Author Topic: I don't understand landlord math  (Read 2446 times)

Montecarlo

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I don't understand landlord math
« on: April 14, 2019, 02:57:45 PM »
Let's take a hypothetical property valued at $215K

$1,350 monthly rent
10% vacancy


Taxes: $2,150
Depreciation/Maintenance: $2,150
Insurance: $1,000
Water/Sewer: $750

Revenue: $14,600
Operating Costs: 6,000
Cash Flow: $8,600
ROI: 4%

And I'm not even making conservative assumptions.  Why would anyone do this over corona at the beach stock market investing?

Even leveraging with a loan doesn't seem to help much, see attached picture.

What am I doing wrong with my math?




Another Reader

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Re: I don't understand landlord math
« Reply #1 on: April 14, 2019, 03:06:12 PM »
What are you doing wrong?  Buying the wrong property.  You should look for properties that gross 1 percent per month.  In your example, substitute $2,150 for the rent and recalculate.

Also, in many markets, over time the property will appreciate.  If it appreciates at 3 percent per year. add that to the percent of value you receive in the cash flow.

Montecarlo

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Re: I don't understand landlord math
« Reply #2 on: April 14, 2019, 03:14:05 PM »
I chose those #s because they are median house prices and rental listing in my zip code.  It seems cray cray.  Housing prices would have to be 20% lower for me to be interested in renting at $1,350 a month

maizeman

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Re: I don't understand landlord math
« Reply #3 on: April 14, 2019, 03:21:51 PM »
I chose those #s because they are median house prices and rental listing in my zip code.  It seems cray cray.  Housing prices would have to be 20% lower for me to be interested in renting at $1,350 a month

In lots of the US right now, getting into rentals makes absolutely no sense. I'm definitely in the corona-at-the-beach-index-fund crowd, but I know I've seen a fair number of folks on the forum who are definite advocates for real estate generally agree with that statement in the current price/rent/interest rate environment.

To be fair there are also people who argue buying and renting out still makes sense even in the ridiculously overpriced booming coastal cities like SF and NYC. They generally make an argument that you'll make your wealth from price inflation -- and to a lesser extent rent inflation -- and so are okay with renting at a loss early on.

Depending on your assumptions you can make the projections work on that, but you're taking on a much bigger risk if optimistic assumptions about future price and rent inflation in those markets turn out to be incorrect.

If I'm remembering correctly, @waltworks got heavily into rentals during the 2008/9 crash and then a couple of years ago cashed out and moved over to the stock market, because their houses has appreciated in value so much and rents handed increased at the same rate. Great example of how the rule about stocks of "if you own it but wouldn't buy it at today's price, you should sell" can be applied to the real estate/rental space as well, as long as you bring the right level of mental and emotional discipline to the process.

Another Reader

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Re: I don't understand landlord math
« Reply #4 on: April 14, 2019, 03:30:34 PM »
What rents for the median rent may not be the same as what sells for the median price.  Also, some landlords bought when prices were lower.  To sell to sit on the beach probably costs significant tax dollars on the capital gain and recaptured depreciation.  Less knowledgeable buyers may buy the median priced house to rent.  Some of them will sell when the returns are not up to their expectations. 

W/R/T Maizeman, the taxes on sale are a factor, and the return on the initial investment in many cases looks pretty darn good.  Inertia plays a part.  If the income is high enough, why kick the sleeping dog? 

Montecarlo

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Re: I don't understand landlord math
« Reply #5 on: April 14, 2019, 03:41:49 PM »
What rents for the median rent may not be the same as what sells for the median price. 

How would I go about figuring out what a prospective property would rent for?  I can see other listings, but won't necessarily know if the landlord is listing at an unrealistic price.


Another Reader

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Re: I don't understand landlord math
« Reply #6 on: April 14, 2019, 03:47:06 PM »
Property managers and closed listings.  Zillow, and Rentometer give you some idea but are not perfect.

Villanelle

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Re: I don't understand landlord math
« Reply #7 on: April 14, 2019, 04:21:43 PM »
I've been a landlord for about 9 years and during that time, our place has been empty for a total of 6 weeks, and 4 of those week are because we had some work done between tenants.  And yes, we have turned over tenants (4 tenants) during that time.  We had people offer to waive having us clean the place in between tenants in order to get in.  And no, we aren't underpriced (at the moment, we are actually well over FMV, as far as I can tell).  It's a place with a very tight rental market, and our place is very desirable as a rental.

In a very hot market, 10% vacancy isn't going to happen unless you grossly overprice or there is something wrong with the property. 

Papa bear

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Re: I don't understand landlord math
« Reply #8 on: April 14, 2019, 04:36:52 PM »
Thatís not landlord math.  Thatís bad investor math.

There are a lot of people on these forums that would say thatís a decent deal. Iím not one of them.  Thatís a terrible rental.  You could buy it and get appreciation, but thatís just a crapshoot. 

You want to get a rental that would return 20% cash on cash returns.  Those places are increasingly hard to find. 

To really know the market, you need to be researching listings regularly.  And you should probably go check out a few places in person to get an idea what they are like.  Drive byís can be useful to get an idea of location, yard, parking, etc. 

Once you know the market rents, find a house that is underpriced for that rent.  If itís an investment area, prices will be based on rents.  Maybe you can do some capital improvements and move the property up a tier.  If itís more of an owner occupied area, prices are based more on demand, not on a rent multiplier.  Try to find a home that, while priced correctly for owner occupied, may have a higher rental demand. 


