The following is the presentation I gave on Thursday, October 13, 2016 in Fort Collins, CO on the Young Professional Nomad model. I was scheduled to teach this class live again on October 17, 2017 but due to a personal conflict that evening, I ended up just giving everyone temporary access to the recording instead of teaching the class live again.
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What is the Young Professional Nomad?
The Young Professional Nomad (often abbreviated Young Nomad) is usually a young college graduate that has their first job out of college. They’re used to moving every year while at college and, for the right reason, they’re willing to continue to move each year. They see the opportunity to complete the Nomad model as the right reason.
Since Young Professional Nomads are often college graduates, it may help to get some information about using Nomad to pay for college. Review the class on College Nomad for more information on that.
Young Professional Nomad Earnings
Young Professional Nomads usually have moderate to slightly better than moderate earnings. The following table from Time.com shows the 2016 average salary of a variety of bachelor degree majors.
|Bachelor’s Degree Major||2016 Average Salary|
|Math and Sciences||$55,087|
For the Young Professional Nomad we are modeling buying houses that would require them to start with a gross salary of $3,721 per month or $44,655 per year.
The income shown above assumes that you have no other debt. If you have student loans, you’ll need to do one of two things.
First, you could earn more to purchase the same price homes that we are in this model. I’ll talk about the price of homes here shortly.
Second, you could purchase less expensive homes. I’ll talk about toward the end because the National Association of Colleges and Employers ran a survey and found the following.
In the table above, it shows that while the median is high enough for Computer and Information Sciences, Engineering, Liberal Arts and Sciences and Business, there are several fields where the median starting salary for Young Nomads with bachelor degrees is not enough to complete the model using a $286K home.
If we look at the 25th percentile, we need to focus on a yearly salary of $25K to capture more than 75% of the graduates for pretty much all categories. I’ll get pretty close to that with my example toward the end of this presentation.
However, there are other surveys of salaries that suggest that even $25K is high. For example, the Huffington Post cites a survey by Accenture in 2015 that suggest that 41% of graduates earn less than $25,000 per year.
Required Income Increasing Over Time?
You may notice that you’ll require more income each year that you buy the next property. This is because of primarily two reasons.
First, the property values are going up each year by about 3%. That means that while the houses you own are going up in value, you are also buying slightly more expensive houses each year.
The second reason you will need more income each year (and this is probably the bigger reason) is that we are modeling this with slightly negative cash flow (not taking into account depreciation). The slightly negative cash flow means you need to earn enough to offset that negative cash flow and have enough to qualify to purchase the next property.
Later in this presentation we will look at buying a less expensive home that has better price to income ratios where you can earn less each year. But, before we do that… let’s look a little deeper at the original model.
My Assumptions for $286K Model
I’ve been using pretty much the same assumptions for the previous presentations I’ve done this past year. I’ve gone into them in detail several times prior so I will not go into the details again here, but to refresh your memory about what I am using, here’s an old screen shot showing the assumptions from the Nomad Calculator Classic.
You can see interactive versions of the charts below and adjust the assumptions for yourself by going to https://goo.gl/ELPRj2.
The charts showing estimated gross income (monthly and yearly) above assume that you have no additional debt. If you do happen to have additional debt, for each $100 per month in debt payment, you need to earn $222.22 more per month. So, if you have a car payment worth $300 per month, you’ll need to earn about $667 per month to keep the same debt to income ratio (DTI). We’re assuming you need to be below 45% DTI to be able to qualify for the mortgage.
Price of Houses
So, if we start looking at the same home, but those homes are going up 3% more per year, the following shows the value of the homes we’re purchasing each year for the first 10 years as a Young Nomad.
To learn more about why I use 3% appreciation and whether that is reasonable, you can watch the entire presentation I did on appreciation rates.
So, in year 1 you’ll be buying a $286K house. The next year you’ll buy a $294,580 home and the first home you bought will be worth $294,580 as well. We will continue with that until we buy 10 homes.
Appreciation on Each Home
So, if property values are going up by 3% each year, how much are you gaining from appreciation by owning each home? The following chart shows the amount of appreciation you earn from owning 1 home in the year shown.
So, in the first year, even when you’re living in the home, the Young Nomad earns about $8,580 in appreciation. If they’re making the minimum required to do the plan of $44,655 per year, that means that by purchasing their first home, they’re earning 19.21% of their salary.
