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Did 3 Rental Properties Really Just Generate $34,295 in 6 Months?

July 9, 2019 5 Comments

Wowza, that is a big number!

My favorite thing about doing these updates? I put up with a few minor annoyances for 6 months, then find out my reward. And it is massive.

Isn’t saving and investing about delayed gratification anyway? Whenever you hear someone dismiss real estate investing offhand, ask them how much money they’d have to earn to put up with the slight annoyances.

A Quick Look Back

I am the proud owner of 3 properties I have never seen that are located thousands of miles away.

Here is how it went down:

July 2011 – Bought Atlanta area property for $20k investment
July 2014 – Bought Memphis area property for $24k investment
May 2017 – Cash out refinance on Atlanta property to pocket $36k (why and details)
September 2017 – Bought Memphis area property for $26k investment (search and details)

I think of my portfolio as a snowball gaining 30% more mass each year – yes, I am getting a 30% a year return. My role is to keep it moving with as little as work as possible. I’m pretty hands-off.

Added together, my property managers now collect $3245 in rent each month. My mortgage payments total $1918. With ~10% to the property manager, I’m clearing $1000 a month in cash flow if all goes well!

Let’s look at each individual property, then do a bit of analysis.

Rental #1 Numbers – Atlanta

The OG. Hard to believe it was 8 years ago I purchased my first rental property, way back when I was 25 years old. What is harder to believe – that I was so young or that it is still the same tenant all this time?

There were a couple of repairs so far in 2019. First the insurance company drove by and told me I needed to fix the loose shingles and siding. That was a couple hundred bucks.

Then the water heater needed to be replaced. By Googling the brand they wanted to install, I was able to pretty easily negotiate $200 off the price. But it still was around $1k total with another plumbing issue they fixed. Ouch.

That hurt the cashflow, which already was compressed after my refinance in 2017 (and below market rent). But still a positive number for the first half of 2019. And once again the appreciation was massive – up another $9.4k in only 6 months!

Rental #2 Numbers – Memphis

This one is going well. There were a couple minor repairs, but that is fine since the tenant is entering her 3rd year. I’d rather keep the same person than go through the expensive turnover process.

Out of my 3 properties, this one is the most balanced in terms of return from cash flow and appreciation. In 3 fewer years, it has nearly as much cash return as the Atlanta property!

The Atlanta property has 3x the equity return, however this property still has a very nice 21.4% compounded annual growth rate. So even if you don’t luck into appreciation or wonderful market timing, you can still make a killing on boring old properties in boring old cities.

Rental #3 Numbers – Memphis

Still the original tenant for 1.75 years, which means the cash flow is going very well.

But what really helped the numbers are Zillow and Trulia adjustments. They seemed way low just 6 months ago, now they are finally above the purchase price.

The result is a positive return on investment for the first time for this property. A 14% compounded annual growth rate isn’t exactly exciting, but I expect that number to keep rising as we get further from the closing costs.

I think that might be pretty typical when purchasing a rehabbed property. The first couple years it appears to be a meh investment, but looking back 8 or 10 years looks incredible.

Overall Portfolio Numbers

32.1% yearly rate of return! In just the last 6 months the portfolio earnings (net present value) jumped up $34,295!

Here is the complete breakdown:

What About Risk Adjusted Returns?

I don’t love doing this review because I think it paints the wrong picture. It is easy to dismiss these results as lucky timing or risky.

And there is some validity there – without great timing these numbers wouldn’t look nearly as good. I expect somewhere between a 20-25% yearly rate of return through a whole up and down market cycle.

But the point I want to drive home is that these rentals are not risky. Holding any property for multiple decades reduces a lot of the risk, when the returns are largely just inflation. This is a play on leverage paid by someone else (the tenant). But to make that leverage low-risk, the asset needs to have tangible value (not greater fool value). Each of these rentals is below the cost of construction in areas with a jobs.

These returns are incredible because the risk is so low. Speculating in Miami, Brooklyn, or SF would have had much greater returns over this period, but with a completely different risk profile. Don’t group these cheap rentals in a city like Memphis in the same “risky real estate” category.

You could even argue these properties have more tangible value than the stock market everyone loves, making it is less risky.

But I want to hear from you – how do you evaluate the risk of rental properties compared to the stock market?