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maizeman

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Re: I don't understand landlord math
« Reply #9 on: April 14, 2019, 04:46:48 PM »
W/R/T Maizeman, the taxes on sale are a factor, and the return on the initial investment in many cases looks pretty darn good.  Inertia plays a part.  If the income is high enough, why kick the sleeping dog?

You are right, that's a good point particularly about the taxes.

Dealing with a bunch of depreciation recapture can make it a lot less financially appealing to get out from real estate even if on paper you've accumulated a bunch of equity from a rapid run up in housing prices.

ender

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Re: I don't understand landlord math
« Reply #10 on: April 14, 2019, 06:39:58 PM »
Most people buying properties in my town are not making good money either. If they don't get major returns on principal appreciation, most of these places aren't great financially.

Many (most?) people who are landlords don't get this though. Or are willing to take a lower return based on selling.

Archipelago

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Re: I don't understand landlord math
« Reply #11 on: April 14, 2019, 06:43:09 PM »
Let's take a hypothetical property valued at $215K

$1,350 monthly rent
10% vacancy


Taxes: $2,150
Depreciation/Maintenance: $2,150
Insurance: $1,000
Water/Sewer: $750

Revenue: $14,600
Operating Costs: 6,000
Cash Flow: $8,600
ROI: 4%

And I'm not even making conservative assumptions.  Why would anyone do this over corona at the beach stock market investing?

Even leveraging with a loan doesn't seem to help much, see attached picture.

What am I doing wrong with my math?

Another number you need to factor in is property management fees (10% of gross rent). If the deal doesn't make sense using a property manager, then it's not a good property.

waltworks

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Re: I don't understand landlord math
« Reply #12 on: April 14, 2019, 07:37:36 PM »
@maizeman yes, we did sell all our rentals.

The reason people don't sell them (and pay the capital gains/depreciation) is that, as most of you probably know, humans value a loss more than an equivalent gain (double, if the replication-crisis psych folks can be believed!)

So it's *hard* mentally to pay that money when you sell the property. Many people can't bring themselves to do it, even though they probably know it's suboptimal to keep a property that has appreciated beyond all reason as compared to rent.

Also remember that we're basically back (at least in nominal terms) to 2006 housing bubble pricing. Rents have not increased at the same rate. Many of the people buying these properties (and posting here) have never experienced anything but double digit price increases in their adult/investing lives. Everyone feels like a genius right now ("I ignored the 1% rule and now I'm rich!") Folks who have been through a RE cycle or two (especially CA folks for whom boom/bust is normal) are less optimistic.

My personal opinion is that we will see a LONG stagnation in housing prices (many of the "hot" markets are seeing high double digit percentage increases in listings year over year). We could also see another crash (IMO less likely than stagnation). I think it's extremely unlikely that prices will continue to increase faster than inflation, but you never know.

That said, stocks are expensive too. It's the everything bubble. Shrug.

-W
« Last Edit: April 14, 2019, 07:43:03 PM by waltworks »

Another Reader

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Re: I don't understand landlord math
« Reply #13 on: April 14, 2019, 08:05:27 PM »
@maizeman yes, we did sell all our rentals.

The reason people don't sell them (and pay the capital gains/depreciation) is that, as most of you probably know, humans value a loss more than an equivalent gain (double, if the replication-crisis psych folks can be believed!)

So it's *hard* mentally to pay that money when you sell the property. Many people can't bring themselves to do it, even though they probably know it's suboptimal to keep a property that has appreciated beyond all reason as compared to rent.

Also remember that we're basically back (at least in nominal terms) to 2006 housing bubble pricing. Rents have not increased at the same rate. Many of the people buying these properties (and posting here) have never experienced anything but double digit price increases in their adult/investing lives. Everyone feels like a genius right now ("I ignored the 1% rule and now I'm rich!") Folks who have been through a RE cycle or two (especially CA folks for whom boom/bust is normal) are less optimistic.

My personal opinion is that we will see a LONG stagnation in housing prices (many of the "hot" markets are seeing high double digit percentage increases in listings year over year). We could also see another crash (IMO less likely than stagnation). I think it's extremely unlikely that prices will continue to increase faster than inflation, but you never know.

That said, stocks are expensive too. It's the everything bubble. Shrug.

-W

Stocks are expensive and I don't see any reason to conclude appreciation in stocks will be much better than real estate.  If all asset classes eventually revert to their mean appreciation rates, we should see stagnation or declines in both asset classes.  I don't know if holding is sub-optimal and I won't until a decade from now. 

Although the rents as a percentage of value are not very favorable today, my equity grows with each mortgage payment.  Rents are still increasing in my most concentrated market as well.  The income is steady, which unless you focus on dividends, is not the case with stocks.  Excess income is deployed to stocks and cash for the next buying opportunity.  Collecting rent checks and not selling allows me to avoid the hefty tax bite altogether for the heirs. 

I will be looking for 1031 exchange opportunities as markets shift.  If real estate looks like it will take a tumble and rents will as well, I might sell some properties then.

waltworks

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Re: I don't understand landlord math
« Reply #14 on: April 14, 2019, 08:30:11 PM »
No argument that stocks aren't a steal either. But they are low risk as compared to RE (unless you have a lot of geographically diverse RE) and they require zero effort/stress. That counts for a lot in my book.

