As we celebrate another year gone by for our troubled yet still great nation, ask yourself when your own Independence Day will arrive. I’m talking about your Financial Independence Day.
Becoming Financially Independent
Financial independence has to be on your radar as a financial goal. Being able to do what you want when you want, without having a paycheck hanging over your head is something just about everyone craves.
Historically, real estate has been one of the two best ways to build wealth and reach financial independence sooner than later. I’ve talked a lot about the other way, tax-free saving and investing with Roth IRAs and 401(k)-type plans, but real estate can play a part too. I like investing in both.
It’s tough to ignore those double-digit gains real estate has enjoyed in the past in some areas. Plus, our population continues to expand, people always need a place to live, and they’re not making any more of it, right?
Direct Real Estate Investing
I recommend a direct real estate investment where you own and manage the property or live in it if you declare it your residence. It’s the best way to avoid high expenses since the cash flow goes through you, and it’s you who enjoys any tax benefits. Plus, it’s a much more tactile investment than stocks that many investors prefer.
It’s not just some electronic certificate floating around in cyberspace that says you own a part of something like stock, and it doesn’t have layers of fees and management charges like real estate mutual funds and REITS (Real Estate Investment Trusts).
Don’t purchase real estate unless you’re planning to stick around (at least 5 years). Like stocks, real estate prices can be extremely volatile, and as an investor you never want to be forced into selling when the market is down. If your job transfers you to another area and you try moving and renting out your property instead of selling, you’ll find being an absentee landlord is a real bummer on top of much higher management expenses.
Your Perfect Mix
Countless fortunes have been made in both real estate and stock, but you don’t have to put all your eggs in one basket. Choose a mix, one with which you’re most comfortable and best for your individual financial situation.
That way, if those electronic security certificates get lost in the ether someday, at least you’ll have a piece of real estate to live on (or defend, depending on how bad it gets). It’s another avenue, along with your job, Roth IRAs, and 401(k)-type plans where you can stack the deck in your favor.
Whether you rent out your property to others or declare it your personal residence is up to you. Do you want to be a homer, a landlord, or maybe both? Each has its drawbacks, rewards, and an ample time requirement, so choose carefully.
Are You a Homer, Landlord, or Both?
I recommend investing in residential real estate: Single-family homes and multiple-unit properties with up to four dwellings. Any more and things get a bit unwieldy, assuming you’re not quitting your day job.
I’ve been investing in real estate for 45 years. During most of that time, my wife Katherine was my partner in crime, and we’ve learned a lot. We’ve bought, managed, and sold over a dozen properties in Michigan and California, but never did it full-time, rather as a side hustle.
If you’re married, it sure helps if you and your spouse are on the same page. Personally, I know I never could have managed everything myself. I concentrated on the handyman stuff, Katherine the leasing and tenant relations, and we split up the paperwork and accounting. Think of it as running a small business because that’s exactly what you’re getting into.
Be a Homer
My father, the late Robert Dorney, had an incredible work ethic. Growing up during the Depression and being a World War II vet, he also respected the value of a dollar. He gave me my first lesson in direct real estate investing.
My parents bought an old Victorian fixer-upper extraordinaire, right on Main Street in Macungie, Pennsylvania USA back in 1960. The porous old house was in shambles, but my parents picked it up for a song.
My Pops, undeterred, started out using the fireman method, putting out the worse “fires” first. That old house had great “bones” as they say, and even though it took a while he eventually had it looking great inside and out.
He’d work on that old house whenever he could, doing most of the work himself, despite his 70-hour workweek. I helped him out some, learning valuable skills I used later to fix up my own properties. When my parents eventually sold it, Pops told me it was by far the biggest check he’d ever received. The lesson stuck.
Unfortunately, my parents couldn’t take advantage of the $500,000 capital gains exclusion for married couples that exists today, part of the Taxpayer’s Relief Act of 1997, my favorite piece of legislation ever. Even though the tax advantages of homeownership aren’t as grand as they used to be, this exclusion is a game-changer, especially if you expect substantial equity growth in the future.
You can use the same $500,000 exclusion ($250,000 if single) for future home sales, the only limit being the property had to be your personal residence 2 out of the last 5 years, which opens some interesting possibilities I’ll discuss later. Katherine and I have taken advantage of the exclusion multiple times.
That’s why homeownership is still smart if it’s affordable and decent growth is anticipated, despite the lack of tax breaks enjoyed previously. Another potential problem to deal with as a homeowner, although it’s a good problem to have, is what’s known as “dead equity”: Accumulated equity can’t be used to generate more income and is inaccessible until you sell.
It’s not always about money. For a lot of us, “home is where the heart is” is more than a cute colloquial saying—it’s real. Along with the pride of ownership and tons of memories, you may be a homer too, at least for now.
Be a Landlord
As mentioned, many of the tax breaks afforded homeowners were eliminated or reduced upon passage of the 2017 Tax Cuts and Jobs Act. Not so if you rent out your property. Property tax, loan interest, and travel expenses, for example, are all deductible. You even get to depreciate the improvements on the property, giving you an even bigger tax break.
Of course, it’s not all about saving on taxes. You expect your property to grow in value. If low growth is expected, you can concentrate more on generating income with your real estate investment and look for properties with a higher capitalization rate.
Understanding the money end of things is important, but so are the many other duties you’ll need to perform:
- finding and vetting prospective tenants
- collecting rents
- keeping the books, licensing, and taxes
- landscaping
- repairs and general maintenance
- capital improvements
Not everyone is cut out to be a landlord; However, the rewards can be great, and not just financially. You serve the community by providing nice places to live at a fair price, and you get to meet a lot of new and interesting people too.
Do Both
Many landlords get started by renting out their previous home rather than selling it. Or you may decide to quit renting and move into one of the units you own and manage. Now the tax code affords you the best of both worlds. You get to take advantage of the homeowner’s exemption when you sell as well as enjoy all the write-offs that come with rental property during your ownership.
For example, the tax code allows that sweet capital gains exclusion to be taken on the sale of a 4-plex you owned and lived in part of the time. Not the whole thing, but the part you lived in. And you get to treat the rest of it as a business and enjoy all those write-offs too.
Becoming Financially Independent Book Series
If you liked today’s newsletter on real estate investing as a side hustle, you’ll love book 4 of my soon-to-be-released Becoming Financially Independent book series:
Best Debt Elimination Plan: Debt Management Strategies that Get You Out of Debt Quickly and Economically
A Beginners Guide to Roth IRAs and 401(k)-Type Plans: Contribution, Conversion, and Withdrawal Strategies for Building Tax-Free Wealth (formally titled “Best Roth!”)
DIY Stock and Securities Investing: Investment Strategies for Building Wealth and Attaining Financial Independence (formally titled “Best Stock Investing Plan”)
Real Estate Investing as a Side Hustle: Building Tax-Advantaged Wealth Through Home Ownership and Rental Properties (Coming Soon)