Investing With Leverage: Whose Money Is It Anyway?

As the year starts to wind down, I spent some time reviewing our financial books for the condo.  I was adding up the income earned to date, paying required expenses, and thinking about what distributions we should take.  Then, it struck me: Once rental payments started coming in, we haven’t spent any more of “our” money.  Effectively, our tenants have been paying our mortgage, covering condo fees, and building our maintenance reserves.

So, let’s explore how much of our actual cash we’ve spent. I’ll use some rounded numbers to help illustrate this.  We spent about $65k to acquire the condo and get it rented.  Now, that includes all of our closing costs and renovations as well as our initial equity.  Npw, let’s break things down a bit further:

  • Down payment ~40k
  • Closing costs ~10k
  • Renovation costs ~15k

The down payment is not really gone assuming we sell at some point.  It’s counted as part of our initial equity in the property. But that cash is currently tied up, and we cannot use it for any other purpose (More to come on that). If the condo appreciates at all (we sell it for more than we bought it), that will be considered an increase in our equity also known as a capital gain.

The 10k in closing costs are essentially gone.  The allowed ones went into our business expenses and will be helping us to offset current and some future income.  So, these were “real” expenses to us.

We also spent about 15 k to renovate.the unit. You could argue that we had to spend real money to pay for countertops, appliances, and a new HVAC system.  Or, you could consider them as increases in the base value of the property.  Where applicable, that’s what we dis.  The big items were counted as increases in our cost basis, and they are being depreciated over their IRS directed lifetimes. So, an accountant might say the money is not technically gone.

That means we bought an income generating asset that meets the 1% rule.  And we did it for a total of 10k of real expenses.

Baring any major disasters requiring cash above our reserves, every other nickel  from fixing the garbage disposal to putting in new floors (again), will be paid for with other peoples’ money .  Now that’s exciting!

So, we have this great problem…what do we do with the excess cash once we’ve fully funded our reserves?  Pay down the mortgage?  Save for rental property number two?  Invest in Wells Fargo?

Rental Operations: 10 Months Of “Normal”


Last post, I talked about the time we invested to get our first rental property up and running.  As landlords, my wife and I may have an odd perspective on our tenants.  They are, in fact, our customers.  Our goal is to keep them happy enough to continue to occupy our property while paying the rent on time and causing as little wear and tear on the unit itself.  We’ve had 100% occupancy for 10 whole months (yes, I know that’s hardly a world record).  Starting up a rental, I knew we would be spending time and energy to keep our customers happy.  I didn’t know exactly how much it would take, so I kept track of our hours.  Let’s take a closer look at what we’ve done and how much time it took…

Our first tenant came to us on the recommendation of a great friend.  Even better, the prospective tenant was in a pinch and needed a place quickly.  It was November 15, and our place was almost ready. Despite a few missed milestones from Home Depot in delivering appliances and counter tops, we thought we could accommodate this tenant if she went through our application process.   Things checked out, and we settled on a 6 month lease with the intent of signing a new 12 month lease in the late spring during peak rental season in our area.  Because our tenant came to us, we didn’t spend much time or effort to “sell” our unit.  Most of our time was spent developing our lease and application process.  All in all, we spent about 40 hours preparing our lease, showing the unit, and signing the lease with our tenant.  I should mention that we used this e-book, The Everything Lease Addendum: How-to For Landlords by Elizabeth Collective over at to help us write our lease, and it was one of the most helpful resources we’ve found as new landlords.


We spent about 40 hours in November of 2015 preparing our lease and application process.

Our first tenant moved in while the unit was still being renovated.  We never took photos of the empty interior space.

Doh! <Smacks forehead>

We remedied this oversight in August 2016.  But, it was one of the more frustrating parts of trying to rent our unit.  Note to aspiring landlords.  Take photos.  Take great photos. Take lots of great photos.   If you don’t have a decent camera (by the way, your cellphone is not a decent camera) and a basic understanding of photography, hire a real estate photographer.  It’s almost impossible to get web traffic without photos.  And, great photos will set your rental unit apart.  Hopefully, the images will serve you for many  years to come.

