ROI on your investment real estate

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travellight
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ROI on your investment real estate

Post by travellight »

I am just curious what other real estate investors are getting as ROI on their investment properties. I just ran this exercise and found that I am averaging an ROI of 10.3%. I have 6 properties and the ones I bought in 2007 are earning 4.5 to 6% whereas the ones I bought this year in this down market with rents rising are earning as high as 19%. I am under contract on a new property that will bring in an ROI of 14%.
Manbaerpig
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Post by Manbaerpig »

how are you evaluating the value of the property that is being rented?
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travellight
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Post by travellight »

Maybe I am not doing it correctly but this is my formula:

Numerator: annual rental income subtract annual mortage then subtract annual other costs (taxes, insurance, repairs, vacancy)

Denominator: money tied up in the property which is my down payment which is 20%

a real example is the most recent house I bought:

I am renting it for $2200/month. My mortgage cost is (30 yr fixed at 4.25%) is $984 per month. My annual other costs are under $5000 so I use $5000 as a conservative number. My denominator is 50K which is the 20% down; got the house for 250K.

That yields a numberator of 9592 and denominator of 50000 which is 19.1%.
chocolatemuffin
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Post by chocolatemuffin »

Where do you find houses that can rent for $26,400 per year but only sell for $250k?
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travellight
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Post by travellight »

I am investing in Salt Lake city, in some of their nicer neighborhoods. This particular house is in an area called The Avenues.
Manbaerpig
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Post by Manbaerpig »

you're renting single-family-homes out? I'm new to the field but whenever the topic of real-estate investing comes out those tend to be the black-sheep variety, multi-family dwellings I believe lend themselves to those types of valuations a bit better no? or perhaps those are multi-family dwellings... but if not, I think depreciation schedules and risks of asset value reduction should at least be represented with a single asterisk after the return you are picking eg 19.1%*
also I think you are missing upkeep/repairs/insurance/property tax/landscaping/your personal time/property managers but perhaps you did include all these already


another example,
Home Runs : Babe Ruth 714
: Barry Bonds 762*
: Henry Aaron 755


see what I did there?
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travellight
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Post by travellight »

I am a relative newbie at this so I don't know what you mean by the asterisk for depreciation schedules.

I did include taxes, insurance, repairs, vacancy and property management in the calculations.

It is a single family home. One of my properties is a duplex but the rest of SFRs.
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Post by john94549 »

My wife and I bought a condo in Maui in 1990. While it has constantly been in the rental pool since that time, I always found the calculation of ROI a bit daunting, and a bit pointless. The real benefit of all the accrued loss and depreciation comes when you retire, when you can start using up all those losses against your MAGI, when it finally dips below $150K. For now at least, those booked losses just roll over, and over, and over, until used. I should note we don't intend to ever sell the condo. We may use it more often in retirement, and will leave it to the kids. Recapture is not an issue.

I guess some would see that as another thing to add in the calculation.
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aja8888
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Post by aja8888 »

One thing to remember is that the depreciation expense you are taking yearly reduces the "cost basis" of the property. So when you sell it, assuming you will sell it for a gain, the gain is calculated based on the adjusted basis and your capital gains tax will be higher. That added tax will reduce the overall ROI on the investment.
Zippy01
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Post by Zippy01 »

Property one: Put $3,000 down for a four-plex in 1996, after expenses and taxes, net about $12,000 year, with the mortgage to be paid off in six years when my first child goes to college, giving us another $1,000/month net on the property for total net of $24K.

ROI: pretty nice!

Property two: Paid $55,000 cash for a duplex in 2000, no mortgage, after expenses and taxes, net about $7,000/year.

ROI: pretty nice!

I know many people have had horrible experiences with rentals, but for us, it's worked.
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travellight
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Post by travellight »

I think the ROI is kind of interesting to look at since it is an instrument to compare with other investment vehicles for that year. It is a snapshot.

I don't know where else to get ROIs above 10% without volatility. If anyone knows, I would love to hear about it.

