Sorry, But Investing in Rentals Won’t Build Massive Wealth.
You may remember an article I wrote a while back regarding what being a CPA has taught me about becoming a millionaire. I wrote that article because I am able to peer into the lives of financially successful men and women. In doing so, I’ve noticed trends that these people possess and I wanted to share that with the world.
Since writing that article, I have continued identifying similarities among my most financially successful clients. I do this by harnessing my natural curiosity and turning tax calls into wealth-building Q&As. (Yes, sometimes I get too excited and forget that the client is calling ME for advice and not the other way around.)
Regardless, I want to share with you a revelation I have identified that honestly is not surprising, shocking, or head-turning. But it does go against the grain of what is preached continuously on BiggerPockets.
Are you reading this blog to know the tips and tricks related to making money with rental properties? Do you want to become rich through rental properties and become a millionaire? Well, to begin with, making money with rental properties is a process that can actually make you rich if you work hard to be a successful real estate investor. It is of great importance to know that succeeding in real estate is all about making the right investment decisions at the right time.
People often ask us why they should commit the time and energy to buy a rental property when the cash flow is so low. Is it really worth it for a doctor or other high-income earner to deal with the headaches of owning rentals instead of just working at their day jobs?
The truth of the matter is this – one rental property isn’t going to make you rich. And neither will two or three properties.
If you get an average of $250 per door per month in cash flow from a rental property, investing in a duplex will only net you $6,000 a year. Three of these net you $18,000 a year.
This is peanuts compared to a $300,000 per year salary of a high-income earner. You’d need a lot of duplexes before you could even consider cutting back at work.
So why should a high-income earner like a doctor invest in rentals? Is it even worth it?
How quickly can a person build wealth without a six-figure salary reach financial freedom in real estate? 5 years? 10 years? 30 years? Evan Roberts called it in two.
I’ve never met Evan in person, but by sheer coincidence, he grew up in the same working-class suburb of Baltimore that I did. Even stranger, he spent most of his adult life living in the same gritty-chic downtown neighbourhood that I did.
But what we really share is our passion for passive income from investment properties. Here’s Evan’s story, no punches pulled, about how exactly he grew his net worth and reached financial independence in just two years.
Investing in Rental Properties to Build Wealth Is Too Slow
I can’t tell you how many people come to me saying that they want to cash flow $10,000 per month. That’s a worthy goal, and there’s nothing wrong with it—except for the fact that you’ll need to invest roughly $800,000 (that’s equity, not market value) of cash to achieve that level of cash flow.
How long will it take you to save up $800,000? Years probably, maybe even a lifetime.
And that’s the problem with rentals. They simply don’t cash flow enough to generate massive wealth.
You may say that you can buy property at discounted rates, rehab, rent, refinance, and repeat. But we’re still looking at a long—very long, in fact—path to massive wealth generation.
The problem, as I see it is scalability. You can’t scale a rental portfolio the way you can a business. It requires too much capital, too much planning and overhead, and too much time.
Sure, Rich Dad says that investing in rentals puts you in the correct “Cash Flow Quadrant.” Still, they don’t tell you that it’s going to take years—maybe even decades—of portfolio-building to create a stable stream of income that guarantees financial independence. They don’t tell you that you must painfully save to buy one rental property per year, which adds only $6,000 to your annual bottom line.
No one talks about how darn slow investing in rental properties will build your wealth. People only talk about how extraordinary rental properties are, mainly because they have something to sell you. And that something requires you to buy rental properties.
Turnkey companies are one of the worst abusers of selling you the dream of owning rental property. There are great ones out there, but they aren’t building a rental portfolio for themselves. They are building a business that sells the idea of owning rentals for long-term wealth to you!
If the companies claiming that rentals will build massive wealth for you aren’t buying rentals for themselves, what does that say about the product they are selling?
I feel sorry for the folks who have multi-million dollar net worth goals and think rentals will get them there quickly. It’s just not going to happen.
This takes so much time and effort; it isn’t worth it.
It’s during this first phase that you buy your first rental property and you realize that the cashflow you get for all of your efforts is extremely low. Your time is more valuable than this.
So what is this phase really about?
Forget about cashflow; this phase is about getting an education and putting yourself on a path to financial independence.
