Why not use cash for RE rentals?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
Topic Author
countmein
Posts: 521
Joined: Fri Dec 06, 2013 9:10 pm

Why not use cash for RE rentals?

Post by countmein »

I'm looking for a sanity check on an idea that I might change my AA from 50/50 to 50/25/25 (stock/RE/bond). The reason: diversification. I'm uncomfortable with so much in cash/bonds "doing nothing" but not comfortable increasing equity. I see the RE risk as about midway between stock and bond risk.

The "RE" in question: SFH's in two college towns where I know trusted realtors. I'd use a management company to rent and never get involved with tenants. I live in one of the towns and grew up in the other, so I know them well and have confidence in their stability. Let's say expected yields are around 4-6% after expenses (I don't know this for sure yet, just starting to look).

I'm late forties, early retired, paid off house, withdrawing at 2% SWR. My FI is a mix of HY savings, CDs, short-intermediate treasuries.

So basically I'm looking at going from a cash hoard of 25 years down to 12.5. Perhaps that is reckless or perhaps I am being naive about owning these SFHs?
User avatar
Ralph Furley
Posts: 130
Joined: Fri Nov 29, 2019 10:42 am

Re: Why not use cash for RE rentals?

Post by Ralph Furley »

Is it an option to purchase one property for now?

Let the property manager run it for a year and then evaluate your investment returns and your experience. If it doesn't work out, it's a small matter to sell the property. If it works out at least as well as you hope, purchase more properties.

It's not necessary to go all in immediately.
123
Posts: 7086
Joined: Fri Oct 12, 2012 3:55 pm

Re: Why not use cash for RE rentals?

Post by 123 »

While college towns have traditionally been good for rental income opportunities I think the jury may still be out on whether any pandemic reimagining of university education will change things. Students will always want to get "away" to campus. I don't know if things get very virtual they will still need to do that for 4 or more years.
Ralph Furley wrote: Wed Apr 07, 2021 8:27 pm Is it an option to purchase one property for now?

...It's not necessary to go all in immediately.
+1 An investor often learns a lot, very quickly, when they have skin in the game.
The closest helping hand is at the end of your own arm.
RedDog
Posts: 73
Joined: Sat Dec 05, 2015 4:36 pm

Re: Why not use cash for RE rentals?

Post by RedDog »

DW and I own five rentals acquired over the last 13...the very best thing you can do is read several “buy and hold” how to real estate books.

We’ve done well but rentals aren’t for everyone. The advice to start with one house is very sound. I’d also be wary of the current high valuations.
dboeger1
Posts: 517
Joined: Fri Jan 13, 2017 7:32 pm

Re: Why not use cash for RE rentals?

Post by dboeger1 »

Generally, the reason to not use cash is to leverage up the return on your capital. You can certainly pay cash and dramatically reduce your risk in some ways (although liquidity risk becomes much more of an issue that way, but I'm assuming you have plenty of money). The problem is that you're talking about extremely low return for what is arguably way harder than a passive investment. Even if you assume that your property manager handles all the maintenance issues with flying colors (a questionable assumption), you have to take into account bad tenants, evictions, keeping up to date with changing legislation and taxation, dealing with local governments and institutions, changing neighborhood characteristics, losses due to vacancy, irregular spikes in repair costs, complicated tax filing, etc. It's not at all like sticking money in a savings account, so getting an extra 1%-2% is generally considered not enough to justify the extra work. You may as well invest in a side business or your main job, or just stick with bonds. Virtually all serious real estate investors leverage up as much as possible because residential home loans have highly favorable terms making it relatively safe compared to buying stocks on margin, for example. That's how they justify their time and effort. Returns are also highly sensitive to purchase price (same as stocks, but local SFHs tend to be a way less efficient market so there's more room too negotiate). That's why most real estate investors also spend huge amounts of time searching for really good below-market-price deals, and they often snag them pre-market or by offering flexible terms to sellers under pressure, or maybe they take on an existing rental with bad tenants that the previous landlord is struggling to evict. For all these reasons, real estate is just not directly comparable two more passive alternatives. The diversification benefit is also questionable. It will likely be less correlated to stock returns, but it's unlikely you'll be able to diversify across multiple properties in different regions, and any neighborhood can change for the worse. If this were easy money, everyone would be doing it. I would not jump into real estate as just a bond alternative because I was chasing yield.
hi_there
Posts: 671
Joined: Sat Aug 29, 2020 7:00 pm

Re: Why not use cash for RE rentals?

Post by hi_there »

Hi, OP. Is there a non-realtor resource who can mentor and guide you on real estate in the area you are considering? Perhaps personal acquaintances from when you lived there, or even online people? I'm just looking at people I know who rent real estate, including through broker services, and there are just so many moving parts that something is bound to be overlooked.
Havoner
Posts: 35
Joined: Mon Sep 14, 2020 8:44 pm

Re: Why not use cash for RE rentals?

Post by Havoner »

Hey Countmein,

The asset allocation makes sense but be careful about thinking your portfolio is going to be more diversified or safer if you are doing this and buying one or two homes becomes those homes would represent a large part of your investment portfolio if anything went really bad with them like a major foundation repair or a bad title with excessive liens on it. You need to know the yields for sure on the front end for anything that you buy I suggest checking out the bigger pockets website and using their rental property calculators to determine the rate of return you can expect. I would run about 10-20 homes in these areas you are interested in through the calculator just to see if you can find one or two that make sense and have a better return. Lots of benefits to real estate and the trick in it is to buy it at a discount or add value to it and then manage it or have someone else manage it well for a long period of time. Best of luck with this but really encourage you to study this a lot more and not to invest in something that is going to have a worse return than the market but to look for something that can reasonably give 10% or more cash on cash return or an IRR of at least 12% before purchasing it.


Website
https://www.biggerpockets.com

Book on Managing Rental Properties
https://www.amazon.com/Book-Managing-Re ... 950&sr=8-1
ActiveIndexer
Posts: 9
Joined: Thu Feb 18, 2021 9:33 am
Location: Pennsylvania

Re: Why not use cash for RE rentals?

Post by ActiveIndexer »

A few things to consider:

1. Property management is the second most important aspect, market is the first. Make sure you have a reputable property management company with systems in place and be prepared to spend around a few hours per month dealing with emails and reviewing statements. Manage the manager or you’ll bleed cash flow.

2. May want to think about financing the properties. You deduct the mortgage interest, closing costs, etc from any rental income in addition to the other tax benefits of real estate. You could leave the cash you would otherwise pay for the property in a high yield savings so it’s safe so it earns something. Leaving money on the table otherwise and if things go south or you change your mind you can always pay it off anyway.

3. Really think about the college market. Why not a market with a diverse economy and sticky jobs? Think Covid; unforeseen situations that can eliminate your rental market.

