Why EVERYONE should invest (part 2) by Jonathan Beasley
Now while I gave the aforementioned “naysayers” a bit of a hard time in the last blog (and if you missed it, click here to check it out). The reality is, to those of you whom investing IS a novel concept, there will more than likely be some GENUINE psychological barriers, that you need to prepare yourself to overcome. So, let’s quickly address the primary obstacle that most new investors struggle with.
#1. FEAR: Ah yes, humanity’s oldest nemesis to action. It’s interesting. Your brain and nervous system are literally designed to keep you from experiencing pain, harm, and stress. This of course CAN be a useful thing. When my son was a wee lad, and we would build fires together, I would constantly have to tell him to be careful around the flame. You and I both know that the flame can easily burn, and there it presents a REAL danger. And that is one of the distinctions we as people, and potential investors need to make. We need to differentiate between fear, and danger. Danger is real, and if not mitigated, CAN and WILL bring us pain and harm. Danger is real, however, it is mitigated by knowledge. Fear conversely is almost never based on reality. . .it is based on the anticipation (or imagination) of a negative outcome. It is the brain’s projection, of an undesirable future reality. . .one that that may or may not ever happen.
It’s also interesting to note, that by in large fear is learned. . .or at the very least, is enhanced over time. My son was not naturally afraid of the flame as a little boy. Once burned, he was quite afraid. In almost all cases, fear becomes a figment of the “WHAT-IF” cycle. And once you have felt the sting of fire, it becomes very natural to see everything as the proverbial flame that will burn you. . .and as such, our brain has us stay WELL within in familiar territory, keeping us “safe” from the orange glow of the blaze. Going outside the parameters of what you know and have previously experienced, presents your brain with an interesting prospect. Venturing into the unknown can and will trigger fear until you willfully take control through knowledge and action. This is the case with investing as with any other “unknown” or “dangerous” venture. Fear, manifests from a variety of places. . .and I imagine many of you can identify with one or more of the following:
– Fear of failing
– Fear of pain
– Fear of loss
– Having other people vomit THEIR FEAR upon you and taking that as upon
yourself (this was actually MY primary monster to SLAY)
– Fear of what other people will think
– Fear of success
And the list goes on. To me, the MOST heartbreaking component about succumbing to fear is that it is essentially a prison cell, built BY you, FOR you. Luckily, YOU hold the key. . .
A good and wise friend once told me the following as it relates to decision making: “When the facts are clear, the answer is obvious”. I have found that the best method to combat fear, is through action, backed with knowledge. Through these articles, I hope to arm you with knowledge. . .
Now back to Real Estate. . .
According to the NAR, the median price of homes sold in the U.S. in 1993, was $125,000. As of Q1, 2018, the median price is $320,000. That is an appreciation of 256%, during a span of time in which we saw the Great Recession, arguably the single most influential Real Estate bubble burst in American history. Of course, Real Estate is inherently local in nature, and markets will vary city to city and state to state, but for the sake of this article, let’s assume a few things for our proposed Real Estate investment scenario (what your portfolio could have looked like over this span, or better yet what it WILL look like in the future).
1st. We will keep your appreciation data in tandem with national rates.
2nd. We will calculate that you can achieve what is called the 1% rule. . .that is: “you can buy satisfactory properties and rent them monthly for no less than 1% of your acquisition costs.” There are outliers, but this is a fairly easy rate to achieve in most markets if you know what you’re doing. Personally, I don’t like to acquire property for less than 1.3% (this not my only investment criteria, but it definitely gives you a quick rule of thumb to quickly estimate your “cash-on-cash” return. . . will be explained shortly).
3rd. We are going to assume you started investing in 1993 and calculate that you need 20% down to purchase your 3 investments. This is a fairly standard loan to value ratio. We will also calculate that your interest rate is 5%. Historically speaking that is low, but rates have been beneath that for the majority of the subject period. We’ll assume you are doing 25yr loans, your taxes are 1% annually and your insurance is .50% annually, at time of purchase.
4th. We are going to assume you only invest in 3 properties, and they’re all single family. Generally speaking your rate of return would be higher if you ventured into multi-family property (multiple units that are “attached”). But those typically won’t appreciate as quickly either, so we will exclude them from the conversation for now.
So here goes! Let’s say you were a good little boy or girl and had been saving some dough for a rainy day. The year is 1993 and you found a nice little deal. Your down payment is 25k and the price of the property is 125k.
– Your loan on it is 100,000. ($125,000 minus 20%).
– Your payment including taxes/insurance is $710/mo
– Your rent coming in is $1,250/mo
– Your cashflow = $540/mo
Now, since you were a smart enough little boy or girl to save up your downpayment, you’re also smart enough to know that occasionally things are going to wear out, break, or otherwise need to be replaced. So we are going to account for 10% of our rental income, to go towards repairs and vacancy (the lapse of time between renters when no income is coming in).
