Dynamics of Real Estate Investments

[younginvestor2013]

I've always been interested in having an investment property. I just closed on my own condo this year and prioritized having my "own" residence before pursuing an investment property.

Now that I'm all settled into my "own" condo, I often look on zillow for nearby investment properties.

I feel that many here are generally not big proponents of investment properties due to the time involved and potential headaches as compared to index investing.

However, I've been thinking and I think there are three main advantages and unique dynamics to real estate investing that make it attractive:

1) Cash flow - if your revenues are greater than your expenses, you can pocket a nice monthly "dividend"

2) Price/value appreciation - this is more speculative and "unknown" and would not be realized until the sale of the asset at closing

3) Tax advantages - one can save thousands a year in tax deductions by depreciating the asset over 27.5 (I believe) years.

While I think any 1 of the 3 above don't necessarily make real estate investments largely attractive, it is the combination of the 3 that I am beginning to think make them an attractive investment. Especially since I am 25 and have quite a few years/decades ahead of W2 income for me to earn and therefore have tax deductions against.

I think #1 and #3 are the immediate/short term financial benefits, while #2 is more variable/speculative going into a deal, and might not be realized until far into the future.

I don't see why one wouldn't pursue a deal if you can confidently model out good cash on cash returns (i.e., cash flow) while also taking advantages of the yearly tax deductions against a W2 income, which is part of the overall return of the investment.

Of course, the nature of the deal has to be taken into account. I am largely thinking of large established condo associations where the maintenance and regular upkeep is slim to none (Chicago market).

The other factor is tying up the 20-25% needed for a down payment. With the market spitting out great returns, it might be better to keep it in the market vs an investment property.

Thoughts?

 

[unno2002]

We have rental real estate. I believe I started with rentals in my late 20's. I've gone for smaller "Plain Jane" homes in an ok neighborhood. My first rental, bought when I was single, needed a lot of fixing up, so I lived in it for a few over a year, making working on it my "hobby"… Now, we don't live in the same city as the rentals, so everything is handled by the management company. I do not want those 2:00 AM calls that the toilet is flooding….

Figure out what community you want to invest in, and research it. Read the "local" newspaper. Check the tv & radio stations. If you can go there, drive around, or at least use something like google maps to "fly" or "drive" the streets where you might be interested.

I do not go to the listing agent, I've contracted with a buyers agent, mine being connected to the rental management firm. With this arrangement, I know my manager will be willing to handle the property if I buy it.

Inspect - everything. We go in with a general home inspector, and someone from the plumbing, electrical, gas, etc. firms who typically handle the calls from the rental management firm. It's an up front cost that tends to really be worth it if we go thru with the deal. That said, be willing to walk away if it is just going to not be a good unit to own. After reports, upon which we have a deal be contingent, I believe I've walked away from more units than I've bought.

A potential starting point for realty search is
www.zillow.com

It lets you start to get a feel for what's available & the costs without having to start with an agent.

Check into the appropriate local multi listing service (MLS), some allow public access, again without having to go thru any particular agent.

In searching, while we're not looking for a home for ourselves, we are looking for a home and location where we would not object to living. Something decent, in a relatively quiet neighborhood, near resources… When I've been interested in a property, I've made it a point of going to the neighborhood on Friday and/or Saturday night, say between 10:00 PM and 2:00 AM… I've seen too many places that looked ok during the day, but turned into a bad movie scent at night…

Note, that with the right custodian, an IRA account can buy and have as an asset of the account rental property.

 

[gauss]

I am getting into rental real estate for the first time in my life at age 49.

I inherited a condo from my late father and have decided to experiment with it as a rental as opposed to just selling it. The upwards of 10% in transaction fees to sell it here along with potential for it to be worth more next year than this year have played into this decision. The biggest thing was that I could try it to see if I like it without committing to a purchase (since I already own it now).

One thing about writing off the depreciation over 27.5 years:
You might want to check into this further as I believe that the IRS does reclaim some or all of this upon the final sale of the unit. I am not an expert in this yet but I did run across that when I was putting together my potential business case for the condo rental.

