“Don’t wait to buy real estate, buy real estate and wait” – Will Rogers
A common regret heard in reference to investing, whether in real estate or otherwise, is “I wish that I would have started sooner”. Personally, I purchased my first property in 2004 at the age of 22. I didn’t buy another investment property until 2010, so while I don’t get the award for consistent action during that period, starting early is one thing that I did do right!
As you’ll see, my first real estate purchase wasn’t the most deliberate. If you looked at it strictly from the lens of cash flow or appreciation, it is far from a home run from an investment perspective.
However, the knowledge, experience, and eventually the equity from loan paydown would enable many future investments. Even today, I consider this early action one of the best and most important decisions I made in my investment journey.
Living Room
The Search ~ Leveraging My VA Loan and Opting for an HOA
In December 2004, I had been enlisted in the Navy for a little over three years. I was transferring from a ship in Norfolk, Virginia, and returning to my home state of Missouri for a commissioning program at Mizzou. Go Tigers!
I was fortunate that a family friend was a realtor in Columbia, so the search for one I trusted was short.
At the time, the Basic Allowance for Housing (BAH) for my pay grade in Columbia was approximately $600 per month. For a few reasons, I chose to search for a condominium with a Home Owners Association (HOA). One contributing factor was the fact that I was now living just over an hour from the family farm.
If you remember from my previous article, I still had partial ownership in the family horse training business. I expected that I would spend many weekends on the farm, so I wanted to minimize the time I spent mowing the lawn, shoveling snow, and some other time-consuming responsibilities of homeownership.
Ultimately, I chose to purchase a new construction, three-bedroom, two-bathroom condo for $86,000. I did so almost strictly through the lens of the opportunity to be a homeowner and building equity over a long period of time.
While that was not necessarily an incorrect view, I failed to consider many other variables when acquiring what would eventually be an investment property!
Master Bedroom
Four Ways to Make Money on Rental Property
Before I go on and expose my flawed analysis or in some ways lack of analysis, I’ll mention there are generally four ways to make money on a rental property. Let’s take a deeper dive into each of them in a future article, but for today I’ll quickly highlight them for general awareness.
Cash Flow
Cash Flow = ALL Income – ALL expenses
Loan Paydown (Equity)
The tenant’s rent pays down the principal portion of the loan providing the owner increased equity.
Appreciation (Forced or Natural)
Forced: Improvements made that increase the value of the property.
Natural: Influenced by increased supply compared to demand, interest rates, and inflation.
Depreciation (Taxes)
Depreciation is the process used to deduct the costs of buying and improving a rental property.
I did expect that I would likely keep the property when I moved. After doing some rough estimates of rent I expected that it would cover the principal, interest, taxes, and insurance (PITI). And after a number of years, the tenant would pay down my loan and I would enjoy the equity, right?
I’m reaching back in my memory 16 years, but I don’t ever remember really considering many of the other expenses that would impact my cash flow as a rental property. A few expenses outside of PITI that I should have considered include vacancy, maintenance, capital expenditures, HOA fees, and utilities.
Resources, such as BiggerPockets, that provide the education and tools to better analyze rental properties, are more prevalent today. However, a decade and a half ago I hadn’t been exposed to any of this education. Thus, I failed to properly analyze this property as a rental prior to my purchase.
Kitchen
House Hacking
House hacking is a strategy that involves renting out portions of your primary residence to generate income that is used to offset the cost of your mortgage and other expenses associated with owning a home. I had no idea what “house hacking” was at the time. I don’t even know exactly when the term was coined.
However, shortly after I moved in, a high school friend rented a room from me for about 60% of my mortgage payment which included my taxes as well.
Today, many military members that are investing in real estate make the recommendation to those getting started to consider using their VA loan and house hack. It can be done at much larger scales than just renting an extra room also. The same concept can be applied to a duplex, tri-plex, or quad-plex.
It is a powerful strategy to boost your capital building! Admittedly, I stumbled into this combination with my very first property. However, even if you don’t have access to the VA loan, house hacking can be done by ANYONE! It is typically more conducive in earlier stages in life, but I’d highly recommend those trying to build some capital consider this strategy for a few years.
Home Owner’s Association + Land Lease
As mentioned, I bought a condo in an HOA for specific reasons. There can be many benefits of an HOA, but there are also many things to be aware of.
My HOA fee included landscaping, snow removal, trash, a swimming pool, among other things. The HOA was also responsible for insurance on the exterior of the condo, which did come into play due to a major hailstorm that did significant damage!
I think it was the right decision for me at the time. But if you are purchasing a rental property you need to consider the value provided, how that value impacts your possible rental income, and also that the HOA fee will almost certainly rise over time.
There are also bylaws that often restrict what you can do on the exterior of your property or sometimes even if the properties can be used as a rental.
This particular property was built on land that was on a 99-year land lease. At 22 years old, 99 years seems like a long time. The lease ending was a problem I wasn’t all that concerned about dealing with in my lifetime. It is, however, another expense that cuts into my cash flow!
Pool Time
The Leverage of Cross-Collateralization
Cross collateralization is the act of using an asset that is collateral for an initial loan as collateral for a second loan.
Similar to a cash-out refinance or home equity line of credit, cross-collateralization is another way to use the equity in one property to purchase additional properties. My friend, Matt Deboth, wrote this article describing a cross-collateral loan and has been leveraging it to great success on much larger properties!
After years of receiving rent payments and benefiting from loan pay down, I have accumulated a fair amount of equity. If you don’t leverage that equity in some way, it remains idle.
I’d prefer to get a return on my equity. So I have used the equity in this property to cross collateralize and use it as the down payment on three additional investment properties. You don’t always have to “save up the cash” for a down payment. Sometimes you just need to be creative.
Are there risks in cross-collateralization? Absolutely. You are tying multiple assets and debts together. But as Matt described in his article, there are methods to mitigate some of the risks of using this strategy.
Imperfect Action is Better Than Perfect Inaction – Harry Truman
I bought this property in 2004 as a 22-year-old. I used a VA loan and house hacked. I eventually turned it into a rental property and in 13 years have been fortunate to experience less than 2% vacancy (don’t use this number when analyzing your properties!). As it was new construction in an HOA, I’ve also experienced fairly minimal capital expenditures and maintenance.
The cash flow has not been what I would target today. There has been appreciation but not to the extent you sometimes find in urban areas.
Ultimately, if only looking at the numbers, this is far from my best performing investment. But when I consider the age that I started investing, the education from different strategies, understanding the analysis that should have occurred, and the additional property purchases that it has enabled, it is one of the most important investments I have ever made.
As I separate some of the cross-collateralized properties, I will likely move this property in the coming years. I would like to move the equity into better cash flowing properties. But it has served me well!
I don’t recommend overlooking factors that should be considered in your analysis as I did. There are plenty of tools today to help you avoid that.
However, new investors often find themselves stuck in the analysis stage looking for the perfect deal. Much like Harry Truman suggested, NOW is the time for action, even if it is not perfect!
