Let me tell you a story.

This story is about buying one property as an owner occupant, living there for a year, then buying a second owner-occupant property 12 months later and converting the first property to a rental.

## Number of Houses Owned

So, it looks like you own one property from the very first month then buy a second one in month 13 as shown in the chart below.

After that, you don’t buy any additional properties, so you end up owning just the two Nomad properties (one as a rental and one as the home you live in) for a total of 480 months, or 40 years. I’ve represented this as a chart of the number of houses owned over 40 years below.

## Gross Income Before Taxes

For this particular scenario, I assumed you were making $5,000 per month and that you were not getting cost-of-living raises due to inflation. Here is a really simple chart showing that you’re earning $5,000 per month from the very beginning through month 480.

Since you’re not getting inflation adjusted raises, your buying power—when you do adjust for inflation—is actually going down. Here’s the same chart above showing you’re earning $5,000 per month, but this time adjusted for inflation at a rate of 3% per year.

As you can see in the chart above in the first month your $5,000 per month in gross income feels like you’re really earning $5,000 per month. However, over time your buying power gradually erodes and your buying power earning that $5,000 per month is getting weaker and weaker. By the time you get to the last year, months 468 to 480, your gross paycheck feels like less than $1,600 per month in real spending power in today’s dollars.

In the next chapter I will adjust your $5,000 per month in gross income to a 3% inflation rate (as if you’re getting 3% per year raises each year as you work). For now in this story, I want to show you a super conservative modeling of just keeping two Nomad properties where you are not getting raises to your gross income.

## Median Income From US Census Data

For those of you who are wondering if me using $5,000 per month as an income for an entire family is reasonable. According to the US Census the median household income for the United States in 2016 is $55,332 per year. I live in Larimer County and the house that we are modeling for this is in Weld County, Colorado. The median income for Larimer County, Colorado from the Census data is $61,942. Weld is $62,820. The $5,000 per month I use is $60,000 per year, so that estimate is slightly lower—more conservative— than the two counties near me. It is a little higher—less conservative—than the median for the entire United States.

You can review the latest US Census numbers on the United States Census Bureau website:

https://www.census.gov/quickfacts/fact/table/

As a gentle reminder for those that haven’t reviewed their middle school math recently… median means the middle most number. Half the people earn more than that and half the people earn less than that.

## Hourly Rate

Another way of looking at the $5,000 per month for your entire family is to look at your hourly rate. Assuming two people are working in your family to earn $5,000 per month, that means that you and your significant other must each earn $30,000 per year. A full work-year is considered 2,000 hours (40 hours a week times 50 weeks a year), so you must earn at least $15 per hour ($30,000/2,000 hours).

A couple of additional data points that might lend some perspective for those who think my $60,000 per year is unrealistic. My son, who recently graduated from high school and works at WalMart, earns about $10 per hour. WalMart has been in the news lately about how low their wages are for their employees so I suspect $10 per hour is a bottom threshold since they’re notorious for low pay and my son’s hourly is the starting wage for someone just out of high school with no previous job experience.

My wife and I regularly work 60+ hour weeks and have for many, many years. Both my parents worked 60+ hour work-weeks for as long as I can remember. I see lots of friends and clients working 60+ hour work-weeks. So, even if you earned $10 per hour at a job like WalMart, but were willing to work two 30 hour per week jobs, you can earn the income I’m suggesting here. In other words, you don’t need a special high-earning job to do this model; you can brute force a solution by putting in the hours working entry level jobs.

## Income Tax

With our model, we’re assuming you pay income tax on the $5,000 that you’re earning at a rate of 17.9%. That means you’re really not taking home $5,000 per month. Instead, you’re bringing home about $4,105 per month after paying income taxes. I show the first 12 months of this in the chart below.

You use this money to pay your living expenses including your housing expenses.

## Down Payment for First House

The very first month you buy a home with 3% down payment. I am modeling this home after a similar one that I personally purchased two months ago in February, 2018. It is located in our local real estate market in Weld County, Colorado. It is a 4 bedroom, 2.5 bath, 3 car garage new construction home so there are many of the exact homes to choose from. The property is worth $328,000 and you purchased it for $328,000 which included the seller crediting you $5,000 toward your closing costs. We assume you were able to get a 30 year fixed-rate mortgage as an owner-occupant (since you’re moving into the property for the first year) at 4.75%.

