Convince enderland to buy real estate (or not, I guess?) and related questions

[ender]

I have spent much of the past month reading forum threads here about real estate vs stocks for growing a 'stache, looking at Zillow, and pondering whether to continue to research/get more serious. Clearly I am, since now here's a thread on this. It seems that the following is true:

• It is much easier to have better returns in real estate than index funds because the stock market is so much more efficient than real estate

This makes sense to me. Having listened to most of this podcast and reading the thread makes me even more intrigued and convinced that real estate is a considerably better way to FI/FIRE than index funds. I am more and more becoming interested in this vs simply index fund investing. I like the idea of more stable returns, too.

I have a few lot of questions. I am going to use a house with purchase price of $100k throughout all my questions.

1) As I understand the 1% rule, if I am unable to get $1000/month in rent, this is a poor choice. If closer to $2000 it's a great deal.

2) The "cash on cash" idea means that, for this example, if I get $1000/month in rent and "net" $200/month after all expenses, with a $10k downpayment I effectively have a $2,400/$10,000 return or 24% return. If I can "net" $100/month I have a 12% return. These returns are what I should compare to comparable stock market yearly returns (ignoring equity). If my downpayment is $20k, these returns are 1/2 those percentages.

3) Maintenance estimates of about 1% a year are reasonable starting points

4) It seems it would make sense to not max out my 401k next year if I am intending to purchase real estate and need money for down payments, etc. Is it generally advisable to those looking to get seriously into real estate to do minimums for company match in 401k and either taxable or cash savings for purchases?

5) Buying any property - rental or otherwise - without some cash savings is foolish, what are recommended amounts?

6) Is a duplex a good first property, if I intend to live in 1/2 of it? Or is this a better idea in theory than reality?

7) How bad is a bad first purchase? For example, what are the implications of buying a property at 0.75% rent/purchase? Is there a generally accepted "break even" percentage for rent vs purchase cost (ie 0% real return)? or is this a "each place is different" type of thing?

8) What is a good timeframe from the "decide to move forward with real estate" decision and information gathering to actually buying a place? I would want to pay much more attention to sell prices, rents, etc

9) Is there an easy way to see actual sell prices somewhere? Or is this real-estate secrets? It's all public record, I think...


Ok. So that turned into quite a few questions when I wrote them all down :)

[arebelspy]

I hope you don't mind if I go in and edit your post with numbers, instead of bullet points, for ease of answering the questions.  :)

I'll be back to edit this with answers after I do that!

EDIT: Back, with answers!

1) You are correct in your understanding of that rule.  Remember, it's just a rule of thumb.  Not an end-all-be all.  There's some 2% properties I wouldn't touch with a 10-foot pole.  And it may not be a great deal even if it's a 2% property, because you may never see those (theoretical, paper) returns.

2) Correct, if you net that after both expenses and debt service (they are separate things).

3) VERY much depends.  Is the property 100 years old?  5 years old?  Was a rehab last done in the 70s, or last year?  How quality was that rehab?  That number will vary a lot depending on the property.

4) Definitely don't pass on free money, do what you need to to get any match.  Anything beyond that will depend on your situation and opportunities.  There have been times where I didn't max retirement accounts to invest in RE, and other times where I poured money into retirement accounts as the opportunities weren't there at the moment.

5) It will depend on the property.  An old one with a lot of deferred maintenance needs more reserves set aside than a new one.  A quad with 4 units needs more than an SFR (generally).  A 2000 sqft one needs more than an 800 sqft one (generally).  Like the maintenance question, you have to look at the property in general and then set aside based on what it needs, plus any debt service. I like 6 months of reserves, personally, if you're leveraged.  Do a search for cash reserves on these forums for some more discussion.

6) Depends on what's available in your market.  It's really neat in theory, since you get the owner occupied loan benefits and can generate rental income, then move out and make the whole thing a rental.  But if duplexes in your market suck, then it's a terrible idea.  Take what the market gives you, don't force an idea based on theory.  Research into it though, cause it might be a great way to start for you.

