passive income

Flashback to the spring of 2014. I just turned 24, was less than a year out of college, and working a great ‘entry-level’ job.

Also, I was about to close on my first home. This home was very much a ‘starter home’ and probably more house than I should have bought (more details to follow).

You Bought a House at 24?!?

Common question. “How the heck did you buy a house less than a year after graduating?”

Answer: 3 reasons. First, my parents allowed me to live rent free for a few months in the basement to save. Believe me. I did EVERYTHING I could to stock money away for a rainy day. Many millennial’s have this opportunity but few take full advantage of it.

Second, I had some serious side hustles. Most notably, I woke up every morning at 3: 45 AM… Yes, I know I am crazy…. to drive this awesome high school kid to swim practice. He was not old enough to drive and his mother paid me ($200/week) to take him to and from practice.  I lived off this income and other side hustle income while saving my ‘9-5 paycheck’.

As a side note, I used this time to workout or fire off work emails. It’s amazing how productive you can be when no one is awake to distract you.

Third, and lastly, I had a respectable starting salary coupled with a low downpayment. How low? I used an FHA loan that required a 3.5% down payment (we will get more into numbers later).

But…What were you thinking?!

l did not fully understand what I was doing but knew real estate belonged in my life. Oh, and who does know what they are doing on the first attempt? I viewed this as a trial run. This property taught me a lot of what ‘to do’ and ‘not to do’.

My investment thesis was based on the following:

• I do not want to waste money paying rent to someone.
• Find a way to keep my cost of living affordable.
• I want to build equity.
• Real Estate is the best way to generate wealth creation PERIOD.

Diving a bit more into each of these points. Just like saving for FIRE (or retirement), I rather pay myself (first) than pay some landlord. You will never see your rent money again. A portion of your mortgage payment goes towards paying down the loan and the interest payments provide a bit of a tax benefit.

My monthly payment was fairly hefty (keep reading for the numbers) but I planned to house hack by renting out the extra rooms.

The house had 3 bedrooms and 2 bathrooms. My plan included renting the extra two rooms to friends at below-market rents (hint: this was one of the lessons I learned).

Their rents would not cover my entire mortgage, however, I was ok with this.

Why?

The average 1 bedroom apartment in the DC area is well over $1,500. My logic was – Hey! I can own a home for a few hounded bucks a month?!? SIGN ME UP!!!

Owning a house is like having a piggy bank. Every month you stash a bit more equity into the property by paying down your mortgage.  Think of this as putting loose change into the piggy bank.

Also, if you are lucky, the property value stays the same… Or even better increases. This further increases the equity built up in the property. Double win.

As we all have (hopefully) learned, real estate prices do not always go up. Property values may actually GO DOWN! People get into trouble when they rob their piggy bank. This would be known as taking equity out of their house or using their house as a credit card. DO NOT DO THIS.

Thankfully, I picked an area that was a bit undervalued and has some long-term potential. According to Redfin, my property value has increased by about 10.0% since I bought the home.

Lastly, wealth creation. I started my career underwriting commercial real estate loans (yawn!). This experience allowed me to see first hand how wealth was created and how some of the best names in real estate structured themselves.

I was junior and did not understand everything. BUT! I knew these guys were doing something right and they had something that I wanted.

The Numbers

Finally, the part you have all been waiting for. I bought the house for $358,800.00 using an FHA loan with a 3.5% down payment ($12,558.00 down payment for those of you are either lazy or bad with math).

Thankfully, my interest rate was only 3.75% (hope I see that again). My original monthly payment or PITI (principal, interest, tax & insurance) was $2,307.16. I refinanced out of this loan as quickly as possible; more on this later.

My roommates paid $750/month each which meant I collected $1,500/month. This also meant I needed to come up with about $800/month on my own for a mortgage. Pretty good deal considering the average 1 bedroom apartment was over $1,500 at the time.

This mortgage payment number may seem pretty high. Well, because it was.

The monthly payment included $386.26/month for PMI (Private Mortgage Insurance), which is one of the downsides of FHA. Additionally, I only put down 3.5% which means I had a large loan. $346,242.00 to be exact.

The Refinance

My goal was to lower my monthly payment by getting rid of PMI. Guess what? I did.

