Why is REI so popular if it takes YEARS just to break even?

19 Replies

I've really wanted an answer as to whether real estate is a get rich slow endeavor, and after watching Brandon's video on How to Quickly Analyze a Property Deal it seems to be the case

https://www.youtube.com/watch?v=XW_9AUsdPC0

Brandon invests $30,000 into a 4-plex and ends up with a net cash flow of $4,020 a year. At that rate, it will take him 7.5 years just to break even. Sure, he may end up with more because of appreciation/tax benefits...but still almost Seven and half years?! 

During that same amount of time, you could've invested $5,000 into a software business and scaled it up to $10k monthly recurring revenue or $100k a year in less than 6 months (very hypothetical, but you get the point).

Sure, you can get higher cash on cash return percentages for larger size deals, but it still takes so much more time to get a return (since your investment dollar amount also grows in proportion)....

I was really interested in learning more about investing in multi family deals, until I came to this realization. Does anyone have any objections? It really does seem like real estate is a slow man, or woman's, game (at least compared to other sources of building cash quickly like starting a software business) 

Really hope I don't come across as a troll...but I'm just deeply turned off by this.

Real estate investments is about more than just breaking even. If you buy a home for $30,000 less than it's value, then you made $30,000 in equity. At that point, you're just trying to cash flow over your expenses and eventually build a passive cash flow (unless you're a flipper or wholesaler, in which case it's about making sizeable profits per deal). If you get good enough deals, you can even refinance out all of your costs in and then your cash flowing with equity in the property, but none of your own cash. 

As far as software companies go, they are a high risk/high reward kind of venture. The number that succeed like the example you gave pale in comparison to the number that fail. I heard an interview with Chris Sacca (a famous Silicon Valley venture capitalist) talking about the number of pitches he hears for new software firms that he knows are going nowhere. And he is almost always proven right. And software firms that go belly up, usually don't just never break even, they're often close to a total loss.

Here's my $.02

Let's compare a business, such as the software business you mentioned, to a Real Estate Investor's business.

With a software business, the business owner has to do the following to generate a successful business organization. (Not necessarily in order) The Software Business (I'll use SB as an abbreviation from here on) has to design a product. That product has to A) fill a need B) The need has to be large enough that the target market can generate sufficient scale to generate profits and C) has to be either difficult to replicate by competitors or protected by intellectual property rights. The SB then has to spend human capital to develop the product, test the product, then distribute the product. Before the SB can do that, they have to decide how to price the product, how to source the manufacture of the product, hire employees to handle product enhancements/bug fixes, hire employees to distribute the product, hire attorneys to protect the IP. The SB has to determine additional product lines and markets to enter to prevent the inevitable obsolescence that comes with software, etc. You get the idea, you could go on and on for days talking about the things they have to do.

Contrast that to Real Estate Investors. RE is the product. Compared to another business, REI has much lower thresholds for product development and marketing. Whereas a SB has to do their own market research for their product, there is ample market data for real estate in any market. Not only that, but there is no need to hire a sales force to market your widget with REI because RE Agents already exist in every market. As for market data on the need for your product as a REI vs. SB that information is also readily available. Due to the nature of the sales, product development, etc of REI a RE investor can have a very small (often times zero) need for additional employees even with a large dollar volume of business. Capital is readily available for REI at known leverage ratios. SB or other businesses will be on a case by case basis so funding is unknown.

What a REI does is develop a process, what most businesses do is develop a process AND a product.

Now, let's look at the numbers because I think you'll find that the numbers you posted understate the returns of REI as well.

So, let's take a pretty generic case study. We'll use 7% cap rate on a $500,000 multi family property with 10 units. It would be completely reasonable for the buyer to assume (based on naahq.org's 2014 numbers) that expenses would run about 40% of revenue, and CapEx would run 8% of revenue. So a 7% Cap gives you $35,000 of NOI on a $500,000 property. Using naahq.org averages that means you have a gross rent of $58,333, $23,333 of normal operating expenses including vacancy $4,666 of CapEx reserve and a total net revenue of $30,333 at the end of the year. Assuming a 20 year amortization on a 5 year maturity mortgage of 5% interest and 80% LTV (so $400,000 initial balance) your yearly payment is $31,677. (It's obvious at this point the debt service is greater than your net, but again, capex is a reserve not an actual expense YoY, and this example is deliberately a very mediocre set of numbers to illustrate the point). So, let's just go with these numbers. Each year you come OUT OF POCKET $1,344 AND you put $100,000 into the project to begin with. We'll also need to make some assumptions about rent growth etc. Let's assume rent growth at the historical rate of inflation of approximately 3%. After 5 years here's how the numbers look:

