Since we launched rich & REGULAR, we’ve had so many interesting and honest conversations about money, investing and early retirement. Each one has given us more confidence that “we’re onto something” and gives us the energy to keep tearing down, crawling under, or scaling over the walls people have up when money is the subject of conversation.
One of the more frequent conversations we have is about real estate and they all pretty much sound the same so to save us all a step, here’s a not-so-hypothetical transcript of several conversations doubled as a crash course on real estate investing. Enjoy!
Friend: Yoooo! Love the blog man. Lemme hold fifty dollars!
Mr. r &R: Cmon man, you know that’s a LOT of money!
Friend: So I remember you were talking about this a while back. So ya’ll are one of those house-flipping couples?… like on HGTV?
r &R: Nah bruh. We’re old school buy-and-hold investors. We bought our property in 2014 and rent it out. It’s slow money but it’s cash in hand consistently. We like to keep things simple.
Friend: So why don’t you get into flipping then? I could see ya’ll doing that?
Mr. r & R: I meeean, we thought about it but it’s A LOT of work. To be a great flipper you have to have a deep database of agents, buyers, contractors and you’re constantly on the move. We have full time jobs and definitely don’t have the time to make that sort of investing model work for us.
Mr. r & R: Well, there are basically 3 types of investing models for real estate. 1) You can buy -and-hold which means you buy a property, rent it out and collect your money slowly but surely as time goes on. That’s what we do. 2) You can flip, which means you buy the property at a low cost and sell it for a higher one that hopefully exceeds the cost of purchase and improvements you’ve made. Then there’s 3) wholesaling, where you secure the rights to the home but sell those rights to another owner/investor in exchange for a “finders fee”.
Friend: But which one get’s you the crazy money I see on HGTV?
Mr. r & R: That all depends on how you define big money. Plus, with that “big money”, comes big risk. That’s why sooo many people we know that used to invest in real estate got out . They got caught up trying to be like the people they saw on TV and got burnt.
Friend: Got it. So ya’ll do buy and hold. How did you find your rental?
Mr. r & R: Honestly, we found it using zillow, but if we were to do it all over again, I would work with an agent that has MLS listings so we can get a heads up on properties right when they hit the market or sooner. When you’re buying as an investor, it’s a cutthroat game and you have to move quick. If something hits zillow then it’s likely already been available for a while and sometimes that’s too late. That’s another reason why so many investors get their agents license, so they get the listings right off the top.
Friend: So it’s been cool? No major issues with your rental? I’ve heard horror stories of about tenants trashing the place.
Mr. r & R: Yeah man, we’ve had no major issues at all. We bought a property that was newly renovated and only needed a few touches before it was tenant-ready. We put a little bit of work into it, put it out there and it was snatched up in about a week. Since then the rent has increased from $895 to 1,095 and is occupied about 10 1/2 months a year. We’ve lost a few tenants but they’ve always been replaced with another that is willing to pay an even higher rent.
Friend: That’s crazy. If you don’t mind me asking…how much did you pay for your rental?
Mr. r & R: Yeah, it’s all good. It was priced at $62,900 and we bought it for $62K. The person we bought it from purchased it for something crazy like $30K a few months prior to us. I don’t know how much work they put into it but I’m sure they made a nice profit on us as well. Now, the market value is $120Kish. We could cash out BUT we’re more interested in the steady cash flow over time. Particularly, since we’re paying off that mortgage early, our monthly cash flow will double every month. On top of that, our current house will become a mortgage free rental too so we’ll have two that print money every month.
But here’s another way to look at it. We put $18K into that first rental to cover the down payment, closing costs and improvements. If I put $18K into the market in 2014 it would’ve done really well, because the markets have been bananas post-recession. My guess is 15-20% average return annually.