I am planning to use the services of a professional property management firm. I will be basically outsourcing all of the day to day management and interactions with tenants. They also find tenants, provide leases etc etc. The cost is 10% of the gross rent plus a real estate commission of 1 months rent for each tenant change. I will still be responsible for funding repairs, carpet changes, painting etc.


One thing that I am running into here is that the condo association is moving to modify the bylaws to restrict rentals. I am not sure how this will play out if the unit is already renting (ie full grandfathering vs move to the back of the line before next tenant can move in). If this become an issue I will likely sell it.

What is interesting is that this restriction is not currently in place yet potentially could effect me retroactively so to speak. This would be something to understand further before purchasing a condo for rental purposes.

Please note that I have plenty of investment funds in stocks and bonds via mutual funds so this real estate investment is more of an experiment for me.

I hope it works out for you.

-gauss

 

[Senator]

Invest in real estate for cash flow only. The others are extra benefits. If it doesn't cash flow, avoid it.

Know what a decent cash flow is, and know that different neighborhoods require different cash flows. Understand that to get a decent cash flowing property is work. You cannot just go and buy one on the MLS with a Realtor - generally. You want a pocket deal, or one you find yourself. And you need ~25% down.

I have 24 rentals, and it is a large piece of my retirement plan. All were in some sort of foreclosure status, all I found, not a Realtor.

 

[jkern]

I'm a proponent of investment property. I currently have three rental properties. Things to keep in mind:


1) No negative cash flow. At the very least, the renters should be paying off your mortgage.
2) Long term investment and sustainability. Go into it that if need be, you can keep the property for 20 to 30 years. Slow and steady wins the race. No get rich quick schemes.
3) I'm not a huge fan of depreciation. It can benefit you if you are currently in a high tax bracket. However, when you sell the property you have to recapture the depreciation. It doesn't matter because by law you must depreciate. It is what it is.

 

[jerome len]

We have rental real estate. I believe I started with rentals in my late 20's. I've gone for smaller "Plain Jane" homes in an ok neighborhood. My first rental, bought when I was single, needed a lot of fixing up, so I lived in it for a few over a year, making working on it my "hobby"… Now, we don't live in the same city as the rentals, so everything is handled by the management company. I do not want those 2:00 AM calls that the toilet is flooding….

Figure out what community you want to invest in, and research it. Read the "local" newspaper. Check the tv & radio stations. If you can go there, drive around, or at least use something like google maps to "fly" or "drive" the streets where you might be interested.

I do not go to the listing agent, I've contracted with a buyers agent, mine being connected to the rental management firm. With this arrangement, I know my manager will be willing to handle the property if I buy it.

Inspect - everything. We go in with a general home inspector, and someone from the plumbing, electrical, gas, etc. firms who typically handle the calls from the rental management firm. It's an up front cost that tends to really be worth it if we go thru with the deal. That said, be willing to walk away if it is just going to not be a good unit to own. After reports, upon which we have a deal be contingent, I believe I've walked away from more units than I've bought.

A potential starting point for realty search is
www.zillow.com

It lets you start to get a feel for what's available & the costs without having to start with an agent.

Check into the appropriate local multi listing service (MLS), some allow public access, again without having to go thru any particular agent.

In searching, while we're not looking for a home for ourselves, we are looking for a home and location where we would not object to living. Something decent, in a relatively quiet neighborhood, near resources… When I've been interested in a property, I've made it a point of going to the neighborhood on Friday and/or Saturday night, say between 10:00 PM and 2:00 AM… I've seen too many places that looked ok during the day, but turned into a bad movie scent at night…

Note, that with the right custodian, an IRA account can buy and have as an asset of the account rental property.

Very well thought out response and business plan......how do you know when you have found a "good" buyer's agent? And, do the same agents generally handle homes, condos, apartment complexes and commercial property?

