Defining your End State and your COE - Keys to your Strategy

So you know you are getting older when your body aches after changing the oil on your truck! I got slower at it too! This being said, I failed to properly identify my Current Operational Environment (COE) before I started the task and this cost me time and money. Time in that I had to make three trips to the store so the job took longer than it should have and money because I burned fuel for all three trips. Had I taken some time to evaluate my COE before starting then I could have done everything in one trip and successfully accomplished my end state.

So this would be a good time to move on into the next phase of my strategic planning process that I use to develop plans oriented towards achieving long term goals. We have already gone over the definitions of many of the terms I use so now lets start the planning process. First up End State. Defining what your end state looks like is critical as it creates a guide of sorts as you develop your plan. You can make a broad statement such as, “I want complete financial freedom” but, what does that mean? Although the end state is what you wish to achieve, if you don’t know what it looks like, how do you know when you have achieved it?

So here is my end state, “I wish to achieve complete financial freedom that allows me to pursue my hobbies, support my family and travel wherever I want in luxury.”

It is still a bit broad but it defines what financial freedom means to me which is to freely pursue my hobbies without worrying about money, support my family which includes my children and grandchildren and allows me to travel the world. When I say luxury, I primarily mean that I want to fly first class and stay in very good hotels. I’ve flown cattle class for most of my adult life overseas to various places in the course of my career and long flights in coach are not very fun! It was worse for some of my team and comrades that flew with me as I am relatively short but they were at the six foot range so they got a bit cramped on some of our long haul flights.

Although I defined my end state in broad terms, it is still not ready to use for planning purposes. It has given me a vision or long term goal but to truly know what my end state looks like I have to further break this down into the “conditions” that must exist to achieve it. If you recall in my first post about the definitions I use I said that your end state, “encompasses the conditions that allow you to achieve your primary goal.” So, what are the conditions that must exist for me to achieve my end state? Below are what I believe my conditions are, yours may be different but what is important is that you know what they are.

1. Passive income equivalent to $500,000 or more per year

2. No debt with the exception of a home mortgage IF it provides an adequate tax shelter

3. Tax shelter strategies that minimize my tax burden

4. $2,000,000 in liquid assets in my company as a reserve to mitigate market risk

5. $5,000,000 plus in assets separate from the liquid asset requirement

6. Processes, systems and personnel in place that actively manage my business and reduce my role primarily to oversight

These are the conditions that MUST exist for me to say I have reached my end state. If any one of these are missing, I’m not there yet. What you will notice is that every one of these conditions is MEASURABLE and relatively specific. When you develop objectives, goals and an end state you must be able to measure them in some way shape of form. If you cannot measure them, how do you know you have achieved it? If you go back to my first post on strategy, take a look at the picture I used to visualize how you move from your COE to your end state. Each Intermediate Objective (IO) is measurable. So, when you develop your own end state and conditions write them down then, look at each one and ask yourself, “How do I measure it?” One last thing to realize about achieving your end state. When you successfully achieve your end state, you now have a new COE. Remember, your COE is a point in time and the task is to make your end state your new COE.

So, let’s talk about the COE. You have defined your end state so you now know where you are going and what it should look like when you get there. Now, you must define your start point. Although there are many definitions for the word strategy, the reality is that strategy is how you accomplish something. To begin the development of your strategy you have to know your start point and your end point, how you get from one to the other becomes your strategy. So how do we define our COE? Well, it depends. How do you think? What do you know? What are your experiences? These questions play a part in how YOU will define your strategy and what YOU feel is important. Just like my former students, none of them defined the COE exactly the same even though the information they were given was exactly the same. Let us look at what I did to develop my COE.

I broke down the development of my COE into four areas of analysis, researched each area and then wrote down what I felt were key considerations and conditions that affected my end state.

1. Personal financial status

2. Target market selection

3. Target market analysis

4. Political climate

Looking at these the first one is pretty important as this defines the resources you have available to you and will play a key role in defining your level of risk. So what things are important in defining the first one? Let me list out what I looked at.

1. Personal Financial Status

     a. Employment – what is my current employment status & what is my gross monthly income from this employment

     b. Liabilities/Debt – what is my current liability/debt load? (I define this as anything that I pay money for that directly impacts my living situation so this would include things like food)

          (1) What debts are temporary e.g. loans?

          (2) What debt is indefinite e.g. property taxes or insurance?

          (3) What debt is mandatory (must pay to live) e.g. Utility bill, car loan?

          (4) What debt is adjustable i.e. I must still pay it but, I can reduce it in some manner?

     c. Assets – what are my current assets?

          (1) Savings account

          (2) Investments (ROTH IRA, traditional IRA, stocks, bonds, etc)

This is not that difficult to figure out but you do need to sit down and take a good look at what you are bringing in and what you are spending. Many people never do this so when they run low on money they don’t understand where it all went to. You must have a solid understanding of your personal financial position before you can dive headlong into real estate investing as it sets the conditions for the strategies you use moving forward. Be realistic! Don’t paint a picture that is positive when it is not or you may find yourself in a bad position as you move forward. By the same token, don’t be overly conservative as it may scare you off! If you have solid data on your finances then let the numbers do the talking.

