“Are you going to sell your properties?”
Now that I live in a different state than my rental investments, I hear this question a lot.
“Are you going to sell your properties?”
Now that I live in a different state than my rental investments, I hear this question a lot.
This is Part II of the Passive Income for Beginners series. Start by reading Part I here.
When I quit my 9-to-5 job, I had no concept of passive income.
Like most people, I conceptualized money in terms of time: “they pay $25 per hour” or “she makes $60,000 per year.” When I quit my job, I figured I’d live on savings for a few years and then return to the workforce.
You hop on a flight to Brazil or Costa Rica or Thailand. You spend a month reveling in the sand and surf. You taste new foods. You discover new music. You spot wildlife you’ve never imagined.
You don’t check email the entire time. Heck, you don’t even post photos to Facebook. You’re radically offline — like it’s 1972.
Moderation is not my strong suit.
I don’t just eat one chocolate-chip cookie — I either eat zero, or I eat the whole batch. I don’t just travel for a weekend — I either stay at home, or I hit the road for weeks/months/years.
And apparently, I can’t just buy one or two houses. Afford Anything Tribe, I’d like to introduce you to House #5, which is Rental Unit #7 in my ever-growing passive income portfolio.
In this article, I’ll share the no-holds-barred, behind-the-scenes story:
But first … check out the pictures.
If you wanted to “flush” the toilet, you’d have to carry a bucket of ocean water to your bathroom.
This was a necessity. Freshwater was delivered by boat, and it needed to get strictly rationed. If you wanted enough for drinking and cooking, you needed to budget.
People elsewhere in the world, though, have become accustomed to luxuries like unfettered access to showers and toilets. They’ll demand this luxury at any cost, even if their wallets and the environment can’t support it.
Until recently, that was the case in Aruba.
To satisfy demand, Aruba coverts saltwater into drinking water. The process is called “desalination,” and this 70-square-mile island (about the size of Washington, D.C.) is home to the world’s second-largest desalination plant.
But desalination requires a ton of energy. And that’s just the tip of the iceberg when it comes to Aruba’s energy consumption.
To keep people happy, Aruba imports cheddar cheese, Oreo cookies and some curious flavors of potato chips. (Teriyaki-flavored potato chips? Really?) It keeps its roadways well-maintained, offers strong public transportation, and spends a substantial amount of its GDP educating its local children.
(Aruba also imports designer clothes and handbags, which baffles me. Why ship that stuff down to the Caribbean, just so tourists can carry it back to Europe and the U.S.?)
Fortunately, Aruban officials recognized how energy-intensive the island’s lifestyle has become. But they also recognized a concurrent reality: People don’t want to pare back on their lifestyle. People love Oreo cookies and curiously-flavored potato chips.
So instead of sacrificing its quality of life, Aruba decided to make that lifestyle sustainable. In the midst of the last recession, Aruba unveiled an ambitious plan to become the world’s first economy to run entirely on sustainable energy.
In 2009, Aruba built a wind farm that generates about 20 percent of its total energy. It’s on-track to run 100 percent on renewable energy by the year 2020.
Sustainability isn’t just a national issue, it’s a personal one. A country’s leaders can tackle waste at the macro-level. But what about waste within our own lives?
How can you create a sustainable life?
I’m not (just) talking about recycling your beer cans. I’m talking about creating multiple self-renewing sources of income.
It doesn’t make sense to ship coal and freshwater to a remote island. That requires too much ongoing effort. It’s much more sensible to build a sustainable solution.
Similarly, it doesn’t make sense to wake up to a beeping alarm, drink stale coffee, battle rush-hour traffic, sit in a grey cubicle under flickering florescent lighting, and then battle even worse traffic back home.
It’s downright ludicrous to endure this agony year after year, until your eyes strain from the computer screen, your back hurts from your corporate-issued chair, and your face gets etched with frown lines.
Sustainable wealth is much more sensible.
