Rental Mindset

Helping you reach financial freedom through rental property investing

The Approach

The 4 Reasons Why Dividend Investors Should Own Rental Properties

Can you ever have too much of a good thing?

Yes – doughnut holes. Once you have more than 10, you run out of fingers to put them on. Somehow they don’t taste as good after that…

What about cash flow? Can you ever have too much money flowing into your bank account?

This is what dividend stock investors are chasing. Allow me to set the record straight – there is a better way.

The Appeal of Dividend Paying Stocks

First, what is a dividend stock? It is one that actually pays it’s shareholders a fraction of the profits each year. What a novel concept!

Let’s imagine a company – Beagle Inc. Their shares cost $100 each and you buy one.

Beagle is a great company that turns a profit every year. However, they aren’t in an industry where reinvesting the profits back into the company will produce even better results in the long run. So rather than scaling up, they decide to pay a portion of the profits as a dividend to the share holders. Typically this runs in the 2 to 3 percent range per year.

So at the end of the year, your 1 share of Beagle Inc pays you $2.

Not bad! Most dividend investors will reinvest this back into the company or dividend index fund (yes, you can group together tons of companies that pay dividends) to purchase another fraction of a share (in this case 1/50th).

The following year you own 1.02 shares and earn a larger dividend payout. Fast forward a couple decades and with the power of compound interest, you receive larger and larger payments.

Over time investors hope that the stock price rises, the dividend payments slowly increase, and you can start a snowball effect by constantly reinvesting the dividends in new shares.

What’s not to love?

It Could Be Better…

Companies that pay dividends are not going to experience hyper growth. They are usually well established with predictable profit margins. If they saw the opportunity to reinvest their profits to take on a new market, they would.

Therefore, much of the growth of the stock price and dividend payments will be due to inflation. Meaning, if a company like AT&T experiences profit growth, it likely isn’t because they launched some new-fangled product. It’s because as inflation happens, they slowly keep raising prices.

So you have an investment that keeps up with inflation, pays a bit of a cash flow that you can reinvest, and allows you to start a snowball effect of compound interest. Sounds like investing in rental properties!

Rental properties have four advantages though that make them more appealing than dividend stocks.

1. Better Dividends

Most dividend paying stocks will pay out 2 or 3 percent of the share price per year. Of course there are outliers, but they are riskier. You used to be able to get around 5% a year, but that was likely due to times with higher inflation.

How does that compare to rental property investing? Pretty pathetic.

I’ve been earning about 9% cash return per year on my rental properties. This might be a little higher than longer term projections, but it shouldn’t be hard to get above 6% per year.

This is due in large part to #2 and #3.

2. Better Financing

You don’t have to buy a rental property with all cash! You only have to put down 20% of the value of the property and a bank will loan you the rest at a very attractive interest rate. Well, choosing a rental property that can generate good revenue can be a difficult task. This might be the reason why many of the real estate investors tend to hire agents (similar to realtors Lynchburg) who can filter the search process and find good rental properties for them to buy.

That said, what about Stocks? Almost everyone pays the full price up front. You can technically buy on margin, but even then you need 50% and at any point they can decide they want their money back.

With rental properties you lock in that financing for 30 years.

Most investors don’t understand the power of leverage. A stable rental property in a boring, low-cost city with plenty of jobs will keep up with inflation. Combine that with smart leverage and instead of your investment just keeping up with inflation, you are raking in the big bucks.

3. Better Taxes

Dividend income you have to pay taxes on, even if you immediately reinvest it in more shares. By default this is treated as ordinary income, which means substantial taxes.

However the IRS treats certain dividend investments as qualified dividends. If it’s a US company and you’ve own the shares for at least 60 days, you can usually pay the capital gains rate on those dividends. For me that would mean 15% federal. For the ultra-richies it is 20%.

That’s a pretty nice tax advantage for dividends. But can rental properties top it?

Well, ya! Unfortunately, there isn’t just one number that I can quote you it varies. You get to deduct “phantom expenses” like depreciation. This means you didn’t actually have to pay anything out of your pocket that year, but still get to act as you did on your tax returns. However, make sure to have a separate account for these transactions, so you would be aware of the tax or dividend returns you are getting. If unsure, you can take a look at this list of Best Business Checking Account – Our Top 6 Picks for 2022. It would likely give you an idea about the types of business accounts available for enterprises and you can pick the one best suited for your requirements. This way, you could also find a way to save your taxes.

Moreover, with depreciation alone, most of your cash flow will be tax free! I go into this more in Behind the Numbers – How I Calculated the Return on My Rental Properties.

