Real estate is my favorite investment asset class to build wealth for regular folks. For hundreds of years, real estate has built tremendous wealth for millions of people. I don’t expect this trend to ever change in our lifetimes.
Real estate is the main investment the enabled me to retire from finance at 34. Currently, real estate takes up about 50% of my net worth and generate roughly $200,000 a year in passive income. Stocks take up 32% and the rest consists of bonds, alternatives, and risk-free assets.
Real estate is all about asymmetric risk and reward. When the government gives you subsidies in the form of mortgage interest tax deductions, a $250K/$500K tax-free profit, and bailouts for overextended homeowners over and over again, you’d be silly not to invest in real estate!
Real estate is also a great beneficiary of inflation. It benefits from rising rents and rising property values. And when stocks and bonds are declining, mainly due to inflation, real estate tends to outperform. Fundrise funds for example, has outperformed the S&P 500 by over 25% in 2022.
When you can invest lots of other people’s money and not have to split the proceeds if you make a killing, that’s a wonderful thing!
Real Estate: Favorite Investment Asset Class For The Wealthy
There’s a reason why every rich person you know owns multiple properties. There’s a reason why enormous fortunes have been made through real estate as well. How can President Donald Trump still be a billionaire after declaring bankruptcy? Asymmetric risk and reward.
It’s no wonder property owners were once called lords, or now more colloquially, landlords. The wealthy own assets, while the not-so-wealthy lease assets. After 30 years of paying $2,000 a month in rent, your return on $720,000 in rent is negative 100%.
At least through a mortgage you’ve got an asset which you can live in rent free or pass on to your children once paid off. You might not make money as the downturn has certainly shown, but at least you have a chance.
In an inflationary environment, like we will probably experience post pandemic, you want to own property with a fixed-rate mortgage.
As inflation picks up, the cost of the mortgage declines in real dollars. Meanwhile, the principal value of the home increases with inflation. This one-two combination is one of the reasons why the average homeowner is so much wealthier than the average renter.
When it comes to making money, if there is no risk, there is very little reward. The biggest reason for the widening wealth gap is due to the ownership and lack of ownership in real estate.
Example Of How My Favorite Investment Asset Class Can Make You Rich
In early 2003, I put down 20% on a $580,000 condo. My mortgage payment was roughly $2,400 a month at 5.75%. I had just turned 26 and was nervous but adamant I didn’t want to pay more than $2,000 a month on rent.
The $464,000 mortgage payment was split $500 to principal and $1,900 to interest. Rent for a comparable property at the time was $2,000 a month. Therefore, things were essentially a wash if you include property taxes and deductions.
In 2013, the mortgage rate was 3.375% thanks to several refinances on a loan of $285,000 (from $464,000). I’ve painlessly paid down $180,000 (39% of entire loan) in principal through my PMI loan and the occasional ad hoc principal payments. The mortgage fell to just $1,300 with $500 of it going towards principal. Meanwhile, I was renting the place out for $3,400 a month!
Mortgage interest not only dropped from $1,900 to $800 (-58%) during this time, rent went up from $2,000 to $3,400 (+70%).
There are several reasons for this phenomena: 1) Supply is tight in San Francisco due to building restrictions on our 7 mile by 7 mile city, 2) Demand continues to rise due to an increase in jobs from new startups, 3) The economic crisis caused bonds to rise and yields to fall, and 4) The Federal Reserve continues to conduct very loose monetary policy. If you’ve ever deliberated between good location and higher prices or bad location and lower prices, consider the former.
Today, the mortgage is zero because I finally paid the sucker off in 2015 after receiving an influx of cash. I’m now charging $4,400 a month in rent while collecting roughly $3,000 a month in net cash flow after HOA, taxes and maintenance.
10X Greater Home Equity
My $116,100 downpayment has turned into a cool $1,250,000 15 years later with very little work on my part. For 13 years, my tenants helped pay down my principal. All I had to do was find good tenants about once every two to three years.
If I want to sell the property, I can without having to pay any long term capital gains tax due to the 1031 Exchange system. A 1031 exchange lets me defer or never pay taxes if I find a similar income property within 180 days of sale. Talk about pro government housing!
More Reasons Why Real Estate Is A Great Asset
1) Real estate is a hedge against inflation.
You only hate inflation if you don’t have an asset that is inflating. If you own an oil field, a private university, and organic farm, a gold mine, or a rental property, you are loving inflation!
Inflation is increasing the prices of your goods hopefully faster than the input costs and the costs to operate your asset. You think rents and prices are expensive now, but I promise you they’ll look cheap 10 years from now.
As we come out of the global pandemic, inflation will likely stay higher than normal. The ability to earn higher rents and see higher capital appreciation is a powerful combination for wealth creation.
2) Real estate is a money-making play on inflation.
Forget about protecting yourself against inflation. Owning real estate is a play on making money with inflation. If there so happens to be hyperinflation, your cash is devaluing rapidly as your real assets start surging in nominal value. We are experiencing higher inflation expectations as we get out of the pandemic.
With inflation, you get to benefit from property price appreciation and rental price appreciation if you own rental properties. Given interest rates have tanked due to the global pandemic, the value of rental income has gone way up. It takes a lot more capital to generate the same amount of risk-adjusted income today.
3) Generational wealth transfer.
