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

January 2, 2019 2 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)

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 $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.

Image: winnifredxoxo
Image: eatsmilesleep

I’m Now a Hundred Thousandaire! – Rental Property Portfolio Update

January 15, 2018 14 Comments

$101k to be exact. Badda bing, badda boom.

My three rental properties are currently worth $101,091. Even more impressive, since I started on this passive cashflow real estate journey six and a half years ago, I have earned $73,368.

But we’ll get into the numbers in just a second, I feel a silly interlude coming…

Worth My Weight in Gold

I’m feeling pretty solid about the growth of this small portfolio, but what will it take to be worth my weight in gold?

Luckily the fine folks of the internet built a calculator for just that. I know nothing about gold prices and troy ounce conversions, so let’s take their word for it.

190 pounds equals $3.7 million in gold. I have a long way to go.

My portfolio is currently worth 5.2 pounds of gold though. So maybe it would be easier to go on an extreme diet?

Now Back to the Regularly Scheduled Show

2017 was a good year. I made some big changes to the portfolio, setting up for even more success down the line. Let me quickly get you caught up to speed on my major actions:

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)

My first rental property appreciated in price over the years while the tenant paid down the mortgage. It had a lot of equity. Equity is wonderful, but it is like a bank account that doesn’t pay any interest. So in 2017 I put that money to work.

Added together, my property managers now collect $3120 in rent each month. My mortgage payments total $1918. If about ~10% goes to the property manager, I’m clearing $900 a month in cash flow if all goes well!

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

Rental #1 Numbers – Atlanta

The estimated value is conservative. It appraised for $130k back in May when I did the refinance. I would be justified assuming that was the price, but I used $128.6k which is the average of Zillow, Redfin, and Trulia. Not that they are more accurate than an actual appraisal, I just don’t feel the need to pick a larger number to inflate my sense of self worth.

Notice the cash flow here sucks. A measly $267 in 2017? I spent more than that on avocado an toast.

The same tenant has been in the property all six and a half years I have owned it! That does amazing things for cash flow overall, because I don’t have to turn over the property with a million little repairs and touch ups, nor have the 1-2 months of lost rent.

Yet this tenant is often behind on rent. They didn’t pay for December by the end of 2017, so are behind again. Hopefully a tax refund gets them caught up again.

The other big thing affecting the cash flow on this property was the refinance. Mortgage payments went up from $616 to $760. But it also allowed me to purchase a third rental, which offsets the lost cash flow on this property. And gets more equity snowballs rolling!

Beyond the cash flow, this property has crushed it over six and a half years:

I initially invested $20k and it has made me $61k. Wowzers bowzers!

Rental #2 Numbers – Memphis

This one had a much better year on the cashflow. $3083 plus another $1043 in tax benefits.

This isn’t exactly the time to discuss the tax benefits, but basically thousands of dollars are tax free thanks to a fake expense called depreciation. If it is tax free, the equivalent income in taxed dollars is even greater.

The appreciation here is more modest as Memphis isn’t going to have as large of swings as Atlanta. It has been appreciating at 4.5% a year though over the three and a half years.

However this has been a large national upswing. If things go south nationally, Memphis will hold fairly steady compared to other markets, but not hit 4.5% those years. Let’s call it an expected 3% a year for appreciation.

Considering it is leveraged five to one, you still make a killing with modest appreciation at the rate of inflation. That’s a 15% a year return right there!

Doing great, a 20% compounded annual growth rate on this sucker!

Rental #3 Numbers – Memphis

This one is just a few months in. There were only 2 mortgage payments and 3 months of rent, so the cash flow as positive even though there were some additional tenant placement expenses.

When we look at the overall picture, it doesn’t start out pretty. You have to pay closing costs and fund your escrow for future taxes and insurance payments.

My overall return is negative $3.3k. I have to overcome the expense of closing costs before it becomes positive.

That’s ok, it is another snowball rolling and gaining mass!

Overall Portfolio Numbers

Those numbers don’t tell the whole story though. It is more accurate to do a cash flow analysis.

When you have an asset that spits off cash in addition to going up in value, it matters when you get that cash. $1k received six years ago is more valuable than $1k received today. I can invest it and make extra money over that time. That’s what a cash flow analysis accounts for.

If you know when you received the money and how much value you put on receiving the money earlier (I used 2% every half year), you can calculate the total earnings of the portfolio.

29.9% a year return! That is pretty darn solid.

And I still have $10.2k left over from the refinance that isn’t invested yet, that I hope to put to work in 2018.

Long time readers will note that the portfolio return a year ago was 30.7%. It dipped despite a good year in the market due to the refi and adding the third property.

Ya gots to spend money to make money – the dip was largely due to closing costs on the loans. But it allowed me to put lazy money (equity) to work, which will set up for greater returns in the future.

“Ya But I’ve Been Crushing it In the Stock Market with Less Work”

You wouldn’t be wrong to think that initially. After all, the S&P 500 went from $1292 in July 2011 to $2673 by January 2018. It more than doubled!

Actually sit down and run the numbers – what is the compounded growth rate?

<<Quick Google Spreadsheet Formula>> … 11.8%, pretty darn good. “That doesn’t account for dividends though” says the astute reader.

Ok I used this calculator for the Russell 3000 (a more broad index fund) and it spit out a 13.53% yearly return.

Jerry is not impressed. That killer run the stock market has been on doesn’t hold a candle to the returns of these cashflow rental properties.

We are talking 13.5% to 30%. That is massive. And not just “oh it’s 16.5% different” – it is exponentially different.

Over 20 years $100k invested:

Sorry for crushing your positive feelings about this great stock market run. You lose.

Get Going!

The sooner you get your own snowball rolling the better.

I’m not going to pretend my approach will scale well to millions of dollars invested, but I know if you are generating your first $100k (and probably million), you can’t beat these low-cost cashflow rental properties when everything is considered (including risk and time invested).

It all comes back to the cheap leverage available and the margin of safety provided by the tenant’s rent well above expenses.

What are you waiting for? Think you can do it?

If you want to see the spreadsheet with all the calculations and numbers, click here.

Photo: aisletwentytwo, Artist: Alec