Direct Real Estate Returns

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psteinx
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Re: Direct Real Estate Returns

Post by psteinx » Thu Jul 19, 2018 2:03 pm

I realize that's a big blob of text. Some quick key points:

1) You've got to include costs, not just revenues, to do a decent analysis. I had to guess at a lot of these.

2) Particularly in the leveraged case, appreciation assumptions matter a LOT for returns (not for cash on cash, obviously, barring refinancings). This should be fairly obvious. Leverage a property appreciating at 4% or higher at 5:1 should produce great returns, if you can roughly break even on the cash flow side. This merits a fuller discussion, but in general, one should be wary of drawing strong conclusions about long term price appreciation from apparent price changes over short time frames - in particular the last 5-8 years or so coming out of the 2008-9 crisis.

3) On the leveraged side in particular, I think one should be aware that there are a variety of techniques that may work at relatively modest scales, but not at larger scales. To the simple example - WD claims 38.75% returns are rather easy. Echoing another poster - a $100K starting stake (not that unrealistic for many 30-35 year olds) grows to ~$1.85 billion in 30 years at that rate. If such high returns were so easy to achieve, consistently, by pretty much any reasonably intelligent investor, then there should be a lot more billionaires around, I would think...

StealthRabbit
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Re: Direct Real Estate Returns

Post by StealthRabbit » Thu Jul 19, 2018 2:10 pm

Direct RE is just another of many tools / investment options for those who elect to participate.
~10 - 12% Return on equity + Capital Asset appreciation = 13 - 17% net yield / yr over life of ownership. (if you buy wise, in a good market (for rents and resale).

I have used direct RE as ~30 -40% of investment portfolio for the last 40 yrs, probably considerably less post age 70 (quite a ways away for me)
I will probably do more commercial NNN, or business asset, rather than residential. RE comes with overhead (responsibility and time)

Many great resources / discussions here: (Bogleheads + FIRE)
viewtopic.php?t=233216

http://fifighter.com/finance/real-estat ... o-oranges/
viewtopic.php?f=1&t=254316&newpost=4027355

psteinx
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Re: Direct Real Estate Returns

Post by psteinx » Thu Jul 19, 2018 2:11 pm

WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.

So yea, I would laugh at the idea of only a 18-20% return on a leveraged real estate deal. The above scenario very closely approximates my worst performing property which I bought "Turnkey" so I didn't go out and find a good deal, just a boring property with property management in place.
This quote is just to call out the specific claims of WD, again, that I think are highly unrealistic.

38.75% annualized return

"typical deal found all over the U.S. and accessible to everyone."

The scenario closely approximates his "worst" performing property - turnkey with property management in place.

Again, 38.75% as basically a floor, on typical turnkey deals.

To be clear, while I think occasional big returns of 38%+ in a year may be possible, especially with leverage, I am highly skeptical of this as something routine, easy, that can be done at scale, with little hands-on involvement.

ignition
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Re: Direct Real Estate Returns

Post by ignition » Thu Jul 19, 2018 2:13 pm

ignition wrote:
Thu Jul 19, 2018 1:50 pm
WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.

So yea, I would laugh at the idea of only a 18-20% return on a leveraged real estate deal. The above scenario very closely approximates my worst performing property which I bought "Turnkey" so I didn't go out and find a good deal, just a boring property with property management in place.
I plugged your numbers in this calculator: https://www.calculator.net/rental-prope ... lator.html

It sais the IRR is about 16.38% if you hold the property for 30 years (i took the same assumptions as the calculator but changed monthly rent to 900$ and appreciation to 4%). Not sure if IRR is the same as annualized return? If so, this is a lot less than 38.75% (but still a very nice profit of course). Or is the calculator wrong?
Read some more about IRR and IRR probably overstates the annual return unless you can reinvest the cash flows received at the same return. Pretty interesting...

psteinx
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Re: Direct Real Estate Returns

Post by psteinx » Thu Jul 19, 2018 2:20 pm

Couple more points I wanted to emphasize, in comparing direct real estate returns versus returns from more typical financial instruments many folks here invest in (stocks, bonds, cash, (and various funds of these), CDs and the like).

1) The latter are almost entirely passive - require very minimal effort beyond the initial purchase (which itself can be done with little effort once you figure out your overall investment strategy).

2) The latter are generally non-recourse, whereas direct, leveraged, real estate may be recourse. Perhaps seems a remote concern during rosy times, but maybe loomed larger in 2009.

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knpstr
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Re: Direct Real Estate Returns

Post by knpstr » Thu Jul 19, 2018 2:47 pm

psteinx wrote:
Thu Jul 19, 2018 1:56 pm
One could certainly make both more and less generous assumptions.
Your numbers are right for the given ones you chose.
I don't know why anyone would buy a property that cash flows $284 a YEAR. Usually that would be only if the expected LARGE appreciation, but you put 1% for that. So you picked a terrible scenario and STILL came up with 19% return, which says something.

My 6-plex cash flows $10K (all expenses, Mortgage, and counting the cash set aside at 10% of gross rents for repairs to be used or rolled over into cash reserves for improvements)and I put $19,860 into purchase it (down payment, closing costs etc). It was an owner financed deal. Old landlord retiring and all rents were way below market.

Real estate isn't so easy that you can go out and buy any property at any price and just have great returns. At the same time, that doesn't mean there aren't opportunities for great returns out there either.

I personally don't "count" appreciation and inflation hedging in my returns or even depreciation tax savings. That isn't to say I don't get the benefit of that, but I don't count it. I like to follow my cash return and everything else is just a bonus. My area also doesn't appreciate very much, certainly less than national average.

Actual Numbers (yearly):
Gross rents: $37,020 standardized (no late fees, pet fees, early termination fees, etc included)
Utilities I pay: $6,600
Taxes/Insurance: $3,720
Loan payment (P&I): $9,027
Trash/Pest expense: $1,962
Maintenance allowance: $3,700 (true cost any given year may be more or less; so far has been less)
Vacancy allowance: $2,000 (true cost any given year may be more or less; so far has been less)
========================
Cash flow: $10,000
All cash invested $19,860
Cash on cash return: 50%

So far I have never exceeded the allowances so I roll those extra funds into a cash reserve. If reserve ever becomes exceedingly large I'll just re-invest those funds in property or VTSAX. I consider it "prepaid expenses" for my own return calculations although it is cash flow and taxed as such for the IRS.

*** I cannot and do not reinvest my cash at 50% returns yearly, so this is not a compounded annual growth rate. But this investment spits out $10K every year for a one time payment of $20K.
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

WanderingDoc
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Re: Direct Real Estate Returns

Post by WanderingDoc » Thu Jul 19, 2018 2:56 pm

KyleAAA wrote:
Thu Jul 19, 2018 1:40 pm
WanderingDoc wrote:
Thu Jul 19, 2018 12:39 pm
Stormbringer wrote:
Thu Jul 19, 2018 9:24 am
WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.
I'm sorry, but this is just wrong.

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns? It is also impossible, because if sustainable 38% returns were so widely available, there would be trillions of dollars pouring into real estate and bidding up property values to stratospheric levels until the returns came down to normal levels. A person who invested $20,000 at 38.75% for 30 years would have nearly $370 million by the time that house was paid off.

I have been investing in real estate for 23 years, own 15 buildings, and a management company that manages about 3,800 residential units. I have never seen sustained returns even approaching 38%, nor have any of the 100+ investors that we manage for. I have for brief periods of time, had returns like that in special situations (e.g. buying foreclosures for 50 cents on the dollar after the recession) but not sustainable, typical, or accessible to everyone.

The only time I've even seen numbers like that is when someone has come into our office all jazzed up after ordering some program off late night TV.
You just said "its absurd". You didn't even attempt to disprove it but giving a mathematical or even logical reason why you believe what you do.

Those are the returns. The principal paydown, appreciation, and inflation hedging are actual returns but they aren't "realized" immediately. But they would be included on a balance sheet. They aren't imaginary, they are real. Those are the returns of the worst property in my portfolio, which I bought with a 20% down loan in a city I've never been to. Two other properties I have refi'd ALL of my initial capital, meaning I have $0 of my money in the deal and they still pay me in the 5 ways I've outlined.

Just because most of America invests in a vehicle they were told is "good" by the media, word of mouth, bankers, and politicians, it doesn't mean there aren't alternatives.

I have laid the math out in gory and specific detail. The burden of proof is now on YOU. "Warren Buffet" is not a rebuttal or reason or explanation. Neither is calling it absurd.
We'll chat more when you've owned rentals through a major recession or real estate crash. It's been easy to get 30% returns in real estate over the last 7-8 years without any skill, and in fact I've done better, but when your local market is apprecating 8% and you're putting 20% down, it's almost impossible not to. Many of your "risk mitigation" techniques won't work when it comes down to it, you'll find. That said, make hay while the sun shines. Just don't expect 30%+ returns to last indefinitely without the risk showing up, because it will.
In my example, I used a conservative 4% appreciation.
Don't wait to buy real estate. Buy real estate, and wait. | Rent where you live, buy where others pay your mortgage for you.

WanderingDoc
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Re: Direct Real Estate Returns

Post by WanderingDoc » Thu Jul 19, 2018 3:02 pm

knpstr wrote:
Thu Jul 19, 2018 10:09 am
Stormbringer wrote:
Thu Jul 19, 2018 9:24 am
WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.
I'm sorry, but this is just wrong.

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns? It is also impossible, because if sustainable 38% returns were so widely available, there would be trillions of dollars pouring into real estate and bidding up property values to stratospheric levels until the returns came down to normal levels. A person who invested $20,000 at 38.75% for 30 years would have nearly $370 million by the time that house was paid off.

I have been investing in real estate for 23 years, own 15 buildings, and a management company that manages about 3,800 residential units. I have never seen sustained returns even approaching 38%, nor have any of the 100+ investors that we manage for. I have for brief periods of time, had returns like that in special situations (e.g. buying foreclosures for 50 cents on the dollar after the recession) but not sustainable, typical, or accessible to everyone.

