I Want To Be A Real Estate Investor. How Do I Start?

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I’m Not A Flipper — I’m 20-Something and Want To Be A Real Estate Investor — How Do I Start?

I get asked that question almost weekly, usually by the 20-something generation. Their relative profiles are fairly similar with a few obvious exceptions. They’re pretty smart. Most of ‘em have degrees of one sort or another. They make decent money — generally speaking, in the $40-60,000 a year range. They’re evenly split between married and single. To their credit, and my undying appreciation, their ‘spidey sense’ tells ‘em the get rich quick with other people’s money nonsense involves somebody on the losing end, financially. They just wanna know how they can begin the journey to earning their piece of the financial pie.

Fair enough — here’s what I’ve been tellin’ beginners for years.

Instead of using my home market, San Diego, I’ll use a market more in line with values experienced by most regions. Though the concept works just fine, thank you, in San Diego, most prefer to use the numbers the majority of the country is used to. Let’s talk about the concept. But first here are the factors usually involved in the front end of the process.

1. You don’t currently own squat, unless you count the used car you drive to work and the payments taggin’ along with ya. :)

2. You’ve either already saved some money towards this end, or can in a reasonable time, say 6-18 months.

3. Your credit is either fine now, or you can make it so, and sooner rather than later.

4. Ditto with too much auto and plastic debt.

Here’s the end game in a nutshell, so if you’re not interested, you can move on. 

You’ll find a 2-4 unit property in an area in which you’d feel comfortable living, cuz you will be. You’ll be renting the other unit(s) to others. This will not only get you started, but will give you the mostly irritating experience real estate investors need to succeed in the long run. You’ll be buying this property using either FHA or VA financing. I guess in some cases HomePath would work, but I’m not all that familiar with their operation. The down payment and closing costs will end up in the $8-15,000 range.

The numbers

Let’s use the price and rent from a recently closed transaction. Price: $262,500  Rent: $1,350 each side — it’s a duplex. The location is good enough that I’d put my own mom to live there, alone. She’s 81, and I wouldn’t be where I am today but for her. So I care. Here’s how your FHA loan might roll out.

LTV: (loan to value) 96.5% or $253,300 (rounded).

Payments: This will include three separate factors. 1) Principal & interest 2) Taxes and insurance and 3) Mortgage insurance

Principal and interest at today’s rate of around 3.75%, would be approximately $1,173 a month.

Taxes and insurance will vary a great deal from market to market of course. Let’s cut it down the middle and say your annual tax bill will be around $4,000. In San Diego it’d be about that or a tad less. In other places a lot more, blah blah blah. Insurance will run around $1,200, more or less depending upon the state and the carrier, your mileage will indeed vary. So, let’s pick a monthly number and call the monthly tax and insurance portion of your monthly loan payment, roughly $435.

Mortgage insurance will run around 1.25% the last time I checked with the FHA lender. Add another $265 or so to the monthly payment.

We’ve arrived at your monthly loan payment which, in addition to principal, interest, taxes and insurance, will include mortgage insurance. It all comes to a pretty grand total of about $1,875 a month, rounded up a couple bucks.

I know what you’re thinkin’ ’bout now, which isn’t what’s gonna happen. “Let’s see, if our monthly payment including taxes and insurance, etc. is $1,875, and our tenant is giving us $1,350, we’re freakin’ awesome! That’s just $525 a month to us. Why doesn’t everyone do this?!”

You’ll VERY likely be paying for their water and sewer. You can probably, in most markets, have your tenants pay for trash pickup. But how ’bout landscape upkeep? Who’s gonna mow the grass if there’s a lawn? Oh, that includes the backyard too, right? Right. Also, the tenants will probably pay for their own power and gas. That is, if there are separate meters. Most 2-4 unit properties do sport separate gas and electric meters, but not all by any stretch. Sure, your rent would likely reflect no G&E bill, but that almost always goes against the landlord when the dead presidents start their monthly escape from your wallet. When tenants don’t pay for something, they tend to, um, use it like somebody else is. Make a note. :)

Figuring your monthly real world net

This isn’t rocket science, but the rose colored glasses need to be set aside when figuring your actual bottom line. Let me first give the same talk here that I give in person or on the phone to investors. There are two bottom line numbers when you’ve invested, as it relates to cash flow. There are the spreadsheet numbers, over which you sweat blood. Then there are Murphy’s numbers, and he doesn’t sweat at all. He just cackles. Go ahead and do the spreadsheet. Get the numbers as painstakingly accurate as humanly possible. Get every operating expense down to the penny. Then pat yourself on the back, and set it aside for future comic relief. That’s experience talkin’ to ya there.

