This is a long post, but I figured I would post my situation and a decision I am trying to make along with a spreadsheet I made to track financial independence. See link below. You should be able to copy and paste into another Google Spreadsheet to use with your own numbers.
- Age: Upper 20s
- Income: 90-105k engineering background
- Cash on hand: >$50k (over $80k including cash in Roth IRA)
- Current assets: 1 townhome I live in and rent 2 bedrooms out to tenants. I have the option to remove PMI by paying down $40k more of the mortgage to save >$5k a year
- Given my situation above what is the best option for using this cash?
- And what is the best option for using >80k cash in Texas if I were to forgo paying down PMI?
- If I pay down the PMI and no longer have much cash can I move to a new home and put 5% down while keeping townhome #1 as a rental?
I become somewhat obsessed with financial independence and more specifically doing so with real estate mainly because of the advantages of leverage early in life (I'm under 30). I have been following BiggerPockets for awhile now and I read Scott Trench's Set for Life book among other real estate and business books. I have a relatively high paying W2 job that I like so I lean towards an investment path that are on the lower risk and time consuming side. I like the idea of keeping my W2 job for awhile as I get started with investments in a low maintenance way to diversify my income and gain leverage. Many years from now I would like to have the option to live off of my investments, be a full time investor, or otherwise be able to take more risk in my career knowing that I have some passive income to support me.
So far I have purchased one townhome in a trending part of my city that I am "house hacking" by renting out 2 of the rooms to friends. This situation has worked out very well so far despite a few major repair expenses. I plan on keeping this house long term as a rental after I eventually move, and I think it would have decent cash flow if I were to rent it today.
Now I am looking into what the next step should be along the path toward financial independence. I have accumulated quite a bit of cash and now over a third of my net worth is cash. I have been looking for the next investment step......
I am weighing two options for using this cash. Option 1 is to use most of my cash to pay down my mortgage from the original 5% down to 20% to remove PMI. I did the math and because my house appraised higher than the purchase price the return on paying down my mortgage to remove PMI would be a 13% return annually for 7 years (after those 7 years I would be off PMI anyways). And I guess that means that despite having a low interest rate on the mortgage I am essentially paying credit card type interest rates on that portion of the mortgage due to PMI. The main reason I don't like this option is that I am removing leverage, which I wanted while I'm young.
Option 2 is to invest the cash in another real estate purchase (I want leverage). I have read many RE blogs, books and other sources including looking into out of state investing and turnkey investing options like HomeUnion or RoofStock, but I've decided that the best option for my second purchase would be a local investment hopefully in an B+/A- area with either a great location walking distance from attractions and prime for low maintenance young professional tenants or in an area with great schools (right next to where I work). It would be much easier to get into the next investment by using all or most of this cash reserve, but I think I could still get a home up to $150k with cash that will be left over after paying down the mortgage on home 1. $150k does not look like it will cut it for the type of investment I am looking for….
I suppose I could invest this cash in the stock market or something else with high risk/returns (currently have just 1% net worth in crypto), but I generally feel that the nearly all markets (stocks, bonds, EM, etc.) are too high and overvalued even after this weeks drop. I am probably biased in this view because I have been in cash for so long. I just have my 401K in the market and I plan on never touching my 401K portfolio other than re-balancing and portfolio adjustments based on age.
Real Estate Search
Along my real estate investment search I looked into programs online that can help find cash flowing homes like Mashadvisor, but I decided that I would be more comfortable doing the analysis myself. I built a dashboard map that allows me to throw in assumptions (occupancy, maintenance costs, taxes, etc.) and then see prospective returns on a map using MLS listings and Zillow rental data (I average Zillow rent estimates by zip code with Zillow rent estimates by square footage by zip code). Using my financial independence spreadsheet I have decided that it's not worth investing unless the cash on cash return (not factoring appreciation) is over 7% and by using my dashboard I have found that it is very difficult to hit 7% COC….. And I think that I'm in a better market than most, Texas. Given that this return seems difficult to achieve right now and the market may be on the higher side maybe it is worth waiting for opportunities later?