While not exact math, can you see that if you buy 5 homes then you’re pretty close to earning your entire salary each year passively just from appreciation?
Paying Down Mortgage Debt
Each year that you make your mortgage payments as a Young Nomad, you’re paying down debt on your loan. Here’s a chart showing how much debt you pay off each year on a single home.
Just by making consistent on-time mortgage payments, you’re earning over $4,000 per year per house. Get to 10 properties and you’re probably making more than your salary each year in debt paydown.
I used an actual property that was for sale in our local MLS to model this. That means a real purchase price and a real rent number. I did use a higher than normal interest rate, so unless interest rates rise quite a bit, it should be better than what we’re projecting. See my entire presentation on interest rates for more information on that.
So, why did I just stress that I was using real numbers? Because I am about to show you that you have negative cash flow on this property–especially in the early years. Here’s a chart showing you the cash flow (not counting depreciation–which we will talk about next) for a single property over the first 10 years.
A few things about the chart above…
First, there is no cash flow in year 1. You’re living in the property and not getting cash flow in that year in the model. Or are you? For Young Nomads just out of college, I’d strongly recommend that you consider getting roommates. If you buy a three bedroom house, you could rent out two of the bedrooms for $500 each (pretty easy in our local market) and earning $12,000 over the course of the first year from roommate rent (boarder income). Get a 4 bedroom and rent three bedrooms for $500 each and you’re collecting $18,000 for the year. I have NOT modeled this here, but I do suggest you do it.
As a side note: it would be hard to rent 3 bedrooms in Fort Collins or Windsor because of city ordinances limiting the number of unrelated people that can rent a home together.
Back to the chart above… second, you’ll notice that in year 2 there is negative cash flow of $948 per year. Why? If you had put 20% down, you’d have positive cash flow. Since we only put 5% down, you’re financing the 15% that you did not put down. So, instead of coming up with $42,900 (15% of $286K) you’re saying… I’ll pay $948 for the year or $79 per month instead. Especially since you’re not likely to pay that much in year 3 when negative cash flow drops to just $480 for the year. Plus, I’m going to tell you about depreciation next which essentially eliminates negative cash flow completely anyway.
Third, in the chart above, cash flow is essentially break-even in year 4 when it is $1 per year positive and is positive $496 per year in year 5. It continues to grow in subsequent years as rents go up 3%.
When you own residential rental property, you can depreciate the property over 27.5 years. This depreciation is a tax benefit that reduces the amount you owe in taxes. The amount you save in taxes can be looked at like additional cash flow on the property since you’re not paying that amount of money in taxes you get to take home more from your income at work and from your rental properties.
How much is the depreciation benefit from owning one rental? Glad you asked… let’s look…
The chart above shows you the depreciation benefit which it the amount you reduce your income by. The actual amount of “cash flow” you get from depreciation is really this number times your effective tax rate.
Effective Tax Rate for Young Nomads
Here is a table of estimated income tax rates from a calculator that you use to enter in your income and it will show you your effective tax rate at TaxAct.com:
|Tax rate||Single filers||Married filing jointly or qualifying widow(er)||Married filing separately||Head of household|
|10%||Up to $9,275||Up to $18,550||Up to $9,275||Up to $13,250|
|15%||$9,276 – $37,650||$18,551 – $75,300||$9,276 – $37,650||$13,251 – $50,400|
|25%||$37,651 – $91,150||$75,301 – $151,900||$37,651 – $75,950||$50,401 – $130,150|
|28%||$91,151 – $190,150||$151,901 – $231,450||$75,951 – $115,725||$130,151 – $210,800|
|33%||$190,151 – $413,350||$231,451 – $413,350||$115,726 – $206,675||$210,801 – $413,350|
|35%||$413,351 – $415,050||$413,351 – $466,950||$206,676 – $233,475||$413,351 – $441,000|
|39.6%||$415,051 or more||$466,951 or more||$233,476 or more||$441,001 or more|
Remember, when we enter in our Income Tax Rate on the Nomad Calculator Classic, the calculator will calculate the benefit you get from depreciation based on that effective income tax rate.
So, the depreciation benefit goes from about $8,840 per year on the $286K property we used as our example in the presentation to about $1,768 in cash flow from depreciation.