Rental properties create sustainable wealth. So do stock dividends, interest, royalties, and businesses that someone else manages.
In short: Investing creates sustainability.
Investing is our ONLY antidote to the hamster wheel. It’s our ticket out.
Learn as much about investing as you can. Hustle, earn more, and apply all that extra money towards your investments. Buy some index funds. Put a down payment on a rental property. Build a small online business, then hire a VA to manage it.
Make just $10 in passive income per year. C’mon, just $10 per year. Anyone can do that.
Done? Okay, great. Now double it.
And double it again.
You see where I’m going with this …
This is sustainability at the personal level. This is freedom from paycheck dependence. This is how you can maintain an awesome lifestyle without polluting your most valuable (and limited) resource: your time.
P.S. The island in my introduction (with the 4-hour showering window and the ocean-bucket toilets) is Seraya Island, off the coast of Flores, Indonesia. It’s one of my favorite places on earth.
P.P.S. I should take a moment to mention that Aruba does a LOT of things right. Their crime rate is close to zero. They have fewer than 30 traffic fatalities a year. They have 96 percent literacy, 94 percent employment, and many Arubans speak four languages: Dutch, Spanish, English and Papiamento. There’s a lot we can learn from their example.
“Sell the Sizzle, Not the Steak.”
That advertising motto is crucial in their efforts to squeeze more money out of customers. (No disrespect. That’s their job, and they do it well.) But what do they mean by that?
Steak — A commodity. It’s a slab of dead cow meat.
Sizzle — The fun, the friends, the merriment. You want to hear the sizzle of your warm meal as it comes out of the kitchen on a blustery winter night. You want a cute server to deliver it to your table while your best friend regales you with a hilarious story that makes you burst into hearty laughter. You want, just for a moment, to forget about your headaches and relax.
We don’t want a slab of dead cow. We want the sizzle. Advertising’s job is to get us to conflate the two ideas. They want us to associate the restaurant’s brand name with positive emotions. With laughter. With relaxation. With the beautiful, fleeting joy of being alive.
You don’t have to spend $14.99 to find the bliss of life.
When you find yourself wanting steak — create your own sizzle instead.
Here’s what I mean:
The sizzle, as you know, is free. Every cliche says so. “Money can’t buy happiness.” “The best things in life are free.” Our society pays lip-service to these ideals, and deep down, most people believe that the platitudes are true.
But most people don’t live their lives accordingly.
We have to eat something. Steak, tofu, beans — we have to put calories in our mouth every day. Preferably delicious and healthy calories, and preferably in the company of family and friends. We’re not anti-social hermits, and we’re not willing to sacrifice our health for the sake of saving a few bucks.
That’s fine. Eat the damn steak. Or tofu. Or whatever you want to eat. Invite your buddies over and grill out in your backyard. Because that’s also where laughter and joy take place. That’s where the sizzle happens.
You can create your own sizzle. You don’t need to buy it.
Here’s a mindset exercise that might help:
Next time you watch a restaurant commercial, imagine eating that meal alone, in a hurry, while on a conference call with an abusive boss. Not as much fun, right? That means you don’t really want what they’re selling. You don’t want the $14.99 meal. You want the sizzle, and you can create that elsewhere.
Here’s another example. Sorry, fellas, this one is girly:
When I see a cute dress, I’m tempted to buy it. But it’s not the dress I want. I want the feelings associated with the dress: fun, free, beautiful, confident.
The problem is that no $32.99 dress can buy that. What will really achieve the feeling of “fun and free?” Breaking away from the cubicle. Taking a vacation without putting in a formal request.
What will really make me feel “beautiful and confident?” Toned legs. Strong arms. Skin that glows as a result of nutrition, water and plenty of sleep. And no dress, no matter how flattering, can compensate for a lack of time spent leading a healthy life.
So I tell myself, “Forget the dress. Work on your abs.” Don’t spend money on superfluous commodities. Use your money to buy time. And use that time to create the sizzle.
Thanks to Jakeprzespo for today’s photo.
