Rental Mindset

Helping you reach financial freedom through rental property investing

Mindset

Don’t Wrap Your Identity in Investing Highs, Lows Are Sure to Come

I am on top of the investing world!

Things are going right, I am so smart. No luck involved.

Detect any sarcasm there? Just testing your sarcasi-sensor.

I just finished my cash out refinance on my first rental property. $34k was wired into my checking account and it felt so good.

     See: Cash Out Refinance on a Rental Property – My Actual Numbers

Less than 6 years ago I only put $20k into the property. Now I got that back, plus some, and still have the asset (including 25% equity). Whammy!

But I’m not letting myself get too excited about it. With high highs come low lows.

Don’t Wrap Your Identity in Results

Results aren’t always in your control.

Yes, I made a good decision on that property. In 2011 there was talk of a “double dip” recession or “lost decade” of returns.

Without some of the government intervention, it is quite likely those things would have happened. Did I control that? No way.

If I’m being honest, I’m only responsible for a tiny portion of the result. Most of the returns were thanks to things outside of my control.

I have two choices: either think I am a genius who can easily repeat my success, or acknowledge I got a bit lucky.

The problem with taking credit for things outside of your control? When there is bad luck, you think you are a loser.

Don’t pump up your ego too much on the highs, it will make the lows hurt much more.

You control the process. Continue to execute a good process and let the results take care of themselves.

How am I approaching my process?

Keep Buying, I’m Not Capable of Perfect Timing

If I got lucky on timing, maybe I should wait for the next crash and do it again?

If only it were that easy.

That is taking credit for the perfect timing before. I don’t think I (or you) can reliably do it.

Instead I’m going to keep methodically adding to my portfolio. Properties right at the 1% rule with enough cash flow to keep me in the game for decades.

I have to be mentally tough to ride out the lows. If I take credit for something outside of my control right now, odds are I will blame myself when the market hits a downturn.

The next property I buy, the first six years will not go as the one in 2011. That’s ok.

It might go up for 3 years before the market cycle dips down. Or it might begin later this year. Either way, I’m going to hold it for a decade plus, riding out the whole cycle, so it doesn’t matter that much. I just have to not panic or stop buying because things aren’t going well.

     See: How to Visualize the Real Estate Cycle

Looking Forward

I’m not going to maintain a 31% yearly return forever. I believe it will likely settle around 20-25% after a whole cycle. That is good enough!

I’ll keep reporting my return calculations every six months.

I’m also thinking about doing a monthly update of everything I did in the month for my rental portfolio. A time log. I haven’t done this because I barely spend any time on it. But that’s the point – rental property can be pretty passive! Would you be interested in this?

I’m going to start looking into putting that cash out refi money to work with a new rental property. The deals aren’t as good as when I last bought 3 years ago, but I’m sure I’ll be able to find something that makes sense!

I want to hear from you:
How do you keep perspective when you find success you aren’t 100% responsible for?
How do you keep plugging away when things aren’t going well?

3 Reasons Your Rental Shouldn’t EXCEED the 1% Rule

The 1% rule is common advice for cash flow rental properties.

It states that the monthly rent should be AT LEAST 1% of the purchase price of the property.

  • $80k home, you’ll want $800+ in monthly rent
  • $100k home, you’ll want $1000+ in monthly rent
  • $120k home, you’ll want $1200+ in monthly rent

I’m going to tell you something counter-intuitive.

Your rental shouldn’t exceed the 1% rule either.

Why the 1% Rule Exists

You want to make sure your property cash flows. But keep in mind, the ultimate goal is to maximize your total return.

Every month you will collect the rent and pay expenses. The expenses include things you pay every month: mortgage, taxes, insurance, property management. It also includes putting aside money for things that happen frequently, but not every month: minor repairs, tenant turnover. And even expensive items that come up once a decade: new roof, HVAC, water heater, and bathroom remodeling. The latter 3 can easily be sorted by a single company such as the highly recommended plumbers in Port St. Lucie. Getting a new roof installed can’t be sorted by a plumbing-type service, unfortunately they can’t do everything. You would need to look into a seperate tiling/roofing service the likes of a roofing Colorado Springs company would offer.

If you have money left over after all those actual and projected expenses, you have cash flow!

