Rental Property Asset Allocation

Are you holding the proper rental property asset allocation?

My investment account has finally recovered from 2007.  That’s right.  My investment account has finally surpassed my account balance record set way back in October 2007, over eight years ago.  (It actually passed the mark a few months ago, and I just got around to writing this post.)  It was only just about $50K higher in 2007 that it was back in 2000 or so.  My current 401K, which is nearly as high as my investment account is today, was at $0 in 2003 when I started at my current mega-corp, as I have always converted my previous employer 401Ks to an IRA, and a Roth wen i could afford to pay the tax hit.

If you do not have the proper investment allocation, you could be in for a large surprise in your quest for financial independence.  Being financially independent is not just about having a large amount of money.  It is about multiple income streams and redundant sources of passive income.  And living below your means.  Here are a few insights into what I have done to become financially independent.

If you are going to invest in rental property, remember, it is risky.  Max out your HSA first, but do not spend it until you retire.  Then your 401K second.  Then your Roth or after tax IRA.  And some additional after tax savings account money.  Build up your capital before you even THINK about real estate investing.  I have been maxing out my 401K for 13+ years, and have been maxing out any IRAs and HSAs that are available to me.  I have also nearly maxed out the 401Ks (or SEPs) for all of my working career.  Save early and often, you will be glad you did.

I had been mostly in cash in my investment account after 2000, as I was a bit gun shy from the  market crash in 2000.  Looking back, being in mainly cash was not a smart move.  Back then, I had a risky portfolio of tech stocks, and they came down as fast as they went up.  Making $40K a day was great in a small portfolio, losing it was painful.

So I started saving, saving a large amount and spending less.  2007 was a great year for saving.  That was the first year I was able to save almost $100K, which was a huge percentage of what I was making, well over what I made at my main job.  Living below my means, and doing much of my own chores rather than hire them out, and some side hustles, helped immensely.

The stock market has since taken off; so how is that possible, having such as high savings rate and a stock market has been on a rocket ship since 2009 or so, to only be where I left off?

Real Estate Purchases

It takes a lot of capital to get a solid cash flow from Real Estate.  Some investors mistake deferred maintenance for profit, and they suffer when a major repair comes along.  Or several repair in a row.  Or when one bad tenant crushes them, they go broke.

In 2008 I purchased my first 4-plex.  The price paid was $318,000.  Investment properties require at least 20% down, most mortgage companies require even more.  So chalk up ~80K for a down payment, plus another $20K+ in appliances, carpet, paint, etc. and you have an easy $100K spent.

My mortgage on this property has also been paid since 2008, so the equity has increased from a shear payoff perspective.  Add on some additional equity, based on property sales in the neighborhood, and the equity adds up just a bit more.

Since we are talking about investment performance, I will stick to what I have paid off, which can be considered investment capital.  I will not count property appreciation, income generation, depreciation or other gimmicks.   I can sell it in about 30 seconds for what I paid.

Price Paid:  $318,000
Approximate Remaining Mortgage: $217,000
Equity Portion: $101,000

Once I got that first building rented, my investment account started to recover.  In 2009, I purchased another 4-plex, right next door to my first one.  The price had come down a bit, and it sold for $269,000.  Once again, a ~25% down stroke was required.  I also had to evict two tenants right away, give a third a warning, and do some remodeling.  Today, it is actually worth as much, or more, as any of the properties I purchased.   Just looking at the raw numbers again, no counting property appreciation since then.

Price Paid:  $269,900
Approximate Remaining Mortgage: $179,000
Equity Portion: $91,000

In 2010, I made another investment.  My third 4-plex.  Once again, 25% down, plus some minor work.  This was a great deal, and I had all the units rented before the first mortgage payment.

Price Paid:  $269,900
Remaining Mortgage: $0
Equity Portion: $269,900

Again, in 2011, I was ready to go again.  My fourth 4-plex.  It was another deal that was pre-MLS, as was most of my previous deals.  This mortgage is now my target to pay off.

Price Paid:  $245,000
Approximate Remaining Mortgage: $139,000
Equity Portion: $106,000

In 2012, I purchased a mortgage that lead to another 4-plex, my fifth one.  I had to continue the foreclosure, and take on some foreclosure risk.  There was no down payment, it was a cash deal – I bought the defaulting mortgage, not the property.  Taxes were behind, the water bill was delinquent, and the property was in shambles.  I tried to get friends to buy it, but after several attempts, I purchased it myself.  No guts, no glory.

Price Paid:  $205,000
Remaining Mortgage: $0
Equity Portion: $205,000

My two duplexes have been without a mortgage since I acquired them.  I put a large mortgage on my home in 2001 to pay them off.  Now that mortgage has also been paid off.

If you have been counting, that is about $775,000 invested in my properties since 2008.  So that is where my money has gone rather than any investment. If you want a 6-figure semi-passive rental income, you can look to that number as a guide.  And you still need other  sources of income.

If you count my personal residence that I refinanced to buy my first properties, the mortgage balance was about $100K back then and is now $0, so that makes it at least $875,000 worth of mortgage payments and property investments since 2008.  Factor in appreciation, and you have a nice sum of equity that I cannot even buy a loaf of bread with.  Or travel.

Other Investments and Income Streams Are Needed

You will also need some of your investments in the stock market, bonds, IRAs, etc. to help you through bad times in the rental market.  Remember, rental property is just one leg of your financial independence chair.  You will also need investments, pensions, annuities, Social Security, and maybe even a part time job to live in a low-stress lifestyle.  You may not have all of these income streams, but acquire as many as you can.

If all I had were my rentals, it would be like walking across a shaky bridge.  One misstep, and I may suffer.  No one is perfect with tenant selection, I make mistakes too.  Trying to get a higher price and being vacant hurts too.

I have paid a lot of mortgage debt since 2007.  No wonder it feels like I am always broke…!

What have you planned on investing to become financially independent?  Do you have the time to wait for investment growth, or plan on a large lump sum coming your way?  Or will you risk it all on one investment and hope for the best?