Remember when we bought House #3? It’s now rented! Let’s see if this deal is hot or not.
As long-time Afford Anything readers know, Will and I bought our third rental property in May. It’s a 3-bed, 1.5-bath single-family home in a good school district in Atlanta. The asking price was $125,000, and we snagged it for $94,000.
This needed the fewest repairs of any of our houses. Here are the “before” pictures. As you can see, the scope of work was small. Knock out a wall or two; bust up some concrete steps; install a skylight. Voila – instant awesome!
Check out the “after” photos, below.
The total cost of the renovations came to $6,000, which means our “total purchase price” (purchase plus upfront repairs) was a solid $100,000.
It now rents for $1,295 per month. Passive cash, baby! Right away, we see that this passes the One Percent Rule with flying colors.
(The One Percent Rule states that the monthly rent should be at least one percent of the purchase price. Move the decimal point two spaces left. If the monthly rent isn’t at least that high, buy a different rental.)
But let’s dig down deeper. How do those numbers check out?
First, let’s find the “capitalization rate,” or cap rate. This measures the net return that the house provides, excluding your financing arrangement.
Why examine this? Because it shows you the strength/weakness of the deal itself, in a vacuum. Remember, ANYTHING can be cash-flow positive if you buy it with cash. That doesn’t mean it’s a good deal.
The “cap rate” helps you examine the quality of the underlying deal. Once you decide whether or not the investment is worth pursuing, you can calculate how different cash/financing scenarios will affect your passive income.
How do you find the cap rate? It’s easy: Just divide the house’s price by its net income.
Gross Income: $15,540 per year
Management – 10 percent of rent – $1,554/year
Taxes – $1,100/year (includes trash service)
General Repair/Maintenance Fund – 1 percent of purchase price – $940/year
Utilities – The tenant pays everything! That’s one huge benefit of renting out a single-family home, as opposed to a multi-unit building. (In contrast, we pay $300+ per month to cover the tenants’ water bills in our three-unit building.)
Yard Work – The tenant handles it!
Total Expenses: $3,594 per year
NET Income (Income after Expenses): $11,946 per year. Yeah baby!
Right off the bat, I can see that this is a sweet deal. I’m netting almost $12,000 a year for a $100,000 house. That’s roughly 12 percent.
Crunch the numbers, and the cap rate is $11,946/$100,000 = 0.1194, or 11.94 percent.
I don’t know about you, but I think a near-12 percent return is pretty stellar. It’s not as sweet as the 17.8 percent return I’m getting on House #2, but hey, you can’t strike gold every time. ☺
Okay, now we know the cap rate. How much passive income are we collecting?
We have a private loan in which we’re making interest-only payments at 7 percent. (Hold your horses! I know this might create chaos in the comments section. I’ll explain why we choose this below.)
Let’s look again at the numbers.
Net Income: $11,946 per year
Financing Payments: $7,000 per year
CASH FLOW after debt service: $4,946 per year! Wahoo!!
We’re getting $5,000 in passive income each year from this house! That’s one huge step closer to financial freedom.
Why did we get the financing that we did? Look again at the numbers. Look carefully. How much money did we pay out-of-pocket for this investment?
Zero. Zip. Zilch. Nada.
Without spending a dime of our own money, we set up a deal in which we receive about $5,000 in passive income per year. That’s AFTER paying a property manager to do the actual work, plus setting aside a “rainy day” fund for long-term maintenance and repairs.
In other words, we borrowed at 7 percent and used the money to snag an investment that pays 12 percent. This practice is called “arbitrage,” which might be my favorite word in the English language. ☺
“Why get interest-only financing?”
It gives us the most flexibility. We’re earning $5,000 a year in passive income, with no money down.
We can choose – CHOOSE – to use that $5,000 to pay down the principal on the house. (There is no pre-payment penalty). We can use the money to buy another house. Heck, we can blow it on champagne and strippers, if we wanted. It’s our choice.
