In the 10 years that I have been in the RE investing game, I have run across numerous people who use a break-even strategy with investing in RE. Basically it goes like this:

You buy a nice 3/2 house in a good neighborhood and you put a 15 year mortgage on it. The monthly rent on that house is good enough to pay the mortgage payment (PITI) and maintenance too. Fast forward 15 years, you have a paid-off asset in which your tenants made all of the payments AND this asset has even appreciated in value each year since you bought it. Since the rental income was used to pay monthly expenses only, there is no profit to report here and thus no taxes to pay.

Now, on the surface, it would seem the above investment strategy would be the ideal way to invest in RE. This break-even strategy does assume you have a day job that supports your personal lifestyle and provides enough extra income to make 10-20% down payments on future 15 year mortgaged /investment houses.

My question here is this: How does this 'break-even' RE investing strategy work in the real world? I have known investors who have done quite well using it and others that have gone bankrupt using this strategy.

Anyone here care to elaborate on your experiences with this strategy?

Wouldn't you still have to report income and pay taxes on money earned that was used to pay the mortgage? Sure, you can take a deduction on the interest and depreciation -- but you don't get to subtract the mortgage payment fully from the income, correct? While depreciation is an "expense" subtracting from income, mortgage payments are not.

Ignoring that for a moment and assuming that everything really is "break even" after everything is paid... Yes, I think this can work in certain markets and we're doing it with at least one of our 4-plexes. I mean, it cashflows a bit -- but we put all of that into a maintenance account. After replacing a full septic field and roof since we bought it about 10 years ago, we're right about "break even."

But, when it is paid off in the near future, then it will have been worth it.

So, sure, cash(flow) is king and important -- but if you are at least "break even" after all is said is done, then the strategy certain can work. (With the idea that, after 15-20 years when the mortgage is paid off, you'll then be well above break-even.)

- John...

Timing is everything in my hood. We'll have 15 years between peaks (still haven't seen the 2005 peaks). So the "break even" investor who buys at the wrong time will tire and quit well before he sees a penny of appreciation.

most people are not going to quit their day jobs to invest in RE full time. If you have two income household, it's quite easy to have a little extra cash to use for a downpayment on a small rental.

Real world: they go broke or sell because they have too!

Why? Well, Johnny B. Tenant looked great on paper and screened good. Needless to say, Johnny made some bad decisions few months into the lease. The house got trashed. Cost about 5K in materials to fix it up. To save money, they did all themselves... over a 3 month period. More $$ lost. Johnny lost his good paying job too. Can't collect. So how does the "Break Even" landlord recoup this lost? He doesn't. Robs it from his day job earnings.

My big fear with the "Break Even" method is static or even falling rents. Expenses go up over time. If rent does not, what WAS break-even is now actively losing money.

David (MI)

I am not suggesting anyone quit their day job to invest full time. Quite the opposite,...most people who I know who use BE investing are Mom and Pop type operators.

One spouse has a day job earning in the low 6 figures and the other spouse gets stuck managing the tenants. Now, if both spouses contribute equally to managing the tenants, then this type of investing 'can' have a happy ending if there is ever an ending to it.

Also, to be very clear, doing this method does NOT rely on appreciation. If I'm buying a $150k unit over 15 years with a mortgage, I don't need it to appreciate a dime to make a lot of money after that 15 years.

When that mortgage is paid off in full in 15 years -- if it is still "only" worth $150k like when I bought it, then I'm still doing VERY well with that. I either start making great cashflow -- or I sell it for a great profit.

So, I think people need to realize that this is not the same as doing poor cashflow and relying on appreciation to make your money. That isn't it at all really.

Also, on the unit that we're doing this with (I have others that make money just fine -- so I think a mix is good) -- but on the one that is current in this situation, we actually do increase rents and this turns into more cashflow even before the mortgage is paid off. So, the further we go, the more that we get beyond "break even" even before the mortgage is paid off.

But, again, even if it was always "break even" theoretically, we'd still do great after that 15-20 year mortgage.

- John...

Roy, hey Buddy, how are you?

Great topic! Before getting directly to your question, I'll open up a few sub-topics for your consideration / clarification. Caveat: I am not a fan of borrowed money, but I'll ignore that for now and use the scenarios you've laid out.