I am not taking depreciation actively; I calculate those expenses for the ROI to reduce the income. This is how I think it will work when I sell these properties some day (which I don't plan to but that is a different discussion). Let's say in ten years I sell one of them for 300K and that I had bought it for 300K. Clearly no capital gains tax there. Let's go pie in the sky and say I sell that same property for 400K. For the 100K of "profit", I can offset that with all the passive costs accumulated each year. I would think my final profit is minimal with minimal capital gains to pay taxes on.
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Post by chocolatemuffin »

Only 2% ($5k/$250k) in annual expenses? That seems low. How much do you budget for repair and vacancy? Do you carry sufficient insurance? How much is the property tax in Salt Lake City?
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Post by john94549 »

ncounty wrote:I think the ROI is kind of interesting to look at since it is an instrument to compare with other investment vehicles for that year. It is a snapshot.

I don't know where else to get ROIs above 10% without volatility. If anyone knows, I would love to hear about it.

I am not taking depreciation actively; I calculate those expenses for the ROI to reduce the income. This is how I think it will work when I sell these properties some day (which I don't plan to but that is a different discussion). Let's say in ten years I sell one of them for 300K and that I had bought it for 300K. Clearly no capital gains tax there. Let's go pie in the sky and say I sell that same property for 400K. For the 100K of "profit", I can offset that with all the passive costs accumulated each year. I would think my final profit is minimal with minimal capital gains to pay taxes on.
If I understand you correctly ("I am not taking depreciation actively"), you might want to run your numbers through a CPA. The IRS doesn't care if you "take" depreciation or not on income property. It is imputed as if you had, and recaptured on sale at a 25% rate (versus 15% for ordinary capital gains for property held longer than a year). As one of our grand-daughters says: "it gets complicated."
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Mister Whale
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Post by Mister Whale »

You guys are doing better than I am (mine flow negative), but I've got 15-year mortgages on my two properties -- and I hope to keep the properties well into my retirement. I'm looking at them as an annuity of sorts.
" ... advice is most useful and at its best, not when it is telling you what to do, but when it is illuminating aspects of the situation you hadn't thought about." --nisiprius
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aja8888
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Post by aja8888 »

I agree with John94549 above. If you are filing tax returns and claiming the income and expenses as a rental property, then you should be taking depreciation expense as that is part of the expense to eventually replace the asset.

Seeing a CPA or tax professional is a good idea. I can't imagine what a headache it would be if you were audited by the IRS and had to re-file all your tax returns associated with the rental property.
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sportal
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Post by sportal »

ncounty wrote:My mortgage cost is (30 yr fixed at 4.25%) is $984 per month.
Based on that rate, is your mortgage a owner occupied or investor (non-owner occupied) mortgage?

If you own the property without the mortgage, it would bring your calculated ROI down to 8.6%.

Looks like the low mortgage rate, good rent to purchase price ratio, and low expenses make this a nice investment. Time to take a peak at the SLC listings.
aetos
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Post by aetos »

ncounty wrote:Maybe I am not doing it correctly but this is my formula:

Numerator: annual rental income subtract annual mortage then subtract annual other costs (taxes, insurance, repairs, vacancy)

Denominator: money tied up in the property which is my down payment which is 20%

a real example is the most recent house I bought:

I am renting it for $2200/month. My mortgage cost is (30 yr fixed at 4.25%) is $984 per month. My annual other costs are under $5000 so I use $5000 as a conservative number. My denominator is 50K which is the 20% down; got the house for 250K.

That yields a numberator of 9592 and denominator of 50000 which is 19.1%.
The reason you roil seems so high is because you considering the mortgage as an expense rather than splitting it between principle and interest and adding the principle to the denominator to raise your cost basis.
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sportal
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Post by sportal »

aetos wrote:The reason you roil seems so high is because you considering the mortgage as an expense rather than splitting it between principle and interest and adding the principle to the denominator to raise your cost basis.
In that case (using the same math), the ROI is 24% on Month/Year 1 of this mortgage ($275 monthly principal).
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Post by travellight »

I had 2 properties until this year when I acquired 4 more. I am basing my annual expenditures based on past experience over the last 4 years managing a duplex and a sfr. I have had a total of 3 weeks of vacancy in all properties, knock on wood. My property taxes are about 2200$ on a property worth 270-300K. I have full insurance with 500K liability. I took a high deductible ($1000) to keep my costs low. Insurance costs are less than 500/year. I am careful in selection of the properties and have had low repairs so it does come up to 5K per year per property.

