Whether it’s with callers, those emailing me, or even at a speaking engagement, it never ceases to amaze me what some seem to believe about long term real estate investing. But, somebody said it, they sound as if they’ve been there and done that, so they believe it. Don’t get me wrong, some of what this post will pillory are strongly held as Holy Writ by many. But it’s not my intention to offend anyone. It is my intention to hold some ‘em up to the light of day. To be honest, most of ‘em, in my opinion, have gone unchallenged for far too long.
Worshiping at the Altar of the 2% Formula.
This school of thought says if a property rents for $1,000 you shouldn’t pay more than $50,000 for it. For the record, I’ll take a dozen. ‘Course, before the stampede begins, let’s get some questions answered first, alright? Cool. Oh, and surely there are exceptions that will prove what I’m about to say as the rule. There’re always exceptions, but they’re so rare as to be evidence of the rule’s validity.
- What is the quality of the neighborhood in which the 2% property was acquired?
- Would you put Mom or Grandma or your 19 year old daughter to live in that property by themselves? If you even pause in answering that question, the answer is no.
- If you defend the area’s quality, why are the prices so low? Are the rest of the investors who passed on it, um, under informed?
- Compared to unquestionably blue chip locations, do the tenants in these 2% properties compare in quality? Really?
- Would you hold this property ’til retirement if circumstances compelled you? Are you gettin’ all tingly with excitement just thinkin’ about that?
There are many more questions, but you no doubt see the trend here. Again, with rare exceptions even those who get outrageous prices on fixers, fix ‘em up, then rent ‘em, many times don’t get 2% rents to value. I talk to investors daily. As an experiment I’ve been askin’ about the number of properties in their long term portfolio that met the 2% rule. They think I’m messin’ with ‘em.
$200 (Or fill in the blank arbitrary number) per door cash flow
- Based on what?
- How much down payment?
- What’s the interest rate on your loan? Are you paying cash?
- Does your per door formula rely on a previously employed rent/price ratio?
- Did you think about how the property and/or its location will impact your retirement plan? How it might affect your retirement, period?
Again, a lot more questions can be asked. But here’s another formula without a cause.
Counting on your real estate investments to appreciate — even at a ‘reasonable’ rate.
This one may be THE most ill-advised strategy of them all — especially now.
- On what possible data do you predict several years — some go as far as the eye can see — of appreciation?
- Will there be even one year of interruption in your orgy of appreciation?
- If there is a year of rest from all that annual rise in value, will the following year’s rate of increase be far more than the average in order to make up for the lost year?
- In the ‘lost’ year, did the value of your properties retain their value at that point? Or, did they actually lose a bit?
- Consider that due to the 2% rule at purchase, your portfolio’s properties are in mediocre or worse quality neighborhoods. Why will they experience appreciation, year after year after year?
Do you think there’s any answer to any of these questions that won’t elicit snickers, if not outright laughter? Remember, you’re bettin’ on appreciation at the minimum expected rate for your investment to have been worthwhile. Really? Call me next Sunday. I’d like to make some NFL bets with ya.
We could do this with many more of the formulas sold as virtual guarantees of success. Again, speakin’ only for myself, if we took most of these so-called formulas, printed them, then shredded ‘em into confetti, we’d have the best fertilizer our lawns could ever experience, and the greenest lawns in our neighborhoods.
Formulas aren’t evil. Many of ‘em have demonstrable value. Not most of ‘em, many of them. What most formulas are in reality are weak substitutes for strategies based upon real live data. Data that has been analyzed within the context of ALL pertinent info — about the property — and about the investor.
The final question.
Are you really gonna bet your retirement on a buncha formulas? Really?
Bet you’re not.
Photo: PabloSome Serious Questions For Serious Long Term Real Estate Investors by Jeff Brown