I hate generalized advice. If I’m curious about a topic, then I want to know the tactical steps I should take to achieve my goal.
So the only advice real advice I can give is based on my experience. The painful lessons I have learned, and where I’ve had the most traction.
Right now, my single family portfolio is 15 single family homes that produce just over $22,000 in gross monthly cashflow, and the great news is, creating this is totally doable by just about anyone.
Understanding the numbers and the impact these numbers can have on your life is essential before you get started. Here is a breakdown of how the numbers work on my advice on how to structure a very similar portfolio for yourself.
Cash flow is Step 1 and Equity is Step 2
Step 1: Cash flow – Identify where the biggest price to rent discrepancy exists (outside of war zones)
Understand home prices are not in line with rent prices.
I invest in the Chicago suburbs where the average house in a nice middle income suburb sells for about $250,000, and rents for about $1,700.
This is average, so it’s where the majority of people live and psychologically would be comfortable buying a rental property. As a result this is where most people will start to invest.
But we want above average results… way above average, so let’s figure out how to bring in the most rent for each dollar spent.
If we invest in a higher end area the home prices go up to, for Chicago, this would be a $500,000 home. The typical rent for this house would be $2,500. So for an extra $800 per month in cash flow, it costs you an extra quarter million dollars in purchase price.
The returns diminish as your housing price goes up. This is because the price of rent is highest for NEEDS, and tapers off for LUXURIES, whereas home purchase prices works the opposite way. A small modest house is super affordable, but luxuries like size, location, and fancy finishes, cost exponentially more.
Keeping this in mind, let’s analyze what happens if we buy a rental that is below a standard $250,000 home.
A nice small 3 bedroom, 1 bathroom ranch home in a working class area, what most people would call a “starter home,” sells for around $120,000 in the south Chicago suburbs, which is less than half the mid-range home average.
However, this house will rent for $1,400 per month. That means you are getting approximately $300 less in total gross rent for a house that’s $130,000 cheaper, and in this area you will still find quality tenants who will care for your property.
On top of this, your actual net income is actually even better than it first appears because pretty much all of your expenses go down on the $120,000 home as well, like taxes, insurance, and material costs (because of the smaller sq ft, and the expectation of acceptable finishes for the area).
You can go even further and find neighborhoods where the average cost of a house is $30,000, and rent is still around $1,000, but this is typically due to extremely high crime and other systemic issues that you can’t control, so bear in mind at some point the value of lower cost to rent ratios starts to diminish.
This is so important, because where real wealth is accumulated is in this sweet spot of affordable price to just less than average rent.
This also allows just about anyone to become a real estate investor, because with a little bit of frugality, a person on an average salary can save the cost of a down payment for a $120,000 investment house (usually around 20%).
So let’s run two scenarios out over a few years of investing. Let’s say you wanted to build a portfolio of 15 homes over the next 5 years. At the end of 5 years here are the numbers on the average middle class home and the more affordable working class home.
15 Homes ($120,000/home) – $1,800,000 total portfolio value – $360,000 total down payment needed – $21,000 gross monthly rent
15 Homes (250,000/home) – $3,750,000 total portfolio value – $750,000 total down payment needed – $25,500 gross monthly rent
As you can see, the difference between total down payment required to purchase the second portfolio is substantially higher, whereas the overall gross rent increase is minimal.
You’ll also find that the net cashflow is almost the same on both portfolios when you factor in the higher expenses on the higher priced homes.
Why save double the down payment to get essentially the same result in monthly cashflow?
Step 2: Equity – Force it, don’t hope for it
The way the majority of investors look at equity is they buy a home and try to pay down their loan and hope that prices go up.
Across all US real estate, prices have increased a few percent per year over the last 100 years.
The problem is real estate is hyper-local (for every area that sky rockets, another drops or stay stagnant) and you don’t have 100 years to wait around for big gains.
So the solution is forced appreciation.
This means buying a property that is less than ideal and doing something to it to increase the value, and thereby build equity.
I do this on every single property by buying the ugly duckling that needs a surface level remodel but is sound structurally and mechanically.
Think grandma and grandpa’s house when targeting properties. These are the perfect value add deals for massive accumulation of equity.
You will always get more return from fixing finishes (surface level stuff that you can see, like flooring, cabinets, and appliances) than you will from fixing the stuff behind the walls (like mechanical or structural systems).
When was the last time you heard someone walk in a house that is for sale and say to their spouse, we really gotta buy this one, looks at how they replaced all that cast iron piping with PVC. Replacing the cast iron with PVC is probably something that needs to be done in an old house, but unfortunately you probably wont increase the sale value of the house one bit by doing it.
That’s why targeting houses that grandma and grandma have lived in for the past 50 years are some of the best deals you can buy typically.
These are people that typically bought a very practical home and as the years went by, they kept the expensive systems maintained and updated when needed, but the less expensive finishes that really dictate the value of the home are usually original and outdated. These things can be updated fairly easily.
The point is to purchase the home at a price that the cost of the purchase and rehab is substantially less than the sale value.
Like mentioned above, I buy in areas where the typical re-sale value is $120,000 with rent of $1,400 per month, so I typically purchase for $60,000 and put an additional $30,000 into the rehab.
If you are doing both the first step (buying in the best cash flowing area) and the second part (building at least $30,000 of equity into each property by rehabbing the ugly duckling), this is like the crazy magical effective one-two punch of wealth creation.
Let’s go back to the scenario of buying 15 single family homes valued at $120,000 per house now let’s factor in what happens with forced equity through rehab.
15 houses valued at $120,000/house after rehab – $1,800,000 total value – Total cost is $90,000/house ($60,000 purchase and $30,000 rehab) – Still a total of $21,000 gross month rent – $270,000 is total down payment needed (because of the cheaper cost per house) and… are you ready for this… $450,000 of equity created
That last piece is insane and life changing to just about everyone. You create an extra almost half million dollars by doing this second step of buying something than needs work, fixing it up and then renting it, as opposed to purchasing a fully updated home.
Granted this is a little extra work, but doing a surface level remodel on 15 homes over 5 years while working a full time job is extremely doable, and is worth every ounce of effort.
Also, that $30,000 of rehab should factor in contractors doing all the work, not you swinging the hammer.
In both scenarios, whether you do the rehab and build the equity or you just buy a modest, already updated, house and just start renting it out, you will be brining in $21,000 in gross monthly rent which will put you financially ahead of 99% of people with just a full time job.
To me though, it’s sacrilegious to buy a property at market rent when with just a little extra effort you can still get all that cash flow… recurring… monthly… forever.. and a half million dollar cherry on top.
The numbers don’t lie. You’ve got the information. Now the question is what are you going to do with it.