3% of the $328,000 purchase price that you needed for your down payment in this example is $9,840.

To simplify the model, we are also going to assume that you buy this same model of house in month 13 as your second home. Of course, the house will have gone up in value a little bit by the time you buy it in month 13. We’re assuming the house values are going up 3% per year. Our market has been going up much faster than this in recent years, but there will be times when the market will not go up as fast and there will be times when the market will go down a little bit. Over a long period of time, 3% is a good number to use for estimating the rate property values rise since properties tend to go up at the inflation rate according to studies by Case-Shiller that look at 100 plus years of real estate market data.

Even though you’ll use the same 3% down payment loan program to purchase the next property for you to move into when you convert the first property to a rental, you’ll need a slightly higher dollar amount of down payment for buying the second property since the property value is slightly higher.

## Account Balance

For this scenario, I’ve assumed that you started with $40,000 in your bank account. I will cover doing this with far less in savings in the next scenario. For this scenario though, where I am handicapping you by limiting your income to no inflation-based raises, you’ll need to start with some additional down payment in your account.

The very first month, you use almost $10,000 as the down payment for your first house. You use another $10,000 or so to buy your second house in month 13. The other $20,000 will be used to offset rising expenses of owning the two houses. You have rising expenses on the two houses from things like property taxes and insurance. In many cases, these could easily be offset by small incremental raises in your income, but for this particular model you won’t have that luxury.

Here’s a chart showing your account balance for the first 2 years.

Remember, you started with $40,000 but immediately bought a property and used just under $10,000 for a down payment. Mortgage payments are paid in arrears. That means the payment you make on February 1st is for the month of January. So, when you buy a new home you get a month where you do not need to make a payment on your loan. If you sell it will seem like you’re making an extra payment. For example if you sell on June 1st, you might think you don’t need to make June’s mortgage payment; that’s not true. Your June 1st payment is really for May so you will make that payment. If you never sell—like we are modeling in this scenario—you won’t need to worry about this.

## Cash Flow

When you buy your first house, you are living in it and so the expense of the mortgage, property taxes and insurance are really your housing living expenses. Below is a chart showing how your expenses on your first property in the first year are negative.

The lower expense in the first month is that delay of a month of mortgage payment because mortgages are paid in arrears. You are still paying taxes and insurance for that month and that’s why it is not zero. But, you are not making a principal and interest payment.

By the time you get to month 13, you are no longer living in the property. Instead, you have a tenant paying quite a bit of your expenses on this property. You do have some negative cash flow on this property when the tenant first moves in. The negative cash flow, as you will see, does eventually go away with time as rents increase. But, when you first move out and convert it to a rental, even with the tax benefits of depreciation, you are negative about $260 per month. If you had put 20% down as a down payment (about $60,000) instead of 3% down as a down payment (about $10K) you’d be at about break-even cash flow instead of negative $260.

So, if you think about it, you’re really financing the difference in the down payments of $50,000 in the form of monthly payments of $260 per month. However, the $260 per month payments actually go down over time as rents go up. Let’s look at that $260 going down over time by looking at the same chart but for the first ten years instead of just the first two.

As you can see we’re negative $260 per month for the first year we’re renting the property. Remember the first year we’re renting is actually the second year we have owned it since we are living in the property for the first year. Each year, as we start a new lease, the rent bumps up a little making the amount that we are negative a little less negative. In month 97 though, we finally become slightly positive. From then on, we have positive cash flow on that property.

So, from month 13 to month 97 or 84 months total, we have negative cash flow on this property. If we had paid the full $260 per month that were negative in month 13 for all 84 months, we would have paid about $21,840 in negative cash flow. Above I pointed out that if we had put 20% down as a down payment, we would be at about break-even cash flow. Instead we used a down payment of $10,000 (the 3% down payment). So, instead of paying an additional $50,000 in down payment, we paid far less than even $21,840 if we had maintained the full negative $260 per month for the first 84 months.

So, we’ve just been discussing the cash flow on just the first property, but remember we’re buying a second property to move into in month 13. What does that look like? Here’s a chart showing the first property in addition to the second property over the first 2 years.