This significantly lowered my monthly mortgage payment (figure below… keep reading).

I refinanced my house after about six months. But… How did I do this after only six months?!?

Typically you need to have 20% equity or an 80% loan to value (LTV) to avoid PMI. However, my mortgage broker was very creative AND good at his job. I also benefited a bit from rising property values.

First, let’s start with the property value.  After I bought my home, multiple houses on my street sold. Each house sold for more than the previous (aka more demand for my neighborhood).

All the houses are cookie-cutter and nearly identical. What do these sales mean for me? This meant the appraiser had better sales comps to justify my property being worth more. It also meant someone would likely pay me more for my house if I wanted to sell ( I don’t).

Now for the loan part. Over six months, I paid my loan down a bit and benefitted from a rising property value. However, I was still not at 80% LTV and I was stuck with PMI payments.

BUT! My mortgage broker recommends an 80/10/10 loan. This means that I have one loan at 80% LTV with no PMI (this is a conventional loan), the second loan at 10% LTV and 10% equity in the property. WINNING!

Let’s look at how this new loan structure lowered my monthly payment. I now had two loans which were $1,682.28/month and $203.17/month, respectively. My total PITI was now $1,885.45. Conclusion, I lowered my mortgage payment by $421.71!!!! This lower payment also meant I could rent the entire house and earn a profit every month (more on that later).

My roommates were still paying $750/each for a total of $1,500 a month. I was responsible for $355.45/month for my mortgage. This was a bargain. I was sold on house hacking and loved that I was able to keep my cost of living low. This allowed me to save most of my income.

Current Use

I moved out of my ‘starter home’ in late 2015 when I realized that I wanted to own more real estate. More importantly, I wanted to own real estate that was CASH FLOW POSITIVE.

This lead to the purchase of an old row home (The Fixer-Upper) in DC.

I rented out my room while keeping my two other tenants. The entire house rented for $2,350.00 and my monthly PITI was $1,885.45. This meant I had $464.55/month ($5,574.60/year) in cash flow after paying my bills. Not bad for a property I never intended to have positive cash flow. This was a great trial run and gave me a ton of insight.

The house has been rented almost 100% of the time since I moved out. The rents have fluctuated a bit but nothing noteworthy.

Future Plan

I will continue renting this home for the foreseeable future. The returns are not amazing but I still have tenants paying down my mortgage.

I love this location, how walkable the neighborhood is, and the close proximity to biking/running trails. I might make this my FIRE home and move back in once I ‘retire’. This house could serve as a great home base in between trips. Before moving back in, I want the house to be debt free. This will mean aggressively paying off my mortgage for a few years.  I will not do this for other properties since I plan to retire with over $1 million of Debt.

Over the past month, I went “house hunting” for my next rental property, which is why I have not posted recently. Five bidding wars later, I have nothing to show for my time spent; and thats ok. Some of the winning offers were all-cash offers lower than my bid. Other bids were five-figures higher than my offer. I will write more on my real estate endeavors in the future. Digressing, I would like to discuss my current journey to achieving FIRE (Financial Independence, Retire Early).

The best place to start is the final destination. This is the “why” and the reason for this blog. I do not want to work my life away or spend countless hours stuck in an office with people I do not like. Time is a precious and finite commodity; I do not want to waste unnecessary time being held prisoner by Corporate America. I rather spend time exploring the world, growing friendships, spending time with family and focusing my energy on things I am actually passionate about. As a result, the goal is to retire in my early or mid thirties; I am currently 26.

I plan to ditch the alarm clock, wake up naturally most mornings and enjoy a cup of coffee while reading the news. Not having a typical 9-5 job will allow me the flexibility to travel whenever I want and for as long as I want. I will be able to allocate my time to volunteer work that I am passionate about. I will be able to train and compete for the various activities that I long to cross off my bucket list (full iron-man triathlon, climbing various mountains, hike the Appalachian trail, and biking across the United States and Europe, etc.). Complete freedom! And hey, if I feel like working or freelancing, I will have that luxury as well.