The only time I've even seen numbers like that is when someone has come into our office all jazzed up after ordering some program off late night TV.
That would be return on year 1. Of course all of that return is not immediately re-investable necessarily. And some of it is speculative/estimated (the estimated for appreciaiton and inflation). For example, in his example 24% of that is equity/appreciation. It would not make sense to refinance to unlock that since the costs of doing so would wipe it out. So it isn't a 38% CAGR. However, that does not mean that the 38% return on year 1 is miscalculated.

Naturally returns can be VERY high at the start in real estate and gradually reduce to cap-rate if no equity is ever taken back out to invest in other areas. You already know this as you are a seasoned investor.

It'd be better to specifically rebut his estimates. Do you disagree with any of his assumptions on year 1?
Is 4% appreciation outrageous?
is 8% Cash flow outrageous?
Is 4% for principal pay down outrageous?
Is 3.75% for tax benefit/savings outrageous?
Is 3% inflation outrageous?

His estimate for year 1 total return is not far off in my opinion, but as I said, it isn't CAGR either which I think may be what people have a problem with, which is fair to point out.
Precisely. Tell me why my numbers are wrong or outrageous. They are rather on the conservative side. Cartoons and emotions are not sufficient to disprove mathematics, data, and real world experience.
Don't wait to buy real estate. Buy real estate, and wait. | Rent where you live, buy where others pay your mortgage for you.

WanderingDoc
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Re: Direct Real Estate Returns

Post by WanderingDoc » Thu Jul 19, 2018 3:30 pm

The very long post should have been quoted, not sure what happened.

1. Using a 1% appreciation rate is dishonest. I don't even think YOU believe that is accurate. Middle of America run of the mill markets are typically 3.5%. I like to invest in 5-6% appreciation markets but assuming 4% is not outrageous.
2. No one uses a 20 year loan on 1-4 unit properties. 30 year fixed is most common, so you should use that. 15 year has too many disadvantages so I wouldn't even entertain.
3. Principal paydown is a positive, not negative return - at least on this planet. If a tenant pays $950 per month in rent, and $200 of that goes directly and specifically to pay down the loan principal, it is indeed a return because the tenant payed it, not the owner. I directly increases my net worth - independent of fluctuating property values. It's a real return of 3-5%.
4. By definition, if a property returns 8% with an all cash purchase (no loan), Leverage, even a small amount say 40% LTV, will absolutely up the return on your DP.
5. Vacancy rates vary greatly, but SFHs are often 93-95% on the low end in average markets. I don't invest in the "average" house, investors get to hand-select specific
deals in specific markets. My colleagues and I routinely have had 97-98% occupancy in our markets. I always assume 95%.

ignition wrote:
Thu Jul 19, 2018 1:50 pm
WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
From a prior post, so I don't have to write it out again:

Buy a property at $100K, $20K down. Monthly rents of $900-$950. I personally buy in markets with 6-8% long term appreciation, but lets be very conservative and use the general longer-term real estate appreciation value across the entire U.S. - 4% annualized. Even though nobody buys every single house in the U.S.

Returns:
Appreciation of 4%: 5:1 Leveraged return of 20%.
Cash flow: 8%
Principal paydown by tenants: 4% (typically closer to 5%, but again I'll be worst case scenario)
Depreciation/net tax benefit: Depreciate $80K over 27.5 years = $3K per year, at a 25% tax rate this is $750, 3.75% return ($750 of $20K down payment is a 3.75% return annualized)
Inflation hedging/profiting: You pay the lender the same Principal and Interest over 30 years, in dollars that are worth less every single year, conservatively: 3% return

20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.

So yea, I would laugh at the idea of only a 18-20% return on a leveraged real estate deal. The above scenario very closely approximates my worst performing property which I bought "Turnkey" so I didn't go out and find a good deal, just a boring property with property management in place.
I plugged your numbers in this calculator: https://www.calculator.net/rental-prope ... lator.html

It sais the IRR is about 16.38% if you hold the property for 30 years (i took the same assumptions as the calculator but changed monthly rent to 900$ and appreciation to 4%). Not sure if IRR is the same as annualized return? If so, this is a lot less than 38.75% (but still a very nice profit of course). Or is the calculator wrong?
Don't wait to buy real estate. Buy real estate, and wait. | Rent where you live, buy where others pay your mortgage for you.

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knpstr
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Re: Direct Real Estate Returns

Post by knpstr » Thu Jul 19, 2018 3:41 pm

WanderingDoc wrote:
Thu Jul 19, 2018 3:02 pm
knpstr wrote:
Thu Jul 19, 2018 10:09 am
Stormbringer wrote:
Thu Jul 19, 2018 9:24 am

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns?
His estimate for year 1 total return is not far off in my opinion, but as I said, it isn't CAGR either which I think may be what people have a problem with, which is fair to point out.
Precisely. Tell me why my numbers are wrong or outrageous. They are rather on the conservative side. Cartoons and emotions are not sufficient to disprove mathematics, data, and real world experience.
The interesting part is Buffett only put $100 of his own money into his first partnership. That $100 become however many billions he is worth today. His partnerships were setup that he got a large part of the limited partners returns after reaching a return hurdle.

He always invested his personal investments (used to live off of) on the side. That's where his farm and his real estate investment (as quoted above) fits in (among other things). He had $174,000 after leaving Columbia and considered just outright retiring (at 26 years old) before he started his partnership.
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

ignition
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Re: Direct Real Estate Returns

Post by ignition » Thu Jul 19, 2018 3:50 pm

WanderingDoc wrote:
Thu Jul 19, 2018 3:02 pm
knpstr wrote:
Thu Jul 19, 2018 10:09 am
Stormbringer wrote:
Thu Jul 19, 2018 9:24 am
WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.
I'm sorry, but this is just wrong.

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns? It is also impossible, because if sustainable 38% returns were so widely available, there would be trillions of dollars pouring into real estate and bidding up property values to stratospheric levels until the returns came down to normal levels. A person who invested $20,000 at 38.75% for 30 years would have nearly $370 million by the time that house was paid off.

I have been investing in real estate for 23 years, own 15 buildings, and a management company that manages about 3,800 residential units. I have never seen sustained returns even approaching 38%, nor have any of the 100+ investors that we manage for. I have for brief periods of time, had returns like that in special situations (e.g. buying foreclosures for 50 cents on the dollar after the recession) but not sustainable, typical, or accessible to everyone.

The only time I've even seen numbers like that is when someone has come into our office all jazzed up after ordering some program off late night TV.
That would be return on year 1. Of course all of that return is not immediately re-investable necessarily. And some of it is speculative/estimated (the estimated for appreciaiton and inflation). For example, in his example 24% of that is equity/appreciation. It would not make sense to refinance to unlock that since the costs of doing so would wipe it out. So it isn't a 38% CAGR. However, that does not mean that the 38% return on year 1 is miscalculated.

Naturally returns can be VERY high at the start in real estate and gradually reduce to cap-rate if no equity is ever taken back out to invest in other areas. You already know this as you are a seasoned investor.

It'd be better to specifically rebut his estimates. Do you disagree with any of his assumptions on year 1?
Is 4% appreciation outrageous?
is 8% Cash flow outrageous?
Is 4% for principal pay down outrageous?
Is 3.75% for tax benefit/savings outrageous?
Is 3% inflation outrageous?

His estimate for year 1 total return is not far off in my opinion, but as I said, it isn't CAGR either which I think may be what people have a problem with, which is fair to point out.
Precisely. Tell me why my numbers are wrong or outrageous. They are rather on the conservative side. Cartoons and emotions are not sufficient to disprove mathematics, data, and real world experience.
According to the "rental property calculator", your IRR is only about 16.38% not an annualized return of 38.75%: https://www.calculator.net/rental-prope ... &x=84&y=23)

jminv
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Re: Direct Real Estate Returns

Post by jminv » Thu Jul 19, 2018 4:00 pm

Stormbringer wrote:
Thu Jul 19, 2018 9:24 am

I'm sorry, but this is just wrong.

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns? It is also impossible, because if sustainable 38% returns were so widely available, there would be trillions of dollars pouring into real estate and bidding up property values to stratospheric levels until the returns came down to normal levels. A person who invested $20,000 at 38.75% for 30 years would have nearly $370 million by the time that house was paid off.

I have been investing in real estate for 23 years, own 15 buildings, and a management company that manages about 3,800 residential units. I have never seen sustained returns even approaching 38%, nor have any of the 100+ investors that we manage for. I have for brief periods of time, had returns like that in special situations (e.g. buying foreclosures for 50 cents on the dollar after the recession) but not sustainable, typical, or accessible to everyone.

The only time I've even seen numbers like that is when someone has come into our office all jazzed up after ordering some program off late night TV.
I like the way you put it since the argument between whether it's really 20% or a touch under or the 38.75% isn't as illustrative as how you put it. Another example would be if an investor bought 1 x 100k house per year and put 20k down on each house then in 30 years he would have $1,324,232,089.86 at a 38.75% annual return. You can be a billionaire if you invest in 30 inexpensive rental homes in 30 years and put 20k down on each house. There are a lot of smart landlords out there who are not billionaires. Even taking the assumptions - including that both rental yields and home appreciation remain elevated - at face value, the return is around 20% which would actually give a final value to this strategy of $28,385,157.66. 'Conservative' ,sustained, and readily available 38.75% annualized returns is a good way to get investors for more properties.

gmaynardkrebs
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Re: Direct Real Estate Returns

Post by gmaynardkrebs » Thu Jul 19, 2018 4:06 pm

ignition wrote:
Thu Jul 19, 2018 3:50 pm
WanderingDoc wrote:
Thu Jul 19, 2018 3:02 pm
knpstr wrote:
Thu Jul 19, 2018 10:09 am
Stormbringer wrote:
Thu Jul 19, 2018 9:24 am
WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.
I'm sorry, but this is just wrong.

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns? It is also impossible, because if sustainable 38% returns were so widely available, there would be trillions of dollars pouring into real estate and bidding up property values to stratospheric levels until the returns came down to normal levels. A person who invested $20,000 at 38.75% for 30 years would have nearly $370 million by the time that house was paid off.