I tailored this spreadsheet based on my own situation, but I think it can be manipulated easily for other situations especially for others with W2 jobs. I added the option to add up to 6 real estate investments in 6 consecutive years. Activate a particular real estate situation by adding a 1 instead of a 0 on the On/Off row. As a long term investor I assume that the appreciation for any real estate purchases would be 2%/yr. I am believer that over the long term real estate for the most part just increases with inflation (which is plenty after factoring in leverage). 3% may be a better assumption, but given that I believe the market is on the higher side I’d like to stay conservative. I threw the spreadsheet together in one afternoon so there may be some issues. I'd like to eventually tailor the spreadsheet to capture the tax difference of investing in a before tax 401k vs. an after tax Roth, but for now I am just evaluating financial independence based on net worth without factoring in taxes after FI. The values listed in the spreadsheet are not for my finances. I jumbled the numbers.
I'd appreciate any feedback on the spreadsheet too.
Here is a quick snip of how my Dashboard looks with the property price and potential monthly cash flow under the location marker. The color of the marker indicates COC return. One problem I'm dealing with is that everything in Houston is skewed due to Harvey..... At this point with my low experience I do not intend to purchases flooded properties. Although I would be interested in purchasing properties that have flooded and then been rehabbed. It will be interesting to see if these properties still sell at a discount.
And here is a quick snip of the spreadsheet. Nothing too fancy, but you can plug in your numbers and I think it gives a pretty good indication of where you're headed. I'm using this to track progress to Financial Independence, which I define as having enough net worth to afford my current budget plus 3% expense growth per year at a 3.75% withdrawal rate. At that point I feel like I could leave my job, commit to real estate or starting a business full time or take more risk in my career while paying off most of the bills and still living somewhat frugally.
Short answer to a long post here. I appreciate how diligent you are at analyzing the numbers. I wouldn't pay off the PMI. I'd invest in a rental.
I would think you have enough to do that now. I'd either move into the new one and house hack again to keep you down payment low or put the 20 percent down on a 100k house in Houston or San Antonio. I know my market is strong and I'm sure Houston is too. Finding good deals is the biggest challenge. I don't diversify much. I don't do crypto. To make real estate work for me, I put all my eggs in one basket for a while and focused on it. After the first couple, it picked up momentum and got easier and easier. Now I find that I may want to diversify but will maybe lend some money to someone else like me - staying in the RE space. Stocks and Mutual Funds just don't appeal to me much any more. Leverage in RE just puts my returns above what I got in the market and I have more liquidity - not that RE is super liquid, but it's not all in a retirement account that I can't access until I'm much older. I want options before the normal retirement age. Whether I retire or not, I want that option. That is just my two cents.
If you come to SA, look me up. You are well on your way to success. Keep up the good work.
My hat is off to you. I like your attention to detail with your spreadsheet.
Have you explored investing out of state? I'm not suggesting a turnkey operation unless that's what you'd feel more comfortable with. Just start tracking employment numbers, vacancy rates, and property taxes (among the myriad other details that go into real estate investing) and start figuring out if another market might be more likely to deliver the cash on cash return you're looking for.
It's also important to remember that sometimes the best deals aren't on the MLS. I find that it's rare to find anything listed that even conforms to the 1% rule, so even something in a promising location is probably over-priced in relation to what it can rent the expenses you'll incur for so you need to get creative with your offers. Make offers you find on the MLS that are more realistic and that hopefully can provide a win-win for you and the seller. Start networking in your community and tell people about your interest in buying properties and see if you can find someone thinking about selling but who has not engaged a realtor yet. Just get out there and talk to people and making offers!
Another option for you since you have some cash on hand is becoming a private lender. If you haven't found a winning deal for you yet maybe someone else can and just needs some capital to make it happen? You may be able to lend money with your cash reserves or your IRA and get a better rate of return than letting it sit there in a savings account or CD. Of course you'll have to analyze the merits of each investor and their particular deals with the same rigor as your own deals but the payoffs could definitely justify the risks. I first heard about this concept through Tyler Sheff's Cashflow Guys podcast and I'm sure a quick Google search on the topic will provide a wealth of information to get you started.
