I would absolutely love to invest in real estate, but the land near me is just getting out of hand in terms of cost vs profit. In order to make it affordable or even feasible for me, I'll have to wait for another market downturn.
Commercial, after reading this short thread, is the way to go it seems. I originally wanted to do residential, but those 2am Sunday calls and dealing with crappy/late-payment tenants or even finding a tenant just isn't my cup of tea.
I firmly believe that most small landlords don't get nearly the returns they think they do because they don't accurately track their actual income and expenses. I've run the numbers on a lot of small residential rental properties and just can't come up with adequate projected returns to offset the additional risk of them unless you go into less desirable areas where properties are still cheap - but then of course you're taking on even more risk. I've been interested in residential real estate and just don't think the numbers work for me. I use the stock market instead, low cost passively managed diversified index funds.
Residential rental real estate has a rule of thumb that 50% of the market rents will be eaten up by operating costs. Some people will claim to beat that, but looking at their numbers in detail will tend to show overlooked or disregarded expenses (ie, "I self manage so management is $0" when really you should be accounting for that time somehow) or front end loaded expenses (they spent $50,000 renovating the unit so repairs are low, for now, but will come due all at once in 10 years). When evaluating a specific property the 50% rule may not be enough but it's good enough to get you started.
I put together a spreadsheet years ago to evaluate residential rentals and I just kept coming up with a real return of 5% - 8%. That is right around the real return of a stock market index fund and not enough to entice me. Any higher returns came with properties with big question marks or a lot more work than investing passively.
Many people will say to bank on appreciation, but to me you can not count on anything beyond matching inflation. Housing price growth in general may surpass inflation, but only in specific areas and - here's the big one - only in owner occupied properties. Rental properties tend to not make the jump from rental to owner occupied; they tend to sell to other investors to use as rentals, so the market and pricing for them are completely different than that for owner occupied properties. The reasons for that are varied. The finishes on rentals are lower grade (otherwise you're losing money renting them out!), the maintenance is different, they tend to be in less desirable locations than owner occupied houses, etc. Another big one is they're often sold with tenants in place and you'd never get an owner occupant unless you empty the unit first before trying to sell it - and of course that means zero income during the period where you're trying to sell it.
I'm certainly not saying nobody makes money on residential real estate. There are some that do really well with it, but it takes more than just buying the first house you come across and putting it up on Craigslist for rent. At least that would be a learning experience, though!
On rental commercial property, which is my day job, the work is different, risks are different, and returns can be terrible to very very good. I think SVreX has it right on the nose for the market right now - small owner/operator businesses have a terrible time finding reasonably priced well maintained commercial rental units and when they do find it they will stay for as long as they can. Your eviction requirements are much looser than residential but then again so is your leverage. Loans are harder to get, and terms are less favorable. We do office space and tenants are beyond pleased to have an actual human they can talk to that has the power to say yes or no, and that cares about the property and businesses there. We don't lose tenants to landlord issues, we lose them to growth (we're full so no space to grow into) or market issues. Then again, that style of management makes this a J-O-B and not a passive investment. On that front, commercial management is pretty easy to find, but I don't know how to find *good* commercial management since we've always self managed. Generally there will be a local coalition of commercial real estate brokers and you could can find references there or through BOMA, https://www.boma.org/ the Building Owners and Managers Association. Expenses can be breathtaking on a commercial property just due to size. It's not unusual to have a $100k roof, or a $50k masonry restoration job, or the like. So you have to either have large maintenance reserves or a really good line of credit. A property like SVreX has recommended has advantages there as you can stipulate that all in-suite maintenance is the tenant's responsibility and the landlord is only responsible for the exterior shell of the building. That can lead to some shabby interior work being done but whether that bothers you is personal preference. It would drive me crazy so we have it to the point that our tenants call us for everything - sometimes even stuff like hanging TVs. Which I love to do so I'm happy with that! It beats finding 20 holes behind a TV mount after they move it later, too.
Sorry for the novel. I could go on, but this is a lot to chew on for the moment. Any thoughts or questions yet??
Edit: I forgot to add - land as a real estate investment for the small guy seems terrible to me. Zero income, only expenses, total gamble on if it will ever be worth even what you paid for it much less more. Land investment is the zillionaire's playground. They can afford to buy millions of dollars in land and sit on it for a decade or two in the hopes that one or two parcels will pay out big. Leasing to farmers is a very low income, isn't it? I've never seen the case for the average person to be able to make a reliable and decently sized income off of land investment.
