Rental Property (Missouri)

Home purchase #1

Enter the REAL ESTATE GAME Passive Income Dude!

The home pictured above was my first real estate purchase, completed towards the end of 2011.  It was a great first home for my wife and me, and we lived in it for about a year before turning it into a rental property.

In this page of PassiveIncomeDude, I would like to share as many details as possible of this particular investment: specifically the home's purchase details, its rental performance, and the challenges and benefits I've experienced thus far. My goal is to be as transparent as possible about my passive income journey with my readers as I think we both learn the most from each other that way! So here we go...

Home Facts
*Purchase Date: Late 2011
*Purchase Price: ~$168,500
*Layout: ~1700sf, 3 bedrooms, 3 bathrooms, finished basement
*Finance Details: 30yr fixed, 3.875%
*Amount Financed: $168,500, 100% of the purchase price
*Amount of Own Money Invested: $0

As you can see from the facts above, both the purchase price and my loan financing were very favorable.  My price/sf was relatively low for new construction, and my financing was absolutely excellent with 30yr fixed debt, at a great rate, and 0% down.  I could talk AT LENGTH about why these two items (purchase price and financing) were great (and I will in future articles), but for now trust me when I say that the beginning facts of this investment were pretty decent. Finally, the home was in excellent condition, as we were the first owners.  Below is a picture of the kitchen to offer a little more perspective on the home.  Not a large, luxury house by any means, but still very modern and nice in my opinion.  We were very thankful and happy with it.

Equity Details:
*Loan Balance at start of rental period: ~$161,000
*JULY 2016 Approx. Loan Balance: ~$146,000
*Current Home Value: $170,000 
*Implied equity: $24,000

These numbers are decent, but not great.  Considering I put literally $0 of my own money into the property, except for paying the mortgage while I lived there, I have very little personal risk in this property to start with.  The bank is in fact holding the risk. I will write an article on this idea later, but trust me on this perspective of risk for now.  And the money I paid to live there during that twelve months before it was an investment as a rental property has now been essentially 100% recoup'ed in equity by my tenant's paying off the mortgage debt for these few years.  Were I to sell the home now, I essentially lived there for free and perhaps even came out with a little cash.  Additionally, the Missouri market has had a major downturn the last few years, in which my home that was once valued at ~$190k, is now closer to right what I purchased it for around $170k.  So, and here is the key takeaway in my opinion: with almost ZERO capital appreciation, I took a $0 investment and created a good amount of "tenant paid" equity...around $24,000! And this number will only grow as time passes.  This shows the power of buy-and-hold real estate investing.

Rental Performance:
In this section I will detail my monthly cash flow each year and will also provide a number I call 'Total Earnings', which is essentially the annual sum of monthly cash flow received plus the annual sum of the 'mortgage debt' paydown. I think this number is a better measurement and can explain why in the following example: say I pay more towards my mortgage payment each month than what is required.  As a result, my monthly cash flow will be lower or perhaps even negative if I am putting a lot towards the loan balance, but my 'mortgage debt' paydown would also be higher as a result.  So, given the allocation decisions one can make, I think 'total earnings' is a better representation in my opinion of which direction your property is "moving" as an investment.  Here are this property's numbers:

2013
Monthly Cash Flow: -$179
Total Annual Earnings: $1,216.97
Occupancy: 82.10%

2014 
Monthly Cash Flow: -$40.66
Total Annual Earnings: $3,531
Occupancy: 98.9%

2015 
Monthly Cash Flow: -$291.01
Total Annual Earnings: $247.56
Occupancy: 68.49%

2016 (JAN-JUL only) 
Monthly Cash Flow: $62.00
Total Annual Earnings: $2,269
Occupancy: 100%

So as a reader of this blog, there would be a few things that would instantly stand out from the above facts for me as a reader:

1) That house is costing you money almost EVERY MONTH, not making you money.
2) What happened in 2015????
3) "I know about rental property investment numbers and this is not a good one."

Ah, but do me a favor and read on!  My thoughts to the above numbered statements would be:

1) You are right.  Since I moved towards the end of 2012, this house really has not cash-flowed well for me.  But understand the following: While I lived there I paid a total of $13,549 in mortgage payments.  Since it's been rented, my tenant has paid down $15,000 in equity! So, I essentially at least lived there for free, and I hope you'll then see that there are benefits to "waiting out" improvements in the cash flow situation.

I'd also add that most rental property's numbers are not great in the first few years, but that they just get better with time.  I anticipate this fact happening with this property.  Finally, there are also other 'excuses' I could make, which are: I consistently paid several hundred dollars extra towards the mortgage at first making my cash flow numbers look worse than they could have been, this was my first home purchase so I have learned a few things since then, :), I've been very frustrated with the two property management companies I've used (more on this in a different article, but please let me know if you know a good management company in Missouri), my investment 'spread' - or rent payment above my mortgage PITI (principal, interest, taxes, insurance) and all expenses really isn't that large and as a result one month or so of vacancy actually wipes out my cash flow for the year, etc. etc.  The reasons or justifications could go on and on.  But no excuses!  The good thing about this blog is that it keeps me honest with the numbers.  And we know numbers don't lie!

2) 2015 was the year my property sat vacant for four straight months.  I anticipated tenant turn over, and the company I was with did not move quickly enough to find a replacement before the summer-move cycle was over.  This was a rough time for this investment.  This was also a time in Missouri where rental rates dropped significantly and vacancies greatly rose across the whole market. Rough, but we got through it!

3) I would agree that for some of the rental property investment benchmarks that are out there, this is not the best investment.  It was a home we chose to live in and greatly enjoyed it while we lived there, and then decided to turn it into an investment.  It hasn't performed incredibly well, but it hasn't been a disaster either.  I anticipate the numbers only getting better with time, and I haven't even mentioned some of the tax benefits that are part of owning real estate, which I won't get into here.  Still, a lot of good lessons learned with this being my first home purchase, and probably most importantly, it got me in the real estate game.

Benefits/challenges:
I'll keep this section short since I already detailed some of these items above, but in closing I will say the following:

 In my opinion, when you can lock in a highly levered amount of  debt, at a low, and fixed interest rate, on a property that was not over-paid for and is in excellent shape, over time you will significantly beat any stock, or bond, or dividend growth investment you can find.

Ponder the above statement and I hope you see its truth!  

What are your thoughts?  Please comment if you have any insight or ideas on what I've shared about this property. I'd love to hear it.

Thanks for reading,

Passive Income Dude