I've got a decent financial start, but where do I make the money?

20 Replies

Hello everyone!  This is my first "real" post around here, and I look forward to seeing what all of you would suggest for someone starting out in this business from my position: 

I'm in my mid-thirties, and I'm in a pretty healthy financial position compared to many of my peers.  I work in an industry that is completely unrelated to real estate, and I make a healthy income that would probably be considered upper middle class (though I'm by no means rich).  I have my home paid off, no debt, and we have approximately $100K in cash in the bank between myself and my fiancé.  I'm employed in a government job, which carries a healthy pension with full retirement at age 55.

We arrived at our current position without the original intention of becoming investors.  We were both quite frugal with our money early on, having lived through a couple of serious recessions in the time since we finished college.  We took the boring and secure approach of paying down our home, and eventually paid the place off about a year ago.  Since that time we've been saving cash.  We recently came to the realization that our cash "reserve" is getting fairly large, and it's being underutilized  in a bank account, where it's only losing value against inflation.  

We've debated a few options at this point, and we're both pretty conservative with our desire to explore the fringes of risk.  We both feel more comfortable in real estate than we do in the stock market, but it's really hard to decide where to go at this point.  

Here are a few of the options we're exploring around the dinner table:

1) Buy the upgraded home we've been considering, and use some of our cash to place a downpayment on that property of at least 20%.  We would then rent out our free-and-clear property, which  would probably pull between $1,500-1800/month in rent, based on what we've seen locally.  We'd then use a combination of the rental income and our salaries to pay down the mortgage on the next place, and move on from there eventually.  At least the mortgage interest on the new place would be tax deductible as a primary residence, and we would get a lower mortgage rate on the new property as an "owner occupied" residence.  In a few years we could have a couple of paid-off properties, and build our portfolio from there.   

2) Continue to live in our current home, and put our cash toward a down payment on a rental property.  From what I've seen it's really hard to touch a single family home or duplex in this area for under $250K (at least in decent condition), and the condo market seems a bit saturated to me.  But, we could easily put 20% down on an income property if we took this approach, while saving $50K for a reserve, and presumably rent that place with a positive cash flow.  Of course, we lose the mortgage interest tax deduction, and will probably have a higher mortgage rate as a result of it being a non-owner occupied property (though I can't say how much higher that rate will be). 

3) We could continue to save cash, and likely buy an investment/rental property outright in another year or two (at the most).  We'd then have the advantage of not spending any money on a mortgage, and therefore be able to earn more income from the property each month.  Of course, that means leaving a large some of cash in the bank for another year or two, which is earning virtually nothing to offset inflation.  It also means that we're going to potentially pay at least 5% more for the property we acquire, since the Denver market seems to be continuing to grow, and increase in price.  

I'll admit that we're both intrigued by the first option, as we've seen a few places we wouldn't mind living ourselves.  We also believe that our current home is likely to appreciate favorably in the next few years. 

You'll also surely note that none of the potential paths I mentioned involve using very much leverage.  I'll admit that there are some clear advantages to leveraging ourselves a bit, but I'm also pretty leery of doing so (I guess I'm more risk-averse than most).  Simply put, we've seen a lot of friends go through hard financial times in the past few years, and don't want to toss away the security we've worked so hard to earn over the past few years.  Nevertheless, we do want to provide ourselves with the best future possible, and we're starting this venture with a better profile than most of our peers:  good income, decent amount of cash on hand, a paid-off house, and excellent credit.  

So, if you were me (us), where would you start? 

Thanks in advance for any advice!

Hmmm…   maybe it's just me, but I don't currently see my post, just my title.

@Kevin H.  I like your first option with one added measure.  You have good credit, you have cash waiting for you in equity on your current home (100% equity)...use it.  Refinance.  Take the cash and buy another cash flowing property.  Then do it again with that property.  (you bought it with cash, so you can refi that same cash out of it).  Keep doing this until you can't get anymore loans...then partner with someone that can.

