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letsgobobby
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bb
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Re: economics of landlording

Post by bb »

Does that maintenance cover new furnace, new roof?
Certainly that kid of return does not sound great on the
face of it. Do you expect the house to appreciate?
petulant
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Re: economics of landlording

Post by petulant »

I would calculate the return based on net after-tax income divided by the value you would actually receive from a sale. We don't know your basis, when it was bought for what, etc.

Should you keep it? It can be a great inflation hedge as long as you think your local market would keep pace with inflation.

You might also check the numbers for slapping a modest mortgage on it. If the stars align you might be able to increase your ROE, make it a better inflation hedge, and invest elsewhere.
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Sandtrap
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Re: economics of landlording

Post by Sandtrap »

If you are using this as a jumping off point where it appeciations in value such that you can sell and get into a duplex, or larger, where you have "economy of scale", then that may be great. (FWIW IMHO AFAIK, a single family home rental has the worse economy of scale as far as R/E rentals) If you are not reliant on the income stream, then that is great. If you have other substantial income stream and resources and large assets such that you have "staying power" then that is great.

Conversely, Are reliant on this property rental as a reliable and growing income stream? Do you not have other reliable and substantial income streams? Are you a "distance owner" and have to rely on a management company and 3rd party sources for repairs and so forth? Is the property located in an area where the clientele is more likely to default? Is the property located in an area where R/E appreciation value does not have a history of increasing by much or not at all or very very slowly?

Also, if the property is located in a high appreciation area and sub area with high curb value IE: Waikiki, Scottsdale, etc, then it can indeed be worth it in the long long run.

Some thoughts to consider.
Hope this helps.
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avalpert
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Re: economics of landlording

Post by avalpert »

There are other variables you need to consider such as location risk, you have assumed no vacancy, etc. Off the top line numbers it seems like a marginal value as a rental and frankly, if I wasn't planning on acquiring more rental units it doesn't look like it is worth holding.
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Re: economics of landlording

Post by VictoriaF »

Do you need to be in landlordingm, Bobby? From what I know about you, you have other things to do. If you need to park extra cash, get I Bonds to delay taxes until a period of low income. Beyond I Bonds, look at CDs. For example, Andrews Federal Credit Union is now offering 3% CDs for 7 years. Play with credit cards, points and miles to accumulate travel awards that are not taxable.

Best wishes,
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Re: economics of landlording

Post by Sandtrap »

VictoriaF wrote:Do you need to be in landlordingm, Bobby? From what I know about you, you have other things to do. If you need to park extra cash, get I Bonds to delay taxes until a period of low income. Beyond I Bonds, look at CDs. For example, Andrews Federal Credit Union is now offering 3% CDs for 7 years. Play with credit cards, points and miles to accumulate travel awards that are not taxable.

Best wishes,
Victoria
landlordingm

thanks, "VictoriaF" for the funny. :D
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Meg77
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Re: economics of landlording

Post by Meg77 »

This isn't a great rental property. After your basic fixed expenses (tax, ins and mgmt) you are only making $10,000 a year of the $250K asset for a total ROI of 4.0%. That's not great for a rental property; you should be making well above that to make the hassles and lack of liquidity worth it. Otherwise that $250K is better off invested in the stock market (or at least a REIT if you want real estate specific exposure) where you could easily get the same return or higher.

But your actual ROI isn't even close to 4% since you are assuming no maintenance, repairs or vacancies. On top of that you say you have a mortgage, so your cash flow may even be negative. Of course that means you are presumably building equity in addition to some appreciation on the property, and your return on equity may be higher at levels you are comfortable with. There are also tax advantages to holding this kind of investment (though not this one in particular).

I can't tell you if you'll wish you'd kept this property in 30 years. That's more of a personal preference. It will surely go up in value over that time - but so will most investments. You could probably make more of a return elsewhere - even with better residential rentals if that's what you want to invest in. But it's also OK to keep this, especially if you have lots of other riskier assets and no unmet goals the equity in this property could help you achieve. You already own it, and the transaction costs are certainly steep if you decide to sell.
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qwertyjazz
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Re: economics of landlording

Post by qwertyjazz »

letsgobobby wrote:
Meg77 wrote:This isn't a great rental property. After your basic fixed expenses (tax, ins and mgmt) you are only making $10,000 a year of the $250K asset for a total ROI of 4.0%. That's not great for a rental property; you should be making well above that to make the hassles and lack of liquidity worth it. Otherwise that $250K is better off invested in the stock market (or at least a REIT if you want real estate specific exposure) where you could easily get the same return or higher.

But your actual ROI isn't even close to 4% since you are assuming no maintenance, repairs or vacancies. On top of that you say you have a mortgage, so your cash flow may even be negative. Of course that means you are presumably building equity in addition to some appreciation on the property, and your return on equity may be higher at levels you are comfortable with. There are also tax advantages to holding this kind of investment (though not this one in particular).

I can't tell you if you'll wish you'd kept this property in 30 years. That's more of a personal preference. It will surely go up in value over that time - but so will most investments. You could probably make more of a return elsewhere - even with better residential rentals if that's what you want to invest in. But it's also OK to keep this, especially if you have lots of other riskier assets and no unmet goals the equity in this property could help you achieve. You already own it, and the transaction costs are certainly steep if you decide to sell.
Thanks for your thoughts Meg,

The figures listed include maintenance and repairs. Vacancy in this high demand area is around 1% in general and almost 0% in this particular neighborhood. The last 2 rentals have taken 8 days and 3 days to fill (so 11 days in 3 years of tenants).

Part of the economics of this unit and area is that there has been a lot of appreciation in both sales prices and rent rates over the last 4 years. We bought in the $180s and it probably would have rented for under $1000 at the time. So compared to the actual money I've put into this unit it is attractive to rent. However I realize I can sell and put some of the money elsewhere.

Cash flow is not an issue and this isn't an important part of our investments either way. I wanted to avoid discussing the implications of the mortgage because it will be paid off in 8 years and my real question is whether this is something I should keep 'forever' rather than just looking at the fact that I am currently able to leverage (through a mortgage) the rather small down payment I originally paid.
I forget the context but I vaguely remember you posting something along the lines of would you have bought it now
Include transaction costs and take your own excellent advice
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petulant
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Re: economics of landlording

Post by petulant »

letsgobobby wrote:
Meg77 wrote:This isn't a great rental property. After your basic fixed expenses (tax, ins and mgmt) you are only making $10,000 a year of the $250K asset for a total ROI of 4.0%. That's not great for a rental property; you should be making well above that to make the hassles and lack of liquidity worth it. Otherwise that $250K is better off invested in the stock market (or at least a REIT if you want real estate specific exposure) where you could easily get the same return or higher.