– Vacancy and repair budget = $125/mo
– Your real actual cash flow = $415/mo
Ok, so nobody is buying that new Lambo or a beach front vacation home on this (at least not just yet!!!). BUT, there are a few things to consider now. First, at the end of the year, your cash flow will have totaled $4,980. When you consider that the actual “cash” you put in, was $25,000 (your down payment), the cash flow alone gave you a realized return of right at 20%. This is called your “cash-on-cash” return. You are already well ahead of most any index or mutual fund. And this is ONLY 1 of the ways you are making money on the property.
Ok, so we’re fast forwarding 3 yrs. It’s 1996 now. . .and you’ve caught the Real Estate bug hard and fast. You’ve been eating and living frugally, but it has STILL taken you this long to save up the next down payment between your job’s excess income, and the cash flow that you are (hopefully) socking away from investment number 1 in anticipation of number 2. Prices have gone up (as has the value of your first property!). So you found the next property that matches your criteria and your acquisition cost is $137,000. Your downpayment is $27,000
– Your loan on it is $110,000
– Your payment including taxes/insurance is $780/mo
– Your rent (again using the 1% rule) is $1,370/mo
– Your cashflow (after putting aside 10% for vacancy/repairs) = $453/mo
At this point, there are a few BEAUTIFUL things at work for you now. You are bringing in $868/mo, of ACTUAL, SPENDABLE CASH. You can by momma new pairs shoes with this, or if you’re still thinking long term, you continue accruing that cash flow to keep buying more little green houses so you can eventually afford a BIG RED HOTEL (I loved Monopoly as a child.) Also, don’t forger someone ELSE is making your payments for you and paying down your mortgage. The market is working in your favor and helping your property appreciate. . .and you are writing off most if not all this extra income through the tax benefits of rental property depreciation.
Ok, it’s 2 years later, and you are ready for your 3rd and final investment (as it relates to this scenario). The median price in 1998 is $150,000. Your down payment is $30,000 (a NICE chuck of which you could have gotten from your cashflow at this point).
– Your loan on is $120,000
– Your payment including taxes/insurance is $889/mo
– Your rent (again using the 1% rule) is $1,500/mo
– Your cashflow (after putting aside 10% for vacancy/repairs) = $461/mo
So NICE JOB ON YOU! At this point, you are going to sit back with only these 3 purchases and let the magic of loan paydown (compliments of your renter) work its magic. It is now present day 2018 and here’s where the numbers, literally change the landscape of your life. With ONLY 3 small purchases.
Your properties are valued at the current median, which is 320k and the 1% rule would put you at $3,200/mo in rent. Guess what!? The renters you’ve had over the years have JUST paid off your first investment. With the small market rent increases over the years you are now “cash flowing” in that property alone, at approximately $2,500/month. This includes market increases for taxes and insurance, and also keeps you at 10% for vacancy and repairs.
By the time we reach 2023, ALL 3 investments will be fully paid off. They will be bringing approx. $8,000/month in cash flow, and your equity position will be right at a $1,000,000. Most people that I have ever met, could greatly benefit in their later years by supplementing their retirement with a 6 figure real estate passive income, and a 7 figure net worth.
Yes, this scenario assumed a lot of things. You could poke holes that the 1% rule would be harder to achieve over time. And that 10% may not always cover vacancy and repairs. And that you are managing the property yourself. But I also did not factor in you buying more property, or how much cash flow you would’ve raked in over the years to either cover expenses, hire a manager, or buy more property. Not to mention we haven’t even discussed what refinancing and pulling money out could have done for you if you wanted to invest in more properties and create a bigger snowball effect.
Bottom line. Yes, you SHOULD BE INVESTING in Real Estate. The power and leverage it gives you to impact your income and net worth position, is unparalleled, and you can do it using primarily other people’s money. My recommendation to newer investors is always, to learn first, take action early, take action small….and learn more along the way. For me, the level of confidence I felt after my very first deal was absolutely a game changer. And there was a compounding effect that took hold after I punched my fears of action in the face and took the initial plunge into the game of investing. It took me many many years to do my first deal (approx. 15). But once under my belt, it was within a year that I was doing my 2nd, 3rd. . .and 6th deals. : ) Generally speaking, I have found fear to be a liar. Everyone has different experiences relating to it. And some even justify and hold onto them. For me, danger and fear are simply different animals. . .and I do my best not to confuse the two.
For those of who want to venture deeper into the jungle that is real estate, and explore the unknown at a greater level, to those that see and dream about big opportunities, a life of freedom, and a life of unlimited possibility, please keep reading. I mentioned earlier that the best way to combat fear is through action backed with knowledge. It is my sincere hope that you have perhaps gleaned just a little knowledge here today and will glean more in the near future. . .the action part though, as always, IS UP TO YOU.
Happy Investing!
See you next week,
JB.