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How to Achieve Consistent (and Legal) 12%+ Returns Through Passive Real Estate Investing

by Brandon Turner on January 18, 2014 · 75 comments

  
12 Percent Return

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.

So?

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.

Investment Assumptions

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:

12 Percent

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!

Photo: reallyboring

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{ 75 comments… read them below or add one }

Levar January 18, 2014 at 6:53 am

Seeing the calculations broken down in this way, makes me rethink my views of investing in rental real estate properties. I have always over analyzed this situation. Thank you for a 101 breakdown and now I am excited about venturing into this particular market for portfolio diversification.

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Brandon Turner January 18, 2014 at 8:51 am

Hey Levar,

Yeah, I think the math overwhelms a lot of people, but it’s really fairly straightforward once you see it and get some practice. Sometimes when I can’t sleep at night I end up doing real estate math. It’s sad, I know. :) Best of luck and stick close to BP if you need a hand!

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Ben January 18, 2014 at 8:25 am

Brandon what market would you be investing in if you didn’t have the deals you have around you and had to go long distance?

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Brandon Turner January 18, 2014 at 8:49 am

Midwest.

Perhaps Milwaukee, or Minnesota or Texas or Oklahoma – because I know people from the forums in each of those areas achieving great results and I trust that they could guide me in the right direction!

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Dawn Anastasi January 18, 2014 at 9:03 am

Brandon — shhhh – don’t tell anyone about the returns in Milwaukee. Thanks so much! :)

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Brandon Turner January 18, 2014 at 11:47 am

Ha oops, I mean NOT Milwaukee! It’s terrible there! :)

Mike McKinzie January 18, 2014 at 8:45 am

Brandon, I did a deal eerily similar to this in 2012. I live in So Cal and a BP member brought me a deal in Memphis, TN. Price was $52,000 and it needed about $10,000 work. I am all in at $62,000 but the one difference is I paid all cash. It is rented for $895 a month. Using the fifty percent rule, I make $447.50 a month or $5,370 a year. That is an 8.66% return because I used all cash. So why did I use all cash? First, that small of a mortgage is hard to find, I would have to use a HELOC on another property or private money. Next, I am already retired and when the market makes another run, I can sell and carry the paper. There are deals like this in lots of places, you just need to research and network.

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Brandon Turner January 18, 2014 at 8:50 am

Awesome Mike! Great example of what I’m talking about. yes, with the cash you’ll get slightly less return on investment, but like Jason in our last podcast explained, that may be a great thing. Thanks for the comment and best of luck to you!

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Adam Schneider January 18, 2014 at 9:37 am

Brandon,
Well done. I like the rule of thumb and the supporting granular pro forma.

Thanks.

Adam

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Brandon Turner January 18, 2014 at 11:47 am

Thanks Adam!

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Ryan Ebanks January 18, 2014 at 10:47 am

Brandon,
Another great post. BP continues to provide ‘one stop shop’ info that took many of us years and painful mistakes to learn.

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Brandon Turner January 18, 2014 at 11:48 am

Thanks Ryan, that’s definitely my goal!

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Sharon Tzib January 18, 2014 at 10:51 am

Hey Brandon, your click here link under Investment Assumptions section is missing.

Great article!

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Brandon Turner January 18, 2014 at 11:48 am

Oops! Fixed now :) Thanks for reading and the heads-up!

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Kevin Sapp January 18, 2014 at 1:59 pm

Brandon,
Nice post! Another huge benefit is the after tax return, in that most of the 12% (or more) will be not taxable due to depreciation. Real Estate investing provides other options acceleration, repair and misc deductions.

Backing up your statements, I had my worst year yet in my real estate portfolio of 6 properties. Four new tenants with a property management company hit, put soffit and facia on another, lots of repairs and still had an ROI of over 15% before taxes and mine were 25% down payments.

Another huge benefit is the community, once you start making more connections, there are options for more and different kinds of deals. For example, my rentals provided an opportunity for private lending for rehabs.

Kevin

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Brandon Turner January 19, 2014 at 9:28 pm

Hey Kevin, thanks for the comment! Yeah, you are right. I didn’t go into it that much, but it’s definitely a huge factor, that depreciation.

