Is $200 a month a lot of money?
How you answer this question speaks to your level of financial sophistication.
How Far Would You Go for $200?
Most people would not go very far out of their way to make an extra $200 a month. When compared to a monthly salary of $3,000 or $4,000; $200 sounds pretty insignificant.
A person might pick up an extra shift on a Saturday for a little vacation money; but the uncomfort from losing a weekend day keeps them from making a habit of it. Someone might sell an outdated computer or game system for a few hundred bucks, but that money’s usually gone by the end of the weekend.
As a way to create wealth, $200 doesn’t even cross most people’s minds. The average person spends more time buying lottery tickets and gambling in casinos than looking for ways to add another $200 to their monthly cashflow.
Successful Real Estate Investors
I happen to have the best job in the world. I get to produce videos about real estate investors, which allows me to meet many successful people and pick their brains in the process.
I’ve found that all the successful real estate investors I meet are excited about $200 a month in cashflow from one of their rental properties.
In most cases, that $200 a month is the main reason they pursued the property.
The Definition of Wealth
How you feel about $200 a month has a lot to do with how you define wealth. Most people associate wealth with a large dollar amount: Alex Rodriguez signed a $80 million dollar contract, or Bill Gates is worth $80 billion.
Throughout most of my childhood and early adult years, my definition of wealth was 1 million dollars. The day I opened up my bank statement and it said “$1,000,000″ was the day I was going to be wealthy.
Rich Dad, Poor Dad
My definition of wealth changed the day I read the book “Rich Dad, Poor Dad,” by Robert Kiyosaki. If you have never read the book before, your next click should be Amazon.com to order yourself a copy. This book changed the way the world looked at investing.
One of the most important concepts in “Rich Dad, Poor Dad” is the definition of wealth. While most people look at wealth in terms of a large, one-time amounts of money; Kiyosaki says that this has nothing to do with wealth.
Wealth is determined by this simple test:
Quit your job today; and without touching the principle on any of your investments, how long can you live on your passive income?
Passive Income
A few forms of qualified passive income are:
- Interest from Checking and Savings accounts
- Dividends on Stocks (not capital appreciation)
- Cashflow from Real Estate
All of these things A) give you cash on a consistent basis, and B) once set up, are relatively easy to maintain.
How Long Can You Live on Your Passive Income?
To figure out how long you can live on your passive income, you first need to know how much your personal bills are each month. Add up all of your expenses: everything from the house note and car note, to toothpaste and tuna. If you’re married, just do it for your half of the bills.
Let’s say that the average American needs $3,000 a month (after taxes). Since a month is about 30 days, that’s $100 a day.
So how long can you live on your passive income?
I would suggest that most Americans can only live a few hours… maybe a few minutes on their passive income. Most people don’t have anywhere near $100 a month in qualified passive income. They might be getting a few cents in interest from their savings account, but that would only cover a few seconds.
One Single-Family Rent House
Let’s say, in the next three months, you go out and buy one single-family rent house that cashflows $200 a month. Can you see how you may have done more to retire yourself in 3 months than you had in your entire working career?
That one house, and it’s $200 a month cashflow, pays for 2 days out of your month. If you don’t have more than $200 a month right now in passive income, this one house did more to retire you than you had done for yourself in your entire working career.
Now, go buy another one… that pays for 2 more days…
Buy another and you’ve now paid for 6…
By the time you have 15 rent houses, you’ve now paid for all 30 days in the month… and the month starts over again.
Theoretically, you can now live forever on your passive income.
Side Note on Kiyosaki
After seeing Kiyosaki live, buying his board game, and reading many of his books; I’ve come to realize that he is BIG on ideas, but small on details. When you finish reading his books, you’ll be so jazzed on creating wealth that you won’t know where to start… (that’s because he didn’t give you any details.)
Make sure you are part of a local investor group to fill in all the little details that Kiyosaki doesn’t tell you. My favorite is Lifestyles Unlimited where I am both a member and mentor; but you should shop around until you find a group or groups that you are comfortable with. Go to NationalREIA.com for a list of investor groups in your area.
$1,000,000 401k
Now, let’s compare our 15 rent houses to a million dollar 401k. Let’s assume you were the world’s greatest at-home stock trader in the early 2000’s.
