SELF HELP 20

How To Make $1,000 A Month In Passive Income

This newsletter is my process of writing a self-help book, tentatively titled How To Make Money: Financial Advice For Poets.

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I want to talk some more about real estate.

In previous letters I’ve talked about the difference between investing in real estate for appreciation versus cash flow. Yesterday I spoke to an investor, a millionaire for sure, but I’m not sure by how much. Maybe he has many millions, but I don’t think so. And also he is not actually an investor as he is always working. Anyway, he told me about owning property in Jackson, Mississippi, which is interesting because my favorite example of cash flowing property was an investor I spoke to who owned three homes in Jackson Mississippi.

The investor who owned three homes in Jackson bought the homes for a little more than $40,000 each. For $125,000 worth of real estate he was collecting $2,500 in rent per month, which is a pretty incredible percentage. Though the cap ex charges are higher in a $30,000 home, since it cost just as much to fix a roof or replace a fridge as it does in a $200,000 home. The tenants were all Section 8 and he had to give 10% of the rents to the property manager.

When I tell that story to people I say that this is a very conservative real estate investment. What was interesting to me was that he was able to get a portfolio loan against the 3 properties that was as much as the money he had spent to purchase them. The terms weren’t great, since it’s not like a regular mortgage backed by the federal government, but still taking into account the money he paid the bank each month, taxes, cap ex, property management, insurance, maintenance, etc., he was making close to $1000 a month and he had all of his money back.

The biggest problem was taking time to find the houses. And the bank took months to get through the loan process, though maybe that could be streamlined as they did more deals together (he had used a local bank for an out of state property). It would clearly take this investor a very long time to be rich at this rate. But who wouldn’t want $1,000 in truly passive income, not even taking into account the principle he was paying down on the loan each month which was essentially money saved for his retirement?

Then yesterday I’m talking to this other “investor,” though as I said, I don’t really consider him an investor. And also I’m just a little skeptical for a couple of other reasons. This guy hated Jackson Mississippi. He owned 200 houses there and had sold all of them. The cash flow wasn’t worth it, and there were hidden charges people didn’t think about. He talked about the difficult neighborhoods, and a matrix of Section 8 tenants that were incentivized to move every year. They wouldn’t destroy the home, he said, since that could cost them their vouchers, but they wouldn’t not destroy the home either. And the percentages of replacing a roof on a $30,000 home, which everyone always mentions, including me. And what it means to own property that truly never appreciates. Though the rents have risen, the price of the properties are stuck. The houses cost less to buy than to build.

But cash flow, I said. And by cash flow I’m talking about buying a house and renting it for a profit immediately. This is entirely different from the first home you buy, the one that you live in. If you’re thinking about purchasing a home to live in just do it. You don’t need to think about it. Even the worst deal will still be a great deal most likely as long as you plan to live there for a while, and you’re costing yourself money thinking about it too much, meanwhile time is passing…

And I sensed contempt from this man, who built properties in Utah and the West Coast and mainly wanted to talk about developments, though I couldn’t actually see him as we were just text chatting, so maybe the contempt I sensed was coming from myself. He said 20 or 30 years ago he bought 3 houses in Palo Alto (or maybe it was 40 years ago?). He said he made more in appreciation from one of those houses than he made in cash flow from all 200 of his homes in Jackson Mississippi.

Here is the thing though. He was very actively managing those homes in Jackson, whereas the investor with 3 houses (now 4 apparently) had a property manager (a very good property manager, he insisted). Anyway, the guy with 3 (4) homes in Jackson says he has yet to even think about those properties. Nothing has ever come up that has required his attention. He compared the checks he receives to having a trust fund, or an inheritance from a relative you didn’t even know who died one day and in their will had set up a fund to give you $1,000 a month for the rest of your life.

In other words, I’m not sure we’re comparing apples and apples. People like to talk about passive vs active investments. But there is no such thing as an active investment. An active investment is called a business.

On the other hand, if it’s true that the mogul (mogul? No, too strong of a word for someone that’s always posting in online chat rooms and offering advice) made more in one house on appreciation than 200 houses on cash flow, that was something to consider. And even if he was exaggerating (I’m certain of it) the problem is, you can’t really predict appreciation. If you bought in Florida between 2005 and 2008 your house is only just now worth what you originally paid for it. Imagine buying a house for appreciation that loses value and rents for less than the mortgage payment. Now imagine being stuck in a capsule, slowly sinking to the bottom of the ocean.

Same thing, right?

There are charts and statistics you can use to guide your investments, and most of the places we currently expect to appreciate, will. So it’s not even rocket science. And if you live there and it’s your first house even better, though that’s not what we’re talking about right now. Most likely every subsequent investment you make in your life will pale in comparison to your first house.

Just remember, the risk is always priced in. Tell yourself that as you’re trying to sleep. Say it over and over again, the risk is always priced in.

So there are two primary ways to make money in real estate, appreciation and cash flow, but there are infinite tributaries and a lot of gray area. In the last letter I wrote we talked about managing an AirBnB. But I was thinking about AirBnB specifically because it’s often a way for a person to invest in appreciation while maintaining cash flow. That was the original point I wanted to make but I wasn’t able to. Just know that it’s a very high risk strategy. High risk and also high reward.

The other thing to think about is leverage. Whenever I’ve read about cash flow versus appreciation, which isn’t very much to be honest, I never see anything about bundling 3 inexpensive homes and taking out a portfolio loan. I think most people purchasing houses for cashflow wouldn’t even think to explore the smorgasbord of loan products on the market.

The guy who used to own 200 homes in Jackson (something tells me he wasn’t being fully forthcoming, but what do I know) I hope he never reads this, or if he does I hope he doesn’t recognize himself. I haven’t written about him fairly but I’ve also taken pains to hide his identity. The investor though, the guy that figured out a way to get $1,000 in truly passive income monthly without using any of his own capital (though obviously he did have to use his own capital until the process was finished, which took at least 4 months) that guy, I thought, is a genius.

Though if you’ve ever been to a party in Hollywood you already know that genius is a cheap term easily thrown around and essentially meaningless.

xoxoxo

stephen

p.s. Thank you very much for reading. I know not everybody feels this way but I believe the reader is always doing the writer a favor.

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p.s. 2 Here’s a movie I made if you’ve got 75 minutes. I made this movie for basically nothing and I think it’s funny and good. It’s about the time James Franco made a movie out of my memoir, kind of.