But your actual ROI isn't even close to 4% since you are assuming no maintenance, repairs or vacancies. On top of that you say you have a mortgage, so your cash flow may even be negative. Of course that means you are presumably building equity in addition to some appreciation on the property, and your return on equity may be higher at levels you are comfortable with. There are also tax advantages to holding this kind of investment (though not this one in particular).

I can't tell you if you'll wish you'd kept this property in 30 years. That's more of a personal preference. It will surely go up in value over that time - but so will most investments. You could probably make more of a return elsewhere - even with better residential rentals if that's what you want to invest in. But it's also OK to keep this, especially if you have lots of other riskier assets and no unmet goals the equity in this property could help you achieve. You already own it, and the transaction costs are certainly steep if you decide to sell.
Thanks for your thoughts Meg,

The figures listed include maintenance and repairs. Vacancy in this high demand area is around 1% in general and almost 0% in this particular neighborhood. The last 2 rentals have taken 8 days and 3 days to fill (so 11 days in 3 years of tenants).

Part of the economics of this unit and area is that there has been a lot of appreciation in both sales prices and rent rates over the last 4 years. We bought in the $180s and it probably would have rented for under $1000 at the time. So compared to the actual money I've put into this unit it is attractive to rent. However I realize I can sell and put some of the money elsewhere.

Cash flow is not an issue and this isn't an important part of our investments either way. I wanted to avoid discussing the implications of the mortgage because it will be paid off in 8 years and my real question is whether this is something I should keep 'forever' rather than just looking at the fact that I am currently able to leverage (through a mortgage) the rather small down payment I originally paid.
Correct me if I'm wrong, but I think you're disclaiming an interest in cash flow because you don't want us to be worried about whether you're paying out-of-pocket costs. But that's not the reason I brought it up. I think there are three main ways to make money on a residential property: cash flow, leverage, or appreciation. Whether you'll appreciate having the house in 30 years depends on what combination of those things you're using to make money. If you were just going to pay off the property right now and hold it with the 5% ROA forever--probably not worth it, given the headaches and risks. If you're going to use leverage well, it might up the ROE to 10% and make it an even better inflation hedge. So the mortgage/cash flow situation is huge.
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Re: economics of landlording

Post by curmudgeon »

I personally find significant value in diversification of investments beyond "stocks" and "bonds". Directly owned real estate (to me) is valuable for that purpose (better than REITs or gold/commodities). There are definitely limitations in terms of liquidity and concentration risk which go with the territory. I feel like a good baseline position (if circumstances permit) is owning your own home. How much further to go, in terms of type and number of properties, is less obvious. Depending on the area, a SFR often has poorer return in the form of income, but better appreciation potential.

Do some analysis of what the financials of this will likely look like 5, 10, 20 years from now. As the depreciation drops off, the rental income will become more directly taxable income. A sale generates LTCG (unless you exchange). Tax laws may change. Local landlord regulations or rent control may make it less desirable to own.
WhyNotUs
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Re: economics of landlording

Post by WhyNotUs »

While there are very real considerations and obligations to being a landlord, I am surprised that posters are sniffing at a 4-5% return when there is also lots of talk about a realistic SWR in the future being 3% or that 4% is overly optimistic.

I would keep it until I found something that was better that I felt would earn 5% with a similar level of risk. If you know that now, then I would sell it.
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WhyNotUs
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Re: economics of landlording

Post by WhyNotUs »

RE; Having a mortgage on rental

The poster may have been referring to the current year tax benefits for some people of deducting rental mortgage while building equity. That and leverage are the pluses on rental side for some people when the cash flow is not great.
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EasilyConfused
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Re: economics of landlording

Post by EasilyConfused »

WhyNotUs wrote:While there are very real considerations and obligations to being a landlord, I am surprised that posters are sniffing at a 4-5% return when there is also lots of talk about a realistic SWR in the future being 3% or that 4% is overly optimistic.

I would keep it until I found something that was better that I felt would earn 5% with a similar level of risk. If you know that now, then I would sell it.
It's a 4% return that requires WORK. Owning and managing property is not particularly difficult most of the time, but it does require a time commitment significantly greater than buying an index fund or CD. And there's plenty of downside risk.

I am a real estate investor and I would not keep this property unless I had a strong reason to believe in a big price appreciation in a relatively short time.
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Re: economics of landlording

Post by EasilyConfused »

I've read a number of these threads over the years and they usually play out the same way:

1. OP has a former residence that's become a rental house. The monthly rent is usually around .5% of the value of the house. This person almost always already has a plan in mind.
2. Some landlords, also with one rental, in a similar situation say to hang on to the house.
3. Former landlords who extricated themselves from a similar situation tell some landlording horror stories and tell the OP to sell the house.
4. The people with multiple investment properties say it's a bad investment and OP can do better elsewhwere.
5. Side discussions on why anyone would buy property rather than just buy VTSAX.
6. OP does whatever he was going to do anyway.
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TMCD75
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Re: economics of landlording

Post by TMCD75 »

You should up the rent to $1750-$2000 per month, especially if it's fairly up to date. I still think you're doing ok at $1500 per month though.

I'm renting my $150k house out right now for $1200/mo. This is in the Louisville Ky metropolitan area. Everything in the house is up to date and I'm VERY comfortable renting it out the next 5-8 years at this price.
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Re: economics of landlording

Post by EasilyConfused »

letsgobobby wrote:
EasilyConfused wrote:
WhyNotUs wrote:While there are very real considerations and obligations to being a landlord, I am surprised that posters are sniffing at a 4-5% return when there is also lots of talk about a realistic SWR in the future being 3% or that 4% is overly optimistic.

I would keep it until I found something that was better that I felt would earn 5% with a similar level of risk. If you know that now, then I would sell it.
It's a 4% return that requires WORK. Owning and managing property is not particularly difficult most of the time, but it does require a time commitment significantly greater than buying an index fund or CD. And there's plenty of downside risk.

I am a real estate investor and I would not keep this property unless I had a strong reason to believe in a big price appreciation in a relatively short time.
on average doesn't real estate appreciate more or less at the rate of inflation?

re: work, the lower return ($10,000 or so) includes the fee I pay management. That would be about a 4% return. If I don't pay management of 8% per month, my net income is $11,500, which is 4.6-4.7% return.

The idea of comparing it to an inflation-indexed annuity was my thought as well. If everything keeps up with inflation over time, and ignoring the effects of leverage, don't I have a 4-5% annuity?
I think you're underestimating your long-term expenses a bit but your numbers aren't as far off as a lot of people who start one of these threads. I also haven't met any management companies who actually take all the work off the owner's hands, but maybe you've found a great one. And your property carries considerably more risk than an annuity. Also, you say you have a mortgage for another 8.5 years so I'm guessing that eats up pretty much all the cash flow during that time.

