*Author’s note: It is important that I address the fact up front that there are many variables that I’ve left out of this little experiment, not to skew the results, but to keep the math and the concepts simple. Feel free to run the numbers again and include varying interest rates, average costs of selling a home, different average cash-flow, inflation, etc, if you would like.
Here’s a simple way to change the trajectory of your net worth dramatically.
As many of you know, a few years back I ended my tenure with a country band called Love and Theft. In doing so, I willingly took a significant pay cut, and shortly thereafter had no choice but to move out of a house that I loved because I simply couldn’t make the payments. Rather than selling the house, though, I went ahead and put renters in there. By God’s grace the home was in a great area, and I was able to cash-flow a couple hundred dollars each month. (Turns out, for that first year, I grossly under-charged to rent in that location.)
It was a while before I could buy a house again. I didn’t realize it at the time, but it was pure providence.
Allow me to explain why.
While I was completely sold on the principles of passive income—of somehow having my money make money for me—I was also completely intimidated by the idea of trying to do that in real estate. I didn’t know where to start! I didn’t have a bunch of money! I was pretty sure that was for the big boys, and I was pretty sure that I wasn’t one.
So I began my quest for passive income by putting a small amount of money into single stocks here and there, with no understanding of how to analyze a company or build a profitable portfolio. I confess, I essentially started trying to speculate, or day trade.
Spoiler: it didn’t work.
After losing a few hundred bucks, I still felt stuck. Clearly this wasn’t exactly what ol’ Kiyosaki was talking about. He definitely didn’t make millions by losing a few hundred bucks a month on bad guesses.
And then, as I said, providentially, I was forced to move out of my house. The curtain was pulled back, and I quickly understood just how simple it was to make rental real estate work for me. (Note: I said simple, not easy.)
Here’s why this really matters though, and where things get exponential!
From here forward, because we have this understanding of how to manage a property and how to assess cashflow, every single time we move out of a home, rather than selling it, we will put renters in it, immediately increase our stated income (depending on the bank you’re working with, any way) and put together a nice little portfolio of properties.
Here’s a little (very rough) math to show you how powerful that is in the long run.
SCENARIO A: John buys a house at age 25 for $150k with 5% down. Every 5 years he sells that house, takes the roughly 10% of equity that he’s paid into it (the rough avg. at 4% interest over 30 years), and upgrades to a home that is $100k greater in value. So at year 5, he has $22,500 in equity ($7500 down + $15000 in principle paid). He sells the first house, takes that equity out (we’ll be generous, for now, and not even take out the expenses of selling, which would really make this comparison lopsided), and puts it down on house #2, worth $250k. In year ten, he takes out his now $47,500 in equity ($22,500 down + $25,000 in principle paid) and buys a house worth $350k. I’ll save you all the steps in between. At year 40, John lives in a house worth $850k (not bad!) and has an equity position of about $407,500. This is a result of rolling his equity from one house to the next. (In other words, John owns almost half of the house! The bank owns the other $442,500.)
Like I said, very rough math. To point out some obvious flaws, this assumes that John’s interest rate stays the same on every purchase. It also ignores the costs of selling, market dips and swells, and most importantly, the fact that the larger his down payment gets each time, the lower the percentage of equity he will have bought after 5 years. We’re being generous and optimistic though.
SCENARIO B: Now, let’s look at scenario two, wherein you have a belief in the power of passive income and therefore, rather than selling each time, because you have a master plan, you simply move out, put renters in, and put 5% down on the next house, because those renters actually help your debt-to-income ratio instead of hurting it. This allows you to carry multiple mortgages at once.
Year 1, you buy a house with 5% down for $150k. At year 5 you buy house #2 with 5% down, but instead of increasing each purchase price by $100k, you only increases by $50k, so this home is worth $200k. Maybe this is because you’re conservative, maybe it’s because it takes some time to save up a 5% down payment, or maybe it’s just because I want to skew the examples in favor of Scenario A, so that when Scenario B is still better, you’ll realize just how powerful this can be!
Again, I’ll skip the steps in between and get to the point. The down side is, at year 40, you live in a house that is only worth $500k. Poor you. Life is tough. On the other hand, you do own 8 houses, and have an overall equity position of about $1.3 million. (Doing some quick mental math, that’s roughly… more than $407,500.)
Lastly, let’s talk about cash-flow. I’m going to use a fairly reasonable average of $300 cash-flow per month, per house. This should certainly cover expenses of vacancy, maintenance, etc.
House 1 will have generated $300/monthly for 25 of the first 30 years, until it was paid off, at which point a payment of $716 magically disappears, giving you 10 glorious years earning about $1000 monthly. Cash-flow on house #1 would then come to a total of $210000 over 40 years. (5 years living in it = $0; 25 years at $300/mo = $90k; 10 years at $1000/mo = $120000).
Again, skipping all the math in between, and accounting for the fact that you are now living in house #8, your total cash-flow over the last 40 years comes to a measly additional $610,000.
Therefore, grand total net worth gained after 40 years of renting instead of selling comes to $1,991,500. Monthly cash-flow at this point—day 1 of year 40—is roughly $4200/mo.
Wanna get really saucy?? Move out every 3 years instead of 5. Pay for some college for your grandkids and get some songs written about you.
By the way, if you want to begin this process for yourself, I’m a real estate agent in Nashville. I’ll be happy to help, just give me a shout!