However, the average annual rent we’ve collected [approx. $275 a month times 10.5 occupied months out of a year] translates to about a 16% annual return on that original $18K which is nothing to sneeze at. If we’d put that into a savings account, CD or crappy money market fund the most we would gain on that money is like 1.25%…which is practically nothing once you factor in inflation. Also, the unfortunate reality is, so long as people remain in student loan, credit card and other debts, they’ll never be able to save up for a down payment, which means they’re forced to rent.
Somebody’s gotta own the home others rent…why not me?
Friend: Gooot it. I read that there are other benefits to having rentals too right? Like taxes?
Mr. r &R:Absolutely. We get to write off the cost of doing business as a real estate investor so the cost of improvements, repairs, business expenses etc. are all deductible expenses. Honestly, we take the lazy approach and take the standard deduction every year so we get to write off the mortgage interest on that note even though someone else is paying for it. Every little bit helps to push our effective tax rate down and give us more money to invest.
The other benefit is that it diversifies our total wealth portfolio. When we retire early, we’ll know that X% of our passive income comes in from rental real estate, X% comes in from dividends and gains and X% comes from other sources we’ll have set up. That ensures that if one revenue stream dries up, we’re not dead in the water. It also ensures that we need a smaller nest egg working for us in the market instead of a giant nest egg that we’d need to rely on to fund our lifestyle.
Friend: So hold up. Going back to the rental. How did you determine what the rent would be?
Mr. r & R:Rent is really driven by the market and by the property amenities. It’s not hard to just look at available homes for rent in your area, the number of bedrooms, bathrooms, finishes etc. From there, you can estimate how much you might be able to charge for your own unit based on those same factors.
I went a little nuts on the data and also looked at population trends, employment, economic development to get a sense for what types of families were moving into/or out of the area. That helps to add a layer of security around your decision so you don’t buy a home for rent that people aren’t looking for. For us, knowing the new Braves stadium was being built was a gamble but it worked in our favor.
There is also a rule of thumb called the 1% rule. Basically, it says that if you’re buying a property, the gross rent needs to be at least 1% of the final purchase price in order for the deal to work. In our case, that means we needed to charge at least $620 for a property since we paid $62K for it. Out the gates, we were at $915 so we were well beyond that. We didn’t strictly use that rule though. For example, gross rent is just the top line. You really should deduct other expenses/expense allocations like insurance, repairs, HOA fees, vacancy and management fees to get a full picture of the potential profitability. If THOSE numbers still work, then you got a cash cow on your hands. Easy money.
Friend: Man, I wish I knew all this stuff back when you did. I would’ve bought some properties too. Any other tips? I’m bout to go home and talk to my husband/wife and tell ’em we gotta get on it!
Mr. r & R: Yeah man…couple of things to think about though if you’re seriously interested in doing this.
- Unless you’re a handy man, marketer and have free time on your hands, definitely get a management company. They’re the one’s that get the calls when something is broken, handle marketing for your property etc. I would recommend finding one that specializes in the area your property is in because that means they likely have a long lead list of prospective tenants looking for homes in that area.
- Invest in an area you can get to quickly. The whole point of passive income is to have something that works in the background with little to no work. When you do have to check in or respond to an issue, you don’t want to have to go on the other side of town. It’s easier to just swing by in between running errands instead of having to go somewhere that is totally out of your way
- Have cash reserves on deck. You NEVER know when the $hit is going to hit the fan and you’ll have to carry the note or pay for an expensive repair. If you don’t have the money to cover it, then you’re stuck and even worse, may be forced to sell to escape the deal.
- Be patient…buy low- The real key to making money in real estate is in the purchase price. That way if you’re flipping, or using a buy-and-hold, you have a built in margin in the deal. Otherwise, you’ll find yourself squeezed trying to make an unprofitable deal work on the back-end. I wouldn’t buy rentals right now because property values are sky high [in general]. Honestly, I’m waiting for the market to correct so I can catch some unfortunate, unlucky investor who is desperate to sell at a discount.