I've been listening to @Scott Trench 's new book, Set for Life, recently. Scott discusses the concept of dollar-cost averaging a bit as it relates to investing in index funds. This makes a lot of sense to me and I've been doing this for years through the traditional routes of 401(K) and Roth IRA. However, now I am considering how this applies to purchasing rental properties. Here's an example: If an investor plans to purchase 30 rental units over the next several years, would it make sense to just systematically (as mush as possible) purchase 3 or 4 units per year? Similar to dollar-cost averaging with index funds, sometimes units would be purchased at higher prices and sometimes units would be purchased at lower prices (depending on where the market was at the time). In theory, the investor could then spend less time attempted to time the market, trusting in dollar-cost averaging to end up in a good position 10 years down the road. I'm still kicking this around in my head, but wanted to see what others thought of this. Thanks!!
I was in finance for 8 years and had my series 6, 63, and 26. Essentially, you're comparing apples to oranges. When you dollar cost average (DCA) using the typical 401(K)/Roth IRA in which mutual funds are used as the investment vehicle, you're doing it pretty much within the pre-determined investment strategy a particular fund manager is obligated to abide by, outlined in the prospectus. Hence, when you DCA, the performance of the chosen investment does not change; just the price you bought it at.
The performance of a property, however, can differ depending on how you operate it as an investor. A property purchased at a low price does not necessarily mean you'll be profitable, nor does a property purchased at a high price mean you won't be profitable. Each property's performance differs, as does the investor's performance running that property.
So to answer your question, "would it make sense to systematically purchase 3/4 units per year," the answer is no. Each property has to be looked at individually, while you continue to increase your ability to get the best rate of return as an investor.
I agree with Johnny's comments and don't think it makes sense. Real estate market does not fluctuate as much as the stock market and it is a lot easier to see which part of the real estate cycle you are in at a particular time in a particular market. For example I purchased an investment property here in CA in 2010 and sold it last December for twice what I paid for it. I would not buy again in California until the next downturn.
I'd recommend purchasing properties systematically that meet your investment criteria and goals. If that means 0 in one year and 8 in the next, that's fine.
@Steve Smith How about looking at this another way: Don't try to time the real estate market! It's not quite the same as applying a dollar cost averaging methodology but the message is similar in nature. So just a few thoughts on why DCA doesn't really apply:
- If you see a great 10-plex next week you can't decide "Well, I'm going to try and get owner to sell it to me based on moving value assessments 3-4 times over the next 12 months." So you could miss out on the best deal because it doesn't fit in an artificially imposed timeframe.
- You aren't buying a broader "housing index". You're buying a specific property and all of the properties are different. If you wanted to use the stock market analogy you're buying 3-4 different single stocks in large tranches throughout the year. You lose diversification and have to "pick a new single stock" each time. Consequently, you go back to pseudo-timing the market for that stock. In this case, you're timing a market for the unit you're acquiring.
- Even if you believe that can "index" through the acquisition of single properties it's really hard to do that because real estate markets (geographies) behave differently. If you go into an index fund (just something like the S&P 500) your risk is spread across 500 companies. The same can be said for the Russell 2000, NASDAQ composite, etc. When you're buying a rental unit it's not the same as, for example, buying into a REIT.
I think *not* trying to time the market is a better approach. That's because, in my opinion, looking at something static like a "home value" is only one piece of the equation. Mortgage rates don't stay flat. Qualifying it a good time (some will read this as: overpriced) isn't the same as qualifying in a bad time. There's no such thing as other people paying down asset debt in the stock market world. Maybe there is some loose analogue but it's not as direct. So there are plenty of good reasons to not try to time the market. But it's still a little bit of a different thesis that using DCA as a proxy for an investment strategy.
But what do I know, I'm no financial planner nor am I an economist...
I actually DO apply dollar cost averaging to buying rental properties. Here's my philosophy:
I have no way of knowing which part of the cycle we are in. I fundamentally believe that real estate is just as difficult to predict, cycle-wise, as any other asset class. Folks have been telling me for years that the market is about to burst here in Denver, and around the country.
I was told that in 2013 before I had any properties that it was a bad time to buy.
I was told that in 2014 when I bought my first property
I was told that in 2015 while that property appreciated
I was told that in 2016 when I bought that second property
I'm being told that now in 2017 as I buy a third one and have substantial equity in my first two
The market crash is always an impending doom forecast by folks that are not getting into the game for one reason or another. It's always coming next year.
Maybe it IS coming next year.
I'm not smart enough to predict the future though, so I stick to an approach that any simpleton can follow. I look for the best deals that I can in the current market conditions. I put in my homework, and find properties that make a lot of sense for my personal life, that are close by and don't require a boatload of work from me to get ready. I buy properties that are in locations that I believe have excellent prospects, and I buy only when I have a personal financial position capable of withstanding even a crash to the degree of the great depression.
The way I see it, the market could very easily continue to bustle productively and we will see continued gains for another two decades. It could also tank and hit rock bottom. It could stagnate and inflation could make my property soar in value, or a natural disaster could take place and force everyone out of Denver.
Who am I to predict this stuff? No, instead, I buy consistently on an annual (more like 12-18 month) cycle, conservatively, and well within my means. I believe that over the long-term, market averages will be on my side.
A ton of people sound gloom and doom about the market here. It's possible that because of that caution we don't see a correction in the near term. It would be a huge shame to miss out on that continued growth. And, if there's a downturn, the guy with cash flowing rental properties, a few years of experience, and cash in the bank is going to be in MUCH better position to buy more property than the guy that has been waiting and earning nothing on his cash in the meantime.
@Scott Trench you won't be buying more property in a downturn if you are dollar cost averaging...you will be buying the same number of properties as every period.
I get what you are saying, but in my experience, it works out a little differently. To get to 30 units it'd probably be 1 or 2 the first year, 1 or 2 the second year, 2 to 3 the 3rd year, by year 10, you will be at like 4 to 6 or something. Basically the same idea of a Divided reinvestment.
How I understand dca though is you would invest say 20k/ year so some years you'd buy more, some years buy less. Not buy 3 a year
Thanks everyone for your input, I really appreciate the different perspectives.
@Scott Trench , once you live through one complete cycle, the next time around you will be able tell whether you are in the Recovery or in the Hyper supply phase. However if you are patient and financially prepared for the recession - financial freedom can be achieved faster. Unfortunately (or perhaps fortunately) I learned my lesson the hard way, it was expensive lesson but very valuable. And I'm prepared for the next recession. No one knows when the bottom of the market is, but think I should be able to recognize the phase.
If you are consistent, don't overextend yourself and cash-flow positive - over the long term you will end up doing well regardless of when you buy. So your strategy is a good one.
"Dollar cost averaging" is more of sales pitch than a economic principle. Do not get me started on how 401K plans and similar tax laws cause stock market bubbles.
Are we in the Hyper Supply phase, @Dmitriy Fomichenko ? It certainly "feels" like we're approaching the edge of a cliff sometimes, perhaps even experiencing a blow-off top. But the markets I follow still have very low inventory compared to demand, and my understanding is that the Hyper Supply phase has two defining characteristics: New construction (which is happening) and increasing vacancy rates (they haven't yet broken their downward trend). I don't mean to fork the thread -- which is about NOT timing the market :P -- but I'm just curious what you're focusing on with regard to market phases.
@Nolan O. I don't know your market, but I have an eye on couple markets that I am interested in and will be able to tell when the recession phase is around. I am not looking for the bottom of the market, I don't think anyone could say that for sure. I would like to buy in Phase IV, rather than Phase II or III.
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