Thanks for the comment!

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Gabe Sanders January 18, 2014 at 2:02 pm

Excellent post and demonstration of what is possible with real estate investing done the right way.

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Brant Richardson January 18, 2014 at 2:23 pm

Exactly what I am doing in MO. SFR’s purchased for 50-55k that need 2-10k of work and rent for $850-900. They are not home run deals but I can find them from out of state with help from my realtor right on the MLS. It is confidence inspiring to see that my analysis matches right up with yours. Like in your example, the real numbers come out just a little better than the 50% rule predicts.

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Brandon Turner January 19, 2014 at 9:26 pm

Thanks Gabe!

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Brant Richardson January 18, 2014 at 2:25 pm

Oops, the post above was not supposed to be a reply to Gabe Sanders.

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Brandon Turner January 19, 2014 at 9:27 pm
James Pratt January 18, 2014 at 3:05 pm

GREAT POST, Brandon! I’ve been telling people for years R E IS the best, easiest and safest investment one can do. Even a fool can make great returns, just make sure it cash flows. Average home valued at $250,000, in thirty years, $800,000 plus. Average retirement plan-$150,000 for retirement, BIG difference.

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Brandon Turner January 19, 2014 at 9:25 pm

Hey James, thanks for the comment! I appreciate the support!

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Mike January 18, 2014 at 3:05 pm

If you buy out of state and site unseen isn’t it a huge risk factor? Same goes for tenant selection and property management. Besides, 50K house would probably attract only low quality tenants.

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Brandon Turner January 19, 2014 at 9:25 pm

Hey Mike,

Yes – definitely there is risk. I’d only do it if I could not do it in my own backyard. However, if you build some relationships first (in the BP Forums, for example) you can reduce that risk. Additionally, I don’t think I’d buy sight-unseen unless maybe from a Turnkey provider I trusted a lot. I’d probably fly out to see it – just to be safe and reduce the risk some.

And Yes and No on the $50k. I think you say that only based on what $50k will buy in your opinion. However, for example, in my area -$50k will buy a nice, 3 bedroom 2 bath home in good condition. Yes, you are not renting to high class people, but you aren’t in the slums either.

There is risk in everything we do, but hopefully that’s what BP is here for – to help mitigate that risk through education!

Hope that helps some!

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Michael January 20, 2014 at 7:09 am

Hi Brandon,
May I ask where you live, which $50K can buy you a nice home in good condtion? I live in Austin TX, and can not find anything close it.
All that said, just would like to agree with your math and concept. I have been a investor in Austin area for over 12 years and have been buying as hold, selling and doing exchange and flipping. I was able to become semi-retired over 5 years ago and my passive incomes from my properties pays my expenses. I am a Realtor and now only work part time for selected clients. I am not very smart, however, I saw the light years ago and realized how easy it is to achieve your goals in Real Estate.

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Jason Merchey January 18, 2014 at 3:27 pm

Bravo on the post. Simple but data-driven, impressive results. I am doing this exact thing in my life at the moment: comparing the 7-8% in real returns (after inflation) per year I can ideally expect to get in stocks vs. x% in real estate. So this is well-timed.
One thing I am running into is a little mental impediment to understanding the increase in cash flow over time. The mortgage stays the same for the entire time you hold the property unless you refi or prepay. So the rise you demonstrate in cash flow on a year to year basis is accounted for by rent raises. Two questions. In how many years out of 10 in a standard suburb in a growing or stable part of the country can one expect to get tenants willing to pay 3% more per year? Does it have to do with the supply of housing, the employment situation, housing prices, wage appreciation, inflation, and factors like that? Is “the majority of years” a decent answer to that question?
My second question, the one that takes ten points more IQ than I have to easily grasp, is, what is the relationship between rent and expenses? Like, how do you know that your expenses are going to be less than the rent going forward in time? I would imagine that in some years, they would covary and both go up. In that case, does the rent outpace the expenses because the rent is a number that is double what the expenses are? How about the possibility that rents won’t be able to be raised safely but expenses do rise 4% – how does that look on the ledger? Help me out brotha.