* Side note:  Don't refi your own house if it's paid off.  You don't need to.

Now, the alternative, using all cash and leaving it in your houses to die (equity), means you will probably be (your in your 30's now) 80's before you will have acquired even 5 houses.  How long would it take to put together the cash to buy your next house?  If, on a government job, you are able to put aside $10k a year into savings for investment, that would mean it will take you at least 10 years to get your next $100k...and your next house.  Project those numbers out and it could take you 50 years to get the $500k you need for 5 properties.  Why, when you have your own "bank" called Equity in your current (soon to be) rental?  If your lenders (typ) will let your refi 6 months after you buy a house (all cash), then you could recycle those funds (using the same cash over and over again) every 6 months.  That could be 2 houses a year, and in the same time period it might take you to put together the $100k for your next house (each time), you might be able to have 20 properties.

Here's the best part.  Doing it all new cash for each house, would cost you $500k ($100k x 5)...using the refi method, it would cost you nothing.  That's right, nothing.  No matter how hard you try, every time you refi, you get the same money back.

@Kevin H.  

First, congrats on being financially responsible and getting yourself in a good position.  

I'd recommend running the numbers on your paid off house as if you were going to buy it as a rental.  Does it meet you goals?  Just because you have no debt on it, does not mean its the right rental for you.  Maybe selling it is the best option?  You could then re-deploy the capital in other properties.

Doing real-estate without leverage is really giving up on one of its primary advantages as an investment. If you are cautious, try to get yourself to a place where you stick to low LTV - borrow only 60%. You can double your exposure and still be in a very low risk situation. Even in the housing bust, few properties lost 50% of their value.

I'm in a similar situation to you, I don't like leverage and I have my primary residence paid off.  My resulting choice is to invest in the stock market and live without leverage.  I focus on my consulting business to bring in more money.  I am well educated about real estate, and I know I'm missing out on an opportunity for diversification, leverage and good returns - but I'm held back by my fear of leverage.

You need to decide: what scares you most:

1. stock market

2. leverage

3. low returns

If you are happy with low returns, do a low-leverage/no-leverage real estate investment.  You'll still do better than your bank account and you won't have to deal with the stock market.

I think you should try to use 'some' leverage, but less leverage than is available at first.

IMHO a house you live in is nothing but an expensive doo-dad.  Not an investment.  So, the best move from a financial point of view is to live in the cheapest house that meets your needs.  If you can afford a bigger, fancier house, go for it.  But realize that buying that bigger, fancier house is no different than trading in your old car for a shiny new one.  There is a difference in that cars (mostly) depreciate pretty quickly and house (mostly) appreciate over time.  Houses, however, do require a lot of money being pumped into the - interest, taxes, insurance, routine maintenance, major upgrade and big items like furnaces and roofs.   If you look past the "I paid $100K 30 years ago and now its worth $250K" and add up ALL the costs that went into getting to that $250K of value you're almost certainly in the hole.

Yes, mortgage interest is tax deductible.  So you spend $1 on interest and save 28 cents, 33 cents, or whatever on your taxes.  You're still poorer because of the interest.  Interest being deductible simply means you're paying that bill with pre-tax dollars rather than posts tax dollars.  But you're still paying.

I agree with @Joe Villeneuve  that leverage on income producing properties improves your returns.  It increases your risk because any drop in values eats your investment (down payment and other cash into the purchase) first.  But then any appreciation piles onto your investment.

Renting your existing house may or may not be a good deal.  You mention $1500 in rent, but say nothing about what its worth.  Assuming its in Arvada, I'd guess its value is well north of $150K.  I've looked in Arvada for rentals and nothing there meets my criteria.  Admittedly my criteria are tougher than many investors, but even fairly liberal critera can't be met in our area.  At this time its nearly impossible to find any profitable rentals anywhere around here.  Pueblo, maybe.  I wish I'd have been able to buy two dozen rentals back in 2007-2010 instead of just two.

