This article was posted on Wednesday, Jun 01, 2016

The last seven articles have focused in various ways on the four (4) items that a thoughtful investor should consider before writing that first deposit check. Although certainly not touching on everything a new investor might confront during his or her investment career, these items are:

When to do it:  The interest rate cycle has a lot to do with whether the investor’s chief source of lump-sum gain is equity build-up or appreciation (Part VII). 

A person in the accumulation phase of her property career would probably be better off (in the long term) by buying when interest rates are towards the top of their cycle (and values near the bottom). Then, as rates cycle down, property values could be expected to increase and eventually the owner would be able to refinance the property and harvest the down payment for her next building.

Not everybody expects to refinance or sell the buildings in their portfolio. An investor’s wish may be to retire with a steady inflation-adjusted cash flow, with the expectation of keeping the building until it becomes someone else’s problem. Or perhaps a loving grandfather gifts his first grandchild with a single building on the day of her birth. The income from that building can augment her earned income for the rest of her life. An older man with a young wife could wish to simplify his portfolio for her benefit. Or perhaps all the buildings will go into a Trust that will provide for his descendants for generations. I think the Kennedy’s did that with a large commercial block in Chicago.

Depending on a building’s purpose, a wise purchase may be made regardless of the interest rate environment. But the investor should know his or her intent.

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Analyzing the investment:  In Part III we looked at a way to determine (a) a reasonable purchase price, (b) the down payment, and (c) the cash-on-cash yield to the investor. This required only the simple calculator found in most smart phones.

The process we used balances interest rates against prices, and is kind of neat to play with.

Notice that nowhere are we emphasizing the property’s location. That’s certainly not because location is unimportant. Rather, it’s because the market has a great way of offsetting these things. For example, an inferior location may mean higher cash flows. It then becomes the investor’s decision: “I never thought I’d want to buy in that area, but goodness!  Those cash flows are something to behold!”

Probable gain: The classic four sources of gain available to income property investors are appreciation, depreciation, equity build-up, and cash flow (Part II). Not every beneficia is equally available at each moment of the investment’s life. For example, it’s quite possible to keep the property well past the point where tax depreciation runs out. Another example: once the tenants pay off the loan, equity build-up from loan amortization ceases. Even appreciation is vulnerable: we remember the period just after the Unpleasantness of 2007 when investment properties briefly (that time) lost value. That could happen again for one reason or another. So investments in income properties are certainly not without jeopardy, but the cash flow usually (but not always) remains and, historically, values tend to eventually recover. 

Possible losses: Don’t ever believe, just because you’ve never actually met anybody who has lost money in income properties, that there is no possibility of loss. In Part VI William J. Bernstein identified the genres of risk as inflation, deflation, confiscation, and devastation.

Apartment buildings may be resilient, and much risk may be insured around. But some manner of jeopardy always remains. As just one example, apartments are considered inflation hedges, meaning that their value increases with inflation. That’s a good thing. When their value increases, your equity climbs as well. But what happens if the stagflation (inflation combined with high unemployment) of the mid-1970’s returns? Your expenses increase because of inflation. Your rents stay the same (or even decline) due to unemployment. Additionally, inflation would force the underlying variable rate mortgage to reset ever-higher. So inflation may elevate your property’s market value (a good thing), but income doesn’t rise so you’ll eventually lose the property (a bad thing).

So there you are. Inflation has raised your equity until you are rich beyond the dreams of normal everyday avarice, but you can’t make the mortgage payment. So if somebody twists the ends of his mustache and whispers, “Want a risk-free investment, little girl?” run the other way, just like your mother said.

This article will begin with a short discussion of mindset and budgeting. Then we’ll follow a novice investor through the purchase of her first property. We’ll be in that little group off to the side, sipping our Starbuck’s and noting the things this young investor considered in terms of the four major investment points, what she completely missed, and how it might work out. 


Successful investors almost always share two common characteristics: the ability to (a) defer gratification and (b) manage money. Many things wanted are just not purchased. If something is truly needed, it is acquired after careful shopping and at the lowest possible price. Eventually, over time, funds are slowly accumulated for the purchase of her first investment property. The hopeful young investor-in-training who is unable to do these two things will find it very difficult to acquire or keep money.