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Brandon Turner January 19, 2014 at 9:22 pm

Hey Jason, thanks for the comment. To answer your questions:

1.) Not sure on that data, but that’s why I generally like to pretend the prices will NEVER go up. This is how I factored the 12%. However, on the graph in the photo above, I did add a 2% increase, which might be high or low, depending on the area.

2.) Good question! Try running that through the Rental Property Calculator! You can put in different values for income vs. expense increases. I tend to do them the same (2% each in the above photo) but you can try other things just to see. I would tend to think both will rise, on average, with inflation – but that may not be true. I might have to dig into this concept more later!

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Jason Merchey January 20, 2014 at 7:13 am

Alas, two of the three primary advantages (excluding things such as tax benefits) to passive property holding include debt paydown and increasing the rent over time. And as you pointed out, leaving out appreciation is prudent for analysis. However, I lean more heavily on my own projections (not subject to others’ criticisms!) because even 3% does wonders for your value in just 10 years. 30 years and it’s a goldmine. In my projections, I figure I would hold on to properties for 30 years. A) it coincides well with my retirement b) that is how long my loan will last and c) more years = more “diversity” of years such that if you see a 4 year downturn you will have more time to see the (hopefully) resultant 5% per year increases to make up for that approx 20% loss of appreciation. In a word, appreciation is the engine of a good buy and hold I think. In fact, I would rather invest at market value on a very rentable and predictable-condition home than I would to get one for under market and determine that it was easily obtained because it isn’t that hot of a house. Right now in Charleston, it’s a seller’s market for sure, and thus, low offers on MLS deals tend to get rejected. Two exceptions are buying off-mls, which I don’t currently have a great plan or desire to accomplish (and I have to use a loan, thus undercutting my edge), and fixer uppers, which cna of course eventually become a winner of a house – though you have to torque it to be so. I have been thinking a lot about leverage lately, and I just don’t get excited about buying and holding if it’s just a cash purchase. It’s okay but not as easy as stocks (I have a trusted broker to do the mental heavy lifting for me). Finally I would just highlight the idea that if rent increases are torn at by flagging demand and expense increases due to overall inflation, that reduces the strength of the raising the rent reason for rentals. That leaves debt paydown, and yes, though the tenant pays it, the glimmer of that is lost because you are paying a huge amount of said rent to the bank. And I don’t like banks. So my point is that a projection bereft of appreciation isn’t very sexy to me. And my town seems to be a net-positive one in regard to population influx, and I am a home inspector with an infrared camera, and at present I am working with a Realtor, so my hope is that all three of those things can help me to avoid purchasing poorly, which will translate to debt paydown on a 4.8% interest loan, rent that at least keeps up with inflation more years than not, and finally the workhorse – appreciation of 3% a year x 30 years.

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John Thedford January 18, 2014 at 5:46 pm

Thanks for another great article. I cannot bring myself to do absentee owner investing:)
Convince me please! Our deals have dried up and I am having a hard time finding anything that will pay 1% of the purchase price. Not knowing a market and not having someone to trust as far as a property manager is a big problem for most investors that otherwise might be willing to be absentee owners. Brandon…consider getting your PM license. We all trust you! Just think of the huge amounts of money you can make for others:)

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Brandon Turner January 19, 2014 at 9:17 pm

Hey John,

Definitely try jumping into the forums and start finding out who’s got the best deals! This is a great way to narrow down specific areas – and you’ll have a point of contact for a property manager, agent, etc!

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Brandon Turner January 19, 2014 at 9:18 pm

And someday we’ll have to open up BiggerPockets Turnkey Real Estate! ;)

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JerryW. January 18, 2014 at 6:08 pm

Brandon, thanks for taking the time to post this. I wish I had found Bigger pockets 40 year ago … wait they didn’t have Bigger Pockets or the internet 40 years ago. Oh well it’s great to have it now.

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Roy N. January 18, 2014 at 8:28 pm

Jerry,

The Internet did exist 40 years ago … in its first generation form (arpanet) … it was just a little slower and far less crowded back then ;-)

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Brandon Turner January 19, 2014 at 9:16 pm

Lol thanks Jerry! I agree, the internet sure has changed things!

