What does FIRE (Financial independence Retire Early) look like with real estate investing??

Our first visit to Hawaii

The FIRE (Financial Independence Retire Early) movement has been increasing in popularity over the last decade, and needless to say I am a firm believer of the concept. The idea of being able to sustain your lifestyle through passive income gives one tremendous opportunities to explore passions that would otherwise have taken a backseat to the daily grind. The FIRE realm is again broken down into lean FIRE, fat FIRE and obese FIRE. Lean FIRE is when one estimates annual expenses close to $50-60k to sustain one’s lifestyle in retirement. Fat FIRE is more generous requiring about $60-100k in annual income to sustain one’s post retirement lifestyle and you may have guessed that obese FIRE means your annual post retirement needs exceed $100k. I have read multiple blogs that primarily focus on investing in the stock / bond market (allocation in stocks decreases typically the closer you are to retirement) with annualized returns of around 8-10% and factoring in compound growth where they talk about what your nest egg should be to hit these goals. The general consensus is that you need around 1.5 million dollars in your retirement account invested in a combination of index funds and bonds to allow safe withdrawal of around 4% annually (which also equals anticipated annual return – inflation) to hit lean FIRE. If you are shooting for fat FIRE that nest egg should be around 1.8-3 million dollars and over 3 million dollars if the desire is to obese FIRE.

Now those who are self employed find that they hit those goals much faster since they can stash away more in their retirement accounts pre-tax. But I think one has to give serious thought to what the alternative out there is (especially if you are on a W2 and a much better candidate for multiple conventional loans), and this is where I think real estate investing gets very exciting. Let’s talk numbers!

Working backwards, say you are looking to lean FIRE… and would like an annual income of 60,000$ from your rental real estate portfolio, this translates to around $5K monthly. In previous posts we ran numbers for how to arrive at net income from a rental. Suppose you are invested in a high cash flow market and have a net income of around 500$ per rental property per month… that means with 10 rental properties you are all set to lean FIRE. So how much money then do you actually need to invest in each property to generate the 500$ net income? Again this will vary depending on your market and your initial down payment. But assuming a 20 – 25% down payment that keeps you leveraged and increases your overall return on investment, in a good cash flowing market, an initial investment of around 50,000$ should be adequate. Which means that with around 500K you are all set to lean FIRE. Now, in a High Cost of Living Market or in a market where it is not typical to see a 10% return on investment you may need more initial capital to lean FIRE. But there are so many strategies to explore such as BRRR (Buy, Rehab, Rent, Refinance, Repeat), house hacking, living in a property for a year before renting it out (thereby making you eligible for less money down and more attractive loan terms) that give you the opportunity to put less money down to own a rental. In my experience, I have found that in the markets I choose to invest in, 50,000$ gets me a nice rental that cash flows around 500$/ month.

Now it is important to factor in annual increases in rent… With my first rental, I immediately cash flowed around 400$, but with increasing rents and having refinanced it at a lower interest rate, I now cash flow over 500$. And through retirement, its important to remember that your rents will at least match inflation, therefore all you have to do is keep cashing those checks. It is also important to remember that although cash flow is key to rental investing, a big portion of your return on investment is from building equity through property price appreciation and debt pay down and you can easily tap into this equity by choosing to refinance and pull out the built equity. Tapping into the equity you have built in your rentals is also a means of equity stripping which helps with asset protection. If you tap into this equity and pull out your initial investment, then you are essentially in the territory of infinite returns (cash flow/ 0$ investment = infinite returns). And that is a very sweet deal….

I think its worthwhile to mention at this point that each individual is only allowed 10 Conventional loans including your primary residence, but that usually easily translates to 20 Conventional loans for a two income household. And once your conventional loan options are exhausted, portfolio lenders and non-recourse loans are out there to explore. Now, I have only been talking about single family home rental investments, but if you are willing to scale to Multifamily units or small apartment complexes, then that does make for a faster leap towards your FIRE goals. In my opinion though, Single Family Homes as rentals are a sweet spot given the ease of acquisition, smooth operation, property value increase historically and the increasing demand for Single Family Home rentals. That being said, I do see many favorable points to making the jump to apartment complexes with around 100 units, this is another sweet spot where ease of maintenance and operation make this a favorable option for those with the resources. But more on this in a later post…

Ideally you want to be diversified- therefore it would be nice to have a retirement account nest egg that can fund part of your FIRE, and a rental portfolio that feeds the rest. Here’s to getting closer to those goals and to a rapid FIRE….