 

[calmloki]

One of the best things about RE is it keeps one from making impulsive moves - unlike the stock market, where bad news (EBOLA! BE-HEADINGS! ELECTIONS!) can result in selling your holdings in a rush and at a loss. Forced savings account. RE worked and works well for us, now we are moving some of the cash that has accumulated into property loans for investors - just another part of the RE experience.

Will say that buying was always easy for us - selling is tough, and yes, all that depreciation that was taken is recaptured at sale time.

 

[catman2020]

I may be a lone voice here on this thread, but I'm personally not a fan of real estate as a retirement investment - unless you get a really great manager or you approach it as a 'second job' and get some satisfaction from the various aspects of dealing with maintenance and providing a 'service' to your renters.

I just exited a commercial investment property. I did well in the end because of the sale but really didn't enjoy it as my 'second job' - to me it seemed like a bunch of small 'head-aches' without much 'job satisfaction.'

I'm sure real estate can be a great way of building equity and cash flow, but be prepared that you may have to give up some of your freedom when issue arise.

 

[Dash man]

Put together a spreadsheet that includes all potential costs for you to include in your decision making process. Include some vacancy time, maintenance, mortgage principal and interest, insurance, association fees, management fees, property taxes and your share of any utilities. Determine what kind of return you require for your investment. When you find some potential properties research the potential rental rates and determine your cash flow and rate of return. If you don't meet your desired rate of return just move on unless you can negotiate the price down. There's an app called Zumper that can help you see what current rentals are listed at if you don't have access to MLS. Make sure you have funds for the unexpected. Check the finances of the associations do there are no surprises there. Good luck!


Sent from my iPhone using Early Retirement Forum

 

[Rick_Head]

Of course, the nature of the deal has to be taken into account. I am largely thinking of large established condo associations where the maintenance and regular upkeep is slim to none (Chicago market).

Thoughts?

If you are looking at condo, a look at the books of the condo association is more important than a look at the unit. Condo fees can/will rise, special assessments happen and you have no control. A unit might look to cash flow at a reasonable level today and be seriously negative next year when the board finally admits they don't have sufficient reserves.

Buying a condo is not the same as a SFH or an apartment building. Caveat emptor. I'm NOB so YMMV.

 

[Senator]

Research apartment classifications. There are four classifications, A, B, C and D. Your investment returns need to be commensurate with the risks. A D category building should be a 12% cap rate, no less.

In CHI, which is very tenant friendly, expect to lose money, unless you are a savvy landlord. It may take several months to evict a tenant, plus lots of legal fees.

 

[wolf]

Great idea. Did same when I was young. Retired now. Rental income
great.

Here's what worked for me:

1. Would help if you are a "DIY". Do repairs and renting yourself. Cash
flow lean in early years.

2. Depreciation is good. Can use excess rental loss against ordinary income.

Yes, if you sell rental property, accumulated depreciation taxable.

However: 1031 exchange. Buy another like kind property, you
can defer any gain, and defer your depreciation.

Also, if you hold the property long term, when you pass on, the
rental property gets a "step up basis" to market. No capital
gain tax, and no tax on accumulated depreciation.

3. In my case, live in Bay Area, California. Palo Alto, Cupertino,
area. Appreciation super high. AS well as rents.

Reason. Location, Location, Location.

If you want appreciation. IT'S LOCATION.

Location= Good Schools, Employment, Weather.

Stanford, UC Berkley, Google, Facebook, Apple, HP,
etc.

 

[tryan]

I am largely thinking of large established condo associations where the maintenance and regular upkeep is slim to none (Chicago market).

Having owned a few condos as rentals in my youth ... I now avoid them like EBOLA. Rules, fees, and special assessments dictated by committee makes it nearly IMPOSSIBLE to make money. Oh, and did I mention the resident owners HATE tenants and landlords. Good luck it you dare show up at the bi-annual meeting.

Time on your side ... buy a multi live in one unit rehab as needed....move into the next vacancy. You'll learn ALOT. What you learn will help you decide if you can stomach this for the long haul. If you can't, selling will be easy due to sweat equity.

