Be Careful of Dead Equity!!

Michael Swan · 2016-12-30T17:43:07-08:00

What prevents us all from becoming super wealthy? Plain and simple it is the return you get from your net worth. So, for an experiment take your net worth. That means, if you were to sell everything today and paid off all your loans etc... What would you be left with?A few years ago I figured out that if I were to do this, I would have about $2,500,000.00 in Equity or Net Worth. I thought that was something else at 49 years old. Then I calculated my ROE or Return On Equity. I figured out that our passive income from all this RE was at $72,000 a year. To figure out my ROE, I took that passive income and divided it by my $2,500,000 in equity or Net Worth. Guess what? It wasn't very impressive. My Return on Equity or my return on Net Worth was almost 3%.Wow!! That was a real eye opener. That was pathetic. What that told me was that I had too much dead equity sitting in pricey California single family rental properties. So, what I did was learned and read and learned and read and attended seminars etc... What I learned was people with dead equity and were successful RE investors took that equity and did one of 2 things. The first was they refinanced that equity out (tax free) or the route I took, which was the incredible tool called the 1031 exchange. All I did was started to trade this pricey San Diego Re in for undervalue apartment complexes in Ohio. Right now our passive income has risen to $120,000.00 a year and our ROE is now up to about 5%. Again, this is tax deferred and the Net Worth is still the same. The difference was, increasing the front doors from 12 to 78. That is including 2 personal residences that don't give us any passive income. Those personal residences have loans and take money out of our pocket each month.Remember, If you keep the proper leveraged debt 30-50% on each property you keep a level of safety and ROE. Let me know what your ROE is currently and what you plan to do about it.Happy and prosperous New Year to all here at BP!!!Swanny

Matt R.

Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes

9y

Originally posted by @Ethan Cooke:

Thanks Michael for starting a great discussion and thanks everyone for great contributions.

I am new to BP and really enjoying the learning. I own 3 SFR's in San Francisco which are leveraged at about 65% LTV. I have invested in SF because I know the market and the long-term appreciation is great. But like @Michael Swan, @Account Closed and @Amy Greger, I am considering shifting into a higher cash-flow market (presumably with less appreciation).

What markets should I be researching and who should I connect with who knows various markets in the West? I'm seeking a market with:

- good cash flow

- decent appreciation

- low volatility

- ideally reachable in 2-3 hours (by car or plane) from San Francisco

Thanks!

When rei hedge funds are surveyed, the vast majority make most of their returns via appreciation.

The new president elect says "real estate is an appreciation game" and if one is to believe his financial statements 80%-90% is "dead equity." Some of the dead equity is in Cali, LA ocean front and SF. It should be noted that dead equity produces hundreds of millions in cash flow.

The Trumps did do a project in Cincy 40 years ago with 1000+ units. Donald was 25 years old and headed to run the project. Purchased in a sherrif's sale and they were the only bidders. Turned it around and sold it several years later. It changed hands a few times since and fast forward decades eventually those "1000 cash flow units" went abandon, bankrupt and now I think has been turned into low income housing. At one point there were 300 evictions going on at the sametime before it was abandoned. Btw all the owners were out of state.

Good luck with your search!

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Michael Swan

OP

Rental Property Investor · San Diego, CA · Member since 2014 · 1k+ posts · 2k+ votes

9y

Hi @Peter Mckernan,

I love the Newport Beach Area. Someday I will be able to rent one of those places. Thank you for the kind words. I keep learning everyday.

@Matt R. Thank you for giving me a counter example of how in certain instances that keeping that equity in place, could be beneficial in the future. We all need to make that decision based on our experiences etc. I am glad that you presented the information above that you did. The properties I purchased in 2011, 2012, and 2013 in San Diego were all 1br, 2br, and 3 br condos. They have individual insurance, management, utilities, etc.. to deal with. They were in Santee and Lakeside California. By no means highly desirable. They were in solid lowere middle class areas of San Diego. You would call them solid C class products. The prices on these condos had doubled in a three to four year period. I did not feel that incomes could support these inflated prices. I have lived in San Diego since 1978 and have seen this rerun before. Now if it was prime beach front or some kind of highly desired property, that would have bee different. These were run of the mill condos in a lower middle class area of San Diego.

Our plan all along was to sell when prices doubled and they were starting to give loans to Morons. In 2015 and 2016 we pulled the trigger and realized that when we went to sell these condos many had sub par credit and not much money in the bank. FHA Loans with 3% down was commonplace and low 600 credit scores to boot. Sooooo, we 1031 exchanged that incredible equity for what I have described in our thread. Was it the right thing to do. Only time will tell.

Swanny

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Michael Swan

OP

Rental Property Investor · San Diego, CA · Member since 2014 · 1k+ posts · 2k+ votes

9y

Oh I forgot to tell you @Peter Mckernan

We still have two personal residences with about $600,000 equity and one 2br 1bath Rental Condo in Santee, Ca. with about $190,000 equity. We have not sold that rental property. We bought it with about $30,000 down for $100,000 in 2011 and it is now worth about $250,000. The HOA fees have risen to $300.00 on that one. The tenants have a lease until July 2017. The most it could rent for is $1500.00 right now. You see why we want to get that equity out, before the values get way above the incomes of the buyers?

We have a good problem. I think. Heads I win and tails you lose. With only $70,000 debt on a $250,000 property. That is similar to the 9 others we 1031 exchanged for Apartment complexes in Ohio. Sooooooo, we still have lots of equity still in pricey unsustainable middle class areas of San Diego.

Swanny

Be Careful of Dead Equity!!

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