this is why I don't like the 1% rule (three-year update)

[clarkfan1979]

Three year update from previous thread

https://forum.mrmoneymustache.com/real-estate-and-landlording/this-is-why-i-do-not-like-the-1-rule/

Original post was from November 20, 2020. I advocated to keep my Kauai rental. Some agreed and others did not.

I was estimating house value at 900K on November 20, 2020. If I sold, I would have put 386K into the S & P 500 (3798) on January 20th, 2021.  Three years later, S & P 500 (4594) is up 21% + 5% for dividends for a gain of around 100K

I kept the rental and I'm estimating the current value at 1.15 million. I calculated 250K for appreciation, 28K for principle pay down and 46K for cash flow for a total of 324K. The cash flow in 2021-2022 was a little low due to deferred maintenance and staying at the property for 17 weeks. The cash flow was better in 2023 because we had less deferred maintenance and only stayed at the property for 4 weeks.

The rental does require work. It's not 100% passive. However, we logged 21 weeks of vacation at the property over the past three years. We also did work while on vacation at the property which makes it complicated from an investment perspective.   

Current Rent
Upstairs: 3950
Basement Unit: 2200 (I charge $2300 but I pay $100 for their utility use to the upstairs tenants)
Total: 6150

Monthly Expenses
PITI: 2444
Insurance: 205
Taxes: 407
Utilities: 113 (internet & propane)
Hawaii GE Tax: 281
Total: 3450

Gap: 2700/month

For 2023, we are looking at a 100K gain (stock market) vs. 324K gain (RE), which is a gap of 224K

For 2022, it was a 23K gain (stock market) vs. 260K gain (RE), which is a gap of 237K

Due to good recent stock market performance, the gap shrunk in 2023. However, RE is still ahead.

I'm probably going to pocket an extra $500 in December 2023 because the tenant in my lower level unit is breaking the lease and I'm going to keep their deposit. They are required to stay 6 months, but they only stayed 2 months. It's a 20-year old kid with a rich dad that co-signed. The dad makes 2.5 million/year as a commercial real estate broker.

I will have some vacancy in December, but the deposit will cover it. My upstairs tenants are hosting Christmas and have 12 visitors from Honolulu for 3 days. I told them yesterday they can use the downstairs unit for free because it will be empty and Merry Christmas.

I already have the new tenant lined up and should have a signed lease in about 5 days. The new tenant is a 20-year old in the fitness industry. Most of their income is from endorsements (social media influencer). Their income is $54,000/month. They won't move-in until January 22nd, but they will start paying rent on January 1, 2024.

Paying rent 3 weeks before your ideal timeline is pretty normal for this market, if you are moving from the mainland. My upstairs tenants did the same thing last year. My current tenants upstairs work for a construction company and the company pays the rent. The company had them in a hotel for 5 weeks ($15,000?) before they could secure long-term housing. Paying rent for 3 weeks before you get there seems extreme. However, it's way cheaper than paying to stay in a hotel for 5 weeks.   

[Midwest_Handlebar]

Thanks for posting. The amount of wealth in Hawaii is shocking to me. The returns you demonstrated is why I moved the majority of our assets into rental residential real estate over the past few years. It's very possible to hit 15-20% returns consistently with an appropriately leveraged real estate portfolio on a small-medium scale.

I would still be working if I had stuck to the retirement account/index fund route.

[crking]

Hey Midwest, any chance you'd like to expand on your real estate portfolio? I'd be interested in region as well as percentage of your total portfolio the real estate portion is. I assume you are referring to physical rental properties but if not, which platform(s) do you prefer? Do you self-manage your physical properties? Thank you!

[Midwest_Handlebar]

I'm always expanding my portfolio, but I'm not taking outside money at this point if that's what you're asking. I have a meeting tomorrow to plan out 6 1031 exchanges over the next 2 years (converting all the Covid equity to increased cash flow).

I self manage 13 physical doors at this point, and should be able to double that in 1-2 years. If you want to get 15-20% returns consistently it's a lot of work. Managing rehabs, tenant selection, maintenance requests, banking relationships, optimizing taxes, etc. I'm not a guru and it's not "passive". I have roughly 75% of our net worth in real estate.

[clarkfan1979]

I'm always expanding my portfolio, but I'm not taking outside money at this point if that's what you're asking. I have a meeting tomorrow to plan out 6 1031 exchanges over the next 2 years (converting all the Covid equity to increased cash flow).

I self manage 13 physical doors at this point, and should be able to double that in 1-2 years. If you want to get 15-20% returns consistently it's a lot of work. Managing rehabs, tenant selection, maintenance requests, banking relationships, optimizing taxes, etc. I'm not a guru and it's not "passive". I have roughly 75% of our net worth in real estate.