The spreadsheet says that your annual NOI (net operating income) will be around $20,000. But that figure assumes both sides are rented, which ain’t the plan. Your real spreadsheet NOI should approximate $3,240 or so — $270 monthly. That’s after all operating expenses (including taxes and insurance, so remember not to shock yourself by double counting them when computing your monthly bottom line), a vacancy rate, and exiting your unit’s rent.

Your principal, interest, and mortgage insurance payments amount to $1,173 + $265 = $1,438 a month. Subtract the (spreadsheet monthly NOI) $270 from that, and you’ll get $1,178. That’s what the spreadsheet says, more or less, will be your before tax (as in April 15th) monthly cost of living. When we compare that figure to having opted to buy a traditional detached home, you’re probably saving in the neighborhood of $400-900 a month. Figure $1,500 PITI + $265 for mortgage insurance = $1,765 monthly. That doesn’t include those pesky utilities, water/trash, gas & electric. We’ll lump those together and add $200 more to your monthly nut. That brings the traditional detached home to just under $2,000 a month, pretax, using the same price and loan.

The difference is simple. You’d save around $800 monthly, +/- by opting for the duplex. That’s almost $10,000 yearly.

Now for the reality check

Throw the spreadsheet numbers out. Instead of applying the vacancy rate and operating expenses on which you worked so hard for accuracy, simply divide the gross schedule rents for BOTH sides by two. Then, decide that’s your real NOI. Might it be even less? You bet. Murphy knows where all of us live. Sooner or later it’ll be your turn in his barrel, cuz that’s the way it works in real life. Not to worry, cuz you’ll still come out ahead with the duplex approach. Understand that real estate income properties don’t pledge allegiance to the spreadsheet. I know, it’s crazy.

After tax

The traditional detached homebuyer will benefit from $13,400 a year in tax shelter, ballpark. That’s interest paid and taxes the first year of ownership. If their marginal income tax rate, state/fed, is around 30% or so, that results in a direct tax savings of roughly $4,000 for the year. They get to take interest/taxes dollar for dollar against their job (ordinary) income.

The duplex buyer who lives in one side would (assuming sides are perfectly equal) be allowed half the interest and taxes as direct write-off on their income. In other words, $6,700 a year, or about $2,000 in tax savings. But wait! There’s more!

They get to take the half that’s rented, and depreciate it. Depreciation is a ‘paper’ loss that you didn’t experience. In this case it’ll be, more or less, around $3,800 annually. Again, unlike the interest and taxes you deducted on the ‘owner occupied’ side, this is a phantom loss. You still get the tax shelter from it though, which is almost always way cool. This property’s depreciation would generate an additional tax saving of $1,140 yearly. When combined with the tax savings garnered from your ‘homeowner’ side, $2,000, your total annual tax savings the first year comes to give or take $3,140. In other words, the guy across the street who brags about the superior tax savings generated from his traditional detached home, gets pretty quiet when you show him your monthly before tax cost of living.

He’s ahead about $860 a year in tax savings. However, before taxes you lived for nearly $10,000 less than he did. Even if you ignored your spreadsheet’s numbers, your Murphy numbers still beat him by $7,000 a year before income taxes.

This doesn’t take into account the strategies which would accrue to having opted for a 2-4 unit property vs traditional home. When you ultimately wanna sell and move, you can neatly separate the two ‘entities’, AND their equities. But that’s another post altogether.

