Author Topic: Isn't getting just 4% yield after Expenses still good because of Depreciation?  (Read 966 times)

andysandp

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I understand that people shoot for the 1% rule.  1% rule is the monthly yield on Rent after ALL EXPENSES such as Vacancy, Management Fees, Condo Fees, and setting up Repair Funds.  The 1% rule is the same as getting 12% yield on the year.

What's wrong with just getting a 4% Yield?  Isn't getting 4% Yield after ALL EXPENSES still pretty good because of Depreciation?

Let's assume $100,000 Condo, 5% Rate, 25% down, 30 year Loan.

After 30 years, assuming 3% growth each year, the Condo will be worth $242,726.

Depreciation is $3636 a year. ($100,000 Divided by 27.5).
If you are at the 30% Tax bracket, Gov is giving you back $1090 each year for 27.5 years.
If you Invest this $1090 each year for 27 years, assuming 10% from S and P, you would have $159,488.

So after 30 years you have $242,726 in Equity + $159,488 from investing the Depreciation, = $402,214

Now add the cash flow from all the excess rent.  If you invested the cash flow into S and P, you should be at least $100,000 after 30 years.
Now the total you have is $502,214.

$502,214 is already better then investing $28,000 for 30 years at 10% compounded return.

Shouldn't 4% be the minimum Yield instead of trying to shoot for 12%?  Any thoughts?

« Last Edit: April 12, 2017, 08:17:24 PM by andysandp »

MRL

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There are a lot of assumptions here, so I'll make a few more to try and answer
Lets just for argument's sake say that the condo has no land value meaning you get to depreciate the entire $100k (you only get to depreciate structures)

and lets say you rent it out for $1000 a month = $12K less vacancy and maintenance = 10K a year

a 75k loan @ 5% will give you a monthly mortgage payment of $403 = $4836 a year

What's the condo association fee? lets use $200 a month (and assume it stays the same as the building ages) = $2400 a year

In my area, we pay property taxes of about 2.7% of the value = $2700 a year

So using my quick back of the envelope type math here, I show you making a profit of $64 a year, but if the property appreciates as you say, the property taxes will soon displace any small profit you were making.

So...yes, you can invest the depreciation, keeping in mind that if you sell the condo to "capture" that equity, you will be subject to depreciation recapture.

other things to think about - will the kitchen, bathrooms, carpet, floors, etc survive 30 years of renters? re you going to self-manage? if not, subtract another 8-10 percent from rents

I don't think that 12% has to be your hard and fast rule, but it does give you some breathing room for some of the various contingencies you may run up against.

andysandp

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So in my example I'm saying a 4% yield after ALL expenses including Management Fees, Vacancy, Condo Fees, RE Tax, Repair Funds, etc.

That means I could be getting $9000 a year in Rent, and then pay $5000 a year for Repairs, Real Estate Tax, Management Fees, Vacancy, Condo Fees, and Repair fund etc.

That leaves me with $4000 a year which is 4% yield on $100,000.

I used this Rental Investment Calculator to get my final numbers.  http://www.calculator.net/rental-property-calculator.html
It doesn't include Depreciation however.

From Depreciation, Gov is giving me back $1090 each year for 27 years assuming 30% Tax Bracket.  If I invest that $1090 each year, at 10% I would have an extra $159,488.

So in 30 years I have

$242,726 in Equity (assuming 3% growth each year)
$159,488 from investing the Depreciation (assuming 10% in S and P for 27 years)
$100,000 from investing the excess Cash Flow (should have at least $100,000 from investing into S and P)

= $502,214.  This is better then 10% compound Return.

I thought most people are looking for the 1 percent rule.  The 1% Rule is the monthly yield after ALL Expenses.  1% Rule is the same as 12% yield which is great.  By whats wrong with just 4% yield?



« Last Edit: April 12, 2017, 08:34:06 PM by andysandp »

Coach Carson

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Andysandp, I know people have different definitions, but my understanding of 1% rule is that it's GROSS rents as a % of total investment.

So, $1,000/month x 12 = $12,000 = 12% gross yield on $100,000 investment.

But if you lose 50% of your rent to expenses, you're NET yield is $500/month or $6,000 per year. So the 1% rule typically leads to a 6% yield (pre-tax, not counting depreciation) on free and clear property.  That's also called a Cap Rate.

Obviously, there is an argument in some cases for only buying real estate with a 4% cap if you can do well with depreciation and appreciation. If you tried to buy prime commercial property in Manhattan or many other desirable locations around the world, it would be 4% or even less. So, investors are doing it.

But I think for most of our purposes (seeking FI), you'd be better off getting a better return in real estate than 4%. It's a lot of work to only get a small premium over or be equal to the S&P 500's very passive yields over the long run. And there are better deals out there if you hunt around. But it's a personal choice.