Unemployment. Early Retirement. Semi-Early Retirement. Self-Employment.
I wasn’t sure how to categorize myself. Not anymore.
My corporate life consumed more of my identity than I care to admit. Surprising since I was actively working toward my exit by building passive income through real estate investing. But this transition away from corporate and into investing felt awkward.
Maybe it’s because it didn’t go down the way I expected. The way I had planned. I didn’t prepare for life after rat race. I dreamed about it, romanticized the notion of it. But mostly I was just working toward it.
And much like taking a vacation, about two weeks into severing my corporate ties, I felt lost. Even a bit depressed.
I had no real hobbies. No outside interests. Not even many friends. My physical body was obese and flabby, pale and accustomed to circulated air. Mentally I was scattered, still in the habit of checking my phone every two minutes for the next “urgent” email communication. Other than drinking, eating heavy food and watching TV, I had no relaxation outlets.
And since real estate investment isn’t exactly a nine-to-five job, I found myself with a lot of extra time. At first I planned out the rest of the year. Developed annual goals for investing. The remainder of this year: cash out my 401(k)s, buy a residential multifamily and increase my passive income. The following year: sell my small multifamily properties and use profits to buy another commercial multifamily, further increasing passive income. Over the next two years: get apartment manager certification from NAA, network to find lenders and understand options to finance rental properties without w-2 income, and find a CPA who specializes in real estate professionals.
It took maybe an hour to write all of this out. Don’t get me wrong, pretty solid plan. But not all encompassing. And that’s when it hit me.
I needed to get a life.
What is the point of having this free time and passive income if you don’t have any passions to pursue? I finally had that most precious resource: time. I better not waste it now!
The first couple changes were for my physical well-being. My health had always been good. For mid-late thirties, not bad, but not great. No illnesses, or chronic anything. I quit smoking about a year ago (a two-year effort!). Uncomfortably obese. Still enjoyed boozing it up. But watching my extended family struggle with health issues made me focus on preventing mine.
So I started walking every morning with my mom. This ticked a few boxes – enjoying the outside air and serenity of the outdoors daily, spending quality time with my mom, and getting in some activity.
Then I tried morning Zumba classes a few times a week. And then some yoga classes. I had a membership to a pretty cheap gym for over a year and was just now using it. Nothing major, but it was something.
And it felt good.
I didn’t lose 20 pounds in 30 days. But I did have something to wake up for. Now that I had more extra time, I focused on budgeting as much as I could, maximizing the value of all expenses. Cooking became another love, and I experimented with new recipes and flavors.
The library became a source of intellectual stimulation, and I tried to read a few books every month. This broadened my horizons, and gave me permission to explore new topics without the pressure of some exam or quiz from my boss or peers.
And a pass to state parks gave me entrance to Texas treasures, and I made an excuse to visit parks on a regular basis – like a mini vacation. Sometimes on my own, sometimes with family or friends. Packing a small cooler with food, waking up early to beat the heat and spend some time on the trails. Maybe a dip in a river or lake afterwards, getting some sun, and some good food.
So by the time my 401(k)’s finally cashed out, I had built up a bit of a life for myself. Some of that corporate anxiety had shaken off. I dropped a few pounds, got a bit of a tan, and started looking for that next real estate project. My first residential multifamily that would boost my passive income and confidence.
It took awhile.
My scope was small and specific, mainly due to my price point and my employment status. Since I no longer had a W-2 job, I needed a commercial loan. These are designed to look more at the property than the person. As the loan applicant, you show that you can make a profit off the property that will more than cover the loan. When you purchase for properties at four or less units, your income must cover the loan. This is fine if you are employed, or have at least two years of profits from self-employment or investments.
I had neither. At least, not enough profit to make a bank happy.
And I didn’t have a ton of money. Granted, no small sum in my opinion. Cashing out my 401(k)s gave me six figures, more cash in my bank account than I had ever seen, or even imagined.
But buying multifamily properties for passive income is no cheap endeavor. Since my funds had to cover the down payment and any renovations for the property, plus liquidity, my price point was narrow. And this took my search out of my local city and into smaller towns. In the smaller towns, residential multifamily real estate is more affordable. But I didn’t want to invest in an area with no jobs. I’d have trouble keeping the place occupied.