If you are new to FIRE, you might be wondering how is this possible. The plan is rather simple; I will spend less than I earn and aggressively save the difference. Saving a large portion of my income (over 50%) will not be enough to fund several decades of retirement. The cash will be invested into dividend growth stocks and income producing rental properties. Dividends and rents will provide a (mostly) passive income stream that is capable of comfortably funding my retirement needs in perpetuity.

Now, where did the journey begin?

Flash back to 2013, I was a recent college graduate, full of energy and ready to take on the (corporate) world. After applying to almost 100 jobs, I was fortunate enough to land an entry level analyst position at a larger company. Full of ambition, the dream was climbing the corporate ladder for the next 40-50 years, making tens or hundreds of millions of dollars along the way and living a luxurious life-style. I would have an expensive car, an awesome house and all the other toys associated with the “baller life style”.

I have always been a fairly frugal person and came from very humble beginnings. Quickly, I realized material luxuries were not for me; thankfully, without making any regrettable or sizable purchases.

I was fortunate enough to live in my parents basement for a few months rent free after graduating. My only expenses at the time were food, transportation, my cell phone bill and discretionary fun. After receiving my (very modest) first paycheck, I squirreled as much of it as possible into savings. During this time, I focused on building up an emergency fund and saving as much as possible. As a Finance/Economics major, I had a firm understanding of the 8th wonder of the world, compound interest.

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

– Albert Einstein

Additionally, I took on part-time work to further increase my savings. It was shocking to see how much money I saved after a few months. My father recommended that I buy a house and rent out the additional rooms to subsidize my cost of living. Full disclosure, I did not save enough for a traditional 20% downpayment. Rather, I utilized leverage and put 3.5% down on a move-in ready starter home. There was nothing luxurious about this quaint (read SMALL or TINY) 3 bedroom/2 bathroom home (it was actually a duplex). However, it was a great place to live in my early 20’s.

I rented out the two spare rooms for $750 each which covered a majority of my mortgage (For those of you with sticker shock, I live in the Washington, D.C. area, which is very expensive. $750 for a room is a bargain. Especially when the alternative for a studio or one bedroom apartment is $1,700-$2,300/month). While keeping my cost of living low, I continued to save as much as possible, grow my emergency fund and invest. Having an emergency fund proved to be very useful. Within a month of each other I had my appendix removed and fractured my elbow (biking accident).

About a year later, I switched jobs and received a sizable pay increase. However, you would have never known based on my lifestyle. I did not run out and lease a new car or take a fancy vacation. Rather, I increased my savings rate and found ways to save more. Once spring hit, I began biking to work 4-5 days a week and gave up my gym membership (~$20/month). The bike ride to work was 18-miles round trip (9 miles each way), a more predictable commute than driving (traffic sucks), and saved me $18/day on parking. I would like to thank Mr. Money Mustache and Go Curry Cracker! for writing about the cost savings of biking to work. I was already a biker but their posts influenced my actions.    

The new job was fairly demanding and I often worked nights and weekends. In fact, ~80 hour work weeks were becoming the new norm. My boss loved me or at least the work I was doing. Based on my performance review you would have thought I was a rockstar. However, I realized that hard work often goes unrewarded in the work place. Despite my prodigious annual performance reviews, my employer has yet to even provide a cost of living wage increase for almost three years. This is even after I asked. Naturally, this is one of the many reasons why I hate Corporate America and favor entrepreneurship.

Ahhh yes, entrepreneurship, my first true love since the age of 5 (Hello lemonade stand).  As I just mentioned, hard work often goes unrewarded in the work place. I have never liked the idea of someone else controlling how much you are going to earn or if you will even be employed tomorrow. After noticing I no longer need to work ~80 hour weeks at my day job (I still get paid the same either way), I focused my energy on entrepreneurial endeavors outside of work place. As a result, I now manage a few dozen properties in the city for other people. I also have two properties of my own. Both properties are cash flow positive and I am looking to acquire a few more properties. Rental cash flow will subsidize my retirement and help me permanently leave Corporate America.

In a nut shell, this is the short version of why I want to retire early and leave the work place. I am very excited to see how this journey evolves and look forward to sharing my progress with all of you. In future post, I will talk in more detail about dividend income, rental income, what my life in retirement will look like and steps that I will be taking to get across the finish line. I hope that you will continue to follow my journey.