Our first tenant left after about 8 months; she needed a larger space to accommodate her kids who were moving back in with her after finishing college.  So in August, we needed to go through all the tenant screening steps in addition to creating the marketing materials for our unit.  In total, we spent 33 hours taking photos, building a virtual tour, and updating our lease. We showed the apartment 4 separate times (about 1/2 to 1 hour each time).  So, our total to get the unit re-rented in July/August was just under 40 hours.


About 40 hours to re-rent the unit

So, what happened in between?

Remember how everyone who told you not to become a landlord cited not wanting to fix toilets!?  I can tell you that we didn’t fix the toilet ourselves.  Within two months of leasing the unit, we had a pipe inside our floor/the unit below ours start leaking. We spent 7.5 hours coordinating/supervising/figuring out who would pay for the repair in January of 2016.

Book keeping and taxes occupied a bunch of time in 2016: about 14 hours in April went to tax preparation & research.

Remember how I said we’re making about $20/hour when you include all the searching and renovations?  Let’s take away those startup costs.  We’ll remove the ~200 hours we spent searching for a rental property.  And, let’s remove the 400 hours we spent renovating.  Now, for some fun math: $17,000 divided by 200 hours of operations.

Wait for it


Not bad for a side hustle.  That works out to the hourly wage of a hand or foot model!

Hands.  Photo Credit: Alex Tran

Hands. Photo Credit: Alex Tran

Real Estate Investing: It’s Not That Passive, But It Beats Working For Your Boss.


600 hours.

And that’s just what I kept track of once we had an offer submitted.

I’m going to delve into what I’ve experienced during the purchase, renovations, and management of our first rental property over the 2 years we’ve been involved in it.  Keep in mind that we’re brand new to this business.  There’s a lot of startup activity we’ve gone through to get to this point (and probably some more to come).


Even this ole dog can get up and move if properly motivated. An income stream for life? Let’s go!

On The Hunt

Let’s start with some data that I don’t have.  If you’ve read any other post on this site, you can probably guess that I like data. During our search process, we digitally screened North of 150 properties. I made 2 spreadsheets for this task.  One mimics the Multiple listing service but adds a few more columns.  With this first tool, I could see all inputs from the listing and get a rough estimate of cash flow.  For properties that looked interesting, I would fill out a more detailed sheet.

Spreadsheet#2 calculated several measures of profitability (or loss) based on some more specific details.  I filled out upwards of 40 of these detailed sheets.

Finally, we went to see about 5 places.  We made offers on two.  We were outbid on the first.  And, the second took 10 months from the time we wrote our offer to the time we actually closed.  I would guess we spent about 200 hours screening for our rental in 2014. Let’s amend my total at the start of this post to 800 hours.


Ah, the thrill of the chase…is so much better if you get the treat at the end.

The Grab

In October of 2015, we found a short sale: a 2 bed, 2 bath condo that priced about 25% below market.  We walked through the unit and saw lots of potential.  No major problems, just an interior badly in need of updating.  So, we put in an offer almost on the spot.  We made a list of the major things we needed to do with 3 point estimates to complete each.  And then we waited.  We filed contact extensions.  We waited some more.  In summer, we went on vacation and then updated our financing pre-approval.  We found out we were pregnant…and filed another contract extension.  About 8 months from the time we put in our offer things started moving.  Finally!  All told, we spent about 20-25 hrs between the end of 2014 and August 2015 keeping the contract alive.


Now, there were lots more forms to fill out from the sellers’ bank.  We coordinated the appraisal and the inspection.  The bank finally set the closing date for September 30, and things went more smoothly.  We made a more detailed punch list of our renovation activities and a schedule.  That’s the time you see in September: about 63 hours of effort to get us through closing and actually into the unit on the 30th.


Sometimes you get in over your head. Almost.