FWIW I do turnkeys in a select market and those earn mid to upper teens cash on cash, which is on top of the equity I’m building. If you truly want to be passive that may be a better way to go. Plus all of the major capital items are new. Keep in mind turnkey comes with it’s own set of pitfalls and you’ll need to thoroughly vet providers/operators.
User avatar
climber2020
Posts: 1793
Joined: Sun Mar 25, 2012 8:06 pm

Re: Why not use cash for RE rentals?

Post by climber2020 »

countmein wrote: Wed Apr 07, 2021 8:19 pm I'm late forties, early retired, paid off house, withdrawing at 2% SWR.
At that withdrawal rate, your risk of running out of money is pretty close to zero. You’re also likely to die with a much larger portfolio than you have now. Why do anything?

This could be a “snatching defeat from the jaws of victory” type of situation.
denovo
Posts: 4710
Joined: Sun Oct 13, 2013 1:04 pm

Re: Why not use cash for RE rentals?

Post by denovo »

countmein wrote: Wed Apr 07, 2021 8:19 pm I'm looking for a sanity check on an idea that I might change my AA from 50/50 to 50/25/25 (stock/RE/bond). The reason: diversification. I'm uncomfortable with so much in cash/bonds "doing nothing" but not comfortable increasing equity. I see the RE risk as about midway between stock and bond risk.

The "RE" in question: SFH's in two college towns where I know trusted realtors. I'd use a management company to rent and never get involved with tenants. I live in one of the towns and grew up in the other, so I know them well and have confidence in their stability. Let's say expected yields are around 4-6% after expenses (I don't know this for sure yet, just starting to look).

I'm late forties, early retired, paid off house, withdrawing at 2% SWR. My FI is a mix of HY savings, CDs, short-intermediate treasuries.

So basically I'm looking at going from a cash hoard of 25 years down to 12.5. Perhaps that is reckless or perhaps I am being naive about owning these SFHs?
I think you should read this thread.

If you are going to farm it away to a property manager, why not just invest in REIT's.

viewtopic.php?t=226980
"Don't trust everything you read on the Internet"- Abraham Lincoln
User avatar
Sandtrap
Posts: 13090
Joined: Sat Nov 26, 2016 6:32 pm
Location: Hawaii No Ka Oi , N. Arizona
Contact:

Re: Why not use cash for RE rentals?

Post by Sandtrap »

countmein wrote: Wed Apr 07, 2021 8:19 pm I'm looking for a sanity check on an idea that I might change my AA from 50/50 to 50/25/25 (stock/RE/bond). The reason: diversification. I'm uncomfortable with so much in cash/bonds "doing nothing" but not comfortable increasing equity. I see the RE risk as about midway between stock and bond risk.

The "RE" in question: SFH's in two college towns where I know trusted realtors. I'd use a management company to rent and never get involved with tenants. I live in one of the towns and grew up in the other, so I know them well and have confidence in their stability. Let's say expected yields are around 4-6% after expenses (I don't know this for sure yet, just starting to look).

I'm late forties, early retired, paid off house, withdrawing at 2% SWR. My FI is a mix of HY savings, CDs, short-intermediate treasuries.

So basically I'm looking at going from a cash hoard of 25 years down to 12.5. Perhaps that is reckless or perhaps I am being naive about owning these SFHs?
REAL ESTATE PURCHASING GUIDELINES (as a "business") (one view of many)
If you look at it as a R/E investor might, then you might consider the following:'

1. Can I buy this house at "X" price and not lose money if I sold it next month, even with the 6% R/E sales commission. (purchase wisely)
2. Can I rent out this house after I buy it and over the next 3 years have my mortgage paid (if not a cash sale) and generate at least a 6-8% Net CAP?
3. Will the potential annual appreciative value of this home be extremely positive based on the curb value of properties around it, the general area, and history of the region, as well as local economic conditions and indicators?
4. Is the properties intrinsic value such that I would want to live there myself and enjoy being there?
5. Is my present financial position so strong that I have the "staying power" to ride out a R/E dip and still come out ahead on this property?
6. Is my present financial position so strong that if a tenant does not pay rent for 6 months (zero rental income), I will survive?
7. Eventually, there may be a tenant lawsuit for various reasons. What would you do? Can you afford it?
8. Etc.

*Cap rate: Net operating income divided by sales price. Example: net operating income is 100,000. Sales price is 1,000,000. Cap rate is 10 percent. Cap rate is very important in investment property analysis.

*Suggest searching the forum archives for R/E and R/E Residential Income Property, Landlord, Tenant, etc, for posts/threads by experienced R/E landlords, such as "Denovo", "Sandtrap", etc. who have long experience with multi-unit and large R/E holdings as a business to get an overview.

Questions:
Do you want to expand your R/E Residential Income property holdings over time?
Can you purchase a property within a reasonable distance from you and "self manage" the property?
Do you have enough to purchase a 3Plex or 4Plex? (SFH is sometimes/usually the least efficient R/E rental model)
How much do you plan to "leverage" right now? (IE: if more than your cash reserves now?)
Would you be willing to mortgage the rental unit, cash for down payment, ample cash working capital set aside?
Do you have a "business plan"?

(dislaimer): There are lot's of ways of approaching the above information based on personal experience and opinion. This is one.
j :D
Wiki Bogleheads Wiki: Everything You Need to Know
Aged Maduro
Posts: 216
Joined: Thu Dec 17, 2020 7:17 pm

Re: Why not use cash for RE rentals?

Post by Aged Maduro »

countmein wrote: Wed Apr 07, 2021 8:19 pm I'm looking for a sanity check on an idea that I might change my AA from 50/50 to 50/25/25 (stock/RE/bond). The reason: diversification. I'm uncomfortable with so much in cash/bonds "doing nothing" but not comfortable increasing equity. I see the RE risk as about midway between stock and bond risk.

The "RE" in question: SFH's in two college towns where I know trusted realtors. I'd use a management company to rent and never get involved with tenants. I live in one of the towns and grew up in the other, so I know them well and have confidence in their stability. Let's say expected yields are around 4-6% after expenses (I don't know this for sure yet, just starting to look).

I'm late forties, early retired, paid off house, withdrawing at 2% SWR. My FI is a mix of HY savings, CDs, short-intermediate treasuries.

So basically I'm looking at going from a cash hoard of 25 years down to 12.5. Perhaps that is reckless or perhaps I am being naive about owning these SFHs?
As a single family home investor myself, i have a few insights:

Since you are early retired and living off of investments it is not a good idea to take on much debt, even if it is "good" debt. If you want to finance these, i would use a 30 year fixed rate mortgage with at least 40% down so you get healthy cashflow right from the start. If you want to use a property manager you will have to to make the numbers work. You will not be able to afford paying a property manager if you only put 10 or 20 percent down.

Also, consider just paying cash. It's the only way you find a good deal in this market. Don't believe it when people say you can't get a good return when you pay cash. When you take into account the appreciation, rental income, tax write offs and depreciation you can still get a return of at least 6 percent if you don't overpay for the property. That's not bad. It's certainly a lot better than bonds.

