Author Topic: Real Estate - The numbers don't seem to work for me  (Read 2245 times)

Fredster4

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Real Estate - The numbers don't seem to work for me
« on: November 01, 2016, 07:15:30 PM »
Reading about the basic rules of being a landlord and what I've garnered are the 2 basic rules: the 1% rule and the 50% rule. The 1% rule states that your goal should be to rent a place (per month) for roughly 1% of what you paid for it. The 50% rule states that you should not plan on keeping more than 50% of your rents over the long term because the other half of your rental income will go toward long term upkeep of the property.

Using these 2 rules, it's very basic that your return will be roughly 6% of your investment. If you want to use leverage, that's a different equation but keeping it simple, a 6% percent return on investment should be a walk in the park over the long term with the completely passive practice of investing in index funds - without getting too much into the relative risk of your various investments - real estate has risks too.

So if you can make 6% return for doing practically nothing (passive investing), why would you invest in real estate for the same return but with a tremendous amount of management and headache - people don't pay rent - you can't evict them - things needing to be repaired all the time.

I don't understand the numbers behind the decision to do it.

Who can help me out?

waltworks

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Re: Real Estate - The numbers don't seem to work for me
« Reply #1 on: November 01, 2016, 08:41:57 PM »
1% and 50% rules are conservative rules of thumb. They don't account for potential use of leverage (though I agree it's unfair to compare to stocks, IRL leverage is easier to obtain/use with RE for most people), potential appreciation, tax benefits through depreciation, etc, etc. The 50% rule includes paying for professional management, too, which in theory makes RE minimal hassle.

So if you're using those rules, 6% should be about the *worst* you can do. Any number of things could go your way and you can do much, much better.

-W

Unstoppable

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Re: Real Estate - The numbers don't seem to work for me
« Reply #2 on: November 02, 2016, 07:50:05 AM »
These are very general rules of thumb. Another general rule of thumb is that long term, rentals will underperform the S&P 500 when owned outright.  Leveraged real estate should outperform, in general. This is a very broad brush statement though.

Depreciation, appreciation, value add scenarios, outsouring or not absorbing management, etc. all impact the actual result of that statement though. That and what property class, what area, etc.

 

Fredster4

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Re: Real Estate - The numbers don't seem to work for me
« Reply #3 on: November 02, 2016, 11:35:50 AM »
That being said, in my opinion, rental real estate would not only have to outperform the SP500, they'd have to SERIOUSLY outperform it before I would do it. Because I don't see being a landlord as completely passive, as I do investing in the stock market.

The only reason I can see favoring real estate is the steadiness of the rental income, versus the variations in the stock market.

I would like to see modeling of each approach over time. A model that includes the time involved in being a landlord. Let me know if you've ever come across anything like that. Thanks.

Unstoppable

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Re: Real Estate - The numbers don't seem to work for me
« Reply #4 on: November 02, 2016, 12:58:06 PM »
To be honest, it does SERIOUSLY outperform over time. But you cannot just go buy anything, in any area, and put a manager on it. And you have to qualify what defines passive investing.

My one friend has 27 single families right now, in an area that will not appreciate beyond inflation, and averages 21.5% annual return (before depreciation). I know quite a few examples of this. He manages himself, but would still beat the market average with paying for management.

If you buy, improve, and then rent the returns can be enormous, but now you are getting further into the gray area of "what is passive?" Is RE passive in the true sense, ever? What if you hire out all the rehab work, and the management, etc?

Another Reader

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Re: Real Estate - The numbers don't seem to work for me
« Reply #5 on: November 02, 2016, 01:52:01 PM »
Returns on rental properties come from two sources, net income and appreciation.  If you receive 6 percent in net income and the property appreciates 4 percent, that's roughly what you can expect from the stock market.  However, you also benefit from depreciation, which does not have to be recaptured if you hold the property forever or exchange into another property.  You can also deduct other business expenses, if they relate to the rental.

Unstoppable

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Re: Real Estate - The numbers don't seem to work for me
« Reply #6 on: November 03, 2016, 08:19:15 AM »
Yes, Another Reader, that is the returns on a cash purchase. Leverage (within reason), can increase these returns. You get the principal paydown and the profit from rent and appreciation can provide much larger ROI respectively due to the decreased initial investment.


Another Reader

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Re: Real Estate - The numbers don't seem to work for me
« Reply #7 on: November 03, 2016, 04:02:49 PM »
Leverage can be positive, negative, or neutral.  If it's positive, more leverage will increase your rate of return.  In most cases, it also increases the risk.

It's NOT passive income, and you need to understand real estate to be successful.

arebelspy

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Re: Real Estate - The numbers don't seem to work for me
« Reply #8 on: November 05, 2016, 11:57:40 PM »
The above answers cover it pretty well (essentially that it's a 6% cash on cash return, and then appreciation should net you 3-4%, and tax benefits some more, and principal paydown, if you have that, etc., so the return is much higher than six percent), and I'd also add that a 1% is minimum cutoff.  You often shoot for more.  That means you may get a 10-12% cash on cash return, plus all the above benefits/profit centers.

It's NOT passive income, and you need to understand real estate to be successful.

100% agree.  It's a lot of work (learning, and implementing), mostly done up front (and some ongoing, but not nearly as much as the up front work).  But it can pay off nicely, if done correctly.
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