Bogleheads.org

Can anyone provide their thoughts on why 'Paid for' (in my own cash) Real Estate Investing is a no brainer or not a no brainer? That could be in comparison to it being leveraged (via a mortgage) vs. investing in something else entirely.

I think I understand some of the risks if investing in real-estate and it is leveraged via a mortage, but if I have cash to pay for say a $90,000 property which I do, I feel like I'm just loaning out my existing money and getting it back slowly over time by someone 'maybe' paying me monthly rent. Figure a theoretical rent of $450/month (made that up) = $5,400/year. (minus whatever expenses to maintain I guess - what would those be?..and I guess it depends on what the renter is responsible for vs. what I want to provide if anything and I don't know what is 'typically' done (?))

Where at some point a long time in the future I'll actually get my $90,000 of cash back at that rent rate in about 16.6 Years! Then in theory I may be able to sell this property for $90,000 and some small appreciation (fingers crossed I guess, 16 years anything could happen and I'll be approaching age 60) versus another use of that $90,000 in cash and say buying 9 used cars at $10,000 that are undervalued (for whatever reason) and hoping to sell each at $12,000 and making a $2,000 profit per car = $18,000 that could be done over say the next 6 months, seems like a lot less risky. Or putting it in the Stock Market alternatively.

As well - if I didn't have the $90,000 and I had a mortgage on top of this vs. paying cash for the real estate, how on earth could that somehow be 'better'?

Someone enlighten me as to what I'm not following/understanding that has done it/does it. Would love to learn and understand a bit!

Off the top of my head.....

It takes some number of months to rent out the unit. Say 2. That's minus $900.
You need to do some expected repairs. I'll throw out a conservative number of $1100.
You pay property tax. Let's pull a number out of the air and say $2000.
Your renter leaves in the middle of the night at month 10 in your ownership and you can't find them. You keep a month of security deposit and lose a month of rent. Minus $450.
Likely, this renter did at least some damage to the rental. Figure $450 to bring it back to rentable condition.
There will be tax advantages but when you sell, some of these are given back. I don't know how to put a number on this.
You will spend your time managing this. Let's say you spend 100 hours a year and value your time at $10 an hour. That cost you $1000.

Compare all that to investing in something like VTI and getting back a conservative 5% for doing absolutely nothing and taking absolutely no work. If you wanted to make things equal in a different way, subtract that 100 hours from above and go work at McDonalds for 100 hours a year on weekends.

Oh....then you go to sell and the best you can do is $80k minus real estate agent fees.

lgb wrote: ↑Sat Jan 04, 2020 10:02 am Where at some point a long time in the future I'll actually get my $90,000 of cash back at that rent rate in about 16.6 Years!

You would plan to hold the monthly rent steady for 16.6 years?

This is clearly not the right business for you.

Then in theory I may be able to sell this property for $90,000 and some small appreciation (fingers crossed I guess, 16 years anything could happen and I'll be approaching age 60) versus another use of that $90,000 in cash and say buying 9 used cars at $10,000 that are undervalued (for whatever reason) and hoping to sell each at $12,000 and making a $2,000 profit per car = $18,000 that could be done over say the next 6 months, seems like a lot less risky.

So your plan is to purchase "undervalued" cars, but pay full value for properties? And you intend to flip the former in 6 months and the latter in 16+ years?

I'm not a landlord, nor would I wish to be. But I'm guessing you are comparing apples to doorknobs here.

Don't invest in anything you don't understand.

JoeRetire -

A lot of what you mention are things that could be true, but not what I specifically stated. You just filled in some assumptions that could or could not be true. I was doing a most basic calculation of if all goes well at the current (in theory) monthly, certainly you could increase rents, or the area could become depressed and not support the current rent forcing it to be lowered to not have increased 'vacancy'.

Nor did I say the $90,000 property was undervalued or overvalued or just right. In some areas all available properties could be considered overvalued, which I wouldn't get involved in. I would assume you'd always be looking for something undervalued - but since you brought it up - maybe people don't always think like that.