I am a similar age to you and have used paid off rental real estate to essentially replace bonds and balance out my equity holdings. I am at 70% stocks, 20% paid off rental real estate and 10% bonds. I plan on keeping this allocation forever. Paid off rental real estate is great for long term, low risk financial independence. I would rather have a handful of paid off investment properties than a large portfolio of leveraged ones. Once you have enough wealth to live a good life, and it appears that you do, there is no reason to lever up and add uncessary risk.
Valuethinker
Posts: 42360
Joined: Fri May 11, 2007 11:07 am

Re: Why not use cash for RE rentals?

Post by Valuethinker »

dboeger1 wrote: Wed Apr 07, 2021 8:44 pm Generally, the reason to not use cash is to leverage up the return on your capital. You can certainly pay cash and dramatically reduce your risk in some ways (although liquidity risk becomes much more of an issue that way, but I'm assuming you have plenty of money). The problem is that you're talking about extremely low return for what is arguably way harder than a passive investment. Even if you assume that your property manager handles all the maintenance issues with flying colors (a questionable assumption), you have to take into account bad tenants, evictions, keeping up to date with changing legislation and taxation, dealing with local governments and institutions, changing neighborhood characteristics, losses due to vacancy, irregular spikes in repair costs, complicated tax filing, etc. It's not at all like sticking money in a savings account, so getting an extra 1%-2% is generally considered not enough to justify the extra work. You may as well invest in a side business or your main job, or just stick with bonds. Virtually all serious real estate investors leverage up as much as possible because residential home loans have highly favorable terms making it relatively safe compared to buying stocks on margin, for example. That's how they justify their time and effort. Returns are also highly sensitive to purchase price (same as stocks, but local SFHs tend to be a way less efficient market so there's more room too negotiate). That's why most real estate investors also spend huge amounts of time searching for really good below-market-price deals, and they often snag them pre-market or by offering flexible terms to sellers under pressure, or maybe they take on an existing rental with bad tenants that the previous landlord is struggling to evict. For all these reasons, real estate is just not directly comparable two more passive alternatives. The diversification benefit is also questionable. It will likely be less correlated to stock returns, but it's unlikely you'll be able to diversify across multiple properties in different regions, and any neighborhood can change for the worse. If this were easy money, everyone would be doing it. I would not jump into real estate as just a bond alternative because I was chasing yield.
This is a fantastic post which deserves to be read very carefully.
Valuethinker
Posts: 42360
Joined: Fri May 11, 2007 11:07 am

Re: Why not use cash for RE rentals?

Post by Valuethinker »

Aged Maduro wrote: Thu Apr 08, 2021 8:32 am
countmein wrote: Wed Apr 07, 2021 8:19 pm I'm looking for a sanity check on an idea that I might change my AA from 50/50 to 50/25/25 (stock/RE/bond). The reason: diversification. I'm uncomfortable with so much in cash/bonds "doing nothing" but not comfortable increasing equity. I see the RE risk as about midway between stock and bond risk.

The "RE" in question: SFH's in two college towns where I know trusted realtors. I'd use a management company to rent and never get involved with tenants. I live in one of the towns and grew up in the other, so I know them well and have confidence in their stability. Let's say expected yields are around 4-6% after expenses (I don't know this for sure yet, just starting to look).

I'm late forties, early retired, paid off house, withdrawing at 2% SWR. My FI is a mix of HY savings, CDs, short-intermediate treasuries.

So basically I'm looking at going from a cash hoard of 25 years down to 12.5. Perhaps that is reckless or perhaps I am being naive about owning these SFHs?
As a single family home investor myself, i have a few insights:

Since you are early retired and living off of investments it is not a good idea to take on much debt, even if it is "good" debt. If you want to finance these, i would use a 30 year fixed rate mortgage with at least 40% down so you get healthy cashflow right from the start. If you want to use a property manager you will have to to make the numbers work. You will not be able to afford paying a property manager if you only put 10 or 20 percent down.

Also, consider just paying cash. It's the only way you find a good deal in this market. Don't believe it when people say you can't get a good return when you pay cash. When you take into account the appreciation, rental income, tax write offs and depreciation you can still get a return of at least 6 percent if you don't overpay for the property. That's not bad. It's certainly a lot better than bonds.
Every personal real estate investor I know has emphasised this point with the line "you make your money buying, not selling".
I am a similar age to you and have used paid off rental real estate to essentially replace bonds and balance out my equity holdings. I am at 70% stocks, 20% paid off rental real estate and 10% bonds. I plan on keeping this allocation forever. Paid off rental real estate is great for long term, low risk financial independence. I would rather have a handful of paid off investment properties than a large portfolio of leveraged ones. Once you have enough wealth to live a good life, and it appears that you do, there is no reason to lever up and add uncessary risk.
The big thing is that rents tend to rise with inflation, whereas bonds do not, other than TIPS and ibonds. On the other hand, personally owned rentals are not at all diversified.

I think the advice to be conservative with debt is a good one, especially for a non-working investor.

The house has to be cashflow positive from the get go. No reliance on appreciation in value. If that happens, well it is kismet (good fortune).

This, at least, from everyone I know who has made money in personal property ownership (with the caveat that I live in a market, England, where prices have gone up about 5x since 1994, and where mortgages then were at nearly 8%, and there are now mortgages available at 1.99%).
Valuethinker
Posts: 42360
Joined: Fri May 11, 2007 11:07 am

Re: Why not use cash for RE rentals?

Post by Valuethinker »

Sandtrap wrote: Thu Apr 08, 2021 8:00 am
countmein wrote: Wed Apr 07, 2021 8:19 pm I'm looking for a sanity check on an idea that I might change my AA from 50/50 to 50/25/25 (stock/RE/bond). The reason: diversification. I'm uncomfortable with so much in cash/bonds "doing nothing" but not comfortable increasing equity. I see the RE risk as about midway between stock and bond risk.

The "RE" in question: SFH's in two college towns where I know trusted realtors. I'd use a management company to rent and never get involved with tenants. I live in one of the towns and grew up in the other, so I know them well and have confidence in their stability. Let's say expected yields are around 4-6% after expenses (I don't know this for sure yet, just starting to look).

I'm late forties, early retired, paid off house, withdrawing at 2% SWR. My FI is a mix of HY savings, CDs, short-intermediate treasuries.

So basically I'm looking at going from a cash hoard of 25 years down to 12.5. Perhaps that is reckless or perhaps I am being naive about owning these SFHs?
REAL ESTATE PURCHASING GUIDELINES (as a "business") (one view of many)
If you look at it as a R/E investor might, then you might consider the following:'

1. Can I buy this house at "X" price and not lose money if I sold it next month, even with the 6% R/E sales commission. (purchase wisely)
2. Can I rent out this house after I buy it and over the next 3 years have my mortgage paid (if not a cash sale) and generate at least a 6-8% Net CAP?
3. Will the potential annual appreciative value of this home be extremely positive based on the curb value of properties around it, the general area, and history of the region, as well as local economic conditions and indicators?
4. Is the properties intrinsic value such that I would want to live there myself and enjoy being there?
This might be the one point that I question? Best rental yields are on small homes & multiple unit investments, which would not suit my lifestyle. Your point below (4 plexes) alludes to that?