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Mirko January 19, 2014 at 11:09 am

I, too have a similar problem. I am in So. Cal., where these good deals are just not available. I have a difficult time finding or even adjusting to, dealing with an out of state broker and PM. As a matter of fact, in 40 years in RE I have always advocated investing in your own backyard instead of going far afield. Maybe it’s time to readjust my thinking?

What kind of due dilligence should one do when forming a relationship with a far-away broker and/or property manager?

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Brandon Turner January 19, 2014 at 9:05 pm

Hey Mirko,

Yeah, I think it’s definitely something to consider. I’ve always liked investing in my backyard – because I can – but I wouldn’t be opposed to going elsewhere as long as I did my research. The best advice I’ve heard is to just get referrals from other investors!

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Erik January 19, 2014 at 11:22 am

It works but I would strongly argue it’s NOT passive investing to find a property, secure lending, hire for repairs, find a property manager, assume real risk to property. It’s still a business operation as opposed to a passive investment. You are achieving 12% by your efforts, not the passive market forces. You are also bearing risk to achieve. Articles like this are smart, but grossly oversimplify what’s actually involved.

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Lemarts January 19, 2014 at 6:24 pm

Erik, you are speaking the truth. I have implemented this out of state RE investing and it’s successful but not passive. It takes a lot of work and effort although finding a broker/ property mgr who understands technology and transparency is making it easier to mgr from a distance. The analysis is overstated on vacancy rates and I’m not sure you can find monies for 44k on a 30 yr note. More like 20 yr. Rates on investment properties are higher and typically will balloon after 5 or 7 yrs. The article is good but be careful and study your own analysis first. I agree by experience Erik with you, oversimplified.

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Brandon Turner January 19, 2014 at 9:15 pm

Hey Lemarts, agreed -it definitely takes work. Check out the response to what I just wrote to Erik, but I’ll add this –

1.) $44k notes are of course out there. Just contact any portfolio lender, credit union, or small bank in a more rural area. The average home in my area is $50k – how do 90% of the population buy a house? It’s not cash!

2.) Investment notes on 1-4 units are typically 1% higher than regular, which is why I went with 5% in the analysis – and these loans (1-4 units) typically will be amortized to 30 years as long as you have less than 4.

3.) Even if it was amortized over 20 years, the ROI wouldn’t drop. Yes, the cash flow would be less, but the loan-paydown would be more, so it would pretty much even out … might even be higher.

Anyways, thanks so much for reading and commenting!

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Julie January 20, 2014 at 11:41 am

I just found a SFH using almost this exact example. The price was $54,000 and it is not in the slums. The plus is there is a long-term renter there and there was no repairs needed, except some minor (mostly aesthetic) things that come in less than $1000. This town, close to where I live, it is very common to find houses for $50,000, not in the slums.

I got a normal conventional, 30 year at 5%. And yes, there was some work up front (finding the property, lining up financing, inspection, etc), but once everything is is place, it is “passive” in the sense that you are not putting in many hours for the gain. Quality renters help lessen the amount of “work.”

I have seen foreclosures that need more than $5000 in repairs and have seen ones that need less. Sometimes, people just can’t pay their bills, doesn’t always mean they will trash the place. I have also see REO properties that the bank will fix up before it goes on the market.

I have two other rental properties and while one of them is out of state, so I have a property manager, the other is not. I would say I AVERAGE 2-3 hours a month of work, tops, for both houses and most of that “work” is emails and a few phone calls. I think you could call that passive. A lot if this depends in the market where you buy.

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John Thedford January 20, 2014 at 2:16 pm

Julie: If I may ask–what market are you buying in?
Thanks
John

Brandon Turner January 19, 2014 at 9:11 pm

Hey Erik,

I agree- the set up is not passive. But you can’t tell me working for 40 hours a week, taking 10% of your income, and investing it in the stock market is passive either? To do that, you’d have to work 4 hours a week just to pay for that investment. In fact, by that definition, nothing on earth is passive except maybe the lottery (if someone goes to the store and buys the ticket for you.)

