Dave Ramsey gets a lot of flack from the investment community.
For those who don’t Dave, he is a personal finance writer and radio personality who weekly encourages folks to clean up their life, save money, get out of debt, and build wealth slowly. He’s adored by millions of people and I’ve yet to meet someone who didn’t appreciate his encouragement for people to get out of bad debt and transform their lives (If you haven’t yet read “The Total Money Makeover” by Dave Ramsey, do yourself a favor and get it today.)
However, while people may love his debt advice… he lives in a world of controversy over his adamant stance that anyone can achieve 12% returns through mutual funds. Whether on Twitter, on his radio show, or on numerous personal finance blogs- Dave is consistently challenged over his claims of this magical “12%.”
I’m not here to debate whether or not anyone can get that 12% through mutual funds. I’ll leave that for others. However, I am here to show you how you can, easily, achieve 12% and higher returns on your money by investing in rental real estate.
And yes – I’m going to show you how to do it passively.
There are a lot of different ways you can get 12% returns through real estate (and I hope you share your strategies in the comments below this post!) However, this post is going to show just one example of how you can achieve 12% – 14% returns on your money – without plunging toilets, dealing with renters, or working for the Mob.
Even better, you don’t even have to live in the same area as your investment.
Is this the right path for you? I don’t know! But this is one tried and true method that works … and probably works a lot better than your mutual fund account.
(one quick note: we are going to get nerdy and do some math today. For those uncomfortable with the math, just go slow! I’ll try to make it easy. For those more nerdy than I… yes, there are different ways to calculate return on investment (like the fancy Internal Rate of Return). I’m going to keep this pretty simple and basic, but feel free to do your thing and run the numbers your own way end let me know what you get!)
12% Returns from 123 Main Street?
123 Main Street is a 3 bedroom, 2 bath home located in a medium size town outside a major metropolitan area. The home is a foreclosure that can be purchased for $55,000 and needs about $5,000 worth of small repairs (paint, light switches, a new front door, etc) to make it “rent-ready.” Once rented, it will bring in approximately $900 per month in rent.
Notice, this isn’t a spectacular deal. This doesn’t even meet the 2% rule. This is just a good deal in a good location.
“But Brandon!” you exclaim “I don’t have these prices around where I live.”
Keep reading and stop hyperventilating. This strategy doesn’t require you to live nearby. Would you rather drive by your property each month or drive to the bank? Exactly. Stay with me … this is going to get juicy.
Alright, in order to get 12% or more return on investment, you are going to have to have an investment (duh!)
In this case, we’re going to assume 20% down. Yes, there are ways to invest in real estate with no money (getting infinite returns!), and if you want to read more about that click here. However, that takes some special work.
So 20% down on a $55,000 purchase is $11,000.
However, you also have closing costs, so let’s estimate those at $4,000.
Finally, you have the $5,000 for repairs the property is going to need to get it rent-ready. So total investment on this deal is going to be $20,000.
Also, the loan will be for $44,000 ($55,000 – $11,000 down payment) which, at 5% for 30 years, works out to $236 per month.
Now, let’s see what kind of return we can expect…
Let’s Do Some Math
First, let’s do some simple 50% Rule Math.
The 50% rule states that over time, and averaged out, 50% of a property’s income is going to fly away in expenses before the mortgage even gets paid. This 50% includes expenses like maintenance, vacancy, property management, evictions, legal, taxes, insurance, and more. While it is just a rule of thumb, I find the 50% rule to be incredible accurate with my investments. (To learn more about the 50% rule, click here.)
So, using the 50% rule, we can see that:
$900 x 50% = $450
minus the $236 mortgage = $214 per month (or $2,568 per year) in passive cash flow.
$2,568 / $20,000 = 12.84% ROI – and that’s purely on the cash flow, not even looking at the fact that the loan is being paid down every month, property values have historically gone up and up over the long run, and there may be extra tax benefits by owning this property. Including these easily push the return over 15%.
But what about using the real numbers – not the 50% Rule? To do these numbers, you’ll want to pull out an excel document or use the BiggerPockets Rental Property Calculator. With about 2 minutes of work, I can see the following:
Check that out – using the “actual” numbers, it looks like we could estimate a 14.01% return on investment.
That’s what I’m talking about!
But Wait -There’s More!
Alright, I know you are pretty excited already – after all, a 14% ROI is really good, right? However, this gets even better.
The 12% we got using the 50% rule, and the 14% we got using the actual numbers are only the cash on cash return. In other words, this is ONLY looking at the property’s cash flow – not any of the other benefits to owning that property.
What other benefits?
For one- each and every month, the mortgage is getting paid down so your equity is growing (in 30 years, you’ll owe nothing!)
Or how about the tax benefits?
Or the fact that historically, over the long run, prices have always risen (except for a few hiccups!)
So clearly, the actual return on investment is going to be much higher than just the 12% or 14% from the cash flow.
Is This Kind of Deal Possible?
Yes, of course. If you don’t believe me, you haven’t been listening to the BiggerPockets Podcast, where most of our guests have invested in FAR better deals than this example.
Personally, I don’t invest in anything I can’t get at least 20% cash on cash return on. So it’s totally possible to do this, no matter where you live because this strategy doesn’t depend on living near the property.
Now, of course, this kind of deal is not necessarily “easy” to find. 99% of properties are probably not going to work out. However, as I’ve said before, incredible returns are for incredible investors. This is the mission of BiggerPockets: to create smarter investors to achieve those incredible results.
Incredible returns can be found for those who put in the time to learn how. However, this is not a process that takes years to master. This is simple math, buying decent properties that produce decent returns. If you are just getting started, I’d recommend checking out The Ultimate Beginner’s Guide to Real Estate Investing.
As to “where” to find these deals – that’s a topic for another article. However, I’ll give you a hint: talking to other investors on the BiggerPockets Forums is a great way to start.
You don’t need to be Dave Ramsey to get a 12% return on your money – and you definitely don’t need to sink all your money into mutual funds. Consider the approach I’ve outlined before, play with the numbers, start looking at locations, and you never know how high (of returns) you can go.
Questions? Comments? Leave your thoughts below!