I work for multiple employers as a contractor during nuclear power plant refueling outages. Like any job my job has pluses and minuses, but for the most part I like my job. I work for multiple employers and typically am off work in the summer and the winter. Some of my co-workers work more jobs than me and thus earn more on a yearly basis, however this is a steep trade off. Most of these jobs are travelling jobs and it certainly takes a toll on family life to be away from home. Although my specific career has additional restrictions, pretty much all W2 jobs (save for upper level management) have only 2 ways to increase your yearly pay; increase total hours worked or increase your rate of pay. Both of these options have severe limitations that don’t exist with real estate investing.
There Is A Limit To Hours Worked:
There are 168 hours in a week and 52 weeks in the year. For the most part, even the most industrious nuclear contractors will be hard pressed to work over 36 weeks out of the year. This is due to most refueling outages and contract work occurring in the spring and the fall. About 10 years ago our industry also introduced “The Fatigue Rule” which limits how many hours people who work on safety related equipment can work. As a basic overview during the first 60 days of a plants refueling outage (Most plants have outages that are under 30 days long.) workers can do 72 hours per week and any other time are limited to 55 hours per week. No matter how good you are, you aren’t working more than that. Once in a very great while an exception is made for truly specialized, unique situations, but those are 1 time things and are extremely infrequent. Utilities face very steep fines for violations.
One of my favorite examples of someone working more hours to change their life is the BART custodian who earned over $250,000 a year by working over 4,000 hours in a year. He took advantage of his seniority for overtime bids and worked holidays and weekends to take advantage of the increased rates available. This is obviously an extreme example. No one wants to work over 4,000 hours a year and it isn’t a practical long term method to build your wealth.
I’ve strategically cut back my total hours worked by eliminating my lower paying jobs and travelling for work a bit less to increase our overall work-life balance. In addition to a limit on the total number of hours available to work, the other problem with working more hours is that you have to do it each year. Once you stop it is gone. At least with a pay increase once you get it you have it with no extra inputs needed.
There Is A Limit To Pay Rates:
I’ve spent my career pushing pay rates up as hard as I can. But realistically there is a ceiling and I’m not far from it, heck I may already be there. I might be able to eke out a $1 wage increase here or there, but there is unlikely to be any large increases. Assuming 2,000 hours of straight time equivalent hours per year, A $1 an hour raise is $2,000 for the year. Even if I am way off and can increase my pay rate by $5 an hour, that’s still only $10,000 a year and after that raise any further raises are much harder to get. For people covered by collective bargaining agreements they have no control over their rate of pay and often the increases are very slow if they happen at all. If your pay rate is not in your control this is another major reason why real estate investing is a great way to build wealth.
With Real Estate There Aren’t Limits:
I’ve written several articles detailing the rental houses we have so far. On average even with a loan we are seeing $400 per month of positive cash flow. Each house I add gives me an extra roughly $5,000 per year, every year, the equivalent of 2 1/2 times what I would normally see from a raise from my W2 job. The next question is how many houses can I add per year?
Perceived Limits In Real Estate:
Monthly Cash Flow Per Unit: Before we talk about scale, lets talk about getting 1 unit right. There are many ways to invest in real estate, I am advocating one with a high level of cash flow. I see people all the time advising to follow the 1% rule on a “class A” property. For a property like this you would pay $120,000 and rent the house out for $1,200, perhaps netting $100 a month after expenses. Scaling to 10 units or more when you only make $100 a month per unit, or worse, post a loss, isn’t the game I’m advocating playing. Investing in single family houses in low cost of living areas that can rent for around 3% of the cost of the property is what I’m going for. On Average a $30,000 house that I can rent for $900 to $1,000 a month. I am aiming for $400 per month in positive cash flow. With real estate you can control what type of property you buy, how much money you spend on the rehab, how much you charge for rent, and how you approach financing. Following the 1% rule by aiming for real estate that rents for 1% of its cost is a recipe for failure.