Ok back to the 1% rule… it is a quick way to determine if the property is going to cash flow.

But how much cash flow? That is a more complex calculation with a ton of variables:

  • How much tenant turnover is there in the neighborhood?
  • What interest rate is your mortgage?
  • What are the property taxes in the area?
  • How much life is left on the major expenses like the roof?

Obviously it will be good to dig into those questions and calculate with more accuracy if you are thinking about purchasing the property.

But at first glance, is the rental even capable of cash flow? Just use the 1% rule.

If the monthly rent is 1% of the purchase price, you can keep investigating. But make sure the rent isn’t much more than that!

Wait… Isn’t More Rent Good?

Yes, absolutely. But what are you giving up to get more rent?

For this analysis we are considering properties that are at market price or just below.

If you put in the work to find an incredible deal, like sending out mailers that say “I want to buy your ugly house” or going to foreclosure auctions as seen on sites like Auction.com, that changes things. You are trading your effort for a lower purchase price. In that case you should exceed the 1% rule. Some people might even want 2% to make it worthwhile.

I am currently purchasing properties through turnkey providers – they do the purchase and rehab, then sell the finished product to an investor. They might claim the property is worth more than the purchase price, but it really isn’t. If they could sell it for more, they would. Maybe they price it 5% lower to sell it quickly, but that is still pretty much market price.

So if the purchase price is fairly fixed (when you pay someone else to do the work and take on the risk of rehab), that leaves rent as the variable to look for in the 1% rule.

This is where people get in trouble. There are three reasons this can be an issue:

1. Expenses Aren’t Always What They Seem

Let’s look at a snapshot of a city right now. Here are some ballpark numbers you can get in Memphis:

  • A neighborhood
    • $120k price
    • $1100 rent
    • 0.92% ratio
  • B+ neighborhood
    • $100k price
    • $1000 rent
    • 1% ratio
  • B- neighborhood
    • $80k price
    • $875 rent
    • 1.1% ratio
  • C neighborhood
    • $60k price
    • $800 rent
    • 1.3% ratio

The quick 1% rule analysis shows ratios improve on cheaper properties. What do you think? Go with the best ratio?

What would actually happen if you owned all 4 of those properties for the next 15 to 20 years? Would the cash flow match that pattern? Keep in mind the cash flow is rent minus expenses…

I bet there would be a tightening effect when you consider actual expenses.

Worse neighborhoods are going to have more vacancies. The tenant moves around every year and doesn’t treat the property as well.

Better neighborhoods? You are more likely to get a tenant for multiple years, who treat the property well, leading to minimal repairs.

The quick 1% rule is misleading even for cash flow.

2. Appreciation Potential

You’ll often hear from cash flow investors that appreciation is the “icing on the cake”. Meaning it isn’t the main reason they invest.

I don’t quite agree. You need cash flow to keep the investment sustainable, but the biggest part of the return over the 15 or 20 years you own the rental? Without a doubt, appreciation. Especially if you understand the power of smart leverage.

Let’s not chase appreciation in a stupid Miami high-rise condo sort of way, but let’s keep it in mind as a cash flow investor.

We just looked at the numbers today for different classes of neighborhoods in a city like Memphis. Would you expect different appreciation potential for a C property and an A property?

I would, mainly due to the selling options. With class C properties, often the tenant can’t qualify to buy a home. They are stuck renting without a choice. If you sell, it likely will have to be to another investor, so the properties are less liquid. As you get into nicer neighborhoods, you’ll find tenants who can to qualify for a mortgage, and the potential to sell to an owner-occupant.

More interesting – what if the city and time isn’t held constant?

Let’s look at some potential numbers for a city like Dallas 4 years ago:

  • A neighborhood
    • $140k price
    • $1200 rent
    • 0.86% ratio
  • B+ neighborhood
    • $120k price
    • $1100 rent
    • 0.92% ratio
  • B- neighborhood
    • $100k price
    • $1000 rent
    • 1% ratio
  • C neighborhood
    • $80k price
    • $875 rent
    • 1.1% ratio

The deals in Memphis would have been better too. The A class properties might have been around $100k with a $1000 rent, right at the 1% ratio.

So the A property in Memphis would be the same as the B- property in Dallas. Same cash flow numbers, which one do you think has greater appreciation potential?

