Investing Architect

Category: Long Term Rental Properties

Investing Architect explores DFW
Over the years, I’ve been asked by several long time clients about investing in the Dallas Fort-Worth market. At the time, the main reason for their interest was location diversification. While I always thought it a good idea to diversify holdings over markets with different characteristics, I thought there wasn’t a significant difference in location characteristics to achieve any meaningful diversification.

Then oil prices dropped in the $40s and calls about investing in DFW became more frequent. Now the equation has changed from “hey, let’s invest in another city” to “Dallas is Texas growth with less ties to the oil business”. The case for diversification took a whole another dimension. So, I decided to explore the DFW market in greater detail to see if there were any investment opportunities there for our clients. And since nothing beats “boots on the ground” I made the drive north on Interstate 45 and spent a few days exploring different areas, looking at properties and trying to get a feel for the state of the market.

The Process (of elimination)

Before I discuss my findings and impressions of the DFW market, I would like to take some time to explain our methodical process for assessing a new market. This would be very helpful to you if you’re considering investing your hard earned capital in a new market. My process for assessing a new market can be summed up in two steps:
1. Focus your attention on the areas that fit the criteria
2. Analyze those areas at a deep level
The first step is crucial especially when you’re analyzing two very large metroplexes like Dallas and Fort Worth. We went about it by being clear about our universal criteria for long term investment properties:
1. Located in the best school districts
2. Recently built (10 years old or less preferably)
3. For single family homes at least 3 bedroom 2 bath 2 car garage and 1600+ sf (it is still Texas after all)
4. Safe neighborhoods with nice amenities
5. Decent return on invested capital
6. Good growth prospects
The first one (school district quality) is the ultimate elimination criterion. We’re just not interested in areas that aren’t zoned to great schools. So the first task at hand was to find out which were the school districts I should focus my attention on. I did look at online data for school quality but nothing beats local knowledge. This is where a long term reader of Investing Architect generously gave of his and his wife’s time to point me in the right direction. Their suggestions matched what I subsequently researched online and it resulted in a much greater focus. Therefore after this all important step was finished, I had focused my attention on areas zoned to a handful of school districts in the North/Northeast suburbs of Dallas and Fort Worth.

The next step was to research the local MLS for recently built, 3/2/2+ single family properties to get an idea about prices. Based on our pricing benchmarks from the Houston market, we decided to focus on properties priced from the mid 100s to the mid 200s. In my experience, you will experience diminishing returns and higher price to rent ratios as you move north of those prices.

Next, properties were grouped by area and we drove by each area to assess the overall neighborhood quality and made extensive notes about each neighborhood.

Then, we performed a detailed cashflow analysis on all properties we scouted to get an idea about rent levels, operating expense and price to rent ratios.

Finally, we retrieved and analyzed detailed demographic and psychographic reports to assess growth prospects through population growth, income levels, and psychographic behaviors of residents in the different areas. I will attach a copy of these reports for you at the end of this article

The findings

First and foremost, the understatement of the year is: The DFW area is experiencing tremendous growth. You don’t have to have a PHD in economics or population patterns to figure that out. You can feel it by simply driving through these areas where entire towns are being developed at the same time. While homes are built at a break neck pace, roads are being expanded, grocery stores, schools, fire stations built. There’s a feeling of great momentum and thrust upward. Driving through downtown you see headquarters and Class A office buildings of Telecom, IT, tech, health and oil companies aplenty and you get a sense of the economic engine that’s driving this growth. Now before you point out that these are just “gut feelings” unsupported by data, don’t rush. I will provide plenty of data in the paragraphs that follow. But there’s something to be said about the fact that economic vitality is something that you can feel simply by driving around and observing what’s going on in an area. So, right off the bat, the DFW market had the right vibe for a prospering growth market.

In driving through neighborhoods in Allen, Frisco, McKinney, Fort Worth, Grand Prairie (to name a few) and walking through properties I was impressed by the construction quality and overall neighborhood plans. I saw brick and stone exteriors, granite counters, laminate or wood floors pretty routinely. I also saw lots of neighborhoods with walking trails, parks, lakes, fitness centers etc. Another quality box checked!