What is really HOLDING YOU BACK from investing in Real estate??

Believe in yourself…

My first mentor in real estate investing was a dear colleague, a second generation real estate investor who nudged me to start building my real estate portfolio around 2012, which in hindsight was the perfect time to get started. But it wasn’t until a few years later that I eventually took the plunge. And I didn’t necessarily set accelerated goals for myself till more recently. Pondering over what really holds us back, it is clear we have to fight both internal and external influences to get started. I’d like to take a closer look at these factors today hoping that the insight will help you take the leap.

How we hold ourselves back can be broadly categorized into our understanding (or lack thereof) of how money works for us (the concept of Assets and Liabilities) and our own limiting beliefs (the things we tell ourselves that stop us in our tracks).

Start Understanding Your Own Financial Scorecard: Kiyosaki
From “Rich Dad Poor Dad”

Reading “Rich Dad Poor Dad” was eyeopening for me, because it introduced the concept of Assets and Liabilities to me in a whole new light – an Asset being anything that puts money in your pocket and a liability being anything that takes money out including your personal home and that fancy car that you just leased. It got me thinking about how I needed to accelerate asset building if I ever wanted to have options other than staying in the rat race till retirement age. Because as long as I wasn’t generating enough in monthly passive income to replace my income from my job wholly or in part, I was essentially stuck.

The Concept of ESBI by Mr Kiyosaki | by P C Marddaraj | Medium

The book also clearly puts you into one of four categories, and I realized that I was boxing myself into an E or at most an S, while the smart thing to do would be to be a B or an I. As Warren Buffet’s famous quote goes: “If you don’t find a way to make money while you sleep, you will work until you die.” Sounds kinda morbid, but it just hit me how true this was. Not to mention the numerous tax incentives and deductions that the tax code offers Business owners and Real estate investors for stimulating the economy, that in turn play a huge role in accelerating their personal growth.

But truly, even armed with this knowledge, we still have to fight our limiting beliefs – the little voice in our head that tells us how maybe we don’t have it in us to see this through, or maybe we need to know more, have more reserves, or that it’s too risky, what if we fail? Most often the only thing standing between us and success is our self-doubt. You could have no rentals, looking to take the leap – or a few single family homes, looking to venture into Multifamily homes – or be a long time investor in Multifamily homes considering taking the leap to small apartment complexes – sometimes we just freeze in Analysis Paralysis. That’s when it’s great to have a mentor or a community of like minded people who have similar goals, support us and in a way hold us accountable. This is why I also feel that a strong “WHY” and Goal setting are so important to taking the first baby steps. We covered the Why in a previous post and I want to briefly touch on goal setting as a means to get you out of a rut – telling yourself that you want to own x number of doors or properties in y years or I want to have x in passive income by year y and more importantly surrounding yourself with supportive people who will hold you accountable to that goal is a great way to get started and boost your self. Do not underestimate the power of the company you keep – in propelling you forward and in holding you back, so choose wisely.

But everything said and done, you still have to be able to defend yourself against all the external influences that say it can’t be done…. like the well meaning friends who think it’s the wrong time to be investing in real estate (gently remind them that if you invest in cash flowing properties and do your due diligence you will be able to weather storms), or the relatives who share horror stories of a friend who had to go unclog a toilet in one of his rentals on a weekend (that is what property managers and handymen are for) … or the spouse who just isn’t ready to take the plunge (because trust me, when they say NEVER- it just means they are not yet ready and you still have more persuading to do, hopefully with solid numbers backing up your proposal). When you are ready, please don’t let someone else’s limiting beliefs become your own.

Because when you don’t hold yourself back and don’t let others hold you back – when you finally do take the plunge, you will see that your first property will set you free. Once you see the numerous benefits of investing in real estate firsthand, you will kick yourself for not having started earlier…

How to RUN NUMBERS for a real estate deal and when to pull the trigger…

Now, that’s a room with a view!

