In the real estate community, the “experts” advocate real estate investing as a means of gaining financial freedom. A popular pitch used by such real estate promoters / educators / snake-oil salesmen is that real estate will help you make a ward of cash with very little work to do. Never have to sit inside the cubicle 9 to 5 anymore. Hang out on the beach sipping margaritas all day. Blah blah blah.
This is not nonsense. This is doable. There are landlords whose monthly rental income can support most, if not all, of their desired lifestyles and beyond.
Most people, with the right mindset and determination, can turn this into a reality. The ultimate question is how, which is often failed to address by many experts.
Let’s break this down into 3 parts.
You know what step 1 consists of: Buying your 1st investment property.
You know what the end goal is: Sunbathing on the beach.
What happens in between? What is the path from start to end goal?
Before you submit your resignation letter to your boss, please consider what I have to say. There are benefits of having a 9 to 5 job at the beginning of your real estate investing career.
Without further ado, let’s look at why we should keep our 9-to-5 (for a while)?
Take some time to grow
Before we conclude that anyone and everyone who owns any number of investment properties has just won a lottery ticket and is set for life, let’s run some numbers.
Numbers vary greatly depending on the location of properties. But for the purpose of debate, let’s say you own an imaginary house in Pleasantville. Pleasantville is an average town, where an Average Joe or a Plain Jane lives in. It is mostly composed of hard-working average income workers. There are some proud homeowners, with a healthy number of renters mixed in. It is not a warzone, nor it is Beverly Hills / New York Manhattan. Just somewhere in between.
You collect $1000 in rent. Does that simply mean that you have $1000 of extra money that you can use each month?
For the $1,000 you collected, you have to pay $50 water / electricity, $75 for maintenance, another $75 for property management, $250 for insurance and property tax, and $350 for mortgage. That means you have $800 worth of expenses each month.
Since the income is $1000 per month and the expense is $800, that leaves you with $200 in your pocket.
Are you going to be able to live with $200 a month?
On the good side, collecting even just $200 a month with little work AND having someone to pay off your mortgage is an amazing thing. That said, let’s be honest. That one single house is not going to be enough to cover for all of your expenses. For 99% of us, you need more than 1 house, more than $200 / month to support our lifestyle. Maybe unless you are these guys…..
For the rest of us, one house is not enough to retire. That’s okay. You just need to buy more. You just need more time to grow. You buy one, then another one, then another one, and at some point, your houses will be able to fully support your lifestyle.
So how many do you need? It all depends on your lifestyle. Some people need 10 houses. Some might need 30 houses. Some never feel enough and
become addicted simply enjoys the thrill of having money coming into their account, the more the merrier!
Bottom line is, until you hit your magic number, find a way to make a living for yourself. You still need to put food onto the table. Get a job. Run a business. Fix and Flip a house for a profit. Do whatever you have to do in order to stay afloat before you have reached that stage.
Better/Easier to get loan to buy houses for people with a 9-5 job
The Hard Way
A good friend of mine, a seasoned investor, recently got a loan for his buildings. Since these are commercial properties, he got a commercial loan.
During the whole application process (which took him months), he and I always joke around that he needs to be rich in order to get a loan from the bank.
It is very true. Fees from the attorney, mortgage broker, the bank (yes, banks charge you money for getting a loan from themselves) add up to almost $30,000 for getting the loan.
His commercial loan is geared towards more for seasoned investors and larger buildings. If you are new to the real estate, chances are for your first investment property (or second, or third, for that matter), you have better options. You can use a residential loan instead.
The Easy Way
Keep in mind that a residential loan is not just for your own home. Most 1-unit to 4-unit houses, even if they are investment properties, can qualify for residential loans.
So why residential loans are better?
Lower initial cost: instead of paying $30,000, your cost for the loan is around one tenth of it. Roughly $3,000 or so. Often you can include your fees as part of the loan, so you need even less money up front.
Lower ongoing cost: All things equal, interest payments for residential loans are in general 1%-2% lower per year. That means if you you have a loan of $300,000. You just save yourself $3,000-6,000 per year.
Have ability to lock in the mortgage payment amount, if you choose to: Consider this scenario.
You bought a commercial building. At the beginning, you were able to get a cheap mortgage, because every bank in the market is charging a very low rate, say 4%. Say that means a $2,000 monthly mortgage payment, and you make $800 profit monthly with this building.
5 years later, based on the terms of your commercial loan, the interest rate for your loan is due for a change (we call them “resets”). The rate has jumped from 4% to 8% (again, that’s what every bank charges now). Now since the interest rate doubles, your mortgage payment doubles as well, from $2,000 a month to $4,000 a month. Suddenly, your $800 monthly profit has vanished, and turned into $1,200 loss each month. ($800 gain turns into a $1,200 loss because you need to pay $2,000 more in mortgage payment).
That’s the issue with most commercial loans. The mortgage payment resets every so often (usually every 5 to 10 years), and it can seriously turn against you when the interest rate is high. Unless your building prints a lot of money, you better hope the interest rate is low whenever the interest rate is due to reset.