On the type of building SV and I are saying might be a good commercial entry point, here's an example locally:
I do not believe I have ever seen a "FOR LEASE" sign on this building but it always looks full. (Note Collision Solutions is a tenant, and I've seen multiple tenants in here before. I don't think they have the whole building, they're just the only ones with a sign.) It's near the city center, in a neglected pocket but very very close to downtown. The owner bought the vacant land (1 acre) for $65,000 around 2004, and built this building on it. I don't know what a building like this costs to build, but it's 17,000sf so this specific building might be too big for a first time landlord. Regardless, this guy is likely to have done very well on a cashflow front, and before another decade is up I imagine he's going to be rolling in it. Why? Because it is 1/4 mile from a $240 million project (CoverMyMeds new headquarters) that's just breaking ground now. Not that you can bank on that, of course.
If I was looking for another property something like this would be on my radar.
In reply to dculberson :
You're not wrong on the 5-8% returns, because, guess what, real estate as an investment competes with the stock market and any other potential investments. So in some ways, the real estate value is set by the 5-8% return potential and not the other way around.
If the returns got better, investors would flock and prices would increase, if returns got worse, investors would seem greener pastures and prices would go down.
I have also noticed like you that there are 100 ways to run the numbers and each way can 'prove' something different.
Robbie said:In reply to dculberson :
You're not wrong on the 5-8% returns, because, guess what, real estate as an investment competes with the stock market and any other potential investments. So in some ways, the real estate value is set by the 5-8% return potential and not the other way around.
If the returns got better, investors would flock and prices would increase, if returns got worse, investors would seem greener pastures and prices would go down.
I have also noticed like you that there are 100 ways to run the numbers and each way can 'prove' something different.
The problem with the real estate as an investment compared to the stock market is that RE requires a lot more work.
In reply to mtn :
Yeah I agree, hard to beat money for zero work. I thought dculberson was controlling for that as much as possible by making sure to include the cost of management in his return calcs.
RE still has much larger transactional costs (one of which is time), not many ways around that.
I'm in total agreement with both of you! RE has a loss of liquidity, a loss of diversification, and a local risk amplification compared to the stock market. You're all in one basket, in one location, in a form that takes high dollars and high time commitment to sell. I would require a pretty serious premium before I would put my money in that. Definitely more than the ~10% average (7-8% "real," after inflation) return you get from the stock market.
It’s also much easier to leverage money in RE.
$50K cash investment can control a half million dollars worth of real estate. When you apply the 5-8% to the half million, it changes the game.
That's only part of the story. You're also leveraging into a half million's worth of risk, interest, and expenses. There's no free lunch, and the 5-8% ends up being on your cash involvement not on your levered amount.
I can see higher returns that that on commercial property, but single family or small multi-unit residential just doesn't make more unless you're in riskier areas or happen upon an amazing deal, which is very rare in today's market. I'd love it if you could show me an example property for sale today that honestly tops 8% for residential, in an A or B area. Honestly meaning not zeroing out management costs, vacancy losses, maintenance reserves, etc.
In reply to dculberson :
Nope. Not gonna try. We are in agreement. That’s why I recommended commercial.
We've been doing commercial real estate speculation for the last 8 years or so. It is speculation, not investing. In the real world with economic swings, there are good purchases and bad purchases. When we began, there was a long discussion of residential vs commercial and a long list of pros and cons for each. As mentioned before, I am not the person to call at 2am with a clogged toilet in your apartment. Commercial leases usually have clauses for interior maintenance, HVAC, CAM(common area maintenance), etc and who is responsible and at what threshold.
I would start with small commercial, spend a few $$$ on having a local real estate lawyer write up a simple boiler plate lease that's easily customized and get it advertised. Just be sure to know your local code and zoning for all of the "do's and dont's" based on your property location.
Thanks for the comments. I share the view that due dillegence and research is needed before jumping in. I wanted some thoughts before I even start running the numbers, but th 1% rule seems tough at this time... Seems like everyone wants to be a real estate billionaire and someone will tell you how for only 6 low payments of 99.95.
I will say this: few investment options offer as much chance for the small guy to build a big portfolio quickly if you're a hands on type. I was fascinated reading this thread:
In less than ONE YEAR, the guy goes from having some cash on hand to having $386k in equity in seven rental houses and $3,525/mo in cashflow. I think it took a combination of experience, luck, and tons of perseverance for him to do it, but it's an amazing read. It is certainly not a passive investment, though!! At least not for that first year.