I have been investing in real estate for 23 years, own 15 buildings, and a management company that manages about 3,800 residential units. I have never seen sustained returns even approaching 38%, nor have any of the 100+ investors that we manage for. I have for brief periods of time, had returns like that in special situations (e.g. buying foreclosures for 50 cents on the dollar after the recession) but not sustainable, typical, or accessible to everyone.

The only time I've even seen numbers like that is when someone has come into our office all jazzed up after ordering some program off late night TV.
That would be return on year 1. Of course all of that return is not immediately re-investable necessarily. And some of it is speculative/estimated (the estimated for appreciaiton and inflation). For example, in his example 24% of that is equity/appreciation. It would not make sense to refinance to unlock that since the costs of doing so would wipe it out. So it isn't a 38% CAGR. However, that does not mean that the 38% return on year 1 is miscalculated.

Naturally returns can be VERY high at the start in real estate and gradually reduce to cap-rate if no equity is ever taken back out to invest in other areas. You already know this as you are a seasoned investor.

It'd be better to specifically rebut his estimates. Do you disagree with any of his assumptions on year 1?
Is 4% appreciation outrageous?
is 8% Cash flow outrageous?
Is 4% for principal pay down outrageous?
Is 3.75% for tax benefit/savings outrageous?
Is 3% inflation outrageous?

His estimate for year 1 total return is not far off in my opinion, but as I said, it isn't CAGR either which I think may be what people have a problem with, which is fair to point out.
Precisely. Tell me why my numbers are wrong or outrageous. They are rather on the conservative side. Cartoons and emotions are not sufficient to disprove mathematics, data, and real world experience.
According to the "rental property calculator", your IRR is only about 16.38% not an annualized return of 38.75%: https://www.calculator.net/rental-prope ... &x=84&y=23)
He should have put down 1%. Then his IRR would be 34.7%. Next to owning a dog, I'd say that IRR is the best way to make yourself feel like a master of the universe for doing absolutely nothing.

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knpstr
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Re: Direct Real Estate Returns

Post by knpstr » Thu Jul 19, 2018 4:42 pm

ignition wrote: According to the "rental property calculator", your IRR is only about 16.38% not an annualized return of 38.75%: https://www.calculator.net/rental-prope ... &x=84&y=23)
Correct return goes down as equity accumulates.
To keep rate of very return high you must do cash out refinancing.

Just to mention a 16% cagr is quite good as compared to stocks which are often said to be at 10% cagr, which some say that is too optimistic
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

CantPassAgain
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Re: Direct Real Estate Returns

Post by CantPassAgain » Thu Jul 19, 2018 4:59 pm

gmaynardkrebs wrote:
Thu Jul 19, 2018 4:06 pm
Next to owning a dog, I'd say that IRR is the best way to make yourself feel like a master of the universe for doing absolutely nothing.
Internal rate of return is the most comprehensive, honest way to report investment returns. What is the:

A) Date and amount of the beginning investment

B) What were the portfolio contributions and withdrawal amounts and dates during the measurement period, and

C) What is the ending investment amount and date.

From there you get the real picture of investment performance.

For real estate investments, one has to tweak a few definitions to get to the answer but it's essentially the same:

A) The beginning investment value is the out of pocket cash layout at the outset (downpayment, ALL financing costs, every penny out of pocket to make the deal happen)
B) Assume no contributions or withdrawals from the "portfolio"
C) What is the value of what the investor is entitled to at the end of the measurement period. This would be the FMV of the property minus mortgage obligations and accumulated cash flows (accumulated cash flows meaning all net cash flows of running the real estate business since day one with no adjustment for taking money out to live on/spend freely).

To me this is the best, most simple way to understand a real estate investment return.

WanderingDocs return numbers may be accurate for any particular investment for any particular year but each and every year compounded in perpetuity? No effing way.

But even so, the returns look pretty good, and so what? He is the right person in the right place at the right time and he is running a business (I don't care what he says otherwise) that has different risk reward characteristics than passively investing in the stock and bond markets.

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Abe
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Re: Direct Real Estate Returns

Post by Abe » Thu Jul 19, 2018 5:05 pm

Many years ago I read a book titled "How to Wake Up The Financial Genius Inside You", by Mark O. Haroldsen, a real estate guru at the time. A lot of the book is about the power of compounding and real estate investing. He talks about the four basic advantages (returns) of real estate investing: (1) cash flow (2) equity buildup (3) inflation (4) tax shelter. You can calculate these returns separately as a percent of out of pocket investment and come up with an extremely high return in aggregate. The problem IMO is that these returns are for the most part not compound returns. If I invest $20k in the stock market and assuming I could get 38.75% return, my $20k investment will grow to roughly $370 million in 30 years. If I invest $20k down in a $100k rental and I get the same 38.75% return calculated using the total return of cash flow, equity buildup, inflation and tax shelter, I don't think my investment will grow to $370 million in 30 years. :(
Slow and steady wins the race.

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Re: Direct Real Estate Returns

Post by KyleAAA » Thu Jul 19, 2018 5:05 pm

WanderingDoc wrote:
Thu Jul 19, 2018 2:56 pm
KyleAAA wrote:
Thu Jul 19, 2018 1:40 pm
WanderingDoc wrote:
Thu Jul 19, 2018 12:39 pm
Stormbringer wrote:
Thu Jul 19, 2018 9:24 am
WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.
I'm sorry, but this is just wrong.

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns? It is also impossible, because if sustainable 38% returns were so widely available, there would be trillions of dollars pouring into real estate and bidding up property values to stratospheric levels until the returns came down to normal levels. A person who invested $20,000 at 38.75% for 30 years would have nearly $370 million by the time that house was paid off.

I have been investing in real estate for 23 years, own 15 buildings, and a management company that manages about 3,800 residential units. I have never seen sustained returns even approaching 38%, nor have any of the 100+ investors that we manage for. I have for brief periods of time, had returns like that in special situations (e.g. buying foreclosures for 50 cents on the dollar after the recession) but not sustainable, typical, or accessible to everyone.

The only time I've even seen numbers like that is when someone has come into our office all jazzed up after ordering some program off late night TV.
You just said "its absurd". You didn't even attempt to disprove it but giving a mathematical or even logical reason why you believe what you do.

Those are the returns. The principal paydown, appreciation, and inflation hedging are actual returns but they aren't "realized" immediately. But they would be included on a balance sheet. They aren't imaginary, they are real. Those are the returns of the worst property in my portfolio, which I bought with a 20% down loan in a city I've never been to. Two other properties I have refi'd ALL of my initial capital, meaning I have $0 of my money in the deal and they still pay me in the 5 ways I've outlined.

Just because most of America invests in a vehicle they were told is "good" by the media, word of mouth, bankers, and politicians, it doesn't mean there aren't alternatives.

I have laid the math out in gory and specific detail. The burden of proof is now on YOU. "Warren Buffet" is not a rebuttal or reason or explanation. Neither is calling it absurd.
We'll chat more when you've owned rentals through a major recession or real estate crash. It's been easy to get 30% returns in real estate over the last 7-8 years without any skill, and in fact I've done better, but when your local market is apprecating 8% and you're putting 20% down, it's almost impossible not to. Many of your "risk mitigation" techniques won't work when it comes down to it, you'll find. That said, make hay while the sun shines. Just don't expect 30%+ returns to last indefinitely without the risk showing up, because it will.
In my example, I used a conservative 4% appreciation.
4% could only be considered conservative in the context of the last 8 years.

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Re: Direct Real Estate Returns

Post by KyleAAA » Thu Jul 19, 2018 5:07 pm

WanderingDoc wrote:
Thu Jul 19, 2018 3:02 pm
knpstr wrote:
Thu Jul 19, 2018 10:09 am
Stormbringer wrote:
Thu Jul 19, 2018 9:24 am
WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.
I'm sorry, but this is just wrong.

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns? It is also impossible, because if sustainable 38% returns were so widely available, there would be trillions of dollars pouring into real estate and bidding up property values to stratospheric levels until the returns came down to normal levels. A person who invested $20,000 at 38.75% for 30 years would have nearly $370 million by the time that house was paid off.

I have been investing in real estate for 23 years, own 15 buildings, and a management company that manages about 3,800 residential units. I have never seen sustained returns even approaching 38%, nor have any of the 100+ investors that we manage for. I have for brief periods of time, had returns like that in special situations (e.g. buying foreclosures for 50 cents on the dollar after the recession) but not sustainable, typical, or accessible to everyone.

The only time I've even seen numbers like that is when someone has come into our office all jazzed up after ordering some program off late night TV.
That would be return on year 1. Of course all of that return is not immediately re-investable necessarily. And some of it is speculative/estimated (the estimated for appreciaiton and inflation). For example, in his example 24% of that is equity/appreciation. It would not make sense to refinance to unlock that since the costs of doing so would wipe it out. So it isn't a 38% CAGR. However, that does not mean that the 38% return on year 1 is miscalculated.

Naturally returns can be VERY high at the start in real estate and gradually reduce to cap-rate if no equity is ever taken back out to invest in other areas. You already know this as you are a seasoned investor.

It'd be better to specifically rebut his estimates. Do you disagree with any of his assumptions on year 1?
Is 4% appreciation outrageous?
is 8% Cash flow outrageous?
Is 4% for principal pay down outrageous?
Is 3.75% for tax benefit/savings outrageous?
Is 3% inflation outrageous?

