Summary: People often ask us about how much money they need to have to start investing in real estate. We find that question difficult to answer directly, because how much money an investor needs is directly related to the approach that person takes towards investing.
There is a massive difference between what an investor can build with no money down versus $400,000 down when using traditional financing. There’s a massive difference between how much money an investor needs if he/she is focusing on the BRRRR strategy vs turnkey rentals. And there is a massive difference between buying for appreciation and buying cashflowing properties.
This is all to say, that much of how much you need down to invest comes down to you. In this series, we look at six different case studies modeled out over five years to help you decide what type of investor you want to be. Given the size of these scenarios, this post will be split into two parts.
How much money do I need to invest in real estate?
“How much money does it take to start investing in real estate?”
And, “Is it really possible to achieve financial freedom in less than five years while working as a physician?”
As you can imagine, we get asked these questions a lot.
But, besides just using what we’ve been able to accomplish as an example (and our students and friends as examples), wouldn’t it be nice to see how different scenarios actually model out depending on how much money you have to invest?
That’s what I thought!
That’s what we’re going to do in this two-part post: walk through six case studies, each modeled out up to five years of returns based on investor action.
The point of showing you these scenarios is so that you can see how much money it takes to get to financial freedom depending on the path you choose to take. My plan is that this not only helps you see the options but also helps you clarify what you want to do with your money, time, and investment strategy.
How much is achieving financial freedom in five years or less worth to you?
The case studies explored in this post all start off with a minimum $50,000 a year down payment. Some will involve having a larger down payment upfront, but all will be limited to adding in an additional $50,000 per year in investment funding.
Some of you are probably questioning how someone can even save up $50,000 a year to put towards buying real estate year after year. Depending on your salary and spending, this may not be an easy thing to do. It may take sacrifices.
Maybe you won’t put away money in your 401K besides what you need to match. Maybe you’ll downsize your car. Or maybe you’ll house hack a property. Or… maybe you’ll give up your Nordstrom card and going to Starbucks. (Note: we did each and every one of these things to save up money for real estate during our journey!)
Or maybe you’ll only save up $25,000 a year initially, knowing it will just take you a couple extra years to get to financial freedom.
Ultimately, you will figure it out if growing your real estate cashflow and wealth is your top priority.
Before we get started with the numbers….
While you’re reading through these examples, please note some important similarities shared by all of them.
One, all of these case studies are based on buying in a relatively cheap cost of living area.
If you live in California or Hawaii and are determined to invest locally and buy $600,000 duplexes, it’s going to take you a much much longer time to get to financial freedom. (Or you’re going to have to save up $150,000+ a year for down payments.)
Second, all of these case studies are based on you buying cashflowing rentals. These are rental properties that put money in your pocket after expenses each and every month.
If you buy properties that do not cashflow, and you bank on market appreciation only, you are taking a risky path and will either crash and burn or get lucky. Because we do not believe in gambling on your future, all the case studies below assume that you buy properties with a base return of 10% cash-on-cash (cashflow made on the cash you invest).
Third, every case study has either you or your spouse achieving real estate professional tax status at some point. This is because the tax benefits of achieving this status are so phenomenal that they will lead to exponential growth.
If you are single, when you’ve built your portfolio up enough, achieving REPS will pay for you to cut back to half time just in tax savings. You will just have to do the math each year to determine when cutting back at work is justified (if you even want to do it in the first place!).
Fourth, you must put all of the cashflow you earn from real estate investing early on back into more property. It is imperative to exponential growth. Otherwise, you will not achieve Fast FIRE in a timely manner.
Finally, keep in mind there are lots and lots of ways to make money in real estate. These scenarios are just a few very basic ones. You may even choose an approach that is more blended and combines these different scenarios. Ultimately you will have to find the approach that works for yourself and your family.
Case Study #1: The Basic Approach
With $50,000 saved to spend each year on real estate, all cashflow is reinvested.
Year 1:
In this scenario, you have $50,000 saved, which you will put down to buy a $200,000 duplex. If you get 10% cash-on-cash back from that $50,000 down payment, you’ll get $5,000 in cashflow a year.
Note the $5,000 in cashflow is tax-free because you have significant paper losses that shelter all of your property’s income.
You also have equity paydown by your renters on your property (approximately $2,500 per year). You’ll also likely have rent appreciation (usually 2-4% per year) as well as market appreciation and forced appreciation (which is based on what you do with the net operating income of the property). Since these other variables will complicate the model immensely, we’ll exclude them for the sake of this article.
So, in total, you’re making $5,000 in cashflow to start, but you’re actually earning significantly more each and every year.
Year 2:
The second year of this plan, you buy yourself another $200,000 duplex (because you have saved up another $50,000 down payment).
