I wrote an article about 9 months ago titled Newbies Take Note: Why You Shouldn’t Buy Houses for $30,000, in which I advised you NOT to buy cheap houses. The article set off a mini firestorm on the BiggerPockets Blog. But today, I want to give you a “case and point” and perhaps convince more of you.
I am remodeling an SFR.
Actually, remodeling is too loud of a word; updating is more like it – putting some lipstick on that pig, if you will. I’ve had this house for about six years, the last four of which I’ve had the same tenant, and now that she’s moved on, it’s time for a little paint, a little cleaning… a little “lipstick.” 🙂
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I hardly can tell you anything new about creative finance. I am sure that you’ve read Brandon’s book and, as such, know it all. Nonetheless, perhaps you can allow me to underscore a few points that are pertinent to the present narrative.
Why We Buy Income-Producing Property
This is an easy one to talk about since there are only a few bullet-points that need to be mentioned. The reason we buy income-producing property is to:
- Protect Buying Power of Money
- Increase Buying Power of Money
- Create Wealth
Relative to protecting the buying power of money, what we are talking about is ensuring that our money buys the same amount of stuff tomorrow as it does today. While I have no intention of dragging you into an in-depth discussion of monetary and price inflation, I will acknowledge that it (the inflation) is a fact in a fractional reserve monetary system.
And what does inflation do?
Well, the increasing number of units of currency by definition suppresses the value of all currency in circulation, which translates into the reality that, as time goes on, it takes more units of currency to buy the same stuff. It is easy to see, therefore, that in order to afford to buy things in the future, we must position ourselves to increase the amount of currency we hold by an amount inversely proportional to inflation. Furthermore, if we can grow our number of dollars faster than the impact of inflation, then by definition, we can not only protect, but increase our buying power.
Needless to say, this process must be done through investment income.
Finally, the reality we don’t focus enough is that cash flow, while we can build up a significant enough amount to live on, fundamentally is there only to bridge ownership into equity — we buy stuff that we think will grow equity, either organically or through forced appreciation, faster than the marketplace. This is how we create wealth, and CF simply facilitates the holding period.
Real Estate is Great for All 3… or Is It?
Well, supposedly real estate accomplishes these stated objectives well, since as time goes on, we are able to increase rents, thus protecting the buying power of our currency. And over time, that house we’ve bought will be sold for much more than what we paid, and there you go – easy…
Before you run to buy a bunch of pigs — I mean cheap houses — let me tell you why I have a vacant house. You know why my tenant moved after 4 years? Because I was going to raise rent by $25 per month!!!
That’s right — the tenant moved over a seemingly insignificant amount of $25/month. This should make you think.
What is apparent to me, and should be to you, is that to some people in this country, $25 is not insignificant at all. My house is a fine house. It is in a safe area, close to everything. But the nature of the beast is that the type of tenant who wants to live there considers $25 big deal. What is also apparent to me is that while Brandon and I are debonair about forcing appreciation through income, although this is not an issue for SFR but pertinent nonetheless, we have to pause for a second to realize that raising rent from $900 to $925 is a very different proposition from raising rent from $475 to $500.
Simply put, to people who can afford $475, 25 buck is a huge deal, while to those who can afford $900, an extra $25 is much less of an issue!
I told them I’d be raising rent $25 and they moved – bam! And to boot, the house in this location is still worth only what I paid for it and will likely never be worth substantively more. I bought a cheap house because in the beginning I thought that this was all I could afford!
I don’t buy pigs anymore – do you?
Agree? Disagree? Make your arguments below!