I do see and feel a lot of Jack FFR1846 mentions though.. It also seems like if you have a mortgage involved, you're really just participating in what others that can benefit in the real estate scene are selling - so banks get their interest %, real estate agents get their % later on, home improvement gets their fix it and flip possibilities, government gets their property tax interest etc... - it's like this 'thing/host' that supports a multitude of leeches in a broader sense....

JoeRetire - you're probably right though - it is apples and door knobs I guess. Just seeking to understand before considering investing is all, so will seek knowledge from those that are involved and are landlords. Thanks for the input!

In my world you buy real estate for one of three reasons;

1. To live in. You want control of where you live and control of some of your fixed expenses.

2. Speculative. You believe what you're buying is under valued and/or will increase value over a period of time.

3. Income. The ROI makes sense because of reason 2 or yields enough to off set the liquidity and expenses mentioned in prior posts.

Leverage can optimize the return if rates are cheap relative to the return. But it also increases risk if property values sink as we saw in 2008-2012 (and in other cycles). The one real benefit to the U.S. mortgage system is that 30 year mortgages are generally not "called" if values sink as they would if you had options on a stock. Therefore if you are patient and have the cash flow you can wait through a down cycle.

No guarantees. Real estate is local and all kinds of things can happen. Industries can die, water sources get polluted, et cetera. On the other hand you can hit a home run by buying on a dip and an area flourishes.

You pays your money and you takes your chances!

Beyond the "numbers".. . . .

Do you want to be in "business"? (R/E income property is a "business")
Do you want to be a landlord?
Do you want to build a R/E residential income property empire?
Are you willing to build and grow this business over many decades? (R/E income property is a slow business).
Do you have "deep pockets" to sustain periods of vacancy, high expenses, tenant lawsuits, etc?
Do you have a reliable and/or multiple income streams to support your growing new "business"?

. . . . . Do you want to be a businessman?

j

lgb wrote: ↑Sat Jan 04, 2020 10:02 am Someone enlighten me as to what I'm not following/understanding that has done it/does it. Would love to learn and understand a bit!

I have not followed it but the Bigger Pockets website is often mentioned as being a good website for professional real estate investors.

https://www.biggerpockets.com/

I'm not really sure just what you are asking but there are lots of people that make a good living being real estate investors and also car dealers. Both are also part time jobs so you also need to consider the time you are spending in addition to the return on your investment. There is also a lot of competition so neither is an undiscovered opportunity where there is easy money to be made.

One consideration with buying and selling cars is that in most states you will need to get a car dealers licences and you may not be able to do it legally out of your house because of zoning restrictions.

lgb wrote: ↑Sat Jan 04, 2020 10:02 am .....if I have cash to pay for say a $90,000 property ....

One thing I would caution you about is that even in a low cost of living area renting a $90K property will have a lot of special challenges. The problem is that someone could buy a property like that to live in and have a mortage payment of around $500 a month. Unless there is a special situation, like a college student, for most people the only reason to rent a property like that is because they have a lot of financial problems and drama going on in their life and they cannot qualify for a mortage.

The maintenance costs and expenses are also proportionally a lot higher. For example a new furnace or roof on an $180k house will not be anywhere near twice as expensive as for a $90K house.

Read this thread: viewtopic.php?f=2&t=269901

Yes, it is almost 700 posts long, and there is a fair amount of chaff amongst the wheat, but you can skim read it quickly and will soon work out to whom you should pay attention.

I can only comment on my own situation in answering your questions; others may have differing perspectives (and below is a repeat of what I have posted before).

I own 10 rental properties and have never sold one. The longest-held property I have has been rented out for 20 years. When I first started renting out that property, it barely broke even but now it generates cash. The depreciation means that I pay tax on a lower amount than my net income from those properties. However even if i were to sell it right now, the depreciation recapture - taxed at marginal rates - is dwarfed by the capital gains - taxed at LTCG rates* - on that same property. As others on this thread have said, with rentals, "time and inflation are your friends".

*which can be mitigated / delayed by doing a 1031 exchange.

Also, as Sandtrap says, this is not an "investment", it is a business.

