Two years ago, my friend David from fiology.com asked me to take a close look at his performance as a real estate investor. Now that he has filed his 2019 tax return, I’ll be updating his numbers to include the most recent information.
If you are new to this case study, I recommend you read the original post to get the full context. If you already read the initial post, feel free to start here for the 2019 update.
As you might recall from the original post, David used to own 6 rental properties that he started acquiring back in 2011. The rental properties are part of David’s plan to fund his family’s living expenses when he is no longer working a traditional job. In 2019 David acquired a new property, which will be Property #7 for our purposes.
Introducing Property #7: this new property was acquired in February 2019 for a total of $54,000 as follows: $40,000 purchase price, $2,000 closing costs, and $12,000 of rehab. Notice that to properly calculate the rate of return, we have to account for all costs required to bring the property to rent ready status (thus the inclusion of the rehab and closing costs).
David didn’t collect rent on this property for much of the year as he had a labor in lieu of rent agreement with the tenant. Other than that the expenses were fairly standard (insurance, property taxes, etc.), so the property is at a net loss for 2019. Also, the property did have a mortgage, but David is almost finished paying it off, so for simplicity we are assuming no mortgage on this property.
Summary of Key Numbers
The table above summarizes the four key items that drive returns for rental real estate. The information is broken down by year and by property. If you want a full explanation of each component and even some background on the 6 legacy properties, see the original case study.
Analyzing the 2019 Numbers
Overall, 2019 was very similar to 2018. The total economic value from all the properties (i.e. sum of all return drivers for all properties) in 2019 was $36,571 vs $40,209 in 2018. The decrease was mainly driven by the new property. When you take property #7 out, the 2019 total economic return is $40,423. This is to be expected as new properties generally need upfront work and can remain vacant longer than properties that are already stabilized.
Cash flow: $23,284 in 2019 vs $29,087 in 2018. This 20% decrease is mostly driven by the new property. If we exclude property #7, the decrease is only $370.
Mortgage principal pay down: $927 in 2019 vs $878 in 2018 for an overall increase of 5.3%. Makes sense, the more you pay down your mortgage, the more of each payment goes into principal.
Appreciation: 10,160 in 2019 vs $8,595 in 2018. If you recall from the original case study, over historical long time periods real estate prices are pretty much in line with inflation. As such, I assumed that David’s properties appreciated at an annual rate of 2.5%, roughly in line with inflation for the last decade or so. Any 2019 appreciation on top of the 2.5% comes from the fact that property #7’s value is now being counted as well.
Tax shield: $2,200 in 2019 vs $1,649 in 2018 for an overall increase of 33.44%. The increase is largely driven by the new property as there is additional depreciation coming from it. There were more interesting tax changes from 2017 to 2018. If you are into that, you can read more on the 2018 update.
Return on Investment (ROI)
The original case study goes into more detail as to how the ROI is calculated and why. Here, we’ll just cut to the chase and go straight into the discounted rates of return:
From what we already explored above, it is no surprise that the 6 legacy properties were fairly consistent. Properties 1 and 4 had slightly better years in 2019, while properties 2 and 6 did slightly worse. Meanwhile, properties 3 and 5 had almost identical returns in 2019 as they did in 2018.
Property #7 had a negative return on its first year. As discussed above, this is mainly due not receiving rental payments while still having to cover rehab and operating costs. It’s not uncommon for rental properties to have a negative ROI on their first couple of years. In fact, this was also the case for properties 5 and 6 on their first year.
2019 was a pretty consistent year for David and his 6 legacy properties. It will be interesting to see how the new property performs in 2020 and beyond. 2020 should also be an interesting year to look back on given the COVID-19 pandemic and all of its economic implications. I am particularly interested to see how the portfolio holds up during the economic turmoil and to see how it compares to other assets classes (stocks, REITs, etc.).
As you may recall from the initial case study, David’s goal is not to become a big real estate tycoon and create a full time job for himself. He simply wants to have enough houses to supplement the retirement income he will have from his military pension While 2019 was not as profitable as 2018, this is mostly due to the initial investments into property #7. If this new property stabilizes similar to the others, it should add to David’s cashflow and overall returns for years to come.
I’ll be updating the case study again next year when David files his 2020 tax return. Stay tuned!
Do you currently own rental properties or are you interested in owning them in the future? Would like to see more case studies being featured here? Let me know in the comments 🙂