However, I define passive income as work done up front to create lasting income later with minimal involvement down the road. I think RE can be 99% passive, but of course managing the manager will take some work – but again, so does picking the right stock broker/money manager/etc and pouring over financial statements. So I think it’s comparable with other “passive investments.” More work upfront, but much more significant returns later (and as a math nerd, it’s shocking the difference between 8% and 12% when spread over 30 or 40 years!)

And of course it’s oversimplified – it’s a blog post! ;) It’s designed to get the brain working and thinking a different way (and of course – get conversation going, as we’ve done! Thanks!)

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Michael January 20, 2014 at 7:34 am

I Completely agree with Brandon,
To find,purchase, repair and find a qualified tenant is a lot of work. However, once is set up, the rest does not require a lot of time. ( Make sure to screen the tenant the best you can).
Between my own properties and others that I manage are the total of 28 doors. On average I spent less than 10 hours a week on them. I will not trade that for any 40 hours a week JOB>..lol…

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David January 19, 2014 at 11:30 am

I wish someone would have share that simple 50% rule with me before I started investing. It’s so true and easy to use. Without it things seem better than they actually are.

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Brandon Turner January 19, 2014 at 8:55 pm

Same here David! There are a few properties I never should have purchased!

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James January 23, 2014 at 6:43 pm

Newbie question about the 50% rule…I understand the concept that expenses will equal 50% of the rental income on a property. My question is this; are you setting up a “maintenance account” and setting this money aside? And is there a point that you would roll that money into you ROI calculations if you’ve been lucky and didn’t have a lot of costs?

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Keith Weinhold January 19, 2014 at 11:48 am

Nice math breakdown, Brandon. Thanks. In addition to the 12-14% cash-on-cash return you describe above, I like to add another 20% to that number just to account for appreciation of the asset alone. This takes ROI up to 32-34% (and that’s even before loan amortization or tax benefits).

Why add another 20% return? If one is leveraged 5:1 and the asset appreciates just 4% per year, there’s a additional 20% ROI on your initial out-of-pocket cost!

Carefully-bought leveraged real estate is almost an incredible investment. For the uninitiated, it even looks too good to be true. It really is true.

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Brandon Turner January 19, 2014 at 8:57 pm

Thanks for the comment Keith! You are correct – when appreciation is applied, it can do wonders. I tend to leave it out, though, when running my analysis so people (Like those below ;) ) don’t jump on me and say “nah nah nah- not so fast!”

Thanks for jumping in!

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Jeff Rabinowitz January 19, 2014 at 12:16 pm

Keith, you do realize that leverage cuts both ways and that real estate does not always appreciate, right? In fact, sometimes it depreciates dramatically. I have been investing for 12 years (and still am). Can you guess how I know?

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Keith Weinhold January 19, 2014 at 3:42 pm

Thanks, Jeff. I’ve also been investing twelve years. Indeed, leverage cuts both ways. It magnifies gains as well as losses. You would probably agree that the 4% appreciation used is a safe long-term average though.

Let’s look at the other side. If appreciation exceeds the long-term average and provides a 10% annual gain like it did for many US markets in 2013, that’s a 50% return to the 5:1 leveraged investor on appreciation alone!

Add 50% to Brandon’s 12%-14% cash-on-cash return, and there’s a 62%-64% return for the investor before even adding in loan amortization and tax benefit.

It’s not too good to be true. It’s leveraged real estate.
________________

When an investor disposes of a property after a long-term hold, they can look back and determine where their returns came from. Commonly, equity growth is greater than cash flow benefit.

One percent of Brandon’s 12%-14% cash-on-cash return is more valuable than one percent of a 20% or 50% leveraged appreciation (equity) return. Why?

Because cash-on-cash return (cash flow benefit) is liquid money in one’s pocket now. That liquidity can immediately be consumed or re-invested for more returns.

But converting new equity growth to cash can often be difficult.

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Rick McCray January 19, 2014 at 1:08 pm

Great post! I am more interested in wholesaling and investing in tax liens right now. In another decade I think my investment strategy will shift and I will want to put some lower cost rentals under my belt. Great info Brandon!

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Brandon Turner January 19, 2014 at 8:58 pm

Thanks Rick! Yeah, wholesaling can provide some much-needed cash to turn into future wealth! Keep rocking it!

