Hey military FIRE friends!
Throughout this blog, I've referenced the value of real estate as a component of both your investment portfolio AND as an additional source of income. In this post, I'm going to lay out my personal formula for the three types of investment properties* I've used and what each does for your FIRE journey.
(*Note: I made this little typology up myself after acquiring several properties and getting my real estate license in Virginia... I needed some method to the madness. So take it for what it's worth!)
As a military member, you have the unique advantage (and disadvantage) of moving every couple of years. Though there are obviously downsides to this nomadic lifestyle, I choose to see this as an advantage because it allows me to build my real estate investment portfolio in markets across the country. Kind of like built-in diversification.
But no one should go around buying homes willy-nilly. You need a strategy. I've divided my strategy up into three types of homes: appreciation, cash flow, and equity.
Appreciation Homes:
Let's start with the "classic" investment home: one you expect to appreciate over time. This one is the easiest to understand because it's a lot like buying a stock. You try to buy low and sell high; in this case, when the value of the house hits a certain profit mark. In the meantime, you either live in it or rent it out. Your goal isn't to have massive rental profits, though you should be looking to make $200-$300 a month after all your costs.
Though appreciation homes are the simplest to understand, they tend to be the riskiest type of real estate investment. After all, before the 2008 housing crash, everyone thought the market would keep climbing up and up forever. Then the market went bust, and folks in major military cities like Las Vegas and Phoenix were instantly under-water on their mortgage. All that appreciation evaporated just like a stock crashing.
However, there are two benefits that appreciation homes have over your typical stock boom and bust. First, you can increase the value of a home without relying on the market alone. That's right, I'm talking about sweat equity: buying a run-down home and renovating or expanding or otherwise improving it so it is worth more in the same market. No question this effort costs money, but there are a bunch of sources to look at for which renovations get you more bang for the buck. If you're at all handy (hello DIY) then you can do minor upgrades yourself (eg, a new coat of paint costs next to nothing is worth a ton of money) and add value on the cheap.
The second benefit is that, unlike most stocks, you can generate income with your property while you wait for it to appreciate. You can live in it yourself while you're located nearby and then rent it out, letting someone else pay down your mortgage while the market climbs.
My first house purchases were appreciation properties. I got lucky -- I had pulled all of my money out of the stock market before the crash in 2008 and bought a cheap foreclosure in Phoenix when the banks would take almost any price to get these homes off their books. When then-boyfriend-Mr. FIRE was stationed in Vegas in 2010, the market was still super low, so I went house-hunting with him. We ended up buying His-and-Her Houses -- one for him to live in and one for me as an investment (our realtor was thrilled). And later that year I picked up a property in San Antonio with the same goal in mind.
If the principle of appreciation homes is to buy low/sell high (and we bought low) the next step is to figure out when to sell. All of my homes were rentals; Mr. FIRE rented his Vegas house out after he left the military and moved to DC. So unless you hate being a landlord, there's a certain inertia to holding onto rentals that generate decent income. Add in the allure of "timing the market" to sell at the absolute peak value and all the arrows point to holding onto an appreciation property TOO LONG.
So here's my rule: don't get greedy. Pick a price that makes sense, where you will make a decent profit after closing costs and realtor fees, and sell when the market hits that point. In 2012, I sold my first house in Phoenix and made about $60k in profit. Add in the monthly rental profits I'd made and my little investment of $25k in downpayment had tripled in about 3 years. In 2017, the Vegas market was nearing pre-2008 bust levels. That meant it was time to sell both Mr. FIRE's and my houses. Same profit story there, only even better. There's no question that both markets have continued to climb since our sales, so one way to look at it was that we "lost out" on additional profit. But it is just as easy to wait too long and miss the peak....and in housing, it can be a short, steep fall, as the Vegas housing graphic to the right suggests.
Summary: Single-family homes in low markets or in need of improvement. Rental profits: decent; ~$200 per month. Goal: buy low / sell high to realize gains.
Cash Flow Homes:
The second type of investment property I call a "cash flow" home. These are relatively cheap properties that rent for a high price and therefore cash flow lots of money each month. This money can then be harvested to buy more/different properties, invested in the market, or used as passive income in your retirement.
There are a couple basic rules for a cash flow property. First, it needs to be cheap: usually somewhere around $100,000 purchase price. Second, you need to use the 1% rule for rental rates: the monthly rent needs to be at least 1% of the purchase price and ideally more. So a $110,000 house needs to rent for at least $1,100 per month. (I'm not the inventor of the 1% rule -- see this fabulous blog for more info). There are more complicated ways to do this math, but I'm a pilot and 1% is an easy rule of thumb to use and remember.