This isn't a disaster, and you'll probably end up with more money than you put in. And if you're one of the lucky ones, your property might take off and appreciate like crazy. I just think the odds are that you could do better elsewhere.
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Re: economics of landlording

Post by Meg77 »

letsgobobby wrote:
petulant wrote:
letsgobobby wrote:
Meg77 wrote:This isn't a great rental property. After your basic fixed expenses (tax, ins and mgmt) you are only making $10,000 a year of the $250K asset for a total ROI of 4.0%. That's not great for a rental property; you should be making well above that to make the hassles and lack of liquidity worth it. Otherwise that $250K is better off invested in the stock market (or at least a REIT if you want real estate specific exposure) where you could easily get the same return or higher.

But your actual ROI isn't even close to 4% since you are assuming no maintenance, repairs or vacancies. On top of that you say you have a mortgage, so your cash flow may even be negative. Of course that means you are presumably building equity in addition to some appreciation on the property, and your return on equity may be higher at levels you are comfortable with. There are also tax advantages to holding this kind of investment (though not this one in particular).

I can't tell you if you'll wish you'd kept this property in 30 years. That's more of a personal preference. It will surely go up in value over that time - but so will most investments. You could probably make more of a return elsewhere - even with better residential rentals if that's what you want to invest in. But it's also OK to keep this, especially if you have lots of other riskier assets and no unmet goals the equity in this property could help you achieve. You already own it, and the transaction costs are certainly steep if you decide to sell.
Thanks for your thoughts Meg,

The figures listed include maintenance and repairs. Vacancy in this high demand area is around 1% in general and almost 0% in this particular neighborhood. The last 2 rentals have taken 8 days and 3 days to fill (so 11 days in 3 years of tenants).

Part of the economics of this unit and area is that there has been a lot of appreciation in both sales prices and rent rates over the last 4 years. We bought in the $180s and it probably would have rented for under $1000 at the time. So compared to the actual money I've put into this unit it is attractive to rent. However I realize I can sell and put some of the money elsewhere.

Cash flow is not an issue and this isn't an important part of our investments either way. I wanted to avoid discussing the implications of the mortgage because it will be paid off in 8 years and my real question is whether this is something I should keep 'forever' rather than just looking at the fact that I am currently able to leverage (through a mortgage) the rather small down payment I originally paid.
Correct me if I'm wrong, but I think you're disclaiming an interest in cash flow because you don't want us to be worried about whether you're paying out-of-pocket costs. But that's not the reason I brought it up. I think there are three main ways to make money on a residential property: cash flow, leverage, or appreciation. Whether you'll appreciate having the house in 30 years depends on what combination of those things you're using to make money. If you were just going to pay off the property right now and hold it with the 5% ROA forever--probably not worth it, given the headaches and risks. If you're going to use leverage well, it might up the ROE to 10% and make it an even better inflation hedge. So the mortgage/cash flow situation is huge.
thank you, I am not an experienced real estate invesor but it is strange to me that a property could be a good or bad investment depending on whether I owed money on it or not; and therefore the investment could go from bad to good (or good to bad) over an 8 year period depending solely on whether I had paid off my mortgage or not.
Whether you have a mortgage on a real estate investment matters because it impacts what your return really is. Let's assume a property worth $100K is providing net rental income of $1000 per month and appreciating $2000 per year. Your total return is therefore $14,000 per year. If the property has no mortgage, that's a 14% annual return on equity. If the property has a $70K mortgage, that's a 46.6% return on equity. And return on equity is what is really important, since that's the amount you can theoretically get out of the property and invest elsewhere. Of course having a mortgage would decrease your net rental income, but it would also add principal reductions to your total annual return. So it changes the picture dramatically.

It doesn't make sense to disregard cash flow and the impact of leverage, because if you do you're left only with appreciation as a form of return. Real estate generally appreciates at the rate of inflation, and if that's all you are getting then you may as well just own a CD or money market account instead. Cash flow is the most important element of residential real estate investment; it should be the foundation of the decision of whether to buy or sell. Appreciation is icing on the cake, but it's not a meal on its own.

For what it's worth, I recently faced this brutal truth and sold my former homestead which I'd been renting out for a few years. I loved that condo, it's in a great area, it was low maintenance, and it stayed rented. It didn't cash flow though because I still had a mortgage on it on a 15 year amortization. Like you, I justified keeping it because it had appreciated nicely and I was building equity each month even if I was losing a few hundred bucks on it. But I own a few other rentals and this was by far the worst performer purely from an ROE/ROI standpoint. Even once it was paid off I'd only earn 4-5% a year on it. And I had two other rental mortgages at 5%. So I sold it and paid one off. It was the smart investment decision, which I remind myself each time I walk by it and wistfully imagine that I could still own it. I can buy other rentals that will have better returns though - and that is after all the point of investing.
"An investment in knowledge pays the best interest." - Benjamin Franklin
petulant
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Re: economics of landlording

Post by petulant »

letsgobobby wrote:
petulant wrote:Correct me if I'm wrong, but I think you're disclaiming an interest in cash flow because you don't want us to be worried about whether you're paying out-of-pocket costs. But that's not the reason I brought it up. I think there are three main ways to make money on a residential property: cash flow, leverage, or appreciation. Whether you'll appreciate having the house in 30 years depends on what combination of those things you're using to make money. If you were just going to pay off the property right now and hold it with the 5% ROA forever--probably not worth it, given the headaches and risks. If you're going to use leverage well, it might up the ROE to 10% and make it an even better inflation hedge. So the mortgage/cash flow situation is huge.
thank you, I am not an experienced real estate invesor but it is strange to me that a property could be a good or bad investment depending on whether I owed money on it or not; and therefore the investment could go from bad to good (or good to bad) over an 8 year period depending solely on whether I had paid off my mortgage or not.
Well, compare it to a 10-year bond. If your goal is to have interest rate risk exposure and yields in the 5-7 duration range, you would sell a lot of your bonds that drop under 5 year duration, right? That's what a duration-based bond mutual fund does. So the same bond can differ in desirability based on its remaining duration.

Real estate is an investment where a mortgage has a similar effect. It dramatically affects the risk and return profile of an investment, and shifts over time since the amortization on a traditional mortgage increases your equity over time (the bottom part of your ROI) and becomes more principal than interest (keeping the cash flow the same but changing what's counted as expense and what's counted as profit, both economically and for taxes). You might start out with $30,000 in equity and a 8% ROE and shift over time to $50,000 in equity and a 6.5% ROE. It's analogous to how the same bond will have a falling YTM and lower risk as it climbs the yield curve down.

If what you mean is, why would this affect this particular property versus another property, the answer is that it does and doesn't. If you can make a good investment out of it with a mortgage or not, you can probably do the same with another similar property. But to move to another property, you have to pay the transaction fees you've already pointed out.