The demographic and psychographic reports had even more good news in store.

Dominant_Tapestry_Map_Fort Worth

Demographic_and_Income_Profile Fort Worth (1)

Up and Coming Families – Segmentation

Professional Pride – Segmentation

For a snapshot of the analysis we did for Forth Worth, above are the demographic and income profile as well as psychographic “tapestry” reports for the area. Median incomes between $65,000 and $127,000, robust population growth between 3.84% – 5.5% (depending on radius), and top two psychographic groups being up and coming middle class families and upper middle class professionals is a very good combination for a market in which to invest.

Now for the moment of truth: The numbers. First the good news: Operating costs in DFW are lower than what we typically see in the Houston market. Property taxes in the DFW area were as much as 30% lower than in comparable Houston properties. The typical tax rate before exemptions in DFW was 2.5% while in Houston it would be closer to 3.25-3.5%. Same story with homeowner association dues – Typical annual fees in DFW were $300 a year while in Houston we average $450-550 a year. Finally, leasing fees are lower in the DFW market averaging about 70% of one months’ rent. Now for the not-so-good news: Rents for comparable properties are 10-15% lower in DFW. In the properties we analyzed, the monthly rent averaged about 0.85-0.9% of the purchase price. So essentially, a property purchased for $175,000 will bring in $1500-1600 in rent whereas the same property in the Houston market would bring in $1700-1725.

After thoughtful consideration of the factors at play, a couple of things become clear. First, since the 2008 recession, property values have risen at a faster clip than rents. The appreciation rate is good news for long term returns but not so good news for in-the-meantime cashflow. Second, I wondered what was the reason for this disparity in growth rates. Or put differently, why does a Tenant in Greater Houston pay a higher rent for a similar property than their counterpart in DFW? Logically, your mind first jumps to income levels. So we decided to look at income levels in the submarkets we researched. In some cases, average and median incomes were even higher than those in Houston and in all the cases they were comparable. So if income wasn’t the deterrent, what was? The best educated guess I’ve come to so far is that management companies and leasing agents in the DFW area have been shy to price rent increases into new inventory and have relied on backwards-looking average rents. That could be good news for investors purchasing property in areas with lower inventory levels because there’s a possibility to boost returns and get higher than backwards-looking average rents. But, in the end, the analysis has to be performed with what is, not what could be.

At the current moment, based on our findings, the DFW market offers cash on cash returns of 5-6% and internal rate of returns of 15-17% for well located, recently built properties that employ a self management system with 20% down payments. If we have to account for professional property management, cash on cash returns are in the 2% range (so basically, break even) and internal rate of returns of 10-11% (assuming 3% annual appreciation). The compensating factor is that appreciation is likely to average much more than 3% so actual returns will likely be higher once it’s all said and done. But again, we analyze for what is erring on conservative side – not best case scenario investing.

To conclude, I was very impressed by what I saw in DFW – I think the market has excellent potential for growth. So I am keeping a keen eye on the market for any opportunities I can pass on to my clients both in the single family and small multifamily space.

P.S As heartbreaking as it is for this Houstonian to admit, I had the best brisket ever at this place in Deep Ellum called The Pecan Lodge. It was so good, I think they should classify it as a dangerous substance. 🙂
October 7, 2015
What to expect when you are investing – Houston 2015 Edition
Consider the following scenario: You are a successful professional and through hard work and living beneath your means you have managed to set aside some capital. Thus far, your career has been fine but you want something more. You wonder what might be possible if you were to invest the capital you have managed to save in real estate. Would it be possible to create enough of an income stream to achieve financial independence? Or put a different way, can this investment lead to an income stream that would give you the freedom to invest your time how you want, rather than how you must? You start reading and researching and after a while you are overwhelmed with different strategies pulling you in a thousand directions. Good old paradox of choice. But then you take a step back and look at the big picture: You’re not a gambler, or a speculator and you don’t like excessive risk. You want to invest your capital in real estate but don’t want to invest all your time (i.e don’t want it to turn into your full time job). Therefore you eliminate all forms of investing that don’t fit well with your investment personality and risk aversion. You come to the right conclusion that the best strategy to achieve financial independence is a long term investment strategy. Then one day, you read one of my posts on BiggerPockets or stumble on an article from Investing Architect. And it all seems to make sense. It’s a Lego-perfect fit. At which point, you dive into our archives and read until there are no more.