So, while you can make money buying a rental here with cash, your actual returns are going to be pretty low.  Some might say there's good appreciation potential.  Certainly that has happened in the last few years.  But I'm concerned we're approaching bubble-ness.  LOTS and LOTS of new construction here now.  Much of it apartments.  That is a huge change from five years ago when there was little construction at all and none of it in apartments.  As those units come online, supply increases.  That will ease some of the current pressure on rents.  If you spend $200K on a house here and get $1800 a month in rent, and account for all expenses including a PM, you would net about $10,800 a year.  That's a 5.4% cash on cash return.  Too low, IMHO, for rentals.  Leverage will help, but its still not a great deal.  Self managing would allow you to earn the PM's cut, which improves your returns.  But you're really "buying a job" to earn that piece.  That's not bad, as its a pretty easy job that generates a pretty good paycheck.

I wish I knew what to tell you to do because I'd go do it, too.

Jon Holdman, Flying Phoenix LLC

@Kevin H.  I like your first option, too. When I list choices, I usually put my favorite first, so don't talk yourself out of a new home if that's what you really want. Interest rates remain incredibly low. You have the discipline to manage debt. You could look for a property that needs some work or has an unfinished basement to further add value and build equity.

I agree with @David C.  and would run the numbers on your house as a rental. Further, I would be extremely picky about who you rent to if you go that route. Consider hiring a PM to screen and lease the place to reduce DIY landlord risk even if you manage on your own. 

There's nothing wrong with option 2, but it's hard to find a good value in today's market. Investor rates aren't much higher, especially given your situation. 

Good luck with your decision.  

I would not buy a HUGE home, but another, perhaps slightly nicer one with part of it. Use the rest to buy rental properties, keeping a nice cushion for the two of you and for the rental properties.

Congratulations on your frugality. Don't stop now. :)

Originally posted by @Joe Villeneuve :

@Kevin H.  I like your first option with one added measure.  You have good credit, you have cash waiting for you in equity on your current home (100% equity)...use it.  Refinance.  Take the cash and buy another cash flowing property.  Then do it again with that property.  (you bought it with cash, so you can refi that same cash out of it).  Keep doing this until you can't get anymore loans...then partner with someone that can.

I cringe when I see this type of thing...Kevin has zero landlording experience, and someone advises him to jump into the deep end of the pool...yikes! Yeah Kevin, go buy a 20 unit, you'll be rich! Then the over-leveraging, Jesus, Mary and Joseph! Talk about working without a net!

Very irresponsible.

Kevin, I can't help but state the obvious...crawl before you walk, walk before you run.


@Arnie Guida  All Kevin needs to do is hire a good Property Manager.  That takes care of his lack of Landlording experience.

I never told him to buy a 20 unit apartment....he would be buying one house at a time.

Define over leverage vs. over risk.  Over leverage is when you have more debt on the property than the property is worth...not the case here.  The lender won't let him.  over risk, is when you have 100% equity.  If you paid $100k in cash for a property, you are invested $100k of your money in the property.  You lose the property (how about a lawsuit having nothing to do with your property), your out $100k.  You leverage the property 75%, and you're only out $25k (minus whatever CF you've had up to that point).

The banks place risk in the laps of the lender (them), which is why they want skin in the game).  They don't think a person that has no cash in the property is taking a risk.  The person that loaned the money is.

On a financial note.  Basic math tells us that if you subtract the amount of cash you put in from the amount you get back, that tells you where you are in income/loss.  So a negative number means it costs you (loss), a positive number means you have a profit...and you are ahead.

If I put $48k in cash into a property, and I get $8k back in cash flow per year, I'm behind until the 6th year.  Equity doesn't count.  I can't buy pizza with the part of the house (a brick or two) that I paid off...and, when I access that equity (retirement ?), will it still be there?

If I put $50k into a property in cash, then refinance out, and use it again on another house, and my CF (with the debt) is now $5k per year (but I only have $12k (75%) still in the property in cash), it takes only 2.4 years to break even...and, since I can refi in 6 months, I will have potentially doubled the return on that 45k with that 2nd house.