First, does the term 'break even' assume that all work is hired out? It should. Investors who contribute their unpaid labor are not breaking even. They'll dress it up with terms like "sweat equity", but if they have to sell during a market down turn, or if they get into trouble and foreclosed on that sweat equity evaporates. To truly break even, the property must generate enough income to pay for all routine maintenance, cover debt service, insurance, taxes, and also create reserves for capital repairs and improvements. MOST investors I know use the term 'break even' meaning it covers the mortgage payment only, but they set nothing aside for monthly maintenance and capital reserves.

Second, aiming too low. Why would an investor want only to break even for 15 years? You can DIE or become substantially disabled over a 15 years span quite easily and have nothing to show for their investment except a debt-laden property that may/may not be breaking even. Ever picked up a rental where the "investor" spouse dies or gets physically disabled, and the widow/spouse doesn't keep up? I have. To me, 15 years is too long and represents a sub-par investment. I aim for 7 year, maximum, to recover all funds invested and also own the property free and clear. Otherwise, the deal isn't good enough.

Third, opportunity cost. Compare the ROI your money is making to other truly passive investments. I can invest money used for the down payments on houses in a Vanguard S&P 500 mutual fund and it will throw off--on average--about an 11% yearly return, cash on cash. No toilets, no tenants....just money in the bank. Any investment that involves extra hassle should return a premium over a 100% passive investment.

Back to the original question about 15-year break even houses. It's probably better than what many folks ever do, which is take a "Get Rich Quick" real estate seminar, load up with 30-year loans and HELOCs/HELs, then get discouraged after 3-4 years and sell. These people make little or no money.

How does the strategy work in the real world? I've bought 7 houses from folks where it didn't work out. There are probably some folks it worked out for okay. I think you can do better.

Also, I think some of you are really missing the "break even" part. As I said, people doing this method still need to build up a maintenance and emergency fund. So, they need some cash flow, of course. But, in Tim's example, we'd be just fine. As I said, we've paid for a new septic system ($13,000) and a new roof. So, I consider those emergencies into the "breaking even" plan.

In other words, a "break even" investment strategy is NOT the same as "this property barely cashflows, but does enough to barely pay all of my bills and I hope it appreciates over the next 20 years." That is not at all what I'm talking about here -- and I don't think Roy is either.

THOSE people do indeed have major problems usually. Again, not the strategy being talked about here, IMO.

- John...

Sid, no financial advisor recommends assuming 11% returns on S&p 500 or any index fund. 7-8% is the norm.

If you put 20% down and it is paid off in 15 years, that's a 11% return without any appreciation.

To be even more clear, a 15 or 30 year mortgage is going to have a low low interest rate that is FIXED and can be refied at no penalty. So that kind of mortgage is insurance

Hey Sid, I am doing fine,...glad you see you back here where you are needed the most.

One of my sub-topics is I don't like borrowed money either, however, I would have never attained the RE assets I have now without mortgages or other forms of leveraged assets. I am using the Dave Ramsey snowball method of paying off debts right now and it is working. It requires discipline.

Really,really understanding expenses is often lacking....people easily understand those expenses that are billed regularly...not so much with roofs, hvac, property upgrades.

I think your plan is good. Since you have a w-2,job you will be able to use the depreciation against your income.

from alot of what I have seen in our area often what may not to make a lot of sense on the surface has a simple answer.

Money laundering.

Way to go Jim in OC,..

Roy, like you, I have also known some who have gone bankrupt doing this.

I think the risk is fairly minimal if there is a couple, both earning good income, who do this AND DON"T GET OVEREXTENDED.

If a couple earns 150K/year and purchases 2 houses valued at 400K total, they should be fine IF neither loses their job, and the housing market stays relatively decent. At that income (at least in the midwest), they should have no problem setting aside many, many thousands of dollars every year.

The problem comes with people who overextend themselves financially. The people I know that went bankrupt bought too much real estate and didn't have sufficient income when it came time to refinance and when the tenant pool literally dried up.

Roy, I too started with debt and I agree that without debt I wouldn't be where I am today. I might be in a BETTER place than I am today. Regardless...here we are.

