Why investment properties make so much cents!
I was fortunate enough to get into the real estate game early. Much earlier than becoming a broker. I had the good fortune of having Mike Jensen, the Ft Collins real estate mogul, as my roommate in college. Mike was in my ear a lot about investing in real estate. He encouraged me to secure a first-time home buyer loan through a local credit union. I had no credit so my father agreed to co-sign. I bought my first investment property in Fort Collins in 1995 with only $3600.
This decision kicked off an incredible real estate education through the act of doing. I would like to share my lessons with you.
The purchase price for the Ft Collins Property was $120,000. The first-time homebuyer program allowed me to purchase the property with a 3% down payment. Therefore my investment came to $3,600 and I used $116,400 of the bank's money to get me into the game.
I bought the Ft Collins Property to live in but quickly realized it would generate a great deal of cash flow (total rent - mortgage = cash flow). So, I moved out and it became my first investment property. I managed the property for a number of years then hired a management company.
When I graduated college my wife and I moved to Denver and decided to shift my investment property closer to home base. I was also tired of the management fee eating into my cash flow. We sold the Ft Collins Property in 2005 for $185,000 and netted $65,000. My original investment of $3,600 had now become $65,000 to reinvest.
The proceeds from the sale ($65,000) had to be reinvested correctly in order to defer the taxes on the gain.
A 1031 exchange is a tax-deferred exchange of real property! Wait, What? -> This program allows investors to sell an investment property, buy another one and postpone or defer the taxes due on the sale. Therefore, we were able to reinvest the entire $65,000 in proceeds from the sale with no immediate tax obligation.
We bought our second investment property next to the Denver University (DU) campus in 2005 for $310,000. Our model at the time was to buy property close to college campuses. Vacancy risk was lower due to the renewing rental pool of students at the university. A low vacancy was a plus, but renting to college students presented its own set of challenges. While managing our new investment property we stumbled upon another powerful real estate tool - the power of multiple payments.
Making a second mortgage payment directly reduces the loan balance. I’ll say that again, A second mortgage payment directly reduces the loan balance. For example, if the mortgage payment was $1,300, $275 of the payment reduces the loan balance and $1,025 of the payment pays the interest on the loan. If we made a second payment of $500, that second payment directly reduces the loan balance. Therefore, with the second payment of $500, we reduced our loan balance by $775. This resulted in a 65% increase of the payoff rate on the loan.
Now, this is where the real magic begins!
Our DU property was appreciating and….we were now paying down the loan 65% faster. This resulted in our equity getting compounded!
We sold the DU property in 2013 for $400,000. Additionally, we paid down the loan to $192,000. So after the sale (another 1031 exchange to ensure full use of all the proceeds), we had $208,000 to reinvest. We had now turned that original $3,600 investment into $208,000! By doing so we were able to double our investment portfolio and we turned one house into two townhomes!
We bought two townhouses in the Berkeley neighborhood in 2015.
Berkeley was a wonderful next step. We exited the slumlord game and entered into the new construction rental game. Our renters were much easier to manage and we learned that having pride in our property…translated into tenants having pride in the property as well, what a revelation - duh!
A minimal initial investment of $3,600 in 1995 has turned into over $1M in real estate wealth in 2018. We would’ve had to sacrifice a lot if we decided to simply start saving the $208,000 needed for real estate investment. Instead, we made savvy investments, used other peoples money, deferred our taxes and compounded our equity to make our dreams a reality. Would you like to do the same?