@Joe Villeneuve  

I don't think judges set judgement amounts based on your leverage?

This makes no sense to me:

If you paid $100k in cash for a property, you are invested $100k of your money in the property. You lose the property (how about a lawsuit having nothing to do with your property), your out $100k. You leverage the property 75%, and you're only out $25k (minus whatever CF you've had up to that point).


Anyone else here?  Is leverage a valid asset-protection scheme?

@Joe Villeneuve  

On a financial note. Basic math tells us that if you subtract the amount of cash you put in from the amount you get back, that tells you where you are in income/loss. So a negative number means it costs you (loss), a positive number means you have a profit...and you are ahead.

No, that tells you where you are on cash flow, not income/loss.  Positive cash flow is not the same as profit.  Negative cash flow is not always the same as loss.

Or am I once again starting the Robert Kiyosaki can make up his own words argument?  this feels familiar.  Joe - are you an RK disciple?

Originally posted by @David C. :

@Joe Villeneuve 

I don't think judges set judgement amounts based on your leverage?

This makes no sense to me:

If you paid $100k in cash for a property, you are invested $100k of your money in the property. You lose the property (how about a lawsuit having nothing to do with your property), your out $100k. You leverage the property 75%, and you're only out $25k (minus whatever CF you've had up to that point).


Anyone else here?  Is leverage a valid asset-protection scheme?

 Yes.  The amount of equity doesn't set the amount for a judgement, but the fact that you have an unencumbered asset makes it a target. 

Originally posted by @David C. :

@Joe Villeneuve 

On a financial note. Basic math tells us that if you subtract the amount of cash you put in from the amount you get back, that tells you where you are in income/loss. So a negative number means it costs you (loss), a positive number means you have a profit...and you are ahead.

No, that tells you where you are on cash flow, not income/loss.  Positive cash flow is not the same as profit.  Negative cash flow is not always the same as loss.

Or am I once again starting the Robert Kiyosaki can make up his own words argument?  this feels familiar.  Joe - are you an RK disciple?

 Money coming in is profit, money going out is a loss.  Cash is liquid.

OTOH If you buy four houses and put $25K down you have $100K in equity that a lawsuit could attack.  Exactly the same as if you have as if you buy one house for $100K.  So while I understand that if you have a $100K house with only $25K in equity you have less exposure on that house than if you have a $100K house free and clear.   But if you have $100K in assets, distributing them doesn't magically make the assets less exposed.  So, IMHO, the "asset protection" argument is a red herring.

Now, the down side to buying four houses with leverage vs. one is the exhibition transaction costs associated with real estate.  Fortunately its mostly on the sales side.  Buy one $100K house free and clear and your costs will be about $2000, probably less because you avoid all the loan-associated costs.  Buy four with leverage and your costs are easily $10K.  Sell one $100K house and you LOSE about $8K for selling costs, so you end up with $92K in your pocket.  Sell four that are 75% leveraged and you'll lose $32K, leaving only $68K in your pocket.

Property managers are the most overpaid job in this business, IMHO.  Most month it take five minutes, if that, to deal with the tenant.  So, they collect $180 on a $1800 rental for five minutes work.  If you have a vacancy, my limited experience is you're going to spend around 10 hours answering calls, showing the place and signing the lease.  For that a PM here would get $900 or $90 an hour.  PM's are a necessary expense if you're investing far away.  If your rentals are close they are, again IMHO, a costly luxury.  One of the key metrics for choosing mutual funds is the expense ratio.  Even 1% is considered very high.  Yet we coax new investors into buying rentals and using a property manager that's going to eat 15% or more of their returns.

Jon Holdman, Flying Phoenix LLC

From your first post it doesn't sound like you plan on using REI as a way to escape your day job. If you plan on working until retirement & iIf you don't plan on self managing I would recommend you think big. Maybe talk with Joel Owens about how you can leverage that 100k into a larger property. He has several times talked about a 75%-10%-5% deal, where the bank funds 75%, owner carries back 10% and you bring 5% to the table. Then you can acquire something in the 2m range where onsite management makes sense.

