Rental real estate post - what's the catch?

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boggler
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Rental real estate post - what's the catch?

Post by boggler » Tue Sep 03, 2013 4:21 pm

From a post on Quora: http://qr.ae/I03wb
In the past 6 months I received $430,000 (won lawsuit).
I had $5,000 before I won this lawsuit.

When I won the lawsuit and collected the money, it did not make me any happier. In fact, it had 0 change in my life.

About me: I'm 24 years old, a single founder entrepreneur, YC-funded. I've never had a job in my life, and no company has ever wanted to hire me in Silicon Valley.

This is what happened:

I invested it in real estate. I collect rent, and I make $30,000 a year, pure profit. I hire people to take care of my houses.
I convinced myself that I didn't have to work for the rest of my life. My annual expense is exactly $30,000. I'll never need to get a job again. I can focus on my startup.
Because I put myself on this mindset, I am now frugal as hell. I do not over-spend, and I try to maintain my $30,000. This money has made me much more frugal than I was before. Now, I am scared to spend every dollar because I'm afraid I'll lose my money.
I moved to a shared-house in the ghetto. I pay $500 for one room rent. It's the cheapest in the entire San Francisco area. I only eat $20 a day. That is my budget.

Summary: I don't have to worry about working ever again, in my entire life. But this has made me very frugal in order to keep this in check.

What you should do: Invest it. Don't leave it in the bank. Buy real estate and collect rent. There is no better investment out there.
This is a 7% annual return. Furthermore, it's a real asset, and thus on average should keep up with inflation. This seems too good to be true. Aside from the obvious factors like maintenance, having to find tenants, vacancies, etc.... what's the catch? Something seems fishy about this argument but I can't put my finger on it.
If you're trying to live off a perpetual portfolio, why doesn't everyone do this instead of investing in stocks that only pay out a 2-3% perpetual inflation-adjusted return?

redhounds
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Re: Rental real estate post - what's the catch?

Post by redhounds » Tue Sep 03, 2013 4:50 pm

I own/have owned different types of rental property. Single family housing, apartment units, and commercial. It's not that easy to clear enough to make 7% after paying someone else to do all of the work. Managing rentals is a part time job, at best, and, at worst, a full time pain in the rear. That said, many people do have good luck with rental real estate, but it's definitely not for everyone. I also have zero interest in renting a room in the ghetto, but that wasn't really your question.
--Red

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Watty
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Re: Rental real estate post - what's the catch?

Post by Watty » Tue Sep 03, 2013 5:01 pm

Something seems fishy about this argument but I can't put my finger on it.
It is the part about being able to get 7% a year after paying for a property management company and funding adequate reserves for maintenance, vacancies, and other problems. That would be hard to do unless it was some sort of a fantastic purchase in a distressed sale.

Furthermore, it's a real asset, and thus on average should keep up with inflation.
Not exactely, each year a house gets older and the typical houses that are being built today will be getting pretty well past their prime in 100 years if they even last that long.

There are excpetions but many of the houses built in the housing boom after WWII are already getting pretty tired. The post is about someone that is 24 years old so could still be owning the house 70 years from now so I would have to be skeptical about how desirable it will be then.

An interesting thing to do is to try to find out the address of the house where your parents or grandparents lived when they were kids and then look up that neighborhood to see how the houses have done over the years.

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Clearly_Irrational
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Re: Rental real estate post - what's the catch?

Post by Clearly_Irrational » Tue Sep 03, 2013 5:05 pm

You get paid for three things: Risk, Lack of Liquidity and Annoyance/Complexity

Rental properties have all three.

In general rental properties tend to be better than stock and bond portfolios for generating income streams due to sequence of returns risk.

His numbers sound a bit optimistic and he's glossing over some things but in general you could expect an equal investment portfolio of properties to outperform a stock & bond portfolio.

Rentals are essentially a leveraged bet on inflation and population growth.

Even with a property management company rentals are less passive than a stock & bond portfolio, however they're more passive than a small business. Returns therefore tend to be somewhere in between.

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Re: Rental real estate post - what's the catch?

Post by cflannagan » Tue Sep 03, 2013 5:13 pm

This is why I opt to invest into REITs instead of buying an actual investment property.

A LOT lesser work for us ;) Sure, we might not get as much in return for amount we invest into REITs rather than investment property, but we have no concerns/worries/liabilities (ie: problem tenant hellbent on giving us hard time or anything like that).

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Re: Rental real estate post - what's the catch?

Post by leonard » Tue Sep 03, 2013 5:25 pm

The catch?

You leave your multi-hundreds of thousand dollar asset(s) in the hands of relative strangers - unattended. They can pretty much do with it as they want when your not around. They can do plenty of damage and create huge headaches during that time.
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Re: Rental real estate post - what's the catch?

Post by n517rv » Tue Sep 03, 2013 10:34 pm

Real Estate "Investing" is ACTIVE investing. It's certainly not for everyone.

