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Money Magazine and Rental Properties

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I was reading a Money Magazine article which was brought to my attention by Debt Free 4 Ever

Debt Free 4 Ever seems to agree to get rid of the rental properties. I don't agree.

I'd keep the rental properties. The key will be to getting tenants so that they don't sit empty. That will make a huge difference right there. With them being empty, they are probably losing thousands per month. The mortgage payments keep coming in, but they have nothing to balance it off. I wouldn't spend time on the $3 unlisted phone number until that taken care of.

Why wouldn't I sell the properties? In this market it can take some time to sell and even then it will be probably be at a loss. If they can get tenants and tread water (make nearly as much as the mortgage) with that investment for long enough, it will likely pay off.

I'm ashamed at the advisor suggesting treasury bills will do better than real estate. It depends on a lot of factors that we don't have such as the mortgage interest rate the family is paying. However, it seems that the advisor doesn't factor leverage into the equation. If they have 20% on two $250,000 properties, that's $100K invested. If those $500,000 worth of properties grows at 3% that's $15,000 a year - a 15% return on the original investment. On the other hand, if the
family puts their money into treasuries, that $100,000 may grow at 5-6% (I'm trying to be generous) - yielding $6,000 a year.

I realize that the rental marketing is softening in some areas. Even if that's the case, is it softening so much that the $1000 a month doesn't make up for it? It's worth noting that the 3% is on the conservative side. Long term, I think real estate generally appreciates at 5-6% (I wish I could find the source where I read that, but it doesn't seem outrageous to me). Granted we've had a run up, so for the next few years, maybe 3% is right. However, why not take a long term view of things?

It seems like sometimes the advisers like to throw the baby out with the bath water.

Last updated on December 19, 2006.

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Money Management, Real Estate

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4 Responses to “Money Magazine and Rental Properties”

  1. Aaron says:

    You left out interest payed on the loan that gave you all that leverage, so your math is way off too.

  2. Foobarista says:

    I glanced at the article, and it sounds like they’re having a hard time finding tenants for their properties, so they’re in a world of hurt on them. Not every property is a good rental, and many first-time real-estate investors are awful at finding good rental properties, since they typically do their search as if _they_ will live in them.

    Sure, the article is making a rather silly point about 3% housing appreciation being equal to a 3% T-bill (as if any real-estate investor on the planet pays cash for investment property!), but properties that are likely costing a couple grand per month aren’t doing their net worth any favors.

    Leverage only works if your asset – or at least your asset portfolio – can service the carrying costs. If it can’t, the negative carrying costs have to be figured into the overall return on the investment. And the “cost of money” is a problem: carrying costs are in current dollars, while profits are in deflated dollars that aren’t realized until you sell the property.

    In your example, the $15K/year appreciation versus $1K/month loss likely translates into a fairly substantial actual loss if there’s much inflation at all.

  3. That’s a very good point.

    I’m sure the properties won’t be a positive now, but I’m betting that with some income from them the bleeding would be cut to the point where it’s not a problem (if you are bringing in 150,000 a year). I have a property that I’m losing money on each month (probably about $200), but it’s better than selling in this market where I’d have to realize a $25,000 loss. Over time, I will be able to raise rates (with inflation) and turn it to a positive while my mortgage stays the same.

    I should have added in negative carrying costs, but I wouldn’t expect those to be more than a couple of thousand a year. If your carrying cost losses are more than that, you seriously overpaid for the property. At that point you are probably going to have a tremendous loss in selling or choose the bleeding.

    I personally prefer the bleeding because there seems to be likelihood that things will turn around if you can hold out long enough.

  4. Lazy Man says:

    Aaron, I purposely didn’t calculate the individual payments – so yes, things like interest and taxes aren’t put in. I was just explaining the idea of leverage and how it wasn’t taken into account.

    There are number of articles that go further into the math, but for the sake of this I was making the assumption that the rent cover the mortgage (typically including interest and taxes). That may be optimistic. If the rent is $200 less than the mortgage, there’s still a $6K gain or more. And remember, I’m using 3% housing appreciation and not the 5-6% that’s more typical over the long term. If I had used those numbers, it could be closer to a 20K difference. The fact that it’s even close with the conservative numbers tells the story that I wanted to tell

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