Going OldSchool – Gettin’ Rich Slowly Probably Won’t Crush Your Spirit

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This is for those who’ve saved just enough to get themselves into a heepa trouble, but don’t wish to try out any of the plethora of no-down techniques for investing in real estate. (Not that there’s anything wrong with that. 🙂 ) The rewards can be magnificent…or not. The vast majority who first venture into real estate without anywhere near sufficient capital, much less cash reserves, end up without their original stake, potentially dinged credit, phone calls from creditors, and sometimes, one less spouse. Why is that? They think they know far more than they really do. Duh.

Allow me an alternative path for those itchin’ to head out on the real estate investment highway.

Wanna know what, in my opinion is the best thing about this giant boiling cauldron of ‘new normal’ in all things real estate? The fact that complex, sophisticated techniques aren’t necessary now. Not by a long shot. Don’t get me wrong, I bring multiple strategies into play for many clients on a regular basis. But relatively speaking, though they may appear complex or sophisticated, they’re really not, at least when compared to past recessions. So if you’ve saved up roughly $10-15,000, have I got an opportunity for you.

Buy a duplex with FHA financing.

The interest rate is about 4%. There’s some mortgage insurance added on, I think to the tune of .9%. But the actual interest rate charged on the loan is about 4%. If you can buy a duplex in your area for $250,000 or so, the down payment would be just under $9,000. Then there are the closing costs, which will depend upon your lender, and how much you can shift to the seller. Let’s say it takes $13,000 to close, including everything.

Let’s also assume with the money you’ll be saving in month to month housing costs, combined with what economists like to call ‘disposable income’, you’ll be able to add $1,000 a month to your loan payment.

Over the first five years of ownership, adding the extra grand to your payment will result in a gross equity of about $98,000 — not bad, considering you started with less than $9,000 in gross equity. In other words, with an initial investment of $13,000 + $1,000 monthly for five years, you’ve increased your close of escrow equity position of $8,750 (3.5% down payment) into over 11 times that amount. That’s an annual return of 9.73% — without counting any tax savings whatsoever, which is not a small factor by anyone’s measurement.

This assumes the duplex will be worth the same in five years as you originally paid for it. Might it be worth more? It’s possible, but I wouldn’t bet the ranch on it. Could it be worth less? Sure it could — I don’t know where you are, or what the future holds. My crystal ball has been on the fritz since I predicted the Padres would sweep the Yanks in the ’98 Series. 🙂

A lot can happen in five years. You and your spouse could be making a ton more at work. Or not. Interest rates could be 3% — or 11.5%. However, if you follow the plan religiously, we know one thing for sure. Your equity will have increased by over 11 times what it was to start — and that’s assuming no appreciation whatsoever.

Compare that to possibly squandering your $13,000 on something for which you have zip, zero, nada experience. Been doin’ this since Ford was in office, and I can tell ya that for every nothin’ down success story you read about, there are a buncha folks who got their spirits crushed. On the other hand, you will have ‘created’ almost $100,000 in real equity dollars knowing exactly how much you were gonna owe at the end of five years.

Most probable worst case scenario? The economy goes to hell in a hand basket and you find yourself with a 4% fixed rate loan for 30 years, with a tenant helping you make it through. Compare that with the wretched souls who lost the money it took them so long to save, who would then find themselves so far behind the 8-ball they can’t even see Square-1.

Tell me again — how long did it take you to save that $13,000?

About Author

Jeff Brown

Licensed since 1969, broker/owner since 1977. Extensively trained and experienced in tax deferred exchanges, and long term retirement planning.

11 Comments

    • Severe oversimplification, bordering on irresponsible. What are your assumptions? Are we moving into this duplex or renting out both units? In either case, in most areas of the country, this type of investment produces significant negative cash flow. You are paying WAY more than your initial $9,000 down payment. With so little down your mortgage payment will be larger than net operating income. Every month you’ll be in the red so you better have a large paycheck and a stable job. And what if property values go DOWN in value? You’ll be stuck with a negative cash flow on a property that you can’t sell.

      It sounds like your article is geared to inexperienced real estate investors, so be responsible and give complete information next time.

  1. Jeff Brown

    Geez Larry, from which branch of Dale Carnegie University did you graduate?

    This is a simple post, meant to be conceptual in nature, not a freakin’ case study with charts, spreadsheets, and footnotes. However, let’s address your comment, point by point, shall we?

    You said, “Are we moving into this duplex or renting out both units?”

    If you’re literally unaware that FHA loans (those requiring 3.5% down payments) are for owner-users, with the exception of loan fraud, I wouldn’t know where to begin with you. When I wrote, “Let’s also assume with the money you’ll be saving in month to month housing costs….” — I thought the use of the phrase “housing costs” be a sufficient hint for most readers to surmise we might be talking about the investor living in one side, while renting out the other. I stand corrected.

    You said, “You are paying WAY more than your initial $9,000 down payment. With so little down your mortgage payment will be larger than net operating income.”

