This great article appeared in my inbox. Real estate investing is one of the options I’m considering after I pay off the condo (vs. cash flowing an MBA).
Dave Ramsey only supports all-cash real estate investment. In other words, no leverage. He lost his first fortune via loans being called on leverage real estate investments, so that’s not surprising. I’m not 100% against taking out a conservative loan while investing in real estate, but regardless of if you pay all cash or not, you need to be conservative in the following:
- no more than a 15 year note. 30 year notes are bullshit. they absorb too much of your money in interest and encourage properties with too much leverage with too many eggs in 1 basket. They also mostly never get paid off, and they have all the interest stacked at the beginning.
- Rent needs to cover 100% of mortgage. Otherwise the deal is poop. So you may need to increase % of down payment to make this happen.
- set aside emergency cash for vacancy, assuming 1-2 months/year. If you can’t afford to set aside the emergency cash, you can’t afford the property.
- property needs to cash flow 10%-15% per year (e.g. $100k property needs to give you $1000/month exempting mortgage principal paydown, a.k.a. when you payoff the property, you need to be getting $12k / year on your $100k investment. Vacancy/taxes/upkeep will knock that down to $10k perhaps, and the pain in the ass of dealing with real estate is why you’re now getting a 10% return vs. 7% in index funds. You’re working for that 3%. Many people may not like that, but personally I like the idea that I have more thoroughly vetted / more thoroughly control the underlying investment.
The 2% rule says if you can find a property priced such that the rent is 2% of the purchase price, it will cash flow. Note that you cannot use this to figure out what the rent should be. The market dictates the rent. Rather, you have to use it to determine how much you can pay.
- mortgage interest writeoff is cool, but the purchase price / cashflow is what makes the deal, with an emphasis in the purchase price. If you can sell it for more than you paid into it, you can dump it if/when you need to. A property that cashflows well is cool, but if you suddenly need to come up with $50k, you don’t want to be selling at a loss.
- depreciation is cool, but you have to realize that depreciating the property means that you don’t have $250k of tax-free property value growth (like on a primary residence), so keep that in mind.
- Location location location. I would prefer a strategy to buy and hold forever cashflowing properties that are close to me, easy to manage, and likely to attract quality tenants. In California this is super expensive, so I think the best real estate opportunities for my cash flow level are probably in a different state, which is sad. But we have to ADAPT! And deal with reality as it is. So get your game face on and look at some shit in Utah.
- When you buy properties, you need to be creative to get a good deal. When I bought the condo, it was a short sale during the worst part of the stock market. Now that the market has recovered, you can’t just go out and pick up fantastic deals off the floor by looking at Redfin. You need to contact a real estate agent and try to make offers on some properties before they hit the market. You need to come up with several different angles on a deal to make it happen. You need to think about if renovation money would raise the rent enough to make an ugly duckling more palatable. You need to think about more than just where *you* would want to live. You might need to live in a weird basement for a while and rent out the top floor to pay off a house more efficiently. Even if you like the way a deal sounds, you should still come up with several alternatives.