So you'd really want to model the return on holding this property for another time period (say a year), what it looks to sell it and invest the proceeds in another rental property that you might consider (losing out on the 6% or more commission), and what returns you might expect on a stock/bond portfolio using the equity (taking into account loss of diversification but benefit from no longer managing, reduced risk).
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EasilyConfused
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Re: economics of landlording

Post by EasilyConfused »

letsgobobby wrote:
Meg77 wrote: Of course having a mortgage would decrease your net rental income, but it would also add principal reductions to your total annual return. So it changes the picture dramatically.
Interest reduces returns - check
But how does principal reduction improve them? Am I not just moving money from one very low return place (cash) to another (equity in property)?

I ignored cash flow because a property could still be a good investment even with negative cash flow, right? Imagine a property that is worth $120,000, that I buy for 0 down and have to repay over 1 year at 0% interest ($10,000 per month). I can rent it at $1000 per month. The cash flow will be negative for one year, but the rent is nearly 10% of the purchase price each year and thus seems to be a good investment. And would the worthiness of the investment change after the mortgage were paid off?

It is correct, we own this as a rental after previously having lived in it. We did not live in it for 24 months so will pay capital gains taxes upon its sale regardless of when that is. The question is whether this property contributes positively to our long term wealth accumulation or is more of an albatross. If the property had gone up from $180k to $200k and rents from $1000 to $2000, it would obviously be a solid rental to keep. However prices and rents went up concomitantly, so even though rents have increased 50%, prices have increased almost as much so the equation is not that much different (although maintenance is relatively smaller as a percentage of the rent).

I'm not attached to this property emotionally, in any way. Just want to keep it if it is a good complement to a traditional 60/40 indexed portfolio, and want to dump it if it's a drag. If it's somewhere in the middle - which has been my sense - I will probably keep it for the diversification benefit.
Expenses on rental property, not including mortgage principal and interest payments, average 45-55% of monthly rents. That includes taxes, management, maintenance, vacancy, etc. and it holds true across property types. Since you're talking about holding for 30 years you're very likely to experience an average rate of expenses over that long of a term. So your hypothetical property renting at 10% of purchase price, if you own it free and clear, will return about 5%. Add in annual appreciation of about 3% and you're looking at 8% returns. When I factor in the concentration risk of ownership and the hassle of landlording even your hypothetical house is an instapass for me. So you can imagine how I feel about your $250K property that rents for $1,500.

But since your question is whether your property contributes positively to your long-term wealth accumulation the honest answer is "yes, probably." It's just that if I were in your shoes I would add "but not nearly enough to be worth it" to the end of that answer.
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EasilyConfused
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Re: economics of landlording

Post by EasilyConfused »

letsgobobby wrote: Everything I've ever read suggests a monthly rent of 0.5-1% of the current value is a good/typical real estate investment, my hypothetical is 0.8%. You must have unusual metrics to 'instant pass' something so solidly in the middle of all the recommendations I have seen - but I am definitely not an expert.

So you would sell this property and net say $100k ($250k sales price - 6% broker and 1.8% excise tax and a few miscellaneous closing costs = $230k, then 18.8% capital gains tax on about $45k = another $7000, currently owe $120k) and invest it per the rest of my portfolio? I mean, to be honest, if I am choosing between $100,000 in my pocket or $7000 in net income each year net of all expenses, fees, income and property taxes, everything - the $7000 per year is more appealing, because it excludes the price appreciation and the increase in equity from principal payments I'm getting separate from the income stream. It seemed to me that the property would be less attractive over time because more and more cash would be tied up in the equity but that the current situation, while not phenomenal, was certainly attractive enough to maintain.
Typical real estate investors don't actually do all that well. I do have tougher cash flow metrics than most because landlording is much more of a business than other forms of investing. So if I'm going to have to run a business I want to get paid more than I do for passive investing or I'm not going to bother. Others don't seem to view things through the same lens as I do, and if they're content with a lower return that's fine. I'm sure they can do more volume that way than I can -- it takes me a long time to find a deal. I just don't have any interest in getting 5% returns on a high-risk asset like a SFH.

You've somewhat changed the question by bringing your mortgage into it. The OP assumed a $250,000 asset. When you bring the mortgage into it you've cut that in half so obviously you're getting a lot less back if you sell it and your return on equity when you hold is higher. But how are you getting to $7,000 per year in income? 50% expenses on your $1,500 monthly rent gets you to $9,000. But now that you've brought the mortgage into the question you have to subtract at least the interest portion of the payment from the income as well, and I would not enjoy making the principal payments since I'm killing my liquidity by locking my cash into this house.
petulant
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Re: economics of landlording

Post by petulant »

EasilyConfused wrote:
letsgobobby wrote: Everything I've ever read suggests a monthly rent of 0.5-1% of the current value is a good/typical real estate investment, my hypothetical is 0.8%. You must have unusual metrics to 'instant pass' something so solidly in the middle of all the recommendations I have seen - but I am definitely not an expert.

So you would sell this property and net say $100k ($250k sales price - 6% broker and 1.8% excise tax and a few miscellaneous closing costs = $230k, then 18.8% capital gains tax on about $45k = another $7000, currently owe $120k) and invest it per the rest of my portfolio? I mean, to be honest, if I am choosing between $100,000 in my pocket or $7000 in net income each year net of all expenses, fees, income and property taxes, everything - the $7000 per year is more appealing, because it excludes the price appreciation and the increase in equity from principal payments I'm getting separate from the income stream. It seemed to me that the property would be less attractive over time because more and more cash would be tied up in the equity but that the current situation, while not phenomenal, was certainly attractive enough to maintain.
Typical real estate investors don't actually do all that well. I do have tougher cash flow metrics than most because landlording is much more of a business than other forms of investing. So if I'm going to have to run a business I want to get paid more than I do for passive investing or I'm not going to bother. Others don't seem to view things through the same lens as I do, and if they're content with a lower return that's fine. I'm sure they can do more volume that way than I can -- it takes me a long time to find a deal. I just don't have any interest in getting 5% returns on a high-risk asset like a SFH.

You've somewhat changed the question by bringing your mortgage into it. The OP assumed a $250,000 asset. When you bring the mortgage into it you've cut that in half so obviously you're getting a lot less back if you sell it and your return on equity when you hold is higher. But how are you getting to $7,000 per year in income? 50% expenses on your $1,500 monthly rent gets you to $9,000. But now that you've brought the mortgage into the question you have to subtract at least the interest portion of the payment from the income as well, and I would not enjoy making the principal payments since I'm killing my liquidity by locking my cash into this house.
By his numbers he's at 36% expenses.
EasilyConfused
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Re: economics of landlording

Post by EasilyConfused »

petulant wrote:
EasilyConfused wrote:
letsgobobby wrote: Everything I've ever read suggests a monthly rent of 0.5-1% of the current value is a good/typical real estate investment, my hypothetical is 0.8%. You must have unusual metrics to 'instant pass' something so solidly in the middle of all the recommendations I have seen - but I am definitely not an expert.