4. More Control

When you buy a share of stock, you joins millions of other shareholders. Occasionally there might be a shareholder vote, but I think it is safe to say you have zero control.

What if the company decides to go invest heavily in some new market or pay the CEO a $100M bonus? Your only option is to sell your shares.

As a direct investor in rental properties, you run the show. You can reinvest the cash flow, just as you would with dividends, but there are also many more knobs and levers you can use.

One powerful strategy is the cash out refinance – over the years as you build up equity, you can refinance your loan to access the equity tax-free. That’s right, you can receive tens of thousands of dollars, pay zero dollars in tax, and reinvest it in another property (or any other way for that matter). Wow.

You can also “trade up” – selling your property, paying zero in taxes with a 1031 exchange and buying a duplex, four-plex, or apartment building. This is certainly something 1031 exchange brokers can help with!

Maybe remodeling the kitchen would allow you to charge higher rents… think something like that would be possible in dividend investing?

Rentals vs. Dividends

Both are chasing the same thing – cash flow. Yield. Dividends. Whatever you want to call it.

Both allow for the snowball effect of compound interest, which over the course of decades is extremely powerful.

Both are largely dependent upon inflation for growth in the underlying asset, as well as for the cash flow to increase.

But with these four advantages, rental properties clearly win.

What do you think? Should dividend investors consider switching to investing in rental properties?

It’s All About the Ratios Baby – Why I Invest In Rentals from Thousands of Miles Away

Have you heard someone say “the DOW is up 250 points today”? Or that is a specific stock has gone up $10 in the last year?

Well that sounds great, but how the heck am I supposed to know that that means without knowing where it started?

In the words of Einstein, it’s all relative.

What was the DOW at before and what is it now? What is the ratio or percent change?

It’s All About the Ratios Baby

Let’s look at an example to see why this is important. Let’s say you purchased 1 share of Dingle Enterprises at $10,000. And lucky you, it goes up 50 points!

Sweet, you made $50 with no work at all! But is that a good return?

Obviously you have to evaluate it based on how much money you originally put in … in this case your return was half a percent. Not so exciting now.

When we are evaluating rental properties, we won’t deal in absolutes (only a Sith deals in absolutes). We have to look at the ratios – in this case the rent to purchase price.

Example Time

Look at Zillow for a home in your area and let’s evaluate if it would be a good rental. Here is one in my part of San Francisco. Every property has a Zestimate, which is the estimated sale price, and a Rent Zestimate, which is the estimated rent. Those numbers aren’t all that accurate, but they can give us an idea of the ratios. As of the time of this writing, the numbers for this property are $1,091,542 and $4,500.

Don’t be the idiot that says “wow, I get paid $4,500 every month for doing nothing? Awesome!” The ratio of rent to purchase price is 0.41%.

Or to put it another way, the monthly rent is about 1/243rd of the purchase price.

Ok, now let’s look at a random property in a market I would potentially invest in. Here is one in Atlanta. The Zestimate is $104,430 and the Rent Zestimate is $1,110.

The ratio for this is 1.05%. The monthly rent is about 1/95th of the purchase price.

Wow, see that difference? In terms of ratios, it is a 2.5x improvement!

If you think I cherry-picked these examples, go ahead and take a look yourself. Look up a property in your area and see the rent to purchase price ratio.

Expensive markets will reliably be below 0.5%. Areas with potential for cash flow rental property investing are reliably over 1%.

There is More to Consider

Don’t be the idiot that just looks at the numbers though. The area has to have job growth and new people moving there.

But this is a quick way to eliminate markets from consideration. Especially if you live on the East or West Coast, you’ll see you should look out of state.

Also don’t be the guy who says “if I drive just 2 hours to Stockton then the ratios are just about .1%” (or insert any podunk “suburb” where people generally don’t want to live).

Really? So you want not quite as good of returns in a town that is miserable with poor job prospects so you can spend your weekends driving there to keep an eye on it? Uh ok.

Don’t be the person who says “ya but the appreciation is better in San Francisco”. It could be. Or it could crash. Sounds a lot like gambling – you will probably be just as good at timing which color the roulette ball is going to land on. And besides, over decades the appreciate will trend equal to the more boring linear markets that keep chugging along.

An Investment, Not a Part Time Job

The numbers told me to invest out of state. The properties are also way less money, so someone can get started with just $20k rather than $60k for the cheapest properties a couple of hours away from me.