If you follow this math and try to get closer to 2%, it works out to a hefty profit. In general, a $100,000 house will have a monthly payment of ~$500 with the 25% downpayment required for most investment properties. 1% means a $500 monthly profit; 1.5% means $1,000 monthly profit; 2% means $1,500. You get the picture. Scoop up a couple of these guys (which you can, because they're cheap) and you will have enough for another purchase almost every year, which in turn makes you more cash. Rinse, repeat. Now you're moving up the property wealth ladder.
Unfortunately, you can't find cash flow properties in just any old city. Since we were stationed in DC at the time (I'm not sure you could buy a cardboard box for $100k in Washington DC!), we had to venture to Mr. FIRE's home state of Michigan to buy up a couple of properties in Grand Rapids, a city that had low home prices and a booming rental market. It was our first venture away from military cities, which made me a little nervous. But the prices and profits couldn't be beat. So don't be afraid to venture a little farther afield; alternately, try to pick up these properties when you're stationed at lower housing market locations -- I'm thinking Maxwell AFB, MCAS Yuma, or good old Fort Bragg.
What about type of property? Single-family homes can be good cash flow properties, but look out for duplexes or triplexes to really maximize your return. These multi-family homes not only rent for more, but also offer a safety cushion if one unit is vacant because you're still bringing in income. We have one single-family and one duplex in Grand Rapids, and while we initially funneled the profits from those houses into the renovation of our current (equity) home, now that it's done we home to pick up a couple more cash flow properties by the end of the year, increasing our passive income for retirement and making FIRE happen all the sooner.
Summary: Single-family homes and multi-family homes around $100,000 purchase price. Rent for at least 1% of purchase price. Goal: big monthly income (>$500) for FIRE or to roll into more investment homes.
Equity homes:
The last type of property we invest in I call "equity homes". These are usually the homes Mr. FIRE and I live in (hey, I like nice houses....and FIRE doesn't have to mean sacrifices everywhere) and then rent out for a looooonnng time after the military moves us.
The goal of equity homes is, well, equity. By paying your mortgage each month, you're paying down the principle of the loan you got from the bank. The more you pay down the loan, the more money you receive when you eventually sell the house. Now, this is a pretty silly wealth strategy if you plan to pay the whole loan down yourself: first, you'll be paying a ton of interest that you won't get back unless the house goes up in value, and second, you'll only be getting back the money you put in.
But as a military member, it's pretty unlikely (read: impossible) to spend 30 years in the same house paying the same mortgage. What is far more likely is that you'll buy a house, live there a couple of years, then move on. You can either rent or sell the house once you leave it. I've made the case for renting it out in other posts, but for an equity property that is the whole ball of wax. Bottom line: you want SOMEONE ELSE paying down that mortgage. Then when you sell it years later, you reap all the benefit of the equity that someone else paid in.
So what types of houses make good equity properties? Ones with BIG mortgages. We personally draw the line at $500,000 and above. At that purchase price, your tenant will be shoveling at least $1,000 a month into your equity. Now, you won't realize that wealth until you sell the house, but then it will be a nice chunk of money in your pocket at closing. And since capital gains tax doesn't apply to military members if they have lived in the house for 2 out of the last 10 years, you could have 8 years of equity built up by someone else and get it tax-free.
As to rental profit, you're really just looking to break even on an equity home. You don't want the house to cost you any money to hold onto, but since monthly rent will be $3,000-$4,000 just to cover the mortgage, you probably won't be making much of a monthly profit.
Mr. FIRE and I own 3 of these types of properties: 2 in DC (since it's hard to live well and NOT have a huge mortgage there) and our current home in Colorado. We lived in (and renovated) all three of them. I love these types of homes because they let you live a comfortable lifestyle without sacrificing your FIRE future.
Summary: Single-family homes worth more than $500,000. Live in, then rent and let tenants pay down the mortgage. Break even on monthly rental profits. Goal: sell and pocket the equity.
Bringing it all together:
The key to any good investment strategy is balance, and my real estate strategy is no different. Over the years, Mr. FIRE and I have owned 4 appreciation homes, 2 cash flow homes, and 3 equity homes. We sold 3 of the appreciation homes when the market was right and are selling our first equity home this year. I suggest you mix and match these property types based on (1) what you can afford and (2) your risk tolerance and family needs. I probably wouldn't own more than 3 equity homes, but that's because I worry about covering 3 big mortgage payments if all were empty at once. I don't have that worry with cash flow homes -- in fact, we're in the market to pick up a few more soon.
Of course, the best of all worlds is then the types overlap: an equity home where the market appreciates or a cash flow home where small renovations improve the value. But if you're a savvy buyer, a good landlord, and balance your portfolio of these homes, you're sure to capitalize on your constant military moves toward a FIRE future.
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