Calculating a cash on cash return can be difficult for me because I'm doing cash-out re-fi's to buy additional real estate.

My original investment of rental #1 was 50K. It was a single family purchased for 182K (20% down) with 10K of rehab in 2007. I did a cash-out re-fi in 2017 and pulled out about 148K. I used the money to purchase rental #3 in 2018, which was 603K with 50K of rehab.

Rental #1 is now worth 510K. Rent is $2600/month and PITI is $1600/month
Rental #3 is now worth 1.17 million. Rent is $6250/month and PITI + utilities + GE tax is $3550/month.

What is my cash on cash rate of return? 

[Midwest_Handlebar]

Yeah, I have no idea. I guess your cash on cash would be $44.4k in cash flow, divided by the original $50k invested, or 89%. I don't really like cash on cash as a metric though. I prefer return on equity. How much debt do you have on the two properties? If you started with $50k and reinvested all the cash flow to pay down the debt you could back into a number if you know how much your equity is. Assuming you had $924k in equity now, your cash on cash would be 20% annually since 2007. If more, your return would be higher. Regardless your return is incredibly good.

I spent $782k for 6 condos from Aug 2019- Feb 2022. I just spoke with a realtor that thinks they're worth $1,219k combined now. So $437k in appreciation. On top of that I had probably $80k-$100k in tax savings and they now cash flow $3k a month. I also brrr'ed them at low interest rates to build the portfolio, but now only have $250k in debt.

What is the return?..... I have no idea. All I know is I now have $1M in equity while I was "WFH" during COVID that I didn't have before.

[Midwest_Handlebar]

I was thinking about this tonight and I think we put in $325k total ($25k down on the 1st condo, and $10k per month over 30 months). We turned it into $970k in equity and $90k worth of tax savings and $100k in cash flow (total $1,160k). So 257% in 3-4 years? More sustainable than Bitcoin...

[Psychstache]

I don't know that it would change things, but wouldn't it be a more fair comparison to calculate the investment scenario as 386K into the S&P 500 on January 20th, 2021 PLUS adding an additional monthly investment into the S&P of $3,450 (since those PITI etc expenses would not exist now that the rental is sold in this multiverse)?

[Midwest_Handlebar]

I'm not following where you're getting your numbers or dates, but the S&P 500 has returned 29.42% from Jan '21 with dividends reinvested. This is pathetic when compared to an individual's real estate portfolio that is actively managed.

I view our retirement funds as simply a short term tax arbitrage strategy at this point. I would love to pull it out and be 100% invested in cash flow real estate with 50% debt leverage at this point.

[clarkfan1979]

Yeah, I have no idea. I guess your cash on cash would be $44.4k in cash flow, divided by the original $50k invested, or 89%. I don't really like cash on cash as a metric though. I prefer return on equity. How much debt do you have on the two properties? If you started with $50k and reinvested all the cash flow to pay down the debt you could back into a number if you know how much your equity is. Assuming you had $924k in equity now, your cash on cash would be 20% annually since 2007. If more, your return would be higher. Regardless your return is incredibly good.

I spent $782k for 6 condos from Aug 2019- Feb 2022. I just spoke with a realtor that thinks they're worth $1,219k combined now. So $437k in appreciation. On top of that I had probably $80k-$100k in tax savings and they now cash flow $3k a month. I also brrr'ed them at low interest rates to build the portfolio, but now only have $250k in debt.

What is the return?..... I have no idea. All I know is I now have $1M in equity while I was "WFH" during COVID that I didn't have before.

I agree that the math would be easier if someone was using the extra cash flow to pay down the mortgage.

We didn't do that. Once we got to $2,000/month in cash flow or $1,500/month after vacancy & repairs in 2015, my wife transitioned from full-time to part-time work. We have funded our lifestyle with $1,000-$1,500/month of rent money since 2015. That slowed our RE portfolio growth, but it was a huge boost to quality of life.

In 2024, we might actually be able to live solely off of our W2 income and save/invest all of cash flow from rent. It's a realistic goal, but I don't want to sacrifice quality of life to make it happen because it's just a number on a spread sheet. 

Across 3 rentals and a primary we have 1,065,000 of debt on 2,420,000 of RE equity (56% equity). 

[Midwest_Handlebar]

Ok, your annual return since 2007 is ~22% not including the cash flow. I'm guessing it would be closer to 25% if you factored that in. Regardless you've done very well for a long time with real estate. S&P returned 9.38% during the same period and you would only have $242k if you put your original $50k into an index fund. You made $1M+ because you bought your rentals when you did.

