When market dynamics change, long term real estate investors have to adapt their approach to stay on track and accomplish their goals. Previously, I articulated the case for branching out into other growing markets and different property types when market conditions restrict supply to the extent that it threatens the investor’s acquisition needs. Today, we are going to get deeper into the nuts and bolts of purchasing new construction, luxury small multi family properties (duplexes) in a growing Texas market with a detailed case study.
Income and Expenses
Annual Rental Income: $31,800 ($1325/side/month)
Operating, Management, Vacancy and Leasing Costs: $11,534* (36%)
Net Operating Income: $20,266
Purchase Price: $279,000
Down Payment: $69,750 (25%)
Loan Amount: $209,265 (4.75% 30 Yr Fixed Conventional)
Debt Service: $13,099.50 ($1091.63/mo)
Positive Cashflow: $7,166.50 ($597.21/mo)
*Breakdown of Operating/Management/Leasing/Vacancy
Property Taxes: $5400
Management : $2544
Leasing fees: $1000
Let’s begin with a basic example and build from there. Suppose you acquire one duplex that performs as outlined above. Next, you follow our advice and decide to grow your capital base first so you can maximize cashflow at retirement. Therefore, you utilize current positive cashflow to aggressively pay off the debt on the property. If you just use the property’s own cashflow without any additional investment from your job income, the mortgage will be paid off in 170 months or (14.2 years) at which point, if rents haven’t risen a penny in that decade and a half (chances of August snow in Houston are higher), your property would produce a pre-tax income of just over $20,000 per year. That’s in addition to your capital base growing four fold from the $70k initially invested to $280,000 of paid off real estate (if we assume zero appreciation). Suppose you need to get this done in 10 years vs 14 – how much would you need to contribute monthly from your job income? Roughly $500 per month! That’s lower than most people’s monthly Starbucks “contribution”.
Now what if your income needs far exceed the $20k/year produced by one duplex. Let’s look at a scenario where you acquire 3 such small multi family properties. It’s commonsensical that if you are able to pay off one duplex using its own positive cashflow in 14.2 years, you will be able to pay off 3 in the same amount of time since you’d be working on all three simultaneously. But what may not be as self evident is that if instead of using each duplex’s own income to pay off its own mortgage, you use the combined income to pay them off one at a time, you will start seeing results sooner. More specifically, the first duplex would be paid off in roughly 7 years, the second in just over 4 years and the last in just under 3. So, while the total time to pay off all three is the exact same, the investor that has one duplex completely paid off after 7 years has a lot more options on her menu than the investor who has the same mortgage balance spread over three properties but none paid off. And more options lead to victory. Similarly, if you want to shorten the time in which they’re paid off, a small contribution from your monthly job income could shave about 30% of the time to get to retirement. In this scenario, the investor would end up with pre-tax income of $60,000 per year and a paid off portfolio of real estate worth just shy of $1M if rents and values don’t go up one penny.
In these case studies, I intentionally omit to consider any rent or price appreciation as part of the analysis due to my conservative nature. But you don’t have to be a real estate expert to know that over long enough periods of time both prices and rents go up (excluding markets where prices are artificially inflated by bubble conditions and rents are controlled). Even under the most conservative of appreciation assumptions (I.e inflation rate), the investor that controls the highest asset value (3 duplex scenario above) reaps the largest benefits on both the income and net worth front.
Finally, any investment performance must be judged relative to other available alternatives. So in that sense, I want to end this with this question:
When we take up the case of investing $70k to purchase one small multifamily (or $210k to purchase three), can you think of any other investment alternatives that in 14 years would turn your capital into $280k (or $840k for 3) AND produce $20k (or $60k for 3) per year respectively?
Or let’s make it a bit more fair. Can you think of an alternative that can do HALF as well?
In the next post, I will discuss the Top 5 qualities that make this property type and it’s growing market a solid investment for a long term real estate investor. So please stay tuned.
If you would like a detailed cashflow analysis of the numbers discussed above, please email me or if you’re reading this from your email just hit reply.