Sound familiar? Read on.

After reading “How to create a six figure income with real estate investing” (one of our most popular articles) you look through the illustration of the Domino Strategy at work with nine investment properties. And you get really excited. But wait a second – this case study describes the purchase of nine properties priced at $105k each! A quick look at Houston listings for sale reveals that the properties in that price range don’t match the characteristics of properties I describe in these articles.

The source of your confusion comes from the fact that all case studies I’ve written about in the past reflected the property parameters at the time. The Domino strategy Illustration I mentioned above was prepared nearly four years ago when those property prices were available. Needless to say, things a changed a bit since then…

That brings us to the main question of this article: What should a long term investor expect when investing in the Houston area in 2015?

Property specs and price spectrum

First a quick recap of the property characteristics of the target investment property:
- Located in a great school district
- 10 years old or less (unless well maintained)
- At least 3 bedroom, 2 bath, 2 car garage
- Between 1600-3000 square feet
- Better than average finishes (think tile vs linoleum, laminate vs carpet, hard countertops vs formica etc)
- Safe neighborhood with attractive amenities
- Easy access to highways and employment centers
- Offers a fair return on investment (more on this in a bit)
In the current market, properties that fulfill the above criteria fall in a price spectrum between $160,000 and $215000. Those are the outer price “borders” but most properties we are sending to our client’s inboxes these day fall in the $170,000 to $190,000 range.

Cashflow numbers

I know you can’t wait to see the cashflow numbers so I won’t take anymore time. Let’s look at a property I just sent to client before I sat down to write:
- Asking Price: $178,900
- 2300 sf, built in 2002 (well maintained), 3/2/2
- Projected Annual Rental Income: $21000
- Annual Operating Expenses: $6837 (34%)
- Annual Debt Service: $8830
- Annual Cash Flow: $3407
- Invested Capital: $39500
- Internal Rate of Return (10 year hold): 19.64%
- Cash on Cash Return: 8.66%
Obviously, not every property will fit those parameters exactly but this should give you an idea about what to expect when investing in single family investment properties in Houston in 2015.

In the end, remember this. Although property prices, interest rates, down payment requirements may (and often do) change, the investing principles and strategies remain the same.

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In case you may not know this already, I am a guest author for BiggerPockets Blog and write there on a pretty regular basis. In the weeks to come, subscribers to our email list will begin to receive those articles as well as they’re published.
September 3, 2015
The fascinating paradox with long-term real estate investors

There is this fascinating paradox I encounter regularly in our real estate practice. The overwhelming majority of real estate investors I have the privilege to help, fall on the conservative end of the investing spectrum. They are driven by unbiased logic, need empirical evidence and have a long term focus. If you haven’t left this site yet after reading an article or two, you can probably relate.

But with all that focus on logic, numbers and the “long game” they still succumb to doubts that run counter to all those things. See, we like to think of ourselves as rational beings driven by unbiased logic but the truth is we are hard-wired to respond to certain impulses and fears.

Let’s look at two related misgivings I hear frequently from our clients:

1. “I wish I had met you in … (2008, 2010, 2012 – you name it) so property prices would have been more favorable.”

2. “Shouldn’t I wait to acquire investment properties since we’re in a Seller’s market and prices are high?”

These statements indicate valid concerns but they’re paradoxical in that they run counter to the very core of the conservative long term investor.

Silly Rabbit … Market Timing is for traders

Real estate prices in most markets (Texas included) were substantially lower in 2008-2013 than they are now. Furthermore, most investors that purchased during that time were able to lock in quite a bit of equity and very favorable price/rent ratios. That’s especially true if you consider the increase in rents during the same amount of time. Those are facts that no one can dispute. But our investor clients forget a couple of critical issues when they express the wish to have invested earlier.

