To give you a little background, I was always a stock market kind of guy. I am a Certified Financial Planner™, I have been in financial services for over 20 years, I managed over $100 million of clients investment portfolios, I sat with over a thousand individuals and families to help with their financial planning and I just flat out love personal finance.
So why is it that just within the past few years I have discovered the tremendous benefits of buying investment properties?
Now...before you say to yourself that you are not handy, have no interest in dealing with tenants, fixing toilets, trying to collect rent, evicting tenants or rehabbing properties, I also have zero interest in any of those things and do not deal with them. This horrible picture of being a landlord I painted in my mind is what kept me blind to the potential for so long. It also does not help that I live in NY where buying investment properties is prohibitively expensive and subject to big market swings. See how easy it was for me to talk myself out of it and just keep on investing in stock index funds.
I used to think that the keys to being successful with rental property were the following:
The property had to be within driving distance of my house.
I should only invest in properties I was willing to live in myself.
I had to be willing to manage the property and do minor repairs to keep costs down.
As long as I was not losing too much money each month it was worth it in the long run.
I should aggressively pay down the mortgage so one day I owned the property free and clear and could enjoy the income from the monthly rents.
These (incorrect) beliefs were what I eventually used as my investment criteria when my family moved from a townhouse and instead of selling it, we turned it into our first rental property. This property fit all 5 bullet points above. I was scared to pull the trigger, yet also very excited. Owning a rental property and being a landlord was something I always wanted to experience.
After only a few months I realized that I did not enjoy dealing with tenant issues. I was also losing money each month because of maintenance and repair issues that always seemed to come up. After a few years of being a “hands on” landlord I decided to sell the property and get my sanity back. I learned this was not the correct way for me personally to invest in real estate, but I was still determined to own investment property because of all the benefits I am going to share with you. Technology, education and relationships are what allowed me to explore other unconventional options and find what I believe to be the right way to invest in real estate (at least for me for now).
It is important that you know what I am ultimately trying to accomplish by investing in real estate. There is no one correct way to invest in real estate. Your personal goal is what will dictate the way you decide to ultimately go about it. What is right for me might not be right for you.
So here is my number one goal: Cash flow. I want to have enough passive net rental income coming in that it covers my monthly living expenses. Imagine that..not having to work for money anymore. That would be awesome!
This is not a retirement plan. This is a now plan. I want to increase my current income without having to trade my time to get it. Yes, it will take years for me to build up a portfolio to reach this goal, but it will be long before the traditional retirement age. The best part is these investments improve my life now and also pave the way to a happy stable retirement. My goal of cash flow is only one of the benefits to owning investment properties. It just happens to be my main focus right now, but later on all the other benefits will start to play a major role in my continued financial happiness.
Helping people and doing the right thing is very important to me. I am in no way looking to become a slumlord or cut corners to achieve a higher rate of return. I am providing clean, well maintained homes in good locations to working class families. I am also not willing to buy houses in terrible areas where there is high risk of property damage and constant tenant turnover. I want this to be as stress free as possible.
The sweet spot for me is blue collar neighborhoods with low property taxes, decent school districts, diverse employment opportunities, 30-45% of the population rents their homes, strong population growth and a downtown area within 30 miles. Good investor markets can be found in areas like Indianapolis IN, Dayton OH, Kansas City MO, Jacksonville FL, and Birmingham AL just to name a few.
In order to make the numbers work, the monthly rent typically needs to be around 1% of the value of the home. For example, if I can purchase a 3 bedroom 2 bath house for $120,000, it would need to rent for about $1,200 a month in order for it to be a good investment. Notice that I am not counting on nor am I concerned with price appreciation. If the value of the house goes up that is great, but I am not investing for that purpose. I want the monthly cash flow so I can build that passive income stream. Typically, homes that have big potential to appreciate do not have a positive cash flow each month. This includes most high cost coastal areas like California, New York, Boston and Seattle to name a few. The opposite is true for areas that have great cash flow. They are what we call linear markets (small steady climb in prices with no wild swings) and typically do not have a lot of appreciation.
Now that you have an idea of what type of properties and areas I am looking to purchase homes here is how I am actually able to pull this off while living in NY. It all started with me finding a few outstanding podcasts (Get Rich Education, Real Wealth Network, Creating Wealth Show) and stumbling across an awesome online real estate investing community called BiggerPockets. I learned that there were companies operating in these markets that would buy distressed properties, complete a full rehab (new roof, hvac, kitchens, bathrooms, floors) flip them to an investor like me (at retail prices) and then manage the property for me going forward.
This business model is called “Turnkey” which is admittedly not the most profitable way to invest in real estate because I am buying the properties at full retail price, but it still works for me (for now). Investing with a Turnkey provider requires education and due diligence. There are some shady companies out there calling themselves turnkey providers so you need to be very careful with whom you decide to trust. It took me a year of learning, researching and speaking with different people before getting comfortable and moving forward. The turnkey provider truly becomes your partner and is by far the most important piece to this puzzle. They will make or break your entire long distance investing experience. I always get a third party inspection done along with a full appraisal required by the bank that is providing the mortgage. This at least gives me peace of mind that the house is what the turnkey provider is telling me it is.