You also have $5,000 in cashflow from the previous year, which you hold in reserves. Now you’re making $10,000 in cashflow per year, your renters are paying $5,000 down on your mortgages a year plus all the other sources of profit above.
Year 3:
Year three, you buy another $200,000 duplex. You’re up to 6 doors, $15,000 in cashflow and you now have $15,000 of income saved up from cashflow from these first three years. Your renters are also paying off over $7,500 in your mortgages. You’ve probably also had some rent and property appreciation.
Year 4:
Let’s say you reinvest that saved $15,000 in cashflow you’ve now saved over three years into a property year four and buy yourself a triplex instead of a duplex.
Year four, then, you’re up to 9 doors, having put down $65,000 on a downpayment for a $260,000 triplex.
You’re now making over $15,000 in cashflow from your duplexes. (In reality, we know this has likely increased from rent appreciation but to keep the model simple, we’re not factoring that in.) Plus now you’re getting an additional $6,500 in cashflow from your triplex, for a total tax-free cashflow of over $21,500.
Your renters are now paying off >$11,000 towards your mortgages. (This means at this point they’ve paid off >$25,000 of your loans for you.)
Year 5:
Year five, you buy yourself one more triplex (putting down $71,500 because your cashflow is growing each year). You’re up to 12 doors and cashflowing almost $30,000 tax-free.
This is the year you claim real estate professional tax status and you cost segregate all your properties. (Writing off a conservative loss of 25% of the property value, equivalent to $236,000 from your $946,000 in properties.)
This shelters your clinical income, giving you a tax refund of about $59,000 if you assume a conservative base 25% tax bracket.
You now have $59,000 in tax savings + $30,000 in tax-free cashflow going into year six. Your renters have paid off about $30,000 in your loans the last five years. You have almost a million dollars in properties. (And this didn’t take into account any type of appreciation!)
Case Study #2: The Niche Approach
With $50,000 saved to spend each year on real estate, all cashflow is reinvested.
Now, let’s say you don’t want to follow the basic plan. You want to get much greater returns with minimal cash in. What are your options?
One is to explore rental property niches. There are lots of niches – from AirBNB to student housing to respite housing. But, to keep things simple, let’s just look at an example using supported living, something we’ve done with a couple of our properties in Spokane.
Because we currently have one supported living property earning a cash-on-cash return of 20% and another with a return of 40%, let’s split the difference and look at what happens when you get a 30% return on your properties.
Year 1:
Year one you buy yourself that $200,000 duplex. Your cash-on-cash return is 30%, so you’re bringing in $15,000 on your $50,000 down payment. Your renters are still paying down $2,500 on your mortgage.
Year 2:
The next year you buy yourself a $260,000 triplex with $65,000 down. Your cashflow goes up to $34,500. Remember, your renters are also paying down your mortgages to a tune of over $5,000 per year at this point too.
Year 3:
Year three, you buy yourself a fourplex with the $50,000 you’ve saved and the $34,500 of cashflow you earned the year before. That’s $84,500 down payment, which should buy you an almost $340,000 property, which cashflows $8,400 a year.
You’re up to almost $43,000 in tax-free cashflow. You own 9 units. Your renters are paying down over $8,000 a year in mortgages.
Year 4:
Year four you claim real estate professional tax status year four as you buy another fourplex, bringing your total doors up to 13. Since your niche is supported living, in reality, you probably met criteria the year before since you self-manage. But let’s pretend you didn’t quite make it year three.
This year you put down $93,000 in a down payment to buy yourself a $370,000 fourplex This down payment comes from your $43,000 in annual cashflow plus you had saved the $50,000.
You add over $9,000 in cashflow to your ledger, bringing your cashflow to $52,000. Your renters are now paying down $13,000 per year in mortgages.
You also write off $292,000 in a paper tax loss. (25% of your 1.17 million in property – assuming that nothing has gained market value!!) You will do this using cost segregation and 100% bonus depreciation. This saves you $73,000 in taxes (assuming the 25% tax bracket).
Year 5:
Year five is crazy.
This year you come in with $52,000 in cashflow and $73,000 saved in taxes. You also add your $50,000 in savings to that for a total down payment of $175,000.
Because you want to continue serving supported living clients, you decide not to go into commercial size properties (which often require more down). Instead you buy two fourplexes at $350,000 each. Your cashflow jumps another $26,000 – so you’re now at $78,000 in tax-free cashflow!
You also cost segregate the two new properties, getting another $175,000 paper losses, saving yourself $43,000 in taxes (assuming you are in the 25% tax bracket).
You go into year six with over $78,000 in cashflow (assuming no appreciation of any sort and extremely conservative tax estimates), with your renters paying down $21,000 on your mortgages each and every year. Your properties are worth almost $1.9 million dollars without any appreciation.
For part one of this two-part blog, click here!