When you are looking to buy a rental investment property, its crucial to know how to “run the numbers”. This is the foundation of analyzing any investment deal, rental or not, and the end result should align with your goals – for example, a decent goal would be to hit a COC (cash on cash return) between 8-10%. This is basically just expressing annual cash flow from your rental (after all expenses are deducted) as a percentage of your initial cash investment (down payment and closing costs). Depending on your market and aptitude, this number could be as low as 5% or as high as 15% before you consider the deal noteworthy. Knowing the numbers also means that you could then work backwards, arriving at an offer that may be much lower than asking, but one that allows you to hit your COC goal… So let’s dive right in…

COC = (Annual net cash flow/Initial investment) x 100 expressed as a percentage

Cash flow = Income – expenses

So the real trick then is to be able to estimate accurately rental income for the property you are analyzing and potential annual expenses for the property. An easy rule of thumb is to calculate PITI (Principal and Interest + property Taxes + Insurance)+ 5% possible vacancy + 10% allowance for Maintenance (including Capital expenditures) + HOA and Property management fees if applicable. In some circumstances, including Utilities (particularly with Multi Family Units) and Pool Maintenance may be necessary if these expenses cannot be billed back to tenants, but for the most part in Single Family rentals these expenses need not be factored in. It’s also important to remember that rent estimates on Zillow or Redfin may not be accurate, checking with your agent is important. Also current property taxes may not be an accurate estimate as these taxes are reassessed upon sale of the property.

For example, a Single Family Home SFH you are eyeing is listed for 235,000$. Current tenant pays 1995$. This is your gross income per month. Let’s calculate monthly expenses assuming 20% cash down ie 47,000$, 3.625% interest rate for 30 years (yes, rates are higher for investment properties, please factor that into your calculation), 3000$ in closing costs, property tax rate of 1.9% and no property management fees (self managed)…

Initial investment is 47,000$ + 3000$ (down payment + closing costs)

PITI (Principal + Interest + Property taxes + Insurance) = (828.2+370.3+115.7$) = 1314$

Vacancy + Maintenance = 15% of rent = 299.25$

HOA = 75$

This leaves you with a monthly cash flow of (1995-1314-299.25-75) 307$. So your annual cash flow is 3684$. And your Cash on Cash return is (3684/50,000) x 100 = 7.4%. And if you remember from my previous post, this is all TAX FREE income thanks to Depreciation.

This may or may not be aligned with your goals… You may choose to put an offer in at 225,000$ that would be more aligned with your goal for COC. But your decision is informed …

Now while assessing Short Term Rentals STRs, you will have to factor in a much higher vacancy which may even be seasonal depending on the property location, per night rates, hiring maintenance crews etc. In a High Cost Of Living HCOL market, the numbers may only work with a much higher down payment. Or you may need to tweak the numbers based on Forced Appreciation, ie if you plan to rehab the property after purchasing it (which will likely also increase rental potential), you will need to factor those costs into your initial investment. But the basic principle remains the same. And if you remember from our

Now, go ahead and run those numbers …..

Just remember, Rome wasn’t built in a day… the more numbers you run, the better you get at spotting a great deal; the more offers you put in, the more likely you are to close on your next property. Best wishes…

About me…

I am a physician mom, with two lovely children who are my universe… But I’m also driven by this desire to keep them safe and build something that gives me the financial independence to spend more time with my family, that I can grow and pass on to my children… As a first generation immigrant, I realized that school didn’t provide me with the financial education that life demanded and I learnt some things the hard way and others from mentors I am eternally grateful to. Through this site I hope to share financial knowledge with other moms who are also trying to pass on a legacy of love and inter-generational wealth.

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#finance

#generational wealth

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WHY invest in real estate?