Eventually, I found my goldilocks zone. I found a midsize town close to a major military base with pretty low crime and an established working class. And with the help of my local real estate agent, I found another agent for that area who helped me understand that rental market and analyze properties and rents. Rents ran almost half what they did in my city, so I had to adjust my analyses. But after a couple months of scoping and better understanding the market, I found it. An eight-unit property with rents well under market , no major issues and in need of cosmetic work. There was a huge opportunity to increase value and build passive income with this property.
I put an offer in and went through the long purchase process. A frustrating purchase process. It was one of the most stressful situations I had been through. But I learned more from this experience than I had from any prior investment.
Commercial sales are a bit different than standard residential sales. Residential sales (two-four unit included) typically close in about 30 days, sometimes a bit longer. Commercial sales rarely close in under 45 days, typically taking 60 days. There are different inspections needed. Insurance companies typically have more demands. Banks want to understand your current rents and your plans to increase passive income. They require extensive credit checks, and do a ton of calculations to see if you’re eligible for a loan with them.
I found several lenders that seemed promising, but in the end they fell through. Or, drastically changed their financing terms. One that I found and was with until two weeks prior to close made a very sudden change in the eleventh hour. They called me Friday afternoon to let me know they changed the terms of my 20 year loan. They would no longer cover my renovation budget and would now required 35% down instead of 20%. And they needed a guarantor. Confused and frustrated at this last-minute change, I asked them to put these terms in writing so I could review over the weekend.
And that afternoon, I promptly started drinking. We had booked a long weekend at a lake hotel to relax, and I had just started this weekend off very poorly. My boyfriend, ever supportive, poured us some to-go adult beverages, and we headed to the pool to drink, cool off and vent.
It was just what I needed. After about an hour of cursing the whole process and feeling like a failure, my mind opened up and took a step back (thank you, vodka).
I came into this with a couple of assumptions, or desired outcomes. Since this was my first commercial multifamily, I wanted to assume the whole loan without anyone financially backing me, or no guarantors (like a cosigner). I also wanted to finance this with a traditional bank. This experience forced me to challenge those self-made restraints.
With drinks in hand and immersed in the pool that overlooked the lake, we discussed a few people that I could partner up with. This was a last resort option for me, purely due to pride, but one I had to entertain. OK, not just pride, it was more profitable for me to do this project on my own, otherwise I would need to share my profits. And sharing profits would bring down my return on investment. I had plenty of education in property management and experience investing. I could do this on my own.
The other option that piqued my curiosity was looking for non-conventional loans. I could go for a hard money loan.
Hard money loans can be scary if not understood. Essentially, you are paying interest only on a high interest loan for (hopefully) a short period of time. These loans can be used to acquire a property quickly and get it in shape for a conventional loan.
In my situation, I needed this property to make more money than it was. And I knew I could do it. All units were at least $100 under market rents. While it did need some renovations, there were no major issues in the inspection reports. It would take me some time to get most of the units to renew, but if I did, I would be in a much better position to refinance to a conventional loan.
It would also give me time to ditch my other properties. While my triplex and two duplexes were great from the perspective of passive income and return on investment, they were not on another, all important calculation: debt-to-income ratio.
There were two important calculations I learned during the commercial loan process: debt-to-income ratio, and debt service coverage ratio.
Contrast this to the calculation I had been living by – return on investment. At a high level, return on investment tells you how much money your investment is making. Its typically an annual calculation:
ROI = annual net profit / total cost of investment
For instance, if you spend $100,000 on a property that makes $10,000 annual profit (that is, profit after paying for operating expenses and debt service payments), that investment has an ROI of 10%. My owner-occupied investments had the best return on investment. These require 3.5% or 5% down, so for very little cost of investment, even a little net profit gave me a great ROI.
The stock market typically makes about 8% ROI. As a real estate investor, I targeted a 15% ROI, which is aggressive. A 10% ROI is considered a good investment.
However, these investments did not have good debt-to-income ratios. Debt-to-income ratio is also an annual calculation:
DTI Ratio = total annual debt payments / total annual gross income
For instance, if you make $10,000 annual profit and pay $8,000 in total debt service payments (mortgage payments to your bank), you have a DTI Ratio = 0.8.
