Nomad Overview – For Young Professionals

There are five types of Nomads, but we will be focusing on explaining the Young Professional Nomad here.

Young Professional Nomads

The Young Professional Nomad is typically a Nomad that is under 25 years of age, has a job with great income and is willing to move 10 times in the next 10 years if it is worthwhile to do so. They’ll then keep the 10 properties they acquired as rentals until they’re ready to retire, 40 years from when they bought their first property.

I will show you some of the financial benefits of moving 10 times in the next 10 years and keeping those properties for 40 years below. Then, Young Professionals that might consider being a Nomad can make an educated decision.

Nomad Model Assumptions

For this particular Nomad model we will be using the following assumptions. I do model Nomad using a wide range of assumptions in other classes and posts that show how the model changes based on things that could happen in the future.

I do feel that the assumptions I am using for this model are conversative, but if you’d like to see how the model may change based on some changes in the assumptions let me know.

Houses

In our model we will be buying 10 houses over 10 years. What type of houses will we be buying? I have used an actual property currently for sale from our local MLS as of July, 2015 in Northern Colorado to do this model, so it is based in reality.

We will be using a property that is priced at $238,875.

Each year the house that we buy will be more expensive than the previous year because we are assuming that property values are going up by 3.0% per year. So, the house we buy in year two will be worth $246,041 when we buy it.

So, the value of the 5 houses we would be buying over the first five years are shown in the chart below.

Financing

One of the benefits of the Nomad model versus other investing strategies is that we will be moving into the properties and getting owner occupant financing. That’s why we will need to stay in the property for the first year.

Since we are getting owner occupant financing, we can put as little as 5% down (although it may be in our best interest to put more down). I have modeled Nomad in this case assuming we are putting down 5% of the purchase price when buying each property.

Deferred Down Payment and Negative Cash Flow

Since we are not putting a full 20% down and only putting 5% down when buying these properties we really are deferring the full down payment over time. This is like financing the rest of your down payment. This typically will show up as negative cash flow on the property.

If we had put a full 20% down, we would not have had negative cash flow at all.

The following chart shows us that the down payment required for buying the first house is $11,944.


We’d be getting an owner occupant loan at an interest rate of 4.500%. That is actually the rate that includes lender paid PMI.

This would be a 30 year loan with monthly payments. That means that the loan would be completely paid off after 30 years and we’d then own this property free and clear of all mortgages.

Rental Income and Expenses

We are living in the first property for the first year and then buying a second property and converting the first one to a rental property.

We are assuming that the rent for the property the year we bought it—even though we are not collecting that amount in rent because we are living in it—is $1,500. The rent goes up at a rate of 2.0% per year.

That means that by the second year, when we will be renting out the first property, the monthly rent on it will be $1,530 per month.

On the expenses side, we calculate the property taxes to be 0.60% of the value of the property. So, as the property value goes up each year, so do the property taxes. In the first year, property taxes will be about $1,433.

Similarly, we calculate the insurance on the property to be 0.50% of the value of the property. So the cost of insurance goes up as the value of the property does too. In the first year, insurance will be about $1,194.

For this particular property we also have an HOA. The cost of the HOA is $250 per year and it increases at a rate of 3% per year.

We are assuming that when we do start renting the property, the tenant will be paying for all the utilities like electric, gas, water and sewer. So, we do not need to handle those expenses.

Maintenance

Over time, the property will need maintenance like paint and carpet, carpentry, plumbing and electrical repairs and more. We are setting aside 12% of the rent each month for this maintenance. That means we are saving about $2,095 per year (per property) to cover some of this maintenance.

Property Management

In this version of the Nomad model, we are assuming that we are managing the property ourselves. If you were to hire a property manager, you’d want to factor that in as an additional expense (which I do to see how it would work in other scenarios).

We do assume that there will be some turn over of tenants on the property. We will do our best to minimize this by looking for a replacement tenant 60 days prior to the current tenant moving out among other things. Looking for a tenant well in advane of the property going vacant should reduce our vacancy to almost zero, but we will still model Nomad in this case to say that the property is occupied 97% of the time.

The following interactive chart shows you the expenses on the property and the income on the property. Trying clicking on and off various expenses and rent to see their relative sizes.

Benefits of Rental Real Estate

Let’s take a couple moments to go over the different benefits of owning rental real estate and then I can share with you how implementing this specific type of Nomad model for Young Professionals would directly benefit you.

There are four primary areas of return that we get from owning rental real estate that contribute to your overall Return On Investment (abbreviated ROI). Here is a chart showing the four:

return-on-investment

Of the four, two of them are largely dependent on how the real estate market performs over time. They are appreciation and cash flow. If the real estate values do not go up, your return from appreciation will be negatively affected. Likewise, if the rental market does not stay strong you may find your return on investment from cash flow is adversely affected.

return-on-investment-market-dependent

Of the four, the two areas that are largely independent of the real estate market are debt paydown and the tax benefits. If you make payments on your loan as you’ve agreed, you’re going to get those returns. It is as close to a guaranteed return as you can get. Tax benefits too. If the tax law remains the same, you’re going to get that benefit whether the real estate market stays hot or cools.

return-on-investment-market-independent

Benefits of Rental Real Estate for the Young Professional Nomad

Let’s take a look at the benefits you’re likely to see as a Young Professional Nomad by going through the returns for the first home you buy and then we can add additional properties to the model and look at that next.

1 House in the First Year

First, the benefits from one house.

In the first year, the property goes up in value $7,166.


You end up paying down about $3,661 on your loan.



