Earlier this week I posted how I became a millionaire in debt through my real estate holdings. Based on the comments half of you thought I was taking too big of a risk while the other half thought it was a great strategy long term. Here are some of the factors I considered:
Real estate is an asset class, you wouldn’t put all your money into one stock why would you put it all in a house?
For majority of Americans their house comprises 65% of their net worth. If I told you to put everything you owned into Google stock you would think I’m crazy, but wouldn’t think twice about tying up all your money in a single property. Houses are liabilities as they don’t generate cash flow, instead I have two properties that are assets because they provide rental income.
Here are the numbers I looked at when deciding on my strategy:
We borrowed $140,000 locking in a 3.25% average rate from two properties. The first was a cash out refinance from the first rental property, while we did an equity line on my primary house. A cash out refinance is where you take money out of the property when you refinance. With a drop in the interest rates from 4.2% to 3.1%, despite a higher loan balance my payments was nearly the same. The equity line was an adjustable rate which was then converted to a fixed rate the following year. Although the loans were for 15 years we based our payback at 10 years.
In the first year we would average around $1000 a month in added equity, or $12000 a year. In all rentals you need to factor in vacancies and repair work, which is often 20% of the total rent in a year. Thus the $12,000 in equity translates out to $9600 per year. ($12,000 X.80) = $9600. I’m borrowing at 3.25% and earning 7% in equity annually.
It is riskier when you don’t have income streams
Every investment has risks. Cash is a 100% loss due to inflation. You can invest in stocks and lose 90 to 100% of your money. How risky is having 100% of your income tied to a job? Dividend investing? Yes, but it will take many years before you will have enough to live on. Only real estate can provide a large enough cash flow, and the best thing is that you’re using other people’s money to pay it off.
In 10 years I will have an additional $140,000 Net Worth paid for by renters.
Had I sold all the properties that equity would be sitting in my house doing nothing. Instead over the next 10 years thank to my renters I will have an additional $140,000 in equity. That doesn’t include additional principle being paid off during that period. Real estate is actually safer because I am diversified in three properties instead of one, much like investing in stocks. Instead of one asset, I have two additional income streams. I will also be able to charge 30-40% higher rents than I do today, while locking in majority of my housing costs. Think about where rents were in 2003 as compared to today, now imagine where they will be in 2014. How long would it take for you to save $140,000?
Despite gaining an additional $140,000 in equity I will pay no tax on it.
That’s the beauty of cash out refinancing and borrowing money. It is not taxed and the interest is a tax write off. If I was to earn $140,000 at a 33% tax rate I would owe $46,200 in taxes. Instead I would owe no taxes due to this gift called depreciation. Buildings and fixtures wear and tear over time so the government allows you to take that as a write off. Often the depreciation will offset any gains I earn so I will pay no taxes annually.
I know the accountants reading this will insist that the tax man will get that $46,200 eventually when you sell. I’ll write in my next post how I will never have to pay that tax, instead using it to grow my net worth even faster.
Does my real estate strategy still seem risky? Do you have all your net worth tied up in one property? How is your experiences with rentals so far?