Recently, I was speaking with my wife about my golden handcuffs and my deep-seated desire for freedom. You see, freedom for me equates to a life without debt, a life where the weight of our $638k mortgage is a thing of the past. (I know; first-world problems.)
In my daydreams, I often envision the liberation that comes with unloading this hefty burden. This freedom would give me the flexibility to leave my current job in banking if I chose to. Driven by this vision, I began to map out a strategy to become mortgage-free in just five years. To some, this might seem like an escape plan from the clutches of debt. To others, a potentially missed opportunity in investing.
The Plan: A Five-Year Sprint
The first step in my master plan was to use a mortgage calculator to understand how extra payments would accelerate the paydown.
Starting this March, I’ve decided to make an extra $600 monthly payment towards the principal. It may seem like a drop in the ocean, just $7,200 a year, but every epic journey begins with a small step.
The next step was finding creative ways to increase income to make these additional payments, while ensuring continued investment in the stock market to not miss out on potential gains.
This second phase of my plan involves capitalizing on the next crypto bull run — I’m eyeing a potential sale when Bitcoin skyrockets, hopefully near $100k+. This could allow me to slash $100k+ off the mortgage in one fell swoop.
The final step hinges on using a significant portion of my annual bonus, which is, admittedly, a bit of a gamble because nothing is guaranteed, especially discretionary bonuses.
However, in this challenging job market (at least in my industry), I keep getting calls from former industry colleagues who were recently laid off. Now, I want to achieve freedom like my life depends on it.
The Pros and Cons: Freedom vs. Opportunity
Now, let’s get into the meat of the matter: the pros and cons of this approach.
Pros and Cons of Early Mortgage Payoff
Pros of Paying Off Early
Psychological Relief: There’s an undeniable emotional benefit to being debt-free. I remember the first time I paid off my credit cards and student loans, so I can only imagine the euphoria I’ll experience shedding this weight.
Financial Security: Without the mortgage, my monthly expenses drop, offering more flexibility and security, especially in these uncertain economic times.
Equity Building: Every extra payment increases my home equity, essentially saving for the future in a different way.
Cons of Paying Off Early
Opportunity Cost: The interest rate on my mortgage is only 3.5%, almost tantamount to ‘free money’. With the S&P 500 historically achieving a 10% return per annum, I may be missing out on substantial gains.
Liquidity Risk: By channeling extra funds into the mortgage, I’m limiting my liquid assets, which could be crucial in emergencies or for seizing other investment opportunities.
The Final Verdict: A Personal Choice
At the end of the day, this decision boils down to personal preference. The allure of being debt-free, even at historically low mortgage rates, is strong. It’s not just about the numbers; it’s about the feeling of financial liberation and the security that comes with it.
As I journey towards this goal, I find myself oscillating between the logical allure of investment gains and the emotional pull of debt freedom. Whichever path you choose, there is no wrong answer. Stay disciplined, stay focused, and achieve those dreams.
Exploring how compounding plays a role in real estate investments.
Real estate investing and compound interest are often seen as distinct worlds in the realm of personal finance. However, when their paths intertwine, a fascinating love story unfolds. Today, I want to delve into how compounding interest, a concept commonly linked to savings accounts and stock investments, plays a significant role in real estate investments.
The Basics of Compound Interest
Before we dive into the world of real estate, let’s refresh our understanding of compound interest. Simply put, compound interest is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods. It’s a powerful concept, often described as “interest earning interest.” Over time, it can lead to exponential growth of your investment.
Real Estate: A Different Arena
Real estate investment is typically perceived through the lens of rental income or capital appreciation. However, it’s crucial to recognize that compounding can be an integral part of this investment strategy. The key lies in understanding how your real estate investment grows over time and how reinvesting returns can fuel this growth.
The Role of Compound Interest in Real Estate
1. Mortgage Paydown
When you invest in a rental property, the rent you collect can be used to pay down the mortgage. Over time, as you pay more towards the principal, you build equity in the property. This equity is a form of compounding. As your equity increases, you have the potential to leverage it to invest in more properties, thereby multiplying your investment.
2. Capital Appreciation
Real estate typically appreciates over time. This appreciation, when combined with leverage (using borrowed capital for investment), can result in a compounding effect. For example, if a property worth $100,000 appreciates by 5% annually, its value after one year is $105,000. The compounding effect becomes evident as the 5% appreciation in the following year will be calculated on the new value, leading to an exponential increase over a long period.
If your property generates positive cash flow after all expenses, including mortgage payments, you can reinvest this surplus into other investments or use it to make additional mortgage payments. This reinvestment strategy harnesses the power of compounding by continuously increasing your investment base.
Strategies to Maximize Compound Interest in Real Estate
1. Long-Term Investment
The power of compounding in real estate is most effective over the long term. Holding onto properties for many years allows both your equity and the property’s value to grow significantly.
2. Property Improvement
Investing in property improvements can increase its value and rental income potential. This strategy can accelerate the compounding effect by enhancing capital appreciation and cash flow.
3. Diversification
Diversifying your real estate portfolio can spread risk and potentially increase overall returns. Investing in different types of properties or in various locations can leverage different market dynamics.
Conclusion
The love story between real estate and compound interest is indeed a powerful one. While real estate investments do not compound in the traditional sense like a savings account, the principles of compound interest still apply. By understanding and harnessing this concept, investors can significantly grow their wealth over time. As someone passionate about investing, I see compounding as a key ally in building a successful investment portfolio. Remember, patience and strategy are vital in letting the romance between real estate and compound interest blossom to its full potential.