A big mistake in the UK market is that individual investors buy 2 BR flats (apartments). Which is what we all want to live in - typical first time buyer property. But 1 BR are much easier to rent out & have higher yields, generally.
5. Is my present financial position so strong that I have the "staying power" to ride out a R/E dip and still come out ahead on this property?
Having lived through at least 2 x -40% down markets (Canada and UK) this is important.
6. Is my present financial position so strong that if a tenant does not pay rent for 6 months (zero rental income), I will survive?
One investor I read said his worst mistake was renting to 3 Canadian private school boys - who were well dressed and well mannered. They had parties every night, all the neighbours complained, and they trashed the place.
7. Eventually, there may be a tenant lawsuit for various reasons. What would you do? Can you afford it?
8. Etc.

*Cap rate: Net operating income divided by sales price. Example: net operating income is 100,000. Sales price is 1,000,000. Cap rate is 10 percent. Cap rate is very important in investment property analysis.

*Suggest searching the forum archives for R/E and R/E Residential Income Property, Landlord, Tenant, etc, for posts/threads by experienced R/E landlords, such as "Denovo", "Sandtrap", etc. who have long experience with multi-unit and large R/E holdings as a business to get an overview.

Questions:
Do you want to expand your R/E Residential Income property holdings over time?
Can you purchase a property within a reasonable distance from you and "self manage" the property?
Do you have enough to purchase a 3Plex or 4Plex? (SFH is sometimes/usually the least efficient R/E rental model)
How much do you plan to "leverage" right now? (IE: if more than your cash reserves now?)
Would you be willing to mortgage the rental unit, cash for down payment, ample cash working capital set aside?
Do you have a "business plan"?

(dislaimer): There are lot's of ways of approaching the above information based on personal experience and opinion. This is one.
j :D
Cap Rate is really the most important term I learned in reading up about this area of investing.
User avatar
hand
Posts: 1601
Joined: Sun May 17, 2009 8:42 pm

Re: Why not use cash for RE rentals?

Post by hand »

countmein wrote: Wed Apr 07, 2021 8:19 pm I'm looking for a sanity check on an idea that I might change my AA from 50/50 to 50/25/25 (stock/RE/bond). The reason: diversification. I'm uncomfortable with so much in cash/bonds "doing nothing" but not comfortable increasing equity. I see the RE risk as about midway between stock and bond risk.

The "RE" in question: SFH's in two college towns where I know trusted realtors.
Ugh; Making non-diversified bets with 25% of your portfolio for what I presume are low single percent returns at best and an operating loss with some hope of home price appreciation from a frothy real estate market at worst. On a positive note, you're entrusting 25% of your portfolio to college students with an absentee landlord - I'm sure they'll take the best of care with it!

As a side note, the "trusted" realtors make money when you buy no matter the long term returns - their financial interests aren't aligned with yours.

There may be a case for real estate as a diversifier if you can do it at scale or in a REIT - this is effectively a very large single "stock" bet.
BogleFan510
Posts: 433
Joined: Tue Aug 04, 2020 2:13 pm

Re: Why not use cash for RE rentals?

Post by BogleFan510 »

Excellent investment, but also a job. We are selling our rental property to simplify our lives. Less return for our 'safe' investments is the price we pay. I see it like index funds have returned less than a well run private business for our family as well, but a family business is not a passive investment. Even for the most efficient passive investments, returns will be less since management will take their cut in terms of salary, dilution via options, selfish managagement decisions, etc.
illumination
Posts: 1343
Joined: Tue Apr 02, 2019 6:13 pm

Re: Why not use cash for RE rentals?

Post by illumination »

You can own real estate in the form of REITs without actually taking title to a rental property. Something like VNQ.

Most people I know that own like one rental...hate it. I had a residential rental and it was a pain. It was a profitable venture, but had I dumped that same money into a total market fund, it would have been close to the same with a whole lot less hassle, I just happen to get in right after the 2008 collapse. The people that like rentals usually own several. It's not passive income like owning index funds is passive , despite what they may try and tell you. I also think people do crazy math that tends to over exaggerate returns, like what they earn in rental income on a property they've owned for 20 years. That's like me saying when VTI goes up 10% for the year, that's really like 30% return on my money, because I originally bought the fund 20 years ago at a much lower price. So my original equity purchase pays me 30% a year and keeps compounding.

I also think picking rental properties is closer to picking stocks. People will want a rental close by, so that means your investment is very dependent on if your area appreciates. Sometimes that works well, sometimes that doesn't. I've absolutely known "smart" people that lost money on rentals that weren't reckless.

I'm not against rentals, I think you can absolutely do well with them and use leverage to your advantage, but I do think most people would be better off not dabbling in them.
MotoTrojan
Posts: 11017
Joined: Wed Feb 01, 2017 8:39 pm

Re: Why not use cash for RE rentals?

Post by MotoTrojan »

Seems like a reasonable strategy but you would be lying to yourself if you thought the risk was equal to the original 50/50 baseline. Personally I would just increase my equity allocation and stick with equity/bonds.
Aged Maduro
Posts: 216
Joined: Thu Dec 17, 2020 7:17 pm

Re: Why not use cash for RE rentals?

Post by Aged Maduro »

I can understand why many people do not want to deal with the potential hassles associated with the direct ownership of investment real estate. However, one must understand that owning shares of a REIT are not comparable to it. Owning and managing your own rental properties is owning and managing a business and within that business you get appreciation, principal paydown, rental income, tax deductions and depreciation. That is powerful stuff over time. If you own shares of a REIT then you own stock and all you get is the rental income in the form of a dividend.

I am not saying REITS are bad, i own some myself. It's just that they do not have all the same profit centers of direct business ownership of a real estate investment company. Just as ownership of shares of any business does not have the same profit potential as directly owning the corporation yourself. The nice thing about rental property is that it is a straightforward and easy to understand small business that just about anyone can take advantage of if they are willing to do some upfront work.
Topic Author
countmein
Posts: 521
Joined: Fri Dec 06, 2013 9:10 pm

Re: Why not use cash for RE rentals?

Post by countmein »

I'm grateful for so many quality replies. Responses below:
Ralph Furley wrote: Wed Apr 07, 2021 8:27 pm Is it an option to purchase one property for now?

Let the property manager run it for a year and then evaluate your investment returns and your experience. If it doesn't work out, it's a small matter to sell the property. If it works out at least as well as you hope, purchase more properties.