And what's with "living in a shared-house in the ghetto" and paying rent... not to mention only living on $30K per year???

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Re: Rental real estate post - what's the catch?

Post by thx1138 » Wed Sep 04, 2013 10:43 am

Clearly_Irrational wrote:You get paid for three things: Risk, Lack of Liquidity and Annoyance/Complexity

Rental properties have all three.
Exactly this.

Also, as another pointed out in many ways rentals include a fair bit of selection and timing risk as well (i.e. they are not diversified investments).

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bogleblitz
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Re: Rental real estate post - what's the catch?

Post by bogleblitz » Wed Sep 04, 2013 10:47 am

1. 7% annual return in rental is possible but so is stock market. VFINX S&P 500 index 10 year annual is exactly 7% as of today 9/3/2013.

http://quicktake.morningstar.com/syndic ... mbol=VFINX

The general rule is that rental property return with management company = stock market return.

2. It might not be 7% every year. One might need a new roof, new heating system, non paying renters which make that return negative for that year. 1 bad year can wipe that 7% annual return to become 1% annual return.

3. Why doesn't everyone do it? Not everyone has $500k cash sitting around to buy a house.
You can use 100k with 20% down payment, which means you are leveraging/borrowing. You can lose the house if house market drops and renters don't pay. Lots of foreclosures in 2008-2012. People who think foreclosures will never happen to them are the same people who think stock market won't drop 50%.

4. Even with a management company that manages your property, it is still not as passive as buying stocks. There are many bad property management companies.

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Re: Rental real estate post - what's the catch?

Post by eucalyptus » Wed Sep 04, 2013 10:56 am

Ah, real estate! It's all so easy when there are tenants and buyers.

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Re: Rental real estate post - what's the catch?

Post by InvestorNewb » Wed Sep 04, 2013 11:03 am

Real estate is tempting but it's also risky putting everything you have into it.

Living off 30k a year in the guetto? No thanks.
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Re: Rental real estate post - what's the catch?

Post by SeattleCPA » Wed Sep 04, 2013 5:50 pm

bogleblitz wrote:The general rule is that rental property return with management company = stock market return.
I don't want to be argumentative, and I'm going to agree with you, boglelblitz in a minute... but I think real estate probably returns something between what bonds do and what equities do. My source on this is David Swensen in his book Unconventional Success. I think Burton Malkiel suggests something similar in Random Walk Down Wall Street though...
bogleblitz wrote:It might not be 7% every year.
Yeah, I agree. I also think the calculations we're given here might be off.

A possibility that occurs to me (and which would sync with recent rental market realities): Yes, someone can get $35K of rental income on a property they bought for $500,000 a year or two ago... but that's not a 7% cap rate if the property is now worth $1,000,000.

Now, at this point, that $35K of rental income actually represents a 3.5% cap rate.

BTW, this person has also earned a lot more than 7% since the purchase because of the appreciation.
bogleblitz wrote:Why doesn't everyone do it?....
Bogleblitz provides lots of good reasons. But to add to his list, you're also not very well diversified. :confused

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Re: Rental real estate post - what's the catch?

Post by boggler » Wed Sep 04, 2013 5:56 pm

Here's a comment I just came across on the Wealthfront blog:
I think rental properties are great but you must be prepared to do a lot of dirty, hard work. I have several properties in my small home town that are less than half the price of a bay area home. I pay the mortgage and my parents take care of the properties and pick up rent.

Finding the right place requires months of keeping you ears to the street. You can’t be afraid to kick out residents. You WILL have to do a lot of manual work to get them in top shape. But they are solid money makers. Just 17 months ago I purchased a 9 unit complex of small apartments for ~$500,000 including upgrades and remodeling, putting $250 down. They make $6000 a month, $1500 for my parents troubles, $2000 for the 15 yr mortgage, $2000 in savings. Another $1500 of my bay area engineer salary goes the mortgage, instead of 401k’s, to own it in full as soon as possible.
That's an incredible return! I'm going to guess he mostly got lucky, though. And clearly his parents are putting in a significant amount of work if he's paying them $1500/month. But even including that, it's 10.6% return in cash. (2000 mortgage + 2000 savings)

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Clearly_Irrational
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Re: Rental real estate post - what's the catch?

Post by Clearly_Irrational » Wed Sep 04, 2013 6:00 pm

SeattleCPA wrote:
bogleblitz wrote:The general rule is that rental property return with management company = stock market return.
I don't want to be argumentative, and I'm going to agree with you, boglelblitz in a minute... but I think real estate probably returns something between what bonds do and what equities do. My source on this is David Swensen in his book Unconventional Success. I think Burton Malkiel suggests something similar in Random Walk Down Wall Street though...
I also disagree but in the other direction. Real Estate should return somewhere between equities and small business ownership on a leveraged after-tax basis. That's not free return, you're being compensated for lack of liquidity, lower diversification and increased annoyance/complexity. (A leveraged comparison is correct unless you only buy companies with no debt)

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Re: Rental real estate post - what's the catch?

