the math doesn't add up, what am I missing?

Question

We're in the process of learning everything we need to know before starting to invest but I feel i'm missing something here with the numbers game. I'm looking for lasting, generational wealth by building a portfolio. let's take some easy numbers to show you what i'm talking about...and so someone can tell me what i'm missing here.

Bought house $100,000

Mortgage payment is $800

Rent Charged is $1,400

(minus the 50% rule, the profit is $300)

so the cash flow would be $3,600/year on that one property.

after years of working hard i've acquired 25 properties., all with about the same cashflow. That leaves me making 90K.

90K is a great salary, with those numbers it doesn't seem like the vehicle for lasting generational wealth that i expected. Am I missing something?

Natalie Kolodij · Answer

Well- on a $100k house with 20% down your mortgage payment is going to be closer to half of your estimate.

You're not accounting for a few things....

1. Most people buy better properties in time, they buy bigger properties, things that cash flow better ect.

2. Over time your mortgage gets paid down- your cash flow goes up.

3. Over time properties appreciate, this gives you access to more funds to pull out against them to purchase more properties.

4. Ideally after depreciation your rentals are at a loss on paper. Depreciation you get to deduct, but don't actually spend money on. So this means that while you made $3,600 for example, your taxable income may be $0.

5. Rentals are not subject to any self employment tax. It's passive income. This means that rentals earning $90k a year means $90k a year. You taking home $90k a year means you're actually having to earn closer to $100k

So at the end of the day, you're making $90k and potentially paying taxes on $0 of it. How much would you have to earn at your job to take home $90k, after income and payroll taxes?

Ben Zimmerman · Answer

Lets take this scenario and look at it 30 years from now, assuming a 3% rent increase, and a 3% increase in the home value per year.

Your 25 homes that you originally paid 100k each for, or a total of 2.5m for, are now completely paid off and debt free.  Except they aren't worth 2.5m anymore, now they are worth 6.1m.  Your homes aren't renting for 1400 anymore, now they are renting for 3400 each.  25*3400 = 85k per month less expenses.  Since we now own the homes free and clear, the only expenses will be upkeep, vacancy , and property taxes since the mortgages are paid for.  At this rate you're likely cashflowing roughly 70k per month.

6.1m in net worth and 70k per month in cashflow after 30 years ain't too shabby.

If you want to speed up the process, don't spend 100k on a home if you can buy it for 70, or 80k.  Or refinance your properties instead of paying them all off and use the proceeds to buy even more properties.  Value add?  Brrrr? The possibilities are endless.

Eric Mayer · Answer

You built a nice foundation. Start selling your single families and 1031 exchange into 4-plexes. Fix up/Raise rent over the course of a year or two. Sell 4-plexes and 1031 exchange into 8 unit buildings. And so on...

Amber Linthakhan · Answer

Thank you all for your input. I apparently was missing a few things in my thought process. I’ve just found BP and have started listening to the podcasts starting at the very beginning. Thanks for your input! Looking forward to learning lots more from you all.

Bryan Noth · Answer

@Natalie Kolodij makes some excellent points, especially on the rental income being passive and the tax incentive possibilities.

@Amber Linthakhan another item to consider and mentioned in many earlier BP podcasts is the concept of the escape velocity or threshold, essentially it takes great effort to get off the ground but far less to continue once you are on your way.  The first few properties are hard to acquire and the income generated does not feel like it amounts to much.  However, over time those properties can potentially appreciate in value, debt service gets paid down, rent could also potentially increase.  As those elements compound it hopefully becomes less challenging to grow or allows growth at a much faster rate.

Highly encourage you to listen to the podcasts, especially some of the older ones, there is terrific content and motivation there!

Scott Passman · Answer

@Amber Linthakhan  Based on your numbers there is a need to clarify the 50% rule.  It is based on 50% of gross rental income.  In this case, if your monthly rental income is $1400/month then based on this rule you could expect $700/month in expenses.  By this metric, you would be cashflow negative. The 50% rule is just a general rule of thumb and you would be much better off breaking down the numbers and calculating mortgage (+insurance and taxes), capex, maintenance, vacancies, utilities, landscaping, property management etc. You will be much more accurate and better able to predict projected cashflow.

As for the heart of your question, you are making some assumptions and forgetting a lot of other positives. First off, rents change over time and so the odds are the longer you hold a property the more it will likely cashflow.  Plus, as you pay off properties the monthly cashflow will increase significantly.  Then there is also appreciation of the home that will likely occur which will increase your equity, loan paydown, money saved on taxable income due to the tax advantages of owning real estate etc.  All of these compound over time to build up wealth slowly, but substantially.  The key is to invest smart where the numbers make sense, don't overleverage yourself to the point you can't adjust to market swings and unexpected costs, and stay in the game long enough to realize these benefits.

Russell Brazil · Answer

Buy properties in high demand high growth markets like DC, Boston etc, and in the high demand locations in those markets. Thats a much easiet path to creating generational wealth.

the math doesn't add up, what am I missing?

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