​I am ok to be below the "1% rule" in high cost markets

[Martin S.]

I have found very little discussion in the forum on buy & hold in expensive markets, which is what I have been doing for the last 2 years, so want to share my rational and returns. Would love to hear from other people who operate in high market areas.

Properties:

Located in norther NJ, Tenafly and Closter. Average house price in these markets is 750K and 620K respectively. Located about 50 min to 1 hour from NYC. Schools are A+

The cost of the land in my houses represent on average 75% of the total cost. For instance, one of my houses is value at $700K, but the value of the land alone (0.3 acres) is worth $550K.

I cannot reach the 2% or even 1% and I am ok with that:

Houses (construction) decay over time and eventually are worth zero. So a $300K multiplex in Indiana might generate great cash flow, but eventually building will decay and be worthless and residual value is just the land, which might only be worth $25K. On the other hand, a house in NJ might be worth $500K, have lower cash flow than the multiplex in IN, but residual value for the land is $350K. So the return metrics can never be the same.

Specifics for my houses:

House cost $700K. Land value $550K. Structure value: $150K.

Rent $4,100. Taxes: $1,100. Insurance: $65. Repair allocation: $250. Net: $2,700.

Return metric #1:

I see holding land comparable to holding gold, not decaying and zero risk of been destroyed by tenants. Also over time value stays current with inflation. So one way to calculate return is to say I am getting $2,700 a month in return for a building worth 150K, which actually is a 22% return a year. And for the other $550K (land), I am just holding value to inflation like I would if I were to buy gold.

Return metric #2:

A different way to calculate it is to add to the net profit from the rent the long term appreciate of the land (2.5% inflation rate). So in this case appreciate is $550K X 2.5% / year = $1140. Net profit is $2,700 (rent) + $1,145 (appreciate) = $3,845 / month over a $700K investment = 6.6%

My other houses have a slightly better return since the smaller the house, the better the return ration:

House #2: SFH worth $500K, land worth $375K so return is 7.4%

House #3: 2 family house, worth $450K, land worth $320K and the return is slightly better at 8%.

Other benefits:

My vacancy rate is zero. Show houses for 2 days and get 3+ offers.

Have to deal with small amount of tenants. 1 tenant paying $4K rent is easier to deal with than 4 tenants paying $1K each.

Tenants pay 100% on time and take great care of property.

Conclusion:

1% return is not present in high cost market, which does not mean they are a bad deal. Lower return is offset by lower risk (established neighborhoods, low vacancy, no evictions) and most of the investment been tied to the land which does not decay over time.