Holding until you die/pass the RE on to your heirs is a good plan under current tax law. I'm not so sure that basis-reset rule won't be disposed of at some point, but as of now, great way to pass on money to the kids for those who are concerned with that.

-W

Malkynn

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Re: I don't understand landlord math
« Reply #15 on: April 15, 2019, 04:16:56 AM »
Yup.

Rentals simply aren't a great investment in a lot of markets.
I have a unit will almost exactly those numbers, except worse. However, I am renting it to my disabled mother, so I'm fine subsidizing her rent.

There is no way in this area to rent my unit out profitably yet. The neighbourhood is gentrifying rapidly, so by the time my mom passes or moves into care, I'll either rent it out for much much more, or sell, whichever the market dictates.

In my city, people buy rentals primarily for the property appreciation. A lot of people are running at negative cash flow, especially for smaller condos, which make up most of the rental-by-owner market.

There's a reason more people don't invest in rentals; the math often doesn't work very well. That's the whole point of doing the analysis that you did.

Personally for me, I'm happy with my negative cash flow situation, not only to help my mom, but also for the diversification and for the opportunity to move and buy a second property in the same heating area at a very low price.

We were staying in our first place because it was such a good investment property in a gentrifying neighbourhood, but it's not a house we actually want to live in. Tenants in a not-yet-gentrified 'hood are also a huge risk, so we weren't comfortable renting it out yet. We were kind of trapped.

So now we have a solid long-term tenant, which means zero months unoccupied, and she and my step dad are actually trememdously handy and will work on the place over time... and it needs some work.

Lastly, we don't need this property to make money. It will just be a nice bonus when we sell. We haven't included it at all in our retirement planning. In fact, we're mostly banking on using the equity to pay for my parents end of life care if needed. The rest will be gravy.

So yeah, you have to really look at the numbers to make sense of them. It's not as simple as "buy a property and rent for the average rent amount for the neighbourhood and profit!!"

You have to know your numbers, know you market, know your tax implications, and know your goals in order to make it make sense.

If it was simple, everyone would do it.


SwordGuy

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Re: I don't understand landlord math
« Reply #16 on: April 15, 2019, 10:37:49 AM »
I suggest you start reading the sticky thread on books and then start reading the books it mentions.   Then you'll know how to do the numbers.

You'll also learn various strategies to buy homes at lower costs than the typical retail consumer pays.   You don't need a lot of wins to make good money.

Rental #1 rents at 1.7% of rent-ready cost per month.   
Rental #2 rents at about the same.
Rental #3 would have done better, but my mom passed, life got rough and my wife got injured, so I paid people do do more of the work than we otherwise would have.



Jon Bon

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Re: I don't understand landlord math
« Reply #17 on: April 15, 2019, 02:14:00 PM »

If it was simple, everyone would do it.

Well I somewhat disagree.......

Stocks ARE simple, buy index funds get 8% return. Relatively painless and hard to mess up.

Real estate should return about 15-20% cash on cash. You get compensated for additional risk, more work/hassle, and owning an illiquid investment etc. Owning rental properties is not rocket surgery. Yes they come with additional work but you get additional return. Historically IME it has not been hard to find 1% returning houses*. Finding houses that beat the 1% rule IS in fact difficult. Since the 1% rule has been replaced by the 3/4% rule or even worse the 1/2% rule anything worth buying is pretty much nonexistent. I am just waiting for the 1% rule to come back before I start investing again.

We are just in an epic asset price bubble. The math will work again at some point right?! Maybe the problem is everyone is doing it!!

*This excludes superstar cities.

Malkynn

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Re: I don't understand landlord math
« Reply #18 on: April 15, 2019, 02:32:15 PM »

If it was simple, everyone would do it.

Well I somewhat disagree.......

Stocks ARE simple, buy index funds get 8% return. Relatively painless and hard to mess up.

Real estate should return about 15-20% cash on cash. You get compensated for additional risk, more work/hassle, and owning an illiquid investment etc. Owning rental properties is not rocket surgery. Yes they come with additional work but you get additional return. Historically IME it has not been hard to find 1% returning houses*. Finding houses that beat the 1% rule IS in fact difficult. Since the 1% rule has been replaced by the 3/4% rule or even worse the 1/2% rule anything worth buying is pretty much nonexistent. I am just waiting for the 1% rule to come back before I start investing again.

We are just in an epic asset price bubble. The math will work again at some point right?! Maybe the problem is everyone is doing it!!

*This excludes superstar cities.

Fair point about investing being easy and few people doing it.

I'm in Canada where the markets are a bit different, so I don't really know what's normal in the US

Jon Bon

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Re: I don't understand landlord math
« Reply #19 on: April 15, 2019, 02:36:57 PM »
Ha good point, my knowledge of Canadian RE is basically what I see on those insane TV shows!

But neither place feels very good to invest right now. But fingers crossed that will change in the future.

Malkynn

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Re: I don't understand landlord math
« Reply #20 on: April 15, 2019, 02:46:50 PM »
Ha good point, my knowledge of Canadian RE is basically what I see on those insane TV shows!

But neither place feels very good to invest right now. But fingers crossed that will change in the future.