So you would sell this property and net say $100k ($250k sales price - 6% broker and 1.8% excise tax and a few miscellaneous closing costs = $230k, then 18.8% capital gains tax on about $45k = another $7000, currently owe $120k) and invest it per the rest of my portfolio? I mean, to be honest, if I am choosing between $100,000 in my pocket or $7000 in net income each year net of all expenses, fees, income and property taxes, everything - the $7000 per year is more appealing, because it excludes the price appreciation and the increase in equity from principal payments I'm getting separate from the income stream. It seemed to me that the property would be less attractive over time because more and more cash would be tied up in the equity but that the current situation, while not phenomenal, was certainly attractive enough to maintain.
Typical real estate investors don't actually do all that well. I do have tougher cash flow metrics than most because landlording is much more of a business than other forms of investing. So if I'm going to have to run a business I want to get paid more than I do for passive investing or I'm not going to bother. Others don't seem to view things through the same lens as I do, and if they're content with a lower return that's fine. I'm sure they can do more volume that way than I can -- it takes me a long time to find a deal. I just don't have any interest in getting 5% returns on a high-risk asset like a SFH.

You've somewhat changed the question by bringing your mortgage into it. The OP assumed a $250,000 asset. When you bring the mortgage into it you've cut that in half so obviously you're getting a lot less back if you sell it and your return on equity when you hold is higher. But how are you getting to $7,000 per year in income? 50% expenses on your $1,500 monthly rent gets you to $9,000. But now that you've brought the mortgage into the question you have to subtract at least the interest portion of the payment from the income as well, and I would not enjoy making the principal payments since I'm killing my liquidity by locking my cash into this house.
By his numbers he's at 36% expenses.
Over a 30-year holding period, I doubt that will be the case.
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EasilyConfused
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Re: economics of landlording

Post by EasilyConfused »

letsgobobby wrote: As a novice in this field, I'm still trying to get my head around the idea that a property can be a better investment when it's mortgaged, a worse investment when it's paid for, and paying off the loan at some future date can have the effect of making an otherwise good investment into a bad one.
It's not because you're a novice, it's because you have common sense. This is another area where many real estate investors and I part company. Leverage is a way to amplify your returns in real estate the same way borrowing on your home to invest in VTSAX would be a way to amplify your returns in stocks. It may be a mathematically good play but you'd better have a very high risk tolerance. I do borrow to invest in real estate (although I'm not nearly as leveraged as many) and this is another reason I require such a high return on my money. It's just too easy to wildly underestimate the risk here.
letsgobobby wrote: If you are correct and I average 50% total expenses over the years (does that include the income taxes I would owe on the rental income or is that additional expense/) then $9000 on a $250,000 investment isn't too hot; it's under 4%. On the other hand, even best case scenario I can only realize about 90-92% of its market price, so it's really a $225,000 investment to me, which means $9000 is over 4% - less safe than an annuity, but a little better than first blush.
You should be able to roll your income taxes into the 50% when we're just doing a ballpark estimate like this. If those numbers work for you, it sounds like you're doing the right thing.
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Re: economics of landlording

Post by Sandtrap »

EasilyConfused wrote:. . . . . . . . This is another area where many real estate investors and I part company. Leverage is a way to amplify your returns in real estate the same way borrowing on your home to invest in VTSAX would be a way to amplify your returns in stocks. It may be a mathematically good play but you'd better have a very high risk tolerance. I do borrow to invest in real estate (although I'm not nearly as leveraged as many) and this is another reason I require such a high return on my money. It's just too easy to wildly underestimate the risk here.. . . . . .
well said
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ajjulee
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Re: economics of landlording

Post by ajjulee »

EasilyConfused wrote:
letsgobobby wrote: As a novice in this field, I'm still trying to get my head around the idea that a property can be a better investment when it's mortgaged, a worse investment when it's paid for, and paying off the loan at some future date can have the effect of making an otherwise good investment into a bad one.
It's not because you're a novice, it's because you have common sense. This is another area where many real estate investors and I part company. Leverage is a way to amplify your returns in real estate the same way borrowing on your home to invest in VTSAX would be a way to amplify your returns in stocks. It may be a mathematically good play but you'd better have a very high risk tolerance. I do borrow to invest in real estate (although I'm not nearly as leveraged as many) and this is another reason I require such a high return on my money. It's just too easy to wildly underestimate the risk here.
I hope 'leverage' part is now understood based on EasilyConfused response.

Here are my thoughts. Assuming your SFH is in a great, stable neighborhood - there is certain premium one pays for that, a return of 5% is acceptable (or good) depending on your reasons for keeping it. Not everyone’s goal is to squeeze as much return as possible by taking on more risk. From your responses, I conclude that it’s not in your case. You are thinking of your rental property as a diversifier. You have other investments where you are taking risks (such as money in the market) and other sources of income that will allow for continuation of your current quality of life. You want to keep this property as a potential hedge against inflation, stock market declines and/or job loss at inconvenient times etc. In that case, a 5% return is not bad. Please include the cost of roof replacement every 15 years, painting cost every five or so years and other potential capital expenses such as water heater, etc., Make sure you have a good insurance policy against disasters. I think 45 to 55% of monthly rent is too high an amount for maintenance costs, specially for single family homes in good neighborhoods where turnover is lower and quality of tenants is high. I’m assuming you consider yourself not in full-time “landlording" business but using your previously-lived-in-SFH-and-now-renting as a diversifier for your investments - SS, Tax Deferred & Taxable Investments in the stock/bond markets, and Rental Property.

Difficulty is evaluating the odds of that neighborhood staying great and stable however long you want to keep the property. Hope my assumptions are not wrong and this makes sense.
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DVMResident
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Re: economics of landlording

Post by DVMResident »

Not quite enough information provided to give an exact recommendation. Some considerations:

Negatives:
*$1.5k/mo on a $250k property is not very attractive (middle-low for SFH)
*Most RE markets are richly valued and might be good time to get out
*Requiring a manager

Positives:
*On-cash returns are better due to leverage, but undefined: 8 years left of an undefined note duration, "low" (0-20%?) downpayment
*Solid renters market

Unknown:
*Appreciation potential
*Personal attachment to the area
*Net tax impact: depreciation offsetting of high professional income, ACA's taxes on unearned income (may come out to a near wash)

Personal call, but if this were my property I'd lean towards a selling due the middle-low returns.
TRC
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Re: economics of landlording

Post by TRC »

I'm in a similar situation and often ask myself the same question. Ours is a bit different though.