Rental Income $65,654

Expenses (40% of RI): $25,496

NOI $40,157

Estimated value at 7% Cap Rate 573,678

Estimated Cash flow net of debt service $30,362

Approximate CapEx Reserve $24,000

Amortized Loan Balance 333,819

So final numbers are 100k invested, equity at 5 years $239,859 with a positive cash flow of $6000 during the 5 year span. If you just average the cash flow over the five years at $1200 (again just making this example simple, it's a bit more complex than this) you get an average annual return of 20%. NOT a bad return on a VERY average set of numbers, especially considering the limited barrier to entry to 'owning' a business.

The Brandon example you use is not breaking even in 7.5 years.

He is making 13% annually on his investment.  Also, if he chooses to sell, he will most likely get his $30k back plus some additional equity.

The stock market average over the last 100 years is something like 10%.

I know you are using a software business as a hypothetical.  The reality is it takes at least a year or perhaps several years before you bring software to market.  If you close shop before you bring product to market, you have lost money.  There is no equity.

It is all about risk tolerance.  If you have a very high risk tolerance, invest in a venture capital firm or high risk stock markets.

I think a lot of people are buying into the guru sales pitch that you will get rich fast with real estate.  Real estate is more of a long term play.

True it is a get wealthy slowly approach,  I don't even like the term rich.  I am not rich, but am definitely wealthy.  Family & friends aside, financial wealth is measured in time. How long can you survive without a pay check or having to hustle around for your next big thing? How about in perpetuity?  Never having to face a job interview again?  Is that worth an investment?  That's what we're talking about.  Money invested with a return that will build the blocks to no longer need an alarm clock.

I know of no other medium as tried and true or as stable as real estate.   Comparing RE with VC is laughable.  Go ask some of the players in Silicon Valley!

Personally, 7.5 years is too long of a break-even for me, but mine are still approaching 60 months.  I buy below market value (like @Andrew Syrios points out) with leveraged dollars and my COC returns by definition are 20%+. Could be higher with the added risk of a partner. Then you are talking about potentially infinite COC returns with none of your own money. But the risk and drama are infinitely higher with partners.

Those convinced against their will are of the same opinion still.  Not here to convince the type of person who can't see past next Friday.  We are gauging investments with time horizons in the decades.  Continue to work.  Continue to spend.  Continue to seek the next hot software or whatever and continue running on the gerbil wheel if you wish @Mark Kennedy !

@Mark Kennedy

This is an interesting thread - you are not wrong, and yet you are totally wrong...

1. If you are going to use $30,000 to buy this pig - you are a fool.

2. If you are going to buy this pig strictly for Cash Flow - you are doubly a fool.

Let me give you an example:

1. In 2013 I bought a 10-unit for $373,500. I closed with $5,300 out of pocket...

2. In 2013 it made cash basis $3,000 - this was a tough re-positioning;

3. In 2014 it made cash basis $12,000;

4. Early 2015 I refinanced the building. The current NOI capitalized value came out to $450,000. My loan is $350,000. This means I've put $100,000 on my balance sheet;

5. Currently, in the first 8 months of 2015, cash basis T8 sits at $16,500, which means that I have a very real chance to touch $20,000 of CF in 2015.

6. I will pay no, or very minimal, income tax on this CF.

Thus, an investment of $5,300 of cash has generated up to $35,000 of CF and $100,000 of value on the balance sheet...

Now - you are not wrong, because:

I have an internet platform that earns a little money, and I am in development stages of another one. And you are right, IM can throw off substantive income faster than RE. However - it is not likely to be as stable as well-chosen RE, nor is it going to be leveraged, meaning OPM generating your wealth. While business is indeed the most effective vehicle for CF, equity is a bit of a different conversation.

Finally, the tax code is such that the cash flow from business needs to be eventually shielded by RE. So, purchase of RE is rather institutionalized within the wealth-building process...

hope this helps with the big picture, mark.

Originally posted by @Mark Kennedy :

...but still almost Seven and half years?! 

During that same amount of time, you could've invested $5,000 into a software business and scaled it up to $10k monthly recurring revenue or $100k a year in less than 6 months

 If you've got those skills, by all means use them. I don't, and I don't have any interest in developing them- it sounds like a drag to me.