Buying your first property is about things other than the money. It’s about overcoming inertia and analysis paralysis and real-life knowledge accumulation.
You have to realize that most people who want to invest in real estate never get started. They either lose interest when a phenomenal deal isn’t handed to them immediately, or they get stuck in analysis paralysis, looking at different arrangements and unable to pull the trigger because they can’t be sure about the outcome.
This is why we feel that the most important thing to do is to find a decent deal and move forward and buy it.
Let us make something clear: Your first investment property does not need to be a home run.
Whether your first property earns you $200 a door (an average deal) or $500 an entry (a phenomenal deal) in cash flow, it really doesn’t matter. Your first property will not make you wealthy (unless, of course, you start off with a 100 unit property!).
So now you probably own enough units that your cash flow is in the tens of thousands, and you’ve been reaping the tax savings of REPS. The combination of these two means you’ll probably start noticing the benefits of rentals.
However, for a high-income earner, it may not be enough to be able to cut back significantly at work. It may feel like it’s going to take a long time before you can fully replace your income.
This is a legitimate concern. Buying one or two rentals a year is a long path to growing your passive income.
So what is this phase really about?
This phase isn’t about cashflow; it’s really about using appreciation to grow your net worth exponentially.
What might have felt like decades before you could grow your cashflow high enough to replace your income could potentially be cut down to several years.
In our case, for example, our net worth from rentals has more than doubled in less than four years from property appreciation.
In one case, one of our properties appreciated almost $250,000 in about two years. We sold it through a 1031 exchange and re-invested this money, increasing our cashflow a total of $25,000 a year by turning over this one property.
We have several other properties that have appreciated to a similar extent, so our current plan is to use that appreciated value to purchase larger apartment complexes and hopefully double our cashflow over the next two years.
This step-up growth fueled by appreciation, when combined with our practice of recycling our yearly cashflow earnings back into our business, will mean that we will have replaced Kenji’s clinical income entirely in less than six years.
So now you can see how appreciation can result in a step-change increase in wealth and grow your cash flow exponentially.
And for us, it all started with a single duplex.
This is the outcome of thinking big. And this is why we are here, trying to help all of you build your real estate investment empires too.
How To Make Money In Real Estate And Get Rich?
There is no short cut to make money in real estate or to get rich quickly, but you can slowly and steadily build wealth through successful real estate investing. Investing in real estate stands out as a tried and tested approach to make money, but like every other business, it has some risks associated with it. If done the right way, real estate can be a great source to build wealth. Generally, there are two primary ways to make money from real estate—Appreciation, which is an increase in property value over some time, and rental income collected by renting out the property to tenants. But we shall discuss some more well-known ways to make money in real estate which include both active and passive investing.
There’s an opportunity for greater and more consistent returns with real estate than with other investments. When a property is built, it’s because a group of people see a population large enough to justify it.
“The sheer number of new properties each year is a testament to the growing real estate market. Supply follows demand, and demand is continuing to rise. Populations rarely decrease, which is why the need for housing increases year over year.
The market for multi-family apartments, in particular, is growing. As apartments become more attractive, people are less likely to buy houses. With multi-family apartments, you continue to generate increasing income over time.
Once the property stabilizes, you can collect returns for your investors until you decide to sell. There’s also demand year-round wherever you go.”
Making Money in Real Estate Through Rental Properties
This is the traditional way of making money in real estate and getting rich. Lords and nobles fought over titles that let them collect rent from those living, farming, and otherwise working the land. A few entrepreneurial types drained swamps and built businesses so that they could make more from the ground than they would if they merely leased it out to farmers and ranchers.
We’ve come a long way in the intervening ways, providing many options for those who want to know how to make money in real estate. You may buy land, build a home, and then rent it out. You could find distressed properties, rehabilitate them, and then rent them out. Turnkey properties were purchased by someone else who rehabilitated it before finding a tenant. Regardless of how you acquire the property, it is a buy and holds strategy.
You can own residential, commercial, and industrial real estate property. One of the most significant benefits of owning rental real estate is the steady cash flow it generates. It is the best form of owning investment real estate for earning a passive income. The downside of this approach is that you’re putting all your eggs in relatively few baskets. If there are issues with the apartment complex you own, the rental income from it suffers as people leave or the repair costs eat into your profits.