When prices are down, you have the option to chase appreciation while still getting cash flow.

Where we are right now in the real estate cycle? In Dallas you might get a C or C- property at the 1% rule. Not something I’m interested in.

More: How to Visualize the Real Estate Cycle

3. Your Mental Health

I hope you aren’t approaching rental property investing as a get rich quick scheme.

If you can make over a 20% return a year (like I think you can), you will eventually have a pile of money, but it is going to take a decade or two.

The biggest predictor of success in rental property investing is how long you hold the properties.

What is it going to take to keep you in the game that long?

Fewer headaches. Pay a property manager and let them do most the work.

But also keep in mind the neighborhood and class of property play a role. If you try to beat the 1% ratio by sacrificing in this area, expect to deal with more ish.

Don’t try to be a superhero, you might burn out. Trade a little bit on the ratios to improve your mental health and stay in the game.

Your Rental Shouldn’t Exceed the 1% Rule!

Does it make sense to sacrifice on cash flow to gain in other areas?

With the strategy of paying close to market rate and waiting for 1-2 decades, do you agree your rental shouldn’t exceed the 1% rule?

How about each of the individual points. Do you agree:

  • Expenses aren’t always what they seem
  • Greater appreciation potential can be smartly chased
  • Your mental health is worth supporting

Let’s Get Educated

Have you heard of Hotdogs or Legs? It’s an Instragram hashtag to see if you can tell if a photo is of legs or actually two hotdogs!

I’m in Mexico chilling on a beach, so you are going to have to go without a new article this week.

If you miss me, grab a margarita and try my ‘mexico we go’ Spotify playlist.

Let me also point you toward a couple things you can learn while I’m away killing brain cells with too much mezcal.

Understanding Money

I don’t have an econ background, nor do I think anyone really understands it. I mean no matter how much macroeconomics you know, it isn’t going to make you a great predictor of what is to come.

Yet you don’t have to understand it to benefit. Inflation is what a leveraged rental property investor wants AND it is what the US government wants.

Check out my article digging into the numbers Inflation: The Great Mortgage Destroyer.

Understand how it is measured, so you can decide if the published numbers match your reality:

Understand why governments create inflation:

How will unfunded entitlements be paid? With a dollar that isn’t worth a dollar anymore. With inaccurate CPI adjustments. Who benefits the most? Leveraged rental property investors!

Check out more videos about Inflation and Quantity Theory of Money.

Around the Web

Coach Carson is a real estate pro and great writer. I love his graphics that break down complex numbers into something you can easily visualize.

He wrote a series of articles about different ways you can succeed with rental properties. It isn’t one size fits all. The one that is closest to what I recommend?
The Trade-Up Plan – How to Retire in 8 Years Using Tax-Free Exchanges

Eric Bowlin is another full time investor I met last year at Fincon. I fully expect him in 10 years to be a big baller. He is going places and sharing his knowledge.

The most common excuse of not getting into real estate is no money. Check out How to Raise Cash Like a Champ For Your Real Estate Deal.

Sam at Financial Samurai is already financially set. He wrote an article Focus On Trends: Why I’m Investing In The Heartland Of America. Check it out, it is a great read.

I agree with the premise to invest in heartland real estate, but recommend you go about it a different way. For most people being a direct owner is way better than crowdsourcing like RealtyShares. You want to be financially stable in what you are planning on investing in, especially if you are intending on passing this on to future generations, so you’ll need something like a Trust and Estate Attorney to keep everything in line and legally above board, so be aware and remember to take precautions where needed.

Michael at Financially Alert is one of my best internet friends. Yes, that’s a thing. He has a couple of rental properties that are doing very well. I cannot possibly tell what strategies he uses or how he keeps the property maintained to always make them look lucrative to potential clients. Of course, he must be ensuring the houses are painted, locks changed (he may have to find a local locksmith, for that matter) and pests removes (if any!) in between the moving out and moving in of the two sets of tenants, but to give you a correct estimate, I would have to consult him.

You can check out how he rebounded from a poor start in My First Rental Property was a FAT Failure.

Up Next

I’m going to be sharing the actual numbers of my cash out refinance.

If you haven’t read it yet, start with my article Let’s Double Down! Cash Out Refinance on a Rental Property. This will make sure we all start on the same page for “why” before we get into “how”.