The Flip

You bought it, you broke it.  … Or something like that.  I admit that at times it felt like we were barely keeping our heads above water.  We were both working full-time and then trying to renovate our condo and get it on the market ASAP.  We spent almost $15,000 taking our condo from ugly builder’s white and grimy to a chic penthouse apartment in one of the most desirable locations in the area.  In addition to the cash and contractors’ efforts, it took us about 400 hours of our time spread out over 2 months.  We contracted for the counter top installation, HVAC replacement, and appliance haul away/install.  We did every other bit of paint, flooring, fixtures, cleaning, etc. by ourselves or with the help of one great friend.  But, we kept our vision firmly in front of us and pressed onward.


You might think that cutting floor boards on a Saturday is beneath you.  Or that you’ve progressed beyond replacing the fill valves in a toilet tank.  If so, you’re right.  Go work in your cubicle for another 30 years before you can retire.

For everyone else, I can tell you that there is no more liberating feeling than swinging a hammer to build your own system.  To quote Sam at Financial Samurai, “don’t be too proud to be rich.”


Worth IT.

The Aftermath

Now that things are up and running (we’re entering our 10th month of having the unit rented), we are enjoying the result of all our efforts.  I’ll follow-up with more detail in future posts.  For now, our aggregate has been about 100 hours of total effort to handle rental operations.  Despite the monthly ups and downs, we’ve brought in a gross income of over $17,000.  Divide that by 800 hours, and we’re making $20/hr!  That puts us squarely in the basic Human Resources and Gaming Supervisor categories. Woo hoo!


Before you scoff, remember this is income that:

  • Comes in whether I’ve had a bad day at work or not.  In fact, it comes in whether or not I show up to work at all.
  • Will get better over time (both the hourly rate and the annual gross).
  • Currently has a mortgage associated with it, taking a big chunk of the gross income.  Someday it will be paid off, and then we’re that much closer to financial freedom.  Better still, someone else is paying our mortgage for us.  All of our cash outlays are complete!  More on that in another post too!
  • Allows us to learn about and claim a number of potential tax deductions/business expenses.

Now this is a seedling I am excited to nourish.  Grow little money tree, grow!

How To Be Needed

Working within Corporate America, I see many folks who are enamored with the idea that they are needed.  Their employees should not make decisions without consulting them.  Need to take a business trip? Get an approval.  Need to be reimbursed for said business trip?  Get an approval.  Have an idea for a better way of doing your work? Get an approval.  Want to start your next project?  Get an approval.

It sounds annoying but still innocuous, right?


All these approvals are “No” gates.  They’re just speed bumps on the way to someone at some level saying, “no”.  Just try taking action without approval though.  The entire system is set up to slow down and stop any action or change.

One of the reasons I’m so intrigued by real estate is the potential for passive income.  However, I’m not on the right path yet.  I’ve started setting up a system where I’m needed for everything.  And, it’s hard for me to change, even though I know I’m the only one in my way.

Let me explain.  I suffer from several personality flaws:

  1. I’m cheap
  2. I’m too curious about how things work
  3. I’m slow to trust
  4. Did I mention that I’m cheap?

To illustrate: we bought our condo, knowing that the interior needed to be completely refreshed.  My wife and I (and one of our good friends) spent almost 500 hours in 2 months tearing up carpeting, sanding, painting, installing flooring, cleaning, painting, installing trim, changing electrical outlets, painting, and managing 3 sets of contractors.  And that was on top of our day jobs.  We used contractors for the HVAC replacement, countertop installation, and appliance haul away and replacement.  Otherwise, it was all us.  I schlepped 800 sqft of flooring up 3 flights of stairs… hardly passive income.  That’s personality flaws 1 and 4 coming through.  We stretched our means to buy the property.  We knew going into the project that we needed to stick to our renovation budget, and that meant doing a lot of work ourselves.

Tim Ferriss’s Four Hour Work Week, Robert Kiosaki’s Rich Dad Poor Dad,  Paula at Afford Anything, Sam at Financial Samurai inspired us to act (affiliate links).  And I know they all started small, but I learned a new appreciation for the word hustle during this project.  Here’s the thing: they’ve all made it.  We’re just starting.  So, we don’t yet have systems in place to do the work for us.
When it came time to look for a tenant, we were hesitant to hire that out too.  We were curious to know who would be enjoying our new place.  (Yes, we thought of it in terms of “our”).  And that’s an unfortunate byproduct of personality defect number 2.  As much as we followed our newly established process for screening tenants, there was still some emotion associated with our selection.  In the end, things seem to have worked out OK.  And, we’re again faced with a new round of tenant screening.