But it seems to me that you are offering a potentially plausible, but hardly predictable and repeatable, scenario. 

Yes there are surprises in real estate, but it is for the most part predictable and repeatable. It is also far more self supporting than other business ventures. In a buy/hold scenario, once the property is acquired and stabilized it doesn't take  a lot of your time. You just sit back and let the tenants buy the property for you and add to your net worth.

There is a glaring, fundamental flaw in your question.  I couldn't understand why you were using the term "break even"

The $30,000 invested in the 4 plex is not an expense.  In the example, Brandon still has that $30,000, it's just changed form from cash to real estate.  The income is not used to offset a $30,000 expense, it's added to the $30,000 to create a larger total value (13% annual return mentioned above).

Also, you have clearly never started or run a business if you think it's so easy to just take $5,000 and turn it into $10,000 in monthly revenue.  Give it a try and see how that turns out for you....

Real estate is not a way to "get rich quick" regardless of what they say on TV.

True wealth in RE takes years to build.

"During that same amount of time, you could've invested $5,000 into a software business and scaled it up to $10k monthly recurring revenue or $100k a year inless than 6 months (very hypothetical, but you get the point)." 

Please provide us with an example of someone who had done this.  

Have you?  

What business?  

How?  

Originally posted by @Wade Sikkink :

Also, you have clearly never started or run a business if you think it's so easy to just take $5,000 and turn it into $10,000 in monthly revenue.  Give it a try and see how that turns out for you....

 This made me chuckle as I started a business 6 years ago.  $5k/month does not cover much. It does not cover what a typical business owner wants to make. And depending on office selection, it may not cover office overhead.

As an aside, my son is working on bootstrapping a video game.  It is just him with a programmer helping part time for a share of the proceeds when the game gets to market.  As my son is 20, he can live off of very little as he only has himself to support.  Mom and Dad are investors in this game as we are covering his living expenses.  We are at year 2 in game development.  I am not a programmer but from what I've seen and heard I would expect software to take 1-4 years to get to market.

Originally posted by @Wade Sikkink :

There is a glaring, fundamental flaw in your question.  I couldn't understand why you were using the term "break even"

The $30,000 invested in the 4 plex is not an expense.  In the example, Brandon still has that $30,000, it's just changed form from cash to real estate.  The income is not used to offset a $30,000 expense, it's added to the $30,000 to create a larger total value (13% annual return mentioned above).

Also, you have clearly never started or run a business if you think it's so easy to just take $5,000 and turn it into $10,000 in monthly revenue.  Give it a try and see how that turns out for you....

Interesting way of putting it...so you never actually lose that $30K downpayment, since all it does is transmute into home equity. Very interesting indeed - will have to do more research on this

Thanks for all of your valuable insights 

@Mark Kennedy

The real deal is that banks will loan to buy me  an investment(a rental property)

 I NEVER have to pay the loan back. The renters will pay the loan for me.

All my properties have been, and will be paid for by my renters.

That is the RUB.

Think about this:

My tenants also bought me a vacation home, and my food, and my clothes, and my vehicles.......

Sweet

@Mark Kennedy ,

Dude....I...ugh...yeah, what everyone else just said....I mean I wanted to pop in and say something profound, but I found a zillion posts from the likes of @Ben Leybovich and @Steve Vaughan and @Andrew Syrios as well as others saying what I would have.

Really, the answer is exactly go where the money is. If you can start a software venture with $5,000 and build it to $100k/year after only 6 months, then do it by all means! You likely won't get that in real estate. In fact, I'd like to be your partner in that kind of venture. I was a programmer for over 20 years. Maybe I'd be helpful.

However, I don't think you really think you could develop this software business, so let's be real. What do you think of as a good return on your investment capital? @Wade Sikkink said it well. The ROI is not really returning your investment capital since you still own the asset. Rather it's a measure of how hard your money is working for you. You're not trying to "break even".

How about a quick example. I buy a property with a 10% capitalization rate. In theory I get my original capital back in 10 years, but wait, I still own the property, which I can sell theoretically for what I paid, so I actually got 200% of my original investment. But wait, there's more..... What if I used other people's money (leverage) to purchase the property in the first place, say 90% financing? Ten years later I've actually made nearly 2000% of my original investment. Breaking even is not even a consideration.

If you want to get rich quickly in real estate, systematize a "get rich slowly" strategy and scale it into multiple streams of income. The more streams, the more dough. Too simple!