Here are the complete numbers

$8061 for an Hour of Effort – Rental Property Portfolio Update

January 2, 2019 4 Comments

Well how do you like that?

I like it just fine because my rental properties are humming along nicely. In fact, by my calculations I made $8061 in cash flow in just the last 6 months.

Let’s take a look!

A Quick Look Back

I am the proud owner of 3 properties I have never seen that are located thousands of miles away.

Here is how it went down:

July 2011 – Bought Atlanta area property for $20k investment
July 2014 – Bought Memphis area property for $24k investment
May 2017 – Cash out refinance on Atlanta property to pocket $36k (why and details)
September 2017 – Bought Memphis area property for $26k investment (search and details)

Added together, my property managers now collect $3185 in rent each month. My mortgage payments total $1918. With ~10% to the property manager, I’m clearing $950 a month in cash flow if all goes well!

Let’s drill down and look at each individual property.

Rental #1 Numbers – Atlanta

Just crushing it on the appreciation!

I took the average of Zillow, Trulia, and Redfin – according to those estimates this property along appreciated $16,200 in 2018. Wow.

These returns are pretty impressive, but they are largely on paper (excluding my cash out refinance). You see, when the market turns over the next couple years, some of the appreciation will quickly disappear. That’s ok because there is more to real estate – don’t forget about the cash flow!

The cash flow is back up too. The tenant has been in there for the full 7 and a half years I have owned it, which is great news, but unfortunately they fall behind on rent occasionally.

In 2017 they were behind, so 2018 when they got caught up, my cash flow numbers are doing great!

24.4% compounded annual growth – bada bing, badda boom!

Rental #2 Numbers – Memphis

Steady Eddie.

Appreciated another $2300 over the last 6 months. The best cash flow of any property at $4131.

Oh and I haven’t mentioned a couple other categories too – the tenant paid down the mortgage for me $1228. And I received another $931 in tax benefits according to my calculations (long story, see previous articles).

The all-star property #1 purchased at the depth of the recession has a 24% compounded annual growth rate over 7.5 years. Well this one isn’t too far behind: 21% CAGR over 4.5 years!

Rental #3 Numbers – Memphis

Ok you ready for a dud?

According to 2 of the 3 price estimating websites, this one dropped a ton in the last 6 months. Why? I have some ideas…

First, these are quick estimates. You really have to look at comps to get an accurate price estimate. Luckily, those websites include some nearby “recently sold” properties…

And those time seem to indicate normal prices. One a block away for $125k, not $83k…

You essentially have two drastically different property prices in the area – old ones with no work done over the years or flipped properties. Any flipped property that had a ton of work done will have a higher price tag (like mine).

My best guess is there is some ~1 year period where the last sold price really sets the price estimate. So I don’t believe there is anything drastically different now!

I’ll go with those numbers anyway. Down $12k in price, $4k in cash flow. Ouch.

Overall Portfolio Numbers

Despite the big drop in Rental #3, the numbers are great.

Compared to 6 months ago, my portfolio yearly return dropped from 30.1% to 29.9%. I’ll take it!

Net present value just hit $100k. That is impressive. Basically this is the amount OVER a “100% safe” investment like a CD returning 2% every 6 months (which is still better than you’ll actually find in a CD despite interest rates jumping up recently).

That is incredible to me. It certainly is worth the minimal effort it takes to learn this stuff, acquire the properties, and the occasional phone call.

Here is the half year cash flow breakdown:

The Highest Highs

I know I shouldn’t get too excited though – I’ve caught 7.5 years of a huge bull run of the market. I’m not a genius investor.

Let’s say I have a paper “drop” in value of 30% on my property values overnight. That should would suck, but I’d keep the properties and they would still cash flow.

What would that do to the numbers? Instead of a 29.9% yearly return, it would drop all the way down to 9% per year. Temporarily. And if it took a year to drop 30%, but with the other benefits of cash flow, paying down the mortgage, and tax benefits? 12% yearly return.

That’s better than what people expect out of the stock market! Then things will be back on the upswing before you know it, again raking in huge returns.

Not too shabby. What do you think?

Other Updates from Brian

I’ve been keeping busy with my other ventures, so not much action or plans for Rental Mindset for now. So rather than doing the typical email opt-in for extra content, I’ll just share the link to my full spreadsheet for the above calculations.

