Financial Planners will always tell you to diversify. That’s a good idea except that diversification is usually exercised by most people solely through the purchase of many different mutual funds. It is still investing in mutual funds or the stock market. There are ways to obtain wealth (and financial security) that you may not currently be exploring, ways that go beyond buying mutual funds.
Instead of planning for retirement, plan to reach Financial Independence instead. True Financial Independence is an easily measurable known target, and is a goal that can actually be reached within a short period of time. How? Through passive income. Generate positive cash flow from hard assets such as real estate income property. Rental income is passive income for the most part, especially if you have a solid property manager taking care of the details.
The principles of creating a long-term, on-going cash flow can be applied to most kinds of real estate investments. Mobile home lots, apartments, garage/storage units, and houses all make excellent income producing assets. Houses, in particular, low-end houses, make an excellent vehicle for creating long-term cash flow for a multitude of reasons.
While appreciation is often the most significant form of profit for real estate investors, investing for cash flow is easier to determine and with lower risk. So how do you achieve positive cash flow ethically in the real world? You need to buy in the rare market where high capitalization rates (15%+) are the norm. Such markets are usually depressed like Rochester or Memphis and have a large pool of renters. The reason tenants are willing to pay more to rent than they would have to pay to own in such markets is that they believe property values are falling or level in which case not owning is a good idea in spite of the high rent. Positive cash flow is so rare and so desirable that it eventually attracts out-of-town investors. Their coming into Rochester or Memphis or wherever causes property values to climb so that high cap rates are no longer available.
There are the three primary ways that an investor makes money in real estate: 1. from cash flow, 2. property appreciation and 3. paying down of the mortgage thereby increasing their cash flow and equity. Only if you buy on a bargain basis can you get positive cash flow from a rental property.
Why low-end houses make the ideal Cash-Flow vehicle
First, houses are abundant. Every city, town, and neighborhood has houses. Houses are probably the easiest to buy because they are the most common. Houses are also probably the easiest to buy at a discount, since there are so many sellers who own them in some sort of crisis ownership position: Vacancy, disrepairs, judgments/liens, back taxes, etc.
Houses are the easiest to manage, with the possible exception of storage/garage unit rentals, since these are occupied with stuff and not people, thereby making evictions easy. Well-maintained houses will often keep tenants for a 3-5 year cycle, sometimes longer. Most of the other vehicles have shorter-term occupancy.
Houses are by far the easiest to sell because of the naturally large demand for places for people to live. In most cases the property will sell without holding paper, but many smart investors will sell their houses on some sort of payment contract and be able to charge a 10-15% price premium to the buyer without using a Realtor.
The so-called low-end house can be very desirable from an investor’s standpoint. First, lower-end housing doesn’t mean becoming a slum lord. It means basic, starter homes that are located in good, but not necessarily great locations. These marginal areas typically are more of a buyer’s market, thereby, tilting the negotiation in favor of a hard-cash buyer or a buyer seeking owner financing. Actually, owner financing is easier, much easier in these slightly marginal areas.
Next, these lower level houses can frequently be purchased at various distress auction (tax, foreclosure, estate) sales. In many areas of the US, these houses are bought for prices anywhere from as low as $5,000 to $25,000, without a lot of difficulty (after you know the many inside strategies and secrets).
These homes can typically generate rents of $600 – $900 per month, which based on the low purchase price makes an outstanding return on investment. Returns of 25% – 35% per year are common. It’s not uncommon for smart investors to receive income for 20 years or better from their houses. After this period of ownership many owners will find a stable buyer and sell the house with a vendor take back mortgage (payment contract) and receive another 10 to 15 years of “mortgage” payments.
Here’s an example:
Purchase price: $ 20,000
Rehab: $ 15,000
Cash Investment: $ 35,000
Gross annual Income: $ 9,600 $800 month
Ordinary Expenses: $ 4,320 45%
Positive Cash Flow: $ 5,280 yr. $440 month
After Repaired Market Value: $50,000
Equity Created: $15,000 30%
Cash on Cash Gross Return: 26%
Cash on Cash Net Return: 15%
To put things into a little more perspective, if you were a risk averse investor, how much money would you need to invest in order to earn $5,280 per year in interest income, not accounting for taxes. Assuming the current 5 year GIC rate of 3.5%, you would have to invest $150,857. Based on the example above, you could buy 4 houses with that money and have an income of $21,120 a year. In addition, you would not have to worry about stock market fluctuations or running out of capital if you were withdrawing an income from your portfolio.
Finally, when investing in rental properties you need to keep your eye on the long-term goals rather than shortsighted goals. Property rental is a marathon rather than a sprint with the greatest profits coming at the end. You will want to pay the property off as quickly as possible in order to realize the maximum profit potential and acquire new properties. The real money when renting properties as a real estate investment isn’t in renting out one or two units but twenty or thirty. The more rental properties you own the more money you stand to make from owning them.
In summary, investing in real estate is always a good idea, no matter what the economic environment is. Investing in income producing property is even better as positive cash flow properties provides inflation protected real cash for your retirement.