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Investment Fundamental #8 – Real Estate

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4 plex investment

Wow, it’s been a month since I wrote #7 – Stock Participation Plan. December was a busy month for the blog as there were so many topics to cover.

On to #8 – Real Estate. I am talking about about buying a home to live in and also keep personal finance in the equation. Of course, the best way to do this is to purchase a fixer upper, put some sweat equity into it, and then resell the place after a few years. This is a great way to generate equity and you don’t even have to pay any tax on the gain as long as you live there for at least two years. However, that’s a hard sell to many people, me and the Mrs. included. Instead, we went the easier route and purchased a home we liked about 5 years after I started working. This was our first home and it was a modest home in a newer up and coming neighborhood in the suburb.

Best Homes For Sale at www.zillow.com

In 2000, the local housing market was doing pretty good, not too hot and not too cold. It was a great time to buy because the real estate bubble hadn’t quite begun to inflate yet. The one thing we did correctly was to get a 15 year fixed rate mortgage instead of the usual 30 year. The payment was pretty high, but we were able to afford it with 2 salaries. Eventually, we refinanced to get a lower rate and the mortgage payment went down significantly. We were able to grow our income and inflation also helped ease the pain of the mortgage payment after a few years. This is probably the only time I will ever say that I like inflation.

We downsized to a smaller condo in 2007, but kept the house as a rental. We missed the boat during the real estate bubble and could have cashed out for a great profit. In hindsight, this didn’t hurt us too badly because about 75% of the rental income goes straight to our net worth today. If we sold the house in 2007, I would have put the profit in the stock market and lost a large % anyway. I am not good at keeping cash around because I’d rather invest.

Here are my real estate investing strategies for regular people, the non-handyman types like us.

  • Buy only as much home as you need, don’t take into account future expansion. If you are a couple with no kids, then buy a one or two bedroom condo. Once you out grow it, move and rent out the old place.
  • If the bank will lend you $$$, buy a duplex instead of a stand-alone house. You can rent out one unit and live in the other. In 5 to 10 years, you can move and rent out both units.
  • If you can get a 15 year loan, do it so you will get to positive cash flow sooner. After 10 years, 75% of the mortgage payment goes to the principle. If we had taken out a 30 year loan, only 35% of the mortgage payment would go to the principle after 10 years. Try it in a mortgage calculator.
  • Get a property management company if you don’t want to deal with the renters or with fixing things. πŸ™‚

Right now we have a rental home and a 50% interest in a rental condo and I am looking to acquire another investment property in 2011. I found out that it’s more costly to buy an 4-plex investment property than a home to live in. The finance guy at the bank told me it’ll cost an extra point if it’s a 4-plex and another .75 point if the owner does not live there. I am going to fill out the prequal application soon so I can find out how much the bank is willing to lend us.

What do you think about this post? Good solid strategies or another crazy idea at Retire By 40?

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{ 42 comments… add one }

  • Joe Plemon January 5, 2011, 5:57 am

    I think your strategies are solid, especially the 15 year fixed rate loan. Whereas you are obviously comfortable being a landlord, this isn’t for everyone because of the hassle factor. Also, one has to be careful not to create too much debt because of the risk involved (loss of income while making big payments). However, taking things slowly like you have been doing makes a lot of sense.

    My son and I are in the middle of a house flip, in which we are doing all of the fix up work ourselves. Hopefully, we can have it on the market this spring. We think we will do all right, but time will tell.

    • retirebyforty January 5, 2011, 10:02 am

      Hi Joe, we are not that comfortable being a landlord. We have a property manager for the rental home. I manage the rental condo myself because the maintenance work there is much less. I would love to buy a fixer upper, move in, fix it, then sell it. I think this is a great way to generate income. Unfortunately, I am not a great handy man, but I’m improving slowly. The Mrs. also hates moving so this won’t work in the long run.
      Good luck with your fixer upper. I read about the works that you are doing with your son, great job so far. We also don’t have much time to work on fixing things.

  • Darwin's Money January 5, 2011, 6:54 am

    I feel like not getting into a real estate rental investment is my biggest disappointment as an investor. I do love diversifying asset classes, high ROI and long-term investments. It’s perfect. I just never made it happen. Well, maybe this will be the year!

    • retirebyforty January 5, 2011, 10:02 am

      I think now is a great time to get into real estate. It might not be the bottom, but I think the price is fair these days. Keep looking and you might find something irresistible. πŸ™‚

  • Aloysa January 5, 2011, 7:48 am

    A landlord thing is not for us. We did buy a one bedroom condo because we don’t have kids and we are not planning on having any. We are staying there for a while and then… maybe in a few years we might buy a small house where we want to retire. We would not rent out our condo because we don’t want to deal with renters. I have friends who are landlords and Good Lord! All the stories they told me. πŸ™‚ Good luck with your plans!