Misterwhale: I have the same plan/strategy. I don't plan to sell these and when they are paid off, they are part of my retirement income.

I did the mortgages based on the standard theoretical 30 year fixed with 20% down just as an academic exercise. What I really did is different.

My accountant handles all the tax stuff which I don't really understand. What I think I get though is that my income does not allow me to take the costs off my income each year (too high earning) so those costs are "passive" and go into the basis to help me in the end when I sell. I don't know if that should be calculated in the ROI which I would think would or could fluctuate yearly based on rent and other costs having minor variances.
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Post by travellight »

sbtw, it took a lot of searching and many rejected offers to buy these properties at a good price. I would not say this is common even for SLC. It was be much harder to achieve here in San Diego where I live.

I read another real estate thread and was interested to read one poster (lumpr) who does not want anything that yields an roi below 20. That would be nearly impossible for me to achieve.... I think he did say these were edgy neighborhoods and I am doing the opposite; buying in the best neighborhoods.
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Post by chocolatemuffin »

How do you buy and manage a property in SLC while you are in San Diego? Do you hire a property management company?
Honobob
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Post by Honobob »

I have this 7 page real estate investment analysis that is very thorough. Thank you Twaddle.

http://www.mortgage-investments.com/res ... al-estate/

REAL ESTATE INVESTMENT ANALYSIS


This Excel worksheet has been provided free of charge by Mortgage-Investments.com, Inc.
Mortgage-Investments.com, Inc. are the only National Multiple Listing Service for Private Mortgages
This spreadsheet is copyright of Mortgage-Investments.Com, Inc. but you are invited
to forward this spreadsheet to friends and collegues intact, including the information above.

Mortgage-Investments.Com 8/17/2011
It's slowly dawned on me that we won the real estate lottery!
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FNK
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Post by FNK »

ROI is boring.

ROE on an underwater house is beyond infinite.
Honobob
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Post by Honobob »

Here's a 2003 purchase


% RETURN ON total EQUITY
Year 1 32.73%
Year 2 28.14%
Year 3 25.05%
Year 4 22.82%
Year 5 21.16%
Year 6 19.87%
Year 7 18.85%
Year 8 18.85%
Year 9 18.03%
It's slowly dawned on me that we won the real estate lottery!
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travellight
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Post by travellight »

what is ROE? what was the scenario on the roe on an underwater house?

those are amazing numbers honobob!

I manage the properties myself from san diego. My tenants call me directly when there is a problem and I have developed a network of "fixers" who value me as a customer and I have everything fixed within 24 hours, even if minor. Usually, even the same day. This keeps the tenants pretty impressed and happy. I started out just scanning craigslist and calling till someone answered, getting/negotiating a price with them and then arranging them to do the job. With time, some of these guys have settled into my "go to guys". 1 electrician, 1 master plumber, 1 inexpensive plumber and general handyman, 1 hvac guy. I average 3 issues or calls per year per property.

I have abundant financial resources to fall back on if there was a big problem. Each property is in its own LLC so my assets are adequately protected. That plus having high(er) liability coverage on my insurance policies help me sleep at night. After having paid a lawyer $800 for the first LLC, I've learned to do it myself online so my costs are small, less than $100 per LLC. Reminds me, I need to set up the next one.
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travellight
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Post by travellight »

thanks for that link, honobob. I ran my numbers; it was interesting. Return on initial equity was 40% and increased each year so that by year 10, it was 54%. Return on total equity though also was 40% in year one but decreased each year so it was 12% by year 10. I don't understand these two indices and why one gets better and the other one worse.
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FNK
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Post by FNK »

ncounty wrote:what is ROE? what was the scenario on the roe on an underwater house?
Return on equity. I may have invested a lot into the house (so ROI is OK but nothing special), but now that the value of the house dropped below zero, my equity is negative. Return divided by equity went through infinity at equity = 0 and came back as a negative number.

