Isnt real estate profitable most of the times if you have the cash?

Question

Ok here's wat i think.Lets say i have 250k in cash and i am looking to buy a investment property for 250k. since i am buying it with cash i dont have to worry about mortgage.I buy a good property in a good neighborhood.I hire a management company to maintain and find tenants for the property.Since its in a good neighborhood,it will be full within few weeks.I charge 1500$ rent/month (same as the other properties in the neighborhood).After property management           charges,insurance,property tax and repairs i make about 1000$ profit/month of 12,000 anually. Also i am looking to hold the property for atleast 15 years and property prices generally appreciates over long period(most properties would be worth more today then they were in 1997),After 15 years my 250 k property would be worth around 350k.so with a 250k investment i make 12,000/year +appreciation. Is this the right way to think or i am making a mistake??Thanks

James Hamling · Answer

Your question is extremely general and investments, any and all, the difference is in the details. So in generality I will say you are wrong.

If the property is paid off as in your example, that means all that income is taxable income after the few expenses. Lets say that extra income (you had to get the $ to buy somewhere right) presses you into a higher tax bracket, so now uncle sam takes a bigger cut.

R.E. works like any other investment, the power is in the leverage. Investors in stocks use put's and call's to leverage, in R.E. we use financing. 250K can buy one property that generates your 12K annual net, OR, use leverage and buy say 5 properties at 250K each. Now with the same money you control 1.25 in R.E. rather than 250K. Now at 15 years with the same appreciation you have earned 500K in appreciation alone, which is not taxable until tapped, and then can be tapped tax free as well. Your tax bracket was kept low due to deductions from the properties post tax is modest.

I see several work on the obsession to have a property paid off, and cheers to them, not a bad retirement idea. But if you want to play this game as a career, or wealth generator, the power is in the proper leverage, OPM.

I would always leverage the funds, always. It is not about ownership, it is about control.

Ed O. · Answer

In my experience, the rent to price ratio diminishes as the price of the property goes up. You'd be far better off owning 4 homes at 62.5k or 3 at 75 75 and 100. 
Assume the 75k houses produce 800 a month and the 100k place produces 900 - that's 2500 a month coming in. 
Pricer homes are generally tougher to rent and tougher to keep tenants in, as they would rather own a home like that if / when they are able.

Just my experience. Others, I'm sure, will vary.

Also, you must keep funds on hand in case something major goes out, or in case the place gets trashed and you need to get it rent ready.

Account Closed · Answer

Jeff,

The boat has left the dock on these mREITs in my opinion.  Their spreads/margins are getting squeezed.  I think these mREIT stocks are heading lower from here.  Your thought?

Account Closed · Answer

I think this is what James has in mind, but I could be way off.  Say you have $500k gain after 15 years. You can tap that equity by

1) sell the rentals, or
2) do cash-out refinance.

The cash is tax free when you take it out from your refinance.  The cash-out money can be tax free or tax deferred depending on how you handle it. Talk to your CPA.

To echo what James said above, real estate is about leverage and control. I'd also like to add another aspect to it, which is risk management.  Why take on all the risks when you can pass it to the lenders at a minimal cost given interest rate is almost free net after tax plus inflation.

Jeff S. · Answer

Minh L. am in no way endorsing mreits. The reference was about risk.

Larry K. assume 250k price, 400k replacement cost in a neighborhood of more expensive homes. With inventory dwindling the chances themselves are dwindling that the good buys will continue but...who knows where this market is headed. Some smart people are saying up, up, up.

Larry K. · Answer

12,000 per year (assuming that is right.  you might be a bit light on the expenses) on a 250,000 purchase would be an annual return of slightly less than 5%.  Does that seem good to you?

I think most here on BP would agree this property would have to be in an outstanding, blue chip, A+ neighborhood to accept those numbers.  You'd be in it for the appreciation only on which J  Scott already commented.

Xing Zhu · Answer

Vaishal?The return you talked about over 15 years is too small for you to accumulate wealth to an interesting size. That is why people suggested leverage.

Nevertheless, in real estate market indeed, majority people have made money buying and selling based on their understanding of the market in long ran regardless their experience.

In stock market though, a large majority of people who try to trade actively drop out within a year with  big percentage losses. A majority mutual fund manager cannot beat the benchmarks in their sectors. You need to be within the top one percentile to expect a reasonable performance in long run.

This is why it is wise for most people to play the real estate market, whether they have a lot cash or not.

Jeff S. · Answer

You can always increase return with increased risk. There are mortgage backed REITs that give 17%.

He could borrow against the property at 4% and make loans at 10% and as (if) values increase he can keep pulling out more and making more loans. Eventually he can roll it all into more property and notes.

With notes there is always work because with a high rate the borrower is always looking for a lower rate (playing devils advocate here) and they continually pay-off so the need to reinvest is constant.

J Scott · Answer

Except that his return on equity will continue to decrease as the house appreciates, his IRR will be lower than his ROI unless he reinvests the cashflow and rent increases only mean better returns if expense increases don't rise at the same (or higher) levels.

If he's happy with 4% returns (or 7% if you want to assume appreciation), that's fine -- but there are much better ways to make that return than owning rentals...in my opinion, of course.  He's probably be better off buying two $125K properties instead.

Jeff S. · Answer

Vaishal Patel there is no guarantee the economy will remain strong enough to support increasing values and rents. If you are a long-term buy and hold the real benefit is in the increasing rents IMO. If you compare that with a stock investment it is like a company that keeps increasing it dividends.

If you get 3% appreciation and 4% return your initial total return is 7%. As rents increase your return increases and in not too many years you are handily beating that 10% yield plus you are deferring some income tax while you wait for rents to increase.

Isnt real estate profitable most of the times if you have the cash?

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