It's not necessary to go all in immediately.
That’s reasonable advice, thank you

RedDog wrote: Wed Apr 07, 2021 8:41 pm DW and I own five rentals acquired over the last 13...the very best thing you can do is read several “buy and hold” how to real estate books.
Thanks. Any particular books?

dboeger1 wrote: Wed Apr 07, 2021 8:44 pm …Even if you assume that your property manager handles all the maintenance issues with flying colors (a questionable assumption), you have to take into account bad tenants, evictions, keeping up to date with changing legislation and taxation, dealing with local governments and institutions, changing neighborhood characteristics, losses due to vacancy, irregular spikes in repair costs, complicated tax filing, etc.
Thanks for bringing up these issues.

- bad tenants: Isn’t this management’s job?

- evictions: Is this ever something management handles or am I potentially going to find myself involved in stressful litigation? FWIW both locations are generally landlord friendly, it’s not San Francisco.

- up to date w legislation/taxation: I would think a quick call to either realtor (who are also friends) would suffice here.

- changing neighborhood: Hopefully somewhat mitigated on the front end but yes that is a risk. FWIW both locations are considered stable, highly rentable, and “desirable” (one is year after year ranked as the most desirable place to live in the US). I’m hoping this mitigates risk in exchange for supercharged returns in less desirable areas.

- vacancy, lumpy repair costs: Will be built in to final returns expectation.

- tax filing: already pay my CPA handsomely to file a complex return in multiple states so I’m assuming that this won’t add too much relative complication.

hi_there wrote: Wed Apr 07, 2021 8:55 pm Hi, OP. Is there a non-realtor resource who can mentor and guide you on real estate in the area you are considering? Perhaps personal acquaintances from when you lived there, or even online people? I'm just looking at people I know who rent real estate, including through broker services, and there are just so many moving parts that something is bound to be overlooked.
In the area I currently live in, yes there are friends I can consult. In the area I grew up in, the realtor has been a friend for life (thus high degree of trust) + a few others. So I think the overall answer is yes.

Havoner wrote: Wed Apr 07, 2021 9:01 pm ...Best of luck with this but really encourage you to study this a lot more and not to invest in something that is going to have a worse return than the market but to look for something that can reasonably give 10% or more cash on cash return or an IRR of at least 12% before purchasing it.
Thanks but I don’t see any way I’m going to get 10%+. Perhaps I can find something close to that in town A (where I grew up) which is smaller and less economically diversified (university dominated). Town B (where I currently live) is economically diversified, HCOL, has lots of cache/Cali transplants, protective local gov. I think residential RE here lost a total of 1% in the GFC. I’ll be lucky to get 5% yield here. The idea is that it’s “wide moat” in exchange for probably unimpressive yields (but impressive compared to cash). (This is an area where people buy any property they can get with cash, and renting is an afterthought because it's almost unthinkable that prices could ever seriously drop.)

ActiveIndexer wrote: Wed Apr 07, 2021 9:14 pm A few things to consider:

1. Property management is the second most important aspect, market is the first. Make sure you have a reputable property management company with systems in place and be prepared to spend around a few hours per month dealing with emails and reviewing statements. Manage the manager or you’ll bleed cash flow.

2. May want to think about financing the properties. You deduct the mortgage interest, closing costs, etc from any rental income in addition to the other tax benefits of real estate. You could leave the cash you would otherwise pay for the property in a high yield savings so it’s safe so it earns something. Leaving money on the table otherwise and if things go south or you change your mind you can always pay it off anyway.

3. Really think about the college market. Why not a market with a diverse economy and sticky jobs? Think Covid; unforeseen situations that can eliminate your rental market.

FWIW I do turnkeys in a select market and those earn mid to upper teens cash on cash, which is on top of the equity I’m building. If you truly want to be passive that may be a better way to go. Plus all of the major capital items are new. Keep in mind turnkey comes with it’s own set of pitfalls and you’ll need to thoroughly vet providers/operators.
1. Putting trust in realtors to refer to good management. Is that naive?

2. Mortgage rates are tempting but I can’t get past the idea of holding a mortgage and a lot of cash/bonds at the same time. Seems unwise to operate like a reverse bank.

3. Good advice, thank you.


climber2020 wrote: Wed Apr 07, 2021 9:37 pm
At that withdrawal rate, your risk of running out of money is pretty close to zero. You’re also likely to die with a much larger portfolio than you have now. Why do anything?

This could be a “snatching defeat from the jaws of victory” type of situation.
Excellent point. I’m just finding difficult to sit on $2M in cash (a few treasuries but mostly cash/CDs). Am I really going to park that much dough for 40-50 years? It’s uncomfortable, and potentially dangerous re inflation (although I am mitigating with short ave duration)?

Also, let me ask: would you call it “snatching defeat from the jaws of victory” if I were proposing moving to a 75/25 stock/bond allocation?

Sandtrap wrote: Thu Apr 08, 2021 8:00 am REAL ESTATE PURCHASING GUIDELINES (as a "business") (one view of many)
If you look at it as a R/E investor might, then you might consider the following:'

1. Can I buy this house at "X" price and not lose money if I sold it next month, even with the 6% R/E sales commission. (purchase wisely)
2. Can I rent out this house after I buy it and over the next 3 years have my mortgage paid (if not a cash sale) and generate at least a 6-8% Net CAP?
3. Will the potential annual appreciative value of this home be extremely positive based on the curb value of properties around it, the general area, and history of the region, as well as local economic conditions and indicators?
4. Is the properties intrinsic value such that I would want to live there myself and enjoy being there?
5. Is my present financial position so strong that I have the "staying power" to ride out a R/E dip and still come out ahead on this property?
6. Is my present financial position so strong that if a tenant does not pay rent for 6 months (zero rental income), I will survive?
7. Eventually, there may be a tenant lawsuit for various reasons. What would you do? Can you afford it?
8. Etc.

*Cap rate: Net operating income divided by sales price. Example: net operating income is 100,000. Sales price is 1,000,000. Cap rate is 10 percent. Cap rate is very important in investment property analysis.

*Suggest searching the forum archives for R/E and R/E Residential Income Property, Landlord, Tenant, etc, for posts/threads by experienced R/E landlords, such as "Denovo", "Sandtrap", etc. who have long experience with multi-unit and large R/E holdings as a business to get an overview.

Questions:
8. Do you want to expand your R/E Residential Income property holdings over time?
9. Can you purchase a property within a reasonable distance from you and "self manage" the property?
10. Do you have enough to purchase a 3Plex or 4Plex? (SFH is sometimes/usually the least efficient R/E rental model)
11. How much do you plan to "leverage" right now? (IE: if more than your cash reserves now?)
Would you be willing to mortgage the rental unit, cash for down payment, ample cash working capital set aside?
12. Do you have a "business plan"?

(dislaimer): There are lot's of ways of approaching the above information based on personal experience and opinion. This is one.
j :D
Thanks for the input.

1. I assume I’ll be paying FMV although perhaps as a cash buyer I will get some discount.

2. I don’t know, I won’t be using a mortgage. I’m thinking in terms of gross rental yield minus costs.

3. No guarantees but yes: both towns have seen appreciation, growth, and stability for decades.

4. good one, yes

5/6/7. yes if 12.5 years of cash is good enough.

