We built over $550k of real estate equity over 10 years. We (mostly me) made many mistakes along the way that wiped out the equities, even brought us to negative equities at a time.
True, that we could’ve accumulated more equities had I not made these mistakes. But I don’t regret it. Mistakes made us wiser and more resilient if we learn from them.
I started buying properties in my 20’s with very little experience and money. It was a lot of blood, sweat, and tears. I took 2 steps forward, 1 step back. But it gets easier over time. The profit far outweigh the lost.
Four Simple Steps to Start Building Equity
These are the steps I took to build our real estate portfolio. These principals are simple, but it requires hard work, dedication, and perseverance to acquire and maintain. You must be discipline when executing the exit strategy.
- Buy the right property in the right location at the right time.
- Live in it for about 2 years. Do house hacking as necessary. Take out equity in the form of HELOC when there’s an option.
- Move out and lease the property. Be watchful for negative cash flow.
- Sell the property after 5 years.
You can then repeat the steps for multiple iterations until you build sufficient equity to move on to the next strategy, such as passive income generations, towards your FIRE journey.
We will go through each step and I will list the gotchas, what to do, and what not to do (based on my experience). My hope is that you will be equipped with better knowledge before you jump in to become a real estate investor, if this is what you want.
1. Buy the right property in the right location at the right time
“You make it or break it on the buy”
That’s what every seasoned RE investor said. If you buy the right property, you will make profit over time. If you buy the wrong property, you will either lose money or have to hold it for a long time.
What not to do
The house on the left was one of my earlier real estate investment. It was a cute little house, 3 bedroom, 2 bathroom, open layout, 2-car garage.
It was my first non-detach property. It was an emotional buy.
I bought it at full price at $320k with 6.25% Mortgage and a HELOC since I didn’t even have the 20% down payment. It was at the peak, before the 2008 housing crash. I didn’t want to lose out at that time.
Then, the bubble popped.
At one point, it lost $100k of its value. I had to hold it for 12+ years, renting it out at negative cash flow each month. I didn’t even realize that it was not even a free standing house. It was a Detached CONDO! What it meant, it had a Homeowner Association that I had to fight with to even get it rentable (there was a limit of how many units that could be rented out, the rest needed to be owner-occupied units).
The next time you’re looking at a big development complex with tight space between the house, read the small footprint and zoning code to ensure you understand what you’re getting into.
I finally sold it in 2017 for $40k above my purchase price. But those long years of paying the difference of rent vs. cost ate up any profit.
Moral of the story (of what not to do): Do not buy based on emotion. Do not fall in love with the property. Fall in love with the deal instead.
What to do
“Location, location, location,… timing, timing, timing!“
A couple investment later, I felt that I was a little bit wiser and was ready to make another purchase. This time, I told my realtor to make sure that the property is a free standing house, not a detached condo and no HOA. I made up my mind that this time it would be a logical buy, in an up and coming area.
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We ended up purchasing a split level house with mother-in-law unit on the basement for $375k in 2012. We put 5% down payment and carried a mortgage insurance for a little while. I knew the area was appreciating quickly. We ended up getting rid of the mortgage insurance with a re-appraisal after a year.
We lived in the property for less than two years. We did a little house hack by renting out the basement unit (it has separate entry, its own kitchen, bedroom, and bathroom). Then we moved out to purchase another house in a soon-to-be hot area. The split level house was rented out for a small positive cash flow.
We sold the property for $540k in 2016. Doing a little analysis on the deal:
- 44% price increase over 4 years (11% per year).
- We put less than $20k for down payment. This $20k yielded to $165k spread ($540k – $375k), which was over 800% return after 4 years. Even after closing cost, it was still multiple folds of the seed money that we put into when acquiring the house.
- Positive cashflow while holding the property. But wait, you might ask, wasn’t it negative cashflow while we lived in it? Remember, you get to live for free in your own property. As long as the cost is comparable to rent, you’ll most likely come out ahead. Read My best investment ever: Homeownership?! Excellent article from the FIRE community.
Things to do before buying real estate
Check your credit score, pull your credit report. You want to look good in lender’s eyes so you can get favorable mortgage interest and terms. There are new credit scoring systems recently, but most lenders still use FICO score.
Research for the up and coming area. One way is to go to an established, hot area, then drive a little bit more around the edge of the area and the surrounding. Look for signs of future developments. For example, whenever you’re seeing the city is improving the infrastructure of the area, such as the road and light rail, it’s possible that the area is groomed towards “the next thing”.
Be aware of the signs “Proposed land of action”, especially over bigger land. If you buy a property in the area where the next Costco is, you’ll likely get to ride the appreciation as well. Proximity to Starbucks is always a good sign.
Everybody wants to buy on the hot location. But if it’s already hot, it’s too late. So, timing is the key in addition to location. Some of the area that were deemed as ghetto and unsafe in the past turns out to be one of the hottest area in the city.
Of course there’s a risk of predicting the up and coming area. Everybody has their own risk tolerance.
Lastly, always be prepared for the worst. You want to make sure that every property that you buy can potentially be a long term rental investment. You cannot always bank on: “Oh, I’ll just sell the property when I need the money”. There will be a time when a good property is stale in the market.
2. Live in the property for about 2 years
It is easier to get a loan for an owner-occupied property. You will get a better rate. You have the option to put smaller down payment. If you just get started, always buy the property that you will live in. Do not move out within 6 months since the bank might call out the loan (you signed the paper that you would live in the property).
