How To Be A Nomad—A Case Study
Nomad is a buy-and-hold real estate strategy that—similarly to the sheep and goat herding strategy—involves temporarily occupying a place before pulling up your stakes and moving on. But that’s about all the two have in common.
The nomad strategy we recommend for most people—especially if you're starting out:
1. Buy a multifamily using an FHA loan.
2. Rent the other unit(s) to offset your mortgage payment.
4. Buy your next property (FHA if going multifamily or conventional if single-family) and, now, rent both original units to tenants.
5. Repeat as often as is possible or until it no longer makes sense for your situation.
Why this method?
Financing for an owner-occupant is often cheaper, both in the interest you’ll pay monthly as well as the amount required as a downpayment for the loan. With conventional financing, you can put down as little as 3 percent as an owner occupant, whereas a single family investment property will require a minimum of 20 percent.
This is an excellent way to slowly grow a real estate portfolio with, relatively, very little cash. The benefits to owning real estate are many, and a sizable portfolio of investments will substantially offset your taxable income through mortgage interest deductions and depreciation.
Nomad is the slow and steady way to build passive income. By keeping your properties as rentals, and assuming you buy them right, your monthly cashflow will increase with each successive property.
Buying and holding real estate using nomad gives you the opportunity to build major equity across the properties in your portfolio simply by making your mortgage payments—payments which are covered or majorly offset by rental income. Depending on your situation and risk tolerance, you can access this equity for future investments.
How it works.
Let's look at an example using a real property we've been evaluating.
Here's a duplex that came on the market recently in Northern Colorado.
Current rents: $1700/month ($850 per side)
Utilities (water & sewer): $80/month
We know from talking with the owner that it has a new roof, new furnace and water heater, and a historically low vacancy rate.
We are also confident that these units are currently rented below market value. By comparing comparable currently-rented units as well as rental inventory, rents should be in the $1100-$1200/month range ($250-350 more than current rents)—exactly the kind of hidden potential an investor looks for.
Approaching this with the Nomad strategy, you want to purchase the property for as little cash out of pocket as possible. Here's what that would look like using an FHA loan:
Using our more conservative rental estimate, you are offsetting this monthly payment of $1864 by $1100 from rental income. Now you've got an appreciating asset and a home that is costing you just $764/month (Since we're looking at owner occupying a duplex versus a single family home, the fixed costs of maintaining a home don't factor heavily for comparison's sake, though you certainly need to have extra reserves for unexpected expenses).
We're going to make the reasonable assumption that in four years you will have enough equity in the property to refinance into a conventional loan, thus freeing up an FHA loan for another multi-family property. Why do we make that assumption? By simply making your monthly mortgage payments, your balance will be at $260,242 by the end of 2020. When you factor in a conservative rate of appreciation of 4% from the starting value of $287,000, the value in four years would be $335,749. $260,242 / $335,749 = 78% LTV (Loan to Value), or 22% equity in your home. Added bonus, with a conventional loan you drop that $200/month mortgage insurance. Boom! Time to move.
It just so happens that there is an identical duplex next door to this one for sale. What are the odds? It probably won't be available in four years, but we'll use it to demonstrate the next step in Nomad. Just like home values, rental rates appreciate as well. If we use an estimate of 3%/year, that initial rent of $1100/month will have increased to $1240/month.
Here's what it would look like to buy the other duplex at the appreciated value of $335,749 as an owner occupant, and with your first duplex now as solely a rental property.
In four years time you have:
Two residential properties
Four rental units
Housing expense of just $124/month
Almost $90,000 in equity
Moving forward, you also now have a host of other strategies at your disposal:
Hold on to these properties until the loans are paid off and have passive income of about $8000/month (Simply using a 2% annual inflation rate—not rental market appreciation which is even higher—for 30 years).
Do a 1031 Exchange in the future to finance a larger multifamily property or commercial building
When it's time to move beyond the Nomad strategy, here's a story with plenty of helpful lessons.