8. not necessarily but maybe

9. maybe but I don’t mind the idea of 8-10% management fee.

10. yes, nice idea, thx

11. zero

12. no

Aged Maduro wrote: Thu Apr 08, 2021 8:32 am As a single family home investor myself, i have a few insights:

Since you are early retired and living off of investments it is not a good idea to take on much debt, even if it is "good" debt. If you want to finance these, i would use a 30 year fixed rate mortgage with at least 40% down so you get healthy cashflow right from the start. If you want to use a property manager you will have to to make the numbers work. You will not be able to afford paying a property manager if you only put 10 or 20 percent down.

Also, consider just paying cash. It's the only way you find a good deal in this market. Don't believe it when people say you can't get a good return when you pay cash. When you take into account the appreciation, rental income, tax write offs and depreciation you can still get a return of at least 6 percent if you don't overpay for the property. That's not bad. It's certainly a lot better than bonds.

I am a similar age to you and have used paid off rental real estate to essentially replace bonds and balance out my equity holdings. I am at 70% stocks, 20% paid off rental real estate and 10% bonds. I plan on keeping this allocation forever. Paid off rental real estate is great for long term, low risk financial independence. I would rather have a handful of paid off investment properties than a large portfolio of leveraged ones. Once you have enough wealth to live a good life, and it appears that you do, there is no reason to lever up and add uncessary risk.
Thank you for your firsthand input. Yes, cash is the plan. I’m not trying to get rich, just diversify/ add some theoretical inflation protection. If I was in accumulation phase then I would treat it more like a business, try to maximize return with debt.

Valuethinker wrote: Thu Apr 08, 2021 9:10 am
The big thing is that rents tend to rise with inflation, whereas bonds do not, other than TIPS and ibonds. On the other hand, personally owned rentals are not at all diversified.

I think the advice to be conservative with debt is a good one, especially for a non-working investor.

The house has to be cashflow positive from the get go. No reliance on appreciation in value. If that happens, well it is kismet (good fortune).
Yes, the aim is no debt, perhaps score a minor discount with cash offer, expect ~ 4-6% net yield, assume no appreciation even though both areas have appreciated steadily for decades and sailed through the GFC.

Don’t necessarily agree that a couple of direct RE units are “not at all diversified” vs that money staying in cash in the context of a portfolio that already has cash and stocks. I think they do act as a diversifier, exposing to novel risk/return while increasing total portfolio risk (I would consider cutting back equity a little in response).

hand wrote: Thu Apr 08, 2021 10:58 am Ugh; Making non-diversified bets with 25% of your portfolio for what I presume are low single percent returns at best and an operating loss with some hope of home price appreciation from a frothy real estate market at worst.

As a side note, the "trusted" realtors make money when you buy no matter the long term returns - their financial interests aren't aligned with yours.

There may be a case for real estate as a diversifier if you can do it at scale or in a REIT - this is effectively a very large single "stock" bet.
1. operating loss? can you explain?

2. one realtor is a lifelong friend, the other I have worked with before. It’s true they will always be pro-buy but even as a skeptical person I think it’s reasonable to trust them to provide good advice.

3. REITs are stocks, yield only ~3.5%.

Aged Maduro wrote: Thu Apr 08, 2021 12:56 pm I can understand why many people do not want to deal with the potential hassles associated with the direct ownership of investment real estate. However, one must understand that owning shares of a REIT are not comparable to it. Owning and managing your own rental properties is owning and managing a business and within that business you get appreciation, principal paydown, rental income, tax deductions and depreciation. That is powerful stuff over time. If you own shares of a REIT then you own stock and all you get is the rental income in the form of a dividend.

I am not saying REITS are bad, i own some myself. It's just that they do not have all the same profit centers of direct business ownership of a real estate investment company. Just as ownership of shares of any business does not have the same profit potential as directly owning the corporation yourself. The nice thing about rental property is that it is a straightforward and easy to understand small business that just about anyone can take advantage of if they are willing to do some upfront work.
I should emphasize that I’m expecting to not do much work at all and I plan to drill my realtors on this point. The management company is key. Heck, I would like to even try buying one sight unseen and see how long I can go without ever having to look at it. In exchange, I’m willing to accept lower returns.

In fact, maybe I should try a pure turnkey on a smallish place, low initial investment, money I can afford to lose, aim to minimize hassle almost at any cost, and see what happens?
dboeger1
Posts: 517
Joined: Fri Jan 13, 2017 7:32 pm

Re: Why not use cash for RE rentals?

Post by dboeger1 »

countmein wrote: Thu Apr 08, 2021 2:34 pm - bad tenants: Isn’t this management’s job?
It may be their "job", but it doesn't mean it doesn't affect your investment. They may trash your place or cause neighbors to vacate making it more difficult to fill vacancies. Your original post suggested real estate as a bond alternative. Bonds don't sell illegal substances out of the garage.
countmein wrote: Thu Apr 08, 2021 2:34 pm - evictions: Is this ever something management handles or am I potentially going to find myself involved in stressful litigation? FWIW both locations are generally landlord friendly, it’s not San Francisco.
Again, whether or not it's your "job" is irrelevant. Bonds don't make you go to the courthouse or call a sheriff to enter your property with guns drawn. I'm not saying that you shouldn't invest in real estate, just that it's really not a bond alternative.
countmein wrote: Thu Apr 08, 2021 2:34 pm - up to date w legislation/taxation: I would think a quick call to either realtor (who are also friends) would suffice here.
A realtor isn't going to file mortgage forbearance for you when it suddenly becomes an option during an unscheduled pandemic. A realtor isn't going to monitor things like market trends or rent control legislation in your area and help you set rents accordingly. A realtor isn't going to give you a monthly report on market trends and help you stay ahead of things like gentrification and opportunities to renovate and drive rents upwards. A realtor is not going to alert you every time there's an applicable government incentive for things like solar panels or efficient appliances. Even if they know those things, they're not going to babysit your investments for you unless you pay them, either directly or through repeat business. At the end of the day, you're in the driver's seat, so it's your responsibility. Hiring a property manager is supposed to take care of all of that, but there's no guarantee. It's the same with how a CEO is supposed to run a corporation. They don't always do a great job. That's why there are boards representing investors to keep an eye on CEOs, and there are institutions keeping an eye on boards, and then individuals keeping an eye on the institutions. You can certainly offload work, but can you really fundamentally offload responsibility itself?
countmein wrote: Thu Apr 08, 2021 2:34 pm - vacancy, lumpy repair costs: Will be built in to final returns expectation.
That's good, but again, that's something you just don't worry about with bonds.
countmein wrote: Thu Apr 08, 2021 2:34 pm - tax filing: already pay my CPA handsomely to file a complex return in multiple states so I’m assuming that this won’t add too much relative complication.
You got me there!