What have I been spending my time on? I still have my day job of kids coding tutoring and then spent much of 2018 creating an app in the environmental space. It is called Pledge Balance – the basic idea is that a lot of people care about the environment but don’t have a simple action to take. It is a pledge to balance the negative impact of your driving and flying with a tiny payment that goes 100% to the ?. My drive today was 17¢ to balance, which is invested in projects like planting ?. Just launched in beta for iOS, so I’m excited to see where it goes!

$5,162 in Passive Income – Rental Property Portfolio Update

July 1, 2018 13 Comments

It’s been a while, have you missed me?

The thing I love about investing in rental properties is the passive income. I’ve been sitting back making money.

In the time since my last article, I make $5,162 in passive income and an additional $9k in net worth (equity value).

Let’s take a closer look at how I got there!

Purchased Turnkey Rental Properties

I am the proud owner of 3 properties I have never seen that are located thousands of miles away.

This is all possible by the magic of capitalism. Small businesses exist to flip rental properties to investors and other businesses to handle the ongoing management. For a reasonable fee, they do most the work for me!

Here is the timeline:

July 2011 – Bought Atlanta area property for $20k investment
July 2014 – Bought Memphis area property for $24k investment
May 2017 – Cash out refinance on Atlanta property to pocket $36k (why and details)
September 2017 – Bought Memphis area property for $26k investment (search and details)

Let’s drill down and look at each individual property.

Rental #1 Numbers – Atlanta

The appreciation just keeps on rolling on this one. It ran up in value so much that last year I refinanced to put the equity to use by purchasing property #3.

Over the last 6 months it has appreciated another $4k!

The cashflow is going just ok. The tenant has been in the property for over 7 years now, and has fallen behind on rent again. Once the next payment comes in, the cashflow numbers will look much better.

I’ve had several short phone calls with the property manager over the last 6 months about the late payments. The current plan is to file for eviction to really grab the attention of the tenant, and to get a payment plan down in writing. I’m not concerned because we have been through this already with the tenant and know they want to stay in the home, but also want to protect against the worst case!

The overall numbers continue to be very strong – it has a compounded rate of return of 23.5%!

Taken individually, that is great. But since I was able to reinvest the returns into more properties, the portfolio’s return is even better.

Rental #2 Numbers – Memphis

My Memphis properties lean a little bit more towards cash flow over appreciation. But actually both are going well!

Over the last 6 months the $1875 in cash flow, thanks to only one ~$200 maintenance call. The tenant signed a new 2 year lease as well, which came with $150 off for doing so (but made back through rent increases each year).

It is appreciating nicely too. Nothing insane, but going at a 4% a year clip right now. Through the ups and downs that might average out to closer to 2%, but leveraged 5x that’s still pretty solid!

Look at that – 4 years at 20.5% a year! And climbing, 6 months ago it was 20% a year.

Rental #3 Numbers – Memphis

This is the latest addition, and it is closing in on the 1 year mark.

The tenant is in place and starting to generate some solid cash flow. The value is now above the purchase price by a little bit.

There were a few hundred dollars of maintenance expenses, and the property manager got the record keeping messed up a bit, so we had some back and forth. But overall pretty smooth and very little time spent.

Still a negative overall return, as I dig out of the hole of the closing costs. This is to be expected though, my rental properties are a long-term play.

Before we go on to looking at the overall portfolio value, let me explain one new change this year.

Tax Benefit Changes

When it is your own personal portfolio, you get to do the accounting however you want. What you report to the IRS is standardized, I’m talking about your own scoreboard.

I pretty much just made mine up. I have a couple friends who are accountants who will likely cringe at some of these details.

First, I decided to use a 2% discount rate every half year. Monthly record keeping is overkill. Every year would be fine, but I like to check in on things more often than that. So I arrived at this non-standard measure.

Then I decided to include tax benefits as part of my cash return number.

The return is broken into two categories: cash and equity. Cash is the benefit I get now from tenants paying the rent. Equity is the return on paper from appreciation and paying down the mortgage.

There are additional benefits of rental properties that don’t neatly fit into those categories. One is the tax benefit from the fake expense of depreciation. On my taxes for each of the properties, I get to say I had a ~$3k expense that I didn’t actually pay. Pretty cool! What’s that worth?