There's a 550sqft condo near my office retailing for 750K +$500/mo condo fees +property taxes. Yeah, there's NO WAY to rent that at positive cash flow in this market.
A large 1 bedroom in a luxury building just a few blocks away is under $2200 and includes parking.

maizeman

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Re: I don't understand landlord math
« Reply #21 on: April 15, 2019, 03:31:54 PM »
We are just in an epic asset price bubble. The math will work again at some point right?!

That's the big question everywhere and across all investments.

SeattleCPA

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Re: I don't understand landlord math
« Reply #22 on: April 15, 2019, 04:12:32 PM »
OP, you might find it interesting and illuminating to look at this paper (link below) which describes how very probably investments in housing beat equities in most cases:

https://www.frbsf.org/economic-research/files/wp2017-25.pdf

The issue is both asset classes return about the same arithmetic mean return but that housing subjects investors to way lower variability in annual returns.

FWIW, I'm a passive equity index fund investor using David Swensen's asset allocation formula. But if I was forty years younger, I would consider emphasizing real estate based on what the above referenced paper shows.

Buffalo Chip

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Re: I don't understand landlord math
« Reply #23 on: April 15, 2019, 04:33:03 PM »
Let's take a hypothetical property valued at $215K

$1,350 monthly rent
10% vacancy


Taxes: $2,150
Depreciation/Maintenance: $2,150
Insurance: $1,000
Water/Sewer: $750

Revenue: $14,600
Operating Costs: 6,000
Cash Flow: $8,600
ROI: 4%

And I'm not even making conservative assumptions.  Why would anyone do this over corona at the beach stock market investing?

Even leveraging with a loan doesn't seem to help much, see attached picture.

What am I doing wrong with my math?

Itís the same math that says that the stock market is a good investment when the Shiller PE ratio is above 30. We dummies who donít understand this advanced investment math are in cash that only offers a 2-3% return.

afox

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Re: I don't understand landlord math
« Reply #24 on: April 15, 2019, 04:50:57 PM »
I know this is going to offend some but Ill write it anyway:
The reason that overpriced property is going to sell to a landlord is that many landlords are naive. The buyer of that property simply isn't going to analyze their expenses and rates of return and compare them to an alternative. For some, the math is just jibberish and simply does not matter. For many real estate investors the primary alternative (investing in securities) is just not something they are willing to consider. They don't trust an asset that is not instantly tangible or exists on paper or via a computer. Of course not every real estate investor is naive, but many are, and the OPs listing is proof of that. I am constantly surprised at how unsophisticated and often gullible many real estate investors are.

This is not necessarily a bad thing either. These investors are often providing a service (artificially low cost housing) to renters in their community. Also, by investing in RE they may also be protecting themselves from even worse investment decisions such investing in securities with an unscrupulous advisor. Of course not all RE investors are naive but many are. Of course, there are many naive securities investors too. In fact, in many cases its naive investors that make it possible for opportunistic and sophisticated investors to make money via mis-priced assets.

 

Montecarlo

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Re: I don't understand landlord math
« Reply #25 on: April 15, 2019, 05:13:00 PM »
Of course not every real estate investor is naive, but many are, and the OPs listing is proof of that.

:-(

sol

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Re: I don't understand landlord math
« Reply #26 on: April 15, 2019, 05:35:30 PM »
Around here the landlord math is even worse, as far as you've taken it, but then your property (and rents) appreciate at 8-10% per year.  Add in $21,500 per year in capital appreciation on that property (on top of the cashflow you've calculated), which you bought for only $45k out of pocket, and suddenly things look different.

10% per year appreciation on an asset you buy with only 20% down is 50% ROI per year.  You could rent it for a small loss each month and still make a fortune when you sell in five to ten years.  Or 30.

In a way it's not too different from buying the index, which only returns about 2% as dividends.  That's like your rental profits.  All of the rest of the money you make is capital appreciation, because other people are willing to buy your assets at ever-increasing prices.

Montecarlo

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Re: I don't understand landlord math
« Reply #27 on: April 15, 2019, 05:45:11 PM »
My understanding is historically, after accounting for booms and busts, housing appreciations is very little in real terms.

waltworks

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Re: I don't understand landlord math
« Reply #28 on: April 15, 2019, 06:57:59 PM »
There is a lot of debate about that, though the only person who has really tried (Schiller) concluded that for the US. The historical data are messy/unreliable enough that it's hard to be very sure, though. Records for sales of properties 80+ years ago often don't exist anymore.

Keep in mind that's just capital appreciation, which is not your only return. If you live in your house and then go to sell it after 30 years, yes, you would have done much better in the stock market in most cases. If, on the other hand, you (using 4:1 leverage!) rented that place out the whole time, and spun those funds into more real estate, you'd have killed it (most of the time).

You're more at risk for losing everything (flood wipes out all your properties that are all on the same block, big company moves out of town, Detroit, etc) much like owning individual stocks. And it's hard to sell a house (and expensive) compared to stocks. Finally, of course, it's much less passive than stocks or bonds.

So don't be fooled by the "housing barely appreciates". That's superficially true but doesn't mean it's not a good investment.

-W

My understanding is historically, after accounting for booms and busts, housing appreciations is very little in real terms.

afox

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Re: I don't understand landlord math
« Reply #29 on: April 15, 2019, 08:49:17 PM »
Around here the landlord math is even worse, as far as you've taken it, but then your property (and rents) appreciate at 8-10% per year.  Add in $21,500 per year in capital appreciation on that property (on top of the cashflow you've calculated), which you bought for only $45k out of pocket, and suddenly things look different.