Post by SeattleCPA » Wed Sep 04, 2013 6:49 pm

Clearly_Irrational wrote:I also disagree but in the other direction. Real Estate should return somewhere between equities and small business ownership on a leveraged after-tax basis. That's not free return, you're being compensated for lack of liquidity, lower diversification and increased annoyance/complexity. (A leveraged comparison is correct unless you only buy companies with no debt)
Clearly_Irrational, I must disagree that we're disagreeing. :happy

If we take a property with a 5% cap rate, apply a 2% appreciation rate, and then lever things up with a 4% mortgage, I think we'll beat the unleveraged return of equities. I was referring in my post to an unleveraged (all cash) situation.

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Clearly_Irrational
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Re: Rental real estate post - what's the catch?

Post by Clearly_Irrational » Wed Sep 04, 2013 6:54 pm

SeattleCPA wrote:Clearly_Irrational, I must disagree that we're disagreeing. :happy

If we take a property with a 5% cap rate, apply a 2% appreciation rate, and then lever things up with a 4% mortgage, I think we'll beat the unleveraged return of equities. I was referring in my post to an unleveraged (all cash) situation.
Fair enough. I'd have to say that I'd consider an unleveraged set of rentals to be significantly less risky than an unleveraged portfolio of equities.

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Re: Rental real estate post - what's the catch?

Post by bogleblitz » Wed Sep 04, 2013 7:51 pm

boggler wrote:
That's an incredible return! I'm going to guess he mostly got lucky, though. And clearly his parents are putting in a significant amount of work if he's paying them $1500/month. But even including that, it's 10.6% return in cash. (2000 mortgage + 2000 savings)
10-15% is what I'm getting for rental property as well. The more you borrow/mortgage, the higher your rate of return. The riskier it gets. My mortgage is about 4% interest rate.
You really have to be passionate about rental property. As mentioned in the Wealthfront blog, you need to be aware of what good properties are for sale in your neighborhood. I looked 6+ months, seen 50+ multi family houses, made 10+ offers this year 2013 before I was able to buy my 3 family house near Boston, MA. I often lost to people who had all cash to buy the investment property.

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Re: Rental real estate post - what's the catch?

Post by boggler » Wed Sep 04, 2013 8:05 pm

bogleblitz wrote:
boggler wrote:
That's an incredible return! I'm going to guess he mostly got lucky, though. And clearly his parents are putting in a significant amount of work if he's paying them $1500/month. But even including that, it's 10.6% return in cash. (2000 mortgage + 2000 savings)
10-15% is what I'm getting for rental property as well. The more you borrow/mortgage, the higher your rate of return. The riskier it gets. My mortgage is about 4% interest rate.
You really have to be passionate about rental property. As mentioned in the Wealthfront blog, you need to be aware of what good properties are for sale in your neighborhood. I looked 6+ months, seen 50+ multi family houses, made 10+ offers this year 2013 before I was able to buy my 3 family house near Boston, MA. I often lost to people who had all cash to buy the investment property.
For those with enough assets, how come more people aren't doing this? if you're planning to hold the property for a while, it seems like a much more stable income stream with much lower risk. And the effort doesn't seem so bad.

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Clearly_Irrational
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Re: Rental real estate post - what's the catch?

Post by Clearly_Irrational » Wed Sep 04, 2013 10:46 pm

boggler wrote:For those with enough assets, how come more people aren't doing this? if you're planning to hold the property for a while, it seems like a much more stable income stream with much lower risk. And the effort doesn't seem so bad.
Well, many of the Forbes 400 have significant real estate holdings. In 2010 the % of net worth holdings of non-home real estate for the top 1% was 35.5% and for the next 9% it was 43.6%. So I'd say it's not exactly a secret.

There is no free lunch however, you get paid more for a reason. (Reduced diversification, lack of liquidity, less passive)

For me personally when I first started reading about the self-made wealthy I kept seeing the same story over and over again "Well, I do X now but I made all my first money in Real Estate".

Don't take any of this to mean I'm knocking stocks and bonds, much of it depends on your personal situation and goals.

Personally I like the advice in the Talmud, which loosely translated says something like "Divide your assets into three portions: 1/3 Land, 1/3 Liquid Assets, 1/3 Commerce". I define rental properties as falling under land and stocks/bonds as falling under liquid assets. Not everyone will agree with that translation or my interpretation but I think the concept is pretty solid since it dovetails with the economics definition that says there is only four ways to make money: wages, rent, interest & profit.

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Re: Rental real estate post - what's the catch?

Post by Clearly_Irrational » Wed Sep 04, 2013 10:48 pm

bogleblitz wrote:10-15% is what I'm getting for rental property as well. The more you borrow/mortgage, the higher your rate of return. The riskier it gets. My mortgage is about 4% interest rate.
You really have to be passionate about rental property. As mentioned in the Wealthfront blog, you need to be aware of what good properties are for sale in your neighborhood. I looked 6+ months, seen 50+ multi family houses, made 10+ offers this year 2013 before I was able to buy my 3 family house near Boston, MA. I often lost to people who had all cash to buy the investment property.
That matches my numbers and experience. I tend to look at a large number of properties before actually getting the one I want. In my opinion it's still possible to add alpha in real estate.