His estimate for year 1 total return is not far off in my opinion, but as I said, it isn't CAGR either which I think may be what people have a problem with, which is fair to point out.
Precisely. Tell me why my numbers are wrong or outrageous. They are rather on the conservative side. Cartoons and emotions are not sufficient to disprove mathematics, data, and real world experience.
In my experience, none of your numbers are conservative. They are certainly realistic in a strong market, but they are not at all conservative. A conservative estimate is one that would mostly hold even in a very poor market, and most of these won't and didn't in the last several recessions. And in fact, 8% cash flow is probably even on the optimistic side for many markets (perhaps not yours, but many). That's why I say to wait until you've been through a recession or two like the rest of us. You'll see. I think what people are trying to point out is that your limited real world experience is much less generalizeable than you think. And your 1st year return will naturally be much higher than your 10th year return. You aren't and probably can't compound at this rate, which is the point. I have made more than 30% in random years in the stock market, but that's not what matters.
Last edited by KyleAAA on Thu Jul 19, 2018 5:16 pm, edited 1 time in total.

ignition
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Re: Direct Real Estate Returns

Post by ignition » Thu Jul 19, 2018 5:13 pm

knpstr wrote:
Thu Jul 19, 2018 4:42 pm
ignition wrote: According to the "rental property calculator", your IRR is only about 16.38% not an annualized return of 38.75%: https://www.calculator.net/rental-prope ... &x=84&y=23)
Correct return goes down as equity accumulates.
To keep rate of very return high you must do cash out refinancing.

Just to mention a 16% cagr is quite good as compared to stocks which are often said to be at 10% cagr, which some say that is too optimistic
Not sure, according to the table the IRR in the first year is -17.97%.

Also please note this is not a 16% CAGR. It is a 16% IRR. A 16% IRR only becomes a 16% CAGR if you reinvest the cash flows you receive every year at a 16% CAGR. For example if you don't reinvest the cash flows in this particular case the CAGR is only about 10.61% (23K initial cash outlay + 451K profit = 474K)

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Pajamas
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Re: Direct Real Estate Returns

Post by Pajamas » Thu Jul 19, 2018 5:22 pm

ignition wrote:
Thu Jul 19, 2018 3:25 am
Tenant rights are pretty strong here and it usually takes at least 6 months to evict a tenant.
Tenant rights in the U.S. vary a lot by state and city. 6 months might seem pretty good to some landlords in some areas facing a tenant who knows how to work the system. There are even cases of people trying to claim ownership of a property they moved into without the owner even knowing or claiming long-term rental rights for a short-term AirBnB rental or similar. Of course there are a lot of bad landlords who abuse tenants, too.
Abe wrote:
Thu Jul 19, 2018 5:05 pm
If I invest $20k down in a $100k rental and I get the same 38.75% return calculated using the total return of cash flow, equity buildup, inflation and tax shelter, I don't think my investment will grow to $370 million in 30 years. :(
Well it certainly won't with your negative thinking! You create your own reality and it's better to think BIG.
Last edited by Pajamas on Thu Jul 19, 2018 5:29 pm, edited 1 time in total.

WanderingDoc
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Re: Direct Real Estate Returns

Post by WanderingDoc » Thu Jul 19, 2018 5:29 pm

KyleAAA wrote:
Thu Jul 19, 2018 5:07 pm
WanderingDoc wrote:
Thu Jul 19, 2018 3:02 pm
knpstr wrote:
Thu Jul 19, 2018 10:09 am
Stormbringer wrote:
Thu Jul 19, 2018 9:24 am
WanderingDoc wrote:
Thu Jul 12, 2018 6:51 pm
20% + 8% + 4% + 3.75% + 3% = 38.75% annualized return on your $20K down payment. The kicker here is that rental real estate returns very typically grow every year because if your expenses increase at the same level as rents, the way the math works, the difference becomes greater every year (kind of complex to explain here, so we can forget it and assume the 38% return).

Let me emphasize that this is a typical deal found all over the U.S. and accessible to everyone.
I'm sorry, but this is just wrong.

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns? It is also impossible, because if sustainable 38% returns were so widely available, there would be trillions of dollars pouring into real estate and bidding up property values to stratospheric levels until the returns came down to normal levels. A person who invested $20,000 at 38.75% for 30 years would have nearly $370 million by the time that house was paid off.

I have been investing in real estate for 23 years, own 15 buildings, and a management company that manages about 3,800 residential units. I have never seen sustained returns even approaching 38%, nor have any of the 100+ investors that we manage for. I have for brief periods of time, had returns like that in special situations (e.g. buying foreclosures for 50 cents on the dollar after the recession) but not sustainable, typical, or accessible to everyone.

The only time I've even seen numbers like that is when someone has come into our office all jazzed up after ordering some program off late night TV.
That would be return on year 1. Of course all of that return is not immediately re-investable necessarily. And some of it is speculative/estimated (the estimated for appreciaiton and inflation). For example, in his example 24% of that is equity/appreciation. It would not make sense to refinance to unlock that since the costs of doing so would wipe it out. So it isn't a 38% CAGR. However, that does not mean that the 38% return on year 1 is miscalculated.

Naturally returns can be VERY high at the start in real estate and gradually reduce to cap-rate if no equity is ever taken back out to invest in other areas. You already know this as you are a seasoned investor.

It'd be better to specifically rebut his estimates. Do you disagree with any of his assumptions on year 1?
Is 4% appreciation outrageous?
is 8% Cash flow outrageous?
Is 4% for principal pay down outrageous?
Is 3.75% for tax benefit/savings outrageous?
Is 3% inflation outrageous?

His estimate for year 1 total return is not far off in my opinion, but as I said, it isn't CAGR either which I think may be what people have a problem with, which is fair to point out.
Precisely. Tell me why my numbers are wrong or outrageous. They are rather on the conservative side. Cartoons and emotions are not sufficient to disprove mathematics, data, and real world experience.
In my experience, none of your numbers are conservative. They are certainly realistic in a strong market, but they are not at all conservative. A conservative estimate is one that would mostly hold even in a very poor market, and most of these won't and didn't in the last several recessions. And in fact, 8% cash flow is probably even on the optimistic side for many markets (perhaps not yours, but many). That's why I say to wait until you've been through a recession or two like the rest of us. You'll see. I think what people are trying to point out is that your limited real world experience is much less generalizeable than you think. And your 1st year return will naturally be much higher than your 10th year return. You aren't and probably can't compound at this rate, which is the point. I have made more than 30% in random years in the stock market, but that's not what matters.
Take a look at any real estate returns calculator with amortization to 10 years (or more). You will see that Year 1 returns are very typically the LOWEST, and it trickle a up from there.

The reason? It's a bit difficult to explain on this medium. Basically even if you assume the same %age for rents and expenses (pick a number, 2% or 3%), since rents to begin with are a higher dollar amount than expenses, 3% of $1000 is greater than 3% of $400, so mathematically if you plot out the chart which includes rents, expenses, and amortization - the absolute dollar amounts for rental yield and expenses separate farther and farther each year.

Outside of the math, real world investors who actually do this see this play out real time (ie. their properties tend to make more $$ at Year 10 vs. Year 1. So yeah, year 1 numbers are usually the worst, that's why when someone buys a "break even" property in say Seattle or Portland, first 3 years their cash flow may me $0, but after 10 years, they are earning $800-1200 per month in net income due to the way the math works out as I've tried to outline above.
Don't wait to buy real estate. Buy real estate, and wait. | Rent where you live, buy where others pay your mortgage for you.

WanderingDoc
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Re: Direct Real Estate Returns

Post by WanderingDoc » Thu Jul 19, 2018 5:37 pm

ignition wrote:
Thu Jul 19, 2018 5:13 pm
knpstr wrote:
Thu Jul 19, 2018 4:42 pm
ignition wrote: According to the "rental property calculator", your IRR is only about 16.38% not an annualized return of 38.75%: https://www.calculator.net/rental-prope ... &x=84&y=23)
Correct return goes down as equity accumulates.
To keep rate of very return high you must do cash out refinancing.

Just to mention a 16% cagr is quite good as compared to stocks which are often said to be at 10% cagr, which some say that is too optimistic
Not sure, according to the table the IRR in the first year is -17.97%.

Also please note this is not a 16% CAGR. It is a 16% IRR. A 16% IRR only becomes a 16% CAGR if you reinvest the cash flows you receive every year at a 16% CAGR. For example if you don't reinvest the cash flows in this particular case the CAGR is only about 10.61% (23K initial cash outlay + 451K profit = 474K)
My experience tells me otherwise. If accredited investor can get a 16-18% IRR investing in real estate 100% passively (we can and do) - I would never actively invest in individual deals that I control. There is a reason why we do, the upside is (much) greater than a 16-18% IRR.
I can refi 2 properties today that will give me back more in tax free $$ than I initially put down as the all-in down payment. Well, if they produce $6000 in net cash flow per year, the IRR is no where near 18%. It is many multiples of 18%. Those calculators dont account for equity capture via a cash out refinance. I don't have any property in my portfolio that returns less than 30%, save a single property I bought for fun in a city I've never been to.
Don't wait to buy real estate. Buy real estate, and wait. | Rent where you live, buy where others pay your mortgage for you.

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Re: Direct Real Estate Returns

Post by knpstr » Thu Jul 19, 2018 5:48 pm

ignition wrote:
Thu Jul 19, 2018 5:13 pm
knpstr wrote:
Thu Jul 19, 2018 4:42 pm
ignition wrote: According to the "rental property calculator", your IRR is only about 16.38% not an annualized return of 38.75%: https://www.calculator.net/rental-prope ... &x=84&y=23)
Correct return goes down as equity accumulates.
To keep rate of very return high you must do cash out refinancing.

Just to mention a 16% cagr is quite good as compared to stocks which are often said to be at 10% cagr, which some say that is too optimistic
Not sure, according to the table the IRR in the first year is -17.97%.

Also please note this is not a 16% CAGR. It is a 16% IRR. A 16% IRR only becomes a 16% CAGR if you reinvest the cash flows you receive every year at a 16% CAGR. For example if you don't reinvest the cash flows in this particular case the CAGR is only about 10.61% (23K initial cash outlay + 451K profit = 474K)
The year 1 is negative due to transaction costs since it assumes you sold at each given year. 8% of asset value in this case

Yes, thanks for pointing that difference out. Of course reinvesting your cash is an important part of capital allocation. As mentioned above some choose to cash out there equity To keep money working harder since property equity has a 0% rate of return, it drags on returns.
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

gmaynardkrebs
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Re: Direct Real Estate Returns

Post by gmaynardkrebs » Thu Jul 19, 2018 6:01 pm

When people talk about the IRR as X%, is that in real or nominal returns. The reason I ask, is that most of the calculators don't ask what the inflation rate is. it's very hard to evaluate a 30 year investment without using real dollars.