You listened to Jim Cramer every day and managed to act on his good advice and avoid the bad advice that lost everyone else 40% of their portfolio in 2008. You sold everything before the market crashed and now you’re ready to retire.
The challenge you now face is how much money to take out of your 401k in your retirement so that it lasts the rest of your life
Or.. as Del Walmsley likes to put it: so you can hurry up and die before you run out of money.
The Conventional Wisdom Plan
You seek the advice of a financial planner and they give you the conventional wisdom on retirement:
1. Conservative Investments
You’re told to put your money in conservative investments that will only yield 2-4%, but at least you can have some peace of mind in retirement. Sounds reasonable.
2. 4% Drawdown
You’re allowed to draw down your 401k at the rate of 4% per year to live on: $40,000 per year.
Before the crash of ‘08, 4% was generally accepted to be the right amount to draw down in retirement. The book “The Number” lays out research from William Bengen showing that those who drawdown at 5% have a 30% chance of running out of money.
3. A Little Interest
Won’t I be getting some interest, too?
Yes, but it will be at a very low interest rate and getting smaller each year as you eat into your principle. Let’s say, another $10,000 per year.
$50,000 a year doesn’t sound as great as you had always imagined, but at least you don’t have as many expenses as you used to (you did pay off your house, didn’t you?).
4. Pay Taxes
Wait, I thought we were done!
Sorry, here comes the worst part… Now you have to pay taxes. You were sold on the 401k as a way to defer taxes, but you didn’t realize that defer was not the same as avoid. You pay roughly $14,000 in taxes which leaves you with $36,000.
$36,000 a year just happens to be $3,000 a month or $100 a day.
15 Rent Houses Did the Same Thing Faster
15 rent houses did the same thing as your million dollar 401k, but did it take you your whole working career and a huge chunk of your paycheck to build?
No. You can buy 15 rent houses in 5 years or less.
The Five Year Plan
Here’s how to buy 15 rent houses in 5 years:
Year 1: Save $5k from employment to buy 1 house with a hard money loan. (1)
Year 2: Save $5k and refinance $5k out of the 1st house to buy 2 houses. (3)
Year 3: Save $5k, refinance $10k out of last year’s 2 houses, to buy 3. (6)
Year 4: Save $5k, refinance $15k out of last year’s 3 houses, to buy 4. (10)
Year 5: Save $5k, refinance $20k out of last year’s 4 houses, to buy 5. (15)
This example only took $25,000 out of pocket over a 5 year period… much less than a million dollar 401k …and much faster.
But Wait… There’s More
The story doesn’t stop there, with 15 rent houses and $3,000 a month in cashflow. The beauty of real estate is that there are so many different ways it makes you money.
While a 401k gets smaller and smaller in your retirement, rent houses continue to increase in value and cashflow year after year.
1. Equity Capture
If you bought those houses correctly, you should have captured equity in each house. Let’s say you captured $20k in each house. That’s $300,000 added to your net worth.
2. Market Appreciation
Real estate doubles in value every 20 years. That means: by the end of your retirement, your real estate holdings would have exploded in value.
If each house was worth $100,000 when you bought it, then all 15 were worth $1.5 million. You could potentially add another $1.5 million to your net worth over the next 20 years.
3. Cashflow
Rents rise over the long run, adding to your cashflow year after year.
4. Principle Paydown
Your tenants will be paying down the notes on all of your houses. If you had 20 year notes on each house, you would have them all paid off in 20 years, adding another $1.5 million to your net worth.
5. Tax Advantages
Real estate investors pay the lowest taxes of any for-profit group in the United States. The cashflow is virtually tax-free when you account for the depreciation deduction the IRS allows you to take.
If you decide to sell and capture your equity, you can roll the profits into a 1031 tax exchange to defer the capital gains tax. When you pass the properties down to your children, they take over the property at the new cost-basis, wiping out all the capital gains tax.
Conclusion
Now, do you see why I stopped playing around with small-ball investments and focused on real estate? Real estate is the most powerful wealth-building tool that is available to everyone in the United States.
Stop playing small-ball and start investing in real estate.
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I think you missed one more advantage. When each house note is paid off your $200 a month jumps up to like $800 (rent minus insurance and taxes). Once your 15 properties are paid off, your cashflow could go from $3,000 a month to like $12,000 a month. That rocks!