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Re: Rental real estate post - what's the catch?

Post by boggler » Wed Sep 04, 2013 11:29 pm

Clearly_Irrational wrote:
boggler wrote:For those with enough assets, how come more people aren't doing this? if you're planning to hold the property for a while, it seems like a much more stable income stream with much lower risk. And the effort doesn't seem so bad.
Well, many of the Forbes 400 have significant real estate holdings. In 2010 the % of net worth holdings of non-home real estate for the top 1% was 35.5% and for the next 9% it was 43.6%. So I'd say it's not exactly a secret.

There is no free lunch however, you get paid more for a reason. (Reduced diversification, lack of liquidity, less passive)

For me personally when I first started reading about the self-made wealthy I kept seeing the same story over and over again "Well, I do X now but I made all my first money in Real Estate".

Don't take any of this to mean I'm knocking stocks and bonds, much of it depends on your personal situation and goals.

Personally I like the advice in the Talmud, which loosely translated says something like "Divide your assets into three portions: 1/3 Land, 1/3 Liquid Assets, 1/3 Commerce". I define rental properties as falling under land and stocks/bonds as falling under liquid assets. Not everyone will agree with that translation or my interpretation but I think the concept is pretty solid since it dovetails with the economics definition that says there is only four ways to make money: wages, rent, interest & profit.
I've heard the "made money in real estate" story a lot as well.

How come I don't see this mentioned more on this forum? It seems like a no brainer, if at least for diversification reasons. And if you don't want the hassle, just hire a property management firm. Am I doing the math wrong to say that if you get a good deal on a property, you're making an extra 2-3% per year over stocks? That's HUGE over 30 years!

What's the Boglehead approach to this, assuming you hire a property manager? Does it have a place alongside the three fund portfolio?

The yield on REITS right now is 3-4%, which is WAY lower than 10%.

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Re: Rental real estate post - what's the catch?

Post by White Coat Investor » Wed Sep 04, 2013 11:58 pm

You can make money in rental real estate. There are plenty of people who do so. 7% is certainly a reasonable return. I'd expect more because I think I can get that out of stocks with far less time and effort and risk. But if I were offered a 10% unleveraged return in real estate? Sure, I'd take that. I'd probably leverage it up if I could get 12-15%.
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Re: Rental real estate post - what's the catch?

Post by boggler » Thu Sep 05, 2013 12:13 am

EmergDoc wrote:You can make money in rental real estate. There are plenty of people who do so. 7% is certainly a reasonable return. I'd expect more because I think I can get that out of stocks with far less time and effort and risk. But if I were offered a 10% unleveraged return in real estate? Sure, I'd take that. I'd probably leverage it up if I could get 12-15%.
So for someone willing to put in the work to get the place and manage a management company, should they do this instead of or alongside investing in stocks and bonds? I've been on this forum for a while now and haven't yet heard anyone recommend rental properties. Why?

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Re: Rental real estate post - what's the catch?

Post by Clearly_Irrational » Thu Sep 05, 2013 12:23 am

boggler wrote:How come I don't see this mentioned more on this forum?
Mostly because it's a stock and bond forum. Don't be fooled though, real estate isn't a slam dunk, there are at least as many ways to go wrong with real estate as there are with stocks.
boggler wrote:It seems like a no brainer, if at least for diversification reasons. And if you don't want the hassle, just hire a property management firm.
A good property management firm definitely helps make it less annoying, though obviously it cuts into your profits. (Usually around 7%-9% of gross rents)
boggler wrote:Am I doing the math wrong to say that if you get a good deal on a property, you're making an extra 2-3% per year over stocks? That's HUGE over 30 years!
It depends on your level of leverage. With no leverage the stock market wins hands down, though obviously that's not a great comparison since the individual stocks represent levered businesses. With 20% down (5:1) leverage over a 40 year period you'll probably see something like 15% nominal returns. (assuming positive rates of inflation and population growth)
boggler wrote:What's the Boglehead approach to this, assuming you hire a property manager? Does it have a place alongside the three fund portfolio?
I would say that it may have a place for some people depending on their time availability and risk preferences.
boggler wrote:The yield on REITS right now is 3-4%, which is WAY lower than 10%.
Well obviously yields are not total return, so they tend to have a larger return than that. Additionally REITs are only a proxy for direct ownership and so don't return the full premium.

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Re: Rental real estate post - what's the catch?

Post by boggler » Thu Sep 05, 2013 1:04 am

So, in terms of return, it sounds like the big advantage that rental real estate has over stocks is that it can easily be leveraged to get a higher return. This is harder to do with stocks due to the higher interest rates and risk of margin calls. Is this correct?

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Re: Rental real estate post - what's the catch?

