A friend of mine came to visit a little while ago; we went to school together at the University of Cincinnati College Conservatory of Music and he was a groomsman at my wedding. Unfortunately, following graduation and my wedding we went our separate ways for about six or seven years, but as life would have it we reconnected lately. Well – he told me that he is considering putting some money into investment real estate, and asked me the question that I hear so often – What’s the best way to invest in real estate for a newbie?
A few words about my friend are in order. He is a professional person. He has switched career track thrice now and has finally found something he really loves. He has steady employment and makes sizable income. His credit is good enough to do anything he wants, and he has managed to put some money away. He is single and up until now he has chosen to rent an apartment in lieu of buying, though he has lived in the same city for over a decade.
Does this sound like you? I thought it might 🙂
Indeed – I think that my friend’s circumstance is representative of a lot of you ladies and gents out there, and for this reason I think that a lot of you would benefit from the advice that I offered to my friend.
WHAT ARE YOU TRYING TO ACCOMPLUSH?
This was the question I asked him and you should ask yourself. Why – because what you do is a function of the answer. If you are trying to achieve a comfortable middle-class life with all of the bells and whistles that come with that, then perhaps buying a Single Family House (SFR) is the best way for you to put some money into real estate – the American Dream, so to say. This, however, would do nothing positive for your bottom line financially.
If making a good financial decision and generating some kind of investment return is at the top of your consciousness, and you are willing to inconvenience yourself a bit today for the benefit of tomorrow, then a SFR may just be the opposite of what you need to be doing.
DO YOU HAVE AN INCOME & LOSS STATEMENT?
This was the question I asked my friend, to which he answered no. I knew I had to start there…
Income and Loss Statement is part of a larger document called the Financial Statement. The Income & Loss statement tracks your financial position as it relates to the your income and your expenses. So – you right down all of the Income on the left side of the page, and all of your expenses on the right side, and then you total each column and subtract total expenses from the total income. The answer is what we in the business world call Cash Flow, but in your own personal finances this is simply your savings – what’s left of your income after you pay your bills.
Now – most people’s mode of income generation is a job; my friend is no different in this respect from most and likely neither are you. The reason he and I were having this conversation, however, is his realization that he needs to find ways to increase his cash flow with ways other than getting a higher-paying job. As I mentioned at the outset, he is on his third career and finally realizing that at least for the time being he has hit the ceiling in his earning potential. Traditional investments, his experience tells him, seem to be doing nothing for him relative to generating additional income, which is why he now figures that real estate may hold the answer. Amen brother – better late than never, as they say…
HOW WE IMPROVE CASH FLOW
When most people want to have more money left at the end of the month, they automatically gravitate toward the income side of the equation – they think that they need to make more money, as I discussed in the video above. However, those of us who’ve been around for a while are aware of 2 powerful realities:
- The more you make, the more you’ll tend to spend.
- The more you make, the more you are taxed on what you make.
Indeed, unless you can earn so much more that the taxes won’t matter to you, and have the discipline not to spend everything you earn, then this strategy is kind of a looser…
FORTUNATELY, THERE IS ANOTHER WAY
The Cash Flow formula has two parts which are a zero sum gain:
INCOME – EXPENSES = CASH FLOW
In order to increase the Cash Flow, we can either drive the income up, or drive the expense down. Sorry dear friends – this is not a sexy article about high-flying creative finance or some other silly thing like that. This is a down to earth; let’s get back to the basics kind of article – how much you spend has more to do with your capacity to get ahead financially than how much you earn!
So, I sat my friend down and said to him: as you are looking at your expenses, which one stands out as the one of the biggest and yet easiest to get rid of? And the answer – RENT. He is renting an apartment and spending quite a lot of money. Are you? You could be living for free – I said to my friend and now say to you!
BEST WAY TO INVEST IN REAL ESTATE FOR A NEWBIE
I once had a great conversation with a Realtor in Fort Collins, here’s what I realized after talking to him. In lieu of renting, or buying a house which is going to cost you money every month, you should buy a small multiplex and become a home owner and landlord at once. As an owner-occupant you’ll qualify for the best available financing terms, and if you buy the right kind of building, the income from the rented units will potentially pay for all of your costs of ownership and then some. Not only that, but if you did nothing else in real estate your whole life, one day this building will be paid off – BY YOUR TENANTS, and you will have more supplemental income than any of your compatriots living off of Social Security.
For a multitude of reasons, all of which fall outside of the scope of this article, I think that a triplex (3 units) is the best configuration for you to consider. Now, the numbers vary from one marketplace to the next, but in many parts of the country you can easily buy a triplex for $150,000 or less whereby units will rent for $700. If you buy the right kind of building, the Operating Costs (expenses of ownership not including mortgage) should run no more than about $600/month.
Having put down 20%, my friend has that amount, and having financed the remaining $120,000 with a thirty-year note at a current 5%, your payment would be about $645/month, meaning that the combined cost of ownership of this triplex will be about $1,240/month. Therefore, if you were to move into one of the units and rent out the other two others at $700/month thereby generating $1,400 of monthly revenue, the income should cover all of your expenses, plus leave you with a few bucks – you’d be living for free!
- For my friend, who is single at this point in time and is living in an apartment to begin with, this arrangement would not represent much “cramping of his style”, but living for free certainly would impact his financial position in a positive way.
- Keep in mind that in this situation my friend’s cost of money is fixed for 30 years at 5% – it’ll never go up. The rents, however, presuming he’s bought the right kind of building will certainly go up over time. In this way, purchasing a small multi-family will be a sort of a hedge against the dollar over time.
- When he eventually does have a family and it becomes impractical to continue living in an apartment, he’ll be able to buy a house and rent his unit in the triplex. In this case, the additional rent coming in will more than likely cover his payment of the newly bought family home.
- As his mortgage is being paid-off, if he bought the right kind of building it will also appreciate in value over time due to monetary and economic forces. In this way, having bought a $150,000 building, by the time the mortgage is paid off the building might be worth 20%, 30%, 50% more. Only time will tell, however it is more than likely to be worth more than what he paid for the building…
- As tenants continue to effectively make his mortgage payment for my friend, eventually the mortgage will be cashed out, which will free up $645. At this point, my friend will have options – he will be able to either:
- By making additional payments on his mortgage, my friend can expedite the process dramatically. For instance, should he choose to allocate $350/month to this, which he can easily do considering it is a fraction of what he currently pays for rent, my friend will pay off his building in about 15 years – half the time.
- Do nothing and simply enjoy the extra cash flow,
- Re-leverage against the property to come up with funds to buy more real estate, or anything else…He is not quite 40 years old currently. By the age of 45 he could be the owner of a free and clear building which will likely be worth at least $180,000 – $200,000. This building will generate at least $850/month of rental income per unit…
Is the deal I described an absolute slam dunk of a real estate deal? No – of course not. Is it creatively financed requiring no down-payment? No. Is it creative? No. Indeed – if you’ve been reading my articles here and on BiggerPockets for any length of time, you know that I would not do a deal like this in a million year. But, my friend is not looking to be on the cutting edge of real estate investing; he is not looking to be me – he just wants to make a financially smart decision for someone who will essentially be a home-owner. This deal, or another like it, gets the job done!
If this sounds like something you may be interested in doing, and you live in Ohio, give me a call. As a REALTOR in the State of Ohio I’ll be able to help you find and buy exactly the kind of building I described!