I agree with you that we must consider the "overall" picture vs. month to month to determine 'break even.' We expect hills and valleys, which is why it is important to have reserves in place before we buy. The HVAC can go out 10 days after we buy the stinkin' place... ask me how I know! That, too, must be included in the ROI calculation: "parked" money in the bank whose only purpose is to protect you when times are tough. Wouldn't it be nice to get back to the days of 8-10% yields on CDs and we could actually make money on our parked funds? I remember those!

Ideally, I want a cushion of at least several thousand $$$ per property sitting in a bank so I don't end up financing a new roof or HVAC. This often makes ROI for real estate look WORSE when compared to a passive investment in a mutual fund where the entire principle is making a return!

Don't get me wrong: I still LOVE real estate. But for me it must do better than break even to be worth the hassle. I hope I have been clear explaining why I feel that break even investing is not as appealing as what I do, which I call "Kickin' Butt and Taking Names" investing. There may be some who are satisfied with break even, and to them, my best wishes!

Side notes:

* Regarding passive investment returns... I was referring to the VFINX (Vanguard 500 Index Fund Investor Shares) fund, which as averages 10.8% since 1976. I should get my license as an investment adviser since I'm apparently beating the conventional wisdom of 7-8%!

Sid, please show how it is mathematically possible to make more money without mortgages than with.

all this is WAY behind my thought process. I buy something, collect rent, pay for what I bought, and have an asset worth $xx,xxx tenish years down the road. Works for me.

When I'm ready to retire, I'll sell them off one at a time, spend the money, sell another, etc. Should be plenty left for my kids also unless I develop a rather exotic, spendthrift lifestyle which I can't imagine I'll do at this point in my life.

Unless the are you are in just won't support it why not just work a little harder and find a similar property that does cash flow after all expenses?

David, I am going to argue that you make less money without a mortgage. I think it's fairly obvious that your return on investment is lower.

That said, without a mortgage, your risk goes WAY DOWN.

Beth (WI)

In my neck of the woods, any person who can qualify for a mortgage and put 20% down, can buy 3/2 brick houses in good neighborhoods for around $125K. Assuming 20% or 25K down, you now have some equity in this house. Equity that a banker would hopefully issue a $20K HELOC on. This HELOC becomes your emergency cash fund. If you take money out of this piggy bank you have to replenish it sometime in the near future.

Sid, as much as you'd like o think, my posts aren't directed to you. They're directed to other readers who might think that index funds really do deliver 10-11%, when even 7-8% is considered to be on the optimistic side and 5-6% is more conservative.

As for mortgages they are again, not debt since they are secured by an asset. You also have a fixed rate.

Another reason I don't argue with folks any more...

"As for mortgages they are again, not debt since they are secured by an asset."

Don't even know where to begin, so I don't. (grins)

"...readers who might think that index funds really do deliver 10-11%,"

personal.vanguard.com/us/funds/snapshot?FundId=0040&FundIntExt=INT

Obviously, I like residential rental property. Roy's question is probably the typical, beginning point for most investor/LL.

I've been all over the map with different schemes in buying and financing rentals over 27 years. I've done BE, I've even done negative monthly, eventually (in my area) rents will catch up. The problems I see most people who fail have is, they don't know how to manage tenants and lose all control of their asset. The other problem is either not having $ to cover repairs and or are at the mercy of repairmen. Being a contractor, I do ALL my own work and I take pride in that. I know some here are enamored with paying people to do their work, but I enjoy doing what I do, if it ever became work, I'd do something different.

Just to note it, the VFINX fund that Sid mentions average over 10% since 1976 has only averaged 7.5% for the past 10 years.

So, in other words, it isn't like 10 years ago I could have bought that fund instead of my 4-plex and came out with the mythical 11% return that was suggested...

I agree with David -- no real planner would suggest that you count on 10+% returns with mutual funds. Because, as he said, it would not be a safe number to use.

And, based on the last 10 years, it isn't anywhere near that.

- John...

Roy, there are no banks or CUs around here that will issue a HELOC or HEL on a rental, much less at 90-100% LTV.