These are just a few ideas. Good luck to you and much respect for your effort so far. Well done. :)
@WillPritchett Thanks for the advise. I like the idea of putting your eggs in one basket just temporarily to really focus on one thing. I have found it difficult to focus with so many options for investing (cities, multi vs. SFH, condos, etc.) and that has been a major factor in my proportionally huge cash position right now.
I have looked into San Antonio, but I am a little concerned with the valuations in the area. I have seen San Antonio pop up on a few overvalued real estate market lists. In my search it looked like there were some nice deals in my price range in the Northeast side, but I am concerned about the rental and vacancy rates in that area. However, I do love the growth prospects along I-10 and along the San Antonio-Austin corridor and I am especially interested in San Marcos. That whole corridor is such a great place to live!
@JosaneCumandala thanks for the feedback. I have explored investing out of state, but mainly through turnkey type companies like HomeUnion and Roofstock. I am not ready to take bigger risks by investing out of state completely on my own.
I realize that the MLS does not have the best deals, but at this point in my path I feel like there is less risk in MLS listing and I do not yet want to spend money and time marketing for deals. I hope to eventually have a good network to learn about deals that are not on the MLS from avenues I trust. I like the idea of sending in low offers that meat my investment criteria for MLS listings that have been on the market for many days. I was able to get home #1 for a great deal by taking this route.
@Tyler M. I have give you kudos for being so organized and diligent, I wish I was like you...
You say you have $50k in cash to invest. Is this cash AFTER you put away some for a rainy day or that's the total amount you have? Remember to keep at least 6 months of reserves of your expenses at all times. You may not need it but you MUST have that in order to avoid a financial disaster.
I am not quote familiar with the Texas market but I would look for a local multi-family deal. Going out of state for you without much experience is very risky, UNLESS you have a very solid team in place in the target market.
Have you gone to local RE meet ups? I think that's a great way to learn and network with experiences RE investors that could also guide you in your local market.
Tyler - I believe that you are going to be super successful over the long-term because of the diligence and thought you put into everything. There is an unmatched understanding of the world that comes from attempting to get into the math and understand every number.
But I caution you, because after all your modeling, and all your predictions, you still need to boil things down the the fundamental, often simple questions that matter in the reality of your model and in the practice of actually investing and building wealth. I've spent countless hours doing exactly what you've done here in modeling out my own finances, real estate, businesses, etc. For me, I've found that out of the incredible complexity comes great simplicity and straightforward mental models that I can apply to my life and business.
To answer your question about what you should do with the $50K, your model should be able to answer this question for you, IF you believe your assumptions. Your model does not do this for you, partly because of how it is constructed (and the assumptions) underlying the real estate projections and partly because it is an art and a skill to build useful models that can truly test assumptions and leverage points.
The fundamental question of what to do with your money (from a strictly mathematical perspective) is to ask yourself what you think you can do with it, and what kind of returns you expect from those options:
- Investments in stocks return X% (you assume 8%)
- Investments in Real Estate Return Y% (You assume 2% property value inflation/appreciation and roughly 0.5% Cash flow as a % of equity, changing over time, for a rolling average of somewhere in the ballpark of a 3.5% return over time, multiplied by your leverage ratio). Frankly, you don't have a clear overall estimate for this, as you just have assumptions for this one property.
- Investment in your mortgage returns Z% (you state a $5,000 return per year on $40,000 invested - 12.5% - but it's not quite that simple unfortunately either, that return is only for as long as there is a mortgage on the property)
The fact of the matter is that you should only invest in another, second property, if you believe that another leveraged real estate investment will produce investment results that are materially in excess of the alternative choices you have. You need to figure out what you believe is a reasonable result for you to expect over the next 7-15 years from real estate investments on average, with and without leverage. Then, execute on that, if you are willing to accept the risks and do the work necessary to give you favorable odds of meeting or exceeding your return expectations.