    Wow, after reading that, Captain Obvious is thinkin’ he’s met his match for sure. I’m literally shocked one might conclude borrowing 96.5% of the purchase price of a duplex in which they won’t be living, might result in negative cash flow. Who’d a thunk? If you’ve ever read anything else I’ve written here or elsewhere, you’d realize there’s a bigger chance of an August snowstorm in Death Valley at noon, than me giving that sorta harebrained advice.

    You said, “It sounds like your article is geared to inexperienced real estate investors, so be responsible and give complete information next time.”

    Can you see Captain Obvious now wildly waving his white flag? You win.

    One wonders what the opening paragraph was attempting to convey?

    “This is for those who’ve saved just enough to get themselves into a heepa trouble, but don’t wish to try out any of the plethora of no-down techniques for investing in real estate. (Not that there’s anything wrong with that. ) The rewards can be magnificent…or not. The vast majority who FIRST VENTURE into real estate without anywhere near sufficient capital, much less cash reserves, end up without their original stake, potentially dinged credit, phone calls from creditors, and sometimes, one less spouse. Why is that? THEY THINK THEY KNOW FAR MORE THAN THEY REALLY DO. DUH (emphasis added)

    Could it be that paragraph is describing folks new to real estate investing? Is it a stretch to conclude the phrase FIRST VENTURE might mean just that?

    You said, “Are we moving into this duplex or renting out both units? In either case, in most areas of the country, this type of investment produces significant negative cash flow.”

    Um, Larry, since we’ve already decided the post meant they’d be living in one side, while renting out the other, the concept of ‘cash flow’ in the strictest investment sense, doesn’t even come into play — nor did I even mention it. Rent received from the tenant allows them to live relatively more cheaply than if they didn’t have income from a tenant. What will they think of next?!

    You said, “And what if property values go DOWN in value? You’ll be stuck with a negative cash flow on a property that you can’t sell.”

    The post says, “This assumes the duplex will be worth the same in five years as you originally paid for it. Might it be worth more? It’s possible, BUT I WOULDN’T BET THE RANCH ON IT. COULD IT BE WORTH LESS? SURE IT COULD — I DON’T KNOW WHERE YOU ARE, OR WHAT THE FUTURE HOLDS. (emphasis added)

    I then said, “Most probable worst case scenario? THE ECONOMY GOES TO HELL IN A HAND BASKET and you find yourself with a 4% fixed rate loan for 30 years, WITH A TENANT HELPING YOU MAKE IT THROUGH. Compare that with the wretched souls who lost the money it took them so long to save, who would then find themselves so far behind the 8-ball they can’t even see Square-1.”

    I wonder if that conveys the thought that having a 4% fixed rate loan plus a rent paying tenant in bad times is possibly a good thing?

  2. Jeff,

    Not to mention you get a great hands on landlord experience without living 30 miles away. You get to see the tenant and landlord side of every scenario. Hindsight being skewed favorably, I would rather have taken this route then by my house at 65 % FMV. In all likelihood I would have far more equity today. I can think of few better ways to get your feet wet in Real Estate.

    Good post as usual.

    Jason

  3. “In other words, with an initial investment of $13,000 + $1,000 monthly for five years, you’ve increased your close of escrow equity position of $8,750 (3.5% down payment) into over 11 times that amount.”

    This is increasing predominantly by paying an extra $1,000 per month (5 years is $60,000). It’s a forced savings plan. Couldn’t one arguably place the same amount of money into the stock market each month with far less responsibility than managing a rental property and get a similar rate of return? Just a thought. Again, no one has a crystal ball on the stock market either.

  4. Jeff Brown

    Hey Jeff — Let’s see, it’s 2010, almost 2011. Five years ago what woulda happened to the average stock market investor who put $13k/$1k/mo. for five years? They’d of lost their butts, that’s what. 2008 woulda cleaned their clock.

  5. I meant to say this in my original comment…I do agree with your premise of getting rich slowly (vs. trying to get rich overnight).

    Yes, I lost some value of my 401K in 2008 but I wouldn’t say it cleaned my clock. Plus it has come back since then through no effort of my own. Perhaps if I was closer to retirement I’d have a different take on ’08.

    In my opinion owning rental property is not strictly passive, even when you have good tenants. Things can go wrong, including market rents can decrease. It has happened to me in the Baltimore area. Our original tenants had to move to a cheaper place b/c they could no longer get over-time at their jobs. We tried to get new tenants in at the previous rate but it didn’t happen. We quickly realized that 2 months without that $1560 coming in was worse than 12 months at $1400 or even $1350.

    I do see the value of your example, particularly with having the tenant next door. That proximity SEEMS appealing for a couple of reasons. If things go wrong you’re right there to respond (e.g. you don’t have to drive across town), and I would suspect that a renter would behave better knowing the landlord is one door down.

  6. Jeff Brown

    If your 401 experience was the rule, there wouldn’t be the problems most employees are facing now. Imagine if indeed you were ready to retire during this time in 2008. You’d of been absolutely ambushed. It will happen every decade or so, which means everyone will wonder when it’s gonna happen to them — before, at, or soon after retirement.

    Not the kinda vehicle I’d want for something as important as retirement.

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