“A majority of life’s errors are caused by forgetting what one is really trying to do.”
–Charlie Munger
In this post, I will share how the real estate investment process worked for my family over time and what steps were involved. If you decide to build wealth this way, you can also expect to experience several similar phases in your own journey.
The key was knowing which step of the process we were in and acting accordingly. As our family and needs changed, so did the lens through which we viewed these investments.
For whatever it is worth, we are in the top 2-3% of net worth nationally, so the journey was successful and is not over.
But my journey and yours are not going to be exactly the same. Time, tax policy, and the market have all changed too.
STEP 1: STARTING OUT–THE SAVING PROCESS
The process of saving for a home down payment was not easy. We both worked, so after marriage, we lived on one salary and saved the other.
To help the process along, we decided to live in a downscale apartment.
Our inexpensive apartment was out of style even for our era. Decorated with blond wood cabinets, linoleum tile, and the ever-present green shag carpets, it was straight out of the 1950s. The lamps looked like flying saucers, but they never flew off.
We could have completed the interior design by purchasing a blond kidney-shaped table, but we never got one.
The exterior of the place was not much better. It was a two-story box with straightforward, cheap stucco construction from the same era. It was beige and neat but bland and as dull as could be.
But we did not lack entertainment. The yard was paved over and doubled as a driveway for the garages. Someone had thoughtfully painted a shuffleboard court on it so that you could play a game and shoot the pucks between times when other tenants drove in and out.
STEP 2: HOME PURCHASE AND THE FIRST RENTAL BUSINESS
We finally got enough down payment together to buy our first house. It was our first real investment.
We needed a big down payment because mortgage interest rates were 13 ½ percent (No, that is not an exaggeration). So, we also borrowed $10,000 from my in-laws so that our down payment could help qualify us.
We eventually bought a very modest starter house. But, as humble as it was, it was still an overwhelming commitment. I remember waking up the day after we moved in and asking myself, “What have we done?”
Somehow, we paid my in-laws back their loan in 9 months. This repayment was before kids. We were good savers but not miracle workers.
Life progressed. We lived in our modest home for 3-4 years but eventually needed a larger place to accommodate a second baby. We toyed with moving up, building out by remodeling, and moving out of the area. Nothing worked.
And then we did what we should have done in the first place: we got advice from a financial planner when we could not figure out what to do.
We asked this planner if we should rent our current house and buy a larger home in a cheaper area.
He said no. He explained that real estate was not always a good investment.
Luckily, we ignored him and rented out our house after purchasing another home farther away from work–but in a cheaper area.
Sometimes it pays to ignore professionals.
After all, we did not make much money from our jobs and needed to take some strategic chances to build wealth. Moreover, it was clear at that point that some sizeable future family expenses might extend throughout our lives.
STEP 3: THE RENTAL AS YOUR NON-RECOURSE BANK AND BUSINESSES
So, we turned one asset into another—a starter home into a rental property. But as you can imagine, we initially did not make much income from it. But it gained value over time, and the rents gradually rose too.
Running rental housing is a business with ups and downs and highs and lows. If you are unwilling to do some repairs or have tenants call you at midnight as the toilets back up, this is not for you.
We were also helped by the fact that we live in a non-recourse loan state. If our rental property failed, the lender could not come after all of our other assets. Lenders would only foreclose on the rental home if we could not make the payments. Therefore, our primary residence was not at risk from possible financial problems at our rental.
And as the rental gained value over time, it served a second function: bank. We had to fund a college education and buy a separate property for a family member at some point. Finally, we also wanted to get another rental property.
We took the appreciated equity and borrowed and refinanced against it, often at lower rates over a period of years.
And eventually, we owned four properties. However, we never purchased any with less than 30 percent down—a conservative approach that helped us weather several housing recessions.
During that time, we continued to fund our retirement. So, it was not an either/or situation.
STEP 4: DE-RISKING THE PERSONAL ASSETS ON THE BRINK OF RETIREMENT
From the beginning, we made sure our homes were insured against local hazards. If you cannot afford to self-fund the cost of a potential natural disaster, insurance is a sensible idea to protect your rental in the worst case.
But we went a step further. We also paid off our primary home loan. And we ensured that the property we purchased for our family member had no debt. I had retired early and did not need debt on the property that any family member would occupy. Again, not everyone agrees with that approach, but I wanted to do it for peace of mind and to ensure our retirement plan was feasible. You can read about some of the concerns with early retirement here.
STEP 5: THE RENTAL AS RETIREMENT INCOME
Using rentals as bank accounts have worked out well for us. But using them as banks has left us with debt, too. So, the income from our rentals is not as high as it could be, and they both have more leverage than I would like.
They both make modest amounts of money.
As you move into retirement, your needs change again, and we are preparing for that. Eventually, we will need more income. So, we plan to pay our rentals off with various money market funds, savings, and Roth funds at some point.
In the latter case, we won’t pay them off until the accounts’ returns are less than the current rental mortgage interest rates. Until that time, we can get a better return elsewhere. Arbitrage is nice.
We may also sell them and get higher yielding returns by reinvesting in another property managed by someone else–or by other means. I am still researching that and may come back to you later with what I find out.
SUMMARY
Each phase of your real estate journey takes planning. Whether saving, expanding, paying for other expenses, de-risking, or planning for retirement, it is essential to define each phase and plan for the next.
It is essential to consult real estate professionals at each step of your journey.
Disclaimer: consult with a financial fiduciary before taking any steps outlined here. Not all advice may be suitable for your circumstances or investment style.
Photo Credit: Jukan Tateisi
License: Unsplash