7) I wouldn't bother with under 1%.  I mean, sure, some people take less return under the guise of "I'll learn so much," but you can learn so much and get paid at the same time.  And more buffer/profit allows more room for mistakes.  If/when you make mistakes landlording (choose the wrong tenants), evaluating a property (pay too much), underestimating repairs, etc. etc., dropping what should be a 10% return to 2-3%, you're okay, cause you learned with a buffer.  If your return was 2-3% projected because you were willing to take a worse return to "learn" - and then you make mistakes learning... ouch.

8) A few months is reasonable.  Take your time, get to know your market. Talk to other investors.  Look at the MLS daily.  Learn what is, and isn't, a deal.

9) Yes, it's all public record, no secrets, unless it's not recorded for some reason (such as ownership in a trust being sold, or something).

[johnhenry]

9) Yes, it's all public record, no secrets, unless it's not recorded for some reason (such as ownership in a trust being sold, or something).

Yes, and this is a great way to learn what real prices are in a given market.  Some properties are held by a trust or LLC, so you don't easily know WHO bought it, but every county I've done business in does make public the amount of the sale on the deed.  Most counties also go ahead and use that amount as the assessed value for taxing and most (from what I've seen) just continue to assess tax on that amount until it's sold again.  Of course there are no guarantees, but it can be reassuring to know you aren't investing in a county that does not aggressively re-assess property values at short intervals.

If you study a market long enough to watch a handful of properties sell, you can then find out what they sold for.  Some counties have free websites to access PVA records, others charge a fee to use it, but every one should let you look up the info at the PVA or where the deed is recorded.  If you are working with an agent, they will often do that leg work for you.

As you see the places you had your eye on sell, it can be good to know what they wound up selling for.

[arebelspy]

9) Yes, it's all public record, no secrets, unless it's not recorded for some reason (such as ownership in a trust being sold, or something).

It depends on the state.  There are quite a few non-disclosure states where the purchase prices are not recorded:

Alaska
Idaho
Indiana
Kansas
Louisiana
Maine
Mississippi
Missouri
Montana
New Mexico
North Dakota
Texas
Utah
Wyoming

Good clarification.  I tend to use the MLS, rather than public records, so I didn't even think of that.

[Cheddar Stacker]

Great list of questions enderland. I'm an interested observer/potential investor as well.

FYI - I'm in Missouri and while all purchase prices might not be recorded there are plenty of places where they are posted in my city/county. County records, MLS, etc.

I'll add a question/topic to the discussion:

10) How important is your exit strategy? I've heard you discuss this before arebelspy, but is it just one factor or the biggest factor? Is cash on cash return more important since you can essentially earn your entire investment back before ever considering the exit strategy?

I've been watching the market from afar over the last 2 1/2 years here. I have one small investment in a partnership, and am looking to make a few more investments over the next year either by myself or with that partnership group.

In my interactions thus far when dealing with MFR's most buyers and sellers pay close attention to the Cap Rate which makes some sense to me. But then when you are a seller of a MFR aren't you then limited to selling within an acceptable cap rate range, and isn't your pool of buyers fairly limited? One reason I'm leaning more towards SFR's is the unlimited pool of buyers when considering the exit strategy since it can be used as either a rental or a principal residence for the buyer. Also, if you're dealing with someone looking for a personal residence vs. an investment, most of the time the purchase will be fueled by emotions more than logic and "return on investment" so the idea of a Cap Rate goes right out the window.

Thoughts?

[sammybiker]

My take....

1) As I understand the 1% rule, if I am unable to get $1000/month in rent, this is a poor choice. If closer to $2000 it's a great deal.    I'm not sure if I would say it's a "poor choice" - if you're looking at a 1% A class deal in an area that is appreciation >5% annually and is just down the street, there may be merit.  I prefer to go after the >2% deals, investing some 2.7k miles away.

