All Forum Posts by: Nick Wiswell

I'm guessing this is tongue-in-cheek, since this is my newbie thread, and at this point I have a lot more opinions about RE investing than actual knowledge about RE investing (that's why I'm here, after all).

I do know a little bit about capital markets, macro forces and equity analysis, but if you'd be paying me to predict market trends you might want to consider a palm reading, that'd be cheaper.

If you're serious, I'm sure we could work something out. I'm curious just to see the things you're willing to pay to know more about.

Thanks Mehran. 

This gives me some pause - if you got screwed by the management company in Indy, that could easily happen to me in Milwaukee. Not everybody gets to partner with Dawn. :)

Minh,

I'd been under the impression that the 50% rule was a relatively conservative assumption intended to provide a margin of safety...

When the utilities aren't billed back to the tenant, I think it makes more sense to just net that out of the rental income. In other words - If the rent is $700 and the utilities are $100 (14.7% of that), then you should just be taking 50% of $600 net of utilities.

The difference between 50% of $600 net ($300) and 50%-14.3% = 35.7% of $700 gross ($250) is $50. That's like a 20% difference in potential NOI depending on the calculation method.

As far as the other items, I thought those were the familiar expenses that go into the calculation of the rule?

25% repairs/maintenance/capex

5% vacancy (I filter for areas that beat that criteria in my spreadsheet)

10% property management

10% insurance + property tax (this one is a lot squishier since it's dependent on the market, as you point out... I will try to figure out a way reliably calculate CoCR by region.)

So I figure 50%, although that should probably be 55% or 60% to be safe given Milwaukee's higher property taxes.

@Dawn Anastasi could weigh in here about the impact of climate and tenant quality... but based on the numbers she already posted above, the 50% rule is actually on the conservative side. The discrepancy could be that she doesn't include property management fees, since she does it herself. Best to hear it from the expert. :)

There's still an opportunity cost. I don't want to wait several years to see my investment start producing cashflow - a lot of compounding can happen in 3-5 years. I could've already invested the proceeds in a new cashflowing opportunity, and already be in the process of reinvesting that cashflow!

Since I wouldn't be looking to sell, I'd only be in trouble if the rents cratered...

After @Account Closed pointed out that the property tax in Milwaukee is particularly high - and that it can have a really profound impact on the return - I decided it was something that really ought to be controlled for. After all, I'd expect the localities with the highest property tax to have lower P/R ratios to compensate.

I wrote out a rough equation for the %CoCR based off the 50% rule:

%CoCR = (50% * Price / (P/R) - Excess Property Tax - Mortgage Payment) / (Price * % Down)

Simplifying,

%CoCR = (50% * P/R - %Excess Property Tax - %Mortgage Payment) / (%Down)

Since %Down and %Mortgage Payment are going to be basically constant assuming I can get a conforming mortgage, it can be simplified further:

%CoCR is proportional to P/R - 2 * %Excess Property Tax

I called this quantity "Adjusted P/R". I got a database of % property tax rate by county from the Tax Policy Center. Then, using a ZIP/county lookup, I calculated the Adj P/R for each ZIP and re-sorted by it instead.

The results are noticeably different. Milwaukee is absent from the Top 10 - it was bumped all the way down to #48!

The filter seems to be practically screaming about the value buy in Naples. But what REALLY surprised me is the one clocking in at #10 - it's in California! (the third CA hit is in Bakersfield, with an adjusted P/R of 13)

Unfortunately El Centro is practically in Mexico, but it's still more accessible than Milwaukee. I will look into it some more.

By the way... here's the bottom 25.

That sounds great.

I knew the property tax was high (although not as bad as IL), but I was under the impression that at least some property tax was accounted for in the 50% rule. 10% return is pretty unimpressive.

Milwaukee is a relatively new location to me (I'd actually been studying Colorado Springs for a few months, before giving up on that idea), so I haven't run any real numbers and I hadn't been set on it by any means. If I can't see my way to 15-20% I'll definitely look elsewhere.

This veers pretty far off topic... I assume you already took a look at the Fed dot plot.

If the Fed keeps that schedule, the term structure of interest rates could invert (it has done so occasionally), but the inversion has almost always been a temporary affair (and it has usually presaged a recession...).