But the thing I like most is that it helps me approach my rental properties as an investment, not a part-time job. It certainly is a thing. Whether you invest in real estate, shares, or crypto through an agent from bit index ai offizielle seite (bit index ai official website) or on your own, the more effort you put in, the better results you get. If you treat it like a part-time job, it will fetch you results likewise.

If my properties were local (or even a couple of hours away), I would likely be the landlord and way more active in maintenance. For instance, I would have checked the condition of the roof, windows, doors, home flagpole, and rain gutters and got them repaired. This would certainly save some money. But would that allow me to set up for long-term success?

All those hours of work would weigh upon me and make me hesitant to add to my portfolio. At some number of properties (4?) I would probably not want to purchase another because I’m already devoting enough time to it.

With the out of state investing, my rentals are much more passive. Yes there is still a little time required with the property managers, but it is more scalable. I am not afraid of the on-going time investment with 10 properties.

More passive with better returns? Sign me up!

What do you think? Have you found investing in your local area more appealing than out of state? What are the ratios like?

Photo: Juli

The Thing Most Investors Don’t Understand about Leverage

It can be frustrating when people just don’t get it.

Like when someone says they don’t like chocolate. Somehow logic just isn’t going to convince them how awesome it really is.

It’s sad because they will never understand and there is nothing you can do to share that joy with them.

A similar thing happens with leverage in rental property investing.

The Common Man’s Access to Leverage

Banks have all kinds of crazy access to loans. When they invest in something they only have to put up 6% of the price in actual money and borrow the rest.

Try walking into your local Scottrade office and doing that. “I’d like to buy 100 shares of Google. I know the price is $736, but I’ll give you $44 and finance the rest at 1% interest.”

Ya right.

Is it a rigged game? In some ways. But you know where the common man has access to leverage? Real estate investing.

20% down, 100% of the upside

The standard mortgage on a rental property right now is 20% down at a 4.5% interest rate. In fact, if you happen to ask around the jumbo mortgage wholesale lenders circle, they might agree to these statistics.

You get to own an asset by paying only one fifth of the price. Where else are you going to be able to do that?

Even better, it’s not like they require the rest of the money within a year or two. You pay the same amount every month for 30 years!

Since you own the rental, you get all of the upside. The bank doesn’t benefit if the house appreciates, you do.

Appreciation with Leverage

By now you know there are 5 different components that make up the overall return on a rental property.

Most people make the mistake of only focusing on one component and forget about the others. Right now we are just going to consider appreciation, but keep in mind this is just one aspect. Don’t forget the others.

The rentals I purchase are in somewhat boring midwest and southern United States cities. Most years they will appreciate at the rate of inflation – this isn’t a speculative beachfront Miami condo I’m hoping to run up 15% per year (as long as there is a greater fool to purchase it from me).

If the property appreciates 3% and inflation is 3%, did I actually make any money? This is where the leverage comes in.

Let’s Run Some Numbers

Over 15 years, what happens?

If you paid all cash, you won’t make anything on the appreciation in real dollar terms. The house goes up 3% per year, but is exactly canceled out by inflation. Your dollars are worth less. After 15 years at 3% inflation, $1 in year 0 has the same purchasing power as $1.56 in year 15.

If you use leverage? Let’s look at a hypothetical house where you put down 20% for a $100k property.

To keep it simple, we will just look at appreciation and assume you don’t pay down the mortgage at all over those 15 years. So in year 15 your mortgage balance is still $80k. This number will never go up, so this is the worst case scenario.

appreciation with leverage

See What’s Going on Here?

The investment just keeps up with inflation, but since you used leverage, you made $44,637!

Had you paid cash, the appreciation is exactly zero.

This is powerful stuff people. You took 1 of the 5 components of rental property return from $0 to $44,637, just by taking advantage of leverage.

With Great Power Comes Great Responsibility

That’s a Spider-Man quote, but it is true – leverage can provide huge returns even when the house appreciates at the same rate of inflation.

Don’t take this to mean you should buy a Miami condo which “projects” for even more appreciation. Instead look for the most boring, predictable, steady growth markets – you’ll still get a great return without needing to resort to gambling.

How Much is Too Much?

Leverage is a powerful tool that most people are brainwashed into thinking is bad. You now know better – this isn’t credit card debt, it’s strategic leverage.

The lending limits right now are 1:5 ratio for your first 4 investment properties (20% down). For properties 5-10 it is a 1:4 ratio (25% down). Remember banks are gambling at a 1:16 ratio backed by the FDIC and our tax dollars!

But is there a point where even with boring and predictable rentals, you can have too much leverage? Sure.