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Re: Direct Real Estate Returns

Post by psteinx » Thu Jul 19, 2018 6:11 pm

WanderingDoc wrote:
Thu Jul 19, 2018 3:30 pm
The very long post should have been quoted, not sure what happened.

1. Using a 1% appreciation rate is dishonest. I don't even think YOU believe that is accurate. Middle of America run of the mill markets are typically 3.5%. I like to invest in 5-6% appreciation markets but assuming 4% is not outrageous.
2. No one uses a 20 year loan on 1-4 unit properties. 30 year fixed is most common, so you should use that. 15 year has too many disadvantages so I wouldn't even entertain.
3. Principal paydown is a positive, not negative return - at least on this planet. If a tenant pays $950 per month in rent, and $200 of that goes directly and specifically to pay down the loan principal, it is indeed a return because the tenant payed it, not the owner. I directly increases my net worth - independent of fluctuating property values. It's a real return of 3-5%.
4. By definition, if a property returns 8% with an all cash purchase (no loan), Leverage, even a small amount say 40% LTV, will absolutely up the return on your DP.
5. Vacancy rates vary greatly, but SFHs are often 93-95% on the low end in average markets. I don't invest in the "average" house, investors get to hand-select specific
deals in specific markets. My colleagues and I routinely have had 97-98% occupancy in our markets. I always assume 95%.
1) I think 1% is reasonable, at least in my area (St. Louis) for the kinds of older properties that will tend to throw off decent rental rates. Inflation is about 2%. Around here, the closer-in areas (city proper and working class inner-suburbs) have been in slow stagnation and decay for many decades, so I assume below inflation returns. OTOH, it might still be possible to do a little better, in terms of rent to price, than your figures. I haven't followed things closely recently, and in any case there's kind of a sliding scale between rent to price and long term appreciation (or depreciation) prospects - one could vary the ratios significantly around here by varying the neighborhoods/properties chosen.

2) Not sure about typical current norms so I picked 20 year as a crude midpoint between 15 and 30.

3) Money going to reduce principal doesn't directly change your return one way or another, but it lowers cash on cash return, absent refinancing. As I said, I think you muddled things by doing your analysis directly in leveraged form. I think it's better to start with an unlevered analysis, then go on to a levered analysis from there, as I've done.

4) Yes, if a property returns > interest rate, then leverage increases returns - we're in agreement*.

5) Vacancy rates vary by location, property type, and timeframe. I used 94% occupancy for my primary analysis - pretty similar to your 95%.

* Edit - that's a slight simplification. Assumes zero financing costs other than the interest rate itself, or, that those are effectively rolled into the interest rate. And this is for total returns only, not cash returns. Cash returns (flows) for an otherwise profitable property can be driven into the red, with leverage, particularly if a substantial part of the return comes from expected/actual appreciation. Absent refinancing/cash-outs, again...
Last edited by psteinx on Thu Jul 19, 2018 6:22 pm, edited 1 time in total.

KyleAAA
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Re: Direct Real Estate Returns

Post by KyleAAA » Thu Jul 19, 2018 6:20 pm

WanderingDoc wrote:
Thu Jul 19, 2018 5:29 pm
KyleAAA wrote:
Thu Jul 19, 2018 5:07 pm
WanderingDoc wrote:
Thu Jul 19, 2018 3:02 pm
knpstr wrote:
Thu Jul 19, 2018 10:09 am
Stormbringer wrote:
Thu Jul 19, 2018 9:24 am

I'm sorry, but this is just wrong.

It is absurd on it's face -- a bunch of amateur landlords routinely getting double Warren Buffett's annualized returns? It is also impossible, because if sustainable 38% returns were so widely available, there would be trillions of dollars pouring into real estate and bidding up property values to stratospheric levels until the returns came down to normal levels. A person who invested $20,000 at 38.75% for 30 years would have nearly $370 million by the time that house was paid off.

I have been investing in real estate for 23 years, own 15 buildings, and a management company that manages about 3,800 residential units. I have never seen sustained returns even approaching 38%, nor have any of the 100+ investors that we manage for. I have for brief periods of time, had returns like that in special situations (e.g. buying foreclosures for 50 cents on the dollar after the recession) but not sustainable, typical, or accessible to everyone.

The only time I've even seen numbers like that is when someone has come into our office all jazzed up after ordering some program off late night TV.
That would be return on year 1. Of course all of that return is not immediately re-investable necessarily. And some of it is speculative/estimated (the estimated for appreciaiton and inflation). For example, in his example 24% of that is equity/appreciation. It would not make sense to refinance to unlock that since the costs of doing so would wipe it out. So it isn't a 38% CAGR. However, that does not mean that the 38% return on year 1 is miscalculated.

Naturally returns can be VERY high at the start in real estate and gradually reduce to cap-rate if no equity is ever taken back out to invest in other areas. You already know this as you are a seasoned investor.

It'd be better to specifically rebut his estimates. Do you disagree with any of his assumptions on year 1?
Is 4% appreciation outrageous?
is 8% Cash flow outrageous?
Is 4% for principal pay down outrageous?
Is 3.75% for tax benefit/savings outrageous?
Is 3% inflation outrageous?

His estimate for year 1 total return is not far off in my opinion, but as I said, it isn't CAGR either which I think may be what people have a problem with, which is fair to point out.
Precisely. Tell me why my numbers are wrong or outrageous. They are rather on the conservative side. Cartoons and emotions are not sufficient to disprove mathematics, data, and real world experience.
In my experience, none of your numbers are conservative. They are certainly realistic in a strong market, but they are not at all conservative. A conservative estimate is one that would mostly hold even in a very poor market, and most of these won't and didn't in the last several recessions. And in fact, 8% cash flow is probably even on the optimistic side for many markets (perhaps not yours, but many). That's why I say to wait until you've been through a recession or two like the rest of us. You'll see. I think what people are trying to point out is that your limited real world experience is much less generalizeable than you think. And your 1st year return will naturally be much higher than your 10th year return. You aren't and probably can't compound at this rate, which is the point. I have made more than 30% in random years in the stock market, but that's not what matters.
Take a look at any real estate returns calculator with amortization to 10 years (or more). You will see that Year 1 returns are very typically the LOWEST, and it trickle a up from there.

The reason? It's a bit difficult to explain on this medium. Basically even if you assume the same %age for rents and expenses (pick a number, 2% or 3%), since rents to begin with are a higher dollar amount than expenses, 3% of $1000 is greater than 3% of $400, so mathematically if you plot out the chart which includes rents, expenses, and amortization - the absolute dollar amounts for rental yield and expenses separate farther and farther each year.

Outside of the math, real world investors who actually do this see this play out real time (ie. their properties tend to make more $$ at Year 10 vs. Year 1. So yeah, year 1 numbers are usually the worst, that's why when someone buys a "break even" property in say Seattle or Portland, first 3 years their cash flow may me $0, but after 10 years, they are earning $800-1200 per month in net income due to the way the math works out as I've tried to outline above.

No. Your return on your INITIAL investment tends to go up over time as rents go up, but you're also deleveraging so your IRR/CAGR are decreasing over time unless you are constantly doing cash-out refis. It's IRR/CAGR that describes how fast your wealth actually grows. It's easy to see why: if you are leveraged 5:1 your equity is going to go up much faster than the rent (not even counting equity paydown), so while you may earn more cash, it's on an even larger base of capital.
Last edited by KyleAAA on Thu Jul 19, 2018 6:27 pm, edited 1 time in total.

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knpstr
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Re: Direct Real Estate Returns

Post by knpstr » Thu Jul 19, 2018 6:25 pm

knpstr wrote:
Thu Jul 19, 2018 4:42 pm
ignition wrote: According to the "rental property calculator", your IRR is only about 16.38% not an annualized return of 38.75%: https://www.calculator.net/rental-prope ... &x=84&y=23)
Correct return goes down as equity accumulates.
To keep rate of very return high you must do cash out refinancing.

Just to mention a 16% cagr is quite good as compared to stocks which are often said to be at 10% cagr, which some say that is too optimistic
I put in the numbers for my property earlier. Using that calculator it says my $19,860 becomes $1,074,170 in 30 years. Or 14% cagr.
Putting $19,860 in vtsax at 10% for 30 years is only $346,545

Of course vtsax is where I park my yearly cash flow rather than just letting it sit. :beer
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

WanderingDoc
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Re: Direct Real Estate Returns

Post by WanderingDoc » Thu Jul 19, 2018 7:04 pm

KyleAAA wrote:
Thu Jul 19, 2018 6:20 pm
WanderingDoc wrote:
Thu Jul 19, 2018 5:29 pm
KyleAAA wrote:
Thu Jul 19, 2018 5:07 pm
WanderingDoc wrote:
Thu Jul 19, 2018 3:02 pm
knpstr wrote:
Thu Jul 19, 2018 10:09 am


That would be return on year 1. Of course all of that return is not immediately re-investable necessarily. And some of it is speculative/estimated (the estimated for appreciaiton and inflation). For example, in his example 24% of that is equity/appreciation. It would not make sense to refinance to unlock that since the costs of doing so would wipe it out. So it isn't a 38% CAGR. However, that does not mean that the 38% return on year 1 is miscalculated.

Naturally returns can be VERY high at the start in real estate and gradually reduce to cap-rate if no equity is ever taken back out to invest in other areas. You already know this as you are a seasoned investor.

It'd be better to specifically rebut his estimates. Do you disagree with any of his assumptions on year 1?
Is 4% appreciation outrageous?
is 8% Cash flow outrageous?
Is 4% for principal pay down outrageous?
Is 3.75% for tax benefit/savings outrageous?
Is 3% inflation outrageous?