First, investing in 2008-2013 seems like a given now that we know “how the movie turned out”. However, at the time, it didn’t seem as such a no-brainer to most investors. I know because I was on the phone with them trying to get them to see it. When the whole nation was curled up in a fetal position waiting for financial Armageddon, it was hard to think about investing for even the most visionary of investors. When you drove into a neighborhood and saw 15-20 foreclosure signs back to back on the same street, it was hard to imagine the time when they would be worth so much more.

But most importantly, that wish disregards a critical truth: The long term investor is fundamentally not an opportunist.

A long-term investor invests to achieve financial independence regardless of the market he’s dealt. That doesn’t mean that a long-term investor cannot or should not take advantage of an especially advantageous real estate market. They absolutely should. However, they should NOT invest only when there’s “blood on the streets” and “going out of business” banners are aplenty. So ask yourself this essential question: Are you a long-term investor or an opportunist and then act accordingly.

Seller markets come with the territory

The average Blueprint plan we devise for our clients entails an investment timeframe of 7-20 years (depending on the resources and goals). Take any 7-20 year period and look at the market conditions over time. It’s not only highly likely that market conditions will change over time – it’s to be expected! As a matter of fact, a scenario in which market conditions remain the same over a decade is almost implausible.

But there’s another fear at work here – no one wants to be the sucker that invests at the top of the market only to ride it downward. That’s understandable. But did you know that the Houston area has been in a “Seller’s market” since the Spring of 2012? What if the investors that purchased properties during that time had succumbed to the same fear and waited for a price drop? They would find themselves wishing they had invested in 2013 when prices were lower. Sometime in the future, investors will speak of 2015 as the ideal time to have purchased because conditions may be less favorable then (read: interest rate hikes).

As long as property valuations are supported by economic fundamentals and we are not in a real estate bubble, the long-term real estate investor keeps her focus on the main goal (financial independence) and executes her Blueprint plan regardless of the market. Sometimes the market is extra favorable, other times it is not. Over the long term, the market will do what the market will do and our goals are still there for us to accomplish. So accomplish them we will.

August 19, 2015
Should you sell your investment property? A comprehensive guide
If you are a real estate investor that purchased well-located investment properties between 2008 and 2012, you are faced with somewhat of a dilemma.

On one hand, you have watched the value of your property rise significantly in recent years on top of any built-in equity you may have secured at the time of purchase. Not to mention that in this market properties sell in a heartbeat for full asking with multiple offers. So you look at the current market value, then look at your mortgage balance and can’t help but feel that it may be time for you to “cash your chips” and go home. After all, no one ever went broke making a profit…

But on the other hand, rents have also risen significantly and you have enjoyed great returns on your invested capital. If you sell, you “kill the goose” and forget about the golden eggs. Positive cashflow, value appreciation, mortgage pay down, depreciation – they all come to a halt.

So what’s the right call – sell or hold on, cash out or stay invested? To be sure, it’s a good problem to have but a problem nevertheless. Below is a methodical way to think about it.

Goal Clarity Above All

Every decision you make in regards to your investment portfolio has to be aligned with the overall mission of that portfolio. Ask yourself: What’s the principal goal you employed your portfolio to accomplish? Is it income, or wealth accumulation?

If the main goal is income, liquidating an income-producing asset without a proper plan to replace it with better income producing asset(s) is counterproductive. Instead, if the goal is to accumulate wealth, selling an investment property to lock in equity gains makes sense.

But wait – I hear you asking – what if my goal is to accomplish both income and wealth? Hence my emphasis on the word “principal”. If you want to maximize income, you don’t want to arrive at “retirement” with a lot of wealth but no way to convert it into income without cannibalizing your principal or subjecting it to high risk of loss (read: bonds). And vice versa. The principal goal determines how many assets you should own to reach it and subtracting an asset (without replacing it) when you should hold on or add on is not a smart move.

Return on equity vs Alternatives

The next thing you want to do is think past the sale.

Let’s say you sold the property and took home a chunk of cash. What’s your alternative investment plan for this capital? If there is another investment you are considering (i.e opening a business, purchasing other investment properties or securities), what’s the expected rate of return of those investments? In some cases that’s easy to calculate based on prior history or cashflow analysis – in others it’s much more abstract and unclear. But you must have at least an idea of potential scenarios (pessimistic, realistic and optimistic). Then, you compare those returns with the current return on your equity.

