It all started several years ago when my son began playing basketball. A couple years into the process, a new family joined the team. Their sons had never played basketball, but they were both over 6 feet tall (at 14!) and still growing. It became my project as assistant coach to help them get up to speed as quickly as possible (FYI, several years later, they both were good/above average players.)
As a result of this effort, our family got to know the boys’ family quite well. We saw each other at practices, interacted at games, and eventually got together a handful of times at their house (they live on a lake — a PERFECT location on a hot, summer day.) During these times I initially found out that the father did something in real estate. Ultimately I discovered he sold (as a real estate agent), purchased and flipped, and bought and rented out real estate. This was his sole means of income, and while they weren’t extravagantly wealthy, they were doing fine financially (at least from outward appearance, which I know can be deceiving.) Better yet, as I got to know them he seemed both knowledgeable (he seemed to know what worked and what doesn’t in real estate — and very practical in his knowledge) and trustworthy.
The Light Bulb Goes Off
I never really thought about his business and how it could apply to me until two things happened:
- I began to wonder about inflation and what my hedge would be in case it began growing out of control. I thought that owning something, a physical asset that had value, would be a decent hedge against rampant inflation. For me, gold was too pricey and commodities seem too difficult. But real estate, which had been beaten down in price at that time, seemed like a viable option.
- As I began to consider rental real estate specifically, I realized that this could be a great way to fund a retirement or early retirement income. (I know, I’m not sure what took me so long to come to this conclusion, but I am a little slow sometimes.) For instance, if I took a sizeable portion of my investments (most in various index funds) and converted them to rental real estate, I could develop a very decent level of income that could fund an on-going retirement income stream.
My Discovery Process
I then decided to find out a bit more about real estate in my market, so I asked my friend, Eric (the dad of the basketball boys), to lunch to discuss the subject. He spent an hour and a half answering my questions about rental real estate in general as well as the specifics of what was happening in our market. He also volunteered to drive me around if I actually wanted to see different parts of town or even meet again if I had more questions.
During our conversation I asked him about potential returns in our area. He answered as follows:
- In our market, there was a spectrum of what you could earn on rental real estate.
- On one end, you could earn a great deal (I don’t believe he gave me a percentage). But the homes were in “the hood”, there would be a lot of tenant hassles, and potentially a lot of fix-up/maintenance costs because the houses are older. But because you could get the homes so cheaply and the rents were at least decent (if you could keep the places occupied), you could earn a great deal — IF you wanted to deal with what was almost guaranteed to be a hassle property to manage.
- On the other end of the spectrum were homes in the very best areas of town. This was where everyone wanted to live and where many real estate investors wanted to invest. There was prestige in owning homes in these areas. The tenants were also generally better and the properties newer. As a result, the homes were priced higher and because rents can only go so high and expenses were high (like real estate taxes), the return wasn’t that great.
- He said that he wouldn’t recommend either end of the spectrum, but somewhere in the middle based on what I was comfortable with for a return and “hassle factor.”
From that meeting I took three months and read every library book I could find on rental real estate. Along the way I took notes and developed questions. I also searched online for more details and specifics. Then after I had this accumulated “book knowledge”, I called Eric back and set up another lunch. We discussed various topics and he answered my questions.
Then I asked him a point blank question:
Could I invest in rental real estate in our market, not in the worst areas of town but in “decent” areas, and earn 10% income back on my investment after expenses but before taxes and depreciation?
He said I could. He then told me that he had about $500,000 invested in real estate and earns about $80,000 a year on it.
We then had a bit more discussion and decided on the following plan of attack:
- I would make $300,000 available to invest in rental real estate.
- I would invest in 100% cash — not borrowing any money. (Yes, I understand leverage, but debt and I don’t get along. Besides, there is NO WAY my wife would take on debt.)
- The goal for him would be to find me properties that would earn at least 10% income on the investment before taxes (FYI, these are personal taxes — real estate taxes on the property would be included in the expenses) and depreciation.
- The places would be in “decent” neighborhoods and be low to moderate on the “tenant hassle factor” scale.
- He would search and recommend properties that fit this criteria based on his knowledge of the marketplace and our city. I can’t understate how valuable this service was once we started the process. If I had tried this on my own, I would be lost and/or have made several very bad mistakes.
- I would use him to purchase any properties that were identified in this way, hence he would be compensated by the real estate commission.
- If we were successful in generating the 10% (or more) return on the $300k, I could make more money available to purchase additional properties.
- We would diversify the purchases by looking to acquire properties with various prices, in various parts of town, with various types of tenants, and so on.
And that’s how it began.
Eric set me up with a regular email notice where I would get updates when new rental properties hit the market. He also sent me everything for sale in the rental market within our main county.
I looked through 200 or so different properties (on paper), trying to determine a pattern for what worked and what didn’t (or at least some sense of what was a good deal and what wasn’t).
He also sent me details on places that have sold, including his best guess on what the rents were for each property. This way I could estimate the sort of returns people were getting on their investments.
The process worked quite well (I’ll post soon on the properties I purchased.)
Where the Cash Came From
To bring this post to a close I should address where I got the $300k to invest. It came from the following sources:
- I took some out of my emergency fund. The fund was way over-funded — well more than six months of living expenses in it. So I took it down to 6-month levels.
- Some CDs (that were earning next to nothing) matured.
- I sold some shares in my Vanguard REIT index fund.
BTW, I considered buying properties through one of my IRAs, but since I might have wanted access to the income prior to retirement AND there are added fees (in the neighborhood of 1%) with purchasing this way, my CPA advised me not to buy through an IRA.
In conclusion, I want to note that in the returns above I am not factoring in any benefit of potential property appreciation. This could be substantial over a long period of time given that my real estate was purchased near its low point.