Engineers have a massive unique advantage in today's economy, one which very few are taking advantage of to build real wealth. That advantage is a high salary coupled with a stable job and a relatively stable industry. That advantage engineers have gets compounded when we factor in the lowest interest rates in human history, in the last 5,000 years it has never been cheaper to borrow money than it is right now. However, few of us are using this advantage to get access to capital and invest in realestate.
In this post, I will be writing from personal experience of having started investing in realestate almost five years ago. Now to be clear, I am not a real-estate tycoon, just a regular guy. I believe this form of investing is, by far, hands down one of the best investment vehicles to build wealth; all of us have access to use, and yet many engineers know little about it or think its not for them.. This post is a guide for those software engineers, friends that have asked me about the topic, and a lot of beginners out there.
I will first go through my real-world example of one of my investments, so this isn't some hypothetical, what if, type of post but as raw and real as it gets. Then I will list some of the advantages I've seen first hand about realestate investing.
My real-world example
In 2014, I decided that I don't want to pay rent and, more importantly, pay down someone else's mortgage, and decided to start looking for something to buy. The issue I had, like most people, I had little savings. I grew up dirt poor in the Bronx, and although I made it through school and got a great paying job, as a software engineer, I had very little savings for that time.
As I did my research, I found the FHA program, which allows us to buy a house with 3.5% down. So I became intrigued that I could buy a 500k home with 17.5k down plus closing costs. While that sounds risky, I thought even if I get laid off and can't pay my mortgage, God forbid go into foreclosure, at least I'm only losing the 17.5k I put down. The FHA program is made for people with a decent salary but who don't quite have the savings. The program has some negative stipulations, that you can read about online and its best to put 20% down if you have it but the point here is you can get started even with very little.
The great thing is we can refinance out of an FHA loan into a conventional at any point and time; this will also eliminate the FHA insurance or PMI payments as they are called. We would do this when the property value has gone up enough to give us 20% in equity, or we've paid enough of the property down to have 20% in equity in it.
For me, this happened within a few years. I bought my home, a multi-family, for 535k. I got into it for under 40k total that includes down payment and closing costs. In 2014, rates were also low, and I had a 5/1 adjustable mortgage of 3.3%, which was slated to go up by 1% in 2020.
The house was a multi-family, so I lived on one side and rented the other. My payment, mortgage + insurance + taxes, was $4,400 a month. My rental income from the other side was $2,300 a month. That means I lived in a home for less than market rent rather than an apartment where I own nothing.
I decided to refinance the home; by this time, the property value in the area went up to 700k for the same property I bought for 535k. Plus, I had been paying down the mortgage for years, I had far more than 20% equity in the home within a few years. After refinancing, I got a good amount of cash that I could use to buy another property. Since I refinanced and the loan is no longer FHA, I no longer pay the PMI, plus I rent the whole thing and make well over a grand because rents are up and my payment is lower thanks to no PMI and the low rates.
Let's break it down:
Advantages that accrue
Perhaps the most significant reason to put our money into realestate over any other asset we could park it into, such as stocks, besides the volatility of those assets, is the ability to gain leverage over our capital.
How does this work in practice? There is almost no other asset that we can take a hundred thousand dollar down payment and turn it into five hundred thousand of capital that you control and steer. A $100k, 20% down, payment on a single or multi-family rental property will get you a loan from a bank of $400k. As of this writing, that loan will be at rates of about 3.0% for 30 years. There is almost no other kind of loan we could take out that is that cheap, not a student loan, not a credit card loan, not margin on our trading account, nothing will be that cheap.
Ok, we got the leverage, but what's the point of it? Well, the point of leveraging capital is to use it to make money and build wealth. If we rent the property every month, we are paying back the loan with the rent money and getting more of an ownership stake, equity, in that property. If we do this right, the property should cashflow too on just the 20% down we talked about before, that means not only are we getting equity but we are getting a little money on top of that which is left over for us to keep, a nice little dividend for us if you will.
We will go into this using real numbers a little further below on this post. However, this isn't hypothetical, and even though realestate is hyper-localized, the model will work almost anywhere in the United States. In addition to that, we don't even need $100k to get started; it is one of the few places of the economy where we can get massive leverage with as little as 3.5% down, we will go into that too.
Multiple ways to make money
The first and simplest thing I have to get out there is that when investing in a rental property and realestate, most beginners don't realize that they will be making money in more than one way. While this is elementary to the pros, it is worth stating the below on here since most of us aren't pros.