“What are you doing with that money?
First we’ll buy a few more rental units. Then we’ll start paying down the loans. In other words, we’re reinvesting the profits back into the business.
“Are you disciplined enough to re-invest that money?”
DUH!! If you’re not, get out of the game!
“Why not just borrow from a bank?”
I’d love to. But banks are sick of us.
“Are you worried that you’re over-leveraged?”
Nope. We use cash frequently, and we have kick-ass equity. We bought House #2 in cash. We paid for repairs on House #1, Unit B with cash. Relative to many real estate investors, we’re quite conservative.
“You allot $1,554 for paying a property manager. Why not manage it yourself?”
“Then why do you include a ‘management’ line-item?”
Because I pay myself for my time.
The management fee is active income I pay myself for the time I spend managing the property. It’s a radically different beast than the passive income I earn from the investment.
Rookie real estate investors conflate ‘paying themselves’ with ‘profit.’ You can’t pay yourself $0, pay someone else a a fair wage, and make an apples-to-apples comparison.
Every investment must allow me to make a profit after paying myself. That way, I can remove myself from the equation and the numbers will stay the same. Remember, the goal is financial freedom, not a lifetime job.
“Are you talking to yourself, in the form of italicized questions?”
“In public? On a blog?”
“You’re a dork.”
That’s not a question.
“You just proved my point.”
Fall is here: leaves are turning red, stores are stocked with Halloween candy, and it’s chilly enough to wear sweaters at night.
Yes, I just compared passive income to vegetables.
I know, you think I’m nuts. I’ve gone fruity! (Haha. Pun totally intended.) But hear me out:
Planting a garden is a pain-in-the-butt. Here’s what happens:
I sprout the seeds in a starter tray, which I mist twice a day. Then I hunt down 40 cheap planters and fill them with soil and compost.
When the seedlings are an inch high, I transplant them to containers. Feed them nutrients. Water them daily. Monitor for pests. Thin them as they grow.
Soon its clear I’ve bitten off more than I can chew – er, planted more than I can grow. I need more space. So I head across the street to the house that I own but rent out to tenants. I ask them if I can tear up a section of my own front yard and use it as a garden. (Side note: It feels surreal to ask permission to dig in my own yard. That’s landlord-ing for ya.)
Before I can dig, I need to chop down a tree. I have a small yard and the only place I can plant is completely shaded. So I spend a weekend sawing down the tree and hauling away the limbs. (Relax, earth lovers: it needed to be chopped down regardless; it posed a safety hazard. Trees in my neighborhood are famous for falling on houses.)
Then I have to till and aerate the soil. I listen to catcalls from the homeless guys who like to gather on the sidewalk in front of my house while I work. (I live in the city. This is normal.)
Next I head to the store and load my car with cow poop – er, “cow manure,” as polite society says. I dig trenches six inches deep, cover it with cow manure, and rake the soil back over it.
By this point, I resent these darn plants. This stupid project has taken at least 50 hours of my time.
Then I transfer each plant into the earth and cover it with mulch. The homeless guys watch and provide commentary. They’re like my personal sportscasters. Or paparazzi.
Now I need a fence. I buy some chicken wire, several stakes and zip ties. I find a shovel and a sledgehammer. It ain’t pretty, but it works. Then I check the price of tomato cages. Hmmm. $4 per cage, times 40 plants, equals – yikes. So I gather 40 sticks. Jab them into the ground. Tie the base of each plant to each stick.
I’m fed up with the plants now. I just wanted to grow some darn tomatoes. No one told me it would be this much work.
This lasts for months. My garden goes from being as demanding as a second job to being so passive I almost forget about it.
Now comes the harvest. I have hundreds of tomatoes. Hundreds and hundreds. Enough to feed the homeless guys. (They help themselves to it.)
You see, I do the tough work upfront – in the springtime, during the youth of the year. I maintain it throughout the summer, the adulthood of the year.
Now fall is here. It’s harvest time. And I have abundance.