You can pass on property from generation to generation, conceivably making their lives a little bit better. Think about all the college graduates nowadays who are complaining they will never be able to afford a home like their parents due to exorbitant prices. Now think how much worse it will be for their children.
If your parents happen to just give you one of their properties, life becomes much less stressful as you don’t need to pay rent anymore! You don’t have to study as hard to succeed either. You can pursue un-lucrative fields such as music, dance, and other fine arts if you so choose because those are your dreams.
The median age for a first-time homebuyer is now about 33. The sooner a person can get neutral real estate by owning their primary residence, the better.
4) Little effort to build wealth.
The most effort comes from researching the property you want to buy and finding the right tenants to pay your mortgage. Once you’ve run various scenario analysis and screened your applicants, you can basically set it and forget it.
My average tenant turnover is 2.5 years. I host two open houses for 1.5 hours each, spend another two hours reviewing applicants, and another hour coordinating the move in and that’s it.
Meanwhile, to turn $116,000 into $1,000,000 through equity investing is no easy feat, neither is saving another $884,000 over 14 years. The whole idea is to invest in assets that work for you, and not the other way around.
5) Real estate generates tax-free profits.
The first $250,000 in profits for singles and $500,000 for couples is tax free if you live in your property for the last two years before sale! If you so happen to be in the top income tax bracket, this is absolutely music to your ears!
In order to bank $250,000 in after-tax profits as a top income tax bracket earner, you’ve got to make around $450,000 in gross profits. This special feature alone makes me want to buy property over and over again. Real estate is a very tax-efficient way to make money.
6) Real estate serves a utility function.
Unlike cash, which serves no utility function, property addresses a fundamental human need, shelter. If our financial system goes to hell, at least you will have a tangible asset you can actually utilize. The only thing I can do with cash is make paper airplanes and perhaps start a fire.
7) Real estate provides semi-passive income generation.
Not only do you get to benefit from rising principal values due to inflation, job growth, and income growth, you get to also benefit from rising rents due to the same reasons!
I first started renting my rental condo out for $2,300 back in 2005. Now I’m charging $4,200 a month for rent going into 2021. That’s a 83% increase in rent while my mortgage payments stayed the same or declined.
You can also potentially earn healthy returns (8% – 15%) that are 100% passive through real estate crowdfunding and owning public REITs. I’m all about taking advantage of real estate crowdfunding to invest in the heartland of America where valuations are lower and yields are higher.
As a retiree, your favorite investment asset class should be able to generate reliable passive income to fund your lifestyle. Currently, real estate accounts for roughly $190,000 of our annual passive income. This way, both my wife and I can stay jobless to take care of your two young children.
8) Real estate is almost dummy proof.
There were a lot of people who didn’t understand the terms of their loans (neg am, balloon payments etc) or who borrowed way more than four times their income with no savings buffer. Good thing for you, you’re no dummy because you’re reading this article and other articles about real estate investing.
Once you run the realistic cost and revenue numbers based on data provided by the seller and comparable properties, you have a base case assumption. If you are achieving a rental yield of 7% and can borrow at just 3.5% after a downturn, your month should be salivating for such a 3.5% immediate spread with principal appreciation potential.
With interest rates plummeting during the pandemic, the value of cash flow went way up. But now mortgages rates are elevated, which likely means real estate prices are likely going to fad a little bit.
See the 2023 housing price forecasts to get a detailed breakdown. There should be good real estate buying opportunities over the next 12 months.
9) Real estate is measurable wealth.
I know that after I finish paying off a mortgage, my net worth will equal the market value of the property. When you invest in private equity, or even public equity, you are taking a massive leap off faith that management and other exogenous variables don’t crush your returns. You pretty much know what you’re going to get in real estate if you follow the course.
When you retire, it’s nice to know you have an asset that’s fully paid off. Eventually, you can leave the property to your kids, who should receive a stepped-up basis to avoid paying capital gains tax.
My favorite investment asset class should continue to have favorable tax treatment. After all, owning real estate is part of the American dream.
Unlike stocks, real estate doesn’t just lose 30%+ of its value over night due to some slight earnings miss. Real estate values are much steadier, which provides more peace of mind. There is a triple benefit to paying off your mortgage and owning real estate free and clear.
10) Priceless feeling when you own real estate.
There’s something nobody really tells you when you finally purchase your own home. Perhaps because that something is unquantifiable. Even though you likely won’t own the house outright in the beginning, it feels wonderful not to pay someone else’s mortgage anymore.
It’s an amazing feeling to be the king or queen of your own castle. To do what you please is great. So long as you pay your mortgage, nobody will ever be able to kick you out. You grow roots and finally gain conviction to launch your life.
11) Real estate provides career insurance policy for your kids.
As a dad of two kids now, all I think about is how to take care of my kids. A rental property portfolio can help take care of your kids by providing shelter and or a job. It’s a competitive world out there! Real estate acts as an insurance policy for your greatest asset, your kids!
12) Real estate is less risky than stocks
Because real estate is less risky than stocks, people can ironically make more from real estate. Due to less risk, people are more willing to buy real estate and with debt. Many people are too afraid to invest in stocks because its value could get cut in half over night. As a result, the average person can get richer off real estate than stocks.
13) Real estate is a safer haven during times of uncertainty
The pandemic and now the war in Ukraine has show the desirability of real estate during times of uncertainty. When the world is uncertain, investors look for real assets that provide utility.