We know every inch of our condo, having spent so much time renovating the place.  In our area, the renting process can be contracted out for roughly one month’s rent.  Each property can be managed (as a contract) for roughly 10% of the gross monthly rent.  Add both of those together, and our unit becomes significantly less profitable.  There’s the added uncertainty around a property manager: will they care about our property as much as we do? Will they present as good of a customer(tenant) interface as we will?  See personality defect#3 at work (Probably # 4 too)?  So, as much as we would like to have a better system in place, here’s what we we’re doing:

1. A pre-screening phone call.  We ask 7 questions of each person interested in seeing our unit.  The questions are:

  • Why are you moving?
  • When do you want to move in?
  • Are you OK with us conducting a background check as part of the application process?
  • Do you have residential and occupational references we can contact as part of the background check?
  • Is your income greater than 3x the monthly rent?
  • How many people/pets will be in the unit?
  • Have you ever been evicted?

2. Once we believe folks are good prospective tenants, we set up a time to show them the unit.  Note: I would love to transition this to an open house type of showing.

3. If they’re still interested, they fill out an application form and we proceed with background/reference/income checks.  To protect everyone involved, we’re using  TransUnion’s MySmartMove. We really like that our tenant’s personal information is protected: we don’t have to handle their data or worry about processing their application fees.  We get to see a quick summary of their current financial obligations, payment history, and a prospective tenant score.


    TransUnion’s Resident Score Range.

4. From there, we conduct rental history, employment, and income verification checks.  If everything checks out,

5. We review and sign the lease.  At last.

Whew!  What a process!  This being our first time screening tenants since the unit was finished, we had to invest a bit more effort to obtain interior photos, put up a detailed website, and prepare our listing on Zillow’s Rental Manager site.  We’ve spent 13.5 hours getting that all set up.  Hopefully, we’ll be able to re-use this for years to come.  In terms of screening tenants and showing the unit, we’ve spent 3.5 hours and showed the condo to 3 prospective tenants.  The third family submitted an application, and we’re processing it currently.  Keep your fingers crossed!

In a future post, I would like to revisit more of the non-recurring effort/ongoing maintenance effort and costs that we’ve experienced thus far.  From my homework in preparing to purchase this condo, I really struggled to find good data on these topics.

So, any ideas how we can systematize our rental property further and make it more of a passive income generating machine?

Return On Invested Capital 

There’s an investment class I’ve deliberately not spent much time discussing yet: real estate.  In light of Brexit and some increased volatility in the stock markets, I think the time is right to start talking real estate.

I don’t mean your home.  I don’t mean that piece of swampland Aunt Bessie left you in Central Florida either.  I mean rental properties.

Ask some people you know if they’ve ever looked into the rental property business.  You might be surprised at how many folks have already taken the plunge.  I know the more folks I’ve asked, the more surprised I’ve been at how many people and who owns one or rental properties.  I think there are a couple of reasons for this:

  1. Almost passive income
  2. Sustainable side hustle
  3. Return on Invested Capital

Almost Passive Income 

Most folks work for their paychecks.  We trade our priceless time for an hourly wage.  Passive income lets us change the game by avoiding this traditional approach to creating income.  I first started reading about passive income as a concept in Rich Dad, Poor Dad (Affiliate link).  To this day, it remains one of my all-time favorite personal finance books.  Passive income has the ability to help each of us achieve our financial freedom earlier.  Passive income lets us get to that “Freedom Uttained” point faster.

Think about it like this: let’s say I have an annual salary of $100k.  And, I spend about 2000 hours a year to get that salary.  That works out to $50/hr.  Not too bad, right!?

I Love Cubicles..