[Jon Bon]

I'm not following where you're getting your numbers or dates, but the S&P 500 has returned 29.42% from Jan '21 with dividends reinvested. This is pathetic when compared to an individual's real estate portfolio that is actively managed.

Is it though?

If I am able to buy 100k stock with only 20% down at 3% interest after 2 years my investment is worth 130. So my gain would be over 100% in that time frame(29,420 gain / 20,000 invested money). that would be pretty awesome. That is also why leveraged real estate can be a huge winner.

I mean I love RE it is awesome. But speculation can be dangerous (see 2008). I'm not saying clark or me or anyone else are going to go broke. I am saying RE will reset at some point, the devil is of course in the timing of when.....

RE is not magic, leverage is kind of magic!

[Midwest_Handlebar]

I agree that real estate doesn't always go straight up and to the right, but my market has seen significant appreciation in the past 2 years even with interest rates doubling. I don't see the market collapsing now that interest rates are declining.

Above trend appreciation in the near future is unlikely to occur, so that's why I'm locking in my gains and redeploying my equity into properties that provide more cash flow.

[srad]

In order for a market to crash there has to be a glut of distressed sellers.  Who is distressed? 

1. Per Google, 61% of mortgages are under 4%, and 40% of homes are owned free and clear.
2. All loans made in the last 15 years have been made to borrowers who have excellent credit. 
3. They all have equity.  Marketwatch article saying homeowner equity hit 10.5 trillion last year.

If someone needs to sell, they will sell the house, get a check and move on with their life.  Don't expect a crash anytime soon.

[srad]

This thread made me look at my portfolio, I didn't realize I'm under a million in debt on my rentals. I'm down to 985k, thanks 3% mortgages! 

Leverage in real estate has produced some solid returns for me as well.  My biggest winner, I did a 190k cash out refi on a rental back in 2016. Purchased 3 properties for 750k and spent about 60k to get them rent ready.  They are now worth over 1.2mm.  60k out of pocket, an obscene amount of my time, for 450k equity in 8 years, not bad.   Another winner is my first rental. Its 15 year mortgage has recently been paid off by my tenants:)   The only thing special with the rest of my portfolio is the mortgages: 3.15% for the houses and 3.25% for the duplexes.  When I refi'd them back in 2020 it was like acquiring an additional door for no additional work. 

I'll say this, Its taken my wife and I 17 years, but we can now live decently off of our rents alone if we choose to.  She retired from her w2 job 3 years ago, I'm in the coasting WFH mode, fighting hard with the "one more year" syndrome. 

And not one of my properties achieved the 1% rule.

[Midwest_Handlebar]

This thread made me look at my portfolio, I didn't realize I'm under a million in debt on my rentals. I'm down to 985k, thanks 3% mortgages! 

Leverage in real estate has produced some solid returns for me as well.  My biggest winner, I did a 190k cash out refi on a rental back in 2016. Purchased 3 properties for 750k and spent about 60k to get them rent ready.  They are now worth over 1.2mm.  60k out of pocket, an obscene amount of my time, for 450k equity in 8 years, not bad.   Another winner is my first rental. Its 15 year mortgage has recently been paid off by my tenants:)   The only thing special with the rest of my portfolio is the mortgages: 3.15% for the houses and 3.25% for the duplexes.  When I refi'd them back in 2020 it was like acquiring an additional door for no additional work. 

I'll say this, Its taken my wife and I 17 years, but we can now live decently off of our rents alone if we choose to.  She retired from her w2 job 3 years ago, I'm in the coasting WFH mode, fighting hard with the "one more year" syndrome. 

And not one of my properties achieved the 1% rule.

Out of curiosity how many doors, gross cash flow and net cash flow do you have? I've spent a lot of time thinking how to design my rentals this year and appreciate other's perspectives.

[srad]

Out of curiosity how many doors, gross cash flow and net cash flow do you have? I've spent a lot of time thinking how to design my rentals this year and appreciate other's perspectives.

I'm at 10 doors. Starting March 1st my new rents will be 17.5k a month, mortgages are $6,774.  The problem with rentals is one rental barely moves the needle.  I got to 10 doors was like, that's enough. I would like more money from rentals, but I don't want the hassle.   You really notice you have rentals at 10.  I'm glad we've been building up a nice side stash with our w2 money.  The VTSAX has never called me saying water is running through the ceiling from a busted shower drain...

I also have done 6 live in flips and as I rolled each houses proceeds into the next, I can buy them with cash.  I'm now living mortgage free in my current residence.