I grew up in the spotlight. Well, kind of. It may have been the small spotlight of an affluent Minnesota suburb and it wasn’t shining on me for any particular skills or talents, but it was a bit of a spotlight nonetheless.
See…my dad was the pastor at the Lutheran church in the community and as any ‘PK’ can attest, people tend to know you when your dad is the one delivering the sermon on Sunday. They know you and are always curious to know what you’re up to and what kind of trouble you’re getting yourself into. It’s a role that comes with expectations and can, at times, be exhausting.
With all of that said, there’s a very beneficial flipside to being a ‘PK’. We’ve all heard the phrase that success is “not about what you know, but rather who you know” and growing up in the public eye of a wealthy community creates networking opportunities only available to those in that spotlight. It’s a perk that outweighs any and all pressure and has opened up doors throughout my life.
At this point you’re probably thinking…”that’s a nice intro and all, but why should I care? I’m not reading this blog for a cost-benefit analysis on being a PK, I want to be a real estate investor.” Well…the reality is that I've been lucky enough to meet with some very successful real estate investors as a result of this network and been gifted with their wisdom.
One of these investors is a huge player in the Minneapolis apartment scene. He has built an empire of 1,000+ apartments on his own dime through passion, prowess, and persistence. He’s not just an amazing investor, but an incredible human being that has been willing to answer phone calls or meet for coffee solely for the purpose of answering questions we have about business, life, history, religion or any other topic that manages to come up.
As we were getting started, AJ & I met with him at Starbucks and the first thing he said to us went something like this…
“I get asked by a lot of people to have meetings like this to talk about real estate investing and I spend most of the time trying to convince them not to do it. Most people look at it as a great investment, but they don’t realize that you have to be crazy to do it. With stocks, you can leave your money alone and let it grow, but in real estate you have to deal with people not paying rent, phone calls in the middle of the night when things break, unhappy and unreasonable neighbors, and that’s just the tip of the iceberg. This will be the most rewarding and fun thing you can do and if you do it right, financially it will be an incredible investment, but you have to answer one question before you decide to do it. Are you crazy?”
Anyone that knows me knows the answer to that question. If something is a challenge and the work will be both difficult and rewarding, I am not only willing to do it, but am drawn to it. If you’re not that person, real estate investing probably isn’t the thing for you. Don’t take that the wrong way…there are plenty of days that I wish I wasn't wired this way.
If you’re still reading at this point and feel you are the kind of person that still wants to take the plunge and try real estate investing, here are a couple of benefits to being crazy.
Returns that can’t be matched by the stock market – Our real estate portfolio has significantly outpaced the stock market since we started this business for a few reasons. I'll dive further into each of these topics in the future, but this should give you a sense of how it works.
1) Cash flow – The rent that we receive from tenants exceeds our monthly mortgage cost plus any repairs needed on the properties. For example, if we bought a $200,000 home with 25% down ($50,000), we would have a monthly mortgage payment of around $1,000 that includes all interest, taxes and insurance for the house. If we have around $200/month in repairs and rent the property for $1,700, we would make $500/month in cash flow.
2) Principal Pay Down – Every mortgage payment we make includes a principal portion that reduces the liability we have on that property. In that same example, around $200 of the monthly mortgage payment would be a principal reduction that we would get if we were to ever sell that home.
3) Appreciation – This is a big deal when it comes to our market of single family homes. In the example above, if the property appreciates by 3% per year, the house would be worth $206,000 after the first year and close to $270,000 10 years later.
4) Tax Benefits – You can depreciate properties over their lifespan, so profits made on the cash the house generates can be offset by depreciation expenses to minimize or eliminate any tax liability. When it comes to selling homes, a 1031 exchange can also be utilized to defer capital gains taxes. This is a bit more complicated and we will definitely devote future blog posts to the concept.
What does that mean in terms of real returns? See below for the breakdown.
Cash Flow (only portion of return that is taxable before selling) - $500/month; $6,000/year
Principal Pay Down – $200/month; $2,400/year
Appreciation – 3%; $6,000/year
Total Return – $14,400/year
Depreciation - $6,000/year (we will walk through this concept and how to arrive at this number in future posts)
Tax Liability - $0 (Cash Flow minus Depreciation)
“Well that’s a lot of money, but the house you bought was $200,000. I can make more than that if I put my $200,000 in the stock market and I don’t have to do anything to manage it”
That phrase represents one of the most commonly misunderstood parts of real estate investing. You may now own a $200,000 asset, but you did not invest $200,000. All you have to invest in real estate is the down payment and any costs associated with the transaction. In this case that amount is $50,000, but there are plenty of financing options to buy real estate with less than 25% down (another future blog post topic!).
Break it down now and you can see why this can be a very lucrative investment. $14,400 in return on an investment of $50,000 in year 1 represents almost a 30% return (with no tax liability too!). As a comparison, the broad stock market index has returned 30% less than 20 times in its almost 100 year existence. That’s a pretty good year.
Continued equity & rent growth vs a fixed mortgage amount – The math in the above example is based on the first year of the investment, but you aren’t going to own and rent a house for only 1 year.
If you fast-forward 10 years, it’s not out of the question to think that $1,700 monthly rent is up to $2,200 and 3% equity growth represents closer to $8,000 year. Your monthly mortgage payment, however, will only increase based on changes in the cost of your taxes or insurance. If we assume those go up by $200/month, your total return for the year changes to $20,000 on your $50,000 investment (a 40% return!)
Control over your destiny – Your decisions and determination will determine your level of success. Your decisions on when to buy, where to buy, how to buy, how to manage, etc. will dictate your returns. Don’t get us wrong, it comes with a lot of work and a lot of risk, but you’re the one driving the boat…and that’s really cool.
Doing work you love with your best friends – If you’re like us and you both enjoy the work and spending time together, this business creates an excuse for daily phone calls, family vacations, creating spreadsheets, designing a space, running a renovation project and much more. It’s fun, it’s rewarding, and for us it’s all about family, friendship, and the future.
Those all sound pretty awesome, so why do I have to be crazy to want to do this? We’ve been investing for less than 3 years thus far and here are just a few of the things we’ve had to deal with so far. These will likely be laughably small in 10 years, but are things you also have to be ready to face:
Sewer drain back ups
Hauling appliances down tight stairwells (#stupidity)
Tenants not paying rent on time
Requests by neighbors to remove fences
A tree falling on a tenant’s car
Broken water heaters
Nervous nights with -20 degree weather
Gutter cleaning (you ever smelled that stuff?)
Doing 20 showings before finding a tenant
Fixing poorly maintained lawn mowers
Correcting a year of journal entries
Not knowing where your day job ends and your night and weekend job begins
Having already made it through 1,500 of our words, you’re already on the right path. Now that you know a little bit about what it takes and the rewards for taking the plunge, what’s your answer? Are you crazy?