What do people think about this strategy?

Question

Hi all.

I have been a somewhat successful stock trader for the last 13 weeks.  I have been getting a little sick and tired of trading.  I would like to get more into the real estate game.

Here's the strategy I was thinking of trying out.  I have allocated $500,000 to real estate.  My plan is to buy 6 units in the Raleigh North Carolina area.  The average 3 bedroom/2 bath townhome/SFR with a garage in a good area goes for around $150,000 to $200,000.  So for simplicity, i'll assume all 6 properties go for $175,000 (obviously, I will be bargaining to try to buy below Fair market)

1st 2 properties=I buy for cash ($350,000)
next 4 properties=I buy with 20% down and get a standard 30 year loan around 4.5%. (so, that would be around $35,000 for each property for a total of around $150,000)

Then, I use the cash flow from the free and clear properties (and the excess cash flow from the other 4 properties) to pay down the debt of the other 4 properties.  I maintain a good reserve for vacancies, evictions and repairs.  If it takes me around 10 years to pay all them off then I will have 6 free and clear properties.  If each one brings in around $10,000 a a year, that will be $60,000 a year in free cash flow.

Do you think I am better off just putting the money in a REIT (or a couple of REIT's) or do you think  strategy like this, although it will have more headaches, will probably be better for my money?

Thnx,

Dave

Will Barnard · Answer

David,
I think your choice of R, NC is a good one, it is a very strong market and I personally believe that in the next 10 years, you will see some positive appreciation.

That said, I think you need to really understand and examine cash flow, operating expenses, and all other expenses associated with being a landlord. Getting $1300 in gross rents per month and having to pay even only $150k for the acquisition puts you at well below 1% rent to acquisition ratio which is a very bad deal from a cash flow standpoint. In that price range, you should be paying much closer to 1.5% which means you need to find some very motivated sellers or distressed sales where you can get in for $100k and rent for $1400-$1500. Now, there is the upshot of appreciation, prinicple paydown by your tenants, and the tax advantages associated with RE, so after factoring that in, I could see clear to paying somewhere closer to 1.2% rent to acquisition ratio and still having what I would consider a positive investment - long-term.

Mike H. · Answer

I have two thoughts.
1) If you're sitting on 600k, you may be better off looking at distressed multifamily. You have plenty of cash to get in on a bigger deal.

2) If you understand the single familly model better, then I see no problem with putting it into real estate. Its a heck of a lot better than what you'll be getting from a cd or bond. And much safer than the stock market.

The only issue I have is your price point. Something seems out of whack with a 180k house only getting 1,300 a month for rent. Thats simply not a good deal. So while the raleigh area might be great, it seems like you're really betting on the appreciation to make a good investment.

If you're looking to gamble and want to use the buy low sell high theory, then maybe those are the better units to buy.
But if you really want to build some cash flow, try ratcheting down your neighborhood and units and you should be able to really put that money to use.

I don't know the area at all but I looked on HUD's website and they've got a decent looking 3/2 1800 sq ft house built in 1996 listed at 117k. Which means you can probably get it for 10 to 15% off list (105k). Add in another 3k in closing costs and 10 to 15k in rehab and you'd likely be all in for 120 to 125k. Rents appear to be going for $1,400 in that area or more (realtor.com).

I'm not saying thats a great deal (who knows what the rehab actually is but built in 96, you shouldn't have too much), but the numbers work a lot better at 125k than 175k. And I'm sure once you get to know the area, you can bring that down even more. The really good deals tend to disappear fast so you just have to keep watching and you can probably get houses for 100k there.

One other note. From the things I've read in the past, I would try to avoid townhomes. They don't appreciate like homes, they don't rent like homes, and there's inherent risk with shared structures and/or HOA's that you typically don't see with homes.  Just my 2 cents on that one as I'm sure others have done well with th's.

But the one thing I will say is that your plan is right on the money. I would only suggest revising your target properties and you'll be golden in 10 years. We won't see these price to rent ratios again for a long, long time - another 2 cents. :-)

Kama Ward · Answer

Raleigh is a good solid place to be, for the stable job reasons you mentioned.  I can't see appreciation doing anything but keeping up with inflation though.

I grew up in the area, went to college there, and later owned a house there. (also my father owns sfrs nearby) I bought in a 'good' area meaning houses in suburbia, not that old and mostly or all owner occupied. I sold 2-2.5 years later for the same price. This was during the dot.com run up. It's just too easy to build more- although they are way built up compared to the old days- Raleigh is nowhere near ATL or even Charlotte.  If you buy in the old city neighborhoods, you might get better appreciation since they are not building more of those and the trend is still back to the city.

You originally mentioned townhomes.  These could have HOAs that would make owning them expensive and a pain. See some threads on owning condos vs. sf. It is easy to obtain single families in Raleigh, so why not do that?

If your rents are $1400 a month, you will end up keeping $700 a month on a paid off house (using the typical rule of thumb on this forum). Will this be enough of a return for you?

It seems that your limiting factor here is you do not want to worry about repairs/fixing. But you are going to have to worry about these things eventually anyway. Why not bite the bullet and go for a distressed/fixer properties, and 'make the money when you buy' as the old cliche goes.  If you have a partner in town or will be moving there, you will have the on the ground eyes that you need for this.

Or why not try one of your in shape townhomes and one fixer and see what comes of it? I would not suggest this to everyone, but you seem to have plenty of buffer.

I'm not sure why this is in innovative strategies. Getting nicer rentals seems to be a classic endgame for many.

Will Barnard · Answer

Some additional food for thought: rather than looking for the almost perfect condition home there, and since u are all cash, find a home in the neighborhood of choice that is a short sale or reo that is thrashed, get a smoking deal on it, fix it up and then rent. U should be able to get better deals that way.

