Author Topic: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month  (Read 1883 times)

pmac

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Does this sound crazy to you?

I keep hearing about the 1% rule in this thread, but recently signed a 6 month lease on an apartment for $2k/month, all utilities, wifi, sewer, included.

I looked up similar units and they are selling for $500,000.

So according to this 1% rule I should be paying $5,000/month, not $2,000 month.


How are people even breaking even on some of these real estate "investments"? I just can't wrap my head around why anybody would every buy in a real estate market so over inflated when you can rent so cheaply?

maizeman

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Re: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month
« Reply #1 on: December 29, 2018, 04:53:15 PM »
If individual units in apartments are selling for $500k, I'm guessing you're in one of the more expensive coastal cities (SFO, New York City, Boston, etc). I know people professionally who have bought condos in big cities in California that currently rent for less than the cost of the mortgage alone, let alone any maintenance/vacancy management costs, etc.

The theory is that rental prices are increasing rapidly, while the mortgage payment will remain fixed so that in 10-15 years they'll be raking it in. I cannot say that I'd do the same in their shoes. But if a person was actually convinced that the rate of rental increases in markets like SFO was sustainable (the average rent on 2 bedroom apartment grew from $2,611 in January of 2011 to $4,492 in January of 2018 so just over 8% per year*), I could see how a person might talk themselves into thinking it was a good idea.

Anyway, that's the short answer. Like a lot of bubbly asset markets, people are buying real estate in some cities for more than it's currently worth based on cash flow because they expect it to go up in value in the future.

*Based on data from here: https://www.rentjungle.com/average-rent-in-san-francisco-rent-trends/

Michael in ABQ

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Re: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month
« Reply #2 on: December 29, 2018, 04:57:08 PM »
Owner/users are typically willing to pay more than investors. If the market is primarily people who will live in those apartments then an investor would be foolish to sell it as an investment because a user will pay more. It's possible that your landlord is either a bad business person or is not really an investor but maybe the previous owner/user. Perhaps they bought years ago when prices were lower and prefer cash flow over a one time sale. Frankly I don't see why when it's obvious that the real estate market is starting to turn down nationwide.

After taking into account expenses (utilities, property taxes, repairs and maintenance, your landlord is probably only netting maybe $15k. If there's a mortgage they're probably upside down. At $15k in net income (before mortgage) that's a 3% capitalization rate which is frankly terrible.



I'd be happy that you got a good deal. Out of curiosity, are other apartments near you renting for similar amounts? If so it further reinforces that we're at or past the peak of the bubble because the rents cannot even cover the mortgage, let alone the mortgage plus operating expenses.

waltworks

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Re: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month
« Reply #3 on: December 29, 2018, 09:42:37 PM »
95% of RE "investors" have no idea what they're doing beyond "rent pays all/most of my mortgage, score!"

That's pretty much it.

-W

theolympians

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There is the aspect of potential renters. If no one in the area is willing or able to pay five grand a month, it doesn't matter what the rule is. Market forces at work.

clifp

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Does this sound crazy to you?

I keep hearing about the 1% rule in this thread, but recently signed a 6 month lease on an apartment for $2k/month, all utilities, wifi, sewer, included.

I looked up similar units and they are selling for $500,000.

So according to this 1% rule I should be paying $5,000/month, not $2,000 month.


How are people even breaking even on some of these real estate "investments"? I just can't wrap my head around why anybody would every buy in a real estate market so over inflated when you can rent so cheaply?

It is all about price appreciation and while people (including myself) have been predicting the end of the crazy price appreciation in California for my entire life and it hasn't happened yet.
I've been keeping an eye in CA prices and rents since I was a teenager, so nearly 40 years and in neither in greater LA  area nor in the SF Bay Area were rentals ever close to the 1% rule, except in few isolated areas.

And yet it is been a fabulous investment.   I bought a house in Santa Clara CA in 1984 for $153,000, with a college roommate,  15 years later I sold it for $444,000 to another single Silicon Valley engineer, who's kept it ever since. Today 20 years later  Zillow says it's worth $1,740,000 and it can't be far off because the identical floor plan one block away sold for $1,625,000 9 months ago, and a very similar house sold for $1,750,000 3 months ago.  That's an 11x appreciation.  Which is 7.25% per year over 34 years.