We bought a beach condo about 2 hours from our house that we rent out in the summer. Purchase price in 2010 was $405K. It has not appreciated that much, probably worth $425K now based on the last one that sold. We put down 200K on it and currently owe about $135K left on the note (15 year note @ 3% interest). We collect about 28K a summer in rent, which is break even for us...or a slight loss if we have repairs maintenance. Our mortgage is going down by about 10K a year. So for a 200K investment, we're gaining 10K in equity each year + any appreciation. Strictly financially speaking, we would have been better off investing the 200K in the stock market and just paid for a vacation up there. However, we use it a lot in the off season and save 2 weeks in the summer for our family. Once it's paid off in 9 years, we'll be 48. So for us, we actually get some enjoyment out of using the property.
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halfnine
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Re: economics of landlording

Post by halfnine »

letsgobobby wrote:...I'm not attached to this property emotionally, in any way. Just want to keep it if it is a good complement to a traditional 60/40 indexed portfolio, and want to dump it if it's a drag. If it's somewhere in the middle - which has been my sense - I will probably keep it for the diversification benefit....
That would be my take on it. Keep it for the diversification benefit provided your stock/bond allocation is the main driver. Whether it does well or poorly relative to the stock/bond portion will only be known in hindsight.
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Re: economics of landlording

Post by DVMResident »

letsgobobby wrote:...I'm not attached to this property emotionally, in any way. Just want to keep it if it is a good complement to a traditional 60/40 indexed portfolio, and want to dump it if it's a drag. If it's somewhere in the middle - which has been my sense - I will probably keep it for the diversification benefit....
+1. Looking at the numbers, it's likely the RE will out pace the stock market on a cash on-sale basis. And by a good margin. It's middle of the road for RE, but typical for SFH (multi-units have better ROIs, generally).

However, it's a drop in the bucket for you. I'd venture a guess you aren't chasing $100 bonuses for opening checking account just because it's not worth your time. Same deal here. Keep it if doesn't take time (which it shouldn't with a manager). Sell it if it's taking time. It's not going to shorten your FI time frame enough to be worth any kind of grief.
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Re: economics of landlording

Post by Stormbringer »

letsgobobby wrote:I own a single family rental that is valued at $250k and I collect $1500 in rent, is this a good long term investment?
I own 14 rental properties. I would not pay $250K for that rental stream, because I can do much better, at least in my market. I'd be willing to pay about $160K for a property in good condition in a stable neighborhood with those numbers.

That said, if you are in an area with rapid appreciation, it could still prove to be a good investment on a purely speculative basis.

Also, I wouldn't want to own that house without at least a 50% LTV mortgage on it.
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bigred77
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Re: economics of landlording

Post by bigred77 »

Meg77 wrote:
letsgobobby wrote:
petulant wrote:
letsgobobby wrote:
Meg77 wrote:This isn't a great rental property. After your basic fixed expenses (tax, ins and mgmt) you are only making $10,000 a year of the $250K asset for a total ROI of 4.0%. That's not great for a rental property; you should be making well above that to make the hassles and lack of liquidity worth it. Otherwise that $250K is better off invested in the stock market (or at least a REIT if you want real estate specific exposure) where you could easily get the same return or higher.

But your actual ROI isn't even close to 4% since you are assuming no maintenance, repairs or vacancies. On top of that you say you have a mortgage, so your cash flow may even be negative. Of course that means you are presumably building equity in addition to some appreciation on the property, and your return on equity may be higher at levels you are comfortable with. There are also tax advantages to holding this kind of investment (though not this one in particular).

I can't tell you if you'll wish you'd kept this property in 30 years. That's more of a personal preference. It will surely go up in value over that time - but so will most investments. You could probably make more of a return elsewhere - even with better residential rentals if that's what you want to invest in. But it's also OK to keep this, especially if you have lots of other riskier assets and no unmet goals the equity in this property could help you achieve. You already own it, and the transaction costs are certainly steep if you decide to sell.
Thanks for your thoughts Meg,

The figures listed include maintenance and repairs. Vacancy in this high demand area is around 1% in general and almost 0% in this particular neighborhood. The last 2 rentals have taken 8 days and 3 days to fill (so 11 days in 3 years of tenants).

Part of the economics of this unit and area is that there has been a lot of appreciation in both sales prices and rent rates over the last 4 years. We bought in the $180s and it probably would have rented for under $1000 at the time. So compared to the actual money I've put into this unit it is attractive to rent. However I realize I can sell and put some of the money elsewhere.

Cash flow is not an issue and this isn't an important part of our investments either way. I wanted to avoid discussing the implications of the mortgage because it will be paid off in 8 years and my real question is whether this is something I should keep 'forever' rather than just looking at the fact that I am currently able to leverage (through a mortgage) the rather small down payment I originally paid.
Correct me if I'm wrong, but I think you're disclaiming an interest in cash flow because you don't want us to be worried about whether you're paying out-of-pocket costs. But that's not the reason I brought it up. I think there are three main ways to make money on a residential property: cash flow, leverage, or appreciation. Whether you'll appreciate having the house in 30 years depends on what combination of those things you're using to make money. If you were just going to pay off the property right now and hold it with the 5% ROA forever--probably not worth it, given the headaches and risks. If you're going to use leverage well, it might up the ROE to 10% and make it an even better inflation hedge. So the mortgage/cash flow situation is huge.
thank you, I am not an experienced real estate invesor but it is strange to me that a property could be a good or bad investment depending on whether I owed money on it or not; and therefore the investment could go from bad to good (or good to bad) over an 8 year period depending solely on whether I had paid off my mortgage or not.
Whether you have a mortgage on a real estate investment matters because it impacts what your return really is. Let's assume a property worth $100K is providing net rental income of $1000 per month and appreciating $2000 per year. Your total return is therefore $14,000 per year. If the property has no mortgage, that's a 14% annual return on equity. If the property has a $70K mortgage, that's a 46.6% return on equity. And return on equity is what is really important, since that's the amount you can theoretically get out of the property and invest elsewhere. Of course having a mortgage would decrease your net rental income, but it would also add principal reductions to your total annual return. So it changes the picture dramatically.

It doesn't make sense to disregard cash flow and the impact of leverage, because if you do you're left only with appreciation as a form of return. Real estate generally appreciates at the rate of inflation, and if that's all you are getting then you may as well just own a CD or money market account instead. Cash flow is the most important element of residential real estate investment; it should be the foundation of the decision of whether to buy or sell. Appreciation is icing on the cake, but it's not a meal on its own.

For what it's worth, I recently faced this brutal truth and sold my former homestead which I'd been renting out for a few years. I loved that condo, it's in a great area, it was low maintenance, and it stayed rented. It didn't cash flow though because I still had a mortgage on it on a 15 year amortization. Like you, I justified keeping it because it had appreciated nicely and I was building equity each month even if I was losing a few hundred bucks on it. But I own a few other rentals and this was by far the worst performer purely from an ROE/ROI standpoint. Even once it was paid off I'd only earn 4-5% a year on it. And I had two other rental mortgages at 5%. So I sold it and paid one off. It was the smart investment decision, which I remind myself each time I walk by it and wistfully imagine that I could still own it. I can buy other rentals that will have better returns though - and that is after all the point of investing.
Well I know Meg is a vastly more experienced real estate investor than I am, so I would definitely place more weight on her advice, but I think you should try to delineate this decision into 2 parts: the investment decision and the financing decision.