Post by l2ridehd » Thu Sep 05, 2013 6:06 am

I own rental property and have most of my life. It is a very good stable return and so far has been an appreciating asset. However it is work. I manage and take care of my own properties. I do most of the maintenance, I manage the contracts, insurance, advertising, and all aspects of ownership. And it is a job and requires actual work. Part time work, but still work. Financially rewarding? Yes. Solid ROI? Yes. Steady income? Yes. Excellent asset growth and tax advantaged. This is not a buy it and forget it business.

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Re: Rental real estate post - what's the catch?

Post by johnubc » Thu Sep 05, 2013 6:23 am

boggler wrote:From a post on Quora: http://qr.ae/I03wb
In the past 6 months I received $430,000 (won lawsuit).
I had $5,000 before I won this lawsuit.

When I won the lawsuit and collected the money, it did not make me any happier. In fact, it had 0 change in my life.

About me: I'm 24 years old, a single founder entrepreneur, YC-funded. I've never had a job in my life, and no company has ever wanted to hire me in Silicon Valley.

This is what happened:

I invested it in real estate. I collect rent, and I make $30,000 a year, pure profit. I hire people to take care of my houses.
I convinced myself that I didn't have to work for the rest of my life. My annual expense is exactly $30,000. I'll never need to get a job again. I can focus on my startup.
Because I put myself on this mindset, I am now frugal as hell. I do not over-spend, and I try to maintain my $30,000. This money has made me much more frugal than I was before. Now, I am scared to spend every dollar because I'm afraid I'll lose my money.
I moved to a shared-house in the ghetto. I pay $500 for one room rent. It's the cheapest in the entire San Francisco area. I only eat $20 a day. That is my budget.

Summary: I don't have to worry about working ever again, in my entire life. But this has made me very frugal in order to keep this in check.

What you should do: Invest it. Don't leave it in the bank. Buy real estate and collect rent. There is no better investment out there.
This is a 7% annual return. Furthermore, it's a real asset, and thus on average should keep up with inflation. This seems too good to be true. Aside from the obvious factors like maintenance, having to find tenants, vacancies, etc.... what's the catch? Something seems fishy about this argument but I can't put my finger on it.
If you're trying to live off a perpetual portfolio, why doesn't everyone do this instead of investing in stocks that only pay out a 2-3% perpetual inflation-adjusted return?
Please do not read the above as factual. The 'author' got the windfall in the past 6 months and even if he were able to get it invested in an unknown number of properties he is only into it for less than 3 months (there has to be a startup time) and has no way of knowing the costs he is about to face with repair and empty rental.

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Re: Rental real estate post - what's the catch?

Post by Methedras » Thu Sep 05, 2013 6:38 am

Please do not read the above as factual. The 'author' got the windfall in the past 6 months and even if he were able to get it invested in an unknown number of properties he is only into it for less than 3 months (there has to be a startup time) and has no way of knowing the costs he is about to face with repair and empty rental.
In my experience, vacancy is the real killer of real estate property returns. Even one month of vacancy out of a year can seriously damage your annual return.

I have in the past "rent-controlled" my tenants by agreeing not to raise their rental rate so long as they stay in the property. This has turned out to be one of the best moves for improving the return of a rental property.

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Re: Rental real estate post - what's the catch?

Post by abuss368 » Thu Sep 05, 2013 6:45 am

SeattleCPA wrote:
bogleblitz wrote:The general rule is that rental property return with management company = stock market return.
I don't want to be argumentative, and I'm going to agree with you, boglelblitz in a minute... but I think real estate probably returns something between what bonds do and what equities do. My source on this is David Swensen in his book Unconventional Success. I think Burton Malkiel suggests something similar in Random Walk Down Wall Street though...
bogleblitz wrote:It might not be 7% every year.
Yeah, I agree. I also think the calculations we're given here might be off.

A possibility that occurs to me (and which would sync with recent rental market realities): Yes, someone can get $35K of rental income on a property they bought for $500,000 a year or two ago... but that's not a 7% cap rate if the property is now worth $1,000,000.

Now, at this point, that $35K of rental income actually represents a 3.5% cap rate.

BTW, this person has also earned a lot more than 7% since the purchase because of the appreciation.
bogleblitz wrote:Why doesn't everyone do it?....
Bogleblitz provides lots of good reasons. But to add to his list, you're also not very well diversified. :confused
This was my understanding too from David Swensen.
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Re: Rental real estate post - what's the catch?

Post by BrooklynInvest » Thu Sep 05, 2013 7:00 am

Speaking from experience -

The downside, cash is tied up - as re capital gains, tenants can be a major hassle, small things take more time to fix than they should.

Upside, standard location disclaimer aside, you're leveraged real estate which in my part of NYC has paid off in excess of stock market over very long run, and the tax man is extremely friendly to the situation.

For reasons others have stated, any smooth return projections are academic at best. Landlord is my second job. For me, I think I've been compensated well for the hassles.

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Re: Rental real estate post - what's the catch?