Just to reiterate, I don't think real estate is terrible or that you shouldn't invest in it. Quite the contrary, I only own my primary residence at this time but am considering rental real estate in the future for myself. I just would never think of it in terms of a bond alternative, any more than I would consider starting my own business an alternative to stocks. They're alternatives only in the broadest sense that real estate is kind of fixed-income-adjacent while a non-debt-based business that produces goods/services is more like a typical corporation. Beyond that though, the level of involvement is completely different. In the case of real estate investing, not using leverage caps you at really paltry returns for that involvement, and the things you would do to reduce that involvement need to be priced in VERY carefully to avoid being at or below bond yields, which is what you're replacing.

I guess another way I would express my skepticism is to point out that yes, real estate may technically diversify your portfolio away from stock market beta as a source of higher returns, but does it really make as much sense to diversify away from US Treasuries as a source of safe returns? They're almost by definition as safe as you can get. That's why those yields are often referred to as the "risk-free rate". If you're worried about the stability of the US government and society, you may want to invest in dried food instead. Bond yields should be your safe floor for investment returns. There's not really that much of a logical notion of diversifying for more safety in fixed income. Diversification is more for your riskier, higher-return assets. It's the downside risks that cause you to want to diversify in the first place. If you want high returns and don't want to be overly exposed to stock market collapses, THAT'S when you diversify into real estate. And if that's the case, then it logically follows that you should be investing for high returns, and that means leverage. Buying in cash and accepting lower returns in order to offload the "work" is kind of like buying a stock that you somehow know is at most going to return slightly more than bonds, but it could also do much worse, and the only reason you're doing it is because you already own the rest of the stock market. I guess there might be some value there, but it sounds like you're arbitrarily limiting your upside relative to your downside risk. I would rather just own the bonds and accept that returns aren't going to be great.

The only good reason I can really think of to invest in real estate without leverage (I'm excluding flipping because I think that's more of a renovation business) is if you really wanted the lifestyle for some reason. Like for example, if you really enjoy being a landlord and want to retire early from another career, and you don't really care about the return or dealing with banks, then by all means, do it as an activity with a little bit of income. But as a true investment that you make in order to fund your retirement? I wouldn't play it like a game. I would learn from successful landlords and try to get the best returns possible for a good price. And unlike with stocks, I don't think the concept of indexing residential real estate makes much sense, because not all real estate is designed for profit generation the same way public corporations are (after all, the S&P 500 doesn't include mom-and-pop businesses that families run for fun or to fit with parenting schedules). It's a business where it makes sense to analyze specific deals carefully and look for characteristics and prices that will be conducive to making money.
Topic Author
countmein
Posts: 521
Joined: Fri Dec 06, 2013 9:10 pm

Re: Why not use cash for RE rentals?

Post by countmein »

I understand RE is riskier than bonds. I'm intending to increase portfolio risk using something that isn't more equities. If I decide to keep port risk the same, I'd perhaps reduce both equity and bonds to fund the RE.

I don't follow the logic that leverage is imperative. Why would that be true for RE but not for stocks? Suppose I find a place with a cap rate of 5%-- why do I need to add the risk of leverage? Expected 10 year US equity returns are no higher. And why pay 3% in debt service and then turn around and loan the same money to the government for 0.7% ?
manuvns
Posts: 877
Joined: Wed Jan 02, 2008 2:30 pm

Re: Why not use cash for RE rentals?

Post by manuvns »

countmein wrote: Wed Apr 07, 2021 8:19 pm I'm looking for a sanity check on an idea that I might change my AA from 50/50 to 50/25/25 (stock/RE/bond). The reason: diversification. I'm uncomfortable with so much in cash/bonds "doing nothing" but not comfortable increasing equity. I see the RE risk as about midway between stock and bond risk.

The "RE" in question: SFH's in two college towns where I know trusted realtors. I'd use a management company to rent and never get involved with tenants. I live in one of the towns and grew up in the other, so I know them well and have confidence in their stability. Let's say expected yields are around 4-6% after expenses (I don't know this for sure yet, just starting to look).

I'm late forties, early retired, paid off house, withdrawing at 2% SWR. My FI is a mix of HY savings, CDs, short-intermediate treasuries.

So basically I'm looking at going from a cash hoard of 25 years down to 12.5. Perhaps that is reckless or perhaps I am being naive about owning these SFHs?
most investment property should return 10-12% for you do that kind of work . maybe more if you fix and manage rental yourself . just need to make few handyman friends.
Topic Author
countmein
Posts: 521
Joined: Fri Dec 06, 2013 9:10 pm

Re: Why not use cash for RE rentals?

Post by countmein »

manuvns wrote: Thu Apr 08, 2021 4:59 pm most investment property should return 10-12% for you do that kind of work . maybe more if you fix and manage rental yourself . just need to make few handyman friends.
What work? The premise is that I'll outsource all the work.
RedDog
Posts: 73
Joined: Sat Dec 05, 2015 4:36 pm

Re: Why not use cash for RE rentals?

Post by RedDog »

countmein,
“Hold” by Steve Chader is good start.
RedDog
Posts: 73
Joined: Sat Dec 05, 2015 4:36 pm

Re: Why not use cash for RE rentals?

Post by RedDog »

countmein wrote: Thu Apr 08, 2021 4:38 pm I understand RE is riskier than bonds. I'm intending to increase portfolio risk using something that isn't more equities. If I decide to keep port risk the same, I'd perhaps reduce both equity and bonds to fund the RE.

I don't follow the logic that leverage is imperative. Why would that be true for RE but not for stocks? Suppose I find a place with a cap rate of 5%-- why do I need to add the risk of leverage? Expected 10 year US equity returns are no higher. And why pay 3% in debt service and then turn around and loan the same money to the government for 0.7% ?
You’re right...leverage isn’t an imperative. A paid off rental house portfolio is better for creating a less risky income stream versus a leveraged portfolio is better for increasing risk/networth.
dboeger1
Posts: 517
Joined: Fri Jan 13, 2017 7:32 pm

Re: Why not use cash for RE rentals?

Post by dboeger1 »

countmein wrote: Wed Apr 07, 2021 8:19 pm I'm looking for a sanity check on an idea that I might change my AA from 50/50 to 50/25/25 (stock/RE/bond). The reason: diversification. I'm uncomfortable with so much in cash/bonds "doing nothing" but not comfortable increasing equity. I see the RE risk as about midway between stock and bond risk.
countmein wrote: Thu Apr 08, 2021 4:38 pm I understand RE is riskier than bonds. I'm intending to increase portfolio risk using something that isn't more equities.
I think you're looking at this the wrong way, letting the tail wag the dog, so to speak. The purpose of investments is not to take on additional risk. Investments are to generate positive returns. The risk is the bad side of the coin. We want to reduce risk relative to reward. An efficient portfolio is one which optimizes both aspects in accordance with one's risk tolerance and perhaps other values. I realize you're probably aware of this, but sometimes we get caught up in certain trains of thinking, and it sounded like you were overly fixated on the risk aspect. Taking for granted that risk and reward are always proportional to each other is how assets get mispriced and investors end up overpaying for things.

