Quick Intro: About a year 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 2018 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 2018 update.
As you might recall from the original post, David owns 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 2017, David’s properties had discounted rates of returns ranging from 2.87% to 25.32% and cash flowed $28,350. So how did they do in 2018?
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 for each of the 6 properties, see the original case study.
Analyzing the 2018 Numbers
Overall, 2018 was very similar to 2017. The total economic value from all the properties (i.e. sum of all return drivers for all properties) in 2018 was $40,209 vs $40,361 in 2017. Let’s look at each component separately.
Cash flow: $29,087 in 2018 vs $28,350 in 2017 for an overall increase of 2.6%.
Mortgage principal pay down: $878 in 2018 vs $831 in 2017 for an overall increase of 5.7%. Makes sense, the more you pay down your mortgage, the more of each payment goes into principal.
Appreciation: $8,595 in 2018 vs $8,385 in 2017 for an overall increase of 2.5%. Exactly as expected given the assumptions. 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.
Tax shield: $1,649 in 2018 vs $2,794 in 2017 for an overall decrease of 40.99%. What in the world happened here?? David marginal tax rate (MTR) changed from 25% in 2017 to 12% in 2018. The main driver for this was the Tax Cuts and Jobs Act (TCJA), which went into effect in 2018 and changed the tax brackets. Additionally, David’s taxable income also went down a bit, which put him into the 12% tax bracket in 2018.
Savvy readers might be wondering: the MTR was cut pretty much in half and the real estate depreciation should be constant, so why is the overall decrease in tax benefit 40.99% rather than 50%? And the answer is: drumroll, please….
Section 199A of TCJA. Without getting too far into the tax weeds here, rental income can qualify as “Qualified Business Income” and provide an additional tax deduction. Taking this deduction into account increases the tax benefit of the rentals and brings it up a bit from the otherwise expected 50% drop.
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 the key numbers we explored above, it should come as no surprise that the ROI is also pretty consistent with 2017 across the board. The more interesting changes occurred on property #6 where the returns increased significantly. From looking at the tax returns 2018 had more rental income and fewer repairs than the year prior.
The ROI on Property #2 on the other hand, had a rather large drop in 2018. Looking at the data, 2018 rental income was about half of the 2017 income. So it looks like like David experienced higher vacancy for 2018 on this property.
While returns from a single property can vary widely as we saw above, having several properties on your portfolio can smooth out the overall returns. Comparing 2017 to 2018 for David’s overall portfolio illustrates that perfectly. There is always a chance of having a bad (or good) year across all of your properties, but the larger the portfolio the less likely this is to happen.
Now, 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, and he is doing great on that in my opinion. His net 2018 cash flow of $29,087 is enough to live a wonderful life in many places across the globe, and many places here in the U.S.. Heck, my entire 2018 expenses were $27,693, so this real estate portfolio alone could support me and my family in most years.
I’ll be updating the case study again next year when David files his 2019 tax return. Stay tuned!
Fun Fact: David and his twin brother Steven were recently featured in Forbes!
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 🙂