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Dave Stephenson January 19, 2014 at 2:51 pm

This assumption means you will never repair anything while you own this property. This is one of the reasons you live in the suburbs, and don’t want to live in the slums you create. Think of your own house. Do you have a monthly budget for repairs and upkeep? 5,000.00 to update? And it’s a foreclosure? Huh? It’s the inverters that don’t spend crap on repairs that give us the slums, not the residents. Invest your money in stocks leave America alone.

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Brandon Turner January 19, 2014 at 9:01 pm

Hey Dave,

Thanks for the comment! However, you mistakenly assume I didn’t account for repairs, which I did. The 50% rule accounts for repairs, vacancies, capital expenditures, taxes, insurance, and all other expenses. So please read through one more and check out my numbers and you’ll see what I mean.

Additionally, I’ve bought several foreclosures that require less than $5000 to fix up. We’re not talking about buying in the slums – just properties that need a little help because the carpet is well-worn. If you wanna improve your ROI to 20-30-40%, then we focus on the rehab-to-refinance strategy.

Anyways, hope that helps. Please re-read (slower) the post and let me know what you see wrong with the numbers!

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Ryan Ebanks January 19, 2014 at 3:53 pm

Keith, great point. Not only is converting new growth equity into usable cash often difficult, it can be inconvenient.

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Cory Binsfield January 19, 2014 at 4:30 pm

Nice post Brandon. Dave Ramsey offers great advice for managing personal finances and terrible advice when it comes to investing. I’m in the cohort where I cringe when he states anyone can get 12% on their money by simply investing in something that did well in the past. The mutual fund landscape is littered with closed funds where everyone thought the snowball would continue to infinity and beyond only to get their head handed to them on a silver plate during a downturn. While real estate offers attractive returns, you still need to be “active” with your “passive” portfolio. This means managing the manager and monitoring the market to ensure your golden goose can continue to lay those passive income eggs.

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Brandon Turner January 19, 2014 at 9:02 pm

Hey Cory, thanks for the comment. Yeah, I’ve never tried following his investing advice, so I can’t say whether it would work or not (might make an interesting blog post though – interviewing people who have!) Thanks so much for reading and commenting!

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Susan Cain January 19, 2014 at 8:09 pm

For truly passive investing, I prefer short-term, first lien mortgages, on which I average 12%. The servicing company sends the monthly payments directly into my Bank Accounts, one of which is my Self-directed Roth IRA.

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Brandon Turner January 19, 2014 at 9:04 pm

Hey Susan,

Yeah – I actually would prefer that someday as well, as it’s much more “scalable.” However, I can see it being difficult to get in with under $100,000 or so, unless you are doing partial notes – which carry some additional risk.

Thanks for the comment!

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Gert January 20, 2014 at 5:52 am

hi Susan and Brandon, what are first lien mortgages, and how can one make money with it? thanks!

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Sharon Tzib January 19, 2014 at 9:05 pm

What servicing company do you use, Susan?

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Jack Galloway January 20, 2014 at 9:53 am

Great job Brandon,
Similar to Mike McKinzie’s comment, I purchase with cash and my true net returns (after all the smoke clears) is about 8% in my area. Should some adjustment be made to your returns to account for the risk of using borrowed money? Thanks for the post. ~ Jack

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Brandon Turner January 20, 2014 at 1:43 pm

Hey Jack, thanks for the comment. 8% with cash is not bad at all – and may very well be worth it depending on your strategy. I’d actually love to purchase with all cash, and I probably will in the future, when I want to make it even more passive. As for adjusting the returns, I don’t necessarily think so – only because those risks are already calculated in with the 50% rule. That would be a bit like saying if I got 12% returns on my mutual funds over the past 20 years, I should not say that because there was a risk during that time of the entire market collapsing. Instead, we say 12% because historically that’s what it did, and that’s what we can expect – we don’t lower the future expectations based on risks of collapse. Hopefully i’m communicating this well – if not, let’s talk more!