Good luck!

lgb wrote: ↑Sat Jan 04, 2020 10:02 am Can anyone provide their thoughts on why 'Paid for' (in my own cash) Real Estate Investing is a no brainer or not a no brainer? That could be in comparison to it being leveraged (via a mortgage) vs. investing in something else entirely.

I think I understand some of the risks if investing in real-estate and it is leveraged via a mortage, but if I have cash to pay for say a $90,000 property which I do, I feel like I'm just loaning out my existing money and getting it back slowly over time by someone 'maybe' paying me monthly rent. Figure a theoretical rent of $450/month (made that up) = $5,400/year. (minus whatever expenses to maintain I guess - what would those be?..and I guess it depends on what the renter is responsible for vs. what I want to provide if anything and I don't know what is 'typically' done (?))

Where at some point a long time in the future I'll actually get my $90,000 of cash back at that rent rate in about 16.6 Years! Then in theory I may be able to sell this property for $90,000 and some small appreciation (fingers crossed I guess, 16 years anything could happen and I'll be approaching age 60) versus another use of that $90,000 in cash and say buying 9 used cars at $10,000 that are undervalued (for whatever reason) and hoping to sell each at $12,000 and making a $2,000 profit per car = $18,000 that could be done over say the next 6 months, seems like a lot less risky. Or putting it in the Stock Market alternatively.

As well - if I didn't have the $90,000 and I had a mortgage on top of this vs. paying cash for the real estate, how on earth could that somehow be 'better'?

Someone enlighten me as to what I'm not following/understanding that has done it/does it. Would love to learn and understand a bit!

OP, your questions show that you are just beginning a study of making real estate an investment. They also show you may also be a beginner on investments in general. In addition to resources on real estate, I would strongly urge you to review resources on corporate finance generally. That said, there is no shame in being a beginner so long as you keep an attitude of learning and openness.

The concept you are trying to understand on leverage is a concept for any business: capital structure. What you are asking is, why would I get a mortgage to make an investment if it doesn't make the return any higher? The answer is, you wouldn't. You only get a mortgage if the cost of the mortgage is less than the return on the investment. This is true for any business that can get a loan.

You can imagine any hypothetical business that requires $100,000 in investment and is expected to make 6% in profits every year after all expenses, subject to a bit of risk. Further, imagine there is no lack of opportunities to make this investment in units of $100,000. Further imagine that somebody is always willing to loan $50,000 on each unit of investment in this hypothetical business at, say, a rate of 4%.

For a single unit of investment, taking the loan reduces your overall investment to $50,000. You also get a new expense of $2,000 per year (.04 * 50,000). However, the pre-interest earnings are still expected to be about $6,000. That means you have after-interest earnings of $4,000. With an investment of $50,000, you just got an 8% return. That is higher than what you could have gotten investing only your own money.

Further, because you reduced your upfront investment from $100,000 to $50,000, you can now take on two units of investment rather than one. We mentioned above that there is no lack of opportunities for this investment in increments of $100,000. Now for the same $100,000, you could expect to make $8,000, or 8%, rather than $6,000, or 6%. The decision about how much of your own money (equity) to use or how much to borrow is called the capital structure.

The key wrinkle is risk, which we mentioned before. The leveraged capital structure has more risk.

Imagine one unit of the business has a bad day with a surprise $1,000 expense. In the original capital structure, your profit on a $100,000 business comes down $1,000 to $5,000, or 5%. You lost 1/6 (16.67%) of your return. In the new, leveraged capital structure for a single unit, your profit comes down $1,000 to $3,000, or 6% (3000/50000). You lost 1/4 (25%) of your return.

Alternatively, imagine that the investment must be sold at a bad time due to a personal emergency. The asset is sold for a 20% discount, or $80,000. In the original capital structure, you lose $20,000 or 20% of your original $100,000. In the leveraged capital structure for a single unit, you lose $20,000 or a whopping 40% of the original $50,000.