What the negative number means is that renting brings money but selling would cost money. In this situation, even negative cash flow would be profitable (if risky). The house should eventually pay itself off to positive equity.
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Post by travellight »

So what you're saying is if you bought a house for 300K and it is now worth 270K, income divided by equity is a negative number. Which translates to not selling but at least there is rental income as opposed to stock equity which can vanish and not have any yield?

I think ROI is still relevant because of rental income. That is annual income for that amount of money put in. To me, that is an advantage of real estate over stocks.... even if equity drops, there is still income to offset a bad scenario.
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Post by Honobob »

ncounty wrote:thanks for that link, honobob. I ran my numbers; it was interesting. Return on initial equity was 40% and increased each year so that by year 10, it was 54%. Return on total equity though also was 40% in year one but decreased each year so it was 12% by year 10. I don't understand these two indices and why one gets better and the other one worse.
Return on total equity adds your increasing equity from loan paydown and appreciation increases, etc. to your initial investment. THE POWER OF LEVERAGE!

The return on initial equity pretty much just counts your down payment. A good argument for low/no down strategies.

What numbers did you use for appreciation and rent increases? Most amatuer investors have no clue. Over a 33 year period I have experienced 7% annual rent increases and 9% compounded annual appreciation.
It's slowly dawned on me that we won the real estate lottery!
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Post by travellight »

I used 0% rent increases and 5% appreciation. I figured I was being a bit conservative but that is the current mood with this economy. If things look up, I'll be doing even better but I like the numbers even with a glum position.
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Post by travellight »

I would think return on total equity should then improve with each year but that is the line that appears to diminish each year to go from 40% to 12% at year 10.
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Post by Honobob »

ncounty wrote:I would think return on total equity should then improve with each year but that is the line that appears to diminish each year to go from 40% to 12% at year 10.
Try your example with all cash...with 50% down..with ZERO down! The increase in equity decreases the return on TOTAL equity because your equity is increasing, a good thing but seperate. THIS is the POWER of LEVERAGE!

It baffles me when people complain about their low returns in real estate because they have seen say $200,000 appreciation on a $100,000 property but the figgers show a low return on equity but they completely forget where the extra $200,000 in appreciation came from.

Think about it. Remember the increase in equity is paid by the tenant and the appreciation fairy!! :wink:
It's slowly dawned on me that we won the real estate lottery!
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Post by Honobob »

ncounty wrote:I used 0% rent increases and 5% appreciation. I figured I was being a bit conservative but that is the current mood with this economy. If things look up, I'll be doing even better but I like the numbers even with a glum position.
Thanks for sharing, but would you sign a 10 year lease TODAY with no increases? Real estate is long term unless you really have a plan for a flip!

5% appreciation? Could be correct, I don't know your NBHD. Here ya go!

http://www.neighborhoodscout.com/ca/san ... ape/#rates

Check out the DIFFERENT appreciation rates IN THE SAME TOWN OVER THE SAME PERIOD! And yet there are posters here that want people to believe that ALL properties in the USA appreciate at the SAME rate! OMG.

I didn't know all this when I started out and there was no internet, but I saw that rents were increasing and PROPERTY values were increasing. Seems like you know that also.
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Post by Honobob »

ncounty,

Oops! Looks like I got your investment area mixed with your home.

http://www.neighborhoodscout.com/ut/sal ... las/#rates

I also manage my properties from a distance but in an area I lived, like to visit and will retire to, Honolulu. Do you have a connection to SLC or did you just pick it as a possible growth area?
It's slowly dawned on me that we won the real estate lottery!
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Post by hicabob »

ncounty wrote:what is ROE? what was the scenario on the roe on an underwater house?

those are amazing numbers honobob!

I manage the properties myself from san diego. My tenants call me directly when there is a problem and I have developed a network of "fixers" who value me as a customer and I have everything fixed within 24 hours, even if minor. Usually, even the same day. This keeps the tenants pretty impressed and happy. I started out just scanning craigslist and calling till someone answered, getting/negotiating a price with them and then arranging them to do the job. With time, some of these guys have settled into my "go to guys". 1 electrician, 1 master plumber, 1 inexpensive plumber and general handyman, 1 hvac guy. I average 3 issues or calls per year per property.