For residential loans (at least in the US), you often have the option of lock in the amount of mortgage payment for a longer period of time. One such residential loan is the 30-year fixed rate loan. You pay your mortgage off for over a period of 30 years, and during the entire 30 years, your mortgage payment is fixed at the same level. That means, you can be certain that your mortgage payment will never go up for the entire life of the loan. That’s one fewer thing (a very important one) thing to worry about when running your landlording business!
If residential loans are so great, why don’t everyone use it instead?
Here is the catch: You need Proof of Income. Banks want to see you make enough money to cover the monthly payments. Most banks want to see you make roughly 2.5 times as your monthly expense. For example, if you monthly expense is $2,000, they want to see you earning $5,000 or higher each month.
If you already own a well-run, profitable business, you have nothing to worry about (maybe you make so much that you don’t need to get a loan to begin with!). For most people, when they are just getting started in business with no extra income on the side, getting a job is the one of the easiest and quickest ways to get the income they need to qualify for a loan.
What about the rental income that we expect to collect from our property which we are about to buy? Isn’t it part of the income?
Glad you asked.
A lot of banks don’t count them as income. Often they want to see 2 years’ worth of rental history, shown on your tax return, in order to recognize such rental money as part of your income. There are banks that don’t have such stringent requirements. For example, I know of a bank that will recognize rental income as long as you have a valid rental lease, but such banks are few and far between. But even with such lax rules, in order to qualify for a residential loan, you will most likely still need some other income to make your numbers work.
Think of residential loans as initial, special discounts offered to you for stepping into the real estate investing world. These loans are cheaper to get, easier to get and cheaper to pay them off. As your real estate business progresses, you will be getting commercial loans anyway, since soon you will be maxing out the number of residential loans that you can get (most banks cap at 10 loans) and/or you will be buying much larger buildings (only commercial loans are allowed for those).
Until then, take advantage of residential loans while you can!
Expect the Unexpected
We expect cashflow properties print you money consistently right?
For most months, this expectation is correct.
Not every month though.
In this past winter, I had the “fortune” to experience two back-to-back boiler blowouts (they are supposed to last for 15+ years) within 2 weeks. They cost $3,500 EACH to replace, so there goes $7,000! (My maintenance guy actually felt sorry for me and gave me a discount…)
Clearly for that month, this property was NOT a cashflow property. If this house were my only source of income, it would have been terrible since there would have been no money to pay for the fix. Without the fix, my tenants would stop paying the rent, leaving me with even less money to pay for the fix. Smells like a disaster in the making?
The cashflow from a 9 to 5 job can help you to survive through these lean and mean winters.
Of course, a boiler blowout was just an example. Burst pipes, non-paying tenants who need to evicted, and other mishaps are things that all landlords will experience at some point in our journey.
What is your plan to survive all these?
Having a cash on hand helps. And you should always have some cash reserved for rainy days (sometimes literally – if you have a leaking roof). Another alternative plan: the money that comes in on the side (from your job) will give you an extra safety net to ride through these blips.
Don’t worry. By the time you own enough houses, you will become immune to these incidents, because the losses in one house will be covered (often more than covered) by the gains in your other houses.
If you only have one house, and your tenant does not pay rent, you lose all of your rental income.
If you have ten houses, and one of your tenants does not pay rent, your lose 10% of your rent, because the other nine tenant supports it.
It is almost impossible that pipes in all of your houses burst at the same time, or all of your tenants are short on money to pay the rent the same month, right?
Putting all together
A job can be a stepping stone for the goal that you ultimately want to achieve. It provides you with the money to sustain the lifestyle as you are growing your real estate business. It gives you the opportunity to obtain cheap financing. It also gives you more buffer to sustain any hiccups that you face in your real estate journey.
Keep in mind that a job is just an option to consider. If you are REALLY against having a job (most entrepreneurs do), any small business, consulting services, any odd works that makes money serve the same purpose. The point is that you should generate extra income outside of real estate. Don’t put all eggs into one basket.
Remember, your most important question is this:
You know your beginning. You know your end goal. Which path do you decide to walk on in order to get there?
For a lot of us, getting a job is the easiest way to get into the real estate game, the true path of gaining financial freedom. Also, remember it is a path, so it takes time and effort to walk through.
Think of buying houses as raising kids. At the beginning, as an infant, your baby can’t walk. He won’t be able to eat by himself. He will sometimes fall and cry. You are his guardian, and his survival is entirely dependent on you.
But then you raise him well. He starts to grow. He becomes stronger and stronger. At some point, he will be able to support himself. And then, he becomes even stronger, so strong that he can help you in return.
Buy houses right. Have the patience to go through the initial phase. Embrace whatever temporary setbacks that you will face at the beginning. Remember, it is only temporary. Keep your houses well maintained. They will start printing money and pay for themselves. Rent will rise and rise and you learn how to manage better and better, so money that goes into your pocket goes up year over year. Before you know it, you will be much more financially better off than you would have thought.
After all, you would care about your investment properties as much as your babies, wouldn’t you? 😉