 

[Sunset]

Having owned a few condos as rentals in my youth ... I now avoid them like EBOLA. Rules, fees, and special assessments dictated by committee makes it nearly IMPOSSIBLE to make money. Oh, and did I mention the resident owners HATE tenants and landlords. Good luck it you dare show up at the bi-annual meeting.....

+1
OP will be hard pressed to make any money if he has no control over costs, via the condo idea.

I like a DIY approach, just replaced a carport post and coordinated a re-roof job on one of my rentals. I like that it saved me couple of thousand, hated that I cannot claim my time as an expense.
By not using a property manager I have saved a full year of gross rent over the past 12 years per unit. !

Maybe OP should think about getting a room-mate to rent out a room.

One big problem with being a landlord is the tenant from H_ll , they can easily cost you 10K in damage, lost rent in many thousands, and legal fees in the thousands. Be sure you have a deep pocket, or large HELOC to pull from to cover yourself.

 

[Texas Proud]

I'm a proponent of investment property. I currently have three rental properties. Things to keep in mind:


1) No negative cash flow. At the very least, the renters should be paying off your mortgage.
2) Long term investment and sustainability. Go into it that if need be, you can keep the property for 20 to 30 years. Slow and steady wins the race. No get rich quick schemes.
3) I'm not a huge fan of depreciation. It can benefit you if you are currently in a high tax bracket. However, when you sell the property you have to recapture the depreciation. It doesn't matter because by law you must depreciate. It is what it is.

My bold... but, this is an important point... when it comes time to recognize your gain on a sale of an asset, you are supposed to put down depreciation allowed or allowable.... IOW, just because you do not take depreciation does not mean you get to ignore it... you would still have to 'recapture' your depreciation that was allowable over the years...

But like all things with taxes.... you can play the audit lottery....

 

[Letj]

Will say that buying was always easy for us - selling is tough, and yes, all that depreciation that was taken is recaptured at sale time.

Not if you do a 1031 exchange. My exit plan is to sell and buy up meaning buying some higher quality lower headache rentals or a commercial building.

 

[Sunset]

Sure you can keep doing 1031 exchanges, until you die, then the issue is solved. Otherwise you will at some point sell without 1031 and recapture all that depreciation as 25% Capital Gain, plus all the appreciation.
A giant tax bill all at once.

 

[wolf]

Sure you can keep doing 1031 exchanges, until you die, then the issue is solved. Otherwise you will at some point sell without 1031 and recapture all that depreciation as 25% Capital Gain, plus all the appreciation.
A giant tax bill all at once.

As mentioned in one other post. Invest in rentals for the long term. Slow
steady gain. If you do it right, you will have no reason to sell. (heirs will benefit). As you increase your holdings, more than 1, rising rents and
appreciation (Location, Location,) you will be able to buy more rentals.

You may find, as others on this post, you have no reason to sell. Just,
spend the rental income and enjoy life. And as, the rentals become paid
off and cash flow increases, you do not have to be a DIY...sub out the
work, and keep the easy stuff for yourself.....

 

[clifp]

One of the best things about RE is it keeps one from making impulsive moves - unlike the stock market, where bad news (EBOLA! BE-HEADINGS! ELECTIONS!) can result in selling your holdings in a rush and at a loss. Forced savings account. RE worked and works well for us, now we are moving some of the cash that has accumulated into property loans for investors - just another part of the RE experience.

Will say that buying was always easy for us - selling is tough, and yes, all that depreciation that was taken is recaptured at sale time.

Calmloki has a lot of experience in the field and gave me some wise counsel, when I started out. If you have interest in it and some aptitude, e.g. DIY skills, an eye for real estate, or background in RE finance, than I really think it can be a good investment. I agree completely with calmloki, for many people it is a far less emotional than the stock market and that is good thing!

 

[heeyy_joe]

I'll stick with RWX and it's 4.5% yield.

 

[Senator]

I'll stick with RWX and it's 4.5% yield.

Stock ticker 'O' is also a decent REIT.

Another option for a real estate investor is investing in mortgage notes.