As you can see, we have the same month without a mortgage payment when we buy the second property and then we’re just paying the expenses of that second property since we’re living in it and not renting it.

## Losing Depreciation and Paying Off Loans

While we are talking about cash flow on I want to show you a couple other interesting characteristics of the cash flow on your first Nomad property which you converted to a rental.

In the chart below that shows the cash flow for 40 years, you can see a few different areas of the chart. The first year, which we have already discussed is when we are living in the property and not getting rent to offset any expenses. In month 13, we start collecting rent and getting tax benefits of depreciation as a rental. As rent goes up, the cash flow becomes less negative and then more positive. After owning the property for 27.5 years, we lose the tax benefits of depreciation. So, you will notice a small change in cash flow around month 330.

However one of the most pronounced features of the chart happens at month 360 which is the start of year 31. What happens then? You guessed it: we pay off the loan we had on the property and cash flow improves significantly. From then on, we see cash flow increase as rent increases. Here is a chart showing the cash flow of the first property over a full 40 years as I just described above.

The second Nomad property never becomes a rental. That means we never get the tax benefits of depreciation. So, the only real change to the cash flow chart is when we pay off the property 360 months after we purchased it in month 13. I am showing just the cash flow on Nomad property 2 below.

And, if we show both properties on the same chart you can see how they interact over the full 40 year period.

## Total (Not) Saved

With this particular model, I am assuming you barely have enough to buy your first Nomad property. In fact, when taxes and insurance go up on the property you’re living in, you need to go to your savings to be able to afford that. You also need to go to savings for the negative cash flow on the rental property.

The following chart shows the first month when you don’t need to make a mortgage payment and how as taxes and insurance go up on the property you’re living in that you are dipping into savings to be able to support this property.

As you dip into your savings for these expenses and the negative cash flow on your property, your savings dwindles over time. Here’s a chart showing your savings account balance over the first 20 years.

We started with $40,000 in a stock market account. We assumed that it was earning 8% per year from stocks. We immediately used about $10,000 as a down payment for the first purchase, but saved almost $2,000 by not having to make a mortgage payment the first month we lived in the property.

We used a second $10,000 or so for the down payment in month 13 when we bought the next property. Again, we got a small rebate by not having to make a mortgage payment the first month.

After the first two down payments, we slowly dip into savings each month for the next almost 10 years. Our lowest balance happens right around the 10 year point with a balance of over $12,000 in our account. After 10 years, the positive cash flow from our rental starts to add more each month to our account than the extra expenses we have coming out of it.

Remember, during this whole time, we are still earning the same $5,000 per month, paying taxes on it and paying for our housing and other living expenses from our paycheck.

Over time, the account balance and new deposits we add to it from the rental property, is invested in the stock market and earning 8% per year. It really starts to compound as shown in the chart below which covers all 40 years.

By the time you get to year 40, starting with savings of just $40,000 you end up with an account balance of just over $1.1 million dollars.

## Equity

Plus, in addition to over a million dollars in your bank account you have 2 free and clear homes worth a total of just over $1 million each which is $2 million combined. Here’s a chart showing the value of the two Nomad properties you own.

## Net Worth

With just one rental property and one owner-occupant home that you live in, you have a million dollars in stocks and cash the bank and two million dollars in equity in your properties. Your net worth is about $3.2 million. Plus, you have cash flow of almost $3,900 per month from the one rental property. Remember, we’re assuming your household income was just $5,000 at this point so you’re earning almost 80% of your paycheck income in passive rental income after all expenses.

If you adjust for inflation, that’s like having just over $1 million in today’s dollars. If you adjust the cash flow from your rental properties after all expenses for inflation, it is approximately $1,200 per month.

## Will You Stop at Two?

Remember, this is what it looks like if you stop at two Nomad properties… one rental and one to live in. It also assumes that you started with $40,000 in savings, can earn 8% from the stock market consistently and that you are not getting any raises at your job for 40 years. It also assumes that you at not seeing an increase in your living expenses other than an increase in property taxes and insurance on your properties.

Most folks will opt not to stop at just two Nomad properties. But before we jump to analyzing the results from buying a third property, I want to change some of our assumptions and show you how that impacts you just having the same two Nomad properties.