How to Find Financial Freedom In Your Home

Beginning investors convert home to rental to generate income

 

Congratulations, you purchased a home! You’ve built up equity and watched your home’s value 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!

Moms and women building wealth to try real estate investing

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.

Use your home to begin real estate investing and making money
Flip the Script to Real Estate Investing

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 Script

Yes, we could.

We took out a home equity loan 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 landlord 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.”

How to start real estate investing using home equity
Playa Del Rey (Silicon Beach), California

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 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?

 

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10 thoughts on “How to Find Financial Freedom In Your Home

  1. I really enjoyed this post and even though I’m not yet a homeowner I can relate in a number of ways. One of the reasons I’m not a homeowner yet is the fear of becoming house rich and cash poor. I can picture myself in a situation similar to yours where I’ll be scrimping and saving to get ahead on the mortgage while doing whatever I can to improve the value and live-ability of the house. After years of repaying student loans, I’m not sure I’m ready for that type of grind just yet.
    I can also picture myself owning a home with the mindset that it would later become a rental. While becoming a landlord might introduce some stress into my life, the financial upside is probably too great to pass up. I’m just hoping that someday when I purchase a home that I’ll be the beneficiary of a dramatic increase in real estate prices just like you 🙂

    1. Thanks Cato. The post is intended to be somewhat inspirational, in the concept that you can hit it big sometimes if you’re working hard and taking on a bit of financial risk. I did get lucky with the Playa home, but I worked my butt off to be in the position for the opportunity. And, TBH, I’ve continued to live rather modestly, so that I can keep building a larger real estate portfolio. It can be hard to stop adding properties once you really get going!

      Regardless, you are smart to know yourself and to determine when (and if) you are ready to take the leap into real estate. Once you make the decision, you will find a way purchase (or convert) your first rental property if you are tenacious (and I bet you are!). Good luck and I hope you find a little Silicon Beach of your own.

  2. Great post Kat! I agree that rental properties is the way to go, I am just not crazy about the landlord business at all. I wish one of my properties had tripled in value, cross my fingers:)

    1. Thanks Caroline! I hear you about landlord duties…not my favorite either!! And I’ll keep my fingers crossed that you have at least one huge gainer. Sometimes good things happen to nice people 🙂

  3. Wow I had no idea those big companies were establishing a presence in LA.

    The great thing about Playa is that you used to be right down the road from turtle racing at Brennan’s – always a fun night, hahah

    I miss my LA days (lived in South Redondo about a half mile from the pier) and posts like this, along with the cold outside, don’t make me miss it any less. Glad to see things have been working out well for you!

    1. I’m on the East Coast too now – just landed on an icy tarmac in Newark, urgh. So I hear you on missing SoCal sometimes. And thank you, I did feel quite lucky that Playa Vista was developed and became the tech hub in the area. Sometimes it all comes together and other times…not so much!:-)

  4. Great read! I am always captivated by the LA scene. Just so foreign and somehow appealing to me, all hunkered down in cold AF Minnesota. Nice work converting that gem into a rental. Part of me wonders if I should revisit CAP rates on my rentals as their values rise. I’d probably get depressed to see the CAP plummet as values soar and rents only marginally increase. Time to sell? Nah – don’t wanna forfeit all that lovely depreciation!

    1. Thanks Cubert! And LA is quite a scene, but I’m also freezing my butt off in the DC Metro right now and thinking LA is sounding pretty good! So, for your rentals, you calculated your CAP rates at the right time using your purchase prices. Plugging in the current FMV to your CAP rate formula is now only meaningful to a new investor who wants to purchase one of your rentals at the higher price. It’s true that the new investor’s CAP rate would be lower than yours, but you are still sitting pretty. You have solid returns and you can capture the appreciation because if you sell you are not limited to investors. Home occupiers will pay the higher prices. Yay! Gotta love real estate! 🙂

  5. Good read. You are so lucky you own a house in Silicon Valley!!! You have hit it big 🙂

    Our house has doubled in value from $600k to $1.3M since we bought it 5 years ago but the rents haven’t kept up. Thus, we are not ready to get into the rental business as it might actually make us cash poor.

    However, it’s something we might get into once we pay off our current mortgage in the next couple of years and we have extra money to play with.

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    1. Thanks Ms99to1! And I do feel fortunate to have hit it big on the Playa house. It’s true though, that in your case you would need rents to rise in order to make the same type scenario work. I am glad that you are considering getting into real estate investing generally, as I think it would solidify your leap into the 1% 🙂

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