It used to be that money was respected. The Greatest Generation came back from WWII hoping only for steady employment. The women at home waited in front of their mirrors, eager for the promised return of huge numbers of no-longer-picky soldiers. Their hope was that their future beau –whoever he might be – would at least be employable. “I know he’s not much to look at, and he talks with his mouth full, Ina Faye. But you can learn to like him – or at least to fake it. His uncle will give him a job!”

Many of the new couples bought a small tract home in Levittown to start their family. Money was tight. Nothing was wasted. Some wives washed dishes in a large bowl in the sink. When they were done, the grey water was taken outside to irrigate the vegetable garden.

Their children took those memes with them when they left home and started their own families. Life was demanding but, with the frugal habits learned by watching their parents, they got by. Then, early in President Reagan’s first term, interest rates began a long term downtrend and the economy started a multi-decade rise. Investment values (which price opposite to interest rates) climbed. By the second half of that clement period, grandmother’s frugal habits were no longer thought necessary. Rising standards of living began as a hope, jelled into an expectation, and finally evolved into an entitlement. This was the economy today’s young investors were born into. 

And that’s the problem. It’s hard to defer gratification and strictly budget when all your young life it was the world’s obligation to provide you with anything you wanted. Or, if not the world’s, it was at least Mummy’s and Daddy’s. Why? Because . . . Special Snowflake.

Personal investing is not a preferred Special Snowflake occupation – unless her parents did it for her. There’s just too much of that dreary deferred gratification.

Fortunately, however, our imaginary young investor has grown up with an appreciation for money. Some never get it. A few kids seem to have it in their blood. Most have to be taught. Emily was taught. Perhaps it was as simple as her parents, both being insurance agents, requiring a co-pay on anything their child wanted (not needed, wanted). When she was 8, the co-pay was 10%. Her parents would buy her something she wanted, but she had to pay the tax. Her parents provided chores around the house so she could accumulate the necessary funds, and she saved her birthday money. As she grew capable of earning more, the co-pay increased. When Emily was a teenager and officially working 20 hours a week at a hamburger restaurant, her co-pay was 90%. Basically, things had reversed and now her parents paid the tax. She was well along towards supporting herself. Emily’s parents smiled a lot.

Our young investor graduated from high school with a profound sense of self-responsibility, a deep respect for money, and an attractive savings account. That’s where this story starts. 


Two weeks after graduating Emily increased her hours at work to 29, which was the maximum her employer would permit, given all that healthcare stuff and everything. As she needed more than 75% of an income, she took a second job as a weekend assistant at a property management company. Her duties were to answer the phone, resolve minor issues, and log any checks that might arrive while she was on duty. 

She showed up on time, found things to do during her working hours, and did not spend too much time in the bathroom or sneak off early. Just those few things made her a valued employee. Later that year a full time position opened up. She applied and was promoted to the accounting department. Emily had always been detail oriented and bookkeeping fit her just fine. She quit the hamburger restaurant and decided to move out of her parent’s home.

Chatting about her impending relocation with a couple of other girls in the office revealed that one of them, Banana Pudding, (her mother admired North West and Blue Ivy, so she added a food group to navigation and horticulture) an attractive girl with a bubbly personality, was single and owned her own home. She rented out the bedrooms (each with its own bath). Emily was offered a recently available bedroom at $1,000 a month. Emily knew – she worked in a property management office, after all – that was about what an aging Single unit (one big room with a kitchen and bath) rented for in a safe area. This house was much nicer and there would almost always be another girl at home to talk to. Banana Pudding kept saying how much fun it would be to live together. Emily let herself be convinced.

Of course, Emily immediately realized that the four bedroom-bath suites grossed $4,000 a month to Banana Pudding. Several weeks later, a little discrete investigation and a couple of quiet late-night talks over an affordable wine, Emily learned that Banana Pudding owned two rent-a-room houses and was in escrow for a third. She tried to buy a house every two or three years, each time moving herself to the new home (“The bank wants to know what? Of course it will be owner-occupied! What do you think I am?”).

Banana Pudding got her first house in a divorce settlement, stumbled into the rent-a-room concept, and ran with the ball. She paid rent to herself, so each home generated four separate incomes every month. Banana Pudding saved the net cash flow until there was enough for a down payment on another house, when she repeated the process.