Thanks for the correction @David C.  . It's still early and I'm suffering from a cold... so a little cloudy. Its actually 75% 10% & 15%. So I guess you would be looking at a 600000$ property... Probably should have checked that out before ***-u-me-ing that I was thinking straight.

@Kevin H. Most of the advice here is ignoring the most important information you provided about yourself. You are clearly a very conservative and risk averse person. You chose a govt job, paid off your home and have your savings in cash rather than say the stock market or any other investment. If you follow the advice of most of the aggressive investors here, whether you make or lose money, you will surely lose sleep. Because there will be issues and short periods of time where you will lose money.And the debt will gnaw at you because thats just how you are. Its true in every investment. I think your first option is the best. Get a new home, it will bring you pleasure. Rent your existing home even if it doesn't meet any x% rule. Since it is paid off it will be positive cash flow no matter what. Choose good tenants even if you get slightly lower rent. This is not just about maximizing ROI but also peace of mind.

@Kevin H.   What are your goals? Where do you want to end up financially???

Do you have 6 months worth of reserves in case of emergency? If not, then take that out and put it in a liquid asset. 

Money is cheap right now, so I am taking advantage of it. You could look for a SFR or a condo as a rental, but do you want to be in the landlord business??? Another thing to note about Denver is that we are in the middle of having 35,000+ apartments come online, so don't expect sky high rents in your math. I am not trying to talk you out of it, but just make sure you consider every aspect.

I personally would go for it and get a SFR or a townhome with a low HOA fee with that cash as a down payment. I also would take some money out of your primary to pickup another property with 6 months of the first one. In two years, IIRC, you should be able to count that income towards your DTI ratio. Then you can look at picking up another property, etc, etc. Then once you become a land baron, 1031 everything into an apartment building;) Good luck and remember we are here to help!

well @Kevin H.  , you stirred the pot on this one didn't you.  Lots of good thoughts for you to sort through.  There's one perspective that I notice has not been addressed yet but should be considered a valid investment direction depending on your mobility.  Once every two years you are able to sell a house that you have lived in for two out of the previous 5 years and you and your wife can take the first 500K in profit tax free.  

There's a couple considerations here in light of the above.

1. The house you are living in now would qualify as long as you have lived in it for 2 out of the previous 5 years.  So you could sell that and take the profit tax free.  Or if you want to test the waters of landlorddom, you could rent it out for another 36 months and then sell in which case you would still have lived in the house for 24 out of the previous 60 months (make sure the math on the clock works) and could take the primary residence exemption.

2. You can do this process once every two years so if you wanted to get into the game of buy a nice house live there two and then sell you will be able to take that money within the limits again tax free.  Eliminating tax enhances your roi quite a bit and you really haven't stretched yourself too much philosophically or financially to do so.  

3. As others have mentioned using primary residences to build wealth is slower, especially if you stay in one forever.  But if you access cash through tax free primary residence sales periodically it can really enhance your position.  Then you can use 1031 exchanges to  keep the sales of your rentals tax deferred and position your rental portfolio for the end game.

But ya know what really struck me as I went back to your original post - you are looking at a pension retirement in the next 20 - 25 years.  You don't have to go out on a limb to win the game.  Given that, a conservative approach carries more credibility.  You're winning the game and some of what you are needing to do is manage the clock and keep the 4th quarter in mind.

Medium ergDave Foster, Exchange Resource Group | [email protected] | 850.889.1031 | http://www.erg1031.com

Originally posted by @Jon Holdman :

Renting your existing house may or may not be a good deal.  You mention $1500 in rent, but say nothing about what its worth.  Assuming its in Arvada, I'd guess its value is well north of $150K.  I've looked in Arvada for rentals and nothing there meets my criteria.  Admittedly my criteria are tougher than many investors, but even fairly liberal critera can't be met in our area.  At this time its nearly impossible to find any profitable rentals anywhere around here.  Pueblo, maybe.  I wish I'd have been able to buy two dozen rentals back in 2007-2010 instead of just two.