I should even tolerate grey cubicle hell for a while at $50/hr.  But, I can’t.  I want more.  And, I suspect most other people do too.  I’ll dive into the details of my experiences with rental property in future posts.  But, for now, let’s say I net about $500 a month from a rental property (net = rent – all expenses/reserve contributions).  And, I spend an additional 5 hours a month managing my rental property.  That sounds pretty doable.  Apparently, Americans spent more than 5 hours a day watching TV in 2015 according to the Bureau of Labor Statistics.  You know where I’m going with this: the simple math says, I just made $100/hr.  Each month (on average).  Until I sell the property.

Turn off the TV and go make your own life better!!!

And that is the beauty of the rental property business.  You still have to trade some time for cash.  But what you get in return is a seedling.  Your first money tree sprout that may eventually blossom into the life you want to live.

Sustainable Side Hustle

Let’s say my wife and I spent almost 500 hours researching, screening, visiting, negotiating, reviewing contracts, rehabbing, and finally renting out our first rental property.  (It was our first, and I’m pretty risk averse!)  Now we spend about 5 hrs a month managing it.  Some months it’s more.  Some months it’s less.  But, we manage it outside of our day jobs.  And, the checks keep coming in.  To be sure, we don’t plan for 100% occupancy.  In fact, we’re coming up on our next lease renewal, and we will likely have some down-time while we make a couple of improvements and complete some maintenance items.  But overall, we’ve found a way to take some of our surplus cash flow and turn it into gold.  Now, someone else pays our mortgage on the rental property.  Their rent covers the routine maintenance costs and fills out a savings account for bigger items.  All we have to do is wait…

Return on Invested Capital

And that brings us to the actual topic I wanted to dive into.  You see, we didn’t pay cash for the full value of our rental property.  We have a mortgage.  So, let’s do a little math with simplified numbers:

We’ll buy a $100,000 property at market value.  In the first situation, we’ll put down 25% because this is an investment property, and the bank wants a little more skin in the game (or they charge a higher interest rate).  The bank offers us a 4.5% rate resulting in ~$500 per month in principal and interest payments.

In the second situation, we’ll buy the same property with a suitcase full of cash.

Is this the best way to buy a rental property?

Our rent is the same for the property: $1500/mo.  Our costs for taxes, maintenance allocations, utilities, etc. are the same regardless of how we bought the property. Again, keeping things simple, we’ll estimate that at $500/mo. Also, for the sake of simplicity, I’m ignoring closing costs,any renovations, and a few other items that are roughly comparable regardless of how the property was financed.

Is it better to buy with leverage or all cash?

Is it better to buy with leverage or all cash?With

With our loan, we put down $25,000.  Each year, we would bring in a theoretical $6000 of profit for this property.  That’s a whopping (hypothetical) 24% return on the investment we made.  Compare that to buying the property with $100,000 in cash.  We bring in $12,000 profit.  Even though the total dollar amount is higher, we’re only making 12% on our $100,000 investment. Not too shabby, but now we’re out of cash.

In theory, we could use the $75,000 we didn’t spend in the first scenario to buy three more properties!  Using leverage, our new situation looks like this:

Full Leverage ROIC

Living dangerously? Or, spreading the risk?


Now, we’re making that same 24% on our money.  And, we’re clearing $2000 a month.  Freedom Uttained point, here we come!  Of course, we had to take out $300,000 in loans to get there.  There’s now a higher chance that we cannot pay all 4 of our mortgages if all our properties are vacant.  But, what are the chances that all four properties are vacant at the same time?  Probably smaller than the chance that the single one is vacant in the case of our all cash purchase!  We just spread out our risk, boosted our returns, and launched ourselves on the path to real estate mogul.

In my mind, this illustrates why real estate is such a neat asset class.  You can buy a full property with 20-25% down.  Doing that with stocks seems way riskier.  If you hold the property long enough, your tenants completely pay off your mortgage for you.  Now, your net returns go through the roof.  Leverage lets us either get into the game a lot earlier or use the cash we didn’t deploy by borrowing to further increase our holdings.  Either way, what we do with our limited resources matters.  And Return on Invested Capital is one way of looking at investments to help us decide where to allocate our limited resources and reach financial freedom that much sooner.