Since the pandemic began, real estate has surged in value along with equities. However, during geopolitical uncertainty, you are seeing real estate outperform as equities correct.
Take a look at this Fundrise returns chart as of Q3 2022. Fundrise funds have outperformed public REITs by over 33% and the S&P 500 by over 29% in 2022. Fundrise also significantly outperformed in 2018 when both public REITs and the S&P 500 were down as well.
Owning physical real estate tends to outperform publicly-traded REITs and stocks in a downturn. Owning private real estate funds that invest in the Sunbelt may perform even better.
I’m a believer in work from home and the demographic shift towards lower-cost areas of the country. As a result, I have diversified $810,000 of capital into private real estate through platforms like Fundrise.
Take Advantage My Favorite Investment Asset Class
I didn’t buy my house with the primary hopes of creating more wealth. I bought my house because I didn’t want to live in a crappy apartment anymore. Here’s my housing expense history if you’re interested with a housing expense framework to help keep your finances in order.
I wanted my own deck, backyard, and freedom to turn up the home theatre system as loud as I wanted. At the age of 28, I wanted to start living a better life after slaving away in the office for the past six years.
If I wanted to make more money through real estate, I would have bought a multi-unit building instead. Life can’t all be about making money. Funny how we like to justify our purchases.
Despite economic Armageddon, real estate is still my favorite investment asset class to build wealth. Very few other assets require so little work and allow for so much outside funding to create so much value over time.
For those who don’t have the downpayment, don’t know whether you plan to live in one city for more than five years, or don’t want to go through the hassle of managing tenants, consider real estate crowdsourcing.
I’ve personally invested $810,000 in real estate crowdfunding. My goal is to gain more exposure to the heartland of America where valuations are lower. Yields tend to also bee higher than coastal city property. The older I get, the more passive I want my income to be.
Renting has its benefits, namely flexibility. But renting itself does not build any wealth. If you are considering investing your money that’s sitting in low yielding accounts, consider investing in real estate. It may be a tough slog the first two years. But in ten years, you’ll probably wish you had bought more!
Explore Real Estate Crowdsourcing
If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise. Fundrise is one of the largest real estate companies today with over $3 billion under management and 300,000+ investors.
Utilize Fundrise to invest in my favorite investment asset class to build wealth. Real estate crowdsourcing allows you to be more flexible in your real estate investments. Fundrise is also the pioneer in the private eREIT, which I think is appropriate to gain real estate exposure for the average investor.
If you are an accredited investor, also take a look at CrowdStreet. CrowdStreet focuses on individual real estate opportunities mostly in 18-hour cities. 18-hour cities like Austin and Memphis have lower valuations and higher cap rates. Further, with geoarbitrage and working from home now common, there should be a good trend towards moving to lower-cost areas.
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“make paper airplanes and perhaps start a fire.” LOL!!!!
A sense of humor from a financial samurai. No wonder I love your site!!! :)
Welcome to my sight Brenda! Hope you are able to read through the lines in many of my posts. If not, don’t get too mad!
I was thinking of investing in REITs rather than having the headaches of being a landlord. Any thoughts about REITS as a good/bad investing choice?
REITs generally perform well. But REITs provides no utility. I think we’re in a Multi year upcycle, depending on where you invest.
The greater the collapses, the greater the opportunity!
Great article Sam. I am a big fan of investing in real estate also. I live in the SF Bay Area as well and I work in the real estate industry. One issue I had with your posting is I didn’t see any mentioning of your HOA fees. I have worked on many condos in SF and I know a typical HOA fee will range from $400-$700/mo. while some of the higher priced condos can have HOA fees that exceed $1,000/mo. I am wondering how this affected your overall returns. For many of us starting out in real estate investing and landlording, condos may seem to be an easier way to start off since the mortgages are typically lower than a single family or multi-family residence. But the HOA fee’s for condo investing must be addressed before moving forward.
If you did already address this in your article please forgive me as I was reading it on my phone. But I didn’t notice any mentioning of your HOA fees and how it affected your returns. Thanks!
My HOA is lower than $400. I didn’t want to get bogged down in the mathematics of it, but at the time of purchase, my HOA was $230. So $230 + $1,900 interest + $500 monthly property tax = $2,630 compared to rent of $2,000. Take 70% of $2,630 to get my cost of ownership of around $1,840 + the amount of interest forgone from the downpayment.
This is why I say it’s essentially a wash compared to $2,000 a month in rent when I first bought.
Thanks for the comment Sam. An HOA of $230 is really good for SF. I am not sure which district/neighborhood you bought in but I haven’t seen HOA’s that low in awhile. My cousins bought condo/lofts in the SOMA area around the same time you purchased and their HOA’s were both over $400 and it continued to rise and it became a major complaint by them.
Real estate can be a great investment if you’re fully ready for it. One of my friends got in too soon. She wasn’t settled financially or career-wise and had to relocate for work less than a year after buying a condo. She wanted to sell before she moved but couldn’t get it done and it’s been stressful for her.
I have an offer out on my third property right now. I have 15 year financing already locked up but now I just changed my mind and will go with the 30 year fixed mortgage. In fact, if I use Quicken Loans I’ll be sure to use the link in your post. ;-) #bloggerlove.