David (MI) - Like Sid, I do not want to argue with you or anyone else. That being said,...I have 2 Helocs right now. One is a Personal HELOC and the collateral is my primary residence. The 2nd (B-loc) is strictly Business and NO COLLATERAL was needed to get it. The bank manager told me that my consistent high FICO score was all the collateral that would be required.

It boils down to CAP rate. If you collect more in rent have more in equity it will be the same financially at the same cap rate.

There are a few concerns to keep in mind. Selling a home is expensive. For a traditional single family home you will be paying 7-8% between realtors commission and other closing costs. You can save some here without a realtor but then the buyer is going to want to save that money for themselves. Without cash flow you are not realizing the gains until you sell. Property is illiquid. It could take a year to sell at the price you want. The market can change between the time you list it and the time it sells. You can take out a mortgage or HELOC in the mean time but that has its own costs. Property generally appreciates and the structure depreciates. It depends on the maintenance you are doing but appreciation is not guaranteed. Rent prices are more resistant to change than home prices when the prices are falling. If you have good cashflow you can afford to hold onto the home if the prices fall.

David (MI)

Yes, but why would you ask such a question? This post has drifted way off course.

All I wanted to know from this post was if anyone here knew more about B-E investing than I do.

Another variation of B-E investing does not even involve a bank mortgage and is more inline with buying cheap houses like I do.

The BE method is a tough nut to crack.

During that 15 years that you have a note on the place, you will need a new roof.......and new windows. Just about the same time that large tax bill occurs, is the time that the hot water tank dies..........then there is the one deadbeat that you get that throws the cash flow projection way off. These large ticket repairs are coming, but who knows exactly when.

Where if you have enough rentals, you can take some of the risk out of the model, it is tough to achieve critical mass. That takes time, money and energy. In today's society, people with those three elements are weird. The folks who are routinely post on here, you have the three elements that will allow you to succeed. But we are the small minority in today's society.

I am getting to the point where I have a new place being paid off each year. That is a great feeling, but boy were there some lean months along the way.

Another key word that I am not hearing is benefits. Once as a young man, I didn't want any benefits - I just wanted cash. Now, I really don't cash - because I have to pay taxes on it.....I just want benefits. So for the BE system to work, a spouse typically works. For me, if I could fund my retirement to the level that I want and not earn a nickle, I would be alright.

Roy, regards from Maine. I have a great paying day job (Doctor) and the rentals, all SFHs barely break even from year to year. No matter, I have paid off 5 of 8, and sold off two that were fully paid for, and with only small mortgages left on the rest. Plan is to continue selling so in two years or so as my kids start college, to pay for what would be otherwise a big expense (doctor's kids don't get much financial aid). With not having to fully find the kids' college accounts, wifey and I have maxed out our retirement accounts, and could really retire now (late 40s/early 50s) but will probably keep on a few more years because I really love my job and build up a cushion.

No need to jump on a chair and scream, but the feeling of freedom is exillorating, and I have followed advice found on this forum and taken the tools out of the truck" for 90% of the manual labor. I still do the painting because I LIKE TO. I'd rather paint a kitchen than watch football on TV or golf.

SO... I won't be able to know for sure until they are all sold, but so far, seems to be working out as planned.

JR in Maine - likewise, my regards from Alabama. I have always wanted to travel to Maine just for one reason - to eat fresh Maine lobster. All we have done here is Red Lobster and I feel sure there is no comparison here.

After reading your reply, you may be (or could be) the ideal person I was making a reference to in my original post this morning. Having a good paying day job opens all kinds of options for you. Does your spouse get involved in the rentals also? I see this as a 2 person endeavor, however, I am sure one person can handle it assuming they have a good business plan and a support team of contractors.

I wish that more people would do like you have done in the way of paying for your children's college education. You invested in rental houses and the rents pay for the college tuition and expenses. Even if you sell the houses after graduation for what you have in them, you have broken even and your kids have a college education paid for by your former tenants.

Roy,

Here's my non-scientific analysis:

The investors I meet who talk about operating on a break even basis usually disappear, never to be seen again.

I always suspect they're bragging about fast payoffs and break even because they made a math error and things are not going well.

One blip and they are underwater.

Some lost their rentals when the job income took a dip and could no longer supports the rentals.

At convention a few years back Joe Nielsen showed that it took $400 per month cash flow to break even over the long haul.

