In 2015 my wife and I bought our first rental property together. We were living in Los Angeles at the time and couldn’t afford to buy anything locally, which prompted us to start looking at out-of-state investments. We ended up making a real estate investment in Texas!
There’s a lot to share about our decision to buy a rental property — I’ll start with numbers and then get into our backstory about how and why we got our place.
Quick note: I don’t want to come off as some nonchalant real estate investor talking about “out of-state investing,” as if it’s some effortless hobby that people pick up easily. I can’t understate this … real estate investing is hard bloody work. And it’s scary! And it doesn’t always work out! Back when we bought this rental property, I was absolutely shitting my pants about the decision. It took a ton of research and courage to pull the trigger.
The numbers: Purchase price, down payment, mortgage, etc …
After evaluating about 50 properties and putting bids on about five, we settled on a brick-finish duplex built in 2003.
Purchase price: $188,900
Original loan: $136,500 (This is a 30-year fixed mortgage with 4.125% interest)
Down payment: $52,400
Total cash outlay: $55,213 This is the total cash that we paid out of pocket including down payment, closing costs, appraisals, option fees, seller concessions, pro-rata taxes, and a million other tiny little charges the bank adds when you close on a loan. We also set aside a $5k “reserve fund” dedicated to this investment property, so the total project cost is about $60k all in.
Over our five years of ownership, our investment has grown by an additional $60k! Here’s a breakdown of how this rental property has made us money:
Cash flow: $16,468 – After all our rental income minus all our expenses, this is the total amount of positive cash flow we’ve accumulated since we bought the place. An average of about $265/month!
Loan paydown: $12,792 – This is the difference between what we owed the bank at the beginning of our mortgage, and the current loan balance today.
Appreciation: $31,110 – Simply looking at property value, this is what it’s worth now vs. what we paid at time of purchase.
Total gains: $60,360
A couple notes about these numbers:
- Because the interest portion of our mortgage payment is tax deductible, this property has saved us a little bit in income taxes over the years. I’m purposely excluding these savings to simplify the overview.
- Another advantage of owning rental real estate is depreciation. We claim a small loss each year as the property gets older and older. But I’m not including this in our figures, either. Depreciation needs to be repaid as gains when the property is eventually sold.
- We started with a $5k emergency fund and float account. This has increased over the years due to the positive cash flow, and along the way we’ve taken some money out to help buy other investments. Gains/losses on this cash aren’t included in our ROI.
All in all, I can safely say that we’ve doubled our money in 5 years. ($60k in gains on top of the $60k in start-up costs that we’ll eventually get back when we sell.) Pretty cool to think about! But real estate investing isn’t all roses — here’s some backstory to complete the picture:
Saving up for a $55k down payment + $5k reserve fund
It took me about seven years to save up the down payment money for this property. I did it the old-fashioned way — spending less than I earned. Keeping most of my savings in a checking account, I just watched my cash pile grow and grow over the years.
In hindsight, this was a poor move. I should have been putting my savings directly into the stock market, or at least in a high-yield savings account. This way it would have risen much quicker! A HUGE opportunity missed on my part as the stock market kicked ass from 2008 to 2015. Big lesson learned for me.
I’ve always been a good saver, but here are the main ways I was able to squirrel away money:
- House-hacking: Before moving in with my wife, I rented out part of my 525-square-foot apartment to roommates, dropping my rent by $700 per month.
- Moving in with wife: As soon as we moved in together, a lot of our living expenses were halved. More home cooking and packed lunches also allowed us to save money.
- Cheap car and travel costs: When we lived in Hawaii, we were within walking distance from my work, and later in Los Angeles the companies I worked for all paid me a mileage fee for any driving. Low car costs helped me save up for real estate investments.
The reason I mention this is that it’s kind of narrow-minded to look at this property and say that our investment has doubled in just 5 years. The true project cost started 12 years ago, when I began saving cash for the down payment.
Why buy a rental property in another area?
We moved to Los Angeles in 2012 (to live closer to family) and quickly realized the housing market was very expensive and not ideal for positive cash flow investments. This got me thinking about buying property out of state.