His estimate for year 1 total return is not far off in my opinion, but as I said, it isn't CAGR either which I think may be what people have a problem with, which is fair to point out.
Precisely. Tell me why my numbers are wrong or outrageous. They are rather on the conservative side. Cartoons and emotions are not sufficient to disprove mathematics, data, and real world experience.
In my experience, none of your numbers are conservative. They are certainly realistic in a strong market, but they are not at all conservative. A conservative estimate is one that would mostly hold even in a very poor market, and most of these won't and didn't in the last several recessions. And in fact, 8% cash flow is probably even on the optimistic side for many markets (perhaps not yours, but many). That's why I say to wait until you've been through a recession or two like the rest of us. You'll see. I think what people are trying to point out is that your limited real world experience is much less generalizeable than you think. And your 1st year return will naturally be much higher than your 10th year return. You aren't and probably can't compound at this rate, which is the point. I have made more than 30% in random years in the stock market, but that's not what matters.
Take a look at any real estate returns calculator with amortization to 10 years (or more). You will see that Year 1 returns are very typically the LOWEST, and it trickle a up from there.

The reason? It's a bit difficult to explain on this medium. Basically even if you assume the same %age for rents and expenses (pick a number, 2% or 3%), since rents to begin with are a higher dollar amount than expenses, 3% of $1000 is greater than 3% of $400, so mathematically if you plot out the chart which includes rents, expenses, and amortization - the absolute dollar amounts for rental yield and expenses separate farther and farther each year.

Outside of the math, real world investors who actually do this see this play out real time (ie. their properties tend to make more $$ at Year 10 vs. Year 1. So yeah, year 1 numbers are usually the worst, that's why when someone buys a "break even" property in say Seattle or Portland, first 3 years their cash flow may me $0, but after 10 years, they are earning $800-1200 per month in net income due to the way the math works out as I've tried to outline above.

No. Your return on your INITIAL investment tends to go up over time as rents go up, but you're also deleveraging so your IRR/CAGR are decreasing over time unless you are constantly doing cash-out refis. It's IRR/CAGR that describes how fast your wealth actually grows. It's easy to see why: if you are leveraged 5:1 your equity is going to go up much faster than the rent (not even counting equity paydown), so while you may earn more cash, it's on an even larger base of capital.
Lets say I put down $40K on a property. My returns each year are $10,500, $11,000, $11,500, .... etc. So my RETURN ON INVESTMENT goes up every year - which is what I care about. I agree with you that the RETURN ON EQUITY goes down, absent cash refinances and 1031 exchanges. So the best thing is to reinvest the cash flow from rentals.. no argument there :)
Don't wait to buy real estate. Buy real estate, and wait. | Rent where you live, buy where others pay your mortgage for you.

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knpstr
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Re: Direct Real Estate Returns

Post by knpstr » Thu Jul 19, 2018 7:17 pm

WanderingDoc wrote:
Thu Jul 19, 2018 7:04 pm
KyleAAA wrote:
Thu Jul 19, 2018 6:20 pm

No. Your return on your INITIAL investment tends to go up over time as rents go up, but you're also deleveraging so your IRR/CAGR are decreasing over time unless you are constantly doing cash-out refis. It's IRR/CAGR that describes how fast your wealth actually grows. It's easy to see why: if you are leveraged 5:1 your equity is going to go up much faster than the rent (not even counting equity paydown), so while you may earn more cash, it's on an even larger base of capital.
Lets say I put down $40K on a property. My returns each year are $10,500, $11,000, $11,500, .... etc. So my RETURN ON INVESTMENT goes up every year - which is what I care about. I agree with you that the RETURN ON EQUITY goes down, absent cash refinances and 1031 exchanges. So the best thing is to reinvest the cash flow from rentals.. no argument there :)
Well you do have to consider total return Doc. Equity and all.
Same could be said of indexing. If you invest $23,000 @10% after 15 years that is 96,000 that year 10% is 9,600 or 41% return on initial investment.
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

WanderingDoc
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Re: Direct Real Estate Returns

Post by WanderingDoc » Thu Jul 19, 2018 7:24 pm

Yup. IMO the best metric for real estate is IRR. The best metric for indexing is CAGR.

With stocks and index funda, best case scenario you will pay 15% in capital gains tax. In real estate, I have legally payed zero every year, if not a small paper loss. Just another oft overlooked point.

knpstr wrote:
Thu Jul 19, 2018 7:17 pm
WanderingDoc wrote:
Thu Jul 19, 2018 7:04 pm
KyleAAA wrote:
Thu Jul 19, 2018 6:20 pm

No. Your return on your INITIAL investment tends to go up over time as rents go up, but you're also deleveraging so your IRR/CAGR are decreasing over time unless you are constantly doing cash-out refis. It's IRR/CAGR that describes how fast your wealth actually grows. It's easy to see why: if you are leveraged 5:1 your equity is going to go up much faster than the rent (not even counting equity paydown), so while you may earn more cash, it's on an even larger base of capital.
Lets say I put down $40K on a property. My returns each year are $10,500, $11,000, $11,500, .... etc. So my RETURN ON INVESTMENT goes up every year - which is what I care about. I agree with you that the RETURN ON EQUITY goes down, absent cash refinances and 1031 exchanges. So the best thing is to reinvest the cash flow from rentals.. no argument there :)
Well you do have to consider total return Doc. Equity and all.
Same could be said of indexing. If you invest $23,000 @10% after 15 years that is 96,000 that year 10% is 9,600 or 41% return on initial investment.
Don't wait to buy real estate. Buy real estate, and wait. | Rent where you live, buy where others pay your mortgage for you.

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Re: Direct Real Estate Returns

Post by KyleAAA » Thu Jul 19, 2018 7:27 pm

WanderingDoc wrote:
Thu Jul 19, 2018 7:24 pm
Yup. IMO the best metric for real estate is IRR. The best metric for indexing is CAGR.

With stocks and index funda, best case scenario you will pay 15% in capital gains tax. In real estate, I have legally payed zero every year, if not a small paper loss. Just another oft overlooked point.

knpstr wrote:
Thu Jul 19, 2018 7:17 pm
WanderingDoc wrote:
Thu Jul 19, 2018 7:04 pm
KyleAAA wrote:
Thu Jul 19, 2018 6:20 pm

No. Your return on your INITIAL investment tends to go up over time as rents go up, but you're also deleveraging so your IRR/CAGR are decreasing over time unless you are constantly doing cash-out refis. It's IRR/CAGR that describes how fast your wealth actually grows. It's easy to see why: if you are leveraged 5:1 your equity is going to go up much faster than the rent (not even counting equity paydown), so while you may earn more cash, it's on an even larger base of capital.
Lets say I put down $40K on a property. My returns each year are $10,500, $11,000, $11,500, .... etc. So my RETURN ON INVESTMENT goes up every year - which is what I care about. I agree with you that the RETURN ON EQUITY goes down, absent cash refinances and 1031 exchanges. So the best thing is to reinvest the cash flow from rentals.. no argument there :)
Well you do have to consider total return Doc. Equity and all.
Same could be said of indexing. If you invest $23,000 @10% after 15 years that is 96,000 that year 10% is 9,600 or 41% return on initial investment.

I can assure you, no RE investor has ever allowed anybody to overlook tax write-offs. More like oft-overstated.

Question: what's the difference between IRR and CAGR and why is IRR better for real estate and CAGR better for stocks?

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Re: Direct Real Estate Returns

Post by golfCaddy » Thu Jul 19, 2018 7:27 pm

Abe wrote:
Thu Jul 19, 2018 5:05 pm
Many years ago I read a book titled "How to Wake Up The Financial Genius Inside You", by Mark O. Haroldsen, a real estate guru at the time. A lot of the book is about the power of compounding and real estate investing. He talks about the four basic advantages (returns) of real estate investing: (1) cash flow (2) equity buildup (3) inflation (4) tax shelter. You can calculate these returns separately as a percent of out of pocket investment and come up with an extremely high return in aggregate. The problem IMO is that these returns are for the most part not compound returns. If I invest $20k in the stock market and assuming I could get 38.75% return, my $20k investment will grow to roughly $370 million in 30 years. If I invest $20k down in a $100k rental and I get the same 38.75% return calculated using the total return of cash flow, equity buildup, inflation and tax shelter, I don't think my investment will grow to $370 million in 30 years. :(
Why would you settle for 38% returns? Use 20 to 1 leverage and buy in housing markets with 6-8% appreciation. If you do it right, it should take 15 years max to reach $370 million.

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Re: Direct Real Estate Returns

Post by Stormbringer » Thu Jul 19, 2018 7:47 pm

WanderingDoc wrote:
Thu Jul 19, 2018 12:39 pm
You just said "its absurd". You didn't even attempt to disprove it but giving a mathematical or even logical reason why you believe what you do.

Those are the returns. The principal paydown, appreciation, and inflation hedging are actual returns but they aren't "realized" immediately. But they would be included on a balance sheet. They aren't imaginary, they are real. Those are the returns of the worst property in my portfolio, which I bought with a 20% down loan in a city I've never been to. Two other properties I have refi'd ALL of my initial capital, meaning I have $0 of my money in the deal and they still pay me in the 5 ways I've outlined.

Just because most of America invests in a vehicle they were told is "good" by the media, word of mouth, bankers, and politicians, it doesn't mean there aren't alternatives.

I have laid the math out in gory and specific detail. The burden of proof is now on YOU. "Warren Buffet" is not a rebuttal or reason or explanation. Neither is calling it absurd.
Here is my analysis of your hypothetical $100,000 home in Anytown, USA that rents for $950 a month.

I would add a few comments:

1. 20% down on a non-owner occupied home for 30-year fixed mortgage is limited to four properties (last I checked, but the change it from time to time), then it jumps to 25-30%. Also, there is a limit of 10 financed properties for Fannie Mae backed mortgages. Then there are points, and higher interest rates. Cash-out refinances on FNMA loans are a challenge as well. This limits your ability to scale before having to switch to ARMs.

2. As others have noted, your overall return on equity decays as you build equity in the property. If you want to keep getting high returns on your wealth (not just your initial investment) you will need to trade your properties for more, and larger ones over time. This introduces significant transaction costs into the equation.