Equity = Current Market Value – Current Loan Balance

Return on Equity = Annual return (net cashflow+debt paydown+ realistic appreciation)/ Equity

If your alternative rate of return isn’t significantly better than what your capital is currently earning, you’re doing yourself a disservice by selling, regardless of the profit. Even worse still, if you don’t have an alternative plan for the capital but simply like the idea of selling something at a profit, then you’re really selling yourself short.

Past performance and hassle factor

Secondly, you want to consider how this investment property has performed for you during the time of ownership. Is this a solid investment that rents quickly to long term tenants and doesn’t turn over often? Or is this the redheaded stepchild of your portfolio that you dread every time it becomes vacant? Further still, is this a property that stays relatively repair free or does it break every other day and twice on Sunday?

Past performance and hassle are major factors in considering a disposition regardless of the equity and profit. Or put a different way, if you could go back in time, knowing what you know today, would you have purchased the property in the first place? If the answer is no then it’s time to sell and put that capital to better use.

Long Term Discipline in good and bad times

Mama said there’d be times like this.

When we speak of discipline in a long term portfolio, your mind typically defaults to unfavorable markets. If times get tough you must have the guts to hold one and ride the storm. But, if times are great, you must also have the strength to resist the siren calls of cashing out and keeping your eyes on the prize. So perform the analysis above and determine:
1. What’s your portfolio’s principal goal?
2. What are the replacement or alternative investments and how do their returns compare to your current return on equity?
3. How has this property performed for you in the past? Has it been a pleasure or a never-ending hassle?
The logistics of selling

Now let’s say that after performing the methodical analysis I described above you determine that you will sell the investment property. In that case there are a couple of important logistics you must consider:
1. What’s the best way to sell a tenant-occupied property?
2. What are the tax implications and how should you structure the sale?
When your investment property is tenant-occupied there are two strategies you can use to sell the property. First you could wait until the lease is up and once the tenants move out get the property show-ready and put it on the market. This strategy will likely make you really nervous because a) you don’t want to pay the mortgage while the home is for sale and b) the timing of the lease expiration may not allow you to bring the property to market at a favorable time of the year. But on the plus side, if you choose this strategy, you could provide full access to the property at any time and to any category of buyer (regular or investor). The second strategy is to sell the property while rented to an investor. For most investors, having a tenant-occupied property is a great plus since they would have no vacancy from day one. That’s especially true if the tenant has been in the property long term and is interested in renewing. The major obstacle with this strategy is that tenants have zero incentive to provide access to the property to prospective buyers. But don’t fret, we have a solution for that, too. On all tenant occupied investment properties we list for sale, we do not allow any showings until a contract has been executed. Since the Buyer is likely to be an investor, they understand why we don’t want to disturb the tenants until the intent to purchase has been put on paper. And there’s a 10 day inspection/feasibility period in which the Buyer can perform all their due diligence and determine if they want to move forward. By restricting showings in such an active market as the current one, you avoid a major disturbance for the Tenant. Instead of asking the Tenant to accommodate as many as 15-30 showings in two weeks, they will simply accommodate a home inspection and appraiser access. Most of our clients are still in acquisition mode, but on all the investment properties we have liquidated in the past 12 months we have employed the second strategy with great results.

Last but not least, you must not forget about pesky Uncle Sam that tends to get really cranky around liquidation time. The major consideration when it comes to taxation at the point of sale is the alternative investment plan for the sales proceeds. If you are planning to use the proceeds to open a business or purchase securities, then simply ask your CPA to calculate your tax liability so you know the after tax proceeds of the sale going in. As with anything else where the government is involved the calculation isn’t as simple as figuring out your profit times your tax rate. So in order to avoid surprises, do yourself a favor and sit down with your CPA. If instead you plan to purchase other investment properties with the proceeds, then it’s time to consider whether a tax deferred exchange (1031 exchange) makes sense for you. In such an exchange, the sales proceeds are never transferred into your bank account but are kept in an escrow account while you line up replacement properties. By structuring the deal in such a manner you defer the taxes you owe on the profit and invest the entire sales proceeds in replacement properties. That’s the short and sweet version and obviously there are many more nuances and technicalities. But no worries, if a 1031 is right for you, we have and can execute it to perfection.