That depends upon what I pay in income taxes.

Under the new tax plan, my marginal tax rate fell from 28% to 24%. So the benefit I get from not paying income tax on ~$3k per property fell a little bit as well.

Note: If you end up selling the property, you have to pay back the benefit from depreciation. This covers it well. There are ways around it though, like a 1031 exchange or eventually passing on to heirs. At worst it is an interest free loan, but since I don’t plan on ever paying it, I include it as a full benefit.

Overall Portfolio Numbers

Drumroll please…

My rental property portfolio is worth $110,020!

Here is the complete breakdown of the cash flows. Not shown are the discount calculations or the $10k cash remaining from the refinance.

Basically I’m crushing it still. The overall rate of return went up from 6 months ago and is back over 30%. It briefly dipped below with all the closing costs of acquiring a new property.

In fact, it would be up even more if I used the numbers on Zillow today – I actually pulled the numbers a couple weeks ago.

The Bottom Line

Ultimately whatever Zillow says doesn’t really matter though.

You can’t get too excited about the exaggerated highs, as there will be lows someday too. You are never as good as they say you are or as bad.

And for anyone who is thinking “everyone’s a genius in a bull market”, my return would be a whole lot more impressive if gambling in high price markets like San Francisco. This whole cash flow rental property approach is based on riding out the inevitable swings in the market.

I’m confident this approach works well over decades – therefore, who really cares what Zillow says. It sounds like I’m making excuses for bad results, not someone who is earning 30% a year!

What do you think? Think you can do it too?

If you want to dig into the complete calculations, click here

Is the Risk Priced In Rental Properties’ Amazing Returns? Part 1

February 12, 2018 12 Comments

I found a twenty dollar bill on the ground this week in Golden Gate Park.

Guess what I did?

I PICKED IT UP!

I didn’t assume it was too good to be true – that it wasn’t real otherwise one of the homeless people would have picked it up already.

I didn’t assume it had feces on it rending it way less appealing than a normal $20 bill.

And I certainly didn’t fixate on the downside of bending over to pick it up, hurting my back to the tune of a $5k hospital bill and an irreparable life-long injury.

Yet these are the kinds of excuses you hear from people about investing in rental properties.

Extremely smart people state that the risk is priced in to rental property returns and explore no further.

What’s at Stake

This isn’t a matter of finding $20. This is your financial well being, whatever that means to you – retiring early, paying for your kids college, exotic vacations, you name it.

We will thoroughly dig into numbers in Part 2, but I believe you can expect over a 25% yearly return on low cost rental properties.

Humans don’t have great intuition when it comes to exponentials. You’ve probably heard the “how thick is a piece of paper folded in half 100 times?”

Investment returns are exponential as well. So instead of intuition, let’s visualize what is at stake.

Let’s compare investing $100k in the stock market with a generous 10% yearly return vs 25%, over 20 years.

That’s a huge difference! $673k vs $8.7M.

If there is one time to not be intellectually lazy, this is it. So let’s take a closer look.

Is the Risk Priced In Rental Property Returns?

When someone says the risk is priced in, they are stating that the reason the returns are greater is because it is balanced out by the risk of losing money.

Imagine a roulette wheel with 36 numbers and no zero. Betting on red, black, even, or odd pays 2 to 1. Betting on a single number pays 36 to 1.

Of course betting a single number has much greater returns, let’s bet there!

Not so fast bucko – it comes with more risk. You will lose so often that it balances out – your expected rate of return is exactly the same as betting red.

Back to rental properties. If you state the risk is priced in without calculating anything, you are stating a belief in the efficient-market hypothesis.

What is the Efficient-Market Hypothesis?

Without getting too technical, it states that all information is priced in relative to risk in an efficient market.

The $20 bill intro ran through some comedic extrapolations of the efficient-market hypothesis.

In other words if I see something that is too good to be true (free $20) in an efficient market (out there in public), there is either information I’m missing that others know (feces) or risk I’m not accounting for correctly (hurt back).

You could state that I had an information advantage – I saw the $20 bill. The whole market didn’t have access to that information, just me.

In other words, believers in the efficient-market hypothesis think it is possible to generate higher returns accounting for risk, but you need some sort of advantage.

I challenge you to not be mentally lazy and just assume the risk is perfectly priced in to rental property returns. Here are some of the advantages that let you generate greater returns.