What really just happened was we got to reduce our taxable income by $8,840 from depreciation on the first property we bought which means that we actually saw an extra $1,768 in tax savings for the year. That’s why we call it cash flow from depreciation.
Cash Flow Including Depreciation
So, while we had $948 in negative cash flow, we really saw $1,768 in cash flow from depreciation. That means our net cash flow including depreciation is actually positive.
The chart above shows the cash flow (green) and cash flow from depreciation (yellow) AND then it adds the two together (orange) to show you the net cash flow including depreciation each year from owning 1 home.
Total Cash Returns
So, what is the total benefit to a Young Nomad buying a home when you include appreciation, debt paydown (which are the only two you get in the first year) and cash flow and depreciation (which you start getting when you convert it to a rental)? Again… I’m so glad you asked. Here’s a chart showing each benefit and then the benefits summed together (the orange column).
You can see the benefits in year 1 are about $12,963. In the second year, it is over $21,000 and grows each year from there.
I want to emphasize that this is per house. By year 3, you’re very likely exceeding your entire salary with benefits of owning the three rental properties.
Rental Property Expenses
I glossed over the expenses portion when I talked about cash flow above. Let’s look back and look at the expenses on your rental property.
This shows you the expenses you have on your first property in year 2 (the first year you rent it).
Your mortgage payment takes up the biggest percentage (the large gray portion of the pie chart). There are property taxes and insurance which go up each year as they’re calculated in our model as a percent of the value of the home.
In this case, there is no HOA, but if there was one it would be included here.
We’ve set aside a certain amount of money from each rent check we collect to cover maintenance expenses on the property. Over time you’ll use this money to deal with upkeep on the property. Here’s the pie chart emphasizing the maintenance piece.
How much is this per year? Well, we use a percentage of the rent we collect, so each year it increasing a little. Here’s a chart showing how much it will be one 1 property over 10 years.
I want to emphasize that you’ll be spending this money. You might get to hold onto some of it for periods of time, but it is budgeted for maintenance on your properties. Which leads me to discuss some good general financial recommendations for Young Nomads.
Financial Recommendations for Young Nomads
Nomad is just one piece of the overall financial plan that people should consider. The following are some additional financial tips and recommendations for Young Professional Nomads. While we are discussing these in the context of Young Nomads, these apply to other types of Nomads as well.
Maximize Retirement Plan at Work
Often employers offer tax advantaged and matching retirement plans. Nomads should maximize their at work retirement plans.
Any match that your employer offers is usually instant, guaranteed return on any money you invest. For example, if you put 3% of your salary into your company 401K plan, some employers will match your 3% investment by placing 3% in your retirement account as well. This effectively gives you a 100% return on your money in the first year.
As a general rule, I strongly recommend that you maximize how much you can put into your retirement plan to take advantage of the tax advantages of 401K, IRAs and other related plans even if there is not a company match.
Nomads, especially Nomads that are minimizing their down payments and have negative cash flow, should have some cash reserves set aside and this is a good way to have those cash reserves.
Save 10% of Your Income
In addition to contributing the maximum allowable into your employer retirement program and maximizing those benefits, Nomads should set aside 10% of their income into investments outside of their tax advantaged retirement accounts. These are cash reserves that will help you get loans, add an additional margin of safety to your maintenance reserves that you’re setting aside and give you added holding power in case of higher than normal repairs or vacancy.
You can keep this money invested, but I’d personally keep it in a lower risk investment.
Once you’ve set up to maximize your retirement plan at work and started to set aside at least 10% of your income for cash reserves, then start to implement the Nomad plan by buying your first home to live in. You don’t have to have a set amount in your retirement plan or cash reserves to buy your first Nomad home. You’ll have a year of building up your retirement account and your cash reserve account before you convert your first home to a rental and buy your next Nomad property.
You can buy your first Nomad property with minimal down, so buying your first Nomad property should be pretty quick. There are several nothing down loan program options as well as a 1% down conventional loan program. Should you not qualify for any of those, there are 3.5% down FHA loan programs which is often one of the easiest loan to qualify for.
