All Forum Posts by: Mike J.

No, I even had to confirm what that meant by looking it up. Thanks for pointing out that possibility.

Great questions. 

1. I was assuming 20% of rent on average being eaten up by vacancies and management and then 3% of the home's cost per year going into taxes, maintenance, and insurance. I'm wholly unfamiliar with how investors in the business do these calculations and figured vacancies and management are better calculated on the rent side (more related to and tied to rent), while taxes / insurance / maintenance are costs that scale with home property value and not rental rates. Of course, rent and home value are related too, so it's just a matter of accounting and assumptions.

2-3. No mortgage, at least in this example, for simplification. House is fully owned. At least from my perspective, (fixed-rate) mortgages are pretty predictable in terms of cash flow, so it's not hard to do the math assuming none and then subtract out mortgage payments later if applicable.

4. This is a great point. I'm more familiar with calculations outside of real estate, so to me X dollars at Y time has some meaning, but we need some context. I don't think a savings account is a fair comparison because that's ultimately much less riskier and more liquid than real estate. The stock market is closer (or perhaps a mix of stocks and bonds) in terms of volatility and risk. But for what it's worth, there's reason to expect long-term future returns below 9% nominal and 7% real, based on the fundamentals. Many large investment companies and financial advisers seem to anticipate lower returns at least right now; for the year 20XX, who knows. Perhaps 6% nominal and 4% real is more realistic.

The highly leveraged scenario is interesting, but of course that's coming at increased risk as well.

Warning: the below is a lengthy, generalized hypothetical. The questions are about calculations of average (yes, "average" is a very dangerous word because most years are far from average) returns on rental properties, considering both costs and typical rents.

It is the year 20XX. Jane Doe owns a nondescript single-family home in Townsville, USA, with a value of $100,000.

Jane is about to leave for another part of the country for work. Or whoever knows why. It is the year 20XX, after all. She is considering two options: (1) selling the property and (2) keeping it and renting it out. Jane has no need of liquidity and the roughly $100k that would be available after an eventual sale. In other words, for the long term, what are the prospects?

The financial gain from (1) is the sale price minus transactions costs and frictions, as well as any renovations or staging done to achieve such a sale. I think we can call this roughly in the range of $100k, probably lower to some degree. Let's assume a neutral housing market, where the $100k is a fair long-term value: not a hot sell at a cyclical peak nor a stinker at the lows.

How much could Jane expect to earn in the long term by keeping the property as a rental in option (2)?

Data over the decades suggests that real estate appreciates roughly with inflation over the long run (less than 1% over inflation), but this is only a historical national average and not applicable directly for any particular market. For now, assume Townsville just about follows the average or slightly worse and properties only follow inflation over the long run.

Likewise, I assume rents appreciate roughly with inflation as well, for some of the same reasons. Let's just say Townsville isn't the next hotspot in the country and rents are flat with inflation.

Jane is moving far away and is unable to keep tabs on the property or screen tenants, so she would need to hire a property manager, say for 10% of the rent, so as to not risk it to a shady fly-by-night operation. She also risks vacancies and the occasional eviction and associated cost, which in the long run let's say takes another 10% chunk out. This property management service is earning its keep, keeping vacancies to a minimum. Is that a lowball estimate?

Other recurring costs for Jane would include property tax (say 1%) as well as any and all maintenance and improvements (1.5% of home value, with some years much more than others), and insurance (0.5%). If a home falls apart, it is not going to keep tenants or keep up in value with inflation, to be sure. Have I missed some other expenses for Jane? (HOA dues, I suppose, potentially) Do these numbers look about right?

So Jane needs 80% of a year's rent (9.6 times a month's rent) to cover 3% of the home's cost to break even, with the rest being profit. How much does a $100k property rent for in Townsville? Any idea of some kind of average or range to expect? $700/month? That would imply a profit of $3,700 / year, or 3.7%, with the principal value and profit both adjusting for inflation. Recall that $100k is the long-run fair value of the property in 20XX dollars, not what an enterprising real estate investor could buy an undervalued house for in a down market.

That looks somewhat in the ballpark of the 50% rule of thumb to me, but maybe I'm misunderstanding what goes into that calculation.

To be sure, real estate is illiquid and risky to some degree, so we would expect a positive return. I'm just not sure by how much. Ideas? In case you're wondering, no, I'm not in Jane's position, just wrapping my head around realistic expectations so I can advise myself and others in future circumstances. Individual markets and circumstances would affect all of the numbers.

Whew, if anybody read even half that, I would be impressed.

I really appreciate the thorough responses, reality check, and sounding board. You don't seem like zealots to me, just guys and gals I don't want to be on the other side of a deal against. ;) I generally know not to bite off more than I can chew.

As noted earlier, domestic REITs seem a bit frothy at the moment in terms of valuations. I'm not that much a guy for individual securities analysis, but overall checking the industry's P/E, P/S, P/B, etc., current interest rates, and history of dividends vs. future returns—all imperfect indicators of the future, to be sure—does not inspire much confidence in future performance, at least for now. I like buying and holding on, but I'd prefer not to reach for a sector into a peak or at least a relatively high point. Maybe I'll jump in when things cool off a bit. I do have a very small concentration in international REOCs / REITs through a fund (in a Roth IRA, of course), despite the weaknesses in those economies.

I will keep the option open of buying a house or condo wherever I end up, though. My mind could always change in the future. And even if I end up selling when moving, the right deal does seem to make sense over renting according to the nytimes calculator and so on, so long as the period of occupancy is high enough.

I'll also suspiciously consider hard-money lending and other such pooling of capital, but I wonder about evaluating the capability and trustworthiness of those doing the heavy lifting without knowing much about REI myself.

And thanks for keeping the real estate market humming along for chumps like me.

Greetings. Mike here from... actually it doesn't matter because when I finish grad school eventually, I'll be somewhere far away, but I don't know where now.

I am considering learning about real estate investment, but I'm not sure it's right for me. The first decision would be buying vs. renting wherever I end up, with the idea of potentially turning the property into a rental after moving out eventually. I'd appreciate any perspective here or perhaps a suggestion about which subforum is most appropriate for more general and theoretical inquiries.

Background:

I have zero interest in day-to-day property management, zero interest in fixing properties, little interest in finding good values on the market, and little interest in spending much time on this after doing the research. Presumably unlike many others here, I don't have a preference for physical securities and a hands-on approach. I am a buy-and-hold investor who prefers (and currently owns) stock and bond index funds to gain controlled market exposure, so my interest is really just in risk hedging and diversification—or potentially higher profits.

My aim is to divert much of my income to investments that will help me achieve financial independence at a relatively early age, retaining a realistic perspective about cyclical market conditions, loss, risk, and expected returns.

Thanks.