In reply to dculberson :
Where was that article where the guy turned $100 into $140k on two trades almost overnight?
There are success stories in all types of investing, heck even playing the lotto. Compared to these, RE is actually at the low end of the risk/return spectrum!
Edit, sorry $800 into $108k.
Fueled by Caffeine said:Thanks for the comments. I share the view that due dillegence and research is needed before jumping in. I wanted some thoughts before I even start running the numbers, but th 1% rule seems tough at this time... Seems like everyone wants to be a real estate billionaire and someone will tell you how for only 6 low payments of 99.95.
Yeah, I can't stop hearing about how "this system works especially well in YOUR market, so come to my free information session!"
Robbie said:Fueled by Caffeine said:Thanks for the comments. I share the view that due dillegence and research is needed before jumping in. I wanted some thoughts before I even start running the numbers, but th 1% rule seems tough at this time... Seems like everyone wants to be a real estate billionaire and someone will tell you how for only 6 low payments of 99.95.
Yeah, I can't stop hearing about how "this system works especially well in YOUR market, so come to my free information session!"
I've always taken the position of:
"If there is such an easy opportunity to make money here, why aren't you doing it yourself?"
In reply to dculberson :
Here in the Midwest farmers use the expression, "You can lead a horse to water". ••••••
Farm Land is really about knowledge.
Knowing which communities are going to open up for development. Commuting distance and time to jobs, etc etc etc
What is the average age of farmers? I don't know off the top of my head but I'd gues somewhere in the eighties ( you can look that up if you want) but that means a lot of them would like to get out of farming. It's hard work, doesn't pay well( typically) costs a lot to get started, so even if you do want to farm chances are you don't have the capitol.
That makes selling a farm hard.
What do farmers ( who love to get crop subsidies) hate most? If you said paying taxes you're right.
If you want I can spell the rest of it out for you.
We are what I would call small time real estate investors. We own two rental houses, both met the 1% rule right from day one. We aren't looking for instant profit, we see these as part of our retirement portfolio. I wished we'd taken the plunge a couple of years earlier as we could have really ridden the SE Michigan recovery in real estate after the great recession (Michigan was really a true depression for a few years).
The first property we purchased in 2014, since then it's appreciated at least 60% (we got a good deal) Current monthly rent is approx. 1.5-1.6% of the outstanding mortgage. We have put in about 15% of the purchase value in improvement, upgrades and repairs. That includes everything from re-building the car port, paint and carpet down to new smoke detectors and a faucet. We've had a series of tenants and it has sat empty for up to three months between tenants, but we still broke even those years including everything.
The second we bought in 2016 with a sitting tenant. That currently rents for about 1.3% per month of the outstanding mortgage. We've put on a new roof (ourselves) plus had a couple of unexpected issues with a blocked sewer pipe and a burst pipe flooding the crawl space, but even so we've only put in approx 10% of the purchase price in repairs and upgrades.
Right now we manage the properties ourselves and do 100% of the repairs and upgrades ourselves as well. Both properties will be paid off by the time we retire at which point we'll turn them over to a management company to lease, maintain, find tenants etc. as we will be moving out of the area.
We chose the area carefully. There are several communities, cities and neighborhoods that were all in a similar price range for both properties and rents. We chose one specifically where the city like and supports rentals, but also insists they are in good condition. Ferndale Michigan for those local. We're fine with that and the biannual inspections that go with it. We also chose the more popular area for younger people. It could be considered a hipster town, and that's perfect. We are not short of young professionals who want to be there and it's already paid off. The increase in value of the properties has significantly outstripped the surrounding communities by double digits %
IF we can do it, anyone with the deposit and enough to see you through a few months empty and or unexpected repairs can do it. We got lucky in our timing, but could have been even further ahead if we'd taken the plunge earlier. You really need to do your homework on the community, property and rental prices. Also don't forget property taxes and insurance, they are significant. Also consider utilities. We make the tenants pay those, but we have friends who have about half a dozen rentals in a different more blue collar area and they roll utilities into the rent as the type of people who they rent too are more likely to not pay the utilities then the owners would be liable for them anyway. It all comes down to your area and target tenants. We also keep very detailed records of ever purchase and all trips to the properties down to the last penny. I mean last year I had a trip to H.D. to pick up yard bags ($1.99 plus 6% tax) and then on down to the rental to clean the yard between tenants. Every last penny and mile is itemized for taxes. It also helps to keep you honest on your expenditure AND to make sure you are either paying the minimum, or getting back the maximum from the State and the Feds in tax.