If you have 10 conservative cash-flowing properties at a 1:3 ratio, I would argue that is not over-leveraged, even if you have a one million dollar loan balance.

The leverage ratio and loan balance is less important to me. What matters more is how predictable the markets are (not gambling on appreciation, which comes with huge crashes) and if there is enough cash flow to provide a comfortable cushion if things don’t go as well as planned.

What are you comfortable with?

Is Your Timeline Your Advantage in Investing?

You know those cheap little hourglasses that come with board games? I think they are fascinating.

They are a physical representation of time. Zero technology. Impressive accuracy. Thousands of years old.

Have you ever seen one with liquid instead of sand? Even cooler.

That’s what we will be taking a closer look at today. Not hourglasses – liquid and time.

Liquid Dreams

A liquid asset or investment is one that can easily be converted to money. Illiquid is the opposite – it is more difficult to convert into money.

The stock market is a great example of a liquid investment, such as investment opportunities you’d be able to find on a site such as stocktrades.ca and others. You can instantly sell to an anonymous buyer at the set price for that split second. It is instantaneous and has a pretty low transaction cost. Millions of people do stock trading which just proves how amazing it can be. In fact, a few of my friends are using the software at TradeZero and they’ve managed to make a decent profit so far. It’s worth giving it a go in my opinion.

Investing in rare art is illiquid. It has significant value, but is much harder to price. You better not be in a hurry to unload it because you likely won’t receive top dollar. The price is dependent upon what someone is willing to pay – be prepared to pay a broker a huge fee to find the buyer. In today’s day and age, Bitcoin has made vast leaps forward in the trading market, this may be a better option for some who want to invest in this area and have it there ready for a later period. Websites such as broker.cex.io can provide a better background for people who may want to go for this option.

Obviously liquid is preferable – you want to be able to access the money in your investments. It gives you options.

But you might have to give up something for that liquidity…

What’s the Cost of Liquidity?

If everyone wants something, the price goes up. Economics 101.

Everyone would choose a liquid investment compared to an equal return for an illiquid investment. So they are not priced the same.

A simple example is a savings account vs CD (certificate of deposit). A savings account is perfectly liquid – you can remove your money at any time. A CD is similar, but you put your money in for a set period of time determined up front – a 1 year CD is common. You can get these types of accounts from many banks (such as Certificates of Deposits – Bank CD Rates – Atlantic Union Bank), with all the information you’ll need to save as much as you can.

Which one do you think provides the better return on investment? The liquid savings account or illiquid CD? The savings account might give a 0.5% yearly return and the CD 1.5%.

If you choose the CD over the savings account, you get an extra 1% yearly return. Or 3 times the return of the bank account.

Same money going in, but you traded your option of accessing the money at any time for a better return.

The Traditional View

Let’s take a look at the stock market since that is where almost everyone invests their money.

Average Joe wants to retire one day so he invests in the stock market. Index funds, mutual funds, individual stocks, you name it. He slowly builds up his positions over the years, purchasing more and more stock.

The investment is extremely liquid, even though Joe knows he won’t be touching that money for a long long time. He has the luxury to sell at any given millisecond, Monday through Friday.

The stock represents a piece of a company that is attempting to make money and impress investors to further drive up their stock price. The company has a shorter term view than Joe – they have to hit their quarterly numbers. They might choose to sacrifice their long term profit to drive up the numbers in the short term.

Is there something wrong with this picture for Joe? Could he use his timeline to his advantage?

The Luxury to Think in Decades

Joe knows he doesn’t need to touch the money for decades. Ok, there might be a small portion he needs to access, but not unless something really goes wrong.

Just like the CD vs savings account example, he can choose a less liquid investment that will have greater returns than the stock market.

There are many possibilities, but investment rental property is my favorite. It walks the fine line of liquidity – expensive transaction costs and paperwork make day trading impossible. Yet it has a fairly well defined price with many willing buyers (it isn’t a Picasso sketch).

And the returns over the course of a couple decades are roughly three times the stock market.

It Still Spits Out Cash Over Time

Even though the asset itself isn’t very liquid, you will still have the ability to access some of the money.

Every month the tenant pays rent – after factoring in all expenses you will get to pocket some cash every month. As the equity builds, you have additional options like refinancing to access the equity without selling the asset.

As you patiently wait over decades, you are pocketing cash the whole time. It comes at set intervals though, you can’t sell at an exact millisecond.

You are giving up flexibility for greater returns.

What do you think, can you use your timeline to your advantage?