10% per year appreciation on an asset you buy with only 20% down is 50% ROI per year.  You could rent it for a small loss each month and still make a fortune when you sell in five to ten years.  Or 30.

Leverage works both ways though. And there are ways to use leverage for equities too like leveraged index funds. But if you know RE prices will appreciate at 10% year then that is fucking amazing and you know what to do.

In a way it's not too different from buying the index, which only returns about 2% as dividends.  That's like your rental profits.  All of the rest of the money you make is capital appreciation, because other people are willing to buy your assets at ever-increasing prices.

Except that the index investor can be drinking coronas on the beach while RE investor is dealing with tenants and plumbers (NTTAWWT). And there are the liquidity, fees, and multitude of other issues for RE. Even so, personally, id choose the RE if I were as bullish about RE capital appreciation as you are. The problem with real estate appreciation is its limited to what people can afford to pay for a home and a more minor issue is that homes get cheaper every year due to technology. How much people can afford to pay is limited by how much they make or how much they can get a loan for which *should be related (but weren't leading upto 2008 crash). Another way to put it, if homes were to appreciate at 10% per year how long would it take until they would be unaffordable for nearly everyone?  Other asset classes do not have the same limitations. 

waltworks

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Re: I don't understand landlord math
« Reply #30 on: April 15, 2019, 09:15:54 PM »
I think @sol is looking through glasses tinted rose by the last decade of crazy appreciation. Seattle (and everywhere else) won't keep appreciating at that rate forever. In fact the party is probably already over if you follow inventory numbers (though I've been wrong before).

But yeah, if you're levered up and making 10% a year, it's crazy. We made a cool half million dollars in the last decade without even really trying to in RE (literally, only one property of 4 was actually purchased with the intent of renting it, the others were all moving-related). So cheers. I don't think buying property willy-nilly now will give you the same results.

-W

sol

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Re: I don't understand landlord math
« Reply #31 on: April 15, 2019, 09:34:34 PM »
But if you know RE prices will appreciate at 10% year then that is fucking amazing and you know what to do.

I don't know that that they will, just that they recently have.

Quote
Except that the index investor can be drinking coronas on the beach while RE investor is dealing with tenants and plumbers (NTTAWWT).

There are lots of RE investors on this forum who don't do squat for their properties, choosing instead to pay other people to manage them.  In the right markets, that's still profitable.  For a landlord with twenty or more SFRs, it's probably the only feasible way to do things in any market.

Quote
Another way to put it, if homes were to appreciate at 10% per year how long would it take until they would be unaffordable for nearly everyone?  Other asset classes do not have the same limitations.

I'm not sure why this argument applies to houses that appreciate at 10% per year but not stocks that appreciate at 10% per year.  I don't see anyone claiming that VTSAX is going to be unaffordable at the rate it's been increasing. 

And as for the "nearly everyone" part, what does that matter?  As we've previously discussed in other threads, the traditional metrics like the ratio of house prices to median wages aren't relevant in most big cities anymore, because there are far more highly paid people in places like Seattle than there are available houses.  Median wages are irrelevant when your city has so many overpaid tech workers that only the top 5% of them can win bidding wars.  And let's not forget that it is always the buyers who are bidding up prices by 10% per year.  It's not like the government has independently decreed that house prices should get so expensive that no one can afford them.  It's precisely because so many people are willing to pay so much that prices keep going up. 

Housing is always a buyer's market; if prices are going up, it's because there are lots of people who want to buy who CAN afford those high prices. I don't think it makes sense to talk about housing becoming "unaffordable" when buyers are the ones bidding up the prices.

Montecarlo

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Re: I don't understand landlord math
« Reply #32 on: April 15, 2019, 10:02:40 PM »
I don't see anyone claiming that VTSAX is going to be unaffordable at the rate it's been increasing.

Wait, what?  Some very smart people have been saying that for years.  Not saying they are right, but to suggest no one thinks equities are overvalued is cray cray
« Last Edit: April 15, 2019, 10:30:38 PM by Montecarlo »

sol

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Re: I don't understand landlord math
« Reply #33 on: April 15, 2019, 10:24:51 PM »
Wait, what?  Some very smart people have been saying that for years.  Not saying they are right, but to suggest no one thinks equities are overvalued is cray cray

I think that "overvalued" and "unaffordable" are fundamentally different concepts.

Montecarlo

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Re: I don't understand landlord math
« Reply #34 on: April 15, 2019, 10:40:19 PM »
Wait, what?  Some very smart people have been saying that for years.  Not saying they are right, but to suggest no one thinks equities are overvalued is cray cray

I think that "overvalued" and "unaffordable" are fundamentally different concepts.

Well that makes your statement all the more curious.  The median home price in the US is $200K.  VTSAX costs $72/share.

$200K compounding at 10% will become more unaffordable for most people than $72 compounding at the same 10%.

sol

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Re: I don't understand landlord math
« Reply #35 on: April 16, 2019, 09:29:20 AM »

Seattle (and everywhere else) won't keep appreciating at that rate forever. In fact the party is probably already over if you follow inventory numbers (though I've been wrong before).

Are you suggesting that, just maybe, The Top Is In?

$200K compounding at 10% will become more unaffordable for most people than $72 compounding at the same 10%.