I find that the first question to ask oneself before venturing into something new is always “Why?”. Because if you understand the “why”, it keeps you pushing forward even when the going gets tough… A good “WHY” is to build something and pass it on to your kids so they can have a comfortable, risk-free life. Another good “WHY” for investing in general is to attain FIRE – Financial Independence Retire Early… It’s something a lot of professionals have been targeting lately- to get to the point where they can work because they want to and not because they have to, to be able to define how many hours they want to spend at work and how much time they want to spend traveling or with family doing the things that have been on the back-burner for so long. To get to that point, you have to generate enough in passive income to be able to cover your annual expenses without tapping into retirement savings (or have enough in retirement savings to tap into it at a reasonable rate and still have it last you as long as it should).

This is where Real estate investing comes in…

When you only have a few hundred bucks coming in every month after expenses, real estate investing may not seem so attractive, but it’s always important to factor in all these components when you are assessing returns. Let’s delve into each individually…

The benefits of investing in Real estate are FOUR FOLD:

Tax free rental income
Debt pay down by your tenant
Property appreciation
Tax savings
Magic four!
  1. Tax free rental income: One of the most important factors to consider when assessing a potential rental property for purchase is COC – cash on cash return. Put very simply, this is the ratio of annual before tax cash flow (Rent-expenses including mortgage payments, property taxes, insurance) to total amount of cash invested (down payment + closing costs) expressed as a percentage. Now in most cases, particularly if you have leveraged your money and taken a mortgage out on the property, this is tax free money due to paper losses from DEPRECIATION, a real estate investor’s friend and one of the many ways the tax code favors real estate investors. A good investment property usually fetches 8 – 12% in COC return that is tax free, already pitching it against returns from S&P 500 index funds. But there is more…
  2. Remember, if you have leveraged money in a rental property and taken out a mortgage on it, then your tenant is paying towards the principal every month, increasing your equity in the property, an oft forgotten return on investment. Let’s say this is usually around 3-4 % of your initial investment in leveraged properties.
  3. And hopefully your property is appreciating in value since your purchase, national averages are around 3 – 4%. But if your money is leveraged, meaning you only put down 20% as a down payment, then your actual ROI (return on investment) is around 15% conservatively. Again this is in a market that is trending upwards, which is the general trend if you have a buy and hold strategy.
  4. And lastly, my favorite- tax savings that are in addition to your tax free cash flow. In most rental investments with a mortgage on them, thanks to Depreciation and other expenses the government allows you to deduct legally, your year end numbers show a “Paper loss” that under the right circumstances you may use to offset taxes on other income, another factor to consider in your ROI. When you factor in Cost segregation, bonus depreciation – things can get very exciting, again proving that the tax code does reward real estate investors for stimulating the economy.

Since everyone understands numbers better with an example, let’s run some numbers… Say you put 40,000$ (20%) down on a 200,000$ single family home rental that rents for 2000$/month.

  • Your monthly expenses PITI (principal, interest, property tax and homeowners insurance costs) are around 1200$; but factoring in vacancy and other maintenance and capital expenses, possible HOA and property manager fees – let’s say your expenses are 1500$ out of pocket (very conservative numbers) – your COC ie cash on cash tax free gains each month are around 500$, which translates to 6000$ per year, fetching you a decent 15% COC. While filing taxes the following year, thanks to DEPRECIATION of rental property value that can be claimed on Schedule E where you report rental income and expenses, this rental income gets sheltered as tax free gains.
  • Your tenant pays around 200$ towards the principal each month, 2400$ annually which is a 6% return on your initial investment.
  • Assuming the property appreciates by 3%, that’s an increase in 6000$ in year one, which is an additional 15%.
  • Factoring in paper losses (depreciation and other expenses the IRS allows you to legally deduct as business expenses required for your rental investment) of around 2,400$, which is again a very conservative assessment, that is an additional 6% return on investment. Giving us a grand total ROI of 42%. Now in a different market where rents are lower or property taxes higher, or in another year when interest rates are higher, your ROI may drop down to around 25%… In yet another market with higher property appreciation, your ROI may be above 50%.

As you can see, the ROI for real estate investment done right beats S&P returns without a doubt.

So the real question then is not “WHY” invest in real estate but WHY aren’t you investing in real estate??

And for those of you thinking of the hassles of fixing a leaky faucet or toilet, and for those who have heard horror stories of tenants trashing a friend’s rental – stay tuned….