The investment decision answers "is this property a good investment"? If I can buy a property for 100k that rents for 2k a month, thats probably a good investment decision even if I have to finance it with a hard money loan at an unattractive interest rate or take a shorter duration loan making it cash flow negative. If I were an active real estate investor I would run the economics on any potential investment (or currently held investment) by assuming a a cash purchase, expected maintenance, vacancy, and tax costs, expected appreciation rate, and build in a capital expense allocation for irregular replacement expenses. I agree most properties on average tend to go up roughly at the same rate as inflation, but maybe that's not a fair assumption if I'm specifically targeting gentrifying areas. This is probably most useful to rank different investment properties by order of attractiveness. It's essentially estimating unleveraged cap rates to the best of your ability. It's also probably a good idea to compare unleveraged cap rates against comparable properties (i.e. single family homes in working class neighborhoods. It probably would be misleading to compare one of those properties to a quad-plex in a horrible part of town or a new construction condo in a premier location).

The financing decision answers the question "how do I pay for this" AFTER I've already decided that a potential property (or currently held property) would make a good investment. With cheap enough financing I can probably make a poor investment property look pretty decent. I would want to know how much financing can this property support by looking at the estimated free cash flows. Do you have the ability to pay out of pocket if your rental goes cash flow negative for a short or extended period of time? How much risk do you want to layer on?

To me, a 4% - 5% unlevered cap rate would not be enough to entice me to commit to the risk and work involved with owning and operating directly held residential real estate unless I had a reason to expect above average price appreciation. Then again others obviously are enticed because those are pretty common cap rates across the city I live in as well.
Last edited by bigred77 on Mon Feb 20, 2017 7:10 pm, edited 1 time in total.
Stormbringer
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Re: economics of landlording

Post by Stormbringer »

letsgobobby wrote:As a novice in this field, I'm still trying to get my head around the idea that a property can be a better investment when it's mortgaged, a worse investment when it's paid for, and paying off the loan at some future date can have the effect of making an otherwise good investment into a bad one.
Let's say you have $200,000 to invest in real estate:
  • You can buy one house for $200,000 that has a $1,000 a month positive cash flow after all operating expenses.
  • Everything about the house (value, expenses, etc.) increases at the rate of inflation, let's say 2%.
If you paid cash, after one year, you would have $12,000 from the cash flow plus $4,000 in appreciation, or a $16,000 nominal profit (8% return).

Supposed that instead, you put 50% down on each of two identical houses. You take out a 5% mortgage, so you are paying about $10,000 per year in interest.

So now you have:
  • 2 x $12,000 in net rental income, minus $10,000 in interest = $14,000
  • 2 x $4,000 in appreciation = $8,000
So your profits went from $16,000 to $22,000, and now you have an 11% return on your $200,000 investment. On top of that you have twice the tax benefit to help shelter your profits, because you are depreciating two houses instead of just one.

What makes this work is that you have lowered your cost of capital. As an investor, you might want to get 10% on your money so the 8% return isn't very attractive to you. However, by taking on the bank as a partner, they are happy to get 5% on their money. You are giving the bank their required return, and keeping the surplus for yourself.
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furwut
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Re: economics of landlording

Post by furwut »

Years ago on a business/financial radio show the host used to give the a rule of thumb that monthly rent should be 1% of the value - in your case $2500/mo. That maybe high but I agree with the many others above that $1500/mo doesn't leave any room for the inevitable expenses.
petulant
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Re: economics of landlording

Post by petulant »

bigred77 wrote:
Meg77 wrote:
letsgobobby wrote:
petulant wrote:
letsgobobby wrote: Thanks for your thoughts Meg,

The figures listed include maintenance and repairs. Vacancy in this high demand area is around 1% in general and almost 0% in this particular neighborhood. The last 2 rentals have taken 8 days and 3 days to fill (so 11 days in 3 years of tenants).

Part of the economics of this unit and area is that there has been a lot of appreciation in both sales prices and rent rates over the last 4 years. We bought in the $180s and it probably would have rented for under $1000 at the time. So compared to the actual money I've put into this unit it is attractive to rent. However I realize I can sell and put some of the money elsewhere.

Cash flow is not an issue and this isn't an important part of our investments either way. I wanted to avoid discussing the implications of the mortgage because it will be paid off in 8 years and my real question is whether this is something I should keep 'forever' rather than just looking at the fact that I am currently able to leverage (through a mortgage) the rather small down payment I originally paid.
Correct me if I'm wrong, but I think you're disclaiming an interest in cash flow because you don't want us to be worried about whether you're paying out-of-pocket costs. But that's not the reason I brought it up. I think there are three main ways to make money on a residential property: cash flow, leverage, or appreciation. Whether you'll appreciate having the house in 30 years depends on what combination of those things you're using to make money. If you were just going to pay off the property right now and hold it with the 5% ROA forever--probably not worth it, given the headaches and risks. If you're going to use leverage well, it might up the ROE to 10% and make it an even better inflation hedge. So the mortgage/cash flow situation is huge.
thank you, I am not an experienced real estate invesor but it is strange to me that a property could be a good or bad investment depending on whether I owed money on it or not; and therefore the investment could go from bad to good (or good to bad) over an 8 year period depending solely on whether I had paid off my mortgage or not.
Whether you have a mortgage on a real estate investment matters because it impacts what your return really is. Let's assume a property worth $100K is providing net rental income of $1000 per month and appreciating $2000 per year. Your total return is therefore $14,000 per year. If the property has no mortgage, that's a 14% annual return on equity. If the property has a $70K mortgage, that's a 46.6% return on equity. And return on equity is what is really important, since that's the amount you can theoretically get out of the property and invest elsewhere. Of course having a mortgage would decrease your net rental income, but it would also add principal reductions to your total annual return. So it changes the picture dramatically.

It doesn't make sense to disregard cash flow and the impact of leverage, because if you do you're left only with appreciation as a form of return. Real estate generally appreciates at the rate of inflation, and if that's all you are getting then you may as well just own a CD or money market account instead. Cash flow is the most important element of residential real estate investment; it should be the foundation of the decision of whether to buy or sell. Appreciation is icing on the cake, but it's not a meal on its own.

For what it's worth, I recently faced this brutal truth and sold my former homestead which I'd been renting out for a few years. I loved that condo, it's in a great area, it was low maintenance, and it stayed rented. It didn't cash flow though because I still had a mortgage on it on a 15 year amortization. Like you, I justified keeping it because it had appreciated nicely and I was building equity each month even if I was losing a few hundred bucks on it. But I own a few other rentals and this was by far the worst performer purely from an ROE/ROI standpoint. Even once it was paid off I'd only earn 4-5% a year on it. And I had two other rental mortgages at 5%. So I sold it and paid one off. It was the smart investment decision, which I remind myself each time I walk by it and wistfully imagine that I could still own it. I can buy other rentals that will have better returns though - and that is after all the point of investing.
Well I know Meg is a vastly more experienced real estate investor than I am, so I would definitely place more weight on her advice, but I think you should try to delineate this decision into 2 parts: the investment decision and the financing decision.