3. In my experience, the biggest mistake investors make is underestimating maintenance costs. Sure, the seller might have left it in pristine condition for you but you need to accrue for roofs, furnaces, windows, kitchen and bath remodels, and any of the many expensive repairs that will come eventually. They also tend to completely ignore transaction costs (selling, refinancing, etc.) in their analyses.

4. Dr. Robert Shiller has done extensive research on home values, and has calculated that nation-wide, homes appreciate a paltry 0.6% real per year. With the Federal Reserve having a 2% target inflation rate, I would recommend using 2.6% nomimal appreciation, although I was generous and used 3% in my analysis.

Bear in mind that home prices must bear some relationship to household incomes (i.e. people need to be able to afford to buy them, or they can't go up) in the long run. Also, keep in mind the 30-year bull market in bonds that has culminated in historically low interest rates. Rising rates make homes less affordable, and therefore less likely to increase in value.

PS. Bonus points for anyone who finds errors in my spreadsheet.
"Compound interest is the most powerful force in the universe." - Albert Einstein

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Re: Direct Real Estate Returns

Post by gmaynardkrebs » Thu Jul 19, 2018 7:59 pm

CantPassAgain wrote:
Thu Jul 19, 2018 4:59 pm
...Internal rate of return is the most comprehensive, honest way to report investment returns....

Au contraire. As I pointed out above, I can dramatically increase my IRR by using a smaller down-payment. Needless to say, anyone who can put down 20%, can with absolute certainty, put down 10%, 5%, or 1%. The idea that this can lead to vastly higher returns is preposterous. Whatever IRR is measuring, it's not what investors are interested in -- more of that nice Mr. Green in their pockets.

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Re: Direct Real Estate Returns

Post by KyleAAA » Thu Jul 19, 2018 8:37 pm

gmaynardkrebs wrote:
Thu Jul 19, 2018 7:59 pm
CantPassAgain wrote:
Thu Jul 19, 2018 4:59 pm
...Internal rate of return is the most comprehensive, honest way to report investment returns....

Au contraire. As I pointed out above, I can dramatically increase my IRR by using a smaller down-payment. Needless to say, anyone who can put down 20%, can with absolute certainty, put down 10%, 5%, or 1%. The idea that this can lead to vastly higher returns is preposterous. Whatever IRR is measuring, it's not what investors are interested in -- more of that nice Mr. Green in their pockets.
Huh? It's exactly what I as an investor am interested in. Given how much capital input at risk, what is my return on that investment? If I can get the same absolute cash flow but put down half the capital, of course I care about that.

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Re: Direct Real Estate Returns

Post by knpstr » Thu Jul 19, 2018 8:46 pm

Stormbringer wrote:
Thu Jul 19, 2018 7:47 pm
Here is my analysis of your hypothetical $100,000 home in Anytown, USA that rents for $950 a month.
Ouch! negative cash flow for the first 13 years!? That's a crapper right there.
Very little is needed to make a happy life; it is all within yourself, in your way of thinking. -Marcus Aurelius

WanderingDoc
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Re: Direct Real Estate Returns

Post by WanderingDoc » Thu Jul 19, 2018 9:13 pm

Classic sign of an index fund investor attempting to explain real estate. Case-Schiller. Sigh, it's silly if not ignorant to expouse that and use it in any calculation. We don't invest in every single house in the U.S. in aggregate. We go deal by deal, street by street, submarket by submarket, terms by terms etc.

I suspect that folks try to apply concepts relevant to indexing (like "investing in the whole market") that are absolutely ridiculous to even bring up when evaluating a real estate deal.

House prices are worth what someone is willing to pay. Period. If people are renting a tent in their backyard in SF for $1000/mo., and keeping it full, it's because the demand is there. You have to account for appreciation AND rent growth. Don't assume that rent growth is static or relates to property values in a similar way across different submarkets.

Unfortunately, there is a learning curve that can only be learned by mentors and doing real estate deals. Not reading investopedia or thinking tenants will call you at 3 A.M. I can't remember the last time a tenant even called me, let alone at night.

The math isn't the same, neither is the investment, neither is the tax implications. It's a hard asset where leverage is the ace in the hole. I appreciate the conversation with the 2 or 3 folks that I feel have a sense of the nuance, instead of just applying index fund concepts to real estate.

Stormbringer wrote:
Thu Jul 19, 2018 7:47 pm
WanderingDoc wrote:
Thu Jul 19, 2018 12:39 pm
You just said "its absurd". You didn't even attempt to disprove it but giving a mathematical or even logical reason why you believe what you do.

Those are the returns. The principal paydown, appreciation, and inflation hedging are actual returns but they aren't "realized" immediately. But they would be included on a balance sheet. They aren't imaginary, they are real. Those are the returns of the worst property in my portfolio, which I bought with a 20% down loan in a city I've never been to. Two other properties I have refi'd ALL of my initial capital, meaning I have $0 of my money in the deal and they still pay me in the 5 ways I've outlined.

Just because most of America invests in a vehicle they were told is "good" by the media, word of mouth, bankers, and politicians, it doesn't mean there aren't alternatives.

I have laid the math out in gory and specific detail. The burden of proof is now on YOU. "Warren Buffet" is not a rebuttal or reason or explanation. Neither is calling it absurd.
Here is my analysis of your hypothetical $100,000 home in Anytown, USA that rents for $950 a month.

I would add a few comments:

1. 20% down on a non-owner occupied home for 30-year fixed mortgage is limited to four properties (last I checked, but the change it from time to time), then it jumps to 25-30%. Also, there is a limit of 10 financed properties for Fannie Mae backed mortgages. Then there are points, and higher interest rates. Cash-out refinances on FNMA loans are a challenge as well. This limits your ability to scale before having to switch to ARMs.

2. As others have noted, your overall return on equity decays as you build equity in the property. If you want to keep getting high returns on your wealth (not just your initial investment) you will need to trade your properties for more, and larger ones over time. This introduces significant transaction costs into the equation.

3. In my experience, the biggest mistake investors make is underestimating maintenance costs. Sure, the seller might have left it in pristine condition for you but you need to accrue for roofs, furnaces, windows, kitchen and bath remodels, and any of the many expensive repairs that will come eventually. They also tend to completely ignore transaction costs (selling, refinancing, etc.) in their analyses.

4. Dr. Robert Shiller has done extensive research on home values, and has calculated that nation-wide, homes appreciate a paltry 0.6% real per year. With the Federal Reserve having a 2% target inflation rate, I would recommend using 2.6% nomimal appreciation, although I was generous and used 3% in my analysis.

Bear in mind that home prices must bear some relationship to household incomes (i.e. people need to be able to afford to buy them, or they can't go up) in the long run. Also, keep in mind the 30-year bull market in bonds that has culminated in historically low interest rates. Rising rates make homes less affordable, and therefore less likely to increase in value.

PS. Bonus points for anyone who finds errors in my spreadsheet.
Don't wait to buy real estate. Buy real estate, and wait. | Rent where you live, buy where others pay your mortgage for you.

Stormbringer
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Re: Direct Real Estate Returns

Post by Stormbringer » Thu Jul 19, 2018 9:39 pm

Alright. Well, I'll watch for you on the Forbes 400. Or maybe your late night infomercial.
"Compound interest is the most powerful force in the universe." - Albert Einstein

gmaynardkrebs
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Re: Direct Real Estate Returns

Post by gmaynardkrebs » Thu Jul 19, 2018 10:13 pm

KyleAAA wrote:
Thu Jul 19, 2018 8:37 pm
gmaynardkrebs wrote:
Thu Jul 19, 2018 7:59 pm
CantPassAgain wrote:
Thu Jul 19, 2018 4:59 pm
...Internal rate of return is the most comprehensive, honest way to report investment returns....

Au contraire. As I pointed out above, I can dramatically increase my IRR by using a smaller down-payment. Needless to say, anyone who can put down 20%, can with absolute certainty, put down 10%, 5%, or 1%. The idea that this can lead to vastly higher returns is preposterous. Whatever IRR is measuring, it's not what investors are interested in -- more of that nice Mr. Green in their pockets.
Huh? It's exactly what I as an investor am interested in. Given how much capital input at risk, what is my return on that investment? If I can get the same absolute cash flow but put down half the capital, of course I care about that.
No. There is only one profit to be made per property. The relevant question for an investor is how much he has been able to put in his pocket from the day he purchased the property through day he finally disposed of it. That is going to be the same amount whether he puts down 10% or 20%. If the IRR calculation convinces him it's more profitable to spread his available capital over a greater number of properties, he is merely taking on greater leverage, with the attendant risks.

Nate79
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Re: Direct Real Estate Returns

Post by Nate79 » Thu Jul 19, 2018 10:33 pm

For those interested in sensible real estate investing as opposed to the common and in some circles claimed only way to invest by leveraging up to the max I recommend the Afford Anything podcast. Paula Pant walks thru all the calculations for real estate return, especially to deemphasize the ones like cash on cash which magnify the use of leverage and penalize a cash investor. Today, thanks to a strong bull market real estate investors seem to think that anyone who doesn't use leverage is stupid and missing the free lunch. There is no free lunch; they are so hyped up in their calculations that they forget about risk.

AerialWombat
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Re: Direct Real Estate Returns

Post by AerialWombat » Thu Jul 19, 2018 10:53 pm

Stormbringer wrote:
Thu Jul 19, 2018 7:47 pm

I would add Also, there is a limit of 10 financed properties for Fannie Mae backed mortgages.
As of Oct. 31, 2017, this is no longer completely true. FNMA underwriting guidelines were changed. There is now no limit on the number of financed properties, as long as the current subject property is owner occupied as primary residence.

My property acquisition strategy is to buy as owner occ, live in it for the mandatory one year, convert it to a rental, buy another primary residence and repeat.

I had originally modeled this with 10 property limit, which would give me an estimated $12 million portfolio in 40 years. Now, no need to stop at 10, except the whole “moving sucks” thing.


