How to earn an extra $500 a month: Part 2

house-under-constructionIn part 1 of this article on how to make an additional $500 per month, FPO explored some rather capital intense methods for bringing in some extra income.  These methods are reasonably low risk, but they are also low return.  There are times, when tying up such a high amount of funds in not feasible.  In those cases, there is the opportunity to exercise some leverage by using the bank’s money.

Are there risks in this? Absolutely.  But there is in everything, including “risk free” savings accounts.  Preservation of principal is guaranteed, but so is loss due to inflation.  the risk of your money dropping in value is ever growing in this case.

The fundamental concept is to borrow at a rate less than your rate of return.  The classic example would be buying an investment property to rent out.  Using the $70,000 example from earlier, this same house can be bought with a loan at a current market rate of 4% with 25% down.  Now the initial investment is $17500 and the monthly loan payment for a 30-year loan is $250.  The net rent collected will be the same $500 as in the previous case, however the net amount after the mortgage payment is $250 extra per month.  In order to get the extra $500 per month, two houses of this type must be bought, or one house of approximately twice the cost.  Going with a single house would result in house that’s a little more than twice the cost as the rent amount versus the purchase price ratio decreases as home price increases.  It’s not a linear relationship.

The above example employs a reasonable 3:1 leverage.  More can be achieved.  In this example for the single $70,000 house, an additional $10000 is borrowed using a business loan at 10% for 30-years.  This rate is higher, but since it’s only $10000 of the total cost, the weighted average cost of debt is still favorable.  This 10:1 leverage scenario carries more risk, but only $7500 per house is needed.  The total income would be $500 per month, and the new payment would be $316 per month, leaving a net income of $184.  This is less than the last example since another $10k is borrowed.  In this case 2.7 houses would be needed to reach that $500 per month.  The total amount that the investor would need to bring to the table under such a scenario would be a little over $20000 to get the $500 per month extra income.  The added benefit is that the houses are also being paid off by rents collected over time.

There is a caution here. 10:1 leverage is very leveraged.  The above examples were done with rental properties, however this will work for most any asset class, including stocks.  In the Case of stocks, this is referred to as a margin account.

Part 3 will discuss some ways that an extra $500 a month of income can be created by making opportunities for yourself, both within your current job and various side jobs.

House purchasing economies of scale

This one is a quick reminder for those attracted to investment properties. The right home to have for the purpose of renting out will be around the price median for a given area. Too expensive of a home, and it will be hard to get what is needed in monthly rent. The exceptions being vacation homes, and the luxury market.

The other end of the spectrum is even more problematic. A $40k house will have many cost items that are the same as a $160k house. Here is a list for example:

Appraisal: $200-$400. The house size can influence price, but not by much.

Home Inspection: $200-$500 depending on tests performed. It is similar to appraisal, but can vary a little more with house size. Most of the inspection will be a fixed cost.

Plumbing: Trip fees and simple fixes will be the same. Toilets will be the same.

Mortgages and titling fees generally disregard house size.

Cable TV, and utility service fees will be the same

Evictions will cost the same

Liability issues will be roughly the same

While this list has exceptions, its purpose is to provoke thought about the “good deals” to be had in low cost houses. Always make sure to do your own due diligence before making any kind of investment, and if unsure…consult a local professional advisor.

Rent subsidies, section 8 housing

There are several different rent subsidy programs, the most common of which is section 8 housing through the HUD. These programs are vouchers which low income households can qualify for and use to pay for part/most of their rent. It is interesting to note that these vouchers ultimately wind up as paid rent and in the landlord’s pockets. Another effect is that these vouchers raise the demand for lower income housing for a given locality. A voucher program drives up the rent on houses at and near the bottom of the market. It is also a contributor towards establishing a steady rent floor. A rent floor is the bottom of the local market where a bunch of close houses exist at a price. In an example area, it’s $900/month for a single family house. These are the houses that are pushed up by the voucher program. A much nicer house can be had for $1200/mo. It also works out, that based on income qualifications, it is hard to get into a house greater than $1100 on the voucher program. The rent ceiling in this area is at $1250 right now.

The lesson behind this: Research the local market if you plan on being either a tenant or landlord and find out how to best take advantage of economic trends dealing with rent floors and rent ceilings, and the spread between the two.

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