Even from a naive mean-reversion perspective, it's pretty obvious where we're at in the supercycle. Take a gander at the 10y T-note:

We hit an all-time historical low (out of hundreds of years of history!) for the T-note yield (1.65%) only a few weeks ago. The 10y T-note is very strongly correlated with prime mortgage rates, especially the 30y rate.

My conviction that this is a great time to be short on long-term debt was a major reason why I started looking into real estate.

But it's a double-edged sword: if people need cheap debt to afford property, that can really hurt prices. I think that could be an issue here, but not so much out in Milwaukee (and it wouldn't matter much anyhow, if the property is going to cashflow come hell or high water).

There is a lot more nuance to this, of course. I love this stuff so I'm happy to talk about it  (in person at the meetup or otherwise).

Originally posted by @Arlen Chou 

It wasn't exactly what I'd expected, but I definitely don't find it off-putting. The equity investor communities where I cut my teeth can be a lot more brutal than this. I find it stimulating. No room for lazy thinking.

The funny thing is, I came to real estate seeking opportunity in "alternative investments", figuring I was thinking outside the box (and the equity cycle) - and I've ended up thinking in inflexible terms about the primacy of cashflow off a 4-plex with a conforming 30-year mortgage (I do think a short-term or ARM is imprudent, given the macroeconomics of the interest rate situation).

I don't think being data-driven means I need to be close-minded. I'm grateful for your perspectives. I can't learn if everybody just affirms my viewpoint.

But I prefer to think I'm not a flavor-of-the-month type with no defense for my convictions, either.

@Arlen Chou The forced appreciation you've been talking about seems to both mitigate risk while offering potential for upside. That gives me pause enough to wonder if I've overlooked opportunities and dismissed my area too quickly.

Still, as @Haim Mamane Palman  insightfully observed, I'm the type prone to analysis paralysis. If anything is clear, the size of the portfolios some of the people on this site - and even in this thread - have built in a couple years tells me that the opportunity cost of doing nothing is vast.

Robert, no doubt. I don't maintain any illusion that the important factors begin and end with the Census data and the BLS data and the price trend.

But I am totally inexperienced with RE investing, and I have no idea how to consider and weight the influence of the "soft" factors. Perhaps some people here can, but I am trying to remain realistic about my limitations. Based on the data I do understand, I do not believe there is a price opportunity in the hot markets, and I know better than to take investing tips from strangers.

As far as interest rates and doomsday predictions go, I consider myself a relatively rational investor. I do not buy into that stuff.

What I would like to share with you is the Federal Reserve dot plot, the graph produced by polling the target rates of the Board of Governors of the Federal Reserve... the people who actually set the interest rates. (This graph is from the September meeting, the most recent data from January is similar.)

You can draw your own conclusions. 

I'd rather lock in a 30-year mortgage at a historically crazy rate on a fantastic cashflow property than start building negative exposure to a rate hike.

Originally posted by @Dawn Anastasi:

Dawn, why do you choose to invest in cashflow rather than hunt for appreciation? Is just because Milwaukee is where you live and where you have local expertise, or something else?

In any case ... it sounds as though late payments shouldn't have an impact on the bottom line, which seems for all the world to actually be 15-20%. I'm having trouble just coming to terms with that - most companies would kill for a 15-20% return on equity! 

Looking at 5 random REITs, I see:

One Liberty Properties Inc. (OLP) - 5.61% RoE

Liberty Property Trust (LPT) - 5.67% RoE

PS Business Parks Inc. (PSB) - 6.76% RoE

American Assets Trust, Inc. (AAT) - 3.83% RoE

Cousins Properties Incorporated (CUZ) - 2.03% RoE

If you want to find something in that range, you need to look at megacorps like Exxon Mobil (18.27% RoE).

But in BP-land, 15-20% isn't good enough - I've gotta go for the hot markets! Why? I'm totally baffled. Compounding a 20% return would make me a billionaire well within my life expectancy.

What's the total annualized return from the appreciation strategies - and if it's so high, why can't the REITs replicate the success? Why hasn't all of the capital in the world piled into these investments that are sure to make you a billionaire?

Or is there maybe some risk and selection bias here? Are there perhaps droves of people that don't post on BP because they took big risks speculating on appreciation and got totally wiped out, leaving the few who didn't telling newbies that buying property that shows a giant cashflow is the wrong decision?

I don't mean to be snide, but statements like "there is less profit in low price/rent areas" would be more useful if you can tell me why there's no way I'm going to actually turn the 15-20% that the pro forma says I can.