The same principles of capital structure apply in real estate. You only take on a mortgage if your expected return from the asset is higher than the expected expense. Then, for the same amount of capital, you take on more investments, like more rental units. This can be beneficial in real estate because rents are considered stable, the asset can often be held until an opportune time, and increasing the total number of assets mitigates risk by diversifying across properties.

Congratulations on taking investments and finance seriously. At this point, I would seriously encourage you to continue studying and thinking much more before actually plopping any money down on a serious investment like a rental property.

So, i’ll give you my thoughts as someone who has owned a rental property for a year, intends to buy more, and has done a lot of self education on the subject.

1) Rental properties take more work and more of an investment in self education than investing in index funds. You can get screwed in multiple ways if you’re not prepared, from failing to project all the expenses, to having unexpected and expensive repair issues, to failing to vet prospective tenants well and ending up with nightmare tenants, etc. Construction, tenant management, and deal analysis are all seperate areas of knowledge that can sink the unprepared investor. I’ve known and heard about many people who have had horrible experiences. Now, at this point you may be thinking that i’m saying that real estate is a lousy investment. That’s not what i’m saying at all. In fact, i think they might potentially be the best investment. However, these are some of the drawbacks.

2) Buying real estate in cash won’t give you a good return on your investment (unless you’re buying very good deals or in appreciating areas). Lets look at your numbers for a moment. You say you think you could buy a rental property for $90,000 and recieve $5,400 annually. Well, 5,400 divided by 90,000 is .06. In other words, it’s a 6% return on investment, and that’s without factoring expenses (vacancy, repairs, capital expenses, insurance, property taxes). Once you factor those things in, what will your return be?… 3 or 4%?… for a merely semi passive investment? Does that make any sense given that index funds (a completely passive investment) have historically gotten returns of around 8%?

3) Mortgages are a tool, and one that’s not available to other kinds of investors. Borrow money to buy stocks or crypto and you’ll probably ruin yourself. Borrow money to buy real estate and you could magnify your gains without necessarily taking on much risk.

lgb wrote: ↑Sat Jan 04, 2020 10:40 am JoeRetire -

A lot of what you mention are things that could be true, but not what I specifically stated.

I was simply commenting on what you actually wrote.

Nor did I say the $90,000 property was undervalued or overvalued or just right.

You were comparing your potential rental property purchase with purchasing "undervalued" cars.

Just seeking to understand before considering investing is all, so will seek knowledge from those that are involved and are landlords.

Being a landlord is a job. In that regard, it's unlike simple investing.

Watty wrote: ↑Sat Jan 04, 2020 12:47 pm

lgb wrote: ↑Sat Jan 04, 2020 10:02 am Someone enlighten me as to what I'm not following/understanding that has done it/does it. Would love to learn and understand a bit!

I have not followed it but the Bigger Pockets website is often mentioned as being a good website for professional real estate investors.

https://www.biggerpockets.com/

I'm not really sure just what you are asking but there are lots of people that make a good living being real estate investors and also car dealers. Both are also part time jobs so you also need to consider the time you are spending in addition to the return on your investment. There is also a lot of competition so neither is an undiscovered opportunity where there is easy money to be made.

One consideration with buying and selling cars is that in most states you will need to get a car dealers licences and you may not be able to do it legally out of your house because of zoning restrictions.

lgb wrote: ↑Sat Jan 04, 2020 10:02 am .....if I have cash to pay for say a $90,000 property ....

One thing I would caution you about is that even in a low cost of living area renting a $90K property will have a lot of special challenges. The problem is that someone could buy a property like that to live in and have a mortage payment of around $500 a month. Unless there is a special situation, like a college student, for most people the only reason to rent a property like that is because they have a lot of financial problems and drama going on in their life and they cannot qualify for a mortage.

The maintenance costs and expenses are also proportionally a lot higher. For example a new furnace or roof on an $180k house will not be anywhere near twice as expensive as for a $90K house.

I'd personally agree the thought that one must really give significant consideration to the "quality" of renter one would have when properties are available with a $500/month mortgage. There are people that seem to do just fine with rentals at that low of a price point, but personally it's not the type of tenant I'd want to deal with typically (and I do have rentals).