Advantage 1 – Your Effort

It is a pain in the butt purchasing real estate.

You don’t just go on E*TRADE and a few clicks later have your $20k invested.

No no no – it takes at least a month involving piles of paperwork and lawyers. The good news is it has been done before many times and is fairly mechanical after you have done it once.

But the really good news is that this keeps people out. Their laziness is your gain.

Advantage 2 – Government Encouragement

A tax code and other policies are basically a set of incentives designed to encourage certain actions from the populace.

The US government encourages individuals to own rental properties by handing out free money. It’s up to you to take advantage of it.

There is obvious tax stuff like deductions on real expenses like interest payments and fake expenses like depreciation.

Even better – a whole government agency is set up to provide cheap leverage to investors. Leverage is how you can achieve such incredible returns. (And it can be safe. Not trying to time a market like Miami, rather going for slow and steady boring cities with jobs like Memphis. See: The Thing Most Investors Don’t Understand About Leverage)

Usually only banks and big corporations have access to investment leverage like this. This is the one area an Average Joe can do it. Wahoo!

It is way affordable too. The interest rate on a credit card is around 20%. If you get a personal loan or a small business loan, I doubt you can find under 10%. And you’d have a max of 5 years to pay that back.

On a rental property it is only 5% and you have 30 years to pay it back. Isn’t that absurd in comparison?

Advantage 3 – It Isn’t an Efficient Market

The US real estate market is pretty decent at sharing information. There are things like the MLS and clear ownership through deeds.

But it isn’t perfect.

The main disruption to the efficiency is foreclosures. If someone can’t pay their bills, they get kicked out of the home and suddenly the bank owns the property. The bank doesn’t want to own a rental property (see #5 for why), so they get rid of it as fast as possible at a discount.

Other disruptions are properties that require a lot of work, which limits the willing buyers and drops the price even more than the repairs will cost. Or people who for whatever reason don’t want to go through the long 60+ day regular process of selling a home and want to unload it for cash now.

There are people more than willing take advantage of this. They put in the work to discover the deals, do the repairs, and flip it to someone like me.

Thanks to the inefficiencies in the market, everyone is happy!

Advantage 4 – Patience is Rewarded

The time frame of most investments is incredibly short.

The stock market is all about quarterly earnings. The long-term investment firms of VC and private equity are max 7 years.

Yet you are building wealth to retire decades from now.

Is that an advantage? Perhaps, especially if it keeps others away.

The expected return after 1 year of a rental property is likely negative, considering the closing costs and tenant placement expenses. It just isn’t a good option to exit the investment after 1 year.

After 5 years? Maybe. But that might be more of a crap shoot on market timing and the transaction costs are still a significant chunk of the profits.

You really have to be in it for the long-haul and willing to ride out the whole cycle.

I bet you can – aren’t you investing in a 401k or IRA that you can’t touch until you are 59.5?

Advantage 5 – It’s Small Bananas

If you remember only one advantage, this is the one.

Sophisticated investors take advantage of market inefficiencies and use them to their advantage.

The return vs effort on single family home investments is great for your personal portfolio, but insignificant for a large fund with millions of dollars.

It takes too much effort that makes it impossible to invest their entire fund in rental properties. And even if they can get a 30% return on just 1% of their portfolio, that still isn’t worth their effort.

A big shot portfolio manager won’t spend his time picking up pennies, even if it is free money.

It just doesn’t scale.

Perhaps it was a little disingenuous of me to show a chart earlier climbing 25% per year all the way to $8M. When you have over say $500k invested, the simple single family home strategy will have to change. The potential returns are lowered when leverage is reduced.

What a great problem to look forward to!

Don’t Take My Word For It, Calculate

I hope this article makes you reconsider your assumption that the risk is priced in rental properties’ amazing returns.

We looked at 5 potential advantages that you have, even if it is an efficient market.

But we didn’t put numbers to it. How much of the return is simply the priced risk? How much of it is market inefficiencies?

In Part 2 I am going to run some numbers to try to answer that question.

Yet it won’t matter one smidgen if you don’t first believe:

The stakes are important enough for you to spend brainpower on this
There are theoretically advantages you have even without any real estate experience

So let’s discuss – leave a comment below and let me know what you think.

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