Save Down Payments for Future Nomad Properties
After you’ve moved into your first Nomad property, you should begin setting aside money for your down payment for your subsequent Nomad properties. Do this even if you plan to utilize other creative strategies to come up with down payments. Any money you set aside can be used as additional cash buffers or allows you to consider a greater number and variety of opportunities.
Down Payments for Young Professional Nomads
I’ve done an entire presentation on How to Get Down Payment for Nomad that you should review for additional ideas on coming up with down payment for Nomad purchases, but I want to remind Young Professional Nomads that you probably had roommates in college.
Roommates can be a great way to do one or more of the following:
Roommates Can Provide Down Payment for Future Nomad Purchases
If you purchased a 3 bedroom home and rented out two of the bedrooms to roommates, you could use that money as down payment for buying additional Nomad properties in subsequent years. In our local market in Fort Collins and Loveland Colorado, renting out a bedroom for $500 per month plus utilities is completely reasonable. If you could get 2 roommates, you could collect $1,000 per month in roommate (boarder) income. Over the course of a year that’s $12,000.
In our local market, we often use $300,000 as a price point for the Nomad model. 5% down on a $300,000 property is $15,000 so $12,000 from roommates through the year is a good way toward an entire 5% down payment.
Roommates Can Offset Your Current Mortgage
Another, alternative way of looking at roommates is that they can offset the cost of the mortgage on the property you’re living in. Principal and Interest (P&I) payment on a $300,000 mortgage at 4.5% per year is about $1,520 per month. Getting $1,000 per month from roommates reduces your mortgage payment buy almost two-thirds. If you happen to be in a market that would allow you three roommates at $500 per month each, you can be living almost mortgage free (not including taxes and insurance).
Bring Your Roommates With You To Subsequent Nomad Houses
When you go to buy your next Nomad property, rent out the previous property and bring your roommates with you to the next house.
How Much Will Young Nomads Need for Down Payments
So, how much will you need for down payments to complete the model using $286K properties? We’ve modeled it assuming you need to come up with 5% down on each home. I have some strategies that we’ve taught in the How to Get Down Payment for Nomad class to come up with down payment or lower the amount you’ll need.
However, if you did not use any of those strategies, here’s a chart showing the amount you’d need for down payments AND negative cash flow. I’ve added negative cash flow in there even though you’ll likely have depreciation to offset it just to be thorough.
So, you’ll need about $14,300 to buy your first home if you need the full 5%. There are some strategies you can use to come up with nothing down (USDA and VA loans or FHA/Conventional with down payment assistance) or little down (1% down or 3% down conventional loans or 3.5% FHA loans).
Be Careful of Debt
One thing to be careful of as a Young Nomad is taking on additional debt. For many recent college graduates your student loans will limit your ability to borrow for buying a home, so you want to to be especially careful not to take on additional debts like a car debt or run up your credit cards. Student loans, car loans and credit card debt all limit your ability to borrow since they affect your Debt To Income ratio.
We did an entire class on paying for college and student loan debt using the Nomad model called College Nomad Overview. I’d recommend that you watch that if you have (or will have) student loans.
Nomad Versus Stocks
In a variety of other presentations I’ve hammered home how good Nomad is so I won’t spend a ton of time going into the equity and cash flow charts that you can see using the calculator yourself or looking at other presentations. However, I will show you the quick comparison of Nomad versus taking the same amount of down payment (and negative cash flow money) and investing it in the stock market and getting 10% return on stocks.
I want to point out that I think 10% return every year on stocks over 40 years seems unlikely. The assumptions I made for Nomad I feel are conservative. Still Nomad crushes stocks.
Buy Less Expensive Homes
We tend to recommend people invest in the second quartile of the market as discussed in the Millionaire Real Estate Investor book by Gary Keller and others. In the book he describes the sweet spot for rental properties in a visual shown below.
But as a Young Nomad, don’t be afraid to move yourself down the price to get started with Nomad. In many cases, buying a lower priced property to get started is a better plan than waiting to buy a more expensive property in the second quartile. You can use a lease option exit to exit the property in many cases to optimize your portfolio moving forward if you’d prefer to not keep the lower priced property long term.
However, be careful not to buy at the very, very low end of the market where you could end up with a property with lots of deferred maintenance in an area that is hard to rent or even sell. I’d recommend buying slightly better quality than the absolute bottom of the market for the Nomad model.