I want to hear your thoughts, just don’t expect a reply until I’m back in San Francisco:

  • Do you think there will be much inflation over the next 30 years? Is it under-reported by the government by even 1% a year?
  • Do you have any real estate websites you follow that I should check out?
  • Is there anything you are specifically interested in learning about my cash out refinance?

Photo: justsayu

Are The Rich Getting Richer Thanks to Your Actions?

Remember the “we are the 99%” slogan? It was everywhere just a few short years ago.

It’s about income inequality. The richest 1% of people, with 25% of the income and 40% of the assets, making decisions through the financial crisis that hurt 99% of the people. A lack of regulation leading to the mess, bailing out banks, quantitative easing, and more.

The Occupy movement peaked in 2011, but Bernie Sanders (and Donald Trump to a lesser extent) showed it is a powerful message that won’t be going away any time soon.

Movements are difficult for me to wrap my head around – What do you think you are accomplishing by living in a tent in the park?

Maybe I’m just too rational, but I do know extreme income inequality is unequivocally bad for the average person. Taken to an extreme, it leads to a class system – haves and have-nots, with little mobility between classes with little or no chance of the average person coming into riches or developing beyond their class.

Things are getting worse. The rich are getting richer.

What if we are responsible? What if the actions of the 99% are the reason the 1% keep getting richer?Tweet this

Voting with Your Money

We have been told our votes put people in charge to act on our behalf. Wouldn’t that be great, but unfortunately it isn’t true.

In today’s world, the economy is king. Every elected official, no matter how powerful, bends to the will of the economy.

Do you think the president is going to make a decision based on your vote or the fact that a bank failure will kill jobs?

Do you think your opinion is more important than the dairy lobby’s opinion, who represent the interests of far more people?

Your real power lies in how you spend your money and your ability to make noise. We have seen a small vocal minority get recognized because of how much noise they make, but I’m not the type to join a movement any time soon.

Let’s take a closer look at voting with your money.

The Hypocritical Environmentalist

“I care about global warming, I am an environmentalist! I can’t believe the government isn’t doing something about this! Rabble, rabble, rabble!”

But what about:

  • Amazon Prime delivering you packages multiple times per week in unnecessarily huge boxes?
  • Flying your family somewhere for a long weekend?
  • Eating red meat often enough to average over an ounce a day?

It is easy to have a disconnect between your view of yourself and your actions.

No judging, me too. It is natural to not dwell on the actions that contradict your view of yourself. If it does pop into our heads, we brush it off with ease. It’s called cognitive dissonance.

Perhaps your indignation about the lack of government action should be directed towards your locus of control. What changes can you make to your life, and how can your actions influence others around you to do the same?

Do you think there will continue to be hourly flights to Cancun if they are only half full? Nope. It is a business, they won’t lose money just for fun.

You are one small part of the economic system that is causing the issue.

Tiny Impact, Why Bother?

Small changes in behavior don’t have much impact on their own. So why bother?

You have more impact on your close friends and family than you think. Simply talking about your change in action (without forcing your beliefs on them like a teenage vegan) has the potential to change their behavior.

That’s where the multiplier comes in. Now your neighbor Carl is a disciple spreading the gospel of your cause. He knows other people, has a different family, and impacts those around him.

With any luck, the impact becomes exponential.

Back To the Rich Getting Richer

We took a detour looking at hypocritical environmentalist, but let’s look at something causing the rich to get richer.

We complain about Wall Street, we complain about corruption, we complain about CEO pay. Yet there is a mental disconnect with our actions.

Wall Street has that power because of the money. Why do they have so much money?

First, they are huge companies with huge revenues. You can switch from Walmart to your local grocer, paying a little bit more, but circulating more money in your town rather than the pocket of a CEO. That is a tough action to take as you are often sacrificing something (like paying higher prices or less selection). I want to explore another area that is win-win.

You are an investor in Wall Street. You are propping up stock prices with your retirement savings.

We all do it actually. Somehow it became the default way to save for retirement. “We have this mutual fund – give us your money and we will take care of the rest. Perfectly safe, nothing to see here.”

Some of us do index funds, but it is all the same. There is a fund fee, transaction fees, high frequency traders get their cut, and the money that actually makes it through that fee funnel boosts the power of the corporation. Empowering Wall Street every step of the way.