Hey? Where did the Quicken Loans banner go? Oh, well. **sigh**
You’re free to use this Quicken Loans link to get a real rate based on your situation. Good luck! I find they have some of the cheapest rates given they are online.
We used Quicken to refinance one of our rental properties this year and it was hands down the easiest refinance I have ever done. I submitted all of the paperwork I needed to online and they even came to my primary residence to do the closing. Everyone I talked to on the phone was professional and helpful. I would definitely do it again!!!
Thanks, FS. And thanks for your input, Holly.
I am already getting exciting about real estate investing. I am buying into a real estate limited partnership as well as making plans for my first home to be a two-family home. Not only are they more house for less money, but they also provide me with a way to build equity with paying a lower portion of the mortgage.
Have you thought about pulling out some of your equity in your condo since it is renting for so high? You could use the equity to buy another property (down payment at least) and rent it out as well. Then, you have two properties increasing in value at the SF rate. what do you think?
I’ve thought about it, but don’t want to borrow to borrow more money. Although things are recovering now, I like to start new purchases with money I’ve earned NOT from previous property. This way, it keeps me motivated to focus on other income streams, and keeps me disciplined from blowing myself up by stretching too thin.
I love property for the reasons mentioned in this book. However, right now, I’m dedicating my time to online endeavors now b/c now is my window. I don’t know if readers other than bloggers will care, but I may write about online income in the future.
I agree that real estate is the fastest way to build wealth overtime. However, I feel that too many people promote the benefits of real estate and don’t promote the negatives that one can encounter. How does one deal with a property that is vacant? Or a tenant that doesn’t pay and destroys the property?
I guess I’ve seen too many people bash real estate over
The past 5 years due to the downturn. Funny how we see things differently yeah?
I have another post in the queue about getting rid of an unlawful tenant you might enjoy. Stay tuned.
@Eric
That sounds like a great plan!
I think real estate only works well if you take out a loan at a decent interest rate and have time to let your renters pay your mortgage off for you.
Hubby doesn’t like loans and if I take one out, he pretty much automatically gets put on the hook to pay it off if I kick the bucket. I’m 63 and don’t have time to wait for the income or appreciation. Taxes and maintenance and marketing all take time and money on a property – and then there is also the added liability.
You present a strong case and a lot of people have made money with real estate. Other’s have lost it…..
Marie, you make a great point about age. Given we have finite lives, RE investing works better for those who have the time, energy, and patience. Therefore, one can make an argument that building a real estate portfolio is best before that age of 45.
I don’t want to be going into debt in my 50’s and beyond either!
Would love to read em!
I love this strategy Sam and I have been working on this myself. I have my own condo, which I live in, and I have been saving up for a second down payment. When I move, I plan to keep my place and rent it out. I have a low monthly payment and it is a high rent neighborhood, so I can easily make $500-$700 per month in profit once I move out.
You fail to speak about the hardest part of being a landlord – namely tenant selection and management. Its been my experience that a great many people look good on paper, but are slow or no payers, or fail to take good care of the property once they become a tenant. Even checking credit and references is imprecise; many prior landlords just want them out and will give a good ref.
It is often said that location, location, location are the top determinants of real estate value. Don’t forget that 3 factors affecting the success of being a landlord are tenants, tenants, and tenants.
All in all, I agree real estate is a fantastic asset class, but I’ll stick with REITs!
Have a read https://www.financialsamurai.com/2011/09/29/how-to-get-anapartment-in-hot-rental-market/
I’ve had 0 days of vacancy in 8 years because I screen them like the CIA.
Tell us about your landlord/tenant experience. Did a very bad experience make you forsake real estate and just go REITS?
Thx
Ok, I get it. There’s enough demand for your properties that you’re able
to treat the tenant screening process as if it were a job interview. In fact, I
think you screen tenants more than many employers screen their applicants.
That works only in a sellers market for high end rental real estate, which it
sounds like you have.
You don’t get exceptional returns from REITs, its a lower return proposition
with correspondingly lower risk. I guess that’s where I feel comfortable sitting
on the so-called “efficient frontier” of real estate investing, sounds like what
you’re doing works for you, but beware the black swan of one bad tenant,
one expensive repair, etc. that could trash your strategy’s returns.
Will do. Please share with us what your landlord and property ownership experience so we can understand more where you are comig from.
Thx!
Sam,
This sounds great.
Do you have earthquake insurance? If not are you concerned about this potential natural disaster?
-Mike
Yep, have EQ insurance. Even though it’s been 30 years since a major earthquake, you never know!
Do you know how many people were killed in the loma prieta EQ vs the number killed by hurricanes out easy or tsunamis? It’s a peculiar stat.
I am itching to get into the rental world. That is probably going to be my next purchase after we sell our current home and buy our next main residence. I would keep the current home as it is a townhouse and PERFECT for renting but the rules prevent me from doing so.
I go back and forth on getting a partner – Sam do you have any experience with that?
Unless your partner is your mom or dad, go at it alone. Not worth the split or the potential conflicts.
I think one of the biggest reasons real estate is such a strong wealth-building tool is leverage. You can deploy 5:1 leverage on your money, and as long as the property is cash-flow positive, you’re in great shape. You can do that deal all day (or until your funding source runs dry).
