# Automatic wealth The 6 steps to financial independence - Masreson M.

ISBN 0-471-71027

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With an initial 20 percent down ($36,400) and counting all costs and upgrades, I’d put about $65,000 into the property. After paying real estate commissions on the sale and picking up roughly $6,000 in amortization, I walked away with about $225,000 in net equity when

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I sold. (My original $65,000 plus about $159,000 in profits from appreciation and amortization.)

In addition to that, I also picked up nearly $5,000 in net rents over the four years, pushing my total profits to about $164,000. About a 250 percent gain on the deal in four years—a very nice return!

Here’s how the deal looked for me:

Sale price of $390,000

Less purchase price of $182,000

Equals appreciation of $198,000

But not all that appreciation was profit. To see what my actual profit was, let’s look at my gross equity and net equity when I sold the house.

The gross equity is the money I had on hand before paying the real estate agent’s sales commission and before my part of the closing costs on the sale. To figure my gross equity, simply subtract the loan balance due from the sales price:

Sales price of $390,000

Less loan balance due at sale of $139,630*

Equals gross equity of $250,370

Now, we take the gross equity and subtract the real estate agent’s commission of 6 percent and the seller’s (my) closing costs on the sale. The result is my net equity:

Gross equity of $250,370

Less sales commission of $23,400

Less seller’s closing costs of $2,000

Equals net equity of $224,600

Net equity is the amount you receive from a sale that you get to put in your pocket, before taxes. (And there are ways to postpone the capital gains taxes on property indefinitely.) But net equity is not your

*The original loan on this property was 80 percent of $182,000, which works out to $145,600. For a 30-year loan fixed at 7.5 percent, about 4.1 percent of the loan is paid off during the first four years. That's why the loan balance due at this point is $139,630.

Step 5: Get Richer While You Sleep 199

profit. To calculate that, you have to subtract your initial costs and any net carrying costs from your net equity.

In this case, the house originally cost $182,000—but I didn’t pay that out of pocket. I used leverage in the form of a standard property loan equal to 80 percent of the purchase price. So my down payment was $36,400.

As the buyer, my closing costs were $4,000. I also put $25,000 worth of renovations into the house. So, my initial costs were:

Down payment of $36,400

Plus closing costs of $4,000

Plus renovations of $25,000

Equals total initial costs (or investment) of $65,400

I had no net carrying costs because the property had a positive cash flow. That is, it paid for itself. . . and then some. So now we subtract my total initial costs from the net equity I received at the sale and we get my profit:

Net equity of $224,600

Less total initial costs of $65,400

Equals profits from appreciation and amortization of $159,200

But those aren’t my total profits. I actually made more because I collected net rents every month. To get an idea of what I netted monthly, let’s calculate my monthly costs.

The monthly principal and interest payment on a $145,600 loan at

7.5 percent for 30 years works out to about $1,020. My taxes were $250 a month, insurance was $75 a month, and I averaged about $75 a month in maintenance. So my total monthly carrying costs were $1,420:

Principal and interest of $1,020

Plus taxes of $250

Plus insurance of $75

Plus average monthly maintenance of $75

Equals total monthly carrying costs of $1,420

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Now we subtract those monthly carrying costs from my monthly rental income and we get my monthly net rent:

Rental income of $1,500

Less monthly carrying costs of $1,420

Equals net rent of $80

Rents increased at about 5 percent a year during the four years I owned the house, so my net rents increased, too. Yes, insurances, taxes, and maintenance expenses went up as well—also by about 5 percent a year. But the bulk of my costs—principal and interest—were fixed. So my monthly net rents increased by $55 to $60 each year. The following table shows why:

RENTS RISE 5 PERCENT A YEAR AND NET RENTS RISE $55-$60 A YEAR

YEAR 1 YEAR 2 YEAR 3 YEAR 4

Monthly Rent Monthly Costs $1,500 $1,575 $1,654 $1,736

Principal and interest $1,020 $1,020 $1,020 $1,020

Taxes $50 $263 $276 $289

Insurance $75 $79 $83 $87

Maintenance $75 $79 $83 $87

Total Monthly Costs $1,420 $1,440 $1,461 $1,483

Monthly Net Rent $80 $135 $193 $253

Yearly Net Rent $960 $1,620 $2,313 $3,041

As you can see, even though rental values rose just 5 percent a year, my net rents more than tripled by year four! That’s because the bulk of the carrying costs are fixed.

If we add the yearly net rents together, you can see that during the four years, the property brought in net rents of $7,934. However, it was vacant for two months—one in year one during renovations and the other in year three during a tenant transition.

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