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188 AUTOMATIC WEALTH
$100,000, and so you’d want to be able to get about $11,000 a year in rental income.
An $11,000 net return would be the equivalent of about 9 percent, cash on cash. But that’s not counting the appreciation on the property—how much more it will be worth over time. If the triplex in question appreciated at the historic average of 6 percent, you’d have an ROI of 15 percent—again, cash on cash.
But if you leveraged this investment by mortgaging the property, you’d do a lot better. In this case, for example, your cash outlay might be a $20,000 down payment plus the $10,000 in fix-up costs, for a total investment of $30,000.
Having a mortgage would increase your costs—roughly by the amount of the interest you would pay (the cost of the money you are financing)—and so you might end up paying an additional $7,000 a year in financing costs. Subtract the $7,000 from the $11,000 net rental income and you get $4,000, which is a 12.5 percent return on the $30,000 you put down.
This, again, is without considering appreciation. Add the $6,000 a year appreciation to the $6,000 and you have a return of $10,000 on $30,000, for a 33 percent ROI.
That’s an amazing number compared to, say, stocks, but it’s not unrealistic if you are investing in solid, well-priced rental properties in up-and-coming neighborhoods.
Here’s the point.
Owning rental properties—if you own good ones (which means better tenants and fewer complaints)—can be a very manageable way to make a lot of extra money on the side, while you are working for someone else or running your own business.
In fact, of all the on-the-side things I’ve done to increase my wealth, rental real estate has definitely been among the very best.
My Disastrous Beginning as a Real Estate Investor
I bought my first rental property in 1980 in Washington, D.C. This was probably the worst investment I ever made. It was a condominium on Massachusetts Avenue, a remodeled building just down the block from the projects.
I didn’t know it at the time—because I understood nothing about what I was doing—but I overpaid for the apartment by about 25
Step 5: Get Richer While You Sleep 189
percent. I also took out a negative-amortization mortgage (that I wasn’t qualified to have) that ballooned every three years and couldn’t be refinanced except by the bank that issued it (because it wasn’t Freddie Mac/Fannie Mae approved). And so I ended up losing money every month—not just on the net rental income but on the appreciation . . . which was going down!
To top it off, I had to scrape together three or four thousand extra dollars every time the balloon matured. And if that wasn’t enough, the attractive young lady to whom I rented the apartment turned out to be a deadbeat hooker. That meant threatening letters from the homeowner’s association, bounced rental checks, and two years of fighting with the D.C. government to try to get her out of there. (I was told that if I changed the locks—even though she hadn’t paid me rent at the time and was plying her illegal trade to the detriment of her neighbors—I’d be arrested and put immediately in jail. So much for sensible legislation and police work in the inner city.)
But the Story Gets Better . . .
That first experience cooled my jets for a while. But then, about 15 years ago, a business associate and I began investing in nineteenth-century mansions in Baltimore. These were beautiful but neglected town houses in the historic section of town, which was, at that time, overrun by drug dealers and hookers (maybe my old tenant was there—who knows?) because the local government had, in its infinite wisdom, decided to put Section 8 housing smack-dab in the middle of the city’s best neighborhood.
The good news is that we were buying majestic ruins . . . with potential . . . for $30 a square foot. By the time we had them completely restored, our cost was $50 a square foot—about what you’d pay to have a cinder-block warehouse built today in the Midwest.
At this sort of entry price, we figured we couldn’t lose. And we ensured against losing by putting some of our little businesses into these buildings and charging them reasonable (but sufficient) rents. This worked out in the short run. We were break-even for the first two or three years while paying off reconstruction and mortgage costs, but were able to accelerate the rental payments as the businesses grew. By year four or five, we were cash positive.
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Today, these buildings produce a high cash flow and, thanks to a new mayor who moved the Section 8 housing and replaced it with student dorms, the neighborhood has become safe and property values have soared.
If you have a business and lease your space, start shopping for a property now. Renting your business to yourself is the single best, most cash-flow-productive, and most tax-wise real estate investment you can make.
My Small Investments Started to Add Up
A few years after we began buying the Baltimore properties, I moved to Delray Beach, Florida, and started buying property there. My first purchase was a very small house on a large lot, which I rented to my brother. The next was a small condominium in an up-and-coming neighborhood a few blocks away.