Emily had a lot to think about when she went to bed that night.

By breakfast she’d decided to do it. She knew what she wanted to get: the home would have to be an easy commute to employment centers (for current room-mates) and in a good school district (for subsequent resale). It took almost all her money, but within three months Emily closed escrow on an aging 4 bedroom, 4.50 bath home. She had a short credit history, but she could put 25% down and was willing to pay a little higher interest rate than Banana Pudding would qualify for. Due to the high down payment, Emily’s loan was the type investor’s got and did not require that she live at the property.

The heirs had listed the property with a local agent and, truthfully, it hadn’t been updated since new and was more than a little run-down. Also, it was on one of those feeder streets with both newer retail stores (there was a Starbucks on the corner) and older homes. The agent said it was the cheapest 4-bedroom in the area, and as Emily looked at it she thought it must be so.

Six weeks of PCDC (paint, carpet, drapes, clean) after work and on weekends made the rent-a-room house livable. There was no money for kitchen or bath updates so Emily emphasized the nostalgia element, marketing it as an all-original mid-century modern. She placed flyers (you know, with those little tear-off telephone tabs) on local utility poles and in the lunchrooms of local businesses. A number of people called her, but absolutely nobody signed up. Emily was learning that the assistant bookkeeper personality does not easily segue into being a successful salesperson.  Emily was not Banana Pudding.

As the days rolled by, things began looking grim. Emily’s problem had now shifted from maximizing gain to minimizing loss. Banana Pudding made a low ball verbal offer to take the house off Emily’s hands, but she wasn’t ready to lose her entire down payment quite that quickly.

Emily ran ads in Craigslist and planted a “For Lease” sign in the front yard. Three weeks later she was showing the house to a prospective tenant for the second time when the woman, Shortsy Cake, began to dish. Shortsy ran a child-care facility and had outgrown her space. Would Emily accept the house being used for commercial child- care?

Emily was obviously anxious to turn this project into a stream of income, but the assistant bookkeeper part of her was cautious. “Are you licensed? Insured? Will you add me to your insurance as an additional insured? What rent do you pay now? How long have you been in business? Will your tax returns show a meaningful profit?” The conversation adjourned to the corner Starbucks, where Shortsy presented some hurdles of her own: “The licensing people have to approve the property for up to 18 children before I can sign the lease.” “I may have to take down some of the partition walls, is that going to be a problem?” “And would you object to a fence if I paid for it?”

The meeting ended with Shortsy quickly accepted all the usual credit and background checks and, to offset the expected higher wear-and-tear, a commercial “absolute net” lease with annual inflation adjustments was agreed upon. Shortsy promised to have her accountant email the last two year’s business tax returns to Emily.

In Emily’s case, it took almost seven months from her initial decision to be an income property owner to actually getting her first check. 

Bullet Points

  • Investing is not for everyone. If Emily was not already good with money (as evidenced by the fact she had no personal debt, was gainfully employed in a position of trust, and had a meaningful savings account) it is unlikely she would have recognized Banana Pudding’s success or been able to copy-cat the principles. 
  • It didn’t turn out as Emily originally expected. Investing sometimes doesn’t. But she was flexible enough to make the necessary adjustments. 
  • Her thrifty nature during adolescence and young adulthood permitted Emily to have the money for the down payment, and because of that her life will be forever different. 
  • If she makes no further investments, when her tenant finishes paying Emily’s mortgage, she will have an inflation-adjusted income from that rented house of close to $4,000 a month (net of expenses). Just one more similar investment will raise her net to $8,000 monthly. Just for reference, the median household income in California is $86,704.  With that (potential) second property, Emily will have a passive income of $96,000 a year regardless of her age when the homes are paid off. 
  • It took several years of savings and much deferred gratification to afford the ticket, but Emily is now firmly on the train. 

This article is for informational purposes only and is not intended as professional advice. For specific circumstances, please contact an appropriately licensed professional. Klarise Yahya is a Commercial Mortgage Broker. If you are thinking of refinancing or purchasing five units or more, Klarise Yahya can probably help. Find out how much you can borrow. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email [email protected] 

If you’ve missed some of the prior articles, basic guidelines on successful investing are in my book “Stairway to Wealth” available at