Since you’re living in the property for the first year, you have no cash flow. Of course, one variation to the Nomad model for Young Professionals is that you rent out bedrooms to your friends.


The tax benefit of depreciation does not exist when you’re living in the property, but you’ll start getting this benefit in year 2.


Here’s a quick summary of the returns you got in the first year.

1 House in the First 2 Years

Now that you’ve seen the benefits from just buying the property and not renting it, let’s take a look at the first year (where you live in it) and the second year when you rent it out for the first time.

The property goes up in value $7,166 in the first year and $7,381 in year two.


You pay down about $3,661 in the first year and about $3,829 in the second year.



You lived in the property for the first year (no rental income so no cash flow) and started renting it in year two. In the second year (the first year renting it), after renting it for about $1,530 and subtracting all of your expenses like your mortgage payment, vacancy, taxes, insurance, setting aside a maintenance reserve of about about $2,137 you end up having negative cash flow of about -$1,090.

Do you remember why? It is because you are really financing part of your down payment. If you had put 20% down when you bought it, you’d have positive cash flow. Since you only put about $11,944 down, you’re financing the rest of it.

But wait… do you really have negative cash flow? Here’s the chart showing cash flow, but then let’s take a closer look at the last benefit: depreciation.


In the first year since you’re occupying the property you do not get to depreciate the property. However, starting in year 2 when you start renting the property you can depreciate the value of the house (not the land) over 27.5 years. That means you get to depreciate about $7,818 in year 2.


Depreciation is a different type of return and one that you’ll want to talk to your tax advisor about to see how it actually plays out for your unique tax situation. I have drastically over-simplified this in an example below. As my good friend and tax advisor told me: there are many other factors that go into this and it is not anywhere near this simple, but it does show you in very rough terms how depreciation might impact you. Your situation will be very different.

Without Depreciation With Depreciation
Yearly Salary $70,000 $70,000
Less Depreciation $7,818
Net Taxable Income $70,000 $62,182
Fictional Tax Rate 25% 25%
Taxes Paid $17,500 $15,546
Extra Cash From Depreciation $1,954

The table above shows that the depreciation benefit means that you’re likely to get to take home about $1,954 from the tax benefit of owning that rental property which more than makes up for your negative cash flow on the property of -$1,090. In fact, you’ll come out $865 ahead when you add them together.

So, let’s recap the returns you got in the first two years. The orange bar shows you the sum of all the returns for that year.

2 Houses over the First 3 Years

Let’s see how this looks when we buy the second house in year 2 and then rent out that in year 3.

The following chart shows you how much each house went up in value from appreciation.


The next chart shows how much you’ve paid down on each loan each year for each house.



The negative cash flow continues. New homes we buy, in this particular model, have slightly more negative cash flow to start. However, the amount of negative cash flow is reduced the longer we own the houses.

Remember too that depreciation helps offset that negative cash flow.


Here is a chart showing you the depreciation benefits of the first 2 houses over 3 years.


And finally, here’s a summary. The orange bars show the sum of all the benefits of all the houses combined.

5 Houses over the First 6 Years

Now that you’ve got the hang of it, I am going to show you 5 houses over the first 6 years.



Total Invested

Just how much money do we need to be able to work the Young Professional Nomad model? Well, there really are two expenses: down payments to buy houses and negative cash flow for the first few years you rent a property.

Even though depreciation will help offset the negative cash flow, I’m going to include it in the chart below as if you don’t get the depreciation benefit to be conservative in my model for you.

So, here is a chart showing you the total amount invested in 10 down payments at 5.0% of the purchase price (1 for each house in the first 10 years). And, the sum of all the negative cash flows of all the properties for that year.


By year 23, all the cash flows are positive so you no longer have negative cash flows.

And, the following chart shows you the total cumulative amount of down payments and negative cash flow to do the entire program.

The Results

So, how does the Young Professional Nomad model do and is it worth doing? Let’s take a closer look.
You bought the 10 properties over 10 years moving into each one then converting it to a rental property. Then you held on to the 10 as rentals for 40 years. You end up with 10 free and clear homes with the following in equity.


Cash flow is a little more complicated because over the first 14 years or so, your net cash flow is negative. The following chart shows the net cash flow per year when you add up all the cash flows for the properties.


For years 11 through 20, you finally can see the negative cash flow goes away and you get completely positive in your cash flow as shown in the chart below.


And for the last 20 years, you have significantly growing positive cash flow as shown in the chart below.


And finally, to summarize, here is the entire cash flow picture for all 10 houses over all 40 years in one chart. You can zoom in on any time period of the chart below as well to see more detail.


If we were to show you a cumulative total of the cash flow and the equity from doing the Young Professional Nomad model, it would look like this:

Would I Do Better With Stocks Than Nomad?

In two words: probably not.

If, instead of investing the down payments and negative cash flow into doing the Nomad model, you instead bought stocks and were able to get a full 10% return per year over the same 40 year period, how well would you have done?

The total investment of $237,775 would have grown to be $6,031,428 by year 40. Compare that to the equity in the 10 houses for the Young Professional Nomad model of $7,565,236 and the Nomad model is a clear winner.

Plus, Nomad will be throwing off $241,474 per year in positive cash flow (net of all expenses) in year 40. I will also point out that you would have collected $1,799,278 over those 40 years in positive cash flow.


Here’s a simplified chart showing the difference in year 40.

One of the benefits of Nomad over stocks is that you don’t have to sell any of the houses like you’d need to sell stocks. You could live off the $241,474 per year.

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