What should I target as a risk adjusted rate of return?

Question

All,

I know this is a difficult question and depends on each investor's needs, but I'm looking for general guidelines for comparing REIT investments to actual real estate.

If I can get a nominal 7.7 ROR investing in a basket of REITs, what kind of risk premium should I target for the trouble of being a landlord?

I'm looking for the minimum cash on cash return I should demand for taking on the risk of being a landlord compared to the after tax REIT return of 5.5% which is almost effortless.

I'm thinking a minimum of 8% cash on cash with a goal of 10%. That would represent a 2% to 4% risk premium over the REIT after accounting for the move favorable tax treatment with direct ownership.

I'm looking at 2-4 unit multi-families and I'm not giving any weight to potential appreciation. I'm interested primarily in cash flow.

Thanks,

Craig

Shaun Reilly · Answer

Well that pricing is very dependant on exactly where you are looking.  With that Boston area pricing you probably talking a place with smallish 2BR units that is pretty far away from the city.

In Western MA you can find TONS of small multies for way less than that.  Even in Franklin County I see lots of stuff that is under $100K.  Most need a fair amount of work, but if you want a MUCH better return that is where you will find it.  Buy the crappy place fix it up and rent it out with a lower cost basis and lots of forced appreciation for added equity.  There is a fair amount of stuff in places like Greenfield and lots of options if you are willing to go out to Orange.

Of course for the semi long distance type things get cheaper in that area as you go South so even more lesser priced places in Hampshire and if you go down to Hampden, especially if you will brave places like Springfield and Holyoke you can buy places for under $50K all day, that need work.

Obviously if you are deciding if the headache of being a landlord vs. buying a REIT is worth it then the thought of buying a big fixer in a lower quality area might not be where your head is at.  However it is NOT hard at all to be all in a 2-3 family in Western MA for much less than you are saying

J Scott · Answer

That's if you did all the management yourself.  You can reduced this by a good bit if you hire out a good management team -- then your management overhead consists of finding deals, finding the management team and making sure they're doing their job.

Or, if you're doing the management yourself, your NOI should be higher, increasing the returns you'll get on the properties.

Either way, I think the 15.5% is a bit inflated as a direct comparison to a purely passive investment.  My gut tells me that 10.5% is probably a better comparison.

Plus, keep in mind that most people will look at COC to determine their return, but with leverage you can both boost your COC and you'll see higher long-term IRR than your short-term COC.  So, it's a question of whether the OP needs the money to live off of (in which case IRR doesn't factor in), or whether the cash flow is reinvested (in which case it does).

J Scott · Answer

Put it this way:  I can't afford myself.

I think the value for the OP of assuming an outside manager is that he can make a more apples-to-apples comparison between his currently passive investment and his potential not-so-passive investment.  He can always decide later to do the work himself (i.e., make it less passive), but it's harder to compare the financial returns if the amount of work involved is so completely disparate.

And a lot of it is subjective, so both 15% and 10% could be right answers...just for different people...

Bill Gulley · Answer

Well, put a pencil to it and see what you get @J  Scott

Starting off, why pay others to do what you can do, if you have the ability and time to do it? What are you worth an hour?

I'd want 15%, J. Scott probably doesn't factor appreciation in to estimates, I do, so, we aren't far apart. :)

Craig Shrimpton · Answer

I don't mind land-lording if it pays enough. My family owned many apartment buildings when I was growing up so I know what a PITA land-lording is. I remember the old man cursing when he had to go out at 2am to fix a broken oil furnace only to find out the tenant neglected to re-fill the tank!

My thinking is if I can get 5-6% after tax with a REIT, doing it myself needs to pay at least twice that. The deals I'm looking at in my area don't come close as they are mostly turn-key.

So it would seem that I'm actually looking at the wrong types of properties.

Possibly my best options for direct ownership that provides at least double the return of a REIT seem to be:

1. Buy run down SFRs and duplexes, rehab them and either flip or rent depending on current conditions.

2. Buy duplexes to rehab, rent out 1 unit and then sell the whole duplex to a buyer looking to get into their first home, but can't quite swing the mortgage without a tenant.

The existing returns on ready to move in duplexes seem to fit with option #2 as an owner occupier probably would be happy with a 5% return, where an investor would not. Or, if the duplex in question is cash flowing, I could just rent the other unit and keep it.

I already have a bunch of REITs and was using them for comparison. There are loads of junker houses for $40-$50k in my area that I can rehab.

Thanks,

Craig

Mike Hurney · Answer

Fellow Landlords/Investors do you get the impression Landlording/Actually buying/owning property is not for Mr. @Craig Shrimpton ?

Let him get a REIT although as @Bill G. says "REITs are not without risk, neither is ownership..."

Bob Obear · Answer

I have deals available and rehabbed rental properties available in Western Ma.  I also run a full service construction and property management business and can service your needs.

Feel free to message me or drop me a line.

Bob

Bob Obear · Answer

I do deals in Western MA, I have done deals in Turners Falls, Wendell,  Ware, Amherst, Northampton, Shutesbury, Southampton, Montague, and Greenfield.  I am currently rehabbing a large Victorian era house in the Highland section of Greenfield.   It is a tricky market with the town being predominantly lower to middle class.  There is a large rental population in Greenfield and a strong landlord/ investor base.  There are several private schools in the area and a fairly substantial business district so this balances things out a bit.

Best,

Bob Obear

Craig Shrimpton · Answer

I have been looking in Greenfield and saw one place that was around $60K, but it looked like it was next to a crack house. Buying the cheap stuff in crummy neighborhoods brings tenant problems plus many of the older units have structural problems, which can cost $$$$.

There were also some possibilities in Ware, but that's kind of far for me to do small maintenance jobs or let people in if they lost their keys, etc.

I wouldn't mind doing the landlord gig it it was worth the time. Having only a single property (looking to get my first one), it's kind of a pain to deal with tenants. My first place needs to be fairly close physically, unless I can find something with a high enough return that makes it worthwhile to hire a management company.

Craig

What should I target as a risk adjusted rate of return?

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