Financing: This is the number one limit I hear people talk about. If you are truly making $400 per month in real cash flow per unit and each unit costs under $40,000, then you should have no problem getting financing. The first property is the hardest. We used a Heloc on our primary residence to provide initial funding. After 6 months we can have the house refinanced based off of a new appraisal and get our cash out, then repeat. Alternatively to build faster, you can leave your rehab costs in the deal and do delayed financing, which limits the loan to the purchase price of the property. Delayed financing works best if you are buying properties that only need minor cosmetic work and require very little rehab costs.
Once your properties have documented positive cash flow the bank will use your income from the properties to qualify against the loan payments, instead of just looking at your W2 income and limiting total payments based on that. This means that your debt to income ratios should not be an issue with investing in this type of cash flowing real estate.
10 Loan Limit: Fannie Mae/ Freddie Mac has a loan limit of 10 properties. Once you have 10 total real estate loans you are done, or are you? There are 5 main ways to sidestep this.
- Option 1 is to obtain a commercial blanket loan. For this you would roll all 10 properties into 1 commercial loan, which will then reset you to 10 available conforming loans.
- Option 2 if you are married is to get 10 in your name and 10 in your spouses name.
- Option 3 is to find a portfolio lender. This is a lender that doesn’t resell the loans and keeps the loans in house. A portfolio lender doesn’t need the loans to conform to these standards since they aren’t reselling them.
- Option 4 is seller financing. Write up an agreement to pay a down payment, assume their existing loan (if there is one) and write them a new loan for the difference with terms that work for both parties.
- The final option is buying with cash flow from your existing rentals. The cash flow from 10 properties should allow you to buy 1 to 2 houses per year with cash.
Bottom Line: 10 loans isn’t a real limit. 10 loans also doesn’t mean you are limited to 10 properties.
Down Payment Limit: There’s a limit to how much available cash you have to invest right? This must be the real barrier to growth! Well, not really. Mrs. C. and I started off using the equity in our primary residence to buy 2 houses with cash. Using the BRRRR (Buy, Rehab, Rent, Refinance, Repeat) method we can refinance every 6 months and take out all the cash we invested. You end up recycling the same cash. Our most recently completed deal was refinancing out House #4. We paid $24,000 for this house, put $8,000 into it and rented it out for $900 a month. 6 months later we did a cash out refinance with an appraisal of $64,000. After closing costs we got a check for $45,000. This completely paid us back for the house and put $13K extra in our pockets.
Since we can do a cash out refi every 6 months we can buy 2 houses per year with this method. Since we had enough starting capital to buy 2 houses this puts us at 4 houses per year. Add in our savings rate of over 33% and the cash flow from these properties and we can buy 5 houses this year. This also assumes that we don’t roll the $13,000 extra from the refinance into buying more real estate as well.
Using the above discussed numbers of $400 per house per month in cash flow adding 5 houses per year adds $2,000 in cash flow per month or $24,000 per year, every year. That’s also at a rate of 5 houses per year and the next year the rate can increase to 8 houses per year. We have 3 BRRRR segments going: the original 2 and the one we bought in the previous year from cash flow and savings. Since they can represent 2 houses per year because of the 6 month refinance waiting period this takes us to 6 houses per year. Add in the cash flow from the previous years houses and our savings takes us up to 8 houses. The following year we would start with 5 BRRR segments meaning we could purchase 10 houses, and that’s without adding in the cash flow and W2 savings available. And it can keep growing at this increasing rate.
My point isn’t that we will increase this quickly, just that the concept is possible and that the upper limit is much, much higher than that of increasing our W2 income. You don’t have to keep on saving up a 25% down payment, you can just continually recycle the same 100% down payment. Buying 5 houses equals a $20,000 per year raise!
