That was a difficult title to type. It was just Friday that I mentioned how my tenants won’t leave and it’s leading to a lawsuit. It looks like it is going to get very messy. Anyone else thinking about the State skit, Get a Job: “What am I nuts?!?!” (was that reference too obscure?)
I’ve given full details on our our Real Estate “Empire” previously. It is an accidental empire. We bought properties in places that we expected to live in (and have lived in) and then moved on for one reason or another.
I’ve got a fever and the only prescription is more real estate (there, that’s a more well known reference). And that means a visit to my real-estate lawyer George Megaloudis.
Why more real estate?
It always starts with the numbers. The place that I’ve been looking at seems to be a bargain with purchase prices around $100,000 and rents around $1250. This is an extremely good price to rent ratio. For those new to the game (and I’m with you there) the price to rent ratio is the purchase price divided by the annual rent. Doing the math ($100,000 / 15,000) and the ratio is 6.53. As a potential buyer, you’d want that number as low as possible… cheaper purchase price and more rental income are what you are looking for. According to this article the long-term average in the US is 9.56. At the height of the market it was over 18.
To put that 6.53 ratio in perspective, here are a couple of real world examples. When I rented in Silicon Valley last year our rent was $3200, but the purchase price of the home would be around $888,000 (this number would repeatedly come up in our community. I heard that “8” is lucky in some Asian cultures. True?) That ratio would be an extremely high 23.13! If it hadn’t already been paid off, my landlord would have been losing thousands each month with the mortgage.
Even with a 15-year mortgage, tax, insurance, and condo fees this property would generate around ~250 a month in income. That’s a great thing because that money is going to be needed for usual costs such as maintenance, rental agent fees, etc. If it’s break-even after those expenses, we would own the property outright in 15 years. That would be $11,000 ($15,000 minus condo fees and taxes) of income a year in today’s dollars. Hopefully rents will keep up with inflation and that will stay the same. Also, the property hopefully will appreciate to 2006 levels where it would be worth nearly $150,000. That would help keep rents high and/or give us an opportunity to sell and get out at a big gain.
I know most conventional wisdom says to buy stock and bonds to fund a secure retirement. However, the older I get (I’m 37 now), the more that I start to view things through a cashflow looking glass. I want to build up businesses and assets that are going to bring income. (Some) stocks do through off dividends, but typically the percentages are really small. With real estate, I get to leverage some of my money, a lot of the bank’s money, and tenants’ money to own an asset that I believe is uniquely undervalued right now.
That’s worth the risk of a few bad tenants.
I heard that its sometimes more cost effective for landlords to PAY their tenants to leave. Have you considered this as an option?
Well, I could just take their payments and hope they leave at the end of September. The relationship has become so caustic that I would take a financial loss on principle alone.
You seem to be approaching the real estate market rationally. You are probably one of the few that will do well with real estate rentals/ownership. I would still build a portfolio of stocks/bonds, but you clearly have the mentality to succeed with rentals, especially since your current dilemma hasn’t turned you off to it.
Thanks, Kirk.
I don’t know if any business venture ever goes smoothly. I try to remember that when I run into a dilemma like I am with my current tenants.
I could go with stocks/bonds, but I’ve started to sour on them a little as they seem a mite unpredictable. Even index funds can have a period like the last 13 year where they haven’t seemed to move much (though if you bought in during the two crashes you are probably quite happy). I can’t really predict the rental market either, but I’m pretty sure it’s going to be around break even for 15 years and after that its significant profit.
I happen to be a landlord as well. My price to rent ratio is 4.5.
I’m thinking now is a very bad time to get INTO the real estate business given historically low interest rates. As rates rise (they have nowhere to go but up), property values will come crashing down.
Yes, but then you’ll be paying the same, right? Lower property values, plus higher mortgage rates balance out, right?
I think property values are already pretty depressed and the forecast for them is to go up. If these forecasts are right, combined with rising interest rates, and a tight lending market, people will be forced to rent and those rates will go up, right?
I go back and forth on the real estate investment option. On the one hand it seems to be the clearest way to wealth, while on the other it seems almost crazy to take on that headache for a few hundred bucks of current income.
Have you given much thought to REITs instead?
I have looked into REITs and even have some funds that have them in a retirement account that I rarely look at. I typically see them as ways to earn a dividend. They are usually in the 4-7% range or something? For me that’s just like buying other equities, just a different asset class.
Two things that I like about owning a home and renting it out are that you get the leverage of using the bank’s money and its forced savings. I can’t be tempted to take the money out and use it for home improvement like I could if I invested in a REIT. It’s also going to be a fairly consistent return. In my calculations, I have it being worth about $11,000 a year (dollars that with inflation adjust as rents do) in income after it’s paid off in 15 years (that covers maintenance). Someone else is putting it off in the meantime. Roughly that makes the math putting some $20K away today (the 20% equity) for (hopefully) a bunch of years of $11,000 in income.
Doesn’t that sound worth a few headaches? What would an annuity returning $11,000 forever cost if I were to buy it today?
Now that I’ve put it in these terms, it almost feels too good to be true and that I’m missing something. Am I?