The investment decision answers "is this property a good investment"? If I can buy a property for 100k that rents for 2k a month, thats probably a good investment decision even if I have to finance it with a hard money loan at an unattractive interest rate or take a shorter duration loan making it cash flow negative. If I were an active real estate investor I would run the economics on any potential investment (or currently held investment) by assuming a a cash purchase, expected maintenance, vacancy, and tax costs, expected appreciation rate, and build in a capital expense allocation for irregular replacement expenses. I agree most properties on average tend to go up roughly at the same rate as inflation, but maybe that's not a fair assumption if I'm specifically targeting gentrifying areas. This is probably most useful to rank different investment properties by order of attractiveness. It's essentially estimating unleveraged cap rates to the best of your ability. It's also probably a good idea to compare unleveraged cap rates against comparable properties (i.e. single family homes in working class neighborhoods. It probably would be misleading to compare one of those properties to a quad-plex in a horrible part of town or a new construction condo in a premier location).

The financing decision answers the question "how do I pay for this" AFTER I've already decided that a potential property (or currently held property) would make a good investment. With cheap enough financing I can probably make a poor investment property look pretty decent. I would want to know how much financing can this property support by looking at the estimated free cash flows. Do you have the ability to pay out of pocket if your rental goes cash flow negative for a short or extended period of time? How much risk do you want to layer on?

To me, a 4% - 5% unlevered cap rate would not be enough to entice me to commit to the risk and work involved with owning and operating directly held residential real estate unless I had a reason to expect above average price appreciation. Then again others obviously are enticed because those are pretty common cap rates across the city I live in as well.
You're right, if he was talking about buying this place up front. But he's already got it and is trying to decide whether to sell it. He's already said that's going to cost him 25K. And I think whether that 25K sales cost is worth it to free up his capital depends on his current financing state. Would you disagree?
bigred77
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Re: economics of landlording

Post by bigred77 »

petulant wrote:
You're right, if he was talking about buying this place up front. But he's already got it and is trying to decide whether to sell it. He's already said that's going to cost him 25K. And I think whether that 25K sales cost is worth it to free up his capital depends on his current financing state. Would you disagree?
I would actually. First I would decide if I wanted to be a landlord. Do I want to directly own residential real estate? It sounds like for the OP the answer is "yes, but only if the investment looks good enough"

I would run the unlevered economics with the current property against a number of currently on the market alternative properties that meet whatever criteria I require (i.e. If I am only willing to invest in rentals within a 30 mile radius of my home then that could be one). Make sure the alternatives are reasonably similar (no single family homes to condos or duplex's). That way I can get an idea if my property is a competitive investment property vs realistic alternatives.

Lastly, if I decide I want to be a landlord and this property would make for a good investment property, then i would investigate the financing. Can i refinance to lower the interest rate, extend the term to help cashflow, take cash out for some other, presumably better, alternative?

It's not just a sell it or not decision, its a process to decide:
Sell and invest the cash in my portfolio of financial assets
1031 exchange into a more favorable investment property
Keep as is
Keep and refinance to a longer term
Keep and pay off the mortgage with outside funds
Keep and refi to take cash out
etc.
an_asker
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Re: economics of landlording

Post by an_asker »

Stormbringer wrote:
letsgobobby wrote:As a novice in this field, I'm still trying to get my head around the idea that a property can be a better investment when it's mortgaged, a worse investment when it's paid for, and paying off the loan at some future date can have the effect of making an otherwise good investment into a bad one.
Let's say you have $200,000 to invest in real estate:
  • You can buy one house for $200,000 that has a $1,000 a month positive cash flow after all operating expenses.
  • Everything about the house (value, expenses, etc.) increases at the rate of inflation, let's say 2%.
If you paid cash, after one year, you would have $12,000 from the cash flow plus $4,000 in appreciation, or a $16,000 nominal profit (8% return).

Supposed that instead, you put 50% down on each of two identical houses. You take out a 5% mortgage, so you are paying about $10,000 per year in interest.

So now you have:
  • 2 x $12,000 in net rental income, minus $10,000 in interest = $14,000
  • 2 x $4,000 in appreciation = $8,000
So your profits went from $16,000 to $22,000, and now you have an 11% return on your $200,000 investment. On top of that you have twice the tax benefit to help shelter your profits, because you are depreciating two houses instead of just one.

What makes this work is that you have lowered your cost of capital. As an investor, you might want to get 10% on your money so the 8% return isn't very attractive to you. However, by taking on the bank as a partner, they are happy to get 5% on their money. You are giving the bank their required return, and keeping the surplus for yourself.
Perfect example, which explains one side of the coin. However, there is the other side of the coin as well, which folks sometime fail to consider when they leverage themselves to the hilt. Such folks go on and become "Dave Ramsey"s :oops:

Let's say that instead of appreciating by 2%, the house goes down in value by 2% per year.

Unleveraged example:
$12,000 from the cash flow plus (negative)$4,000 in appreciation, or a $8,000 nominal profit (4% return)

Leveraged example:
$14,000 from the cash flow plus (negative)$8,000 in appreciation, or a $6,000 nominal profit (1.5% return). Granted there is the double depreciation to fall back on (so, in this example, it might still end up tipping the scales toward this scenario).

But again, my point was not to say the unleveraged is always better. It is just that if you are leveraged, you need to be sure that you have enough emergency money lying around. It is just like being in stocks vs. cash/bonds. It is preferable to be leveraged when the real estate market is at a low (just like it is preferable to be into stocks when the stock market has bottomed out), but it is tough to tell if we are at the bottom or have a ways to go!
travellight
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Re: economics of landlording

Post by travellight »

I like real estate in general and have tried to look at it from a number of different angles. With this particular rental, I wouldn't do the deal if I were buying it now but considering you already have it, I don't know if the cost of the sales process is worth it, probably 50:50. Consider the benefits of depreciation... also, I think the expenses stated earlier are much higher than my own experience in doing this for ten years.

One way I look at real estate is taking the net income and figuring out how much of a stock portfolio I would have to have to throw that amount of income at me each year. Or an annuity yielding that same income... I found that it was more reachable through real estate than those other methods. Also, I have seen my net worth increase each year by more than my annual work salary which is already very substantial due to real estate.

I think it is worth having RE even if just for diversification.
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EHoops
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Re: economics of landlording

Post by EHoops »

Are you receiving the depreciation for the place on your taxes each year? I know some people don't know about this.

If you are and the rental does not cause you much stress, then it's an easy decision: keep it. The depreciation, cash flow, appreciation, and tax deductions make owning rentals in good locations a great choice.
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letsgobobby
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