That would be true if you had to only buy integer units of those things, and pay full price up front.  Fortunately, neither of those things is true.

For example I own half a house, with my spouse.  We have a mortgage, which means I pay a relatively small monthly fee towards the total price of that asset.  I also own a fractional number of shares of VTSAX, and I similarly pay a relatively small monthly fee towards the total price of that asset.  I have paid more money each month towards my index funds than towards my mortgage, which is probably related to why my index funds are worth more than my house.  The value of each can go up or down 10% this year and the amount I pay towards them won't change.  In both cases, I would be happy with a 10% or a 20% increase, and less happy with a -20% correction.

"Unaffordable" means that you can't scrape together enough cash to purchase something, which in the case of 0% down mortgages usually means you're a bad credit risk.  Everything is unaffordable to you if you're a bad credit risk.  In the case of houses around here, prices were increasing because they were affordable to too many buyers.  Unaffordable describes and asset from the perspective of a specific buyer, not the market as a whole.

"Overvalued" describes an asset's current price relative to its future price, regardless of the magnitude of those prices.  A penny stock that has popped 20x in the past week is probably grossly overvalued while being very affordable if it still only costs $0.80 per share.  The Disney corporation is worth approximately $200 billion, which makes it unaffordable to literally everyone, but I think it's very fairly valued given their current business prospects.  I expect it will be worth more next year than it is this year.

Houses in the Seattle area are only unaffordable to people who are not rich enough to buy them.  Like fine art or private jets, most people can't scrape together the cash.  But whether or not they are overvalued is a fundamentally different question, and in the case of low-inventory items like SFRs it's a question that is mostly unrelated to which people can afford to buy them.  As long as there are more eager buyers than sellers, prices will continue to climb.

I agree that there is a whole bunch of speculation around how valuations are related to affordability, but it's a complicated relationship because there are so few houses for sale, and only slightly more very rich people who want to buy them.  Interest rates matter, but I think the distribution of incomes matters more.  We could keep our average wages exactly the same but pay our top 10% of households twice as much (while cutting wages for everyone else) and house prices would approximately double, because it's only those top 10% of households that can buy houses anyway so it doesn't really matter what everyone else makes.  That's roughly what has happened in Seattle, in my view.

afox

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Re: I don't understand landlord math
« Reply #36 on: April 16, 2019, 09:46:11 AM »
Paying other people to manage properties is actually a lot of work. You have to at least manage one person, the less people you manage the more it costs.  Buying and selling properties is a lot of work and its very hard to outsource, even if you are just buying, a lot of research goes into purchases. That doesnt mean it cant still be profitable but investing in RE will always be more work than investing in an VTSAX.

Houses can become unaffordable and overvalued. Stocks can become overvalued but are rarely unaffordable. Companies and funds always use stock splits, fractional shares and other methods to make sure that the majority of investors can afford to buy stock in their company. What I was trying (but admittedly failed to describe) to explain is that home prices are limited to what people (even well paid tech workers) can afford to pay for them, this limits the potential appreciation. Companies in other markets do not have the same constraints, for example there is virtually no limit to the amount of ads that google can sell or how much they can sell them for, thus there is a greater potential for higher returns for non RE investments. This upside is expressed as increased volatility and especially important for the RE investor that purchases rental RE with primary residence mortgages the affect of leverage makes the returns competitive between the two asset classes. 

Its important to understand that most people purchase the most expensive home they can. Mortgage rules limit how much people they can spend and will generally issue loans for around 30% monthly PITI expenses to income. Thus, for the vast majority of home buyers one of two things has to happen for them to be able to afford to spend more on a house: wages have to increase, or loans have to increase. While Sol says that in Seattle the ratio of home prices to income isnt relevant anymore, this is a temporary situation. Local government and market forces will create an increased supply of homes in these areas. Homes in seattle, NYC, SF will always be more expensive than kansas but the rate of increase in these high priced areas will not be exponential. If you feel like you live in an area that is currently priced like kansas but will become the next Seattle, NYC, or SF, then there is lots of money to be made on appreciation but that's obviously highly speculative.
 
All said, im a rental RE investor too. I see RE as an important part of a well balanced portfolio. Im just trying to point out some unfair expectations people may have about rental RE.


FINate

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Re: I don't understand landlord math
« Reply #37 on: April 16, 2019, 09:50:33 AM »
I can buy 1/1000000 of Disney Corp., which may even make sense if I think this is a good investment. This doesn't change the price Disney charges customers for their products. The two are decoupled.

Likewise, I can buy 1/10000000 share of a real property (e.g. a REIT) if I believe this is a good investment. However, I cannot live in 1/1000000 of a house. The "affordability" question for RE is about what consumers of housing can afford, and there's a minimum discrete unit involved, usually based on social convention and housing codes. RE is a bit odd because the investment is the product.

sol

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Re: I don't understand landlord math
« Reply #38 on: April 16, 2019, 10:15:50 AM »
Just remember that home prices are a reflection of what people can afford, because buyers set the prices.  If prices are going up, then by definition there are buyers who can afford to pay that much and more.  It's literally impossible for prices in a rising market to be "unaffordable".

But I agree that prices can go back down.  If prices get high enough to motivate people like me to start listing their properties for sale, and the supply of available homes suddenly grows faster than the population of buyers, then we'll flip the supply/demand curve and prices will go back down.  Or if there is some major economic catastrophe that reduces the population of rich buyers, for a fixed number of listed houses, that accomplishes the same thing. 