How big do you think the differential between salaries in California and elsewhere can get? The current differential is already more than priced in.

I've also made an enormous amount of money in the stock market in the past 36 months. It would be delusional to believe that those 30% annualized returns are sustainable. That is the reason I am looking for alternative investments in the first place.

Yeah, in 1993, right after a major commercial property bubble burst. It was a great deal on a property with obvious unappreciated value.

Probably whatever will leave them the biggest inheritance. Some years could be Milwaukee, some years it could be SF, some years that money could be much more wisely invested in stocks.

Thanks, you too!

@Robert Taylor 

@Jay Hinrichs 

@Account Closed 

@Dawn Anastasi 

@Ali Boone 

@Account Closed 

Not sure what's up with the @mentions. Seems a little buggy.

Sorry for the extra post, wanted to make sure none of the links were broken.

Thanks to everyone who has contributed. It's been pretty overwhelming for a newbie thread.

A lot has been said, but I will try to keep the reply as cogent as possible (I think we're getting to the point where people stop reading the posts).

Yeah, as the saying goes... "There's a million ways to make a buck." I don't doubt that everyone is sharing the experience of what has worked for them - and I appreciate the perspective - but the less I can leave up to chance, the better.

Just about all of my common sense tells me "If you are looking for reliable appreciation, do not buy at the all-time high of a hot property market".

Especially not when the opportunity cost is 15-20% CoC...

I can't help but observe that success in this case would've had a lot to do with not buying into crowd psychology and jumping into a hot market - instead it would have depended on recognizing value and having the discipline to hold through a tough market.

I have no issue with buying value... and there is certainly real value in the Bay. The issue is the price. Risk scales with price.

I don't know this for a fact, but my guess is that if this was anytime from 2010-2012, cashflow AND appreciation would've been possible around here and we wouldn't be having this discussion at all.

Then again, the opportunity in equities was just as big during that period.

Would this be a compelling reason not to use the 50% rule in Milwaukee? I don't live paycheck to paycheck so having a few late rent checks wouldn't be the end of the world. Rent checks that never show up would become a problem.

I can't deny that there is a ton of money tied up in real estate around here, but I have to wonder if the aging tech crowd is going to sell out as they retire and take that $900k somewhere where it can do more for them than help upgrade from 3 bed to a 4 bed.

Or, at the very least, I wonder if the kids are going to go elsewhere when Mom and Dad kick the bucket.

As far as property values and salaries (and the 8x factor in Cupertino), I didn't say that idly.

There is no ACS data for the last two years of salary data, so I made some pretty aggressive assumptions. If salary growth has been less then I'd be even more scared to invest here.

P.S., the projected median family income for mid-2014 in Cupertino was $174.4k (!!!)

Dawn, that's really generous. I will drop you a line if I am in town. Lunch is most definitely on me.

If I do decide to move ahead on a deal, would you be willing to sanity-check it for me?

Materials Engineer. I did my graduate thesis in MEMS process integration and I work in the semiconductor industry.

I seem to have made a major miscalculation by not doing software.

I should really qualify that statement: "California isn't the right place to buy right now." It's been pointed out to me that there are places to make cashflow work in CA (Bakersfield in particular), but if I'm already going to be investing well out of my comfort zone, why not in Milwaukee?

It's more than eight times the median income of families who live in Cupertino. See the graph above for details.

Unless you're getting at something else, in which case I don't follow.

I guess not. Maybe it's just that us poor semiconductor engineers can't keep up with the software folks.

What is pretty clear is that you'd better marry an engineer.

I could write an essay about this, but let's keep it simple: the Federal Reserve directly controls the short-term rate. Haven't you been watching the news? "Patient" is the watchword.

Most likely when the overnight rate is increased around about July-Sep, there will be some compression in the yield curve... so the full impact on the 10y may not be immediately obvious. But I do expect that the interest rate supercycle is going to reverse course in the next few years, and when the 10-year T-note yield starts heading back up, you can bet your bottom dollar that the mortgage interest rates will too.

Globally speaking, there will be some negative pressure from the eurozone as they start their own QE program, and speculators exploit the EUR/USD carry trade. If their QE is successful in kick-starting their economy, though, a recovery in the exchange rate should dampen the carry.

Jay makes a good point, but I think I'm more prepared to accept that risk than the risk of losing my entire down payment in a short sale.

