OK All You Wannabe Real Estate Investors — This One’s For You

Unlike all of the previous buyer’s markets I’ve experienced, this one sports some pretty attractive interest rates, as if the prices aren’t enough to put a smile on your face. Not only that, but down payments for some loans are lower than 5% — and available to those who’re serious about gettin’ started on the investment side of the ledger. Haven’t bought a home yet? Not to worry, as you can still get your investment portfolio started while you get your own place.

AFter you put about 3.5% down, FHA will lend you the rest of the purchase price. You must move in though, which shouldn’t be a problem with most folks starting out. Of course, the difference in the real estate values of San Diego vs East Toilet Seat, North Dakota vary radically. A 40+ year old San Diego duplex can still run over $400,000 easily. Compare that to duplexes in other states, recently built for less than $250,000 — with more goodies included. So beware of leapin’ before applying your local reality to the calculator. Still, in most areas, including San Diego, this will work pretty well.

Let’s take a fourplex with a value of $375,000, sporting rents of $700 a unit. You’ll be moving into one, so your monthly gross scheduled income would be $2,100 monthly. Forget operating expenses for now. Your loan payment, including mortgage insurance should be roughly $2,170 or so. Before ya start jumpin’ up and down on the couch screamin’ “I want one!” let’s now ‘remember’ the operating expenses.

Taxes, insurance, maintenance, water & sewer, trash, and vacancies, not to mention the forever infamous ‘miscellaneous expenses’ will come from your Levi’s. Depending upon your area, and the building(s) in question, you may be able to pass on trash collection to the tenants. Rarely can you do that with water/sewer, though I’ve seen it before a few times. Usually tenants pay their own gas/electric. Let’s say your expenses sans vacancies (or bad tenants) run you around $8,400 a year, or $700 monthly. It could be more, though I doubt it would be much less.

That would leave you with a monthly net outgo of give or take $700-800 — without any bad tenants or vacancies that don’t fill up quickly. Could you rough it, living where ya wanna live for that much? Could ya? Use 150% of that amount just for fun. You could see yer way surviving with a net outgo of not much over a grand a month, right? If maybe ya cut out Starbucks?

But what would be your Plan — long term?

Sooner or later the value will go up, and yeah, your guess is as good as mine when that might be in your area. When it does, you will have new options on your menu. First of all you’ll be able to make a move — but which move? What if was after about five years or so?

1. You’ve made impressive career advancements and your income has allowed you to save bags of money. This money could allow you to buy your own home, condo, whatever. No more tenants living next door. This would mean you’d still own the units, only by then the rents would’ve risen somewhat (probably, not always), and more likely than not they’d pay for themselves with all four units rented.

2. You can sell them, splitting the proceeds between Internal Revenue Code section 1034 and 1031. That’s a highfalutin’ way of saying you’ll be separating the sales proceeds — 75% to a tax deferred (1031) exchange, and 25% to your bank account to do with whatever you please. (As long as you’ve adhered to whatever guidelines are in place at the time for occupancy.) This will result in having created two separate baskets — one for investment one for your home.

3. You can stay put, as your cost of living has no doubt decreased over the years.

What about while yer living there though? What are the pros and cons? Let’s begin with the downside.

Unless you’re now living in a detached single family home, you’re already sharing walls with your neighbors, they’re just not contributing to the reduction of your cost of living, or paying the lion’s share of your loan payment. Your tenants will no doubt figure out you’re the owner. This can be very good or very not so good, as Aunt Ginny used to say. In reality that’s up to how you approach being a landlord. But that’s a whole ‘nother post altogether.

There’s a lot more maintenance ‘cuz there are two, three, or four units, not just yours. They all need what they need, and you’re elected to ensure it’s handled. You can ‘call the guy’ or do it yourself, but it’s on you one way or the other. When units become vacant, and they will, it’s you who’ll hafta clean, paint, and whatever else needs to happen to make it rentable for the next tenant. You’ll get stoopid calls about petty problems — roll with it ‘cuz it’s part of the fun long term. You’ll pass on the management stories when you’re older and financially higher up the food chain.

Here are some of the pros to taking this approach.

25% of the interest and property taxes will be directly dollar for dollar deductible from your job income. In this case that amounts to roughly $10,000 year, depending what your area’s property taxes are. You like that ‘cuz it results in a tax savings of $2-4,000 a year state & fed combined. Then there’s the investment side, which parties in their own way when it comes to tax shelter. More tax shelter? Yep, probably another $9,000 or so. And we’ve already learned that means more tax savings, in this case, an inch or so less than the interest/taxes write-off produced on the house side.

In tax savings alone your bank account should swell by roughly $27-30,000 over a five year period. Better than a stick in the eye, eh?

Most of you, probably three outa four, will be living for far less than rent, especially after income tax savings are factored in. That statement is way too general in nature, but you get the drift.

The happy consequences of living more cheaply, plus the tax savings every year, is your ability to save lots of cash — at least more than if you hadn’t bought the dang thing.

Your tenants are paying for most of your loan’s principal reduction, something worthy of special toasts in the Kansas City area. (Sorry, inside joke.) In fact, if you should stay there five years, they’ll have shouldered the brunt of reducing your loan balance by about $35,000. Better than a kick in the head.

In five years your measly down payment of about $13,000 will have blossomed into, well, a whole bunch more. Chances are in this market the seller can be persuaded to front you all the expenses over and above your down payment. How cool is that? My lender buds, and what I see pretty much every day myself, tell me it’s pretty much become the norm lately. But back to how much you might have in just five years.

$28,000 in tax savings. $35,000 reduction in your loan balance. And let’s add just $6,000 in cost of living savings — come on, it’s only $100 a month. That means without including even a buck in appreciation, you’ve made almost $70,000 — works for me. Make sense to you? And yes, Chicken Little, it’s also possible it could be worth less in five years — not freakin’ likely, but possible.

Look, I’ve been pretty simple with the numbers here, but they’re real. Every buck had a dead president on it, and not one was ‘pretend’ in any way. It’s real, and it just might be the way for you to get started. Are there other ways? You bet. But this one is my favorite when it comes to beginners. It nails so many birds with just one silly stone. It could be the acorn from which your financial oak grows.

So, what’s up with you these days? Been wonderin’ about your retirement lately? Lotta folks been doin’ a whole buncha that lately. Think it’s time to take the bull by the horns? Me too. Get in touch with me and let’s make some good things happen. Have a good one.

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