The tortoise wins every time

Every time I read the story of the tortoise and the hare, the tortoise wins. Every time. I mean duh, it is a book. Books end the same way every time. But this applies to more than just this books. In life most good things come to those who wait. Not waiting around and doing nothing, but purposefully taking small steps everyday to achieve an amazing end result. For most people real estate investing is something other people do. But with a few easy steps I can make everyone a real estate investor. One small step at a time.

The first thing to know about real estate investing is, the faster you get rich the faster you can loose it. Everyone wants a get rich quick scheme, but very few of them really work. I don’t know a single millionaire who earned their millions over night. I am sure they are our there, but I have never met them. The richest people I know, did not become rich quickly. It took most of them decades to make their first million.

Step 1: It’s all about getting a good start

The single most important and simplest thing todo when investing in real estate is to own your own home. This sounds like a no brainer right? Or it should. Would it surprise you to know that only 56% of the single family homes in Texas are owner occupied.(1) That means almost half of the homes in the state are owned by someone other that the occupant. So owning your home already puts you ahead of the game and on the path toward your financial future. Did you know that home owners have an estimated net worth of 31 times that of renters. 

Step 2: Thinking about the first big move

Everyone moves. Most people do it about every 5 years.(2) So lets assume you have been in your home that you owned for the last five years. You have loved living their but it is time to move into something different. The reason you are moving is not important, what you do with the house you are leaving is. Most people think they should sell the house before they buy another one. This is the most popular approach. After all the equity you have in the house is now worth something you can use to buy the new house. ok, yes that is true, but wait. Let me show you what you are giving up.

Lets take a look at what you own, and what it would take to buy it again as a rental property. When you purchased your home there was a down payment on it, right? Which could have been as little as 3.5%. On a $200,000 house. That is $7000. Lets say for good measure it cost another $3,000 to close the deal. You could have moved in for $10,000 tops. On the other had if you went to buy the same $200,000 house as a rental home, you would need to put down 20%. 20% plus closing cost would be around $43,000. $36,000 less if you purchased as an owner occupant. And your rate is better too, but we will get to that in another post.

So now (in year 5) we have an asset which is worth(3) $231,854. If you spent $10,000 to buy it then you have made a 318% return. On the flip side, if you had to put 20% or $43,000 down to buy the house that is now worth $231,854, you would only make a 74% return. Which one do you want? From that example you can see that purchasing investment properties as owner occupied is a great way to purchase them with little money out of pocket. So now that we own one, lets not let it go.

Step 3: Buying your next target property

Once we have decided not to sell the first home two things happen. One we should realize that we need to save more for down payment, and second we need to make sure we can qualify for the extra debt. In a perfect world you would be making enough money that owning two homes would be easy for you to qualify for. But this might not be the case. Buying your second investment property is the hardest one to qualify for. Simply because you are now going to be a landlord and rely on the tenant to pay the mortgage. Unfortunately, you don’t have any experience doing this. The banks are going to be a little hesitant to give you this first loan because you have no track record. Typically they like to see that you have been a landlord for two years.

Once you have down payment of 3.5% plus some extra money saved to pay for closing cost, moving, ect, it is time to buy the next house. Lets say you are moving up to a $250,000 house. A modest move up, after all the house you are leaving now is worth $231,854. Again you are going to put down 3.5%. Since you are buying as an owner occupant you get the benefit of the owners interest rate not the rate charged to investors which comes in handy if you can lock it in for 30 years.

Step 4: Get your move on already

Congrats on closing on your second investment property! This is huge step from casual home owner to the big leagues of real estate investor. Hopefully you will have tenants in your old house quickly who will be covering the cost of ownership.(4) Plan on staying in your new house for 5 years. Now that you know the process, start saving money now for the next down payment.

Step 5: Rinse and repeat

Lets fast forward to year 10. Your have owned your first investment property for 10 years. Five of which you lived in it and the other five you leased it out. You originally paid $200,000 with $10,000 down. Now it is worth about $269,000. Your second property which you paid $250,000 with $12,000 down is worth about $290,000. That is $109,000 return on a $22,000 investment in 10 years.

We also got to take advantage of the tenant paying the mortgage on the first property for us. This has also adds to our return on investment, but because there are too many variables we are just going to concentrate on the loan pay off balance. If the loan on our first house was at 6% we will have $157,000 left to pay at the end of year 10. And if house #2 has a loan of 5% we will still owe $221,536. $378,536 in out standing debt. If you subtract that from our properties value $559,000 – $378,538 = $180,464 in return on a $22,000 investment in 10 years.

I know you are thinking, but wait, I am paying the mortgage to live in these houses for five years. So I have really paid in more than the $22,000. And you are correct, you have, but you had to live somewhere, so why not in a house. It should have been the cheaper to live in a house you own than renting. Plus there are huge tax benefits to owning homes. For example you can deduct the mortgage interest off your taxes which could save you thousands on your taxes every year. Again we are not including that to keep things simple.

What happens if you do this every five years?

The simple answer is your slowly growing very wealthy. Look at the example below. We will purchase a new property every five years. The purchase of the new property will be of greater value than the last because most people upgrade not down grade. We are also going to assume that we average 3% appreciation on the property value, and that the properties cash flow once we move out. Yes it cost of money to live in each of them for the first 5 years, but we have to live somewhere so we are going to negate that cost.

Property 1Property 2Property 3Property 4Total ValuePurchase Price$200,000$250,000$325,000$400,000$1,175,000Cost to purchase$10,000$12,000$35,000$17,000$74,00030Y loan rate6%5%7%20%Loan$193,000$241,250$292,500$368,000$1,094,750Y5 Value – loan balance$52,260---$52,260Y10 Value – loan balance$107,270$68,282--$175,552Y15 Value – loan balance$174,469$139,742$101,430-$415,641Y20 Value – loan balance$256,996$225,722$185,771$78,919$747,408Y25 Value – loan balance$418,755$329,425$289,834$157,883$1,195,917Y30 Value – loan balance$485,452$454,817$419,384$255,929$1,585,582

(sorry the table did not translate well)

As you can see from the chart, after only 25 years you would be a millionaire, and it only gets better in year 30. We also made some mistakes along the way an put down too much money on property 3, and interest rates when we bought property 4 were sky high. We still managed to make a lot of money because time was on our side.

The chart does not show us that in year 30 property one is paid off. Mostly by the tenants I might add. The rent generate from that property could go to pay down the debt on the other notes or it could just be funny money. Either way, rent grows over time by 3-5%. So if you were getting $1200/month on property one when you first started renting it, by year 30 you could be getting as much as $3000/month in rent. Our chart does not take into account using this extra rent to payoff these notes early, but if that was done your net worth would by much greater in year 30.

To view the full analysis of these properties click on the PDF’s below. Please remember that each of these report starts at the time of purchase. So property 3’s year 1 is really year 15 in our time line.

Summary

The slow way to make a ton of money with real estate investing and win every time is to follow these simple steps.

1. Buy a house to live in
2. 5 years later move into new house
3. Keep old house and lease out.
4. repeat as may times as your wife will let you.

randomness

1. This was the most recent number I could find. If anyone knows of a more recent info please let me know.
2. Again, the most recent statistic I could find. NAR said that I think.
3. Based on a 3% rate of return.
4. If the property does not cash-flow right away it is ok. You are still $33,000 up remember.