Congratulations, you purchased a home! You’ve built up equity and watched the value of your real estate increase – smart – you are rich!
But wait, with mortgage payments and home ownership costs, you are struggling to cover your living expenses – you feel poor. You can barely buy dog food and diapers, much less pitch-in for another office gift exchange.
You, my friend, are house-rich and cash-poor. Which sucks. I know because I’ve been there.
Plenty of people are house-rich and cash-poor. And it’s not because they’re all building home theaters and billiard rooms in 5,000 square foot McMansions. No, some are just trying to secure housing in expensive urban areas while getting established professionally or starting a family.
Even though the golden rule is that your monthly housing payment (including principal, interest, taxes and insurance) shouldn’t account for more than 28 percent of your gross income, this rule goes out the window in many metropolitan areas. In fact, in New York City, the typical household spends two-thirds (65.2%) of the their income on housing. In Boston, Chicago, San Francisco, and Los Angeles, home dwellers’ expenditures are not far behind. So while it might be ideal to keep your housing expenses low, you just might find that, well, you can’t!
There was a time when I couldn’t.
When a job transfer landed our family in Los Angeles, we stretched every last dollar to purchase our small home – a sagging, beach bungalow, circa 1950. Ignoring the shag carpeting and wood paneling (and even the grimy bong-pipe in the basement), we dove right in, insisting that “This could be the home of our dreams!” A little renovation work here…a little budgeting there…. we could swing it, couldn’t we?
So we emptied our savings and took a chance on the house and its community. The neighborhood gave off a slightly forlorn vibe, its winding streets littered with curio shops and empty diners. But what the locality lacked in charm, it countered with convenience. To transportation that is. A major international airport (LAX) sat right on its southern border, providing a visual spectacle of lights in the night, yet challenging us to hold conversations on the deck in the day. It was a mixed bag, this neighborhood of Playa del Rey, or “King’s Beach.” We wondered whether our new home would become our castle by the sea or just a royal pain?
We kept up our mortgage payments and used every extra penny for renovations. Amid the drywall dust and drying paint, we wore flip-flops to the shower and moved sleeping bags from room to room, transforming each portion of the home into a comfortable living space. As work progressed, and we settled in, we fell in love with our home and neighborhood. But, truth be told, we were struggling. The mortgage payments and renovation costs left us with nothing to spare – no money for babysitters, dinners out, new clothes, vacations – and, over the years, extreme frugality was wearing us down.
Fortunately, during that time, the real estate market was cranking and local values were climbing. We had a conventional mortgage, so we were paying down the principal and building equity every month. We knew we had money – in the house – on paper. Just no cash in our hands. We were the poster children for the house-rich and cash-poor. Something had to give. We wondered, should we sell the home to free our funds, take our cash profit and resume a more balanced lifestyle? Or could there be a better option? Could we keep this housing asset on our balance sheet while improving our current cash flow?
Flipping the Real Estate Script
Yes, we could.
We took out a home equity line of credit (HELOC) on our Playa home and used the money as a down-payment on a more affordable home in an inland community. Yes, a bit of a sacrifice. But, by moving our family, we generated cashflow immediately from rents that exceeded our expenses on the initial mortgage and the home equity loan together. Even though selling the Playa home for an immediate cash gain was tempting, we knew that we could pave our way to long-term financial security and retirement goals by keeping the house as a rental property. By flipping the script, from cash-draining to cash-flowing, we could keep our home, our most valuable asset, on our balance sheet. We just had to become landlords. Gulp.
Well, I’m going to give it to you straight, there are days when being a landlady can be tedious and frustrating. You handle mundane tasks (scheduling HVAC maintenance) and deal with an array of tenant issues (is the rent check really in the mail?). Although these concerns can usually be managed with positive outcomes, you may look at the various land-lording hassles and wonder “Is it all worth it?”
My answer is YES. Yes, it’s worth it. Because, as financially rewarding as it can be to generate cash flow while paying off your mortgage debt, there is something more. And it lies at the root of every real estate investor’s hopes and dreams. It’s the potential of asset appreciation, the increase of the fair market value of the house over time. I just call it the upside.
My major mind-blowing experience with the wealth-building power of the upside came one day when my phone rang. The handyman was calling to discuss a few minor repairs that were needed prior to relisting the Playa home for rent. He said “Oh, I guess these repairs will be nothing, seeing how the rents are climbing in Playa.” “Yeah, well,” I mumbled, while wondering what exactly these repairs would cost and whether I had the cash on hand for them. He seemed surprised by my subdued reaction and said, “You know, now with Google, Yahoo and Facebook moving into the neighborhood things are really taking off.” Wait, What?? Where?? “The tech companies are moving into the neighborhood – they’re now calling it “Silicon Beach.”
Ah, silicon… The Silicon Beach techies, just like their co-workers in Silicon Valley, paved the way for soaring real estate prices. The little beach bungalow had suddenly tripled in value. I was astounded! Converting our Playa home to a rental property – always a financially sound decision – now seemed like a stroke of pure genius! Was it? Hardly.
The Playa home rental conversion is just one example of the upside of real estate investing. It happens. It can happen anywhere, anytime, with any piece of real estate that is bought or sold. It can be moderate, as prices steadily rise in a region, or it can be explosive, with a surge of growth in local home prices. But either way, the upside potential is always there.
Why focus on the real estate Upside (when we KNOW there’s another side too)
Because, it is the upside potential that fuels dreams and inspires people from all walks of life, from all income levels and backgrounds, to become real estate investors. The question is:
Are you one of those people? What chances are you willing to take? What sacrifices are you willing to make? And, are you willing to flip the script to find the upside?