Is Competitive ROI on Non-Leveraged SFR Reasonable?

Question

I am in the Dallas/East Texas market, and am interested in getting involved in real estate as a long-term investment strategy. Because my aims are long-term, I am comparing potential Real Estate Investments with the long-term performance of the S&P 500, among other investment types. I'm currently trying to understand the math on Real Estate Investing from a Net Worth perspective. Because my primary objective is net worth - not cash on cash - strategies like BRRR are not appealing to me. As such, my strong preference is to evaluate deals on the basis of their Free and Clear values.

To those ends, I have begun evaluating the Dallas market for Single Family Residences that cash flow well, and have a target ROI of 9-12%, disregarding appreciation. However, I have only been able to find houses on the market that would ROI around an estimated 5%-7%. This is based on :

*NAV = Net Asset Value (House valuation)

   Assuming asset is bought at market value.
   1.81% Property Taxes on NAV
   5% Vacancy rate
   2.5% NAV on CapEx + General Repairs
   $6 per $1000 per Annum for Insurance
   $35/mo Legal Fees (Evictions, other)
   No HOA
10% Flat Property Management Fee
   Rent at Approx 1% of NAV per month

To me, a 5% return is not worth the hassle of getting into real estate. Today, I can buy and diversify BBB+ bonds at over 5% interest - no fuss. I'm struggling to get these numbers to work. From what I gather - either my expenses are over-estimated, or I'm undervaluing the Dallas market and not estimating high enough rent. Alternatively, I can look for a super "Deal" to get the target return. However, my calculations show that the seller would have to sell the property to me at about 66% of market value to reach the target ROI (i.e. unlikely).

What am I missing? Is there anyone in the Dallas Market that's not exercising a highly-leveraged strategy, but is still making a competitive ROI with their cash flow? Is there something obvious that I'm not accounting for? I truly want there to be excellent opportunity here, but I need to see the math work before executing an investment.

Bonus Question : What is the (Rent / House Price) ratio you personally have/use when making an investment in the Dallas area?

Drew Sygit · Answer

@Issac Droblyn what type of investments are you looking at? SFR or apartments?

If you're buying Class A properties at retail prices - your cashflow is going to suck!

You make money in real estate when you buy - either from a motivated seller or by having a plan to reposition the property.

Not sure why you're ignoring appreciation as that is the big multiplier in real estate. Just have to be careful with short-term estimates.

Curtis Farnham · Answer

Have you looked at calculating Internal Rate of Return (IRR)? I'm studying a lot of deals and this looks like a much better way to evaluate and compare deals over long periods of time than CoC or other ROI measures, and it makes it easier to compare to stock market returns as well. IRR factors in the time value of money, and provides a much more nuanced way of accounting for cash influx/outgo at various points in time. Excel makes this easy to calculate.

Also, I'm not understanding why you're BRRRR adverse when your goal is net worth. (My goal too.) Seems to me like it's a best-in-class method of building it.

Is Rehab (the first "R") the part that you're not fond of? That's a huge way to build net worth fast. It's forcing appreciation. And the faster the property builds equity, the more options you have if you need to exit the deal.

Or is the refinance (the 3rd "R") what you don't like? The reason this is there, is that you pull out cash that you can put toward your next deal. That's how you scale everything up. You won't scale nearly as fast without this.

Or are you adverse to being leveraged that much? If you leave 25-30% equity in each of your properties, as the BRRRR strategy recommends, and if you're keeping a 6-month cash reserve for each property, and you're being realistic with how much you'll lose on vacancies, repairs, capex, and management, then the investment should still be pretty safe. But you don't have to follow BRRRR in every precise detail. You could leave a higher amount of equity in the deal, say, 40-60%.

Bruce Lynn · Answer

Nice analysis.

I'm super conservative...so my numbers probably more conservative than yours.

I think your tax estimate is low.....I think I'd be using 2.5 as average.

