Most people stash away money for retirement by putting it in a 401k or IRA in hopes that it will grow and compound over time allowing them to retire comfortably at 65. They siphon off a portion of their income each month into their savings, working hard to build as large of a nest egg as possible. They scrounge and scrape together all that they can while simultaneously living frugally to reduce expenses to ensure they will not outlive their retirement accounts. This is the traditional middle-class American's approach to building wealth and saving for retirement. Now, saving money in a 401k or IRA isn't a bad idea but if it's your only means of saving it quickly becomes difficult, restrictive, and time-consuming. But what if you could put in a bit of work up-front to create a compounding savings account that someone else would fill for you? What if each month you had 5, 10, or even 100 people adding to a multitude of savings accounts, all owned by you? How would this affect your ability to enjoy your retirement and enjoy more of your income now? We'll come back to this a bit later.

Is real estate about cash flow?

When the average person thinks about owning rental properties, the canon for success is often the amount of monthly cash flow made after all expenses. Novice investors expect to buy their first house and have hundreds of dollars of extra income coming in each month after paying the mortgage/expenses. However, if you talk to successful investors you will often hear that $100/month in cash flow per unit (on a multi family property) or $200/month per single family is the metric they use for a successful investment (After ALL expenses). $100-$200 a month in cash flow per unit is not a very substantial income and would require a significant amount of doors to replace one's salary. So how do the wealthiest individuals in the world often get there by owning real estate?

Amortization

Let's go back to our thought experiment from the first paragraph, what if you could create savings accounts that others fill for you? You can, that's exactly what you're doing when you invest in real estate and your tenants pay down the loan. Let's say you buy a 4-plex for $500k as your first investment property. You put work in initially to fix it up and ready the units for new tenants and then you give it to a property manager to handle. Now this is your first investment so it's reasonable to assume you may have paid close to market value for it and perhaps didn't get the best deal. Because of this, you break even every month on your expenses. Additionally, you bought in an established, east-coast town with a stagnant population so it doesn't appreciate either. On the surface, this doesn't sound like a very good investment. However, you now have a savings account that someone else is filling for you and all that you have to do is manage your property manager and read your financial statements each month. You put in an initial time investment when you purchased the 4-plex but now do little to no work while your tenants pay the property off for you. With this one investment you will now have a half million dollars saved (by other people) for you in 30 years that requires minimal effort. As if that's not enough, imagine if it did appreciate, cash flow each month, and lower your taxes? That sure would be a powerful wealth builder.......

Appreciation

As previously discussed, when owning rental properties someone else pays down the mortgage for you which is powerful as is, but what about the appreciation that (historically) can be expected when buying property in growing areas? Let's take the aforementioned example of the $500k 4-plex purchased on a 30 year mortgage. Again, let's assume that overall you're breaking even on cash flow every month but you purchased in a decent area and average 3% appreciation over the life of the loan. What would the value of that property be at the end of the 30 years? Well, let's see, $500k compounded at 3% annually for 30 years comes out to $1,213,631. By purchasing a single 4-plex and putting in a few weekends of work up-front to renovate it, you now have over 1.2 million dollars of net worth that someone else paid for. Now again, in this example we didn't get a good deal so we weren't getting cash flow over the 30 years and we only ran the numbers at 3% appreciation on average when in reality it's 100% feasible to get much more if you buy correctly. Are you beginning to see why the wealthiest people in the world almost invariably own real estate?

Real estate requires patience 

More often than not, people begin investing in real estate because they want to escape their day job. New investors want to buy several properties over a short period of time and live off of the income without having to work. They hear stories of successful investors who have been in the business for a decade or more and expect to get there in a quarter of that time. The problem with this is that the much of the wealth building comes from the amortization & appreciation which does not happen quickly. Your property will not appreciate substantially over night and you can amortize a loan in much less than 30 years but it will still take time! For this reason, successful real estate investing is best paired with a high-income career or profitable business. It's very difficult to (in a short time) go from a traditional day job to full time investor without also creating an income stream from the more active (i.e. starting a business) pursuits in RE such as flipping/wholesaling/etc. You absolutely can (and should) buy rental properties that cash flow each month. However, those who accrue millions (or even billions) of dollars from RE investing do so by purchasing property in growing areas and holding them (while occasionally trading up with a 1031 exchange) which allows the compounding of amortization & appreciation to take effect!

This blog was written by Dan Haberkost:  dan.haberkost@gmail.com, 330-410-4952