The only factor that really counts in this decision

What it comes down to is your personal comfort zone. Are you ok being a landlord, with your tenant next door? Are the long term benefits worth it to you? There are no right or wrong answers here. If you’re not comfortable, and it’s not due to false information, there’s likely little that could change your mind, right? I know that’s how I am. Don’t violate your comfort zone. Life is way too short for that kinda stress. But if you are comfortable with this approach, it can put your future financial plans ahead of the normal chronology — and usually impressively so.

Photo: Victor1558

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About Author

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.

26 Comments

  1. As a fellow “20-something” I’ve asked that question time and time again. After getting a few mentors on my team its been suggested to me that newcomers should start with flipping options/contracts, i.e. you get a home under contract or get an option to sell the home and you flip that to a cash buyer for a finder’s fee. This allows us newbie’s build up cash to eventually become a cash buyer for flipping or buy and hold properties in the future. Option 2 is using hard money, which can be expensive. These loans are typically for short-term flips and you need to have some cash to bring to closing. Option 3 is private money. Many private lenders are often more likely to provide you with long-term loans and better rates than hard money lenders. Lastly, you can use retirement funds in a self-directed IRA to purchase real estate. There is lots of great info about self-directed IRA’s on the website and about flipping contracts/options. Good luck on your journey!

    • Jeff Brown

      Hey Rashida — That advice will work wonderfully IF the newbie knows which way is north on the flipping map. If, on the other hand, they’re gonna jump into flipping to gain their fortune, experience shows they’re pretty much doomed.

      A large proportion of first time flippers fail epically. Whether or not it’s merely a large minority or a majority, far too many rookies find out the hard way that successful flipping requires many diversified skills.

  2. Brandon Turner

    Jeff, as a 20s kid- this post is near and dear to my heart! I started with a duplex (the Kurt Cobain one I talked about in my last BP blog post) and helped me build the confidence I needed and expand my comfort zone! I still love duplexes, triplexes, and 4-plexes and they are a huge part of my “retire by thirty” goal :) Thanks Jeff! You are a wise dude.

  3. Joanthan Sowinski on

    I also started out buying a double as my primary residence in my 20s. I have to say that I did not look at the I/E at the time just knew that it would make things easier having that extra income. I certainly didn’t make any spreadsheets; we bought it because we liked the home. Now that I am beginning to focus more on making REI a larger part of my life I have found myself contemplating moving into another multi-unit a few blocks away.

    I recently purchased a small apartment building that took a good chunk of savings out of the equation so buying something with little to no money down is the current goal. I would also like to gain more experience in rehabbing on a large scale before considering other financing options and be more comfortable putting my eggs in that basket. So now I am considering using the 203k loan to rehab one to live in (I realize that will be a different animal but figured its at lease the same species), and it turns out once we begin to collect the rent from our current unit it that first purchase looks very good in a spreadsheet.

    Yes I saw that they are considering opening the 203k back up for investors… I am sure that will be decided the day we close.
    http://themortgagereports.com/10692/fha-203k-eligibility-may-soon-expand-to-real-estate-investors

  4. BTW Jeff, you are sure looking much better in that photo shot! You might have to revise your blog site with all that new hair. Heh.

  5. Excellent post! This is a great way of breaking it down …Sometimes you wonder why more people don’t purchase duplex’s, it’s better to have your home help you save money until it can make you money.

  6. Jeff,

    Don’t forget the spouse factor at 20. If you are not married, it becomes much much easier to buy, move, buy and move again. Unless you and your spouse can live a minimalist lifestyle, or they are excited about moving into new places, don’t plan on moving a whole heck of a lot after marriage.

    Another food for thought, do this 8-10 times with 4-plexes and you can have owner financing on forty units. That’s not to shabby of a way to start out in life. Local guy has 55 units this way.

    This is one of your best posts yet. Really good info for all those starting out.
    Jason

    • Jeff Brown

      Thanks Jason — Ya don’t hafta explain marriage to me. :) Glad I wasn’t drinkin’ coffee when reading your comment.