I think your vacancy rate is low.....I think I would use 7-8%....just talking with another investor tonight about vacancy on single family...of course lots of variables...but when I first started, seemed like tenants moved every year, then 30-60 days vacant a year.  Probably more like 30, but sometimes a bit longer.  Seem like tenancy length has increased to 2-3-4 years between tenants, and I'll bet that increases the next 3-4 years, maybe longer...so maybe your 5% is a good number.   It's a guess anyway I guess.

CapEx...I think you are way low on that....depending on what your philosophy is.....I see some people never make an upgrade and just run the properties into the ground....I guess that works for them, but their rent increases are probably low or non-existent.  I guess that's why some people like value add to squeeze the juice.   What I have observed over the years is I think probably 6-7% gets you better rent bumps and probably a higher end number.  Not sure how you prove that though.   When I hear more sophisticated investors, saying they bought a mom and pop place, and therefore there is big opportunity, then this is what I envision...someone who spent 2.5% or less vs 6-7%.   Those are the people who have old carpet and tile counter tops from the 1950s, vs some kind of solid surface like granite and getting $1600/month rent vs $900/month....of course if your neighborhood and property can support that increased rent.

Insurance is probably about right...might be a little high from what I see....but this number seems to be increasing so you're probably about right on.

Never see people budget for legal fees?

HOA....guess it depends if you buy in HOA neighborhoods or not.   Somewhere I heard virtually all new neighborhoods in Texas will have HOAs...so depends on where you buy and what you buy and maybe how old the properties are.

PM...10% is a good number.

Rent....depends on what you buy, but I don't see a lot of 1% rule places today.....great target, for the most part I don't think realistic in most areas...certainly the better areas.   Might get it in older areas, tougher areas, but I think that will bump up all your costs like legal, insurance, vacancy, and CapEx....so it's a balance.

Who knows where the best place to put your money for long term wealth, but I don't ever think I have ever heard about, read about, or met someone who got super wealthy buying BBB+ bonds with 5% interest....what is average bond return over past 10 years?   Probably more like 3%.  If 2-3% inflation is the Fed Target, you don't really get ahead with bonds in my opinion.   I'm pretty invested into the real estate world so I am very much biased, but probably my best performing assets have been in real estate, and I think all the people I know who have better than average retirements or way better ending wealth had a good chunk of their investments in real estate.   I could probably name 100s of people I know personally or have met in one way or another that became super wealthy investing in real estate....if you don't know any, you can find plenty of books or writings about them....in Dallas...Craig Hall, Trammell Crow, Jerry Jones, Lamar Hunt, Lucy Billingslea, Ross Perot Sr/Jr, Robert Rowling, Tim Headington, John Golf, Jim Lake, Mehrdad Moayedi, Duke Rudman, Robert Dedman, Conrad Hilton, Ray Nasher, Roger Stalbach, Jack Matthews, and the list goes on....many of these are billionaires, and probably the others are 8# or 9# millionaires....and there are plenty 100s of other "smaller" multi-millionaires that started or invested in small real estate ventures in Dallas area.  I'll bet if you are from a small East Texas town, there are even several mutli-millionaire real estate investors in those cities.  You don't always know who they are, but you can ask around and find them...and you'll find some Sam Walton's driving old beat up trucks, wearing work boots and jeans and a dirty give me cap, that are absolutely loaded with real estate investments.  Sometimes they're out mowing the lawn on their million dollar multifamily late on Saturday afternoons, or they're picking up trash, or painting the trim.   Go to those same towns and pop in an Edward Jones office or some other investment advisor office and ask them how many millionaire bond investors they have as clients???

I guess with any investment you have to guess at some return assumptions...so have you figured in rent growth and appreciation for real estate?

Also I guess you invest in what you know and understand to make money....plenty of people have done that.  If you know how to build better mousetraps, build mousetraps, if you know how to trade bonds, trade bonds, or stocks, or oil, or rare earth minerals, but I think for the average American, the best way to get wealthy is to invest in real estate.   I don't think you do it in bonds, or stocks, or playing NFL football.

Is Competitive ROI on Non-Leveraged SFR Reasonable?

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