So, while you can make money buying a rental here with cash, your actual returns are going to be pretty low.  Some might say there's good appreciation potential.  Certainly that has happened in the last few years.  But I'm concerned we're approaching bubble-ness.  LOTS and LOTS of new construction here now.  Much of it apartments.  That is a huge change from five years ago when there was little construction at all and none of it in apartments.  As those units come online, supply increases.  That will ease some of the current pressure on rents.  If you spend $200K on a house here and get $1800 a month in rent, and account for all expenses including a PM, you would net about $10,800 a year.  That's a 5.4% cash on cash return.  Too low, IMHO, for rentals.  Leverage will help, but its still not a great deal.  Self managing would allow you to earn the PM's cut, which improves your returns.  But you're really "buying a job" to earn that piece.  That's not bad, as its a pretty easy job that generates a pretty good paycheck.

I wish I knew what to tell you to do because I'd go do it, too.

Thank you to everyone for all of the helpful replies!  I've definitely got some information to sort through and absorb at the moment, and I look forward to some further exploration of my various options.

@John Holdman:

You seem to see our current market very much as I do, and have mentioned a few of the concerns I am thinking about at the moment.  Prices have appreciated quite a bit in my neighborhood in the past year, which is great from the perspective of the home I currently own.  But, I don't get the sense that this is a great time to go running out to buy a bunch of other nearby properties as future rentals (buy high sell low never sounded quite right to me).  

My neighbors work for a local property management company, and they've been told to expect about $1,800 on income from a rental in our neighborhood (at one point they were considering renting their own home).  Based on what I've seen around here, I'd guess the revenue from a rental would fall in the $1,500-1,800/mo range.  The home I currently own would probably sell between $270-280K, based on comps.  

As you mentioned, there's a lot of building going on, especially on the west end of Arvada. I suppose part of the hesitation I have toward acquiring other investment properties at the moment is that I also get the feeling that we're a bit bubbly right now… of course, I could certainly be wrong!  I will say that the available inventory around here is pretty low, and some places are getting multiple offers (certainly not bottom-of-the-market behavior).  My better half has a coworker who has been trying to move to our area from Bailey, and she has lost bidding wars on two properties in the past month.  Admittedly, I know nothing about those properties, other than that they were located pretty close to where we live.  And, while that is merely one anecdotal report of turbulent waters, it is still enough to raise an eyebrow for me.    

Those factors, among others, are probably why I'm very cautiously wading into the real estate investment arena.  I won't ignore the fact that there are some compelling arguments for leveraging myself a bit, and I certainly wouldn't mind building a real estate "empire" that would someday free me from the umbilical cord of my current career (as much as I enjoy my regular job, I also value financial freedom).  But, I don't want to foolishly jump into this game with the arrogant assumption that I'm smarter than I really am, and thereby get burned badly right from the start.  I guess I see it is a crawl, walk, run approach, as others have mentioned! 

In retrospect I probably should have made some moves or leveraged myself during the last crash, but I wasn't at a good point to feel comfortable doing so at the time.  If we currently had the market we had in 2009-10, I'd probably be making some moves on properties at the moment.  Instead, I find myself sitting on the sidelines waiting for an opportunity.  But, as experts have often said in the past, trying to time the market can also be a losing proposition for the average investor.  But, buying at the top of the market is also quite dangerous to one's financial security.   

Free eBook from BiggerPockets!

Ultimate Beginner's Guide Book Cover

Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

  • Actionable advice for getting started,
  • Discover the 10 Most Lucrative Real Estate Niches,
  • Learn how to get started with or without money,
  • Explore Real-Life Strategies for Building Wealth,
  • And a LOT more.

Lock We hate spam just as much as you