    • retirebyforty January 5, 2011, 10:05 am

      Don’t dismiss being a landlord. You can get a property manager to do all the dirty works for you. That’s what we did with our first rental home. In 5-6 years, I bet you will be able to get enough rental income to cover the mortgage. Then it would make sense to keep it, right? πŸ™‚

  • MoneyCone January 5, 2011, 7:49 am

    Wow! You guys have pretty good with a solid plan and almost flawless execution! I don’t think not selling the house during the peak will hurt in the long run. (The housing market is not going to be down forever!).

    • retirebyforty January 5, 2011, 10:09 am

      Thanks for the compliment, but our execution is full of flaws! Hindsight is 20/20 of course, but looking back we should have sold the house, sit on the cash, and rent for a couple of years. In 2010, the local market mostly bottomed out and we could have bought some nice properties for a great discount. But like I said, I probably would have lost a lot of money in the stock market if I did that so it turned out ok after all.
      Flawfull execution is still better than no execution at all though. πŸ™‚

  • retirebyforty January 5, 2011, 9:57 am

    I plan to have about 50% of our net worth invested in real estate eventually. This sounds like a lot, but I am looking at my long term goal of retirement. I am looking to generate rental income to supplement other incomes and probably will hold the rental properties for a long time. An additional of a 4-plex into our rental portfolio should generate what I’m looking for in the long term. We probably won’t get into the house flipping business. Thanks for your suggestions.

  • BeatingTheIndex January 5, 2011, 10:22 am

    Don’t look back to the past with should’ve could’ve and would’ve. The fact of the matter is you are doing great and the real estate market will recover sooner or later. The recovery timeline should not matter since you are exploiting the house nicely!

  • First Gen American January 5, 2011, 11:46 am

    You forgot the most important part of the advice, Location, Location, Location.

    I think this is good solid advice if your property is an desirable area that has a lot of young professionals. My mother was able to live off her minimum wage job because of the 3 family home she bought. I don’t know how we would have survived without the rental income.

    Then a few years ago, her neighborhood went from bad to worse and it was impossible to get quality tenants after that. After 3 horrible tenants in a row, we realized that it was not a viable location anymore and sold. Don’t underestimate the importance of a good location.

    • retirebyforty January 5, 2011, 6:52 pm

      Location is definitely one of the most important thing to consider. We lived in these places so we definitely took location into account. We’re too soft and squishy to live in the ghetto like Babci did. πŸ™‚

  • Buck January 5, 2011, 12:44 pm

    Who is this, Donald Trump?!?! πŸ™‚ Great advice and excuting of your plans. Hindsight is 20/20, don’t forget. Good points on 15 year mortgage and using a management company to deal with the headaches, money well spent in my book. Would you ever consider using adjustable rates to take advantage of the rock bottom rates and flip into a fixed down the road to lock in?

    • retirebyforty January 5, 2011, 8:11 pm

      That’s me Trump Jr. πŸ™‚
      I don’t like adjustable rates, the rate will only go up later. If I take a fixed rate and interest rate goes down, I have the option to refinance. Real Estate specialist probably knows more tricks than I do though.

  • Jessica07 January 5, 2011, 12:49 pm

    I think you really hit the nail on the head when you advise to only buy as much as you need. It’s easy to go crazy when searching for a home, but really, in the end, “enough” is plenty.

    • retirebyforty January 5, 2011, 8:12 pm

      Enough is good for us. We concentrate on location these days.

  • Little House January 5, 2011, 4:02 pm

    I really like the idea of a 4-plex and living in one of the units. I’m still dreaming of my own bungalow style design in the future, but even though a 4-plex might cost more to finance (as you found out) it would definitely be worth renting out the other 3 units.

    As for buying only what you need, I agree. No need buying a huge house, then there’s just more maintenance and more to clean!

    • retirebyforty January 5, 2011, 8:13 pm

      I’m pretty sure duplex does not cost extra points so that might be a good way to go too if you’re just starting out.

  • Nicole January 5, 2011, 4:25 pm

    Ditto on what FGA said. Even with a property manager there are risks to owning real estate. College students could destroy the place. A husband could murder his wife in the study. It could remain vacant for months. A water main could break. There’s insurance for some of these things but they still take a stomach of steel to deal with.

    My dad played landlord when I was growing up, renting out places we’d lived in after we moved to follow my mother’s job. Definitely not something I ever want to do if I don’t have to.

    • retirebyforty January 5, 2011, 8:14 pm

      Yikes, we’ve had pretty good tenants so no problem yet. You have to do a lot of works up front to screen the tenants. I’d rather take a bit less rental income and have a great tenant. It sounds like eventually every landlord gets to meet the tenant from hell.

      • Nicole January 6, 2011, 3:39 pm

        On paper there was nothing indicating that that nice middle-class couple’s marriage was in trouble…

  • Roshawn @ Watson Inc January 5, 2011, 5:17 pm

    Very interesting strategy. I hear well-deserving caution in your advice, which is so refreshing because many real estate investors lack risk meters. Cheers for your plan.