And I don't think anyone here will dispute that in the long term, house prices are a reflection of local economic conditions.  As long as your city has profitable businesses and the number of high-paying jobs grows faster than the inventory of new houses in the right places, home prices will rise.  Cities like Seattle and San Francisco are economic powerhouses, so prices went up.  Cities like Detroit lost their economic mojo, so prices went down.  In neither case were these changes caused by house prices.  House prices are only a reflection of what is happening in your local economy, not a driver of it.

afox

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Re: I don't understand landlord math
« Reply #39 on: April 16, 2019, 10:47:53 AM »
Ah, Sol seems to think that there is a fixed supply of HOUSES or even of HOMES. Seems you think that the only way for the supply to increase is for you (or other owners) to sell. This is totally not so. Also, I notice im using the term HOME and you are using the term HOUSE.

For the sake of argument lets define HOME as a "dwelling". Lets define HOUSE as a single dwelling building with some amount of land (like a yard).

Certainly the supply of HOMES is not fixed, builders can build more dwellings in the same amount of space. I think we can agree on that.

But the big kicker and where I think we may disagree and that you have yet to realize is that the supply of HOUSES is also not fixed and increases with high demand/high appreciation. 
How you might ask can the supply of HOUSES increase, well here are just a few examples:
-undeveloped land within city limits gets developed for new houses
-undeveloped land outside city limits gets developed for new houses. this land is incorporated into the city (yes, city boundaries expand). voila, you just increased supply in the city.
-land use changes: for example lots of empty retail in the US right now which in some places gets converted to HOUSES. Industrial land gets converted to HOUSES.
-land owned by city, state, and federal govt gets converted to HOUSES. Govt owns a lot of land and often (in areas with unaffordable housing especially), it gets sold to developers to get converted to HOUSES.
-code changes for smaller lots/bigger houses (aka floor area ratios) change so that lots can be split.

I live an area with a booming economy and every single one of these has happened in last few years where I live. The biggest one and least understood is number 2. People often see a chart of city population increasing at a very high rate and dont understand that population density didn't change much, the real increases were due to the boundaries of the city changing!  Your city probably has a long term plan to expand (sometimes called "incorporating") into nearby areas, often the nearby areas are called  something like "growth management areas". This is what allows a city to grow like a company.

Even if you live on an island like Manhattan pretty much all of these are options to increase supply. There is really no such thing as full development.

sol

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Re: I don't understand landlord math
« Reply #40 on: April 16, 2019, 11:02:25 AM »
Ah, Sol seems to think that there is a fixed supply of HOUSES or even of HOMES. Seems you think that the only way for the supply to increase is for you (or other owners) to sell. This is totally not so. Also, I notice im using the term HOME and you are using the term HOUSE.

I am acutely aware of the difference, and am specifically talking about houses. 

In places like Seattle and San Francisco, where house prices have gone so bananas, house prices have gone up so much precisely because you cannot build new ones.  All of those highly paid young professionals want houses with garages, garden space, and a lawn for their budding families to play on.  And there are basically a fixed number of such properties within reasonably commuting distance of their high-paying jobs.  These are coastal cities hemmed in by geography, and they can't just sprawl out in every direction the way Kansas City can. 

So the solution in most of these tightly constrained coastal cities has been increased density.  Condos can be stacked very tall, but I don't buy condos.  I buy SFRs, specifically because they are in high demand and have a very tight supply.

Not coincidentally, the prices for condos have lagged the prices for houses.

Quote
Even if you live on an island like Manhattan pretty much all of these are options to increase supply. There is really no such thing as full development.

Right, but San Francisco and Seattle are a long ways from Manhattan.  There was a time, a hundred years ago, when Manhattan started bulldozing established SFRs in order to build high-rises in residential neighborhoods.  Seattle isn't about to plow over Queen Anne, though.

afox

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Re: I don't understand landlord math
« Reply #41 on: April 16, 2019, 11:26:28 AM »

Its hard to talk about just houses (SFHs) appreciation since increasing the supply of homes decreases the demand and price for SFHs. It doesnt take NYC skyscrapers to bring down SFH prices either, duplex's and, town homes, etc do the trick. There is always someone willing to save a lot of money on housing for the inconvenience of sharing a yard with their neighbor (i am one of them but I own the duplex), thus decreasing demand for the holy SFH.

In areas where home prices are too high its usually due to some kind of political miscalculation like heavily restrictive zoning and building rules. Freakonomics did a story about this focusing on the SF area: https://www.npr.org/templates/transcript/transcript.php?storyId=633224790

Also, RE appreciation is often mis-understood. Often appreciation is discussed (especially by RE agents who spew BS in hopes of increasing transactions) in terms of median or average home price increases. Anyone with an analytical background will understand that you cannot make a statement about trends by comparing the price of apples to the price of oranges. The "quality" (size, features, condition, etc) of homes or houses in an area often gets better with an increase in wealth. So Seattle is experiencing more wealthy residents who demand higher quality homes. To explain this another way just because the median price of SFHs in your area is appreciating at 10% does not mean that your SFH is appreciating at 10%. This is in fact why Shiller developed the home price index. There are several methodolgies for computing a home price index but the Shiller method tracks repeat sales of the same house within a certain period of time. When the subject of RE price appreciation comes up noone talks about home price indices though.