Props to you, however, for opening this thread. I like the way you think. Stick with it, learn more and you will be wealthy soon. Cheers!!

Originally posted by @Mark Kennedy :

I've really wanted an answer as to whether real estate is a get rich slow endeavor, and after watching Brandon's video on How to Quickly Analyze a Property Deal it seems to be the case

https://www.youtube.com/watch?v=XW_9AUsdPC0

Brandon invests $30,000 into a 4-plex and ends up with a net cash flow of $4,020 a year. At that rate, it will take him 7.5 years just to break even. Sure, he may end up with more because of appreciation/tax benefits...but still almost Seven and half years?! 

During that same amount of time, you could've invested $5,000 into a software business and scaled it up to $10k monthly recurring revenue or $100k a year in less than 6 months (very hypothetical, but you get the point).

Sure, you can get higher cash on cash return percentages for larger size deals, but it still takes so much more time to get a return (since your investment dollar amount also grows in proportion)....

I was really interested in learning more about investing in multi family deals, until I came to this realization. Does anyone have any objections? It really does seem like real estate is a slow man, or woman's, game (at least compared to other sources of building cash quickly like starting a software business) 

Really hope I don't come across as a troll...but I'm just deeply turned off by this.

 Did you factor in RISK?

My chances of success owning a cash flowing rental property versus my chances of success in a software startup. I can tell you right now that I have a 0.0000001% chance of making any money in a software startup. My chance of success in real estate are much higher.

402-965-1853

Mark,

Investing is about probability. You want to stack the deck in your favor as much as possible. The same can be said about people sending their kids to Ivy League Universities. 

Let's put things in perspective. How many people become millionaires through investing in real estate compared to investing in a software business or the stock market? If you want to have the highest chance of becoming a millionaire and get off the rat race, you know where to place your bet. Of course, knowing how to place the bet accordingly is another topic. 

Good luck. 

The only way to "get rich quick" is to win the lottery, lol. Every business takes time to nurture and develop and REI is just that: a business. No empire is built over night.

Your first deals may or may not hit, but you are building a network of partners that are there to support you. And as in any other business, the more relationships you have and the more you learn, the better you will become. Think of Gladwell's 10,000 hour rule. Additionally, there are many many ways to invest in RE. You can start by wholesaling a few deals to improve your cash flow situation, or work with a local, more experienced partner to learn the ropes from a seasoned professional, with only a limited cash investment on your side. Or, in your example, you can jump into an income flow property and if you do your due diligence correctly and you have trusted partners, then you can get into an undervalued property that just needs some TLC to turn it into a true revenue vehicle for you. Those properties are amazing to have in your portfolio as they not only generate better than market returns, but they also allow you in the future, to have an asset to borrow against to fund more deals.

In any of those examples you are still dealing with a more stable asset class than anything on the stock market and certainly anything involving VC. RE takes time to build your portfolio, but you'll find that as you grow, the velocity with which you are able to take on new deals will increase.

Happy Deal Hunting!

(972) 955-9553

I get your question, I had the same thought about 5 years ago when I decided to NOT get into RE but leave my main investment money in the stock market.  Instead I started a software development company (onsite computer services) - I develop line of business applications for the transportation industry.  I do OK money wise. I absolutely LOVE my job and I am able to pay all my bills doing it, so that makes me a winner in my book.   The truth of it is I am still somewhat amazed that people will actually pay me to do something that is so much fun for me (programming).  But I sure do wish I had *also* gotten into RE back then vs waiting until now.  Even just part time and my money could have been working for me much better than leaving it in the stock market and precious metals.

Why not do both? A lot of high income earners take their excess cash and invest it in RE for passive income so they can sustain their lifestyle long after their high paying career is over. Others that want to make a career out of RE find a way to create value in properties and scale up to the point where their monthly net provides them with the income they need. My day job is owning an insurance agency and I deal with 1000+ business and property owners. Many of them are wildly successful by any measure but when I look at lifestyles I am most jealous of the older, established apartment and self storage owners. The guy worth $5m+ with RE assets of $10-20m and a good property manager has a much better lifestyle than the doctor/dentist/attorney/small business owner that is worth the same amount but has to spend 50+ hours a week to keep their business running. When I first started dealing with apartment owners one of my biggest challenges was getting ahold of them because it seemed like they were always traveling or on vacation. The lightbulb went on for me when I saw how they lived vs how most other business owners live.

Everyone needs a place to live. Few people need niche software that doesn't exist yet.

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