I agree with the leveraging. The market will fluctuate over the short term but the value should rise over the long term. Even if you are underwater now, in 10 years, it should come back. I love real estate investing too and most of my after tax investment is in rental properties. I’m looking forward to you stock investing post.
And don’t forget about location, location, location. Good thing you live in San Fran, eh? I think cities like San Fran and New York are more resilient than other cities nationwide.
True, but deals are much fewer and far between to be had. It’s almost always a given that what you buy in these cities will seem expensive now.
If I lived in Vegas or Miami, what a field day I would be having! So much opportunity!
Owning rental properties in NYC is a NIGHTMARE. The landlord-tenant statutes are extremely tenant friendly. The lady who owned the house next to me lost her home because tenants were allowed to live there rent free for over 6 months. The city would not evict them until I kept calling the health department about their uncut lawn and PILES or garbage bags.
A little late to the party, but I’m a bit confused on some of your math… while I’m not questioning that long term this has been a good win for you – you said:
“The $464,000 mortgage payment was split $500 to principal and $1,900 to interest. Rent for the property at the time was $2,000 a month, so things were essentially a wash if you include property taxes and deductions.”
If rent was $2000, principal $500, interest $1900, how exactly did taxes and deductions make it “a wash”? Our understanding is that 1 – there is no mortgage interest deduction for rental properties. 2 – RE taxes are only deductions in as much as they can be counted as an an expense against the net rent.
Unless you’re leaving out huge refundable tax credits (or maybe I’m still half asleep) how was this a wash in the first year?
I lived in the place for two years and then it became a rental.
Mortgage interest is deductible to income if you live in it, and is deductible as an expense if the property is a rental.
We own two rental homes and I love them for all of the reasons you listed! I understand them and how I am making money from them. I can feel them, see them, walk around in them. To me, they are more “real” than my other investments.
We have had some shenanigans with nightmare tenants before….but overall, its worth it!
Good stuff Holly!
Tenants can be a pain, hence it’s worth screening aggressively first. It’s why we put our new hires through 15+ interviewers.
Need to screen out bad apples to save pain later on.
And even when you screen people well, stuff still can happen! I wrote a story about owning rental property that will be published at Get Rich Slowly TOMORROW. Make sure to check it out. I anticipate people being really, really mean to me =)
You make a good point about it taking a lot more properties (and thus tenants) in a cheaper market to match Sam’s one property in San Francisco. However, that also opens a lot of doors. First of all, most people don’t have $116,000 for a down payment. Second, when Sam loses his single tenant, he loses ALL of his cash flow. If he gets one bad tenant who trashes the place and he has to evict, it’s going to cost him a heck of a lot. Third, it’s a lot harder to save up to buy more places to build a portfolio, whereas with cheap properties it’s relatively easy to pay off one mortgage in order to free one up under the Fannie/Freddie limits. Fourth, cashing out requires cashing ALL out, whereas if you have 10 cheaper places you can sell one or two as cash needs (or better investments) arise.
In my experience, it seems that real estate investing is actually MORE common/popular in low-to-mid-cost areas. Plus there are a lot more low-to-mid-cost areas than high-priced areas around the country.
Jonathan, please share your experience and your real estate portfolio. How has it done over the past 10 years? Thx
We only started in 2010, so I can’t comment for myself on 10 years. We’ve bought 3 ~$100k SFHs in the past 2 years, all of which are currently rented with their first tenants (no turnover yet). They’ve all been cash flow positive from day 1, values have been relatively constant or perhaps even dropped small amounts (irrelevant in our opinion). While we know we’ll have harder days than anything we’ve experienced so far, we also know that these properties will be successful long-term investments based on the fundamentals and the purchase prices.
We had some coaching early on from friends and relatives who have invested (and continue to invest) in many forms of real estate for 3 decades with very good success, and continue to consult with them when faced with difficult decisions.
Got it. I thought you had been investing longer than 2 years.
How are you financing your properties? You can start a new thread.
It may be worth having a mix of cheaper rental properties and some that are in popular areas such as San Francisco. Can I ask which part of the country you are in, Jonathan?
I currently have 4 homes that were bought on hard money, fixed up (10-25k repairs), refinanced, and rented out. Each took about 20k on average (ranging from 12k – 28k) of my capital to acquire and they all cashflow about $350/mo BEFORE maintenance and vacancy. You can see I can get about 5-6 homes here in Texas with a capital amount of 116k. However, you do run into the problem of running into a loan limit. Yes you can pay off mortgages but I would rather spend my capital acquiring new properties and keeping them financed (8-15% return on capital) rather than paying down mortages (only 4-5% return depending on interest rate).
There are advantages and disadvantages for cheap rentals and expensive rentals. Yes, if Sam only had one rental in SF and lost his tenant, he would lose all of his cash flow. However, because it’s a popular and expensive area, he will have no problem finding another tenant within a few days. In Texas, I can have multiple properties on the MLS for over a month. Cheap rentals are more stable and predictable, but they will never have the potential to appreciate in value by 200k+ like homes on the coasts. I like to think of it as similar to growth stocks (high capital gains) vs. dividend stocks (stable, income producing). It’s good to have both, the only problem is you can only be in one place at one time! Luckily I have a lady friend in SF who may help scope out the market over there…
James – Southern California. I agree, a nice mix of higher- and lower-priced properties would be nice. Incidentally there is still the potential for $200k returns…these houses sold for $250-$300k brand new 6 or 7 years ago. While we’re not counting on the values shooting back up to those levels anytime soon, it could happen.