Target Market Selection. Where do you intend to invest? Before you can move to the next step, analysis, you need to choose your market. If I am going to invest in say, Knoxville Tennessee it would be silly for me to do a market analysis of where I live. Your COE reflects the market you plan on investing in. Most people choose an area close to them, I chose my surrounding area and defined my target market as five specific counties. Sarasota, Manatee, Pinellas, Pasco and Hillsborough counties. This is my initial target market that I wanted to look at and research. I will expand this at a point later in time.

Now comes the fun part! Analysis! Often we hear the term analysis paralysis; do your research but know when to stop and know what is fluff and what is usable. To do this ask this simple question, “so what?” Here is an example, you find that Dairy Queen is adding 10 new franchise stores within your target market. “So what?” Does the addition of these 10 new stores impact your real estate situation? Probably not. However, you looked up information on employment growth and found the current growth along with projections for the next eight years. This DOES effect the real estate market you plan on investing in as it directly impacts supply and demand for homes. When you start to do your analysis and research, map out what you think is important to know. The below is what I looked at.

1. Population Growth

     a. Census data that showed the current growth rate, projected growth rate and demographics

2. Employment and unemployment rates and projected changes

3. Housing information

     a. Owner occupied statistics

     b. Median value of houses

     c. Median gross rent

     d. Housing market trends

     e. Housing market absorption rates

     f. Permitting process (ease of use)

As you can see, I kept it relatively simple. I could go overboard and find all kinds of data out there on my target markets but doing so would just put me into the analysis paralysis loop as I keep digging for more and more data. There is no way you will be able to know everything as things change constantly. What is also important to realize is data means nothing. It is not until you collate this data and transform it into usable information that you can move forward. Here’s a key example. The owner occupied rate for Manatee County in 2017 was 71.4%. So what? The so what of this data point is that your rental market is less than 30% which indicates that this may be a better area to FLIP a home than buy and hold. Now let’s take this a bit further, remember, I am looking at five counties. I did the same analysis for all five counties and here is what I got.

Each column has data which is transferable into useful information about each county but there is a bigger picture as you may have realized by what I highlighted in yellow. The “information” shows that there are two counties that would be good house flipping areas and one county that is definitely a prime candidate for buy and hold. Once you organize the data you collected into usable information you now have a better understanding of your COE and the current conditions that exist.

I won’t go into the political side as this is purely subjective as everyone will have a different take on how the current, local, state and national political climate affects and may affect the current housing environment and, each area's political climate will vary considerably. I’ll leave you with one last chart to show you how I both research and organize the data I collect. This one is based on census data for population growth.

OK, I’ve done all my research, I have all kinds of pretty charts that help me visualize information but what does it all mean? For my former students, they had to translate it into a written statement that gave the commander an understanding of what he was dealing with. If I was doing a COE analysis for someone else I would do this but since it is for me, I tend to just put a list of bullet points together that I can review. This being said, here are some of the key market takeaways that I have in my plan.

• -Population growth rate from 2010 to 2018 average for target market was an average increase of 12.5% with Manatee County leading at 19.21%, Hillsborough at 14.19% and Pinellas trailing at 5.91% growth rate.
• -Projected Employment growth rate between 2018 and 2026 is an average of 10.6% with Sarasota at 12.4% and Manatee at 10.8% and Hillsborough trailing at 9.6%
• -Yearly unemployment rate (2017 – 2018) shows an average unemployment rate reduction of .7%; highest unemployment rate is in Pasco at 3.3% with all other markets between 2.8 and 2.9%
• -Owner occupied housing unit rate between 2013 and 2017 was an average of 68%; this is above Florida statewide rate of 64.80% for the same time period. Highest were in Manatee and Sarasota. Lowest rates was Hillsborough at a 58% owner-occupancy rate
• -Manatee county prices have dropped approximately 13% from 2017 average of $406k for a 3 bed 2 bath home. Current approximate average cost for 2018 is $359k
• -Manatee County absorption rate has dropped below 20% and is hovering at about 18% indicating a slow down in the market moving potentially from a sellers to a buyers market
• -Hillsborough County absorption rate has consistently remained above 20% indicating a sellers market; this will keep prices higher than the rest of the target market areas and make it very competitive in seeking rental units

I have more bullet points than what I have shared above but this gives you an idea of how I organize my COE. When it is all said and done your COE should answer two critical questions. Where are your opportunities and, where are your risks? Will it answer other questions as you look over it? Yes but, knowing where the opportunities are enables you formulate a strategy that takes advantage of these opportunities and, knowing where your risks are is critical in designing contingency/risk mitigation plans. Now you may be thinking, you said that my COE is supposed to become my end state. Your COE doesn’t support a way to do this!

Correct, but this is only because the COE that I have laid out is only focusing on the market environment and not my personal financial environment. There are factors within all COEs that you have absolutely no control over. They are still important as these factors WILL CHANGE over time. If you don’t identify them and keep track of what they are doing you may find yourself moving down a path that is no longer viable. Along these lines here is the last thing I will end this post with. Things change. Remember what COE stands for, CURRENT operational environment. It is a snapshot in time and place that provides you a start point. You must identify key factors within your COE to track and reassess as time passes. This will keep you from continuing down a path that suddenly dead ends due to changes in the COE.

Once you establish your COE and End State it is time to move to the actual planning phase. This is where the fun really begins. Again, I encourage discussion on what I have written and also hope it is of use to someone. My dogs however don’t seem to find it interesting as is evidenced by the fact that they are laying next to my desk snoring loudly.

Hmm, looks like one woke up..