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Jesse January 20, 2014 at 10:32 am

Brandon-

Interesting article! I am glad to see others making these deals. Your numbers match my deals almost exactly with a little variation on the numbers. My goal is to be in a property at 60K (including purchase price and rehab). These properties rent anywhere from $850-$1000 a month. With this criteria, I don’t do a lot of deals but the ones I do have nice returns. Keep up the good work.

Jesse Sumner

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Levi Pollard January 20, 2014 at 4:29 pm

Thanks for the post! exactly why real estate is the way to go! Dave is good for the getting out of debt. But when it comes to investing I totally agree. I don’t want to wait till 55 to take a step back.

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Aaron Yates January 21, 2014 at 10:46 am

Hey Brandon, great break down. These numbers still make me cringe and I’m glad my market brings me much better returns than this.

One thing I still can’t get past right now is this deal forks out $20,000 to get almost 13% Net return. But that can easily get wiped away if you get a long vacancy period and now you are forking out the loan, insurance, and property taxes out of your pocket.

Some markets truly allow for all-in-costs of $25K to $35K and bring rents from $750-$950 so why wouldn’t anyone rather pay the extra, have no loan and get a 25%-35% Net ROI? And these are not ‘War Zones’ that I’m talking about either.

Just food for thought for anyone who may be interested. I’m forced to pay cash so I was forced to find these areas long before I understood any rules or percentages. I think rules put limits and restrictions on people. They get into the mindset that if the deal doesn’t fall in these rules then they need to keep looking.

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Michael January 21, 2014 at 10:57 am

Hi Aaron and Brandon,
Where do you live that selling prices are that cheap and rents are so high?(selling price to rent ratio)
I noticed people are talking about the deals, however, no one mentions where.
I am from Austin, and we can not find anything in a decent area under $120k.

Thank you in advance for your reply.

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Aaron Yates January 21, 2014 at 1:57 pm

Metro Detroit. Not ‘IN’ the city of Detroit. We got hit hard not only because of the housing industry but also because of the auto industry.

People don’t realize how many people as well as companies here depend on the auto industry.

Anyways, a few years back deals were freaking amazing. There still are some good deals but they are usually more run down properties that need full rehab. So the returns have shrunk a little but still great none-the-less.

My first property in 2011, I paid $13,000. Just needed a hot water tank, furnace, drywall repair, paint and some minor other touch ups. My all-in-costs were $18,000. Now my all-in is between $25,000 and $27,000 for the same area.

Someone already put new vinyl siding, roof, driveway and apparently lost it to the bank.

It has been rented ever since for $850. Its already paid for itself and this April will be 3 years I’ve owned it. Now that house would cost me about $30,000 in the current market. It used to be a high $70,000’s neighborhood. Not sure if it will come back or not but I buy for long term cash flow not appreciation.

I wish these deals were still around!!!

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Nate Carlson January 31, 2014 at 7:39 am

Where did the fancy chart come from? Is there a great App out there for quick evaluations? Great article by the way.

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Brandon Turner January 31, 2014 at 8:17 am

Hey Nate, thanks for the comment! The chart is from the BiggerPockets Rental Property Calculator – http://www.biggerpockets.com/buy-and-hold-calculator – Check it out!

And thanks!

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Gary January 31, 2014 at 11:00 am

Love this stuff. Also, as military you can use VA loans and move in with zero down. Then turn that property into a rental. Re-do each year. I have a question though. What program did you use to get the pie chart and all that great info? I’ve been looking for something other than EXCEl. Thanks

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Brandon Turner January 31, 2014 at 7:21 pm

Hey Gary, thanks so much! Yeah, the VA loan is amazing! And the chart – it came from the BiggerPockets Rental Property Calculator – http://www.biggerpockets.com/buy-and-hold-calculator – Check it out!

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Joseph J. January 31, 2014 at 4:21 pm

As a new regular member of BP, I truly appreciate the time you’ve taken to put this comprehensive and easy to get analysis. This article will definitely help me plan my future investment. However, living in SoCal (like some other in the comments), I find it difficult to get a deal similar to this one, but again we’re not fix and I’ll try to look in other states. Thanks again Brandon !

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Brandon Turner January 31, 2014 at 6:02 pm

Thanks Joseph! Glad you liked it!

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