Post by SeattleCPA » Thu Sep 05, 2013 8:25 am

Clearly_Irrational wrote:In my opinion it's still possible to add alpha in real estate.
I think I agree with this. And I actually got pretty excited about direct real estate investment as a category a couple of years ago. As some may recall, I even set up a website that talked about the short sale opportunity, which I thought was very good if done in moderation (For those with historical curiosity: http://www.howdoibuyashortsale.com/smar ... ations.htm)

I share three final comments about this subject though... and basically these respond to the question asked by a couple of people, "why don't more people do this?"

1. Some research seems to indicate that on average direct real estate investment produces returns similar to what REITs produce. I tried to find the Greenstreet Advisors (http://www.greenstreetadvisors.com/) article that describes their research into this area, but couldn't. I kinda think it isn't available or available for free anymore. But I am sure I've read their reports on this before and correctly remember their conclusions. In any event, if this is true, many people who want to be passive can gain exposure via a REIT.

2. As a wealth building tool, and here I share professional observation, real estate's illiquidity and the forced savings element often work well for some people's personalities. It's like you decide to invest, buy a property with borrowed money, and then HAVE to save by making loan payments. Liquid resources (even those in tax deferred accounts) seem to be easier for many people to spend. But I think this doesn't mean that per se real estate is good but rather that it's good for some situations.

3. Again based on professional observation, I would say the category is riskier than many new real estate investors appreciate. One can tend to endup with a pretty out of balance allocation. Especially if you're buying realty in area where you already own a home.

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Re: Rental real estate post - what's the catch?

Post by 3CT_Paddler » Thu Sep 05, 2013 9:51 am

The catch is that its a part time job (or a good chunk of your potential return goes to management), difficult to be diversified, highly dependent on when you purchase (unlike say a 30 year period of DCA in the stock market) and you have tenant risk. And I think people often underestimate the impact on returns of large maintenance items like a new roof or bringing the building up to code for one reason or another.

All that said, my one data point from a family member tells me that their return is and will continue to exceed what they would have earned by investing in a 50-50 mix of stocks and bonds, with a yield much higher than the 4% withdrawal rate recommended for stocks and bonds, even when you include maintenance costs, insurance and taxes.

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Re: Rental real estate post - what's the catch?

Post by SP-diceman » Thu Sep 05, 2013 9:53 am

Whats the catch?
Not everyone wins $430,000 in a lawsuit to "kick-start" their real-estate career.

:happy

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Re: Rental real estate post - what's the catch?

Post by abuss368 » Thu Sep 05, 2013 10:14 am

I read a David Swensen article once where he explain the three forms of real estate investing (in no particular order):

1) Direct ownership
2) REITs
3) Private Equity

Conclusion: He recommended a low cost REIT fund (and named the TIAA-CREF option and Vanguard's US REIT specifically) for the individual investor. As a side note I am curious of his opinion on International REITs.
John C. Bogle: "You simply do not need to put your money into 8 different mutual funds!" | | Disclosure: Three Fund Portfolio + U.S. & International REITs

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Re: Rental real estate post - what's the catch?

Post by prudent » Thu Sep 05, 2013 10:14 am

Good so far for the person quoted in the OP, but c'mon, he's got less than 6 months of experience. Kind of reminds me of the type of person who touts day trading as a sure thing because they were lucky enough to get off to a good start.
Watty wrote:An interesting thing to do is to try to find out the address of the house where your parents or grandparents lived when they were kids and then look up that neighborhood to see how the houses have done over the years.
Where my parents lived as children, I would not feel safe driving down that street today at high noon.
The house where I lived as a child sold for $8,000 a couple years ago. I think that's roughly what my parents paid to buy it in 1962.

Sad, but neighborhoods change and not always for the better.

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Re: Rental real estate post - what's the catch?

Post by bogleblitz » Thu Sep 05, 2013 10:28 am

boggler wrote: I've been on this forum for a while now and haven't yet heard anyone recommend rental properties. Why?
This is a stock and bond index fund website so index funds are recommended.

Privately own McDonald, burger king, subway, any fast food restaurant can earn up to 15+ annual return. Are you then going to come here and ask why doesn't everyone open fast food restaurants and why didn't we recommend it? What's the catch?

Wynn Casino gets a 25% annual return for the last 25 years. Are you then going to come here and ask why doesn't everyone open up a casino and why not recommend it?

The same can apply to any business (hotels, airlines, supermarkets, real estate, etc)

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Re: Rental real estate post - what's the catch?

Post by Clearly_Irrational » Thu Sep 05, 2013 11:09 am

boggler wrote:So, in terms of return, it sounds like the big advantage that rental real estate has over stocks is that it can easily be leveraged to get a higher return. This is harder to do with stocks due to the higher interest rates and risk of margin calls. Is this correct?
That's one advantage, another is that the market in real estate is less efficient so it's still possible to add alpha.

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Re: Rental real estate post - what's the catch?