If I kept the house, there be no mortgage. I'd be collecting rents of 4,500/month my property taxes would be about $250/month and maybe another $150 for insurance, even with generous allowances for repairs, property manager etc. I'd be netting $3K+ a month   Now $36K profit on an asset worth $1.7 million seems very low.  However, the $400K price appreciation in the last two years is what really important.

If I had elected to rent rather than live in the house it would have cash flow negative for at least 5-6 years and the same thing is true for the guy who bought it from me. But what has been made CA and other hot markets such a fabulous investment is leverage.  I only put 10 down, $15,300.  34 years later that $15,300 would have increased by a least 100 fold to $1,550,000 in profit  That's 14+% annualized rate of return, not even counting the almost 30 years of positive cash flow.

Villanelle

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We own in CA. It was our residence and we kept it when we had to relocate for work.  We had enough equity that we wouldn't have had to bring money to the closing, but it was down more than $100k from when we bought (more than 20%).  Bought 2007, would have sold 2010. And we thought there was a fairly good chance we'd be returning to the area in a few year.  (We didn't.)  Initially, we were in the red on the rental. Now, it does make money, but not gobs, and it still wouldn't come anywhere near the 1% rule if it was purchased today.

But it's now not only made up the ~$125k it was down from purchase price, but is up another ~$50-70k. (So up nearly $200k from the low, in 8.5 years since we would have sold.) So it's definitely been worth keeping. 

Not all real estate is purchased initially as an investment. 

waltworks

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Clif, you might want to take a look and see how you'd have done in the stock market with that $153k in 1984.

-W

sol

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But what has been made CA and other hot markets such a fabulous investment is leverage.

Agreed, leverage is the key. 

Far apart from the world of MMM-style real estate advice, there is an entire school of RE investors who only focus on cash flow.  As long as they can borrow more money to generate income, they do.  If they can pay $500 per month in carrying costs to generate $600 in cashflow, then they just made $100/mo (and probably rising) forever with no effort.  They'll do that a thousand times in a row, as long as banks will keep lending to them.  They don't really worry about net values or net liabilities, because as long as the investments are turning out cash every month for no money down they see it as a magical fountain of money.  These are the people who favor interest-only 40 year mortgages.  They will happily take 0.5% or less in monthly rents, as long as their carrying costs are lower than that.

Every time I have cracked open my spreadsheets, owning rental property isn't as profitable as owning stocks over very long time periods.  It can be more profitable in the short term, but ultimately the returns just don't match stocks, and over 40 or 50 years that difference turns into millions of dollars in favor of stock investing.  The only way RE makes sense is because you can safely leverage your out-of-pocket costs in a way that is harder to do with stocks.

clifp

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Clif, you might want to take a look and see how you'd have done in the stock market with that $153k in 1984.

-W

But I didn't have a $153,000, three years out of school  (much less spend it). I put $15,300 down and another $3K in closing cost (some of which was borrowed from parents)
$10,000 in VFINX in 1984 is worth ~$330,000 during the same time period, so roughly 1/3 the return, without counting the cash flow which would make the RE investment even better.

Now to be fair, I bet that real estate returns in Silicon Valley are in the top 5 of any major market in the country in the past 40 years, and I wouldn't be shocked if they were #1. Although the particular city, Santa Clara, probably lagged most areas in Silicon Valley.

As @sol points out it is a lot easier to use leverage in real estate, 5x is standard and 10x and even 20x is possible.  In contrast, 2x leverage in stocks is hard and the interest rates are typically much higher on margin loans, not to mention you don't really have margin calls in real estate.

Now mind you, I still think the average person is much better investing in stock index funds and limiting their real estate to their primary residence. 

But,  I do want to point out the folks buying the really expensive real estate in the HCOL have historically done very well. Especially those, who have been willing to put up with 4-6 years of negative cash flow on their properties.
« Last Edit: January 06, 2019, 09:04:31 PM by clifp »

clifp

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Re: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month
« Reply #10 on: January 06, 2019, 09:09:03 PM »
But what has been made CA and other hot markets such a fabulous investment is leverage.