We can't control the price. What we can control is what assets we purchase. I do not think the Bay offers good value at the moment. If it never offers a good opportunity again, I will have to settle for crying over the lost opportunity in to the giant pile of cash generated by a 15-20% return. I'm still somewhat in shock that that's considered normal here. That kind of return makes you a deity on Wall Street.

Thanks.

@Account Closed 

CA property has blown the doors off any flyover property over the last 40+ years.

Using past trends to predict future trends is extremely dangerous. Rents in the Bay have increased because people have had more money to pay them. Do you think salaries are going to go up at 5% a year forever? I will be glad to hear it, since I work here. I don't see reason to expose myself further to the idiosyncratic risk of the Bay Area.

"Can you show the calculations of how you expect to accomplish that?"

Sure, let's look at a listing. I said ZIP code 53222, so I put that into the MLS, filtered for multifamily. I get a hit for 4119 N 91st St, list price $200,000.

Looking up that address, I find a rental listing for one of the big units for $850. Let's figure the average current rent of the 4 units is $700, $2800/mo.

At 25% down, the payment on a 30 year, $150,000 mortgage at 4.25% is $689.

The 50% rule would suggest that the NOI is around $1400. So cashflow is $711/mo, or $8532 a year. At $50,000 down that is a 17% CoC return. For a property off MLS that doesn't meet the 2% rule.

There may be a problem with this deal - it was a zero effort attempt - but the general feel I get is that this is indeed possible. If the 50% rule is inappropriate here, I'd like to know why.

Oh, but you're PREDICTING the end of CA real estate. 

Just so we're clear, I have no idea. If I knew I'd be busy establishing a short interest on Bay Area mortgage debt. 

The fact that I don't know is sufficient reason not to subject myself to the risk.

And you have NOT explained why investors WON'T pay more for the guaranteed 2% markets cash flow. If the value is in that cash flow why does the market value it so little?

Because people are impatient and chase growth. This is the core of Graham's work... and it's a mispricing anomaly that's persisted for over 100 years. If the equities markets aren't rational or liquid enough to correct this kind of inefficiency, how could you ever assume the real estate markets would?

Thanks all for your responses.

I really didn't intend to start a cashflow vs. appreciation argument in my introduction post! 

Suffice to say I am interested in cashflow, not local appreciation. I like boring - it's predictable. Predictable means lower risk. And if I can make 15-20% CoC by investing in boring then my risk-adjusted return is better than an appreciation investor. And it's better than it would be in the stock market, which is why I'm here, and I'm guessing it's why the rest of you are here too.

If I didn't care about risk I'd have just leveraged an S&P 500 ETF by 2x and called it a day. It's a hell of a lot less work for a 15-20% expectation return.

(Oddly, I never hear people criticize my decision not to do that, even though I'd have made more money doing that in the recent past than by owning SF real estate.)

Bakersfield is an option, and I will give it a second look, but I just wasn't able to make the numbers show 15-20% CoC the last time I looked.

@Dawn Anastasi Thanks - I understand that you're not doing it anymore yourself, but is there anyone in Milwaukee you'd recommend I get in touch with for bird-dogging some multifamily property?

@Anthony He That's great! How did you buy your first property?

 I understand your perspective Bob, but I just don't understand who the marginal buyer is going to be. The engineers are priced out now, and that's a historical first. Mortgage payments are at a historical all-time-high as a fraction of the median income. I don't consider that a sign to buy.

When interest rates reverse there is going to be a bloodbath. That's my take.

If my property is cashflow negative (and it would be in the Bay), I'd be totally wiped out in a housing market downturn. If the property keeps cranking out cash, I won't care. Plus, part of my motivation to B&H is that I am so young that by the time I retire, interest will have eaten away the deferred tax liability on depreciation and the recapture will be very small in real terms.

As far as price-to-rent goes, it's a tradeoff with growth expectations. What I've learned in the stock market is that the fair value of any asset is a function of:

1) Its cashflows (i.e., the rent)

2) Expectations of growth in those cashflows

So the reason that price/rent ratios are so high in the Bay and other hot markets is because 2) is astronomical. But I can't predict growth and I don't want to pay for it.

Basically, I am perfectly willing to sacrifice 2) if 1) will double my investment in 5-7 years, and will do so with less uncertainty.

This is essentially Ben Graham's value investment philosophy. If it works for equity, I can't see why it won't work for real estate.