At the time of writing this post, Selenid and I have officially owned our fourth investment property for 1 year! So, we recently sat down and performed a one year real estate investment review of the property. 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 one year real estate investment review is to give a completely transparent and open view of the financials. This way you can evaluate what investing in real estate willand more importantly won’t do.
It once again is a great illustration of why investing in real estate is a flywheel, not a rocket ship…
Refresher of deal analysis for investment property #4
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 2 units, the cash on cash return would be a 22.8%.
This well surpassed our target CoC return of 10% so we were very excited!
One year real estate review of investment property #4
So let’s see how we did…
After 12 months,
- Our total cash flow from the property was $15,129
- Our yearly cash-on-cash return was 18.03%
So, we underperformed our expectations…
This did not surprise us as we faced some unexpected bumps in the road
The property (as they all do) taught us a few important lessons.
The first is: do not trust real estate companies that flip properties. I’m not saying don’t buy these properties. Because ultimately this rental is a great investment for us. But it was not as truly as we thought. They did cut corners that we had to fix right from the beginning including:
- Sewer drainage
- HVAC issues
Ultimately none of these were hugely major. But we did underestimate our up front renovation/repair costs in our initial estimate and we have learned from this.
The second unexpected issue was that we had two tenants unexpectedly have to leave. One left due to a personal accident and had to move back home with their family. The other tenants left due to losing government assistance and not being able to afford rent. Both were respectful in leaving and did so as soon as they could not make rent. But this did increase our vacancy above baseline expected rates.
While our lower tenants who had to leave were very respectful in terms of leaving, they did not take great care of the apartment. They left it with some moderate damage.
We kept their security deposit which they did not contest. However, the repairs exceeded this amount by a bit.
Despite these issues, we persisted. Both vacancies were filled within a month, however they did result in fully lost rents for that one month.
You may be looking at the cash flow number and be thinking, “Wow, is $15.1K really worth all of this hassle of owning a property and investing in real estate?”
The answer is a resounding yes! I’ll show you why…
This doesn’t begin to tell the whole story
Remember, there are 5 ways that you make money in real estate:
- Cash flow
- Tax benefits
- Principal pay down
- Inflation hedge
So, the cash flow number only tells 1/5 of the story!
Our property experienced a market appreciation of around $12,300 12 months after we bought it. This is modest but pretty good in what is considered to currently be a bad real estate market.
But, as many of you know, we do not rely on market appreciation. It is a whim and arbitrary. We took advantage of it when it helped us though.
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 forced appreciation, the value of our property has risen by ~$217,000 on top of the new value that the refinance was based on.
Now, banks will not use a rent-based method to calculate 1-4 unit property refinance values. 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.
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.
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 again met criteria for REPS for 2022. We also performed a cost segregation analysis of the 4 new investment properties that we purchased in 2022. This will allow 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 29.5 years.
Counting all properties, we cost segregated $290,398. From just this property, we cost segregated ~$72,600. At a marginal tax rate of 39.6%, this results in roughly $29,000 of tax savings!
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 one year of ownership, most of the mortgage payment goes towards the interest on a 30 year mortgage. So this has maybe increased our net worth by $2000 total.
So, not huge gains yet but still a major advantage and wealth builder long term.
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…
On last check, inflation has recently been quoted around 6.4%. This is obviously much higher than the typical 3% that is aimed for. Honestly, I don’t work 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 $15,129 in cash flow in one year. 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 fact, we were able to raise our rents when we unexpectedly turned over the two units on this property.
In contract, your W2 income generally stays the same regardless of inflation.
So, my real estate income will cover this 6.4% inflation or whatever it becomes. My other income and investments largely will not.
That is a big advantage.
Bottom line of this one year real estate review
So, in all, our first investment property performed very well!
Our net worth increased by:
- Cash flow: $15,129
- Appreciation: $217,000
- Tax benefits: $29,000
- Equity pay down: $2,000
- Inflation hedge: $968 ($15,129 * 6.4%)
This all totals a net worth increase of $264,097!
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. And I hope that this real estate investment review in particular demonstrates this. There are always bumps in the road. But the path is still worthwhile with patience and perseverance!
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. $15,000 is and should not be life changing for a high income physician.
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:
- 7 Steps to Visualize the Big Picture in Real Estate Investing
- How To Actually Buy A Real Estate Investment Property
- 3 Best Ways to Invest in Real Estate Without a Crystal Ball
- Powerful Case Study of Passive Hustle in Real Estate Investing
- 5 Biggest Downsides of Real Estate Investing & How to Overcome Them
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 real estate investment after one year? Anything else that you would like to see in our one year real estate investment review? Let me know in the comments below!