Great article!!! My husband and I have 5 rental properties, all with morgages, and would like to buy more but since the economy has tanked, neither of us can find permanent jobs and banks won’t look twice at anyone who is not employed. How do we go about getting a loan to buy a house even if you have the $5K to put down and excellent credit?
Thanks,
Sharon
There are other ways of financing properties.
1. Partner & use hard money
2. Private Money
3. Sub 2 deals
etc…
There are a couple of questions I have regarding the article above.
In today’s market conditions, isn’t $5,000 a little low, even for a hard money loan? It seems to me that $8-10,000 is the number most people are giving me.
In today’s market, is it possible to refinance every year to buy the next house?
If you refinance every year, aren’t you in effect starting over at year 1 on the loan, and thus your renter would NOT be paying off the mortgage?
I’m not trying to be a nay-sayer (I hope to close on my first property soon), but I’ve heard these exact details before, and I can’t get my mind around them with the real-life stories I’m hearing. Can someone explain what I’m missing?
Thanks for the great questions, Meg.
I know it’s a little hard to believe, but I’m seeing it several times a month here in Central Texas and I just got back from Houston where I watched 2 case studies with very little out of pocket. Karen Davis did a 0 down deal in this video and there are more to come: http://www.lifestylesunlimited.com/karen_daviss_6th_investment_property_case_study
If you want to be more conservative, you might bump up the numbers to $10,000 per house and you won’t be out of pocket much more (50k vs 20k).
As for the refi’s: in the example we only refi the previous year’s purchases. that means that each house only gets refinanced once. I’ve seen people refinance in as little as 3 months after purchase and take that money out right away.
Yes, a refinance is going to bump up your mortgage payment, but if you have $200-300 cashflow you should have plenty of buffer and rents will go up over time to compensate for the payment.
Thanks! OK, I have a couple more questions which I should have thrown in with the first batch:
If a person’s financial situation doesn’t appreciably change between Year 1 and Year 5 (ie, they still have roughly the same earned income and the net worth is only increased by the unrealized equity in the rental properties), will they be able to put aside enough reserves to satisfy the additional loan requirements?
And how will their debt to income ratio be affected by the additional mortgages (if everything else is mostly the same, except for the $200/house cash flow each month)?
What kind of an exit strategy would you recommend for a person with 15 houses who has effectively retired? Stay in SF, or would they be likely to be able to earn $3,000/month cash flow in a MF deal?
Thanks!
Thanks for the article, Brian.
My wife and I are Lifestyles members have been trying very hard to get started by using a hard money loan or a double close loan. I know it is possible since there are some Lifestyles investors who have been successful recently. However, we have found that since hard money loans finance between 70%-75% of after-repair-value (ARV), finding a property with enough equity to cover purchase price, rehab and closing costs and only come out-of-pocket 5K is not common anymore.
The few properties that we have found recently that do have enough equity for this to work have a lot of competition from other investors. We have made offers on a handful of properties with this kind of potential only to get out bid even when we have offered 6K-9K over list on all of them.
Your thoughts?
Meg, more great questions…
The nice thing about buying real estate CORRECTLY is that the cashflow and equity get immediately attached to your income and balance sheets…
The only catch is that the banks only take something like 80% of your rental income. That means that you have to make sure you are cashflowing at least $200 on a $1000 rental house. In that case, it will not affect your borrowing power either way as far as I understand. Blake Yarborough (above) can answer that better than I can.
In terms of reserves… you might consider putting your cashflow aside each year to add to your reserve pool. Most lenders want 6 months liquid on each property. (again, Blake can answer better than I can)
Exit strategy for most Lifestyles members is to sell off and buy into apartment complexes with steady cashflow in retirement.
Thanks, James.
The only thing I can say about finding deals below 70% LTARV is that I see them going down several times each month here in Central Texas.
One factor is SPEED. If you are working off the MLS, you have to keep a sharp eye on new listings every day and shoot out offers within the first few days if not hours.
If you want to get more aggressive about finding deeply discounted deals, make sure you have a team of agents. You could even explore other marketing channels such as farming neighborhoods, mailers, etc.
The example was to get 1 the fist year… That might mean it takes 6 months to find that really great deal… Keep on the trail and you’ll get it. Ask others how they are finding theirs.
Different properties have different characteristics.