I started to Google the “best states and cities to buy rental properties” and Texas kept coming up as one of the top choices for rental property investing. Here’s why I felt good about Texas:
- The barrier to entry was low in most small Texas towns. Good-quality houses can be bought for less than $200k. The rental market was also quite strong, with many properties meeting the 1% rule. (Basically, that’s making sure the monthly income on your rental covers the monthly mortgage payment.)
- At the time I was searching (2014 and 2015), Texas had four of the top 10 fastest-growing cities in the US: Austin, Dallas, Houston and San Antonio. Population, job growth, and economic development were exploding, so it was an attractive real estate market. (Here are the hot markets for 2020.)
- Rent contracts tend to favor landlords.
- There’s no state income tax in Texas. This sounded like a much bigger selling point at the time than it actually is. Because I don’t make much income from the property, the tax burden would be pretty low anyway.
- If I’m being completely honest, I mostly felt good about Texas because that’s where everyone else seemed to be buying. Pretty bad advice for an investor — to just follow the crowds — but this dumb luck worked out for me at the time.
Texas has a bunch of downsides and learning curves, too … massive property taxes (more than $5k per year for this small property!), a slower appreciation rate, and a much different local culture that took me some getting used to.
Property management and stuff going wrong
Right from the get-go I knew I didn’t want to be a hands-on landlord dealing with renters, leases, managing repairs, etc. We hire a property management company to take care of all of this for us. I know many real estate investors who buy rental property close to home and manage everything personally — it takes a special set of skills that I just don’t have!
Although my property manager looks after the day-to day operations, this doesn’t mean that it’s all passive income and that I can take my eye off the ball. I stay involved with what’s going on and am constantly in touch with the manager.
As for nightmare tenant stories, this particular rental has remained pretty easy since I’ve owned it, and I’ve had good tenants there. I do have other properties with horror stories I can share later … domestic disputes, trashed units, evictions … and there was that one time when I found out a renter was running questionable “massage services” in my place. :(
Future options for this rental property investment
Past performance is great. But it doesn’t mean future returns will be just as good. It’s important to constantly evaluate the return on current equity and see if better returns can be achieved by making changes. As illiquid as real estate may seem, it’s actually quite flexible with exit strategies and refinance options as equity builds over time. Selling, refinancing, 1031-exchanging, or even using the property as a primary residence are all possibilities.
Selling a rental property
As of today, if I wanted to sell this property I would face several hurdles:
- First, the transaction costs and commissions would probably cost me $15k to $20k.
- I’d have to pay tax on the $30k capital gain that the property has increased in value, as well as regular income tax on the depreciation we’ve claimed in the past five years.
- My biggest problem: We’d have to figure out where to invest the proceeds (do I buy another property? Invest in the stock market? Pay down other mortgages and debt we have?) Because none of these can guarantee a better return, we’re choosing to hold onto the property for now.
Refinance options? Pull cash out or reduce my interest rate?
Because of how much equity has built up, I could refinance the property and possibly borrow $30k from the bank. Also, with interest rates so low, I could reduce my mortgage payments and start a new 30-year term.
However, I’d have some hurdles to jump there, too. Because my income is quite low this year, I’m not sure if I’d qualify for a refinance. Also, we’d still have the issue of where to put the $30k that we could pull out. It’s not quite enough money to buy a new property, and re-investing in renovations doesn’t make sense at this time.
Refinancing is something I’ll research soon. You never know what you qualify for until you ask!
TLDR; all things considered
- Total cash outlay for this project was $60k.
- It’s grown by an additional $60k over the last five years.
- Saving for the down payment took about seven years, in which I missed out on excellent returns I’d have earned if the money had been invested instead.
- Real estate is flexible in terms of finance and exit strategies, but it’s illiquid in terms of selling it quickly.
- Just like stocks, you can’t predict future returns on property investments based on past performance.
- The future plan is to hold this rental and make no changes in the short term.
More to come on this as we track and discuss over time!
Anybody own a rental property in a city or state where they don’t live — maybe like a vacation home? What has your experience been? Any tips or warnings for everyone?
*House pic up top by Ed Schipul on Flickr!