Rental Properties = Passive Income

I can't tell you how much I love getting extra paychecks every month! I get them from my rental properties in California, Arizona, Texas and very soon Detroit, Michigan and Indianapolis, Indiana. (See Rental REI for more information).

First of all, let me share with you an unusual perspective I have regarding Rental Properties. This perspective is quite different and actually goes against some of the real estate investing gurus who say:

"You make money when you buy, not when you sell!"

Although I tend to agree with this statement, I also see the need to diversify your thinking. Let me share a story with you to tell you how I arrived at this different type of thinking regarding rental properties.

Several years ago, I had the opportunity to purchase a five-unit property in Los Angeles. This was quite a while before the California boom hit and real estate prices went soaring through the roof. For memory's sake, let's say the price of the property was about $385K.

After doing the math with the best case scenario, this purchase would have resulted in me taking a $470 per month loss. Technically, the numbers did NOT work. I remember being a newbie on a particular "Dad's" website and posting a question for the "advanced gurus" to answer. Basically, I wanted to know if I should go for it.

I posted my question with full knowledge that since everyone on the forum was a dutiful student of "Dad", I would get some responses in the negative. However, along with my question, I posted my rationale.

Rationale:

What if you look at Real Estate Investing as your 401K. Just as you schedule your paycheck to have several hundred dollars taken out and put into a matching contribution fund with your employer, what if you took that exact same amount and used it to pay the "alligator" of a property? (An alligator is the extra amount you have to pay on a rental property when the rents do NOT cover the mortgage and expenses).

After the same 30 years of investing, wouldn't your "real estate 401K" actually be worth more than your employer sponsored 401K? Not only that but after maybe 5-10 years, two other possibilities would likely surely occur.

#1. You could raise rents enough to eliminate the alligator

#2. The property would increase in value.

If -I should say "when" - the first option occurs then of course you either are breaking even or are now getting a positive cash flow. But more importantly, when the second option occurs then you can re-assess, which might look something like this:

Let's say for the sake of argument that it took five years for you to consistently raise rents enough to cover the $470 alligator. You would have spent, let's say $470 per month times 12 months per year times 5 years, or about $28,200 to feed that alligator. That's a lot of money, right.

IS IT????

Well, here's another calculation that might put this into perspective. Rental properties appreciate, or increase in value, on average about 7% every year. OK, now let's do some math!

A property that is worth $385,000 will appreciate 7% in one year. So one year after you purchase the property, it should increase by $26,950 ($385,000 times .07 = $26,950). So now the property is worth $411,950 ($385,000 + $26,950 = $411,950).

The next year it should increase by $28,836.50 ($411,950 times .07 = $28,836.50). This means that after two years the property is now worth $440,786.50 ($411,950 + $28,836.50 = $440,786.50).

Shall we continue??? Or do you see where I'm going with this?

The following year, it should increase by $30,855.02 ($440,786.50 times .07 = $30,855.02). The property is now worth $471,641.52 ($440,786.50 + $30,855.02 = $471,641.52.

Again for one additional year, it should increase by $33,014.91 ($471,641.52 times .07 = $33,014.91). So, in the fourth year after you purchased this property for $385K, it is now worth $504,656.43.

Summary:

You've paid $28,200 for five years.

BUT.... You've made $119,656.43 in equity.

And you've done it in five years!!!!!!

I have yet to see an employer's 401K, 403b or 123X accomplish that rate of return on your money! And more importantly, 401K Rental Properties are pension plans that can never be stolen from you by corporate executives!!! (Learn more at REI School.)

Options! Options! Options!

So, now theoretically, you can sell the property and walk away with about one hundred grand profit.

You could refinance and pull out that one hundred grand and keep the property (to repeat the process in another five years!)

Or, you could just do nothing but sit back with a smile, and know that: a) the rents now cover the mortgage and expenses

b) your property has increased in equity &

c) you are the smartest thing since black patent leather shoes!

Sounds like a win-win-win choice to me. I don't see how rental properties can Not work if you've correctly run the numbers!

Back to the I-posted-this-question-on-Dad's-Forum Story....

I can't begin to tell you the mean things some of those folks said to me. They basically said I was an idiot...that my logic didn't make any sense. After all, the guru had spoken, and since he said "You only make money when you buy not when you sell" how dare I oppose or question his logic.

I wish I could write that I threw caution to the wind and checked with my crystal ball and knew that in a few short years, the California real estate market would experience a three-year boom that sent that property and many more upwards in value, doubling and almost tripling the purchase price.

But alas, I was alone in Dad's world and nobody saw my vision. So, I doubted myself, listening to others who I thought new better than me, and I didn't buy the alligator.

And you know what? That is totally alright with me. Why? Because now I can use this experience to show someone else the lesson about how to extensively analyze potential rental properties.

LESSON # 47: Follow your OWN logically-sound thinking and reasoning!!!

So, when it comes to Rental Properties, please understand my experience and history. I clearly see Rental Properties as giant piggy banks. If I am able to drop a realistic amount of coins into my piggy bank every month - meaning I can afford it and still have money left over after all the bills are paid - then I'm happy to feed the pig.

I know that this pig is a 30-year-maturing pig. And man, when this piggy is all grown up, he will feed me and my family for a long, long time!

But don't get me wrong, it is definitely BEST to find piggies that don't require ANY coins every month. It is BEST to find reverse piggies who pay YOU a few coins every month and who will, after 30 years, still feed you and your family for a long, long time. (Note: By the way, I use 30 years because traditional mortgage loans are paid off in 30 years at which time the property will be free and clear!)

That's the true beauty of Rental Property. If you can find potential rental properties that

(a) someone else volunteers to take care of;

(b) pays your mortgage for 30 years; &

.... are you kidding me?

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