The only thing I don't keep accurate track of is our time. We consider it a second job. There are months where we've done nothing except make sure the rent is in our account, and there are months where we've spent every weekend and several nights a week working flat out. That's OK, it's part of our retirement fund.
In reply to Adrian_Thompson :
You can't beat timing. Not just market but personal since you need some cash or decent credit to make the plunge. Plus you need to be in a place in your life where every last asset you have won't be called on. ( I'm talking about illness, divorce, job security, etc)
Beyond that a degree of knowledge is required. Both of the local markets, growth, opportunities, taxes, financing, etc. plus how to get things done. A survey, a tittle search, heck maybe a little plumbing or electrical work or someone who does know those things.
Something else to consider. Protect yourself from liability. We should have done this right from the start, but right now we are in the process of setting up two LLC's, one for each property. Now we've set up the companies we are doing quit claim deeds to transfer the properties from ourselves to the corporations. We are also changing the mortgages so they will belong to the corporations as well. This is so if anything happens, someone can't come after us personally. Instead they will have to sue the corporation who's only asset it is the property and the debt. That way we can't loose our own house, savings etc if some horrible accident happens.
In reply to frenchyd :
Absolutly, we're lucky being in Michigan. Property values, proerty taxes (varies by community) and rentals are in a sweet spot that made it work for us, at our age, with our 'spare' cash etc.
We have considered a condo up North in the area we want to retire too. That plan would be to use it as an airbnb that we can also use a few times a year. The advantage is much higher rent, the down side is the lack of consistancy. In theory it can work, but association dues are making it non feasible right now, no matter how many times I run the numbers. Just please please make sure you are bruatlly honest when running the numbers, it's really easy to cheat your way into making it look good. DON'T.
In reply to Adrian_Thompson :
New roof? Free property management? 100% of the repairs and upgrqades?
You don't meet the 1% rule if you don't count your time.
In reply to Adrian_Thompson :
In my experience condo's don't follow the rule about real estate appreciating at about the rate of inflation. Especially when Association dues etc are factored in.
I think it's because the value of the land they occupy may have too dense of occupancy or maybe single family homes only meet that standard. Same thing with Time shares.
The one exception to the rule seems to be empty lake shore. This is only anecdotally but people I've known who buy raw land on a lake get the serious tax advantage of extremely low taxes. While they are paying for the land. Yet lakeshore enjoys great appreciation, typically 2 x inflation .
Perhaps it's only in Minnesota with it's more than 10,000 lakes plus the headwaters of the Mississippi, Red river of the north, and Great Lakes.
But raw lakeshore seems to sell very cheap compared to lakeshore with retirement homes already on it. Obviously Some lakes are more desirable than others. Plus the location of the land certainly is a factor. Sunrise/ sunset, sandy beach or bluff, chain of lakes or river connection. Distance from major cities. Etc.
While past performance is no guarantee it certainly is a valuable indicator. casual reading of county records will provide such indication.
But it's fun to imagine the spread sheet required to prove my initial statement.
Due notice. Perhaps only I hear about these returns from people who buy the land planning on retirement on that lake.
In reply to Adrian_Thompson :
Just to clarify...
I am understanding you have owned a property since 2016 that has appreciated by 60% over that time, but you paid 15% in improvements. That means your real returns if you sold it today are about 45%. You also need to DEDUCT the value of your time- management, repairs, and improvements. (And the costs of marketing the property to sell it)
During the same period, the S&P 500 returned 71%.
I think you have made it clear that the stock market can out perform the returns in RE, and that RE is not apassive investment.
In reply to SVreX :
I don't believe that's a valid comparison.
I'm not disputing your facts merely the cherry picking of them. What other stock market investment would have exceeded investing in the S&P 500?
What would have lost?
Even selection of the S&P 500 during that period? Is there a time if you'd sold early your results would have lost. Or another choice would have yielded better?
To my way of thinking using hind sight is giving you 20-20 vision.
My mother used to brag to me about winning $65,000 on one hand of poker.
As she gambled her way through the 17 million dollars she inherited.
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