Returns Matter


We’re all in a race against the clock.  How we handle the ups and downs sets us up for long-term success … or an ulcer.


Sometimes, the path to financial freedom can be a little scary.  Photo Credit: Alex Brogan

Regardless of whether or not you work for someone else for your living, how we deploy our available resources over our lifetimes matters greatly. Most folks are familiar with the idea of compounding interest: where over enough time, your money makes a tremendous amount of money without you having to do much additional work. Once you have enough money to last your remaining lifetime, you’re financially free. So how do you get there? Making payday loans? Putting all your savings into a big pile of cold hard cash under your mattress or more comfortably into your closet?

Let’s explore the relationship between risk and reward.

Starting with the classic compounding interest chart from high school, we see a hypothetical pathway to awesomeness. 7% average returns from the time you start putting money into the Wall Street piggy bank. Put your hard earned cash into a bunch of 3-4 letter acronyms representing businesses. Add a bunch of time, and the road to Millionaire status couldn’t look simpler, right?

100 over 87 ave yrs

What this view fails to consider is volatility. Here’s what actual annual returns look like for the US market. Not such a smooth pathway is it?

100 over 87 real years

OK, I admit that I played with the scales to make this look more equivalent.  Here’s the first two plots overlaid on top of each other.  Now you start to see why the stock market has been long-considered one of the best investment vehicles around.  Cool, huh!?  The point remains: you had to have some serious gumption to not sell as things were crashing in the late 90’s/early 00’s and 06-09.

100 over 87 yrs real vs. ave

Don’t feel like putting your investment dollars on a roller coaster?  What if you want guaranteed returns? Just about the safest investment around is a CD. The FDIC guarantees all investments for up to $250k. In exchange for that nice safe blanket, you get low returns. Currently 0.5%-1.5% depending on the term. Long-term, CD rates look like this:

CD Rates

Long-term CD rates. Source:

Where CDs may have once provided a decent return %, it’s now tough to lock up your funds for 12 months to 5 years in order to attain rates greater than an online savings account. Probably not the fastest way to financial freedom, right?

CD balance growth over time


What if you are willing to take on a bit more risk than a CD?  For example, it’s quite likely that the US will continue to meet it’s debt obligations.  US Treasury bonds are historically one of the safest investments out there, especially relative to other countries with less stable economies or companies.  Understanding how to assess bond risk and pick out what debt to invest in is beyond the scope of this post, so lets just stick with medium term US debt (10-year US Treasury Bonds). To simplify things, we’re also going to assume that we’re investing our $100 into a fund that costs nothing and lets us take advantage of annual rate changes while re-investing the interest.

TBonds over 87 real yrs



Get to the point already, right!?

Let’s put it all together and see which investment strategy gets us closer in a hypothetical race.  Let’s assume that most folks work about 40 years in their traditional 9 to 5’s.  We’ll start with an initial investment of $1000.  That’s right, $1000…and that’s it.  If you invested $1000 at age 22, what is the theoretical balance for each when you’re 62?  So, we’ll take the most recent couple of years for each of our asset classes (CDs, Bonds, and Stocks) and hold those interest rates constant for 40 years (I know, it’s a contrived example, but it’ll illustrate the point).

40 year race

And the winner is…


As expected, higher returns result in a higher ending balance at the end of one’s career.  And, that’s the take-away: over a long enough time frame, maybe the short-term risk associated with asset volatility can be discounted.  Maybe we spend too much time worrying about 0.25 point returns for a 60 month CD at one bank vs. a high-yield savings account.  Instead, perhaps we should acknowledge that we are our own worst enemy.  Our emotions when news headlines blare negative returns, tempt us into making bad decisions.  We want to, “stop the bleeding.” We sell everything.  In so doing, we typically take a big loss and miss out on the next market rebound.  John Bogle might say just invest in the whole market regularly.  Hold your investments for the long term.  Keep your costs low.

I would distill that into an expression from Las Vegas and simply say, “let it ride!”