We recently made an offer on a house in San Jose. It was a small 3-2 fixer-upper in a decent part of the city. After the offer due date, my wife and I heard back from our real estate agent, they received 15 offers on the house, and the chosen offer was all cash, 8% over asking price. My wife was pissed. So was I.

Generally, when everyone and their aunt thinks an investment is a good idea, it probably isn't. In a seller's market as strong as this one, we’re going to lose.

Our old plan: use every dime we’ve ever earned on a down payment on a home in the Bay Area.

My new plan: use our $150,000 in cash to buy rental properties with financing. Continue working at our 8-6 jobs for another 5 years to help make the mortgage payments, then retire with 600k in assets**. How are we going to get there? To be decided.  

Step 1: Get the wife on board. After all, it’s her money too.

Step 2: Devise a sound plan based on our financial position.

Current Financial position:

  • Combined income: $15,375/month pre-tax
  • Cash reserves: $143,000
  • Less liquid assets (gold, silver, notes): $10,000
  • Credit scores: ~750

Base expenses:

  • Food, rent, random irresponsible spending: $3,000/month
  • Tax: $5,500/month

Proposal:

  1. Acquire between $200,000 and $500,000 in real estate assets with a minimal cap rate of 5%. 
  2. Finance the properties using 10 year mortgages with 25% down. 
  3. Use the income from the properties to subsidize the mortgages. Use our income to pay the difference.
  4. Refinance the loans to 30 year fixed after five years. Optionally use equity to purchase more properties.
  5. Leave the Bay Area.

Assumptions***:

  1. Repairs on the properties will cost 1% of the property value per year
  2. Property values will stay the same over the next 5 years.
  3. We’ll keep our jobs over the next 5 years

The graphs are based on calculations I used to help me compare two investment options; buying a home versus buying a rental. If you have other means that you might have used in comparing the options, please let me know.

Rent vs. Buy: Predicted Net Worth After 5 Years

Feel free to download the spreadsheet with supporting data here.

Stategy #1: First up, house only. This one feels a lot like treading water. Because we have to use all of our cash for the down payment, we’re left in a scary spot with our jobs. Strategy #1, my friends, is how we land ourselves squarely in the rat race. With this one, we NEED that paycheck. 

Buy a house instead of rental property

Figure 1. Financial position over 5 years if we purchase a home for $800,000. Five year retirement goal at 54% completion after 60 months ($322k finishing assets). The grey line represents my P2P lending investment****. 

Strategy #2: Invest in a $200,000 rental property. With 25% down, this leaves us with $92k in cash after the investment is made, and we achieve 80% of our financial goal after 5 years. As a starting point for a real estate noob, this feels good. If things work out, great, I can double down. If they don’t, I can float this strategy along for a few years or more, even in the worst case scenario.

Added benefit: Extra cash leaves us open to newer, juicier opportunities.

Buy 200000 in rental properties

Figure 2. Financial position over 5 years with a $200,00 rental property with a 5% capitalization rate. Asset earns $833/month in rent, our income subsidizes the remaining $982/month. Grey line represents grand total of my P2P lending income and the $200,000 rental property. 80% goal completion after 5 years with no reinvestment.

Strategy #3: Go ham on rentals. Buy $500,000 in rentals, use a significant portion of our after-tax earnings to subsidize rental mortgages and expenses. The net result of the risk over the term? Just 2% closer to our goal.

I realize this strategy will pay off over a longer term, but after 5 years I begin to doubt even my very conservative assumptions.

buy 500000 in rental property

Figure 3. Financing position over 5 years with $500,000 rental property with 5% capitalization rate. The properties earn $2,096/month and we subsidize the remaining $2,443 in mortgage, interest and property tax. 82% goal completion after 5 years.

 

Based on running the initial numbers, we're planning on renting in the Bay Area and preserving our job-sourced income for the next five years. We'll rent an apartment for about $1,800 per month and make a single $200,000 real estate investment in the coming months. I have a lot to learn about buying rental property before then.

Here's my plan before I buy:

  1. Try to find a mentor online and collect feedback about my plan. Do people think it's too conservative? Unrealistic? Adjust plan accordingly.
  2. Leverage existing connections who've achieved success in real estate.
  3. Connect with friends in less expensive cities in California who would be willing to manage my rental property. Deciding which city to purchase in will depend on steps 1 and 2.

If anyone reading this has experience with buying rental properties with bank financing, please get in touch. I'd love to pick your brain.

Footnotes:

**$600,000 in assets invested safely at 5% interest earns $30k/year. More than enough of a financial base to live in an inexpensive part of the country and pursue part-time work. Anything on top of the expenses is gravy.

***Pros can chime in on this, but I believe these are conservative assumptions underpinning a conservative plan.

****I invest $600/month in P2P lending as my “new car fund”. It’s earned just under 10% interest since I’ve begun about 6 months ago. Loans are unsecured, so this money could vanish if the economy tanks. Once this fund hits $60k, I get a new BMW. Before that? I drive my 15-year-old first car.

*****Other considerations for buying a rental include the very strong tax benefits.

 

  1. Home Ownership Guidelines - Federal Government Housing
  2. Home Purchase - Consumer Advice for Mortgages