Agreed, leverage is the key. 

...

Every time I have cracked open my spreadsheets, owning rental property isn't as profitable as owning stocks over very long time periods.  It can be more profitable in the short term, but ultimately the returns just don't match stocks, and over 40 or 50 years that difference turns into millions of dollars in favor of stock investing.  The only way RE makes sense is because you can safely leverage your out-of-pocket costs in a way that is harder to do with stocks.

i'm guessing your spreadsheet inputs looked a lot like mine.  Inflation=2-3% Price Appreciation = 3-4%, rents increase at the rate of inflation.  But if you assume price appreciation at 6-8% and that it will continue for 20+ years, real estate starts looking much more attractive.

Paul der Krake

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Re: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month
« Reply #11 on: January 06, 2019, 09:22:32 PM »
But what has been made CA and other hot markets such a fabulous investment is leverage.

Agreed, leverage is the key. 

...

Every time I have cracked open my spreadsheets, owning rental property isn't as profitable as owning stocks over very long time periods.  It can be more profitable in the short term, but ultimately the returns just don't match stocks, and over 40 or 50 years that difference turns into millions of dollars in favor of stock investing.  The only way RE makes sense is because you can safely leverage your out-of-pocket costs in a way that is harder to do with stocks.

i'm guessing your spreadsheet inputs looked a lot like mine.  Inflation=2-3% Price Appreciation = 3-4%, rents increase at the rate of inflation.  But if you assume price appreciation at 6-8% and that it will continue for 20+ years, real estate starts looking much more attractive.
But doesn't nationwide housing track inflation really well? California housing outpaced inflation, despite the fact that California was already expensive decades ago. Some people bet on California, consciously or not, and won big. But they could easily have predicted that the internet would make cities irrelevant, and bet big on areas outside national parks in Wyoming and Montana instead.

clifp

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Re: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month
« Reply #12 on: January 06, 2019, 09:53:33 PM »

But doesn't nationwide housing track inflation really well? California housing outpaced inflation, despite the fact that California was already expensive decades ago. Some people bet on California, consciously or not, and won big. But they could easily have predicted that the internet would make cities irrelevant, and bet big on areas outside national parks in Wyoming and Montana instead.

Historically I believe it does. But not some much recently. So for example over the last 10 years, the Case-Schiller Nationwide index has gone from 162-206. The 20 city index increased more.
The inflation index went from 162-187 so house appreciated at roughly twice inflation, although far behind stocks.

I'm with you I would have guessed the bubble would have burst.
« Last Edit: January 07, 2019, 01:54:59 AM by clifp »

maizeman

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Re: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month
« Reply #13 on: January 06, 2019, 10:11:11 PM »
I suspect that reflects the effect of extremely low interest rates for a decade. Lower rates meant people could service larger mortgages on the same incomes, which drove housing prices up faster than inflation since the great recession.

If the fed raising interest rates translates into 6.5% mortgage interest rates (common in the years before the great recession, still low by historical standards), the typical home buyer will only be able to afford to pay 80% as much for a new house. Will be interesting to see what that does to house prices going forward.

Gronnie

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Re: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month
« Reply #14 on: January 06, 2019, 10:40:37 PM »
I just signed an 18 month lease and moved into a home in SoCal that Zillow says is worth 1.3 million for $3550 a month. No idea why anyone would own a place like this as a rental, but it works great for me.

FI40

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Re: Wanted: Investors to buy 500k apartment, rent back to tenants at $2k/month
« Reply #15 on: January 15, 2019, 08:00:14 AM »
I just signed an 18 month lease and moved into a home in SoCal that Zillow says is worth 1.3 million for $3550 a month. No idea why anyone would own a place like this as a rental, but it works great for me.

Similar over here in Ontario - I'm renting a detached house worth ~800k, for 2250/mo. Ontario has rent controls so the landlord cannot raise the rent more than 1.8% this year (the ceiling is typically 1-3%).

In these parts, the common wisdom is that housing is the best investment ever since it always goes up so the amount you rent it for doesn't matter that much. It has gone up for quite a while. Starting to pull back these days though, we'll see where it goes.