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Do you own an investment property and are trying to determine if selling it it today’s appreciating market is the right move? Contact us (or if you’re seeing this in your email, hit Reply) and we would love to sit down and perform the analysis together to evaluate all the options.
August 12, 2015
Regret > Loss
The current strategy most Americans use to save and invest for retirement is fundamentally flawed. In order to evaluate the effectiveness of any strategy in an empirical way let’s look at the final results. Then let’s compare them to the results you employed the strategy to achieve.

We will go through that very process using two well known and often quoted studies.

First, a 2007 study performed by the Employee Benefit Research institute found that the average Baby Boomer had an average balance of $75,000 in their retirement account at retirement age. The same study performed recently, found that average balance has risen to $127,000 following the bull market of recent years.

Second, a 2009 study performed by the US Census found that the average college graduate (undergraduate) earns a little over $2M in their lifetime. Graduates with higher level degrees earned $2.5M (masters) and $3.5M (doctoral). But let’s stick with the undergraduate figure for the purposes of this article.

The math here is shocking and unforgiving! After 40+ years of working, earning, saving and investing the average “retiree” ends up with a little less than 2 years salary in their nest egg?! After four decades of tax-deferred 401K contributions, employer matches, double digit average market returns you arrive to find an account with 6% of your lifetime earnings?!

I know, I know. Yes, many boomers invested when the market was at the peak and pulled their money out at the bottom because they were fearful. Yes, they may have neglected to invest during the early years because they weren’t thinking about retirement then. Yes, their portfolios were probably not as diversified as they should have been. And finally, yes, they could have had much more money at retirement if they had the discipline of a robot and were completely unfazed by a 30-40% drop in the market.

All that considered, some pesky questions remain. Is this the outcome Baby Boomers signed up for when they invested their hard earned money? If given a do-over, would they do it again?

Of course not.

Sadly, for most retirement age folks in this predicament the only remaining option is to work much much longer than they had anticipated. But what about future retirees who are 15, 20, 30 years from retirement? After seeing the sad ending to this movie, do you follow the same path on purpose or do you shift strategy, direction and ultimately destination?

America has been called the “land of opportunity” and nowhere is this more evident than the above example. Unlike most countries around the world, an average college graduate earns a couple of million dollars in their lifetime. Think about that. Not the outstanding, exceptional college graduate – the average.

If this average graduate simply saved a dime out of every dollar she earned and never invested it at all, she would end up with 2-3 times more in their retirement account than the average retirement-age Boomers. How’s that for pathetic results?

When you first consider investing in real estate long term, fear of loss promptly ensues. After all, there are many unknown variables:
1. How do you know if it’s the right property?
2. What if the tenants are a major hassle?
3. What if it doesn’t rent quickly?
4. What if there’s a major repair?
I wrote this article to make one simple yet crucial point: Regret > Loss.

When you live in a country where the average college graduate makes over $2M in earnings in their lifetime, that’s a major opportunity. If you squander the opportunity to make something beautiful, to become financially independent and built wealth, the regret will be way more painful than any temporary fear of loss. If all you have to show for millions in earnings is 40 years of expenses, that will be a shame.

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References:

http://www.census.gov/prod/2002pubs/p23-210.pdf

http://www.usnews.com/education/best-colleges/articles/2011/08/05/how-higher-education-affects-lifetime-salary

http://www.fool.com/retirement/general/2015/01/10/the-typical-american-has-this-much-in-retirement-s.aspx
August 4, 2015
Case Study: Small multifamily investments in growing Texas market

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

Vacancy: $1590
Property Taxes: $5400
Insurance: $800
HOA: $200
Management : $2544
Leasing fees: $1000

Total: $11,534.00

Investment Scenarios

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.

Concluding thoughts

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?

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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.

May 22, 2014