This strategy is probably the one most likely to let you generate a steady income that is large enough to live off of once you own multiple rental properties. You may be able to utilize this strategy if you cash out money from a retirement account or equity in your home. If you want to know how to get rich in real estate, understand that this is one of the most secure routes to doing so as long as you manage expenses and the properties themselves well. Melbourne is a perfect real estate market for buying rental properties.
Know the rules for evicting tenants and raising rental rates if you’ll be managing an apartment building. Understand the local building code, community norms for properties in the price range you’ll be buying and cost-effective upgrades if you’ll be buying and flipping properties.
You can’t afford to lose money, turning a middle-class home into the only luxury property on the block. All of this requires the money to buy the stuff. We’d recommend saving up or tapping into funds you have to put down the first down payments on single-family homes or small multi-family housing units. This may come from your savings, equity in your primary residence, or a retirement account.
We’d recommend borrowing against your 401K since the money has to be paid back within a few weeks of losing your job or else you have to pay taxes and a penalty on it. You’d almost be better off pulling money out of an IRA. You have more control over the fees and taxes you’d pay. Set aside thousands of dollars in an emergency fund to cover unplanned repair bills, surprise legal fees, and other costs you haven’t adequately taken into account.
Then you don’t end up cutting into your cash flow with high-interest hard money loans to pay for the little repairs needed to legally rent out the unit or hit your credit cards to pay contractors. Buy a single property with your cash down payment, a mortgage, and your business plan. Set the goal of renting out the unit for 1 percent of its total value per month.
For example, a 100,000 dollar house should rent for around a thousand dollars a month. Then apply your strategy. Sell the fixer-upper or collect the first few months of rent from your new tenant. Rebuild your emergency fund, since you may need thousands of dollars to fix a broken water heater or hole in the roof. Save up enough money for your next renovation or down payment.
Then seek a mortgage to buy that next property and repeat the pattern. Don’t rush out to buy a bunch of stuff. Debt multiplies risk, and you don’t want to end up with a million dollars of outstanding unsecured debt because you tried to manage ten rental properties without any experience as a landlord. Nor can you afford to make a mistake with a property management company. Don’t try to fix and flip several properties at once. Grow slow so that you have the margin to absorb the cost of mistakes.
This is why you should be buying one to three rental properties a year, not the ten some property investment programs recommend. Buy and flip one property at a time, no matter how long that takes, until you have the expertise or expert contractor on your team to handle several such renovations at once. Buy a small apartment building and learn how to manage it or find a good property manager to do the work for you.
Remember that every month results in increased equity in the property, and that’s aside from the income you’re earning. You could dramatically improve the cash flow if you aggressively pay down the outstanding mortgage on a property. For example, you go from making 300 dollars to 1000 dollars per month per single-family rental home.
What is a property that turns out to need far more work than you expected? What if the apartment building isn’t working out as expected? Sell it, pay off the debt, and then start over with the cash you have leftover. You will eventually be making millions in real estate as you build up your real estate portfolio, and you could see a million-dollar net worth in less than five years.
If you own dozens of rental homes, consider selling them to buy professionally managed multi-family housing. When you’re ready to earn truly passive income, that is one route. Selling the properties to other investors and investing in real estate investment trusts or shares of a property managed by others is another.
Getting Rich By Flipping Real Estate
This is another proven way to make quick money in real estate to get rich. Fix, and a flip is a specific form of real estate investing. The investor buys a home, pays for repairs and renovations, and then sells the property for a profit. This type of real estate investing is the subject of numerous reality shows. The reality is that this form of real estate investing is high risk. If you’ve underestimated rehabilitation costs, you could lose money.
If you put too much money into the investment property because you don’t understand your target market and buyer expectations, you’ve probably wiped out your real estate profit margins. Whether there are problems with the selling price, the real estate agent, the neighbourhood, or how the property looks, every month the house sits on the market subtracts the property’s carrying costs from your profit margin.
If you try to do the repairs yourself to save money, the theoretical savings on labour costs are offset by the delays in getting the property to market. If you’re not already a skilled building contractor, there is a risk that DIY repairs don’t meet code or potential buyers’ expectations. Then you may lose everything on the deal because you have to pay for someone else to redo what you thought was done. The ideal fix and flip is a property that only needs cosmetic repairs, but these are truly rare.