9.65% annualized from the beginning of 1992 to the same period in 2022.
At this point, you might be saying to yourself, “Wow, they really knocked it out of the park!”
And you would be right. On paper.
But remember the hidden costs I mentioned? Let’s dig a level deeper.
Because I wanted to pull the money out of the company after the sale, now I need to pay the capital gains on the profits, leaving me with $758,450 after taxes.
Let’s say instead of the 1031, I had paid the taxes upfront. This would have left me with $423,500 of investable capital.
On the day I bought the building, the S&P 500 was at $2926. On the day I sold three years later, the index was at $4108.
Had I invested in the S&P instead of the building, my investment would have been worth $594,578. For those keeping score, this would have been a 40% cash-on-cash and 11.9% annualized return.
So let’s consider the difference: by investing in the building, I made an extra $163,872.
However, over the 3 years, I invested a lot more than money.
From start to finish, I spent countless hours on this project.
My partners and I spent this time identifying the property, negotiating the sale price, due diligence, securing the financing, permitting with the city, researching architects, contractors, and vendors, comparing bids, and then managing the construction project. At the same time we were negotiating with current lessees, updating contracts, and completing routine (and not-so-routine) property maintenance.
Then construction ground to a halt because there was a problem with the sewer in the basement, and we had to bring in new specialists, work with the city to bring the plumbing into compliance, and get new inspections, permits, and the like.
Once we finally completed the construction, the economy and thus the market for brand new, modern office space had cooled. We spent months beating the streets trying to find someone to rent the new space.
And if that wasn’t enough, I got into a disagreement with my business partners about how the workload was being divided, about how we were treating tenants, and about our goals for how and when to exit the project.
The disagreement festered, and even though I can now look back and take responsibility for my part and understand their grievances, the result was a wedge driven between my best friend and me.
This was a man I loved and cared for deeply. We served in combat together, we built our first company together. He was like a brother to me, and we didn’t speak for months.
I was devastated.
For all of my trouble, for all of the time, for all of the blood, sweat, and literal tears, I made an extra $163,872.
Put another way, I made an annual salary of $54,624.
Had I simply taken the money and invested in the S&P with the click of a few keystrokes, all of that time and effort (not to mention the emotional toll) could have been spent mountain biking with my son. I could have gone on dates with my wife, or taken trips or…
Anything, really.
Instead, I took a massive pay cut to manage a project that was outside of my realm of expertise.
Looking back, this should have been a turning point for me.
But, if you haven’t caught on by now, I have had a habit of learning the hard way. I wish I could say this was the last investment of this nature that I ever made, but it wasn’t. Far from it. But that is a story for another day and another newsletter.
I didn’t know it then, but this was my first exposure to the hidden costs of investing.
Nowadays, I have a framework to uncover these costs – before I make any investment.
Now, my first consideration is never profit, but the risk to my time, my relationships, my happiness and overall well being.
I’ve learned, I’ve grown, and now I can say that I’m grateful for the experience.
Next time though, I can assure you that I’ll be doing my best to incorporate the lessons learned.
Because the fact is, it doesn’t have to be hard.
Investing in ease,
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