Will Barnard · Answer

David, I don't disagree with your thoughts, but I would say this: first, never say u can't find a deal at 1.5% there until u actually have tried long enough to prove it. One motivated seller in that area could turn in to a deal line that. Second, I think u are under estimating your repair costs and u have failed to include all the other expenses such as evictions, tenant placement costs, legal fees, accounting, management, capital expenses, and more. I believe after all expenses are accounted for, your actual return would be much lower than the 6%.

David Ackerman · Answer

Hi Will.  Thnx for your reply.  Let me throw out some numbers.  Tell me what you think:

Purchase Price=$175,000 (best neighborhoods in Raleigh area)

Rent=$1,350

Taxes=$110
Insurance=$60
HOA=$120
Vacancy/Repairs=$150

$910/month X 12 = $11,000       $11,000/$175,000=6.2%

So, on the properties I would pay cash for, my return would be around 6% (not including tax savings).

I would be happy getting a long-term return of 6%.  But, my real bet is on Raleigh.  I am betting that in 10 years from now the Raleigh area would have appreciated nicely.  Nobody has a crystal ball.  Nobody can know for sure if Raleigh will appreciate.  If I am wrong, and Raleigh either remains stable or loses some value then I will still make some money.  Obviously if I make 3%/year over 10 years then I will NOT be happy.  But, it would be a better bet then those people that had owned stock in Bear Sterns.

On the other hand, what if Raleigh does appreciate the way I think it will?  What if Raleigh becomes the Silicon Valley of the East coast? Well, then my bet, with very little downside, would turn into a nice investment.

That Risk/Reward scenario makes sense to me.

If I only buy in areas that meet your criteria of 1.5% of rents to purchase price, then I can't do it in Raleigh.  Well, I can't do it in the good areas of Raleigh.  Maybe, if I got super-lucky and had the perfect connections, maybe I could find 1 property in the good areas of Raleigh at an extreme discounted price.  Why do I need to wait for the perfect property if I am making a bet on the long-term growth of an area?

Since I am a stock trader, let me explain it in terms of a stock.  The stock CMG (Chiptole Mexican Grill) was trading at around $80 a few years back.  At that time the PE (price to earnings ratio) was 45.  For those who don't know how PE works, 45 is quite a high number.  I know many investors who wouldn't even consider CMG at that price because the PE was so high.

Today CMG is trading at $384/share.  The PE is even higher at 57.  That is an incredible return on one's money in just a few years.  The people that only looked at the high PE missed an incredible return.

If I were to follow your 1.5% rule, then I would have an extremely difficult time investing in a top quality area in Raleigh.  The reason CMG had such a high PE, was precisely because it was considered a top quality company.  The reason I can't find any properties in the best areas in Raleigh for 1.5% rent ratio is because Raleigh is viewed as a top quality location.

I may be 100% wrong about Raleigh.  But that is why it is called an investment.  There is uncertainty.  But it would seem silly to NOT make a bet just because I can't find a property that meets the 1.5% rule.  Even I am wrong about Raleigh, I will still come out ahead, or at least even, in the long run.  If I am right, then it can be a very nice investment.  I like those odds.

David Ackerman · Answer

Oops...13 weeks is really 13 years.  We human beings make plenty of mistakes   LOL

I chose Raleigh because my business partner is in Raleigh.  We have done 3 units together so far.  Unfortunately, he doesn't have enough money right now to keep investing.

I am debating of moving to Raleigh.  If I would take this to the next level, then I would move there.  I can still trade remotely from there.  My plan would be to slowly weed out trading over the next couple of years.  I would spend my time managing my properties.  With rates at all-time lows, with patience and persistence, I believe this would be a successful strategy if i take a long-term approach.  It would be a new challenge for me.

Kevin Yeats · Answer

David, some of the points that I make will cause you to reflect on "the bigger picture."  That is my attention.

You state that you have been a "somewhat successful stock trader for 13 weeks" and now you find that you are "sick and tired of trading."

Are you sure you have the mental aptitude and fortitude to stick with real estate investing for 10 years or more?

With stock trading, you can monitor your results every minute ... even every second ... with great accuracy and make adjustments.  With real estate investing, it take months to know your results and then you can second guess yourself.

What will you do if one of your six units sits empty for 3 months (13 weeks)?

Why Raleigh, NC?  You list your location as NYC, NY.  Are you moving or are you prepared to be an absentee landlord?  Are you prepared to pay a property manager?

Are you sure you get a loan on several investment properties for the terms you list?

David Ackerman · Answer

Hey Jon

1)Rents are between $1,200-$1,400 (cash flow around $250 a month)
2)I am NOT playing for appreciation.  But I am betting on Raleigh for these reasons:
     a)3 top 50 colleges in area (Duke, UNC, NC State)
     b)State capital (stable jobs from government positions)
     c)RTP (home to companies like IBM, CSCO, Biogen    adds around 40,000 solid jobs to the area)
     d)Growing population.   Major highways being built.  Friendly taxes.
3)Properties I'm looking at have been built in the last 5-6 years.  They each probably need $1,000-$2,000 in touch ups.  But, all the major items are in good shape.

I am really thinking of making a bet to preserve my capital. Kind of like a retirement account.  Hopefully it would help me generate good cash-flow in 10-12 years from now when I look to retire.  I have plenty of reserves.

Jon Holdman · Answer

What rents can you get from those properties?  Are you hoping for any appreciation?  What about rehab expenses?  I've never seen a property that was truly move-in-ready unless it has just been fully rehabbed.

What do people think about this strategy?

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