Are you investing with red money or green money?

I am ecstatic to announce that we closed on our nightmare rental property yesterday, selling it for $85,000. One down, two to go.

This feels like a miracle, and not a small one. If you recall, this property had sat on the market for 8 months as of November. Desperate to offload this negative cashflow unit, we switched to a new realtor at the beginning of December and gave our tenant notice to be out by the 1st of the year. About 10 days after hiring the new realtor, we had the golden offer in hand.

The sale recorded yesterday afternoon and we’ll get a check early next week for around $2,000, not to mention that we won’t be coming out of pocket $100/month going forward with the constant risk of repairs, increasing HOA dues, and the dreaded tenant turnover.

As we celebrated with an insanely sweet late harvest Gewurz that we had procured at the wonderful Larson Family Winery in Sonoma during our epic road trip, we pondered how we actually came out with this “investment”.

Did 10 years of mortgage payments pay off?

I originally bought the 1-bedroom unit as my primary residence 10 years ago at around $50,000 with nothing out-of-pocket. When we moved in together nearly 7 years ago, we opted to keep it as a rental.

About 6 years ago, we refinanced the unit to pay off $10,800 in debt and take out $15,600 in cash, increasing the mortgage to $78,000 and essentially financing our wedding and honeymoon at 6.8% (dumb).

If our slightly intoxicated logic holds up – the investment wasn’t as bad as we had thought.

I paid around $13,000 in interest during those years I used it as a primary residence. We then accrued around $7,000 in losses due to the unit being negative cashflow once we rented it out, for a total of approximately $20,000 out-of-pocket.

Meanwhile, I had a place to live for 44 months, which conservatively would have cost $19,800 at $450/month in rent, we took out $26,400 in cash, we wrote off the mortgage interest and rental losses to varying degrees on our taxes every year (not even going to try to calculate), and we are getting the $2,000 check from the sale.

In summary, we paid out $20,000 and received $48,200 in financial returns over 10 years. That’s a net gain of $28,200 and an annualized return rate of 9.2%.

Not too bad. It’s better than the 7.08% we could have earned by investing that same amount in the S&P 500 over the last 10 years, although I would have traded the 2% difference for the decreased stress. Additionally, we are pretty confident that we could have sold this unit for the same amount at the time that we converted it to a rental, which would have saved us $7,000 in losses plus unaccounted time, labor, and ulcers.

The real problem was that we used RED MONEY.

The concept of red money, green money sums up the enormous psychological burden that our rental properties have become.

Red money is what you need to live, pay your bills, and manage emergencies, the latter being grossly underestimated by most in my opinion.

Green money is the money you have beyond your red money boundary.

When I used red money to buy the unit as my primary residence, that made sense. I was saving a great deal by exchanging mortgage interest for rent and I was going to accrue housing expenses either way.

When we converted the unit into an investment, we started down the wrong path. We had emergency savings and plenty of income, so it felt more like pink money with a green future. However, as soon as I left my lucrative paycheck in favor of entrepreneurship, that money became blood red real quick.

At the end of the day, debt robs you of opportunity and you simply cannot predict the cost of the opportunities that are headed  your way. For us, green money won’t be green unless we can shrug at its loss rather than curl up in the corner sobbing. We should have sold the unit six years ago.

The bottom line: The line between red and green money is a lot further out than one imagines and can shrink back in unpredictably.

What about you? How would you look at some of your less-than-liquid investments should you lose your job or face an attractive, but expensive, opportunity that you would always regret passing up? Do you have enough liquid cash on hand to cover a cancer diagnosis or a major accident without panicking?

Knowing where your red money boundary lies provides a valuable financial marker for your savings goals, and once you reach that point, a tangible peace of mind that you are free to make the best decisions for you and your family.

4 Comments
  1. Fantastic concept of red & green money, Emily, and one I’d never considered before. We are on the exact same path as you were, as we are considering keeping our home when we move an converting it into a rental. It’s paid off so, in one sense, the amount of red money the house will bleed (should the poo hit the fan) will be small. But the opportunity costs could be enormous. We’ve already had huge opportunity costs in paying down the mortgage instead of more fully participating in the 2010 – 2013 rally. Who knows what other opportunities we’ll miss out on by having that money tied up in the home?

    Maybe we should rent? I say that only half in jest.

    All that said, we are totally risk averse and are more comfortable with the notion of eating opportunity costs than in riding the huge waves of the market. We invest in the market to a decent extent, just because it’d be crazy to avoid it all together. But there is something comforting in the idea of a piece of real estate. It has a use value, even if its exchange value plummets. A family (maybe our family) can always live in it, it if comes to that.

    But on the flip side, my mutual fund manager has never called me in the middle of the night to fix his toilet.

    1. I love how you own being risk averse! 99% of people in your shoes would consider themselves swimming in green money, but it really does come down to what we have on the line and how it would impact us to lose it.

      I personally am done with toilet repairs, although we curiously only had one toilet incident in our 7 years as landlords. The real rub was tenant turnover (SO much time involved in listing, showing, and vetting). With a paid off property, the situation can be much more enjoyable. Our neighbor owns multiple rentals, but his rent is always below market, attracting the best possible tenants who never want to leave the good deal or piss off the landlord.

      1. That’s a good point. I guess the upside of having a paid off home (and bearing all those opportunity costs) is that we have the ability to set rent in that sweet spot where we still get quality tenants, but it’s a good enough deal that they’re hesitant to leave.

        I forgot to say congratulations on selling the home, and fantastic returns, too. The way you did it, though stressful, will have a better ROI than what we’re doing. Beating the S&P500 over a decade is no small feat. Well done.

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