A DTI ratio of 0.8 is not good. In my experience, banks like to see 0.45 or lower, meaning you should make at least twice as much in profit as your debt service payments. This lets the bank know you will have plenty of cash to pay for things like repairs and maintenance, lawn care, taxes, insurance, etc. after you pay them. And maybe have a bit of cash left over for yourself.
And then you have the very important metric, debt service coverage ratio:
DSC Ratio = total net operating income / total annual debt payments
So, let’s say, after paying off your taxes and repairs and all of your operating costs, you make $10,000 annually. This is your net operating income, your gross income minus your operating expenses (does not include debt service payments). And your total debt service payments are $8,000. Your DSC ratio is 1.25.
A DSC ratio of 1.25 is typically the bare minimum that banks allow, at least from what I’ve seen. Many want to see 1.35 or 1.4. This metric tells the bank that, after you pay for all the needful business expenses, you’ll have more than enough to pay off their loan. And that “more than enough” is important to them, because 1) they want you to make a profit, and 2) they want you to have enough money to keep the ship running in case there is a vacancy.
As you can see, DSC Ratio and DTI Ratio are two very important metrics when analyzing a deal from a bank’s perspective.
And these were two metrics I was absolutely clueless about going into my first commercial loan for a multifamily.
If I had better understood these metrics, I may have realized why the banks were hesitant to lend to me. Overall, my investments were debt heavy, and I didn’t have a lot of extra money left over every month after operating costs and debt repayments. And as for the almost-mine eight-unit, while it would be highly profitable after rents were increased, at that moment, it was not. And banks can’t count on the future. They look at what’s happening right now.
Granted, this was not well explained to me at the time, hence my frustration. When I asked about their concerns, I got a lot of fast-talking, side-stepping answers. Looking back, that bank communicated poorly, adding to my ignorance of the process. We made a horrible team.
So, since this eight-unit did not yet look attractive to a bank and a hard money loan was a viable option, I went the hard money route. To get the property in my name, I put 10% down and agreed to pay interest-only payments at a ridiculously high rate of 12%. While these terms seemed crazy, looking at the math, they would more than pay off.
Over the course of a year I would increase the gross rents by more than 25%. I would likely fully renovate a few units and get new tenants, and the rest of the units would have renovations done. All would have rent increases. One nice thing the conventional bank did for me was order an appraisal, and the appraiser estimated what the property would be worth after renovations. This was my benchmark, and if I did indeed get that number, I could refinance after improvements and rent increases, and at the very least get an ROI of 15% and some healthy passive income. At best, I would get a cash out refinance that would give me up to 50% of my investment back along with cash flow, the best of both worlds.
And that’s what I did. Or what I’m doing.
In a few months I’m on target to refinance my eight-unit property. I have sold two of my three smaller properties, with the third being listed next week. Once this last property is sold (or under contract), my global DTI ratio will be really healthy, and the eight-unit is already performing outstandingly, with all but one unit’s rent increased. My residents are happy, even with the increases, because I keep the property well-maintained and have made improvements.
I am happy because, in spite of a frustrating financing process that hit a lot of roadblocks, I have learned so much. With the profits from my property sales and possible cash out from the eight-unit, I am prepared for the next multifamily. And this one will go so much smoother. I’ll know how to position myself as a good loan recipient, and how to find the best property for myself. My team of contractors, lawn maintenance, pest control, etc. is already vetted. And the systems I put in place as early as my first investment property are holding true and proving their value.
Most importantly, this process has given me time. Because I’m learning how to make my money work for me, and have stopped trading time for dollars, I am building passive wealth through passive income. I’m not rich. Hell, I’m not making anywhere near what I made in my corporate job. But that’s okay. Making all that money did not make my life any better.
Throughout this process of improving my life, making everyday just one percent better than the last, I’ve discovered that everything in moderation is best. Once your basic needs are met, more food, money, space, etc. won’t make you happier. It may have a fleeting dopamine rush. But the real stuff of happiness isn’t tied to physical things.
Real happiness is freedom.
Happiness comes from having time to pursue what you want. To take care of your health. Having enough money to take care of yourself and your family. To invest in and cherish your friends and family, and cultivate moments that become memories. Happiness can be born from challenging yourself and trying new things.
But really, happiness is freedom. Freedom to find yourself. And be yourself.
Every hour of every day.