2) The "cash on cash" idea means that, for this example, if I get $1000/month in rent and "net" $200/month after all expenses, with a $10k downpayment I effectively have a $2,400/$10,000 return or 24% return. If I can "net" $100/month I have a 12% return. These returns are what I should compare to comparable stock market yearly returns (ignoring equity). If my downpayment is $20k, these returns are 1/2 those percentages.  Sure.
 
3) Maintenance estimates of about 1% a year are reasonable starting points  Sure, for a starting point.  As arebelspy mentioned, a lot of factors are involved here.  But for rough order of magnitude, this is solid.

4) It seems it would make sense to not max out my 401k next year if I am intending to purchase real estate and need money for down payments, etc. Is it generally advisable to those looking to get seriously into real estate to do minimums for company match in 401k and either taxable or cash savings for purchases?    IMO - anything above your company match, when you're looking at 10-20% ROI in real estate, doesn't make much sense

5) Buying any property - rental or otherwise - without some cash savings is foolish, what are recommended amounts?  Correct.

6) Is a duplex a good first property, if I intend to live in 1/2 of it? Or is this a better idea in theory than reality?  Absolutely.  But why stop at a duplex?  Why not maximize cash on cash returns and go after a tri or four pled??

7) How bad is a bad first purchase? For example, what are the implications of buying a property at 0.75% rent/purchase? Is there a generally accepted "break even" percentage for rent vs purchase cost (ie 0% real return)? or is this a "each place is different" type of thing?  First purchases are generally the worst but you learn the most.  I went the conservative route and purchased a recently renovated home...paid 80% of fair market value (was cash buyer) - and learned that I needed to be more patient :)  Still 10% annual cash on cash return/annually.  Re: first purchase, be patient, be ready to act on a good deal...and don't settle for .75%/purchase unless you face significant upside potential.  You're in this to make money. 

8) What is a good timeframe from the "decide to move forward with real estate" decision and information gathering to actually buying a place? I would want to pay much more attention to sell prices, rents, etc  I'm not sure quite what you're asking here...if you're moving forward, best season to purchase as an investor is late Fall and all Winter long.  If you've made the decision to act now, you're primed for the buying season.  But also what arebelspy said.

9) Is there an easy way to see actual sell prices somewhere? Or is this real-estate secrets? It's all public record, I think...  What everyone else said.  And make friends with agents.  A younger, hungry agent is preferred.  The guy that returns your 9PM text messages.  That guy.  True, no bs, recently sold comps will be a great asset

Question for you...

- You're investing in your local market?

[ender]

Thanks for the comments and responses everyone!

I'll be back to edit this with answers after I do that!

No problem, I didn't expect as many as I ended up with...

2) Correct, if you net that after both expenses and debt service (they are separate things).

Yeah. I would not really be counting debt service as "return" (though it kind of is? I'm not sure if I even should include principal payment as any part of return).

5) It will depend on the property.  .... Do a search for cash reserves on these forums for some more discussion.

Aww, you mean there's not a one answer fits all? :)

7) I wouldn't bother with under 1%.  I mean, sure, some people take less return under the guise of "I'll learn so much," but you can learn so much and get paid at the same time.  And more buffer/profit allows more room for mistakes.  If/when you make mistakes landlording (choose the wrong tenants), evaluating a property (pay too much), underestimating repairs, etc. etc., dropping what should be a 10% return to 2-3%, you're okay, cause you learned with a buffer.  If your return was 2-3% projected because you were willing to take a worse return to "learn" - and then you make mistakes learning... ouch.

This is a good perspective. I was not thinking about it in this sense.

If you study a market long enough to watch a handful of properties sell, you can then find out what they sold for.  Some counties have free websites to access PVA records, others charge a fee to use it, but every one should let you look up the info at the PVA or where the deed is recorded.  If you are working with an agent, they will often do that leg work for you.