Why do we all do this? We believe it is in our own best interest and don’t know about any alternatives.

Some of it is effective marketing: telling us we can expect solid returns. Some of it is corporate trickery: 401k plans at work with limited options. Some of it is government intervention: tax breaks that influence our behavior.

But what options do we have?

Controlling Your Own Investments

An investment is giving money or other assets to earn a greater amount in the future.

This fundamental concept is obfuscated in the stock market. We don’t know why we get a greater return, we just hope it does. And it usually works out. Sounds a little like gambling – but that’s why we do index funds, to remove some of the risk.

What if you didn’t shotgun your money around Wall Street, and actually took your money to Main Street?Tweet this

What would that look like? Peer to peer investing, investing in local businesses, starting your own business.

Wait a minute – starting your own business is investing? Yes – you are investing both your money and your effort.

If you are willing to put your own effort in, whether identifying a non-default investment or creating your own, you have the potential for greater returns. If you do the same as everyone else, you can expect the same result as everyone else.

Of course, starting your own business isn’t easy but there are so many resources out there willing to help. If you are planning to start your own business, there are a few elements you need to consider. There will be a lot of paperwork involved, from any licenses or permits that may be needed to staffing capabilities and even finding appropriate premises. Not to mention, you’ll need various marketing campaigns and a well-designed website which is easy for visitors to use. However, resources like those on https://victoriousseo.com/services/off-page-seo/ will prove very useful when it comes to being visible online and reaching the desired target market. With their advanced SEO tactics, the webpage would be visible in no time. Plus, bringing on board other professional gives you the time to focus on what’s important for the business and push it into the direction you want, rather than taking on a workload that is too big.

Does that sound too difficult? What would you even do and is it worth it?

The Easiest Local Business

Investing in rental properties is the easiest way to become a local business person.

Just about everything involved with the rental is local – the tenant, the property manager, the handyman, the taxes, and more. Sometimes the mortgage and insurance too. I would always recommend using local businesses if you want to get into property. I spent ages looking at local property management companies and finally found the perfect one. The same applies to local electricians and insurers.

What makes rental properties an easy business? Everyone understands it and as long as people are living, they need a place to live. There is cashflow along the way, not just a black box of asset appreciation. It is a proven model.

There are an incredible number of ways you can be a rental property investor. You can invest a lot of your effort-asset, or practically zero.

Me? I pay for someone else to do most the work and consider my rental portfolio fairly passive (1-2 hours a month). And my properties aren’t even local – they are on the other side of the country. I believe I can earn a 20% yearly return, and I’m well ahead of pace so far.

Even though the properties aren’t local to me, I am still investing in small local businesses, not Wall Street. Someone found the deal on the house and referred it to a flipper rehab company. The rehab company used a team of contractors to fix it up. The title company does the transaction. The property management company is anywhere from a 1 to 100 person business. If anything breaks, then an experienced handyman or plumber (for example, Alpharetta plumbers) gets a call immediately. In such instances, they might be able to offer better assistance!

Each step along the way, a local business gets its cut. With index funds, Wall Street gets its cut at every step. Who would you rather support?

In the end, I achieve a much greater return by putting in a little bit of effort.

Is it Worth It?

That is for you to decide. It is hard doing something against the crowd. There are common objections that pop up, like it being too risky.

Is it really riskier? For a comparison you have to understand the risk of the default approach. Everyone with paper assets that can see their value disappear over night. No control in the decisions of the company. Huge exposure to lawsuits that drain profits. Not even producing cashflow, just hoping the stock price goes up. Do we believe there is no risk because everyone is doing it?

Understanding the investment and having complete control keeps the risk in check. Diversification is still important. It is possible with different markets and property types.

Hopefully rental properties can be your gate-way drug into more local business down the line. Maybe you want to take on responsibility and cut costs by managing the rehab yourself. Or starting a small property management company. Or even something outside of real estate entirely!

Start with the easiest business and go from there.

You have the power to stop the rich from getting richer.

I want to hear what you think.

What holds more power – your vote or how you spend your money? Do you agree changing the default way to save for retirement would remove some of the power from Wall Street? Would it halt the rich getting richer?

Do you agree rental properties are an easy local business to invest in? What are your objections? Too risky? Too much work?