Reference: https://www.fanniemae.com/content/guide ... /2/03.html

CantPassAgain
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Re: Direct Real Estate Returns

Post by CantPassAgain » Thu Jul 19, 2018 11:08 pm

gmaynardkrebs wrote:
Thu Jul 19, 2018 10:13 pm
The relevant question for an investor is how much he has been able to put in his pocket from the day he purchased the property through day he finally disposed of it. That is going to be the same amount whether he puts down 10% or 20%.
say what

gmaynardkrebs
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Re: Direct Real Estate Returns

Post by gmaynardkrebs » Thu Jul 19, 2018 11:13 pm

CantPassAgain wrote:
Thu Jul 19, 2018 11:08 pm
gmaynardkrebs wrote:
Thu Jul 19, 2018 10:13 pm
The relevant question for an investor is how much he has been able to put in his pocket from the day he purchased the property through day he finally disposed of it. That is going to be the same amount whether he puts down 10% or 20%.
say what
There is only one profit to be made per property.

CantPassAgain
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Re: Direct Real Estate Returns

Post by CantPassAgain » Thu Jul 19, 2018 11:17 pm

gmaynardkrebs wrote:
Thu Jul 19, 2018 11:13 pm
CantPassAgain wrote:
Thu Jul 19, 2018 11:08 pm
gmaynardkrebs wrote:
Thu Jul 19, 2018 10:13 pm
The relevant question for an investor is how much he has been able to put in his pocket from the day he purchased the property through day he finally disposed of it. That is going to be the same amount whether he puts down 10% or 20%.
say what
There is only one profit to be made per property.
How so?

gmaynardkrebs
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Re: Direct Real Estate Returns

Post by gmaynardkrebs » Thu Jul 19, 2018 11:21 pm

CantPassAgain wrote:
Thu Jul 19, 2018 11:17 pm
gmaynardkrebs wrote:
Thu Jul 19, 2018 11:13 pm
CantPassAgain wrote:
Thu Jul 19, 2018 11:08 pm
gmaynardkrebs wrote:
Thu Jul 19, 2018 10:13 pm
The relevant question for an investor is how much he has been able to put in his pocket from the day he purchased the property through day he finally disposed of it. That is going to be the same amount whether he puts down 10% or 20%.
say what
There is only one profit to be made per property.
How so?
:?:

CantPassAgain
Posts: 577
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Re: Direct Real Estate Returns

Post by CantPassAgain » Thu Jul 19, 2018 11:44 pm

gmaynardkrebs wrote:
Thu Jul 19, 2018 11:21 pm
CantPassAgain wrote:
Thu Jul 19, 2018 11:17 pm
gmaynardkrebs wrote:
Thu Jul 19, 2018 11:13 pm
CantPassAgain wrote:
Thu Jul 19, 2018 11:08 pm
gmaynardkrebs wrote:
Thu Jul 19, 2018 10:13 pm
The relevant question for an investor is how much he has been able to put in his pocket from the day he purchased the property through day he finally disposed of it. That is going to be the same amount whether he puts down 10% or 20%.
say what
There is only one profit to be made per property.
How so?
:?:
Well, it isn't the same amount amount of "profit" regardless of down payment and there isn't "just one profit to be made per property" if I am understanding what you mean when you say that. Financing costs play a role. A very simplified example ignoring transaction costs/taxes/maintenance/price appreciation/etc:

A) $200,000 property purchased with 10% down 15 years mortgage at 3% rented out at $2,000 a month: At the end of the mortgage the property owner has accumulated $31,428.79 in cash flows ($2,000 rental income less $1,738.09 mortgage payment X 120 months). Then property owner sells for $200,000. $31,428.79 + $200,000 - Initial investment of $20,000 = $211,428.79

B) $200,000 property purchased with 20% down 15 years mortgage at 3% rented out at $2,000 a month: At the end of the mortgage the property owner has accumulated $54,603.37 in cash flows ($2,000 rental income less $1,544.97 mortgage payment X 120 months). Then property owner sells for $200,000. $54,603.37 + $200,000 - Initial investment of $40,000 = $214,603.37

Am I missing something?
Last edited by CantPassAgain on Thu Jul 19, 2018 11:50 pm, edited 1 time in total.

CarpeDiem22
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Re: Direct Real Estate Returns

Post by CarpeDiem22 » Thu Jul 19, 2018 11:46 pm

I calculate IRRs for a living. For any investment, IRR (Internal Rate of Return) and NPV (Net Present Value) are the two definitive metrics for deciding to invest or not.

Its very easy to calculate in MS Excel. Decide on the life of the building (IRS defines life of residential building as 27.5 year and commercial buildings as 39 years). Post this period, building value is zero. Land doesn't depreciate. List your monthly cash flows in a column in MS Excel for 27.5 years, assuming residential building here (outflow in negative, inflow in positive). List the corresponding dates in the next column. Add a terminal value for the value of the land after 27.5 years as inflow, assuming you own the land. Use IRR or XIRR function and it will give you IRR. Using NPV function will give you the Net Present Value of all your future cash flows (both inflows and outflows).

Note: As you could have gathered by now, you can arrive at any IRR by changing the assumptions of monthly rental, value of land after 27.5 years etc.

Edit: Forgot to mention, only cash flows matter. Market value of the building doesn't matter because it would go to zero after life of the asset is over.

CantPassAgain
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Re: Direct Real Estate Returns

Post by CantPassAgain » Thu Jul 19, 2018 11:55 pm

CarpeDiem22 wrote:
Thu Jul 19, 2018 11:46 pm
I calculate IRRs for a living. For any investment, IRR (Internal Rate of Return) and NPV (Net Present Value) are the two definitive metrics for deciding to invest or not.

Its very easy to calculate in MS Excel. Decide on the life of the building (IRS defines life of residential building as 27.5 year and commercial buildings as 39 years). Post this period, building value is zero. Land doesn't depreciate. List your monthly cash flows in a column in MS Excel for 27.5 years, assuming residential building here (outflow in negative, inflow in positive). List the corresponding dates in the next column. Add a terminal value for the value of the land after 27.5 years as inflow, assuming you own the land. Use IRR or XIRR function and it will give you IRR. Using NPV function will give you the Net Present Value of all your future cash flows (both inflows and outflows).

Note: As you could have gathered by now, you can arrive at any IRR by changing the assumptions of monthly rental, value of land after 27.5 years etc.

Edit: Forgot to mention, only cash flows matter. Market value of the building doesn't matter because it would go to zero after life of the asset is over.
I would argue market value is very relevant. Just because IRS rules say $0 after a few decades doesn't make it so in reality. A good portion of those all important cash flows are going to be for maintenance and capital improvements. Obviously there are a lot of very old buildings out there that have quite high FMVs. I bet some of them are over 30 years old.

KyleAAA
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Re: Direct Real Estate Returns

Post by KyleAAA » Fri Jul 20, 2018 12:05 am

gmaynardkrebs wrote:
Thu Jul 19, 2018 10:13 pm
KyleAAA wrote:
Thu Jul 19, 2018 8:37 pm
gmaynardkrebs wrote:
Thu Jul 19, 2018 7:59 pm
CantPassAgain wrote:
Thu Jul 19, 2018 4:59 pm
...Internal rate of return is the most comprehensive, honest way to report investment returns....

Au contraire. As I pointed out above, I can dramatically increase my IRR by using a smaller down-payment. Needless to say, anyone who can put down 20%, can with absolute certainty, put down 10%, 5%, or 1%. The idea that this can lead to vastly higher returns is preposterous. Whatever IRR is measuring, it's not what investors are interested in -- more of that nice Mr. Green in their pockets.
Huh? It's exactly what I as an investor am interested in. Given how much capital input at risk, what is my return on that investment? If I can get the same absolute cash flow but put down half the capital, of course I care about that.
No. There is only one profit to be made per property. The relevant question for an investor is how much he has been able to put in his pocket from the day he purchased the property through day he finally disposed of it. That is going to be the same amount whether he puts down 10% or 20%. If the IRR calculation convinces him it's more profitable to spread his available capital over a greater number of properties, he is merely taking on greater leverage, with the attendant risks.
That’s fundamentally how investors compare investment opportunities. The amount of capital needed to generate a given cash flow cannot rationally be ignored because you can’t compare NPV without it. While it’s true that a property that isn’t a good investment without leverage probably also won’t be with leverage, it is a vitally important piece of data to compare investment opportunities.

CarpeDiem22
Posts: 129
Joined: Tue May 22, 2018 11:20 pm

Re: Direct Real Estate Returns

Post by CarpeDiem22 » Fri Jul 20, 2018 12:14 am

CantPassAgain wrote:
Thu Jul 19, 2018 11:55 pm
CarpeDiem22 wrote:
Thu Jul 19, 2018 11:46 pm
I calculate IRRs for a living. For any investment, IRR (Internal Rate of Return) and NPV (Net Present Value) are the two definitive metrics for deciding to invest or not.

Its very easy to calculate in MS Excel. Decide on the life of the building (IRS defines life of residential building as 27.5 year and commercial buildings as 39 years). Post this period, building value is zero. Land doesn't depreciate. List your monthly cash flows in a column in MS Excel for 27.5 years, assuming residential building here (outflow in negative, inflow in positive). List the corresponding dates in the next column. Add a terminal value for the value of the land after 27.5 years as inflow, assuming you own the land. Use IRR or XIRR function and it will give you IRR. Using NPV function will give you the Net Present Value of all your future cash flows (both inflows and outflows).

Note: As you could have gathered by now, you can arrive at any IRR by changing the assumptions of monthly rental, value of land after 27.5 years etc.

Edit: Forgot to mention, only cash flows matter. Market value of the building doesn't matter because it would go to zero after life of the asset is over.
I would argue market value is very relevant. Just because IRS rules say $0 after a few decades doesn't make it so in reality. A good portion of those all important cash flows are going to be for maintenance and capital improvements. Obviously there are a lot of very old buildings out there that have quite high FMVs. I bet some of them are over 30 years old.
Life of building is an assumption, which you can adjust as you feel reasonable. IRS-decided numbers are only rough guidelines for us, but for organisations it is a must to use these numbers so that they cannot manipulate the yearly depreciation to adjust their Profit After Tax. Market Value of the house still doesn't matter as it goes to zero after x years of useful life.

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