I have abundant financial resources to fall back on if there was a big problem. Each property is in its own LLC so my assets are adequately protected. That plus having high(er) liability coverage on my insurance policies help me sleep at night. After having paid a lawyer $800 for the first LLC, I've learned to do it myself online so my costs are small, less than $100 per LLC. Reminds me, I need to set up the next one.
I'm not sure that works - setting each one up as an LLC? - Our old factory landlord - in your neck of the woods, Escondido, did that then tried to default on 4 and keep 1 after second mortgaging to the hilt - not yet decided legally but I thought it seemed excessively aggressive.
Prudent Saver
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Post by Prudent Saver »

The ROI calc should include any change in property value. Ignoring it makes the resulting number as useless as the concept of amortized cost.
Be greedy when others are fearful, and fearful when others are greedy.
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travellight
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Post by travellight »

Is there a formula that you use for that, prudent saver? I looked it up online and found that formula but it is simplistic.

Honobob: I have my second home in Park City which is why I invest in SLC. I have had my second home for 20 yrs and only got into the investment properties in 2007. It is just efficient to recreate and manage this side business interest.

The LLCs have nothing to do with defaulting; it is all about asset protection and you can't be too careful imo when it comes to that, when you have significant assets. It is very very cheap to set up and what it does is shield you as the individual from any risk related to that investment property. If a tenant gets blazingly drunk and falls down the porch stairs and sues you, the most they could possibly get is the amount of equity in THAT property. If you own many other properties, they can't access your net worth. There is nothing shady about forming LLCs, imo.
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Post by Prudent Saver »

IRR and MIRR may be useful tools for you. They are discussed at length at various websites.
Be greedy when others are fearful, and fearful when others are greedy.
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Post by Honobob »

chocolatemuffin wrote:Where do you find houses that can rent for $26,400 per year but only sell for $250k?
That represents a GRM (gross rent multiplier) of 9.5. It is my understanding that 10 GRM is typical for midwest. My rentals are more in the mid teens but I can count on higher rent increases and appreciation.

In San Francisco I have seen GRM's in the 30's!

What area are you in that have lower GRM's?
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Post by chocolatemuffin »

Honobob wrote:
chocolatemuffin wrote:Where do you find houses that can rent for $26,400 per year but only sell for $250k?
That represents a GRM (gross rent multiplier) of 9.5. It is my understanding that 10 GRM is typical for midwest. My rentals are more in the mid teens but I can count on higher rent increases and appreciation.

In San Francisco I have seen GRM's in the 30's!

What area are you in that have lower GRM's?
I think you have misunderstood me. I wasn't thinking ncounty's GRM is high, I was thinking it's low. I live in the Silicon Valley area, and the GRM is really high here (easily 15 to 20, and as you said it could be over 30 for the really nice neigborhoods).

I am interested in buying some rental properties, so I digged around a bit more after reading this post and found some lower GRM properties here, but they are mostly condos in San Jose South with relatively poor schools.
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Post by travellight »

I am buying nice homes in SLC. I am under contract right now on one that should have a GRM of 12-13.
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Post by chocolatemuffin »

Any concern about having multiple properties in the same city? If the local economy turns sour, or if a natural disaster strikes a region, it could impact the values of several properties at the same time.
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Post by travellight »

There are pros and cons to this strategy.

The pros are: it is easier to manage to concentrate all your research and knowledge base and service people in one place. The cons are what you mentioned so it behooves you to have picked your location carefully. I chose Salt Lake city because Utah is a very business friendly state and I think it is less likely to lose jobs as a result.

