Can this be made to work..?

Question

Hi there -Sorry if this is a pretty broad question but we're just about to get started in REI and after reading a lot about the topic - and listening to a ton of episodes on the BP podcast - we're currently figuring out our strategy going forward.Our ultimate goal is to build a small portfolio to generate income for retirement.So in a nutshell our current idea/strategy is to..Invest in rental properties,Ideally small multi-family (duplex, triplex)Finance 75% on a 15 year (as we're no longer in our twenties..)Monthly cash flow should be about 100-150$ per unit starting from day 1We'd like to use the latter to retire early on a frugal lifestyle using the cash flow and possibly other streams of income before the properties are debt free!And that's just where we are currently pondering if our strategy is feasible - As we'd like to use a 15-year mortgage and savings allowing us to come up with 20-25% of the purchase price up front we did some number juggling.. using the BP rules for rentals, i.e. roughly 1% in monthly rent, and 50% of the rent usually going towards expenses, insurance, vacancy, etc. that leaves just barely the amount required to cover the mortgage payments.So we'd like to run our idea against you folks to get some feedback - Is it too ambitious/unrealistic? Or could it be made to work when finding just the right deals?All feedback appreciated!Cheers,Jay

Linda Hastings · Answer

@Justin Kovach Thanks for the Note Investing LLC/Property Investing LLC strategy break down (and book reference). I've never heard that one before, but it intrigues me. I'll have to add that book to my list.

Justin K. · Answer

@Jan B. If you treat people respectfully you likely wont have any issues with being sued. Millions of 'mom and pop' real estate investors live their entire lives running properties and never see a lawsuit. I love buying their properties! Although I will say that in my area a lawyer has been running commercials asking people if they have fallen while walking down the street and showing pictures of uneven or snow covered sidewalks explaining that it is the property owners responsibility to maintain their sidewalks and if you happen to fall on their sidewalk you can sue them and of course he will help you get the most for your 'injuries'. My opinion is this might encourage people to fake falls and injuries to get a judgement brought against them. I prefer to hold the equity in my properties like you seem to. I am currently looking at buying some notes because managing the properties (mowing grass, fixing things, etc.) is becoming pretty taxing with my full time job. Once my Note Investing LLC owns a few notes I will write a note for the properties my Property Investment LLC owns. Keeping the property highly leveraged, possibly even 'under water', and then if heaven forbid I ever get sued by someone who has a legitimate case they might take my properties and sell them, but once they are sold by the plaintiff the debt would have to be paid off to my Note Investing LLC. And while I still own them I will never pay the Note Investing LLC an actual mortgage payment, thus keeping my cash flow high. The Note Investing LLC will never foreclose on my Property Investing LLC because the owner of both companies are good friends! This strategy was outlined in the book 'Asset Protection for Real Estate Investors' by Clint Coons. He explains that the first thing most attorneys with injury victims do is they look at the assets the owner owns and how much equity is there, because the filing attorney is only getting paid based on that equity. When the attorney cant make money odds are they wont bring a frivolous lawsuit. If they bring a legitimate suit you are still protected. Clint is an attorney. I am not and this is certainly not legal or tax advice. This is simply a glimpse at a strategy that I am considering in my future.

Jan B. · Answer

Hello @Quoc Tran,thanks for the feedback!Being new to the REI game our basic motivation was to maximize cash flow in retirement with debt free properties.Passive income for our retirement via rents is what we're aiming for - getting a similar cash flow with non debt free properties would require 3-5x the number of properties, wouldn't it?Sorry, as I've mentioned we're complete newbies with what I suppose must be a 'natural' preference to be debt free, eventually.. Happy to hear about different takes on this!Cheers,Jan

Jan B. · Answer

@Justin Kovach Thanks for the info!We certainly loved the idea of moving our properties into a LLC... until realizing the impacts that'll have on our ability to get attractive mortgages (https://www.biggerpockets.com/renewsblog/2016/05/2...)!Got to wrap out heads around the concepts of Note Investing LLC and Property Investing LLC, sound useful..Many thanks for the the book tip, already in my Amazon cart!@Odie Ayaga - I'll check out that podcast episode, thanks.Cheers,Jan

Odie Ayaga · Answer

You can check out Podcast 109 with attorney Scott Smith. If I recall correctly he discusses how real estate is the most litigated industry in America and discusses some of this there. Additionally, Garrett Sutton discusses this in Chapter 23 of Loopholes of Real Estate.

Jan B. · Answer

Hi @Odie AyagaThanks for pointing that out - hard to imagine people going around willy-nilly suing house owners or RE investors.. for me as a newbie anyway.Maybe you can share some more specific examples or stories?Cheers,Jan

Odie Ayaga · Answer

Hi @Jan B. One of the points @Thomas S. was getting at is the idea that your assets become more of a target as your equity in them increases. Think of the difference between a mansion you own and one that you have very little equity in. While a suitor may have an interest in finding a judgment against you that results in them taking over your mansion, their interest is likely to be higher when they acquire it free and clear versus owing a large monthly payment against it.

Jan B. · Answer

Ok, thanks for the additional explanations!I get the idea about maximizing cash flow using, well, perpetual (30y) leverage vs. virtually no cash flow until the property is debt free with shorter mortgage periods. Guess we might have to wrap our heads around the idea of making the numbers work with ongoing mortgage payments.Good thing is of course that we might be able to retire earlier this way with (decently) cash flowing properties from day one vs. cash flowing properties in 15 years.We don't quite get the equity = bad part, though.Isn't that one of the great advantages of being able to buy RE with leverage and having your tenants pay off the debt, i.e. continually increasing your equity?Would you mind explaining how increased equity in a property increases risk?(aside from binding your cash that might be used more profitably elsewhere)Cheers,Jan

Thomas S. · Answer

Holding equity in a rental has some major risks. You become a target for unscrupulous legal attacks, you risk a major loss when the market shifts, you will receive a very low return on your cash as the equity grows. You would be farther ahead to keep your equity at a minimum and by doing so receive the greatest return on your investment. Take out 30 year mortgages and pull out your equity as it grows. At retirement your cash should be invested in income funds while you still collect rental income on your properties. This will maximise your returns, keep your money generating a secure income stream and allow your rental properties to generate the greatest possible returns.Holding equity in a property, due to the opportunity value of cash, will turn a investment property into a liability.

Quoc Tran · Answer

@Jan B.You've probably heard of the concept of "Bad Debt vs.Good Debt". Bad debt includes things with high interest rates greater than 10%, such as credit cards with their 25%+ rates and parking tickets with late fees. This is debt you do not want to hold on to, and you want to pay these off ASAP.On the other hand, there's good debt, such as student loans, mortgages, etc. These debts usually have an interest rate less than 6%. In your case, it would be okay to hold on to the mortgage debt because it's making you money in the form of cash flow, appreciation, and loan-pay-down by renting. The low interest rate will eat a little of that cash flow, but as long as you're on the positive side you'll be fine. Leveraging loans so you can make passive income is all part of the game! :)