Some may be bigger cash flow 400-500/month, but no equity appreciation. Others may have no cash flow, but may appreciate.
If you are buying properties in areas with the best schools, stores etc… You may not be able to always fit hard money. I have been able to buy 23 properties in the last 13 months with the max of est 10k out of pocket. Some were with as little as few hundred dollars!
Properties 1-4, we are able to use 75% of gross rental to “wash”, the payment. If you have a $750 payment (75k loan), and you rent it for $1000. We are able to use 75% of $1000, or $750 to “wash” the 750 dollar payment. This equals zero net affect on you debt ratio.
The great thing about rental properties is that they pay for themselves!
I just wanted to say, what a great article. I will share this with my husband who is a stock investor. I think this may go a long way towards a mindset change. Just as a side note: you use the word, “differ” which should be “defer.”
I’ve finally gotten my family situation settled.I want to know I can secure financing.My fear is someone accepting my offer and not being able to follow through on the purchase. Blake can you help me with KILL this fear?!!!
Earl,
I can do all i can to make you comfortable with the financing, but, you will still be nervous until you get the first one under your belt.
Its kinda like your first dance!
Please contact me and i will spend time and go over the options with you to equip you with the knowledge of the different loan programs & when they are the most appropiate.
It really just comes down to the numbers.
Be sure to assemble a good team.
You will be fine.
Take action.
Very well presented, Brian. Just imagine what a person can do if he already has a sizeable retirement account to use!
I am not an expert but owning 7 rental properties has helped me understand some things and these days I do much better than when I started, so I am going to try to answer some of the questions above [Warning! I talk about me a lot below
]…
*Sharon - I am in a similar situation, I can’t get financing these days because of the number of financed properties I have. So I started looking for partners and I submitted an offer on a house with a partner on Friday, I should be hearing from the seller today. Hard Money would not be my first choice because as far as I know, those are short-term loans and they are expensive; I’d rather share profits with a partner (family member or not).
*Meg - I overspent a little bit on my last deal and my out-of-pocket was barely $5,000. Now, I used hard-money and I still have to refinance the property. With more and more houses selling cheap these days, the comps at the time I refinance may be lower than when I bought the property there is a chance I may have to chip in some money when I refinance that har-money loan but the bottom line is that there are are few houses out there (I can only speak for the Dallas/Fort Worth area) where your out of pocket will be minimal if you do things right.
*Meg(2) - Robert Kiyosaki recommends (and I agree) that you should tighten your belt early in your investing career so you can invest more in the begining and increase your income and net worth sooner. I was a big spender, once I figured out this real estate investing stuff, I started thinking twice before spending on anything I don’t really need because it is money that I could otherwise invest. In regards to DTI, it is like Blake stated, 75% of your rent income is what banks consider, not 80%. But after 4 properties you have to find a bank that will let you deposit and arm and a leg into your checking account, they ask for 6 months worth of reserves for each property, including the one you plan to buy, not to mention down payment and closing costs.
*James - There are properties out there and yes, there is competition, I have been outbid as well. Most likely the investors you are competing with have their own crews or a relationship with a remodeling company so they may be paying less than you would for the rehab, leaving them with a bit more money to pay for the property. I had to overpay for remodeling at first, then I just started getting better rates for repeat business. Also, you have to make sure not to estimate flipping repairs when you should be estimating rental repairs. And like Brian said, SPEED is critical, especially on the better deals, but in order to be quick, you need to have some experience and a reliable GC that will come with you to walk the property the day you find out about it. I have missed some good opportunities for not acting fast.
*Crystal - You are absolutely right, but you missed another word that is misused in the article. Can you find it?
Hope this helps!
-Omar
Thanks to everyone for their thoughts.
James, I can tell you that I made more than 20 offers to get to one executed contract. And I’ll give you a tip; once I got that one under contract, referrals and tips started pouring out of the woodwork! So many of the people on our team knows somebody who has good deals to pass around, so don’t be afraid to tell ANYBODY involved even remotely in real estate (ie, realtors, rehabbers, inspectors, hard money guys, mortgage brokers) that you would appreciate any leads they can give. Competition on the MLS is fierce; I’m seeing that the good deals go to people before the deal even hits the MLS. Those are the folks you want to be talking to, IMHO. Good luck! There’s enough to go around, you just have to find it!