One of the tips I got from this forum that reinforced my methodology was to focus your efforts in what you know. There was a thread from February that was a great read with some terrific tips from lurkr. If you are interested, I can find it and try to give you a link. (as an aside, lurkr's threshold of what he would buy make me look like a patsy. He wants an ROI of over 20% and high cocr (cash on cash return?)). He does that by buying in edgier neighborhoods where buy-in costs are low and buying multi-unit properties. I chose to do the opposite because it suits my temperament and managing abilities; I realize that it may limit my ROI and COCR but I sleep better at night and I think the numbers are still terrific. I had one of those "slumlord" properties that was so cheap to get into that it was irresistible. It was a nightmare to manage and I ended up selling it (got full price with seller financing) and I am now the "bank" on it and I get 8% interest on my money; love it. I could do that all day long, lol.
bb
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Post by bb »

Not saying it is correct but I prefer to look at return as net divided by purchase price and compare to other investments such as stocks
and bonds - neither of which I am going to employ leverage.
I have x dollars - which offers a better return - investment x,y, or z.
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Post by Sammy_M »

In my opinion, capitalization rate is the best way to look at it, using current market value after selling expenses for the denominator. That is, if you're comparing to other investments.

Image

Your debt is equivalent to a negative bond. It doesn't matter what is being used as collateral to obtain it.

Your asset is appreciating over time hopefully, so it's current value after selling expenses is what should matter for financial decisions.

Including management fees, my single-family rentals in the Southeast US are running with a cap rate of 6-9%.

I expect rents and property values to roughly keep pace with inflation, so I expect total real returns to be similar to the above. The tax advantages are such that after tax returns should not be too far off of that mark. Buying distressed properties at a discount might bump overall returns up a hair.
chocolatemuffin
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Post by chocolatemuffin »

ncounty wrote:
There was a thread from February that was a great read with some terrific tips from lurkr. If you are interested, I can find it and try to give you a link.
That would be great. Thanks a lot.
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Post by chocolatemuffin »

Do you hold your properties in a tax-advantaged account? If the rent is high relative to expenses and depreciation, then the tax bill could really dampen the after-tax return. In particular, I live in California so there will be another 10% tax in addition to federal tax.
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travellight
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Post by travellight »

here is the link on that real estate thread: http://www.bogleheads.org/forum/viewtop ... highlight=

if it doesn't open, it is titled "Michael masterson, practical advice on real estate".

I don't know of a tax advantaged account to hold them in; can you elaborate on that? They are just held by my individual LLCs. I don't know how to put LLCs in a 401K if that is what you mean.

You are right though; for most people the real estate scenario is so good that there would otherwise be tax risk exposure that would lower your ROI.


I live in California as well and am in the 35% federal tax group and 10% for state, plus self employment tax, AMT, etc. It's awful; I am salaried so there is no shielding it from taxes. I hope to buy one place in Washington state to be my primary residence after retirement as there is no state income tax there and it would save me the 10% of state income tax.
chocolatemuffin
Posts: 155
Joined: Thu Apr 28, 2011 1:56 am

Post by chocolatemuffin »

ncounty wrote:here is the link on that real estate thread: http://www.bogleheads.org/forum/viewtop ... highlight=

if it doesn't open, it is titled "Michael masterson, practical advice on real estate".
Thanks. The thread has tons of information! I'm sure I'll go back to it again and again.
ncounty wrote: I don't know of a tax advantaged account to hold them in; can you elaborate on that? They are just held by my individual LLCs. I don't know how to put LLCs in a 401K if that is what you mean.
I read some articles, such as this one - http://www.foxnews.com/story/0,2933,199795,00.html, which mentions the possibility of putting a rental property inside of an IRA account. It seems complicated, but does provide a lot of tax advantage if the income is high.
Lumpr
Posts: 335
Joined: Tue May 19, 2009 2:23 pm

Post by Lumpr »

Sammy_M wrote:In my opinion, capitalization rate is the best way to look at it, using current market value after selling expenses for the denominator. That is, if you're comparing to other investments.

Image

Your debt is equivalent to a negative bond. It doesn't matter what is being used as collateral to obtain it.

Your asset is appreciating over time hopefully, so it's current value after selling expenses is what should matter for financial decisions.

Including management fees, my single-family rentals in the Southeast US are running with a cap rate of 6-9%.

I expect rents and property values to roughly keep pace with inflation, so I expect total real returns to be similar to the above. The tax advantages are such that after tax returns should not be too far off of that mark. Buying distressed properties at a discount might bump overall returns up a hair.
+1

IMHO - the Cap Rate is the single best metric for rental property analysis (it is the first number I calculate when I look at something).
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