JT, if you are buying 10 units, you should just get one mortgage to buy the whole 10 unit building. To buy 10 separate units would be inefficient.
The vacancy rate for my rental over the past 8 years has been 0 days. In other words, no vacancy. Tenants have paid for a full month and have moved out before the month is over twice. They give me a 30-60 day heads up, and I put up an ad on CL for two open houses while they are still there.
When you buy in a good location, the demand is always very strong. I highly suggest people go for location, and quality over less desirable locations.
Think being at the top of the pyramid where the base of demand gets wider and wider.
As you know I too dabble at the low end of the market. My goal is to have a minimum of 10 units, preferably all in multi-unit properties. I’m actually in the process of looking at property #3 right now. I am purchasing at a rate of 1 property per year because of everyrthing that you mentioned, plus the benefits of having such a low entry point due to lower priced homes.
This is how I plan on retiring early. My homes are typically cash flow positive from day one with a total payback period of 3-4 years. After that the homes are mine, free and clear. Except for one nightmare tenant, it hasn’t been bad.
I also agree that you make your money when you purchase the homes. One bad deal can cripple the financial prospects of the property.
Sounds like a great plan! Just know that banks are very stringent on giving out mortgages if you decide to quit your job as you mentioned. Hence, either buy all you can before you quit or continue paying cash.
Why don’t you think more people don’t do what you do?
This article accentuates all the positives of owning investment property with none of the negatives (there are too many to list). I bought a multi-family in 2009, and am just now having positive cash flow. I learned a lot of lessons the hard way, but isn’t that the way most lessons are learned?!
The number one piece of advice I can give to newbies is to understand the most important rule in investing in real estate: you make money buying houses, not selling them. I can’t overstate this enough. There is only so much you can do with a property you dramatically overpay for
Thomas – I won’t recommend one house vs. the other, but I’d encourage you to re-examine your thinking on all the interest you’d be paying. Paying $200k in interest over 30 years does NOT make your $350k house really cost $550k. The time value of money is an incredibly important and evidently overlooked factor, especially when you’re dealing with such a long period. First of all, if you had $350k to pay for the house today, you’d be throwing away all the investment opportunity that $350k of cash brings all to save 3.5% interest. Second of all, inflation over 30 years will gradually eat away at the actual value of the money you’re paying to your mortgage (including the interest), while your property gains value to keep up. In other words, in today’s dollars you may only pay $100k (pretend number) in interest. I know this kind of thing may seem like voodoo economics, but it is truly and honestly CHEAPER for even a mildly disciplined individual (financially speaking) to get a 30-year mortgage at these rock bottom rates than to try to avoid paying mortgage interest by paying cash upfront (or prepaying the mortgage).
I love real estate too! It helped me achieve financial freedom, but I chose to invest in income property. If you don’t mind moving every few years, residential real estate can be a goldmine. The $250/500K tax exclusion has no limits.
Right on Jeremy! The biggest savings you can have is through the initial negotiations. Be aggressive, and care the least.
I used the tie up of $116,000 in this property to motivate me to work harder and find new sources of revenue. Buying the property also gave me renewed vigor at work, b/c at the time, I was wondering “what’s the point of working so hard” when I’m not spending my money on anything.
Buying the property allowed me to not only live in a better place after my 1 bedroom rental, but also build wealth over time and give me more purpose to work.
It’s not easy building your own business, but it will never happen if you don’t try.
Just a question, What type of job did you have at 26 (0r 20) for that matter to be able to “Save” $116,000 by that age AND, “save aggressively” while paying such a high mortgage payment for 2 years. For someone who only makes 60,000 per year, saving 116,000 seems impossible, even with a mortgage of only 1700.00 (including everything). Most of the statements you make in your article seem true but I guess you have to have money to make money. Are there any suggestions for a lesser paid individual to try to follow in your footsteps?
I was in investment banking. Feel free to read this post: The First Million Might Be The Easiest.
It was definitely easier to save, but you still had to have a lot of discipline b/c you made more money. Lots of people are broke who made a lot of money.
Thom yes – SPEND LESS is the key, for if you continue to ramp up your spending each time you get a raise you’ll never save anything. Track your spending as Sam suggests at the end of this article so you know where your money is going, and LIVE FRUGALLY for if you make $70k a year and spend nearly $68k of it with fast food instead of packing your lunch, paying others to make coffee for you, buying a bigger car/truck than is needed etc; then your own choices aren’t (yet) saving you what’s needed to escape fiscal slavery. ref book; “the millionaire next door.”
In your question you’ve focused only on Sam’s income… but, one must also focus equally on one’s own total, including everything, spending.
But; it’s a good thing you’re reading this site! Knowledge is power you’re on the right track. Keep making good choices… track your spending… and we’ll all be successful together. See you on the beach!
Ouch this is way below your usual standard! First off too simple, you got lucky, bought in a good area at a time when prices were low, but lighting doesn’t usually strike twice. My sister in law did the same as you and for simular reasons, except thier place turned out to be a total nightmare (triplex) first off cash flow negative, secondly the moment it closed the inspector showed up with a long and expensive list of grandfathered repairs, then a nightmare tenant, took 3 months and thousands of dollars to evict, and I could on and on. They’re hoping to have it paid off by the they retire in 10 years. Both have said they wish they had followed my advice and done a bit more research.
