Rental Property Book Investing Math Doesn’t Make Sense

[Alan Crookham]

I am just getting into purchasing/rehabbing/renting properties. I own one small house in Panama outright that I have rented for years, so I have land lording experience, but not so much in investing and flipping.

Someone gave me the Rental Property Investing book by Brandon Turner, and am in the chapter on analyzing a property and the numbers don’t make sense to me. I know I’m missing something because people obviously make millions of dollars in real estate.

But here is simplified (and very rough) example from the book.

A property costs $100k to purchase and rehab. You can bring in $200 a month in cash flow after all expenses. You hold the property for five years, then sell for about $130k, but still have to spend $17k on expenses in the sale, plus pay off the loan, and all the other stuff, but hurray, you still made $13k on the deal! Also, you made about $17k from rent over five years.

That sounds good on paper, but don’t you have to go buy another house now, and you will have to use all that income on plus to rehab the new house, which puts you back to zero. You would have been better of just continuing to rent and make your $200 a month. I don’t understand what the actual profit is here.

Can someone please explain what I’m missing, or are these the actual margins to expect? How does anyone actually make real money doing this?

Thank you!

[J Scott]

Let's assume you only put 20% down on that property, or $20,000 on the $100,000 house.  After 5 years, you walk with $13K profit and $17K in cash flow (those were the numbers you threw out, I'll assume they're correct).  So, you made $30K profit on a $20K investment in 5 years.

That's a 20% compounded return on your money for those 5 years! Not sure how many other relatively low-risk, relatively passive investments are going to return you 20%.  I don't know of any.

Now, let's say you paid 20% on that $30K gain -- you now have $44K to reinvest (your original $20K plus your $24K gain after taxes).  Reinvest that $44K for another 5 years at that same 20% compounded return, and now you have about $100,000 (after 20% taxes). 

In 10 years, you've multiplied your money 5x with little risk and little active effort.

Now, let's say that instead of just putting $20K in the first year and waiting it out, you invested another $20K each year for those 10 years (perhaps you took $20K from your job or side business).  With the $20K contribution and the same 20% compounded return, over 10 years, you'll have over $700,000.

Btw, if you invest that $700K earning 12% cash-on-cash return in a long-term rental property, you're now earning $85K per year, completely passively.  Not bad for a 10 year plan that only required $20K per year.

(One last thing -- the real money comes from generating a lot of active income on the side, so you can invest more than $20K per year.  If you could put in $50K per year, you're not earning $210K passively for the rest of your life after 10 years.)