In 2003, a couple years after I had graduated from college, I bought a 3-unit rental property in my hometown in Connecticut. I was young, eager, and ready to dive into the world of real estate investing. The problem was, at the time, I was living about two hours away in Boston with plans of moving back to my hometown to be closer to my then-girlfriend. I was intending to house-hack (live on the third floor and rent out the other two units to live rent-free). However, I was working in Boston, and my company ultimately denied my request to move. Further, my relationship with my then-girlfriend had gotten rocky, so I made a major pivot and moved to New York City. Now being almost three hours away, being a long-distance landlord quickly lost its appeal to me. NYC was filled with much more stimuli, and I spiraled into constantly going out – wasting precious money, time, and energy.
Early Mistakes as a Landlord
The few hundred dollars in monthly profits struggled to keep my interest. The only real upside was the income covered my car note on a slightly used Acura TL S (much nicer than the 2005 Honda Accord I currently drive). I also dreaded the constant need to fix things at the property and the hassles of dealing with tenants.
In fact, shortly after closing, I hired a general contractor (who just so happened to be my uncle) for some repairs. Being naïve, I did not even have a written contract. He verbally quoted me ~$6,000 for the work, but by the end of the project, he had added another $6,000 to the bill. I went from having a $6,000 buffer to zero savings. A few years later I sold the property to my sister, where I essentially broke even.
Free of my responsibilities as a landlord, my life continued to nosedive. It would take almost a decade to turn my life around and a few more years before I ventured back into being a landlord. At this point I had developed a healthier relationship with money and my credit score was slowly improving.
In 2016, my sister and I purchased a 6-unit fixer upper for $145k in Connecticut. We put in at least another $100k of cash equity and numerous hours of sweat equity. I was naïve to think it would be like a HGTV episode where we fully gut renovate in only 30 days; 6+ months later we were finally done with the major repairs and ready to start leasing.
Ideally, we would have started with a more turnkey property. However, my credit score was still suboptimal, so we were unable to obtain traditional financing. After some twists and turns, we wound up at a community development fund that provided a mortgage with rates double that of a traditional bank. Not optimal; however, we were momentarily happy to be back in the real estate game. (Will write a separate post of this experience; however, we ultimately sold this property.) It should have been a cash cow; however, there was some overuse of the expense account by my partner, and I continued to dread dealing with the ever revolving door of tenants and upkeep.
I ultimately realized that unless I can invest enough capital to acquire a much larger property with a strong management team, or unless I am house hacking, or I have enough energy to hustle as a fulltime landlord, I am better off investing in crowdfunded real estate.
The benefits of investing in crowdfunded real estate include 1) minimal time and monetary commitment 2) more liquidity, and 3) diversification. Let us explore further.
Minimal Time and Monetary Commitment
A couple of months ago, I opened an account at Fundrise. You can start investing with as little as $10 on Fundrise. I contribute about $400 per month. We invest in what Fundrise calls a Balanced Investing Plan, which seeks to build wealth through investing in assets that provide a mix of cash flow and appreciation in value. Fundrise also offers other plans that focus more on generating cash flow or asset appreciation; there is even a fund that focuses on tech companies in the real estate space.
Per Fundrise, the projected return of the Balanced Investing Plan ranges from 6.5% to 15.3% per annum. Assuming I continue to invest $400 per month, in 22 years, my projected return is $369k.
Another benefit of investing in crowdfunded real estate is we still receive the tax benefit of depreciation, which helps to offset passive income. In addition, crowdsourced real estate offers pass through taxation, meaning income and losses are generally passed directly to investors, which means you can offset other income with losses, if any, from your real estate investments. (Unlike publicly traded REITs, which do not offer the benefits of depreciation or pass-through taxation.)
One of the most attractive features of crowdfunded real estate is the minimal time commitment. There is no need to manage properties, collect rents, evict tenants, renovate units, or deal with insurance claims and legal entities. I still reluctantly own a 2-family property in Connecticut. I have so much going on in my life (family, work) that spending even an hour dealing with tenants or contractors feels like a time drain.
More Liquidity
Fundrise allows you to redeem your investments on a quarterly basis. This is in stark contrast to my experience of trying to sell the aforementioned 2-unit property for 12 months without success. After wasting thousands of dollars on moving out a tenant and on repairs, several buyers were ultimately unable to secure financing. So I unwillingly continue to be a landlord, for now.
Diversification
I have only ever owned investment properties in Connecticut as a landlord. Thankfully, with platforms like Fundrise, I can diversify my real estate holdings. Now, I own a diverse pool of assets like single-family rentals, multifamily rentals, and industrial properties in strong markets across the country.
Challenges of Real Estate Crowdfunding
The counterpoint of only investing in crowdsourced real estate is you are not able to fully capture tax benefits, such as writing off expenses for travel, meals etc.
In addition, by only investing in platforms such as FundRise, you may miss out on directly purchasing undervalued assets you could find at foreclosure auctions. I have personally found properties, which have tripled in value in just 3-5 years. In 2017, we purchased the 2-family property for $89k. We have already done two cash out refinances, so technically we have fully recouped any cash equity and the rest is all profit. The challenge as mentioned, is that while the property appraised for $270k (3x the original purchase), it is proving illiquid to sell and somewhat time-consuming. Being a landlord requires a significant time commitment and hustle. As I get older, I instead prefer to sell options from the comfort of my home to generate consistent passive income.
So, there you have it. Unless you are able to invest heavily and hire an experienced property management team, or to roll up your sleeves and hustle, crowdfunded real estate offers a hassle-free and flexible alternative. You still get certain tax benefits, and you do not have to deal with the day-to-day management of properties. It has been a game-changer for me, and it might be for you too.
