Numbers

The coolest part about a cash out refi? You get a big chunk of cash and pay no taxes!

If you got a year-end bonus of $34,577 you’d have over $10k in taxes taken out. But since a refinance is just a loan, nothing is withheld. It feels great when a $34,577 wire hits your account – way more than my original investment in the property.

The goal is to use these proceeds to acquire an additional rental property. You can think of it as a two step way to use the equity in one rental as the down payment on a new rental. I don’t even have to put up more cash to purchase another property!

Let’s take a look at how we got here.

The Background

I bought a turnkey rental property in Memphis back in July 2014. That means someone else did the rehab and placed the tenant, I just purchased the finished product at market rate. Nothing special on my end.

The purchase price was $93k and I put in $24k for the down payment plus closing costs. Fast forward seven years and I got $34.5k from this cash out refinance. And I should mention, over those 7 years it produced $26k of cash flow!

That means each year I averaged $3.5k just for putting up with a few minor phone calls (tenant turnover, minor repairs, etc.). The property manager did most the work, so even if you think “I am busy, I don’t want more headaches”, what if you were paid $100s of dollars an hour for those calls? Even just considering the cash flow return, that’s what I earned.

Keep Reinvesting the Equity

The key reason why investing in rental properties provides incredible returns? Safe leverage.

That may be somewhat of an oxymoron. Leverage is inherently more risky than not using it. But for rental properties everything is stacked in your favor: 30 years of fixed rates at below what the free market would charge. If you can ride out a decade or two in an attractive market, you are going to win big.

When I purchased it back in 2014, I just had to provide 20% and the bank covered 80%. So they paid 4x more than me, but I got all the upside for appreciation and cash flow. So as the property increased in value and the tenant paid down the principle for me, those percentages shift. Before the refi I owned 55% and the bank just 45%.

That shifting balance is great, but extra equity doesn’t earn you any more money. You have to put it to work to get the exponential benefits. One way to access that money is a cash out refinance – essentially starting a new 30 year loan back at 25% equity.

The Process

The paperwork on a refinance is the same as applying for a mortgage in the first place. A ton. They also do an appraisal on the property to see what it is worth, which determines how much cash out you can get.

For this rental, the appraisal came back lower than expected. 79% of the Zillow price at $135k. Of course Zillow isn’t correct either, but it does give another data point. The way they pick the number is by looking at recent sales – in this case in the last year within 1 mile, same approximate size and bed/bath.

We came back and told the appraiser “look at these other sales”. They ultimately came up to 83% of Zillow price at $142k. That was good enough.

My take away? In a rapidly appreciating market, the appraisal on a refi might not keep up (whereas a purchase they would likely give us the benefit of the purchase price anchor). There were some sales from last August that they used as comps, hurting our average since those didn’t have the 10-15% increase in the last year.

The original loan was at 5.375%. The new one would have been at 4.25%, but I ended up paying $399 extra to make it a 3.49% loan instead. You can run the numbers yourself, but a good mortgage broker will tell you what the payback period is. Meaning I pay $399 now and it lowers my payment $35 a month, resulting in a payback of less than a year. That was a great deal!

Since I am at this lower rate, my principle and interest payments went from $417 to $477 per month. So I just pay $60 more per month.

Reinvest for Exponential Growth

I previously did a cash out refi to fund a new purchase. My property #1 was refinanced after just 6 years to purchase #3. Now #2 is refinanced and I’ll start finding #4. With a little patience, I can achieve exponential growth with my rentals spawning more rentals!

Not to mention my property #1 is again up to 50% equity mine, 50% the bank’s. Property #3 at 40% mine, 60% the bank’s. So it won’t be too long before those can go through a cash out refinance themselves.

“Real” real estate investors would scoff at this because the way they go about it to find below market deals, rehab them, then doing a cash out refinance and repeat. With this method they do a lot more work, but can take that feedback loop from 6-7 years to 6 months. I think that’s great and may do it some day, but I believe absolutely everyone can do my approach – even busy professionals.

Get started the lazy way and you’ll still see incredible exponential growth!

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).

Of course, there are quite a few other options like renting out properties to tenant. There may be homeowners who do this on their own property as well, as accessory dwelling units (https://www.uniteddwelling.com/backyard-homes) are seemingly becoming more popular as a rental option that allows some form of passive income without having to think about investing in different properties. Anyway, my idea was a little different.

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. And I wish to buy a few more. However, this time around, I would like to invest in Awbrey Glen, Bend, Oregon. I have heard that people often want to visit this location for its exemplary beauty. So, I think that investing in properties here with the help of Bernard Group (https://bernardrealestategroup.com/awbrey-butte-bend-or/awbrey-glen/) could be a wise decision. Anyway, I have always been attracted by the idea of buying properties. So, I will continue doing that!

Honestly, 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)

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

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.

They set their practices on doing things the right way and if someone does anything out of the ordinary, it is likely to send them into a spin.

I can see why they think this though. This isn’t a joke to them; it’s their career and what they have worked so hard for. They are always on the lookout for more clients and to grow their firm, hence why so many of them are starting to look at how financial seminar marketing (find out here for information) can drive them forward and put them in good stead when it comes to making a name for themselves in the industry.

So when I put it like that, it actually makes sense when they cringe at some of the methods that I try – probably because that’s not how they would do it.

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. That being said, if you’re planning to buy or sell a property, the requirements and all these cash flow approach might change. You might even require the assistance of a conveyancing solicitor from www.myconveyancingspecialist.com or other similar sites to help you out with the legalities involved.

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

$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)

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.

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. If you are apprehensive about closing costs, you can find the relevant information on websites such as https://houstonrealestateobserver.com/ as well as others, so you can see what is ahead of you and how you can better navigate your way through with your money.

“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?

> … 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.