REAL return on real estate is MUCH lower than many claim here

[Rishi Ramlogan]

Real estate is a good enough investment as is - why tell people fairy tales?

First off, I am talking about pure passive investing. If people want to get into the real estate BUSINESS, and do all the labor that is involved in any business, then that is fine and it can be a great business. But look at an ordinary passive rental property and it comes out no better than investing in the stock market.

And I say this as someone who owns a 2-bedroom condo in the Washington, DC area that rents furnished for $4,000/month long-term (currently on a 25-month lease, i.e. a $100,000 payment guaranteed by the Brazilian Embassy) or up to $8,000/month during peak months when on Airbnb. (Yes, I know most investors invest in the lower end and you can get greater returns there in exchange for more work.)

But in other words, I dumped a lot of money into this property because I like real estate. But when I see things like people saying you'll earn a 50-60% return on your money, that is frankly nonsense. The learning and effort needed to hunt down severely undervalued properties, sometimes out-of-state, the learning and effort of doing renovations and managing contractors, the learning and effort needed to list properties, screen tenants and perform property management - these are things that are needed in running a real estate BUSINESS. This is not a passive investment like making automatic monthly deposits into an index fund for long-term stock investing and then going to spend time with your family. If you own a restaurant and buy pasta for $1 and sell a plate for $10, you don't say pasta is a great investment with a 1000% return!

If you look at PASSIVE single-family investing, i.e. pick a random, well-maintained property at fair market value (and yes, obviously there will be large regional variations - I'm talking averages), you're probably going to need at least a 40% down payment to just not have negative cash flow. Let's say you put 50% down - that may give you the following:

1) a 2% cash-on-cash yield (and even to get that you'll probably need to list and manage the property yourself, which you probably can do since it's a local property not in need of extensive renovations)

2) 6% in leveraged appreciation, since you're leveraged 2-to-1 with a 50% down payment (and assuming 3% appreciation, which is about what Nobel winner Robert Schiller has noted is accurate long-term)

3) a 1.5% equity buildup from loan amortization.

That gives you a return of 2% + 6% + 1.5% = 9.5%. AT FIRST.

But eventually you're going to want to pay off that property. And whether you do that from cash flow or from new money you earn from your job, the return on the loan payoff is 4% (or whatever your mortgage rate happens to be). So if you get a 9.5% return on the first 50% of your money and a 4% return on the second 50%, your total return is going to be closer to 7% or somewhere thereabouts. Unless you plan on never paying off your loans and just taking out new 30-year mortgages into your 60's and 70's. (And yes, I know I am simplifying some things - I have a degree in math so I know how to run these numbers but am intentionally simplifying some things.)

Frankly, you'll probably get your 7% easier from the stock market - Microsoft is never going to call you to fix their toilet or force you to go to court in order to collect your dividend. Again, I like real estate fine now with the artificial stock prices caused by low interest rates, but let's just be honest about the return. Articles about getting 60% returns on your money are why so many investors find themselves desperate to unload their "money pits" despite their 30% down payment.

I think Warren Buffett might know what he's talking when he says that just a generic index fund, purchased over time, is the best way for most people to get rich - and that even for billions, his trustees will be instructed to follow that strategy after his death. And again, I like real estate - more people here just need to differentiate between passive investing and owning a real estate BUSINESS.

[Levi T.]

Originally posted by @Rishi Ramlogan:

Real estate is a good enough investment as is - why tell people fairy tales?

First off, I am talking about pure passive investing. If people want to get into the real estate BUSINESS, and do all the labor that is involved in any business, then that is fine and it can be a great business. But look at an ordinary passive rental property and it comes out no better than investing in the stock market.

And I say this as someone who owns a 2-bedroom condo in the Washington, DC area that rents furnished for $4,000/month long-term (currently on a 25-month lease, i.e. a $100,000 payment guaranteed by the Brazilian Embassy) or up to $8,000/month during peak months when on Airbnb. (Yes, I know most investors invest in the lower end and you can get greater returns there in exchange for more work.)

But in other words, I dumped a lot of money into this property because I like real estate. But when I see things like people saying you'll earn a 50-60% return on your money, that is frankly nonsense. The learning and effort needed to hunt down severely undervalued properties, sometimes out-of-state, the learning and effort of doing renovations and managing contractors, the learning and effort needed to list properties, screen tenants and perform property management - these are things that are needed in running a real estate BUSINESS. This is not a passive investment like making automatic monthly deposits into an index fund for long-term stock investing and then going to spend time with your family. If you own a restaurant and buy pasta for $1 and sell a plate for $10, you don't say pasta is a great investment with a 1000% return!

If you look at PASSIVE single-family investing, i.e. pick a random, well-maintained property at fair market value (and yes, obviously there will be large regional variations - I'm talking averages), you're probably going to need at least a 40% down payment to just not have negative cash flow. Let's say you put 50% down - that may give you the following:

1) a 2% cash-on-cash yield (and even to get that you'll probably need to list and manage the property yourself, which you probably can do since it's a local property not in need of extensive renovations)

2) 6% in leveraged appreciation, since you're leveraged 2-to-1 with a 50% down payment (and assuming 3% appreciation, which is about what Nobel winner Robert Schiller has noted is accurate long-term)

3) a 1.5% equity buildup from loan amortization.

That gives you a return of 2% + 6% + 1.5% = 9.5%. AT FIRST.

But eventually you're going to want to pay off that property. And whether you do that from cash flow or from new money you earn from your job, the return on the loan payoff is 4% (or whatever your mortgage rate happens to be). So if you get a 9.5% return on the first 50% of your money and a 4% return on the second 50%, your total return is going to be closer to 7% or somewhere thereabouts. Unless you plan on never paying off your loans and just taking out new 30-year mortgages into your 60's and 70's. (And yes, I know I am simplifying some things - I have a degree in math so I know how to run these numbers but am intentionally simplifying some things.)

Frankly, you'll probably get your 7% easier from the stock market - Microsoft is never going to call you to fix their toilet or force you to go to court in order to collect your dividend. Again, I like real estate fine now with the artificial stock prices caused by low interest rates, but let's just be honest about the return. Articles about getting 60% returns on your money are why so many investors find themselves desperate to unload their "money pits" despite their 30% down payment.

I think Warren Buffett might know what he's talking when he says that just a generic index fund, purchased over time, is the best way for most people to get rich - and that even for billions, his trustees will be instructed to follow that strategy after his death. And again, I like real estate - more people here just need to differentiate between passive investing and owning a real estate BUSINESS.

Funny that you mention Warren Buffett, he has been quoted as saying he would buy up SFH rentals if he just could get it in bulk for the amount of money he has, Blackstone group did it and now is taking their company public with over 1,000 rentals. Even Buffett launched Berkshire Hathaway Real Estate Group recently.

Real estate is one of the best asset classes there is, it's normally just a local type investment which was it's downfall in the days of old, but things are changing quickly in the industry, thus Blackstone group launching a public real estate company.

Only people not making better returns than the stock market are people who are doing it all wrong. You are right about it being a business, just like trading stocks all day long is a business too, that why you have portfolio managers and property mangers. Just like houses, if you buy stocks at the peak price, it's going to be a long road before you get your value out of it, if ever. So buy your favorite assets when you can get them a steel of a deal!