If I told you I'd sell you Gamestop stock today for $250 because it might go up to $300 again tomorrow, would you buy it? After all, it's more risky, right? I doubt GME pays such great dividends or has such a dominant position in its industry. An efficient market should price assets according to their risk versus expected yield. All else being equal, if there are 2 companies with identical earnings, management, products, etc., the company in the less stable country might be priced lower, for example. If all you cared about was increasing risk, you would overpay for that company. Investors generally don't volunteer to do that. They want to be compensated for risk.
countmein wrote: Thu Apr 08, 2021 4:38 pm Expected 10 year US equity returns are no higher.
Why would you expect a completely passive, essentially risk-free asset to have higher returns? Again, these are optimized for safety, not return. It seems like an odd comparison. You should be expecting significantly more return on your real estate. Again, I realize you realize this, but then it sounds like you're also minimizing the importance of both returns and risks.
countmein wrote: Thu Apr 08, 2021 4:38 pm And why pay 3% in debt service and then turn around and loan the same money to the government for 0.7% ?
You wouldn't, and technically can't. There's no mortgage that you can take out against US Treasuries. The mortgage is limited to the house. Of course, you could buy a house with a mortgage, and as you make new money, you could put that money in lower-yielding bonds. This obviously doesn't make sense from a return perspective, and most real estate investors I know of prefer to pay off mortgages instead of buying bonds for that reason (mortgages are basically costlier negative bonds). However, they also need a certain amount of liquidity, and bonds can be a hedge against falling interest rates, so I could see holding some funds for repairs or something like that in short term bonds.
countmein wrote: Thu Apr 08, 2021 4:38 pm I don't follow the logic that leverage is imperative. Why would that be true for RE but not for stocks?
Leverage is absolutely not imperative. Nobody is saying you can't buy real estate in an all-cash transaction. It's obviously mechanically possible. But you don't do it because you want the risk of owning real estate (unless you're some kind of daredevil or just want to live the landlord lifestyle), you do it for the return, as stated earlier. The point is to determine what's a fair price given the additional risk, involvement, and expected yields. This is ultimately a personal decision. For most people, real estate is not an alternative to a large bond portfolio in retirement, but rather a way to supercharge returns on a small amount of up-front capital during the accumulation phase. In a lot of ways, it's the mortgage they want more than the real estate itself, and if they could get the same loan terms on stocks, they would. But they generally can't. Margin debt is not directly comparable to a mortgage. It's callable and unsecured, and stock prices are almost always more volatile than home prices.
countmein wrote: Thu Apr 08, 2021 4:38 pm Suppose I find a place with a cap rate of 5%-- why do I need to add the risk of leverage?
You don't. Let's say you're looking at a particular house and the same price whether you take a mortgage or not, and either way, it rents out for exactly the same, you have enough money to do all the same renovations, hire the same manager, etc. You will get exactly the same yields either way over the next 30 years, and after those 30 years, you'll be able to sell it for the exact same price. Without the mortgage, you would save on lender fees and interest, so technically, you would actually get better returns from that particular asset without the mortgage.

However, the big difference comes in when comparing opportunity costs. You tie up way more capital up front without the mortgage. Taking the mortgage would allow you to buy more high-yielding properties sooner, or buy stocks alongside the house. It sounds like you're not interested in having some huge real estate empire. You just want 1 or 2 properties to generate some cash flow. That's totally fine. The thing is, you still have to figure out whether the projected outperformance over bonds is worth your time and effort. I guess that depends on the size of your portfolio. If you're talking about generating $500k annually from rents and any job you could get from your previous career would pay at most $100k, then yeah, maybe squeezing an extra 1% out of that money is worth it to you. If we're talking having to do all those things for an extra $20k, that's not so attractive.

And remember, one of your original motivations was diversification. You're talking about investing in a tiny piece of America. Treasuries are investments in America as a whole, backed by the federal government that more or less owns the money printer. It would be a shame to take on such an active investment that ties you to a location just to outperform bonds by a measly 10 basis points, or even worse, underperform. It's ultimately up to you to find the right property at the right price that is going to generate enough extra return to be worth your time and effort. Most SFHs are usually priced according to the bulk of market participants using leverage, which makes it extremely difficult to find screaming good cash deals. Remember, bumping a bid up by $10k costs you $10k up front, but the family wanting to move in with their newborn baby for the school district and stay for 20+ years would be financing that extra $10k over that long time frame, so the impact to them is minimal. This results in prices creeping up, especially in falling-rate environments. On the flip side, they're usually anchored somewhat by rents in the area, which are in turn anchored by incomes and supply/demand. If a property is cheap enough to be lucrative as a cash purchase, then it's probably extremely cheap for a leveraged up market, so those tend to be unicorns. Either that or it doesn't take much extra return over bonds to move the needle for you. If that sounds like you, then more power to you.

Keep in mind that this is a weird time in a lot of real estate markets. There's been a huge rotation from apartment housing in major urban centers to single family homes in suburbs or lower tier cities. This will obviously vary by market, but I would think now would be a better time to search for deals on urban condos that you can rent out rather than higher-priced SFHs that have outpaced rents. Also, nobody really knows exactly how long these trends will last, so just be careful that you don't overpay for something with low yields because you thought rents would be higher or vacancies would be lower. It's very easy to trick yourself into thinking a property is better than it truly is by just playing with the numbers without verifying how realistic they are likely to be in the near future.
Topic Author
countmein
Posts: 521
Joined: Fri Dec 06, 2013 9:10 pm

Re: Why not use cash for RE rentals?

Post by countmein »

Hey, no offense, you probably mean well, but this screed is so non sequitur, tangential, and/or totally obvious that it almost reads like gaslighting.
User avatar
climber2020
Posts: 1793
Joined: Sun Mar 25, 2012 8:06 pm

Re: Why not use cash for RE rentals?

Post by climber2020 »

countmein wrote: Thu Apr 08, 2021 2:34 pm
climber2020 wrote: Wed Apr 07, 2021 9:37 pm
At that withdrawal rate, your risk of running out of money is pretty close to zero. You’re also likely to die with a much larger portfolio than you have now. Why do anything?

This could be a “snatching defeat from the jaws of victory” type of situation.
Excellent point. I’m just finding difficult to sit on $2M in cash (a few treasuries but mostly cash/CDs). Am I really going to park that much dough for 40-50 years? It’s uncomfortable, and potentially dangerous re inflation (although I am mitigating with short ave duration)?

Also, let me ask: would you call it “snatching defeat from the jaws of victory” if I were proposing moving to a 75/25 stock/bond allocation?

Well yes of course; if you're portfolio is 100% bonds/cash, then there's a much higher chance of failure. I had assumed your assets were in a more reasonable allocation that included a healthy portion of stock funds.
Post Reply