There are many forms of buying, rehabbing, selling houses that are called real estate investing. Especially here in Kansas City where our relatively low prices make it easy for east and west coast money to come in and attempt to manipulate our real estate market. Yet, I’d like to purpose to you that the best way for most rank and file, mom and pop if you will, real estate investors is to get rich slowly through real estate investing.
No. It isn’t sexy. No. I don’t get to stand up in front of big crowds, play loud music, speak super fast and tell tales of a deal I did six years ago like it was yesterday. But I do get to help many professional wage earners to secure their retirement worth having through the strategy of buying right and holding the property through successful property management whether that be through their own efforts or that of a professional property manager.
Take the following scenario available in Johnson County, Kansas ( a suburb county of Kansas City, MO) in the town of Olathe.
Ranch house priced at $185,000 because the owners have been in there quite a while and it needs some (quite a bit) of updating. New carpet, paint, fixtures, etc. The After Repair Value is around $195,000 – $205,000 depending on said updates. So not nearly enough to flip, but again, a ranch home in Olathe, Kansas with great schools. A solid rental house for years to come.
Let’s say you buy at $180,000 (I have no inside knowledge, just an assumption) and put 25% down ($45,000). That leaves a remainder to be financed of $135,000 and let’s just say that you get an income property interest rate of 5%.
Principal and Interest equal $724.71/mo.
Now we have to figure expenses, right? For updating, I’m just gonna throw in about $12,000 for all those updates we spoke about. I believe you could do it a little less expensively and yet we are working the property up to the standards that today’s renters are looking for when they lease a home. So yes, you can skimp. And yes, it will cost you vacancy time. In other words, you need to have your home up to the same standards as the homes around you. That will be an immediate cash expenditure, bringing your total investment up to $57,000 in the home. (The down payment plus improvements.)
Now lets talk about rents. A quick look around on a few rental website and comparing some of the 400 plus homes we manage at Ad Astra Realty, Inc Property Management and I believe the rents will be between $1,450 and $1,525. So let’s say $1,475 as the rents. Is that okay?
Expenses will matter, too. We need to account for insurance and taxes and let’s add in some property management, a few unexpected repairs for the year and utilities while the place is empty….which brings up vacancy.
Historically speaking, we used to count vacancy somewhere in the 10% range when doing these figures. Yet, since 2008 I have been hard pressed to find vacancies above 5% here in Johnson County, Kansas. So I’m gonna use 5%.
Now it is math time.
$17,700 Gross Rents minus
$ 885 Vacancy
$ 1,200 Insurance
$ 2,682 Taxes (2018)
$ 200 Utilities
$ 900 Repairs
$ 500 Misc (because)
$ 1,976 Property Management (includes lease-out)
$ 8,697 Principal and Interest
= $660 Cash Flow Before Taxes (Wooohooooo! You’re rich.)
No, $660/yr cash flow isn’t gonna make you rich. Heck, that is only $55/mo m/l. And if you are the type that manages your own rental homes, well, you can add another $1,976 to your earnings. But since most of my sales clients hire me to manage their properties, I thought I’d add that in.
What are the other ways you are making money on this home?
Well, let’s see. There is Principal Reduction. The fact that your tenants are making your house payments for you is terrific! Consulting an amortization table I calculate that your tenants have paid $1,829.53 of your balance in the first twelve months. (Of course, that goes up each year because of the way home mortgages are amortized.)
Then there is Depreciation. You get to tell the government your home is worth less each year. (What a great country!) That is another of the 4 Benefits of Real Estate Investing. That’s another $5,200 m/l in benefits of the property.
Interest totals $6,704 after a year. We get to deduct that as well. So with Depreciation and Interest we create roughly $11,900 of deductions. Say you are in the 32% tax bracket and after subtracting those deductions from your Net Operating Income of $9,357 you have created a tax savings of $813.
Now let us figure your return. Your total benefits without appreciation add up to
$ 660 Cash Flow Before Taxes
$1,829 Principal Reduction
$ 813 Tax Benefits
Total benefit of rental home before appreciation is $3,302.
You invested $57,000 in the home between purchase and fix up. So your overall return the first year is roughly 5.8%
Is that good? Is that bad? I don’t know. Maybe you are making more than that somewhere else? Everything is relative.
Appreciation is where the magic happens though appreciation is only something I can tell you happened as I simply cannot predict what it will be. I can use history. Through the ups and downs of the many economies I have seen in my real estate career since 2002 I can show you that in Johnson County, Kansas appreciation has been pretty darned close to a 3.5% straight line. So can we use that?
If I have your permission then, let’s just say that the $195,000 appreciates 2.5% in 2019 as that is about where I expect it to be. (Again, I never really know.) That adds on $4,875 in benefits. Now you have the 4 Benefits all together and that totals $8,177. So your return skyrockets to 14.3%. Follow me?
The real money made in real estate investing in the Kansas City suburban city of Olathe is in the appreciation. Time is working for you, not against you. And your tenants are paying down the house all the while!
It’s getting rich slowly through real estate investing. Pencil it out another ten years and see the equity you will have and the return that grows as rents creep up while your payment remains the same.
Now obviously, I cannot guarantee any of this. I can only tell you what has worked for me and my clients since 2002. If I can be of any service to you, don’t hesitate to contact me. I’m easily found. Just look in the Contact Information up and to your right.