Post by wshang » Thu Sep 05, 2013 9:39 pm

I am pretty sure it has been said here before:
Don't confuse a job for an investment.

This guy could just as well as bought a share in a local business and did extremely well. It is a well paying venture which is nondiversified over geography, asset class, tax treatment, etc. For a broad investment strategy, what BH can advise this?

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Re: Rental real estate post - what's the catch?

Post by Clearly_Irrational » Thu Sep 05, 2013 10:52 pm

wshang wrote:I am pretty sure it has been said here before:
Don't confuse a job for an investment.

This guy could just as well as bought a share in a local business and did extremely well. It is a well paying venture which is nondiversified over geography, asset class, tax treatment, etc. For a broad investment strategy, what BH can advise this?
It depends on how many rental properties you're talking about obviously. Managing one property yourself is kind of a job but the number of hours is pretty low, most of the time it's just collecting your checks once a month and maybe calling a maintenance guy as well as the paperwork aspect, it does scale with the number of units but it's not directly linear. By no means is the work of running a million dollars worth of real estate the equivalent amount of work of running a million dollar business however, which is one of the reasons why your return will generally be less as well.

On the passive investment scale it's less passive than stocks and bonds but more passive than running a business. With a property management company it's pretty passive indeed though certainly not quite the level of just checking your statements once a year and rebalancing. Most of the time my prop mgmt company deposits my checks, I read my statements and once in a while I have to approve things. If we change tenants or significant maintenance work has to be done I have to do a bit more but even then it's not much work just money and a few phone conversations. I think most of the people who are saying how much work it is have never really owned any rental property.

The ownership part is an investment, doing all your own management and maintenance would classify as a job but only if you have a significant number of properties otherwise it's more like an annoying hobby.

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Re: Rental real estate post - what's the catch?

Post by Diogenes » Thu Sep 05, 2013 10:55 pm

boggler wrote:From a post on Quora: http://qr.ae/I03wb
In the past 6 months I received $430,000 (won lawsuit).
I had $5,000 before I won this lawsuit.


I moved to a shared-house in the ghetto. I pay $500 for one room rent. It's the cheapest in the entire San Francisco area. I only eat $20 a day. That is my budget.

Summary: I don't have to worry about working ever again, in my entire life. But this has made me very frugal in order to keep this in check.

What you should do: Invest it. Don't leave it in the bank. Buy real estate and collect rent. There is no better investment out there.
Lets see, live in the ghetto and eat on $20 a day - sounds like a nightmare. I doubt anyone would choose that lifestyle for real. I also doubt anyone can live in San Francisco on $30,000 a year unless they are on the public dole, or planning to be. To choose that as a lifestyle in your 20's one must be lazy. Likely a false story.

_D_
Truth and clarity are important in all things...

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Re: Rental real estate post - what's the catch?

Post by Pajamas » Thu Sep 05, 2013 11:42 pm

$20 a day for food sounds like a lot for someone living on a tight budget. That's $600 a month or almost 25% of the $30,000 a year.

I am a careful shopper and don't eat meat but buy whatever I want at the grocery store and don't spend $300 a month on food.

The numbers don't make sense and the whole scenario seems fictional or theoretical rather than truthful.

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Re: Rental real estate post - what's the catch?

Post by interplanetjanet » Fri Sep 06, 2013 1:33 am

Something else to remember is that all real estate is local.

In many areas you will not get that good of a cap rate on houses - apartment complexes and lower end housing tends to do better. Unfortunately while cap rates are better in cheaper areas, there may be more trouble keeping things steadily occupied. A small number of properties = a lack of diversification, and you may suffer a significant hit if you have a tenant who can't or won't pay for a while and you have to go through eviction proceedings.

You can get lucky and you can get unlucky. By putting in more effort you can increase your chances of getting lucky.

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Re: Rental real estate post - what's the catch?

Post by connya » Fri Sep 06, 2013 11:26 am

Methedras wrote:In my experience, vacancy is the real killer of real estate property returns. Even one month of vacancy out of a year can seriously damage your annual return.
+1

One of my properties has been vacant for five months. Even discounting the terrible effect on returns, this can create serious cash flow problems. Thankfully I can cover the mortgage payments with other funds and I don't depend on the income for living expenses as the subject of the OP does. Otherwise I would be in a very bad situation.

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Re: Rental real estate post - what's the catch?

Post by longview » Fri Sep 06, 2013 1:04 pm

Clearly_Irrational wrote: A good property management firm definitely helps make it less annoying, though obviously it cuts into your profits. (Usually around 7%-9% of gross rents)
Much like with financial advisors, what's up with management companies taking a fixed percentage? Do any take a flat fee per tenet? Scaling with rent seems a bit random.
(To color my comments: my situation is ER trying to make a large portfolio that is 99% taxable last 45 years)

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Re: Rental real estate post - what's the catch?

Post by modhatter » Fri Sep 06, 2013 1:51 pm

Methedras wrote:
In my experience, vacancy is the real killer of real estate property returns. Even one month of vacancy out of a year can seriously damage your annual return.