Or syndicated apartment deals. Generally the apartment partners can get 8%+. In a recent one I was offered it was a 'guaranteed' 8% return on a $50K investment. That is, your 8% came off the top of the profits, and accumulated to future years as a preferred partner.

 

[wolf]

Calmloki has a lot of experience in the field and gave me some wise counsel, when I started out. If you have interest in it and some aptitude, e.g. DIY skills, an eye for real estate, or background in RE finance, than I really think it can be a good investment. I agree completely with calmloki, for many people it is a far less emotional than the stock market and that is good thing!

+1

 

[SVHoper]

Hi,

You have had lots of great replies... there are very experienced and wildly successful real estate investors on this forum. IMHO real estate investing in good times (vs 2009) is more a personal preference, you pretty much gotta have some interest

Sorry if I missed someone else mentioning these random suggestions:

• Make sure you allocate enough for reserves. Non-investors think mortgage, property tax and insurance then can freely allocate the rest of the rent... but general wisdom is to allocate 40-50% of gross rents to expenses (excluding interest). This ensures sufficient reserves for long-term, large ticket maintenance items and issues. Even condos can have large ticket items (special levy) if sufficient reserves are not held by the Home Owners Association.
• Visit a local investor group. Biggerpockets.com might be helpful. Beware, lots of groups are organized by someone trying to sell you something, not necessarily bad so long as you are aware of the value.
• Make a good chunk of your return when you buy. Difficult to cashflow by paying retail on MLS. Not surprisingly, I am finding it vastly more difficult to buy well than in 2009-2012. Last purchase was a toss up whether I would be better in the market (as I don't plan for a lot of leverage)... answer is yet to be determined.
• May want to juice your return with something extra... fixer upper; short-term rental; off-market purchase; multi-family rent increase.
• IMHO leverage combined with the other points you mentioned, is what helps to give better than 60/40 stock/bond return. Also can hurt if prices drop and you are forced to sell. Many very, very experienced investors were hurt in 2008-9 - perfect storm of issues.
• You cannot know too much about the house/street/neighborhood. If you plan to buy and hold then you also need to know your location in the future
• Just FYI IMHO 1031 exchanges have pretty limiting time restrictions, so not so easy to exchange into a good deal.

Be very, very informed, have fun and wishing all the best.

 

[emi guy]

Great post! I own a four-plex that will be one of the pillars of my retirement plan. I've owned it for ten years now and will be paying it off in the next few years, after I retire and I sell my current principal residence. Once that happens, the rental income will represent about 25% of my retirement income. One of the facts that I like about owning the rental is the flexibility it offers. It can be used strictly as a stream of income or I may decide to move into one of the units at some time. My units are small and efficient; great for my needs.
As someone else mentioned, hopefully any investment property is one that you could "see yourself" living it, if need be. If that is the case, you've solved the "location" issue and over all property condition issue.
I currently outsource all of the maintenance except the very, very minor stuff. I select the contractors and supervise the work but don't do the labor. I also do the new tenant selection. I believe that no property manager will select a new tenant with the same zeal as I will. I've always feared that a manager might just pick a warm body to fill vacancies, increasing the chance of putting a problem tenant in one of my units. Plus, their commissions are astronomical.
I'm in a small town in New England. Appreciation has been very slow but it and rent increases help keep up with inflation. So far I enjoy the experience. I strive to give my tenants a nice, clean place to live at market rates. My taking pride in the place seems to translate into quality tenants. I've had a few problems but more good than bad. Good luck with your situation.
EmiGuy

 

[Senator]

I believe that no property manager will select a new tenant with the same zeal as I will. I've always feared that a manager might just pick a warm body to fill vacancies, increasing the chance of putting a problem tenant in one of my units.

This is the number one secret to residential investment properties. Getting great tenants. It is not hard to attract them, it is not hard to recognize them, it is not hard to rent to them

The issue most landlords have is waiting for them. Price right, market effectively, have a solid rental, and you can have a great tenant in just a few weeks - or less. If not, you have to look in the mirror for your problems.