This past weekend I was at a 5 year old’s birthday party. Her parents are around my age and they have an income property. Two other couples at the party also had investment properties. All of them used a management company to manage their properties. My wife and I always wanted an investment property. We have had roommates in the past helping to pay down our mortgage but we never had a dedicated income property. Over the years we have seen many great properties pop up, but we never go through with it.
What is Considered a Good Investment Property?
Return on Investment (ROI) is calculated as (Gain on investment – Cost of Investment) / Cost of Investment. For example, you buy a home for $200,000 (including closing costs and downpayment) and you net $12,000 per year in profit (Rent minus Mortgage, insurance, taxes, and other expenses). You divide $12,000 by $200,000 to get your 6% ROI. An 8% or higher return on investment is considered good and over 10% is considered very very good and hard to find.
My rule is to never go under 8% ROI unless I think the property value will skyrocket within 10 years. That is, it must be in a good family oriented area with great schools, public transportation, and plenty of shopping. If you want good clean reliable tenants, these are the areas to aim for.
The Math of 2+ Mortgages
Most real estate investors have two or more mortgages. They pay for a mortgage on their primary home and they pay for a mortgage on their investment properties. Whether it’s a 15 year or 30 year mortgage, these investors will pay hundreds of thousands of dollars on mortgage interest, insurance, and maintenance or repairs. If your primary home has a 3% interest 30 year mortgage of $250,000 and your investment property has a 4% interest 30 year mortgage fo $175,000, you will pay just over $250,000 in interest over the 30 year term. Let’s say you make extra principle payments of $300 per month on either home. You can still expect to pay around $200,000 in interest over the life of the term. What if both properties are at 15 year terms? You can expect to pay just over $123,000 in loan interest in 15 years. Keep reading to see why Velocity Banking is a better way to become a real estate investor. Read my other posts on Velocity Banking here.
Why We Are Waiting
My wife and I are using velocity banking to pay off our primary home in 7 years (we have 4 years left!) before buying a new home and converting our current home into an investment property. When you buy an investment property for the purpose of renting it out, you must pay a much higher interest rate on your mortgage. The only way around that is to convert your current home into an investment property after living there for at least 2 years. By paying off our primary home in velocity banking chunks rather an extra monthly principle payments, we are saving well over $200,000 in loan interest and paying only about $35,000 total in that interest.
After we pay off our home, we will save up a hefty downpayment to purchase our dream home so we can rent out our current home. If we rented out our home while having a mortgage, our ROI would have been just over 2%. With our plan using Velocity Banking to rent out our home after it is completely paid off, our ROI will increase to 8%. We plan to pay off our second home with velocity banking in addition to using the rent as supplemental income. Within the next 10-12 years, we should have two fully paid properties under our names with a total interest paid of under $80k. That is a $43k and 3-5 year improvement over the 15 year mortgage example I mentioned earlier and a $170k, 18-20 year improvement over the 30 year mortgage options.
With every property you buy, you can pay it off much faster using the rental income on top of your own income. If our first property takes 7 years, the next will take 5 years, then 3 years, then under 2 years, then under 1 year. By the time we retire, we would like to own fully paid properties in multiple cities including an apartment in the D.C. area, a lake house near the mountains, and maybe an industrial commercial property.
Conclusion
If you want to become a real estate investor, the most efficient way is Velocity Banking. In true Velocity Banking, you would use your HELOC to buy properties full in cash with no mortgages while using your rental income to pay off your HELOC. That means you may need to purchase properties that are under $150,000 or under $100,000 in low population towns like Toledo, Ohio or Hagerstown, Maryland or Erie, Pennsylvania. In our case, we want to purchase properties in a more strategic way that allows us to live in different areas in retirement. If you are interested in the concept of Velocity Banking, consider subscribing to my monthly newsletter. I create blog posts on velocity banking each month in addition to investing, savings, engineering, and side hustles like DoorDash.