I have in the past "rent-controlled" my tenants by agreeing not to raise their rental rate so long as they stay in the property. This has turned out to be one of the best moves for improving the return of a rental property.
I agree to a certain extent. I don't guarantee my tenant this, but indicate that if they are good tenants and take care of the place and pay their rent on time, I will probably not raise their rent. It has also been my experience that when I have kept the rent low for a number of years (at least 10% below market) and I try to raise it even 5%, the tenant ALWAYS leaves. I remember one case. I was renting a townhouse in a very nice area, and it was really a nice place (put a bit of money into it) The tenant was only paying me $825 for about 6 years and the current rent for a comparable unit was $1,000. When I finally raised the rent $50 more to $875 ($125 below comparable), she got mad and left, sticking me for the last two months rent. Go figure.

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Re: Rental real estate post - what's the catch?

Post by Clearly_Irrational » Fri Sep 06, 2013 2:14 pm

modhatter wrote:I agree to a certain extent. I don't guarantee my tenant this, but indicate that if they are good tenants and take care of the place and pay their rent on time, I will probably not raise their rent. It has also been my experience that when I have kept the rent low for a number of years (at least 10% below market) and I try to raise it even 5%, the tenant ALWAYS leaves. I remember one case. I was renting a townhouse in a very nice area, and it was really a nice place (put a bit of money into it) The tenant was only paying me $825 for about 6 years and the current rent for a comparable unit was $1,000. When I finally raised the rent $50 more to $875 ($125 below comparable), she got mad and left, sticking me for the last two months rent. Go figure.
To play it safe I assume the tenant will leave if I raise the rent so I try and do it when a vacancy won't cause problems for me. In general a nuisance raise of $20-$25 is something I can usually get away with because people don't like to go to the work of moving, but larger amounts ($50+) seem to activate some kind of "budget awareness" that makes them more likely to move. For the most part I just try to keep up with market rates.

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Re: Rental real estate post - what's the catch?

Post by ragabnh » Sat Sep 07, 2013 10:51 am

I am not a real estate investor, but I will present real case scenario,

I bought a house in 1996 paid $200,000 including upgrades, I had to leave the US to work overseas 2008, so I used property management company to rent it. The house was paid off November 2012, currently I clear $1100 in rent after all expenses are paid. So that is 6.6% of the original purchase price,

The house is rented almost $1700, I pay 7% property management, Real estate Taxes, home insurance, appliance insurance and landscape $75.00/month. The house is nice and in a good school district, always rented and has been only vacant for 15 days between tenants,

As mentioned all the work I do is check my bank account online to see if the money is deposited.

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Re: Rental real estate post - what's the catch?

Post by boggler » Sat Sep 07, 2013 6:15 pm

ragabnh wrote:I am not a real estate investor, but I will present real case scenario,

I bought a house in 1996 paid $200,000 including upgrades, I had to leave the US to work overseas 2008, so I used property management company to rent it. The house was paid off November 2012, currently I clear $1100 in rent after all expenses are paid. So that is 6.6% of the original purchase price,

The house is rented almost $1700, I pay 7% property management, Real estate Taxes, home insurance, appliance insurance and landscape $75.00/month. The house is nice and in a good school district, always rented and has been only vacant for 15 days between tenants,

As mentioned all the work I do is check my bank account online to see if the money is deposited.
To be fair, it seems like you should be comparing the net income to the current value of the property, right? Because you could sell that and invest it in the stock market if you wanted to.

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Re: Rental real estate post - what's the catch?

Post by travellight » Sat Sep 07, 2013 7:27 pm

I also have real estate investments and think it's a good and solid pathway with the caveats that have been stated already

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Re: Rental real estate post - what's the catch?

Post by JoMoney » Sat Sep 07, 2013 8:16 pm

ragabnh wrote:I am not a real estate investor, but I will present real case scenario,

I bought a house in 1996 paid $200,000 including upgrades, I had to leave the US to work overseas 2008, so I used property management company to rent it. The house was paid off November 2012, currently I clear $1100 in rent after all expenses are paid. So that is 6.6% of the original purchase price,

The house is rented almost $1700, I pay 7% property management, Real estate Taxes, home insurance, appliance insurance and landscape $75.00/month. The house is nice and in a good school district, always rented and has been only vacant for 15 days between tenants,

As mentioned all the work I do is check my bank account online to see if the money is deposited.
Oooh real life numbers :happy So,
$200k invested in VTSMX in 1996 would be $767,367.40 today (according to Morningstar)
200 months rent at $1100 (after all expenses are paid) = $220,000
$767,367.40 - $220,000 = $547,367.40 (Amount house would need to be sold for to be on par with a passive index of stocks)

This is a bit too simplified, as there are many other considerations like tax advantages, rent was probably lower back in 1996 (?), the house having been bought with borrowed money might increase ROI due to the leverage (minus interest costs)... but I find it interesting to compare.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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