I am looking a 3-4 plexes and all the brokers I can find are requirinq 25% plus 6 months reserve. They claim new FHA rules…. Am I looking in the wrong spot? I must keep it rented as I do not have enough income to make 2 mortgages.
Are you looking to put the 4 plexes in a LLC? If so, we could probable do 80% on them. The rates are not as low as Fannie Mae.
If interested, call the office sometime. The number is 713-651-9500.
Good Luck,
Blake
I love this article! Last month, closed on two houses at the same time, one with hard money and one with regular FHA financing. I’m in the process of refinancing to get out of the hard money. This will net zero my total out of pocket investment on both homes.
Blake, lets refinance. I need to catch up to you. : - )
[...] presents How 15 Rent Houses Can Retire You Faster than a $1 Million 401k posted at Lifestyles Unlimited Real Estate Investing and Mentoring, saying, “Referencing the [...]
I agree with the article and the advantages of passive income over basically anything out there. Having a strong foundation built through wisely invested money will allow you to then take a step further and go from single family, to multifamily as well as to begin looking at flips etc. I have 3 single family homes, 1 duplex, and am currently in the closing phase of a 32 unit multifamily portfolio. I have been able to see the good and bad of this type of investing, and I would recommend to anyone who does to ensure you:
1. Read books, go to seminars, join an investment group, and look for mentor-ship programs.
2. Form a parent/umbrella LLC through a lawyer who will then be the on call if and when something legal regarding the entity comes around.
3. Purchase a house after doing due diligence, and figuring out if it meets a certain criteria, ie 12% cash on cash return first year as a minimum, and a CAP (capital appreciation)Rate of 10+ (this can be hard to do given certain demographics)
4. Upon closing, have your parent LLC purchase a sub LLC and then use the Quit Claim legal document to put the property under the control of the sub LLC.
Things to also keep in mind given the current market:
1. Banks require a 25% down payment on rental properties (last time I was researching a single family residence, which was in November 09′).
2. Interest rates are typically 1 point (%) higher or more then for an owner occupied property.
For commercial loans:
1. Most lenders require 20-30% down without the ability to seller finance. There are rare cases however, when seller financing is possible.
2. Lenders typically do a 5-10 yr arm or balloon loan for loans that are less then 1M.
3. Current lenders rates are around 6.875% Amortized over 25 years, when running your numbers.
4. Lenders most of the time require a 1.2 - 1.5 DSCR (Debt Service Coverage Ratio)
To conclude; I have been able to make anywhere from 450 - 1K a month net passive income per property that I have acquired in the past 2.5 years. That is in the midst of this crisis. Most people say don’t buy now, but they completely have lost sight of he concept of buying low, to sell high down the road, whether it be a 5,8,10+ year turn around plan. The rental market for the most part is very strong due to the mortgage crisis, I have seen this where I own the properties: Nevada, Colorado, and Missouri. For anyone willing to take the time to learn, Real Estate has shown time and time again statistically to come out on top and to make the rich even richer as well as provide a method for the middle income to climb out of their bracket.
yes right now i have bought a house with cash and remodeled it. I live in it now and it is paid for. A realtor told me to list it for 60000 if i want to try and sell it. I am in a pickle on deciding whether i should sell it or rent it out and use the money i have in the bank to buy another house and let the rent from this one pay for it. I would really like some advice with pros and cons with renting or getting the cash and buying.
Will,
The way I look at it is that if you are going to put the money to work and it is going to give you a ROI that is higher than the interest you are paying on your home, then get a home equity loan on your home and that loan should give you enough to repay your loan plus some more. Just be careful, when you are a beginner you are propably going to make more mistakes than an experienced investor (i.e. you will spend more than necessary on your investment properties), so just keep that in mind. Also, I always “listen” to what my gut tells me (keeping in mind that I have completely lost the fear of investing in RE), so if my gut were to tell me that I want a house that is fully paid for to keep my family in, then I will factor that “feeling” in my decision process. Just think about how much risk you and your family can tolerate.
Will, since you have 60k in equity in the house, have you considered refinancing the house, taking out around $40k; and using that money to buy 4 more houses with hard money loans?
yes i have thought about that also.
[...] flow exists in the form of interests from savings accounts, dividends from stock investments, and passive income from real estate. Real estate investing is frequently the favored form of cash flow, offering the highest rates of [...]