How Much Did I Make From My First Investment Property in Los Angeles
Although housing price in Los Angeles is ridiculously high, it is actually one of the best place to invest in rental properties
First of all, this is not an article to show off my smart ass or the foot-long between my legs. Unfortunately I have neither. On the contrary, this is an article to use myself as an example to show you how a normal joe like me with a regular 9–5 job can still make some sizeable side income on a part-time basis.
Diamond Hill
Before I came to the United States, I grew up in a slum in Hong Kong, a slum similar to what you saw from the movie Slumdog Millionaire. Yes, such thing did exist in a global financial hub. The irony is, that slum was called the Diamond Hill.
Imagine your living room, dining area, study room, and bedroom are all within a less than 100 square feet space. And when you have to take shit, you have to walk a 1/4 mile to the stinky mobile toilets area at the back of the village. Yes, that’s my life when I was a teen in Hong Kong.
So deep inside, I have a strong desire to own houses. As soon as I managed to pay off my US$50K students loans and credit card debt that were accumulated from my useless master degree, I saved every penny for my first house.
The Search
Just my luck, I graduated in December 2008 in the middle of the recession triggered by the housing bubble. The housing market was at its rock bottom in 2009 and 2010. You could get a single family house in Torrance for US$300K or an one bedroom condo in Marina del Rey for similar price. However, with overwhelming debt and a starting salary of merely US$35K, my American dream remained as just an adolescent wet dream.
After couple years living like a cheap-ass in extreme frugality, I finally managed to pay off all my debts in late 2012. In December 2013, I bought my first house in Hawthorne with 3.5% down payment using the FHA (Federal Housing Administration) loan.
“Why Hawthorne? It’s a fucking ghetto!”
Glad that you asked. Well, I bought the house with the intent to rent it out, so I had to find a place that was close to a major employment hub. Hawthorne is where the headquarters of SpaceX and Tesla are located. I knew that I would be able to find good tenants pretty easily as long as SpaceX and Tesla stay there. As of now, all my tenants are from SpaceX.
Rental Income
After I moved in, I spent about 2 to 3 months buying furniture from IKEA and Target, replacing light switches and light bulbs to more energy efficient ones, putting up blinds and curtains, advertising the rooms on Craigslist, screening potential tenants, etc. No one was born with all these know-hows, you just have to learn as you go. In February 2014, the house was finally ready for business!
Between March 2014 and December 2018, I lived in the master bedroom and rented out the 2 remaining bedrooms. I charged below market rate so that I could have a bigger pool of potential tenants to choose from. On average, each room brought me US$700 per month. With the additional US$100 for the garage parking spot, my monthly rental income was about US$1,500. Not a lot of money, but at least it was a start. So in that 5 years period, my total rental income was about US$85K.
In December 2018, I moved out to live closer to my office and rented out the master bedroom as well. I still charged below market rate. I rented out my master bedroom with the garage parking spot to one of my existing tenants for US$1,000 per month, in condition that he would also act as my property manager. The rent for the other two bedroom was about US$750 each, with an additional US$100 for the parking spot. So my total monthly rental income was about US$2,600 after I moved out. It’s been almost two years since then, so the total rental income from that 2 years period was about US$62K. However, I did have a few months having one room vacant without a tenant when COVID-19 hit. So let me deduct US$5K from the total amount above. With that, the actual rental income was about US$57K in the last two years.
To sum it up, my total rental income in the last 7 years since I bought the house was about US$142K (US$85K+US$57K). In real estate this is called the gross rental income. It is the income before you deduct any rental expenses.
Rental Expenses
Everything sounds tempting so far. However, just like any business, a rental property has its own expenses as well, and they are pretty substantial. The expenses include: mortgage interest, mortgage insurance, property tax, HOA fee, home owner insurance, utilities (electricity, gas, water, trash, internet), maintenance, etc. To list them all out item by item will make this article super boring. So I am going to save you the pain and just give you the lump sum amount of my monthly expenses. My total monthly expenses are about US$2,000. So my total rental expenses in the last 7 years are about US$168K.
Net rental income is the gross rental income minus rental expenses. So my net rental income in the last 7 years was NEGATIVE US$36K.
“What the fuck? You are losing money on your fucking rental? Why the fuck am I still reading your fucking article? You fucking dickhead!”
Please calm down. I know how you feel. Things are not as simply as it looks. Let me explain the concept of “Rental Loss”.
Rental Loss
Rental loss is not a bad thing. It is extremely normal for a rental property in the first couple years to have rental loss. In fact, many people own investment properties just to incur rental loss to lower their tax burden. The reason is that the tax codes in the United States really favor real estate investors. Any rental loss is tax deductible from your other incomes such as your salary. However, you can’t make your rental loss look so ridiculously high that attracts IRS’s attention. Even if you have nothing to hide, being audited is a pain in the ass. The art of the trade is, you need to look like a loser on the book, but a winner in real life.
If I include all the tax deductions such as property depreciation (a topic that deserve its own article), I basically recouped all the US$36K rental loss back into my own pocket.
“I am so confused by all these numbers. Can you just go straight to the point?”
Absolutely! In a nutshell, in the last 7 years, not only that I lived in the house for 5 years rent free, someone else is paying the mortgage of the house for me. On top of that, there is a magic word called “appreciation”.
Appreciation
The asking price of the house that I bought was US$300K. Back then I thought it was a complete ripoff. Similar house in the same community was sold for $250K one year before, and $285K just a couple months earlier. What made this shady seller believe that her house was worth an extra US$15K premium? After an intense back and forth negotiation, I reluctantly agreed to pay US$295K for the house. I was kind of upset because I thought that I bought the house at the peak.
Fast forward 7 years, last time I checked on Redfin, my house is now worth US$539K, which is US$244K above my purchase price. This net amount is called “appreciation”.
Conclusion
The reduction of mortgage principal plus the appreciation of the house increased my net asset by about US$300K, which is already more than the asking price of the house that I bought in 2013. Early this year, I bought my second investment property in a similar neighborhood to repeat the same cycle.
“Lucky bastard!”
I know a lot of you may want to say that straight to my face. I don’t blame you. This is just part of human nature. My former boss bought an one bedroom condo in Marina del Rey for US$350K in the same year as I bought mine. He moved in and didn’t rent out any space. Now his condo is worth more than US$1M. “Luck bastard!” I almost spit out.
When we see other people succeed, especially financially, we see luck, instead of all the thoughts, guts and risks behind the process. We always see ourselves better than who we actually are. Trust me, every morning when I wake up, I see Brad Pitt in the mirror, despite my typical Asian face.
However, if I didn’t take my first step 7 years ago, I would be kicking my ass now. It will take me about 120 years to become a millionaire working as an architect, but with real estate investment on the side, I may be able to get there in less than 20 years, saving me one century of labor intensive hard work and the immortal pill.
If there is one thing to take away from this article, I simply want you to know: Although it is not obvious, but a lot of time, the safest route is often the most dangerous one, while the biggest risk is not taking any risk at all.