      The caveat to getting multiple owner-occupied loans is this: If any/all of those lenders suspect the borrower was really an investor, he/she may have problems. Probably not, but it’s possible. When interest rates go up as they’re sure to do at some point, this WILL happen. It happened in the late 70s, early 80s for different underlying reasons. But the main reason was the same: They’ll look to any reason to rid themselves of a sub 4% loan in order to re-lend that capital at 6.5%.

      A word to the wise.

      • That’s a very good point. I’ve been wondering if banks will force borrowers to refi into higher interest rate notes by calling notes due over often trivial rules in the loan.

        • Jeff Brown

          Most if not all of their reasons will be found in big print in the note contract, Jason. The most used reason might very well be all those who took title ‘subject to’ their loans, who made huge efforts to ensure the lender wasn’t notified of the change of title. That worm will turn, guaranteed. Furthermore, this time around lenders have the law, court rulings, and the Supreme Court solidly on their side. It’ll be a massacre.

  7. I love the idea of duplexes and 4-plexes. Unfortunately, I live in a small city where those types of properties aren’t very popular. The ones that do exist are mostly in war-zones. All great advice.

  8. Chris Clothier

    Jeff –

    Great article – really good detail.

    I’m not a 20-something, but I wish this type of advice was around back then. I would have loved to get involved in real estate at a much earlier age. Good stuff – and I am going to share it out there with newer investors when they ask me how to get started.

    Thanks for posting

  9. I’m aware of a situation where a particular bank decided they didn’t want to do business anymore with a certain builder. They had a handful of convenants buried in their notes with him. One included the right to reappraise his properties. They did so, and due to the drop in property values, his entire appraised portfolio came in much lower than when he first obtained mortgages, resulting in his LTV ratio to rise. Another covenant stated that he was required to maintain a certain level of LTV, so he had to pour more cash into the notes to reduce his LTV ratio. Finally, another convenant in his notes stated that if his liquid assets dropped below a certain point, he would be in default. After pumping cash in, his liquid cash was below this level. Yikes!

    I’ve read articles where if you go to all kinds of troubles, using stuff like trusts, etc., to hide from the lender that you transferred the deed to someone else, they can track you down if they want. Heck, all they need do is lookup who is paying the utilities on all their properties, and see if it lines up with the name on the loan. If not, WHAM!

    • Jeff Brown

      It was even easier than that. They caught the majority of ‘subject to’ folks via their property insurance. ‘Course, the word got around, and other approaches worked for about a month or two. The lenders? Their won/loss record is muy impressivo.

  10. This is EXACTLY how I got started. I bought a four unit building with a FHA loan. I feel I got lucky because the place I purchased is basically a single family home with three apartments below it. The reason I feel lucky is that our “unit” is 2000 sq ft and is a place I would feel comfortable living in for another 10-20 years. Most of the quads we looked we would have basically just been in another apartment and we probably would have been looking for a SFR at this point. I don’t think there is a better way to get into the rental business. My sister has followed in my footsteps and is now looking for her second building and I tell anyone who will listen to do the same. Most people spend 30-40% of their income on their housing, following this plan can allow you to turn that into pure savings.

    The savings in my living expenses has allowed me to pick up a duplex and condo for rentals in the two years since I purchased my home. I have also gone into full time flipping and having my mortgage payment covered made me feel much more comfortable making that decision.

    Great article, if more people followed advice like this they would be in much better financial shape.

  11. Can any of you tell me if it’s a good or bad idea to pay for the real-estate investing school at Renatas in Utah. I’m considering it however not sure if it’s worth the 6k-15k.

    • Do yourself a favor and instead give Jeff Brown a call. The call is free. After you hang up, call Dave Shafer and chat with him next. After chatting with these two, my investment life has been changed for the better.

  12. Jeff Brown

    First off, thanks so much, Greg, you just made my week. :)

    Jackie — My experience tells me those courses are generally ‘how to’ in nature, and nobody, including yours truly, can learn enough in one quick course to make it worth that much. Heck, I have one day ‘events’ where I speak most of the day AND have a couple of my in-house experts speak too. The price is a little over $1k. The difference is that once you go back home, I stick with ya. :)

    Good luck, Jackie.

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