On the concept of selling later, my experience with flips has been 6 to 7% to the realtor, 3% to pay the buyers closing costs, and another 3 to 4% in concessions or appliances, for a total of approximately 12 to 14% cost to sell. Then take out taxes.. I need a wide margin towalk away with any money on a flip.

Roy,

Here's my non-scientific analysis:

The investors I meet who talk about operating on a break even basis usually disappear, never to be seen again.

I always suspect they're bragging about fast payoffs and break even because they made a math error and things are not going well.

One blip and they are underwater.

Some lost their rentals when the job income took a dip and could no longer supports the rentals.

At convention a few years back Joe Nielsen showed that it took $400 per month cash flow to break even over the long haul.

On the concept of selling later, my experience with flips has been 6 to 7% to the realtor, 3% to pay the buyers closing costs, and another 3 to 4% in concessions or appliances, for a total of approximately 12 to 14% cost to sell. Then take out taxes.. I need a wide margin towalk away with any money on a flip.

Yes, my wife is the day to day manager of the rentals. She is a stay at home mom (another luxury of a good paying day job) and our working together on this goal, after a few bumps, has brought us closer together as a couple. I very much like the teaching ou kids real life work and management experience as well.

My plan is to sell the paid off rentals over the next 2 to 6 years as the kids go through college to pay their tuitions. I then "will never be heard from again" in the real estate world but, the Lord willing, we will have the kids launched into successful adulthood, and more than enough resources to live out our lives with or without additional earned income.

jr, what is terms on your 100 ltv loan? rate, term?

JR,

David, the loans are commercial loans, secured by the houses. The interest rates are from 4.5% to 7.75%, adjustable every three years, with a 15 year amortization, no early prepayment fee. No appraisal; we use the municipal tax assessment. No document or other "junk" fees, and I seem to make the banker very happy ever time we do a deal. I supply an annual financial statement and copy of 1040. Other than my signature on the promissory notes, no other paperwork. And he always picks up the lunch tabs.

while we make a little bit of profit in each of our rentals, we are only seeing good cash flow now that we have 3 of them. However, I've been able to buy Junkers with a HELOC, refi out 75% LTV and have none of our own money into the house. When we refi, we have been able to pull out our aquisition + Reno costs. The third rental I got emotional and we ended up putting $30k of our own money on that.

I think we are probably break-even, as we do not use cash flow to live on. We both work, and husband has a union job with great benefits. I handle all rentals except for when I use husband as slave labor :)

Our goal is to pay them off over the next 15 years so that if my husband has to take a retirement offer, he can without having to get another full time job. Things change, though, and if we need to sell them for kids college, we still will make good money.

Experienced investors know firsthand that rents can also go down, put in the break even into a negative cash flow.

Local economies also rise and fall. Breakeven does not account for falling or even slow economies.

I think part of the discrepancy here is that people define "break even" differently. Some people here clearly think that "break even" means that you have no emergency fund and cash flow is basically $0 between just rents and normal monthly expenses.

To me, "break even" means that I might not be pocketing big cash each year -- but that I certainly have enough for emergencies and such.

As I said above, my "break even" property had enough to cover a $13,000 septic field replacement...

- John...

Well, I did it exactly that way! Starting in 2000 I bought 6 properties in 5 years while I was working fulltime. I never took any money from the income. I used 100% to pay the taxes and mortgages, and save up the remainder for repairs and maintenance--and it always got used. The tenants rent paid the expenses, and 12 years later as I as planning to retire,I sold the first one with only 4 years left on the mortgage. My sale price was more than I paid for it. I have now sold 3 of my 6 investments, all with the tenants paying the lion's share of the price and all of the maintenance costs.

The incomes from those sales funded my retirement, and allowed me to purchase 2 side by side condos a block from the beach in Dominican Republic. One of thowse is for me, and one is constantly rented to American teachers working in DomRep at the International School.

In my locale, you get good cash flow from low end properties. With high end properties, you will be lucky to break even but you will have less drama with better tenants and good appreciation. With the low end tenants, it is more of a business than an investment. By that, I mean that you will have less money invested to gain a particular income, BUT you will not get much appreciation and you will invest more time and attention dealing with wear and tear and tenant drama.