    • retirebyforty January 5, 2011, 8:15 pm

      Thanks Roshawn! We are pretty slow with real estate and take the long term view.

  • Barb Friedberg January 5, 2011, 5:33 pm

    Very sensible ideas. Now is a golden time to buy real estate, with low interest rates and deflated prices. The only down side is management can be time consuming and hiring a management co. dips into your profits. You are doing it right. Definitely agree with not buying more home than you need. Just excess all around!

    • retirebyforty January 5, 2011, 8:19 pm

      I am managing the rental condo myself and I do find it pretty annoying to be meeting with tenant at 8pm. :X
      The good thing about investment property is rent will eventually go up. Eventually the rent will be enough to cover property management.

  • LifeAndMyFinances January 5, 2011, 5:37 pm

    I really like the idea of buying a duplex and renting out one of the units. My wife and I had planned on paying off a house in 5 years, but if we also had rental income, we could probably do it in 3. Now that would be awesome!

    • retirebyforty January 5, 2011, 8:16 pm

      Also once you pay off a duplex, you’ll get rental income! That’s much better than a stand alone house. πŸ™‚

  • krantcents January 5, 2011, 7:30 pm

    The ideas are good! Finding the right property is always difficult, because your motivation is to find place that will break even now or relatively soon. Do your research at the front end! Good luck.

  • FB @ FabulouslyBroke.com January 6, 2011, 5:50 am

    I think a lot of people take into account upgrading their home precisely of their forward-looking natures.

    I think any home with 2000 – 2500 square feet is more than sufficient to raise kids in. We lived in something similar to that, with 3 kids and we were fine.

    BF’s family lived in a 1000 square foot apartment.

    • retirebyforty January 6, 2011, 8:27 pm

      I think 2,000 sq feet is plenty to raise kids too. I grew up in a 1,000 sq ft apartment (or less) with 2 brothers and it was fine. Family is more important than space.

  • Well Heeled Blog January 6, 2011, 7:22 pm

    I lived in a 4-plex before and my landlord told me and my boyfriend that when we get married, we should buy a duplex for precisely the same reasons you mentioned: we’d be building up our equity helped by rental income, and it’s cheaper than buying 2 apartments. If I find a suitable duplex, I’d definitely be interested in going that route.

    • retirebyforty January 6, 2011, 8:31 pm

      Good luck with finding a duplex. πŸ™‚
      I wish we’d done that.

  • 101 Centavos January 6, 2011, 7:44 pm

    Very well done, RB40. I’m in complete admiration of yours and Mrs. RB40’s drive to have extra income by having rental properties.

    • retirebyforty January 6, 2011, 8:32 pm

      Thanks 101! Income properties take a lot more time to pay off than stocks, but I think it’s more stable in the long run.

  • retirebyforty January 6, 2011, 8:28 pm

    That’s money well spent especially for a rental house. For the rental condo, the maintenance is much less and I’m doing it myself for now. If it’s a lot of problem I will sign that one up for management as well.

  • youngandthrifty January 6, 2011, 10:52 pm

    I grew up with my dad being a landlord and really admire him for it. He is really the epitome of passive income via real estate investing and positive cash flow.

    I think I would be quite comfortable being a land lady, but we’ll soon see! (Planning on renting out our basement.. I guess it’s like and up and down duplex).

    You’ll be retired by 40 in no time if you get some good positive cash flow going for that 4-plex πŸ™‚

    • youngandthrifty January 6, 2011, 11:22 pm

      Ooh I would like to add a funny landlord story though. Recently at one of his apartment buildings, a disgruntled tenant, who still has the key to the apartment building, decided to steal all the light bulbs in the hallway.

      He went to replace them, and then the next week, the light bulbs disappeared again. So even though he tried to cut costs by hoping this guy will give up, he still will have the replace the lock for the main apartment door. πŸ™

  • lovely leverage January 11, 2011, 6:18 am

    My boyfriend is in the real estate business. What he did with his parents is when his parents paid off their mortgage; they fully refinanced on it ($400,000) and used the loan to pay for a mid-size apartment building (18 units) at 25% down payment. The cap rate was 7% and interest rate 4%, so the spread was 3%. The amortization is 25 years, so by the time his parents retire they will have a constant stream of passive cash flow. We are now trying to do the same thing with my parents. My point is you can start to look beyond 4-plexs because the economy of scale is there for bigger units. Good luck and happy investing.

    • retirebyforty January 11, 2011, 9:25 am

      That’s great! The number looks really good especially the 4% interest rate. It’s a great time to invest in apartment building. I agree the economy of scale favors a bigger complex, but I’m not comfortable putting all my eggs in one basket. That’s what I would have to do to invest in an apartment building. The plan is to have about 50/50 stock/real estate investment. At some point we probably will sell all our rentals and consolidate into an apartment building or a vacation rental property.

  • Thanks for the article… I’m looking to invest in real estate, except everybody’s warning me not to purchase a house for investment purposes… I live in Los Angeles… would you say it’s too risky with the ups and downs of the market?

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