Also, im reading that RE prices are not appreciating at high rates (or maybe not at all?) in the seattle area: https://seattlebubble.com/blog/tag/case-shiller/

Villanelle

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Re: I don't understand landlord math
« Reply #42 on: April 16, 2019, 12:41:38 PM »
I think the fact the generally everyone needs (wants, at least) a dwelling confuses the matter.   It's easy to think that because everyone needs a home, the economy for homes/houses is everyone.  But really, owning a home is like owning a Picasso.  Yes, it is unaffordable to most people, especially in specific locations.  That doesn't at all mean that the price of Picassos is facing an imminent, steep drop.  Because the people who can afford Picassos can, well... still afford Picassos. 

That logic seems to be readily accepted by most people--that the prices of masters artworks are set by a small subset of people and that only the financial picture for that subset matters when determining price, and the trend in prices.  A huge, worldwide economic downturn might in fact affect pricing, as many of the uber-rich see significant declines in their wealth.  Or perhaps all the off-shore banks just take the money they hold and disappear. Suddenly, the uber-rich have less money to spend on things to hang on the wall of their bathroom, and simultaneously, more of them may actually take some of the art down from the bathroom wall and sell in order to be able to afford the property taxes on their many homes and the slip fees for their yachts.  So, supply up, demand down=prices down.  In other words, the market is not immune to basic economic actions and causality.  But that action has to be within the subset of  buyers in that specific economy.  A decrease in minimum wage or SNAP benefits will do fuck-all to the Picasso market because it doesn't touch the members of that economy.

And this is true of the real estate (especially SFH) market as well.  One has to separate home prices and the home economy from the fact that everyone needs a place to dwell.  Living in a home has surprisingly little to do with the price of buying a house, in part because we have renters and shared homes an nonSFH homes.    So yes, everyone needs a home, but not everyone needs to buy a house. 

Once that distinction is made, it's easy to then revert back to looking at the basics of the Picasso markets.  Picassos are available to maybe .001% of the population, so that's the sub-economy that drives the prices of Picassos.  SFH in tough markets are affordable to ~5-10% of the people in those areas.  (For the sake of simplicity, I'm not considering people who change locations to buy, though of course it is a factor)  So it is only the economic fate of that 5-10% that  drives the prices.  If that 10% start hurting, perhaps in the face of a major equities correction, then it would affect SFH prices.  And it may cause more people to liquidate, affecting demand which would further affect prices.  Would an increase in, say, income tax on tips (not TIPS!) affect the prices of SFH in NYC or SF?  Only in the most trickle-up, minimal sort of ways, as servers spend less, which means car dealers sell a few fewer cars so their owners make a few thousand less.  The affect would be minimal, because servers were never going to buy homes in SF anyway.  That change doesn't affect the sub-economy of people who are home-buyers, so it doesn't affect the price of homes.  What a server can afford for a dwelling may affect rent prices for modest homes, but not purchase prices for already-expensive houses. 

Average income doesn't matter when the average person isn't the buyer.  Picassos aren't affordable to the average person.  True, but entirely meaningless when considering what might happen to the future price of Picassos.  The average man can decorate his bathroom with posters from Ikea.  And that bathroom is in a rental condo, not a purchased SFH. 

Telecaster

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Re: I don't understand landlord math
« Reply #43 on: April 16, 2019, 01:50:14 PM »

Also, im reading that RE prices are not appreciating at high rates (or maybe not at all?) in the seattle area: https://seattlebubble.com/blog/tag/case-shiller/

The reason is there have been approximately one gazillion new apartments come online in the past couple years, and about another bazillion in the pipeline.   I suspect housing prices will be stable for a while.   But Amazon has 10,000 job openings (literally) in Seattle at the moment, so maybe not.   

I got into landlording by accident.  I bought a SFR for a family member who was going through a divorce to live in.   She moved out, and it became a normal rental property.   As an income property it has been underwhelming, but I bought right at the bottom of the market and the price appreciation has been stellar.   Anyway, a friend casually mentioned doing a 1031 exchange into say, a triplex which would throw off more cash.  Intriguing idea, which I should thought about sooner, had I been paying attention.  Which brings me to my real point, real estate is extremely tax advantaged.   afox mentioned RE investing is sort of like a job--and it is--but it is a job where you can avoid most income or payroll taxes.   

afox

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Re: I don't understand landlord math
« Reply #44 on: April 16, 2019, 02:16:39 PM »
Agree about the tax advantages of RE. Although pretty much everything is tax advantaged compared to W2 income.

Telecaster

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Re: I don't understand landlord math
« Reply #45 on: April 16, 2019, 02:17:27 PM »
Agree about the tax advantages of RE. Although pretty much everything is tax advantaged compared to W2 income.

Ain't that the truth.  From a tax standpoint, the worst thing you can do is work for a living.   

Buffalo Chip

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Re: I don't understand landlord math
« Reply #46 on: April 16, 2019, 04:57:52 PM »
Agree about the tax advantages of RE. Although pretty much everything is tax advantaged compared to W2 income.

+10. Youíd be hard pressed to find an income stream that is higher taxed than W2 income.

Edit; Friends, donít let friends be wage slaves.
« Last Edit: April 16, 2019, 04:59:59 PM by Buffalo Chip »