Less Expensive Homes and Fewer Bedrooms
You might be tempted as a Young Nomad to buy a less expensive home with fewer bedrooms. It is not wrong to do so, but consider this.
Buying a home with an extra bedroom might cost $10-15K more in our local market compared to a similar home. There is a new construction builder that has 3 bedroom models and 4 bedroom models. The 4 bedroom models are about $10K more.
Going from a 3 bedroom to a 4 bedroom might allow to rent an additional bedroom to a boarder for an extra $500. That’s a $6,000 income on a $10,000 additional investment. Seems pretty good to me. Especially when you consider you’re probably not really coming out of pocket the $10,000 when you buy it… you’re probably financing it. You’ll come out of pocket 5% of $10,000 or about $500 and it will cost you about $50 per month in extra payment to finance $10,000 in a 30 year mortgage. You’re making about $500 per month from a roommate by paying a one-time additional down payment of $500 and $50 per month more.
And, when you convert the property to a rental, you likely won’t make $500 more per month in rent, but you’ll very likely make at least $50 more per month in rent for an extra bedroom and probably more.
Revisiting Less Expensive Homes
So, let’s revisit the idea of buying less expensive homes to cater to the larger number of Young Nomads that aren’t making above median salaries (by definition above median would mean over half of the people graduating from college). In fact, let’s look at the chart again and look at the 25th percentile… which is probably 75% of all the Young Nomads.
So, here’s what I did… I went and looked at what the 20th percentile of homes that sold last month in various local cities. Here are the charts showing (among other things) what the 20th percentile of home sales price was for Fort Collins, Loveland, Windsor and Greeley were.
To summarize, the 20th percentile of sold home prices for the following cities were:
- Fort Collins: $260K
- Loveland: $259K
- Windsor: $275K (We were using a $286K property as our primary example)
- Greeley: $178K
That means that 1 in 5 properties in those cities sold for less than that price and 4 out of 5 were above that price.
The idea is that maybe with your Young Nomad income you start by buying a suburb or less expensive city. In our area that might mean buying in Greeley.
If we were going to buy in Greeley, could we find a 3 bedroom home for $178K. Here’s a chart showing Greely sold prices for 3 bedroom homes only.
I’m showing you this to see if there are 3 bedroom homes that you could buy in Greeley in the $178K price range. The answer is yes. Each scatter plot point is a sale of a 3 bedroom home in Greeley in the last year on the bottom chart.
So, we could buy a 3 bedroom home in Greeley for $178K or less. How about rent?
Here is the median and average rent for a 3 bedroom in Greeley for the last 6 months or so. The average is about $1,443 per month and the median is about $1,495. So, let’s use the Nomad Calculator Classic with a $178K property with rent of $1,395. Similar assumptions that we used above except I’ve reduced the Income Tax Rate to be 13.35 which is the income tax rate for someone who earns $28,000 per year.
Why $28,000? Well, that turns out to be the amount of money you need to make to do Nomad with a $178K property that makes $1,395 per month.
Sure, your properties are appreciating at 3% but it is 3% of a smaller amount ($178K versus $286K) and you’re paying down less on your mortgage each year because you’re not borrowing as much.
But what is interesting is the significantly improved cash flow.
Gone is the negative cash flow! That is a main reason why you don’t need to be earning more each year… your cash flow is helping you qualify for additional purchases.
When you include depreciation, your cash flow starts looking great early on.
In fact, it prompts an interesting discussion on effective retirement.
What is effective retirement? In my mind, when your passive income exceeds the income you earn from your job, you’re effectively retired. You can stop working your job and live off your investments.
With a lower income, you have a lower target to hit. If you need only make $28,000 per year to do this entire model, when does cash flow from your Nomad rental properties exceed $28,000? Great question.
It turns out you exceed $28,000 in year 9 before you even buy your 10th Nomad property. You could effectively retire at the same income after working just 9 years. If you graduated college at age 22, that is at age 31.
If you complete the Nomad model and buy 10 properties, in years 10 through 20… when your probably age 32 through 42, your cash flow would look like this.
How much down payment would you need (and where do you get it from)?
If you got 2 roommates to rent the other 2 bedrooms in your 3 bedroom home and charged just $500 per month to each, that completely funds your down payment to buy the entire Young Nomad model with no negative cash flow.
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