Be willing to live in “rental” neighborhoods and use capital gains wisely.
June 26, 2019 6 min read
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Over the last 50 years, home prices in the U.S. have increased by more than 5% annually on average, according to the National Association of Realtors. This means that the $200,000 home you buy today could be worth more $864,000 in 30 years when your mortgage is paid off.
It’s no surprise that real estate is considered such an effective way to build wealth.
But few actually take full advantage of the opportunity at hand. Based on the National Association of Realtors report, the average homeowner only sells their house every 10 years, though they are allowed tax-free capital gains every two years. Instead of expanding their real estate holdings and experiencing that 5% growth, they settle for the standard single-home approach, thinking much more is too complex and time-consuming.
Related: 6 Amazing Tips on Turning Real Estate Into a Real Fortune
But making your first million in real estate is possible as a real estate entrepreneur and simpler than you think, provided you follow the proven roadmap laid down by countless real estate investors before you.
It’s all about expanding your real estate portfolio. The larger it is, the more that 5% growth will be worth. To do this, start by buying smart, living within your means, making the right upgrades, generating income and then rolling those profits into additional properties.
The best part is this can all be done as a side hustle while continuing your career. In fact, this is exactly how I started, while going to college, nearly 20 years ago. By my estimation, it takes about six years to go through the complete process, but if that entrepreneurial spirit is put to work, here’s what the path to a million looks like.
Get your start in real estate with a fixer-upper
For new real estate investors, nothing is as impactful as your first house. When you buy a fixer upper as your own home, work on it yourself and then sell it or rent it out after two years, you’re able to add real value to the property, and it doesn’t cost you much more than your normal mortgage payment.
You’re going to take out a loan for this purchase, and you’ll want to find something that’s available at a below market price and it is something you can put some sweat equity into. That can include everything from new landscaping to interior improvements, to a new roof or siding. Modern features are in demand, too, like a new HVAC system as well as energy-efficient upgrades to make the property more livable for the next owner.
Related: 5 Real Estate Mistakes That Could Make You Lose Money
Move on to the next one
After two years or so, you sell it and collect the proceeds from your investment and hard work. Maybe you bought the house for $200,000, made some simple improvements to the property, and were able to sell it for $300,000. That’s $100,000 in capital gains that you’re able to pocket tax-free. The next step in the process is to take that $100,000 and split it — $50,000 toward the down payment on another house, which you’ll live in, fix up and sell, and $50,000 to buy a rental property.
Do it all over again
Once again, you’re fixing up the house you’re living in but, by this point, you have a rental property that’s providing you with additional income. And after two years or so, once you’re done fixing up your second home, you sell it and do it all over again, buying more rental units. You move into one and fix it up and over the next two years can now start borrowing against the equity in the previous rentals to buy more.
From that point on, you’re using the equity you’ve built up in your properties to fund your purchases, which you’re fixing up and adding to your rental portfolio, increasing your income every step of the way. Best of all, the value of your real estate portfolio is now larger and growing, so you’re building your overall wealth as you go through this process.
Related: How Andres Pira Went From Homeless on the Beach to Real Estate Mogul
If you keep going along on this path, by the end of six years you should have lived in three different homes that you’ve fixed up and sold, have a portfolio of 10 rentals and have a net worth of close to a million dollars between the net asset value of your properties and the cash coming in from the sale of your homes, not to mention the monthly cash flow.
A tax-advantaged way to grow wealth
The beauty of this approach is that you’re building up larger and larger value in each home that you buy along the way. But, rather than having only a single home you now have many rentals growing in value, which you’re able to use the equity or sale proceeds from each one to buy more.
The first tax benefit of this strategy is the primary-residence exemption. It allows as much as $500,000 of capital gains every two years, but you have to live in the house for the two years. Selling every two years and turning that tax-free gain into more real-estate allows you to use that actual cash gain to invest in new properties.
The recent tax changes mean that there’s a limit on what you can claim for your primary mortgage and property taxes, but those limits don’t apply on rental properties. This means most of your loans should be on your rental properties, not your primary residence. After a few years of following this formula, that should be a very achievable goal, enabling you to buy your own home entirely with cash.
Honestly, the most difficult part of this process is admitting to yourself that, for the next six years, you’re not going to try to keep up with the Joneses when it comes to your primary residence. Instead, you’ll be buying in “rental” neighborhoods, living in older properties and doing it all entirely within your means.
But at the end of the process, you’ll be a legitimate real estate entrepreneur with a portfolio of income-producing assets that will support you and your family for years to come.