As you see the places you had your eye on sell, it can be good to know what they wound up selling for.

This is a great suggestion! I might try to do something similar to this. It'd be a great way to "trial" the "is this a good property?" perspective.

Question for you...

- You're investing in your local market?

I think so, though as best I can tell it's not that great for rentals right now.

[Bobberth]

Great list of questions enderland. I'm an interested observer/potential investor as well.

10) How important is your exit strategy? I've heard you discuss this before arebelspy, but is it just one factor or the biggest factor? Is cash on cash return more important since you can essentially earn your entire investment back before ever considering the exit strategy?

This is a great question Cheddar.  I struggle with this constantly and I think it just comes down to personal preference and your goals.  Do you buy a bunch of properties in less desirable areas (not necessarily the worst areas as it's all relative) that will never appreciate and have a hard time selling but cash flow a ton or buy fewer properties that will appreciate and be easier to sell but generate less cash flow in the meantime?  I know of a hard money lender here in St. Louis that had 80-some houses in North County rented out section 8.  If you estimate $700/month in rent, that's some serious cash each month.  What is the value of those houses?  Assuming natural, open-market sales, each house is worth maybe $20k-$30k, $40k possibly for some.  And that is what those houses are going to be worth 5 or 10 years from now too.  Assuming you can find a buyer though, as most potential owner occupants either won't buy in that area if they can afford to buy or those who want to live there won't be able to buy.

So do you want awesome cash flow each and every month and deal with North County issues or do you buy in West County for great appreciation but terrible cash flow and fewer headaches?  There is no correct answer for everybody.  I personally am investing in South City as a middle of the road mix of the two extremes.  Somedays I am tempted to to go out and buy a bunch of cruddy properties to FIRE immediately but so far, I have resisted that urge.

[ender]

Currently reading through Building Wealth One House at a Time...

I think a good idea would be to create a spreadsheet of rents for my area. I have a pretty good feel for what apartment rents run, but not really a good feel for home costs.

[Bobberth]

Find a real estate agent that knows REI-preferably one with rentals themselves as they will all tell you they are "experts" in REI.  Have them set you up with automatic emails.  My agent has me set up to receive daily emails with updates from the MLS.  Everyday I get an email that lists all properties in my selected zip codes and price range.  It will highlight any new listings, properties that came back on the market and those that had a change in price.  I can add properties to a favorites list and then I can watch the properties through closing as it's linked to the MLS-this is a HUGE advantage over Realtor.com watch lists.  By watching the properties through closing you can see what is selling for what prices and how long is it taking.  I go back to the ones that would meet my criteria and see what I would have paid and compare to the actual price.  This way I can stay on top of the market when I am ready to buy another.

Then get out there and look.  Get to know areas.  Drive around.  Where are the bad parts of town?  What areas are near the bad areas.  What areas are near those areas?  Start looking there.  Any local "rules of thumb" you can question (in St. Louis it's "Avoid the State Streets"-all of mine are in the dreaded "State Streets" as there is great opportunity (and pitfalls!) there)?  Look in what you consider better areas and then compare returns.  Investing is about making money not where you would or would not live.  Make a day and go see 10-20 places with an agent.  Do that as often as you can.  If the agent knows REI, ask them if they have other investors with similar interests that you could tag along with (I've had others tagging along 4 times).  That would be great as you can get more pointers about what to look for in condition, rehab and rents.

Reading and studying is great, but it's nothing compared to boots on the ground.  Make sure you start looking as you're still studying. 

[ender]

<<>>

Reading and studying is great, but it's nothing compared to boots on the ground.  Make sure you start looking as you're still studying.

Great advice.

I actually was poking around on Zillow this morning and found a couple interesting places, at least seemingly close to potential places which would be worth looking at and emailed them. I expect nothing will come of it but I wanted to at least get that ball rolling.