Self Managing Limit: Self managing your rentals takes some time. Depending on how well you do your rehabs and screen / train your tenants this time can vary wildly. I have talked to investors who self manage over 100 properties, but at this level it is becoming a full time job. If we assume on average each property needs 2 hours a month to manage, then someone managing 100 properties would be working 50 hours a week. Although we don’t have a ton of history on this, we are actually trending at under 1 hour per property per month. IF this were to scale we could manage 100 properties with only 25 hours per week total between the 2 of us. Alternatively, the property owner can outsource to a property management company for 10% of gross rents, or hire someone directly to be a property manager. By the time you get any where near these numbers you are already a top 1% income earner.
Hiring your own employee comes with its share of headaches, but you have more control over the situation than going with an established property manager. Either way, going the managed route drops your time from 50 hours a week to 1 to 5 hours a week managing the manager. When you have $900,000 coming in a year (gross rents on 100 properties), it’s well worth spending $90,000 (pretax, so the equivalent of $53,000 post tax) to reduce work hours by 90%+.
Income From Rentals
So with $400 per month for houses with a loan and $600 per month for paid off houses, then the net income for a set number of houses is:
- 5 houses $24,000 / $36,000
- 10 houses $48,000 / $72,000
- 20 houses $96,000 / $144,000
- 40 houses $192,000 / $288,000
- 50 houses $240,000 / $360,000
- 100 houses $480,000 / $720,000
- 200 houses $960,000 / $1,440,000
- 500 house $2,400,000 / $3,600,000
Scaling To The Stratosphere:
Although there are many investors who purchase this many single family houses, the majority will start buying apartments for economies of scale. Instead of doing 100 individual single family home deals, you buy 1 100 unit complex. With buying large apartment complexes scaling is much easier. Buying 1 deal instead of 100 or 500 is much easier to do. Lending is done through commercial loans and is based off the rental income the business receives. Most of the larger apartment complexes already come with property management included.
Although I suspect Grant Cardone earns more money from his celebrity than from real estate investing, he is an example of someone who has built substantial wealth and cash flow through real estate investing. He owns over 4,000 units and has tons of content investing in apartment buildings on his youtube channel. Robert Kiyosaki of Rich Dad Poor Dad fame is another strong advocate of investing in apartments.
With apartments, the value of the building is typically determined by CAP rate, instead of comparable sales, since there typically aren’t a lot of comps on the market like with single family houses. This means that increasing the income of the apartment building vastly increases its value. Here’s an example:
John buys a 100 unit apartment complex for $3,000,000 based on a 10% cap rate, meaning it is producing $300,000 in cash per year, a positive cash flow of $3,000 per unit or $250 per month per unit.
If John can increase the rents by $50 a month, decrease the buildings utility bills through upgraded lighting and systematic water leak fixes, reduce property taxes by challenging the assessments, and bring in a new management team that costs less, then he could increase the cash flow per unit by $75 a month. $75 a month across 100 units is $7,500 a month or $90,000 a year. Now the building makes $390,000 a year, increasing it’s value from $3,000,000 to $3,900,000. This is an overly simplistic example, but it showcases WHY apartments can be the next step up from single family houses and eliminates the issue of scaling slowly in total number of units.
The Moral of The Story:
Increase your savings rate into the stratosphere and use your cash to buy cash producing assets. Repeat. Repeat. Repeat. Escape the wage slave mindset and build a plan to live off of cash flow. I wish I had started doing this years ago, but a horrible start into real estate investing left us skiddish for a decade. Long story short in the middle of the great recession, in a year when Mrs. C. and I earned $22,000 and our son was born, I spent the vast majority of our net worth buying a house at the tax auction for $6,000. Everything cost more to fix than I anticipated and I didn’t know how to do enough of the repairs. The house was constantly a fight. Our relationship was highly strained, as was our budget for both time and money. We ultimately sold the house a bit over a year later for the same purchase price of $6,000. After paying for Realtor fees, closing costs, and a lawyer due to a title issue I walked away with a $1,700 check. I sold a paid for house for $1,700. That was painful. This is why it is really important to have strong cash reserves before investing so an unexpected expense is an inconvenience and not a deal killer.
What do you think of investing in Real Estate as opposed to seeking out further W2 wage growth? Check out the book 48 Days to the Work You Love to figure out what career options are best for you..