- The first and obvious way is in the rent we are collecting; if we get a good property that cashflows, we keep anything left over after our payment.
- The second way is that we are paying down the mortgage and gaining equity, which means we own more of the property at the end of the year than the 20% we put down.
- The third way is the appreciation of the property, this is where the most unknowns lie, but this is no different than the stock market going up and down.
So we have three ways to make money and not to mention the numerous tax advantages, which we will discuss below. If we go into this for the right reasons, 30 years later, it is not uncommon for a property to double or triple in value. That means we own an asset that paid itself down fully, gave us money every month, and ultimately increased in value.
Realestate is one of the few ways to take 100k and turn it into a million dollars in 15-30 years; I don't know of any other asset that lets us do that.
Passive and no significant time
There is a miss conception that is owning a rental property will take up all of your time.
After all Software engineers are busy people, our companies pay us well to work hard, not look after rental properties. This mean's whatever we invest in needs to be self-sustaining; it needs to be as passive as possible.
In my view, realestate is perfect for this, and I speak from experience. In the last five years, I have had exactly three issues pop up in my rental property. What were the problems, and how did I resolve them?
- The showerhead on the tenant's bathroom was dripping, and the shower wouldn't fully close.
- A step in the front of the house cracked and broke.
- A leak from the washing machine on the second floor caused the wall to crack on the floor below.
I fixed every single one of these issues by picking up the phone and calling someone else to fix them. We can google and find a professional business that does this sort of work and call them. It was 5 minutes worth of work for me to do this, I didn't even bother going to look at the issue, I just called someone. The cash flow, plus equity and appreciation of the property, make any amount we spend in repairs meaningless, negligible, and small. Not to mention there are tax write-offs from those repairs which also help us that we will discuss below.
It is important to caveat this: we need to buy a good property in good shape. Alternatively, we need to go in and do the work or get someone to do the work to get it to good shape because what we are talking about in this post is doing this sort of investment for the long term. For this reason, it may take you a while to find the right property to invest in, which is in good shape, and you can be hands-off, but it is absolutely possible to find.
America is such that it rewards specific behavior that society has deemed are suitable and advantageous for it. Owning a home gets rewarded with a tax break, having a kid gets rewarded with a tax break; these things society believes are good for it. Homeowners with kids tend to be relatively stable, and society wants more people to do those things. It goes even further, rewarding us to burrow to get to that point and allowing us to write off the interest on the loan we took to buy our home off of our salary.
Society also rewards the risk-taker, this is capitalist society after all, and usually, it does so if we are creating work for others either directly or indirectly. If we start a business or make money in any way that isn't as an employee, including rental income, we get access to a whole other set of write-offs. Again this is because society wants to encourage us to do more of that behavior rather than kill our motivation to do it at all.
Rental properties are a business, and as such, you get different types of write-offs against the rental income, more info on this directly from the IRS. You could claim your expenses if you did repairs to the property. You can claim depreciation of the property, this leaves more money in your pocket from your asset, because you are using it to rent and it is being worn down. Since I am not a tax professional, I will stop there with the number of write-offs one has access to once they start generating income from a rental property. Still, it will be significantly more than you'll ever get from stocks and paper assets.
Access to more capital later
A hugely under-appreciated aspect of realestate by people who advocate for just paper assets, like stocks, is just how much liquidity realestate can provide.
However, again I would like to debunk the myth that real estate is not liquid. The longer we have been renting and paying down a property, the more capital we have access to, without ever selling the property. We can choose to take this capital out at any point in time, Tax-Free. All of the money from a cash-out refinance loan is tax-free; that appreciation we talked about, we can choose to take that out if the asset went up in value and use it for more leverage. We can use it as a down payment on another property if we so choose.
The cashout refinance is precisely how many of my friends and some former colleagues got to three or four of these properties and are generating enough cash flow, even with the debt, to quit their jobs and completely supplement their salaries.
"25 years from now, what will you tell your grandkids when they ask you 'Grandpa or Grandma, what were you doing when they had the lowest interest rates in human history, and you didn't use it to make any money?" -Dan Pena
I will be writing more on the topic of realestate, how to find tenants, how to manage the property so subscribe to the free newsletter. Also there is an amazing community out there, with a thriving forum called BiggerPockets if you are hungry for more.
Thanks for reading, I am not selling anything, just trying to be helpful. Follow me on Twitter for more similar to this.