I'd hope that you are able to find a property that, with reasonable, conservative assumptions, can produce a greater than 12.5% return annually, with some work and diligence.
All this said, I also want to point out that I think that this is a very conservative model, and I'd hope that you are able to achieve financial freedom 3-5 years sooner at your projected level of spend :)
@Tyler M. I amazed at your analytical skill. I am sure you are making use of it really well. I checked out your excel sheet and really amazing to bring all the investments together with withdrawal rate and trying to get sense of your current situation and future prediction. It's seems complicated but it's not and at the same it's not this easy due other unknown factors. I also noticed you didn't use the RE Cashflow as an income in your calculation or may be its hiding in one of your formula.
In any case, I am numbers guy too and sometimes I get lost in it and get to brain freeze mode. It's good to do these calculations to get an outlook but they are just numbers. Your RE prop won't appreciate as you expect which will reduce your equity every year and has cascade effect. You can do all sorts of prediction with 2%/3% assumptions but they are just assumptions.
My general concept, if I have cash, let's make use of it. I don't pay up any loans if they are less than the rates which you are getting for your cash. If you have borrow the same cash, can you get it for the same interest rate which you will get by paying off. No way! At this point, HML charges 7.75% for any money plus expense. You cannot get cheap cash. Why pay to avoid PMI or mortgage? Lots of people pay off their mortgage, don't do it. Use it build wealth. By paying off, you are not leveraging the best investment in the world, your own home.
I would use the cash to buy rental whether it's MF or SFH depending on your criteria and grow your rental equity and portfolio and add on it. I work with lots of investors similar to you who have full time job and want to have passive income to replace regular income (like Rich Dad Poor Dad says) but it's not realistic. But atleast their goal to make passive income (cashflow) will help them build their cash availability for the future years.
Just my 2 cents. Ping me if you have questions or comment.
That was a great spreadsheet, BUT I would spend the time looking for and analyzing properties to purchase. Nothing is going to happen unless you actually buy some properties.
Keep in mind that you get to financial independence from your investments making you money(stocks with dividends, real estate rentals, owning businesses, etc). Put the effort into that. Become the best at your engineering job so that you can open your own engineering business and then hire people to run the business for you. Purchase some rentals so that they can make you some passive income.
Dont worry about the graphs, charts or spreadsheets. Look up the phrase "paralysis by analysis".
Not everything that you will do will be right. And that is ok. Most days you will hit a single, some days you strike out. Nobody wants to strike out, but it is a part of life. Just keep stepping up to bat.
@Tyler M. Nice work with the spreadsheet, now you know that FI is possible! As someone in a very similar situation (Houstonian, engineer, FI-driven) but a couple of years in, I would like to offer a few tips:
Don't limit your RE investments to what you would want to rent, young professional areas will not bring you the best returns in Houston. I would stick toward your second condition, great schools in the suburbs. Although the deals are harder to find now, perhaps with some effort you can find a deal with the cash you have on a SFH in the suburbs of Houston or San Antonio.
Start focusing on analyzing RE deals, not analyzing your finances. Soon enough you will find one that works for you!
I know this is an old thread, but I just wanted to thank you to the link to your spreadsheet. I'm just starting the education phase of my real estate journey and this is so helpful to start charting my course to financial freedom. Building on the shoulders of giants, as they say.
Out of curiosity sake, what did you end up doing?
@Christine Sparks I paid down the mortgage to 20% to get rid of PMI. Then moved to a higher paying job on the West Coast, leased out that one TX town home, and now back to looking for housing investment opportunities! Hoping that covid creates some investment opportunities by the end of the summer
Thanks for the reply Tyler. I still haven't purchased my first investment property even though I posted this 8 months ago. That'a a nice little reminder that I need to get going! I've been researching and in an education phase and have learned soooo much.
You are now located on my side of the country! I am hoping for the same thing in terms of deals opening up. If you end up replying 8 months from now, I better have a few properties under my belt or I am going to be very mad at myself. Good luck with everything!