Do house hacking as necessary. For example:
- Rent out the basement
- Rent out a room in Airbnb
- Get roomates
Check the property’s worth from time to time. I don’t know about you, but I like to be on the know on the value of my properties. This might mean, check recent sold price of comparable houses to get an idea of what your house worth for. The sold price is the price that the buyer actually pays, thus more accurate than the listing price.
If you have PMI (Private Mortgage Insurance), call the lender to have the property reappraised when you think the increased equity already exceeded 20% of the property value. They might waive the PMI, bringing the cost down for your monthly PITI.
If you put down bigger down payment, go to various credit union to see if you’re eligible to open HELOC (Home Equity Line of Credit). I prefer the local credit unions over big banks since they offer more favorable rates.
Save money for down payment for your next property.
3. Move out and lease the property
“Do not make an emotional decision, make a logical decision”
Remember this statement? This is especially crucial for real estate investment. You always buy the property as an investment. You don’t have to buy the place that you live in.
Of course, when money is no longer an issue, you can buy the property that you emotionally want to live in. It’s a bonus when your dream property is a great investment at the time. But you likely make a tradeoff on most cases.
Moving out can be an emotional experience, especially on the first house that you bought. But you have to focus on the big picture, the long term goal. You always have the option to move back to that house later on, if you really want to. In our case, this never happens since priorities and needs change over time. There’s a better house for your situation at any given time.
MissRandom and I often said, “We will definitely come back to live in this house. This is home”. When I ask her a couple years down the road after the move, “Hey, do you want to move back there?”. Her answer, “Never. I like it here! Let’s just sell it and cash out”. Don’t worry, it gets easier over time 😉
When you just start, it might be challenging to get a mortgage for the next house while you still live in it. Your income will need to cover both mortgages. There’s a certain threshold where the bank won’t lend you money, even though you plan to rent out the existing house to generate rental income.
One solution is to move out to a temporary, cheaper place to rent (e.g. an apartment) and rent out your existing house. In a couple of months, you can show the bank the rental income to be added to your debt solvency. We (mostly I) did this a couple of times since our income would not be sufficient on paper to cover both mortgages (even though we probably could since we live frugally).
One thing to keep in mind is, if your existing property is a condominium or town house, the bank might only count 75% of the rental income towards your debt solvency. Thus, please consider this when you bought a condo / town house.
Then, buy your next property (repeat step #1 – #3). We limit to four properties at a time. It’s not a hard limit. It’s a number that works for us, big enough scale, but not too overwhelming. You’ll get to define your own numbers.
4. Sell the property and cash out
At the beginning of your journey, you define what your exit strategy looks like for that property. Don’t go Que Sera, Sera. Determine how much value increase of the property that triggers a sell consideration.
Take advantage of the owner-occupied capital gain tax exclusion ($250k for single, $500k for married couple). It hurt my eyes (and my stomach) to imagine IRS taking 15% of my hard earned profit (and they did a couple of times). IRS didn’t fix a leaky toilet. They didn’t clean a dirty house after a bad tenant. They didn’t do renovations. Thus, do a little more planning to keep more of your money.
Do a lot of research on the price you’re comfortable selling the property for. Then, determine how much money you should spend in making the place look pretty. Kitchen and bathroom remodel are not always necessary. This is not HGTV. Often times, you make more money selling the place “as is” vs. do a major remodel (you lose time and money doing this). Thus, do the math before making this decision.
But here are the things that we usually do (we think it’s worth it) when selling a property:
- Change carpet (this is usually inexpensive).
- Fresh coat of paint (biggest bang for the bucks).
- Clean up inside and outside of the house. Spend some money on the curb appeal (this is the first thing the buyer will see, both online and in person).
- Stage the property. Just focus on living room, kitchen, and master bedroom. Leave the rest open.
Pick the right buyer, the strongest and clean offer. The highest offer is not automatically the best offer. Check for contingencies. For example, if the offer has inspection contingency, the buyer can practically back out the offer before the contingency expires (e.g. “We don’t like the paint”).
After closing, take time to breath and do a mini celebration. Take a mini vacation if needed (missRandom’s favorite part). Let the money sits in your bank for a couple of days. Do not make a major financial decision in this period! It’s funny how a sudden large sum of money do to you.
Retireby’s take on real estate investment
In closing, real estate can be a great way to build up equity. It can be lucrative at times. But it can be destructive sometimes too. It takes mental toughness to be a landlord. It is very challenging to start. But just like everything else in the world, it gets easier over time.
I remember buying my first property in US. I was still in my 20’s. I saved up $20,000 in my bank and declared to myself, “I’m going to be a real estate investor”. I bought my first condo for $139,000. It was 2 bedroom, 2 bathroom, around 800 square feet. There were trees outside, providing a nice shade on the balcony during the summer. It was a quiet neighborhood, walking distance to grocery. I put 5% down payment. It took less than $10,000 to close. I moved in and called it my first home. I felt so grown up, this must be what American Dream is all about, I thought to myself.
Around 1.5 years later, I ended up selling the condo for $196,000. I remember seeing the big check on closing (I couldn’t remember the exact, but it was somewhere in the $40k’s). I couldn’t believe that I just made an extra $40k in less than 2 years just to live in a place I bought vs. rented. Something clicked in my brain. Fast forward to today, we are on the way to our first million dollar. I could’ve not done it without this first experience.
There were more deals after that, some we made more, some we lost money. But the thought of my first deal always gives me some sort of comfort whenever we’re faced with difficult situation in the real estate world.
Until this day, I secretly drive around that condo just to see it time to time. Ah, the start. You never forget your first. Maybe someday I will rebuy the condo…. Naah, I will never buy something with HOA anymore! 😉