A mornings worth of research would have showed them that being a landlord in Ontario Canada is the fast way to bankruptcy, like the one lady who got a professional tenant, 10’s of thousands in dollars in lost rent before they were finally evicted.
This doesn’t mean your wrong, I know a few people who have done well but mostly because they got lucky and bought when prices were low and were smart.
Typos are purely Steve Job’s fault (iPad is a pain to type on:) )
Note: while my comment sounds like sour grapes it’s not meant to be only that Real Estate is the most emotional of all assets, and the numbers have to make sense.
BTW my nephew bought his place his with help from his Dad and rented out all the rooms and more than covered his mortgage. It was also a fixer upper and he (no longer) a contractor was able to do a lot of his own work
If saving, investing, running the numbers, taking a risk, refinancing my mortgage, and finding good tenants is ‘getting lucky’, then I’ll take it!
I’d much rather be lucky than good.
Just wait until you read more lucky stories here in the future!
Sam, you had $116k to spend on a downpayment at age 26. You were lucky before you even bought the property. Either your family paid for that or you got an extraordinarily high paying job from a young age. Very few people have that sort of money at that age. Lots of very smart, hard-working people will not be able to make such a downpayment at that age.
I also think it is quite deceptive for you to write an article which talks about *only* the positives of investing in a rental place with not even a single sentence paid to the negatives and everything that could go wrong.
Zach,
You are right. I am lucky to get a well paying job which allowed me to save more than 50% of my after tax income for four years before I purchased. It’s all luck.
Every investment has risks. And the clear risk to real estate is over leveraging and having to sell in a bad market.
How much do you save a year, amount and percentage? Did you go to a good school and do well to out yourself in a position to land a good job?
Thx,
Sam
hey Sam
quick update but since posting this comment we went on to buy two more properties:)
very happy with extra income, and planning on increasing the rent next year
Sam may have gotten lucky in this instance, but the principles of wealth building through real estate that he discusses are sound. The second time around he’ll obviously put more thought into making a wise investment based on what he’s learned. Sounds like your sister-in-law didn’t do her research (cash flow negative from the start? a long list of needed improvements that weren’t disclosed in advance? didn’t screen tenants well?). Anyway, I don’t mean to bash your SIL, but those are all amateur mistakes (and yes, I realize those things can and do happen to pros too, once in a while. But it’s clear they are all issues that a little more upfront care could have avoided).
So, basically, you’re sister-in-law didn’t do her due diligence, and then proceeded to be surprised when things didn’t work out? Shocker.
I think the average investor is way to scared to jump back in. I think those that are more educated can see that there is real opportunity. Everyone else will soon to follow but it hasn’t happened quite yet. One of the biggest obstacles is still the high unemployment rate. People are still scared about losing their job and not being able to find anything else.
Without a doubt.
Is this still true in the bay area?
No rule against Bank Of Mom And Dad paying the downpayment. In fact, this is becoming more common place for younger folks nowadays given the price of property, and the wealth accumulated by our parents.
I can’t tell you how many times I see parents attend open houses with their child here in SF. It used to be competing Mano y Mano. Then it became a competition between two working couples. Now it’s a competition against Multi generational balance sheets!
Actually, it’s the opposite. We had to obtain a “gift letter” indicating that we would NOT be paying them back, because then it would be considered debt, and would change our debt-to-credit ratio, thereby disqualifying us.
Great article, Sam! I also agree that real estate is an amazing asset class. I think the toughest thing for me would be coming up with the 20% down payment for the rental property. Would you recommend withdrawing from ROTH IRA (contributions only) to fund the down payment? The Roth IRA is just a side thing for me, as my 401k is my primary retirement account. Let me know what you think.
Hard to say w/out knowing your investing prowess. At this point, I like real estate much beter than stocks.
You bought your house a few years after the tech bubble pop in 2004, a year into the RE bubble when it started picking up steam in 2003. Would you think it’s a smart idea to buy a house in your area with it heating up like it is now again? What do you think will happen to your rental income if the tech bubble popped again?
Tech bubble popped in 2000 March FYI. Check the Nasdaq.
Rent prices are like gas prices at the pump. They are very sticky on the way down. Instead of landlords lowering rent, they just don’t increase the rent.
With rents going gangbusters again, property prices have not fully caught up yet, but they are. I absolutely would buy rental property now.
Good thing about huge bubbles is that a similar bubble’s probability decreases as some of us learn our lessons.
He does have a point though, if you check the charts, 2003 is a very fortunate time to buy.
Right at the start of upswing after the tech bubble burst / 9-11 effects. House prices have not returned to such a price level since: (Purchase-only House Price Index of the last 12 years- .
Not to knock that you got a great investment out of it and have managed it well since, but there is an element of luck to the performance of your purchase. (Good time to purchase, decline in mortgage rates since, boom in rental properties needed in SF in the last few years).
Jerry, in 2003, people were scared to buy. There was the bird flu virus, a war, and remmenants of a burst tech bubble. I bought b/c I didn’t want to rent for over $2,000 a month.
Things looked expensive then just like things may look expensive now to the timid.
I am pretty positive in 10 years, prices today will look cheap.
