2-Year Comprehensive Real Estate Review of Investment Property #3

At the time of writing this post (June 2023), Selenid and I have officially owned our third investment property for 2 years! So, we recently sat down and performed a two-year comprehensive real estate review of investment property #3. And we want to share it with you!

I think this is a really great exercise for us obviously. But also for all of you who are considering becoming real estate investors.

My goal with this two-year comprehensive real estate deal review is to give a completely transparent and open view of the financials. This way you can evaluate what investing in real estate will and more importantly won’t do.

I think you’ll be surprised.

Refresher of initial real estate deal analysis for investment property #3

You can find an in-depth deal analysis for this property from right after we bought it here.

And if you’d like to brush up on how to screen and analyze real estate properties, check out this post.

Anyway, as a quick review, we estimated at the time that after renting out the 3 units, the cash on cash return would be roughly 36%.

However, after 1 year and A LOT of lessons (painfully detailed here), our cash on cash return was a more modest but still excellent 17.7%.

Not too bad.

Two-year comprehensive real estate review of investment property #3

So let’s see how we did after two years…

After 24 months,

Our total cash flow from the property was $46,792.58
Our yearly cash-on-cash return was 20.43%

So, our CoC return actually increased a bit as we continued to beat our goal of 10% or greater CoC for our investment properties!

And this is despite all of the mistakes that we made in the beginning as well as a freak blizzard which resulted in burst pipes and a ton of repairs. This was ultimately covered by insurance, but a debacle to be sure.

And while near $47k in cash flow over two years is amazing, that doesn’t even really tell the whole story…

Remember, there are 5 ways that you make money in real estate:

Cash flow
Appreciation
Tax benefits
Principal pay down
Inflation hedge

So, the cash flow number only tells 1/5 of the story!

Appreciation

This property has experienced some decent market appreciation since we bought it. The current estimate for value is $248,701. And remember, we bought it for $202,000!

So the market value increased a bunch. But that’s just ok for two reasons:

As many of you know, we do not rely on market appreciation. It is a whim and arbitrary. We take advantage of it when it helps us but don’t count on it in the short term. Long term, values will generally appreciate.
More importantly, our property cash flows! So I don’t care what the market value is at any arbitrary time. We plan to buy & hold and enjoy our cash flow.

But, we also have created a ton of forced appreciation on the property. We do love and use forced appreciation because it is very much in our control. Via increasing income and minimizing expanses in this rental property i.e. business, we have forced appreciation. And due to this forced appreciation, the value of our property has risen by ~$400,000 on top of the purchase price.

Now, banks will not use a rent-based method to calculate 1-4 unit property refinance values. Being conservative, you can still use the market value in your net worth calculations. But a seller will pay based on the property’s value as a business i.e. the value after forced appreciation. So this has obviously helped us a ton.

Tax benefits

The tax benefits of real estate investing are tremendous.

Via depreciation, the IRS actually considers real estate properties to be losing money every year. Even when they actually are putting money in your pockets via cash flow.

These passive losses from the property then count against any passive gains. So they won’t offset your W2 or 1099 income, but they will offset things like income from rent collected. This makes real estate very tax efficient.

More about depreciation here.

However, by having you or a spouse obtain Real Estate Professional Status or REPS, these passive losses can count against your active W2 or 1099 income!

It’s not easy to get REPS. You or your spouse have to spend at least 750 hours per year materially participating in your real estate business or spend 1 hour more than your other employment. Whichever is the greater amount.

But obtaining REPS is where HUGE tax savings come in. Let me show you…

Selenid obtained REPS for 2021. We also performed a cost segregation analysis of our 3 properties in that year including this one. This allowed us to take advantage of accelerated depreciation from the properties. That way we take more paper losses from the properties this year rather than spreading it out over the usual 27.5 years.

Counting all properties, we cost segregated $200,000. From just this property, we cost segregated ~$77,000. At a marginal tax rate of 39.6%, this results in roughly $31,000 of tax savings!

Further, we did the same thing with 4 other properties in 2022 which created additional tax savings and protected the cash flow income from this property from taxes.

Principal pay down

The beautiful thing about cash flowing real estate investing is that the tenants’ rent pays for your mortgage.

So, every month, the tenants are increasing your equity in the property and increasing your net worth.

Now, in two years of ownership, most of the mortgage payment goes towards the interest on a 30 year mortgage. So this has increased our net worth by approximately $5,200 total.

So, not huge gains yet but still a major advantage and wealth builder long term.

Inflation hedge

The last way to make money via real estate is an an inflation hedge.

How does this work? Let’s go with an example from this property…

In 2021, inflation was quoted around 7%. This is obviously much higher than the typical 3% that is aimed for. It’s now stable around 4% in June 2023. Honestly, I don’t worry too much about this. But a big reason I don’t worry is because of real estate as my inflation hedge.

Again, this property made $46,000+ in cash flow in two years. But this money is inflation indexed. The reason is because as inflation rises, I raise my rents and am paid at the inflated rate.

In contrast, your W2 income generally stays the same regardless of inflation.

So, my real estate income will cover this inflation or whatever it becomes. My other income and investments largely will not.

That is a big advantage.

Bottom line of this two year comprehensive real estate review

So, in all, our 3rd investment property performed very well!

Our net worth increased by:

Cash flow: $46,792.58
Appreciation: $400,000
Tax benefits: $31,000
Equity pay down: $5,200
Inflation hedge: $1872 ($46,792.58 * 4%)

This all totals a net worth increase of $484,864.58! Even if we use the real instead of forced appreciation method, the increase in net worth is still an impressive $131,565.58!

Obviously, investing in real estate has been a huge factor in increasing my net worth from -$450K to +$400 in 14 months as detailed here.

This is why investing in real estate is worth it.

Too many potential investors get bogged down in the fact that the cash flow from one property will not make them wealthy. And this is true. $23,000 in one year is and should not be life changing for a high income physician.

But…

That tells only a part of the story. There are 4 other ways to make money in real estate, even from just one property. And this analysis does not even take into consideration that its cash flow and appreciation gains helped pay from another investment property that makes us money and increased our net worth!

If you are interested in learning more about getting started as a real estate investor, I consider these 4 posts to be required reading:

You can also check out my free webinar on the 12 steps to financial freedom for physicians to get jump started!

What do you think? How would you grade our comprehensive real estate investment review after two year? Anything else that you would like to see in our annual real estate review? Let me know in the comments below!