Real IRRs - Buy & Hold

[Ian Reynolds]

I see no compelling evidence that buy and hold forever can produce real returns on capital north of what can be had in equities markets with very few exceptions. Please try to poke holes in my arguments below. Id love to hear from investors who’ve held properties for more than 20+ years.

A true investment is one that allows cash to be returned to the investor at some period of time in the reasonable future. If you can never take the cash out, you are generating no real return.

• Many investors purchase buy and hold properties and calculate their returns based on:
  • The equity from loans paying down mortgages + appreciation
• Small amounts of cash from excess funds from rents
• In a stock by contrast, when I purchase that asset my appreciation is materially higher than my cash yield return. At a certain point, I will sell that asset and realize a gain.

Depreciation is a real expense

• · A number of investors in this forum have spoken of using deprecation to improve gains, but for long term buy and hold investing – deprecation of real assets constitutes a real expense. Floors, roofs, foundations, walls pipes, toilets, cabinets, fridges, water heaters, and utilities break down over time.
• · Deprecation is the amount of real capital that needs to be put back into the business in the future.
• · These are costs that must be factored into the portfolio over time.

Capital reserves cost money

• Capital reserves for a portfolio property are a drag on real returns. The cash may earn some degree of interest but it will be a drag against real performance.

Net real taxes are rising faster than rents and real wages

• · Real taxes are rising faster than rents; governments are incentivizing home ownership over rent seeking behavior. The result is that future cashflows will be smaller relative to taxes owed.

Equity appreciation and rising rents relative to the long term rise in equity values is poor when considering inflation.

• · Over a 30 year period, equities are certain to deliver returns averaging between 7-8%
  • o If I invest 10k into a broad based index fund I can sell it for ~76k after 30 years.
• o With inflation at 2% per year – real returns are closer to 5% pre-tax
• · Over a 30 year period if I can manage to get into a rental home just (breaking even) for 10k; which is going to be hard to do outside of the BRRR method my results are dismal.
  • o With inflation at 2% per year – my real return is flat.
• · If I depreciate the building I have to re-capture that when I sell and it hurts my returns.

Recapitalizations are certain to be more expensive in the future than they are today and risk the portfolio.

• · Interest rates have not been this low for 80 years, good luck repeating what can be achieved now with a cash out refi against assets that are inflated in price because of low rates.
• · Financing repairs is, therefore, going to be an expensive drag on returns