Excuses are made every day not to buy. Every time I think things can’t go higher, they do after a while. It’s the power of inflation. $5 gas baby!
I agree with the other posters; you are very lucky and smart to buy at the time. Everything fell right after your purchase to make it a great investment. If you waited just 2 years afterward, you would barely break even or even at loss. Or buying right now; it’s tough to say whether it’s a good investment.
Since I’m playing devils advocate here; if you had invested 10k into apple stock in 2003 when everyone was scared of tech, you would have generated over 600k from each 10k you invested! So you take the down payment you had ~115000 invested in Apple and you would have $6 million and that’s through the biggest decline we had since the great depression and including Apple’s 40% drop from 2012!
Investing in real estate or stocks both takes quite a bit of luck and patience but I like the outlook from stocks for longish term, ie. 30 years. I know because I have a rental and the first year, I paid ~20k for repairs. New roof, maintenance, AC, etc.
That would have been nice with Apple. I know I wouldn’t have had the guts to invest $120,000 in the stock, but $10,000-$30,000 absolutely.
Anybody who bought in 2009-2012 will probably be alright 10 years from now too. RE fills so much utility besides a monetary return.i just hate the commissions.
Dan,
This is a very incomplete analysis of real estate vs. stock investments. Apple was the stock of the decade — literally, that’s what it was called. It outpaced everything. To make a point that by putting a heap load of cash on just one stock, the lottery winner of stocks and the greatest gainer over the decade, is unrealistic and unbalanced. That’s 20 / 20 hindsight. This is in no way a fair comparison of real-world real estate vs. stocks. The exact opposite case could be made if one invested in Enron pre-November of 2001, and trust me, a lot of people did and lost everything.
Let’s go with averages, which is much more responsible. If one invests in a well performing mutual fund, then one might expect around an 8% to 12% yearly return on investment. If you got lucky and invested in a handful of individual stocks, and several did quite well, then a good ROI would be around 14 – 17%. This is already not typical, year over year, but near exceptional.
Investment property, on the other hand, according to the Wall Street Journal’s Complete Real Estate Guidebook, typically offers around 40 – 45% ROI, due to the combination of 1) property appreciation, 2) principle paydown, 3) positive cash flow, and 4) investment property tax breaks (i.e. the power of tax deferrals, etc.). I own 3 rentals and a homestead myself, and I can tell you that these high ROI numbers are consistent with my experience. Like the book says, when you hold on over time, through the ups and downs and keeping the properties occupied, the investor should always do very well and these numbers will usually play out.
So, typically, as the book says, one can expect 3 to 5 times better in real estate than stocks and/or mutual funds.
A common strategy is to have a mix. Get as much rental property as you can, while investing in (and maxing out if possible) your 401K or IRA, and also some individual investments. Another strategy for the more aggressive investor is to refinance your properties, assuming they have increased in value which they typically will over time, and take as much cash out, to use for more investments or stocks (which uses as much of the bank’s money to make you money). This is called wealth cycle investing and it can work wonders, though not for the faint of heart.
Kevin
Kevin,
This is a reply from an amateur investor. I literally know nothing about investing – in anything. I CAN, however, tell you that I have lost my butt a few times in the market by trying to pick the winner or even a winning mutual fund. The stock market may be a good place for savvy investors but a horrible place for uneducated investors like myself.
I can without a doubt say that even without any knowledge of the industry, and without any specific instruction from anyone other than my Realtor, I have made a boatload of cash in real estate. Down payment, monthly payment (which is less than rent right now), and taxes insurance etc. I have seen my investment shoot through the roof over the past 2 years. I have literally made almost 100,000 dollars in 2 years.
I lost 40,000 in the stock market. In my opinion, as an amateur, is… if an amateur can do it and make this much money, why not.
It’s better than the stock market here savvy investors prey on the uneducated ones. Market Movers take and those who don’t know too much get taken from.
Again, this is my opinion, but my bank account likes my opinion.
Thomas
I am in the midst of my property story. But it’s not going as well as yours. We bought in March 2010, and prices have slowly declined . I’m probably underwater, or close to zero. Zillow isn’t a good measure as they have a bunch of wrong info, that I corrected, but they didn’t adjust their valuation. Anyway, we are refinancing to 3.25% next month (hoping is closes on time), but we do plan on being here for another 7-10 years.
Here’s my plan; Pay down to 78% LTV and kick PMI ot the curb (save $325 a month, OUCH!). Assuming the house goes up slowly over the next 7-10 years (we hope), we can then move and rent it out for more than the PITI amount, further reducing our principal. Positive cashflow would be nice, but not necessary. I hope to have that residence paid off by the time I’m 40, and my next house by age 45 or so. Then look into other rental opportunites.
Very vague plan, but that what I’m shooting for. I do agree with all of your reasons above that real estate is still a great investment, and am hoping to play the game myself to build wealth over the years.
Perhaps instead of a next house at age 45, or 40… consider rental property instead and be happy with the house you live in?
Think about our grandparents and how they lived/owned their houses for decades and built enormous wealth!
I completely agree Sam, it’s just that we may have so many kiddos we need to get more rooms. Although, we cuold add on to the house….but then we wouldn’t fit into our neighborhood, our house would be too big for where we’re at to fetch a good sales price.
If we don’t outgrow, I’m definitely thinking about staying here forever…