Here is an example of my most recent turnkey purchase through a company called Spartan Invest in Birmingham Alabama:
Purchase price: $128,000 in Bessemer Alabama
Down Payment : $25,600 = 20% down
Mortgage: $102,400 - 30 year fixed at 5.625% (my highest rate in 3 years)
Closing Costs: $4,400 including insurance and taxes
Total out of pocket cost : $30,000
This property is a 3 bedroom 2 bath ranch that rents for $1,275 per month. The monthly expenses are $979 which include the mortgage ($589), taxes ($90), insurance ($60), property management ($115) plus an additional reserve of ($125) for vacancy and maintenance. This leaves me with a net cash flow of $296 per month. This property has new everything including a metal roof. It will hopefully be a long time before I need to lay out big money for a major repair, but I need to have adequate reserves because you just never know what could go wrong until it does.
$296 a month comes out $3,552 per year in net income. This income ends up being tax free because of a tax deduction called depreciation (more below). Based on my initial investment of $30,000, this is about a 12% return on my investment. It might not sound like life changing money, but remember this is only one of the benefits to investing in real estate. We call this the cash on cash rate of return.
Here are the Benefits of investing in Single and Multi Family properties:
Monthly Income (Cash flow) - I only invest in properties where the rental income exceeds all of the property expenses. This means money in my pocket each month even after paying for the mortgage, property management, maintenance, vacancy, insurance, taxes and utilities.
Loan Paydown - Your tenant is paying off the mortgage for you each month. If you borrow $100,000 on a 30 year mortgage, after 30 years your tenants would have paid off the entire amount. This is on top of all the income (cash flow) you received each month.
Tax Benefits - Depreciation is the key. If you can wrap your head around the power of depreciation you will start to believe in owning rental properties. In simple terms depreciation is the decline in value of the home (even though it is probably actually going up in value) that you can take as a tax deduction spread evenly over 27.5 years. This deduction can offset the income (cash flow) of the property each year, resulting in tax free income. The downside comes when you sell the property and have to pay “depreciation recapture ” tax, but the IRS does allow a way to avoid this tax as well. I will show an actual example of depreciation on the School of Personal Finance website to explain it in greater detail.
Leverage - Leverage provides the opportunity to grow our wealth much faster (or lose it much faster). When you buy a house for $100,000 and borrow $80,000 of it from the bank that is leverage. You are able to control a $100k asset with only $20k of your own money invested. Leverage can be powerful and can work either in your favor or against you.
Refinance - Let’s say you own a property for 15 years and you want to pull some cash out to pay for your child's education, but you do not want to sell the property. You can do a cash out refinance and pull the equity out of the house tax free. Yes, you will start the clock over on the mortgage, but who cares...the tenant is paying it off anyway and you now have a big pile of money.
Inflation - Inflation becomes your friend when you have a lot of debt. As time goes by inflation will not only increase the value of the property, but it will also decrease the liability of the mortgage debt. This is a hard concept to grasp but so very important to understand.
Think about it - the dollar will always be losing value because of inflation. Thirty years ago $1 would buy a slice of pizza, now that same $1 will only buy a third of a slice of pizza. The pizza is the same, the only thing that has changed is the value of the dollar has gone down. It is the same concept when you borrow money. If you loan me $100,000 and let me pay you back in 30 years, I will be able to buy so much more with it today than you will be able to buy when I pay you back 30 years from now. The money is worth less in the future. The longer you have to pay it back the less valuable that money will become. I want to borrow as much long term, low fixed rate debt as humanly possible, and use it to purchase stable assets (like a house) while the loan is being paid back by someone other than me (a renter). Real Estate is the only asset that fits the bill.
So just to recap, I live in NY where the cash flow numbers just don’t work for me to reach my goal. I am investing out of state in place like Kansas City, MO, Memphis, TN and Birmingham, Alabama. I am buying fully rehabbed houses that I have never seen in person. I have great property managers that I trust to take care of everything including maintenance issues, rent collection, tenant screening and placing, getting homes ready for new tenants, handling leases and evictions. The only thing I need to do is manage the property managers and make sure that everything is running smooth. I really do believe that this is so much better than just investing in a 401k for the next 35 years while struggling to make ends meet month after month. This is adding to my current income which allows me more flexibility and opportunities to pursue my passions like teaching people about personal finance.
An even better way to do this would be to find the distressed properties myself, buy them at a deep discount, manage the rehab remotely using a team that I can trust and then pulling my money back out through a mortgage once the house is completed and performing with a tenant. Hopefully at some point in the future I will have built strong enough relationships where I can make it happen, but I am not at that point yet.
Please let me know in the comments down below if you think I am crazy or you think this is a good way to build passive income and eventually become financially independent.