Real estate as an investment

[wzd]

I've been reading the various posts on TIPS, international investing, and the 1966-82 topics, and wanted to start a new discussion on real estate. In particular, I am semi-retired and have invested some money in an apartment building. I find that it has some very nice characteristics: Tax deferal, current income stream, long term appreciation, and inflation protection.

Tax deferal - The tax code allows '1031' exchanges. I had a 4 plex that I sold and exchanged it into a 20 unit building. I used $200,000 in the exchange, but due to tax deferal, the after tax value, if I did not exchange but cashed out was $100,000. This means that I have $100,000 of my money, and $100,00 of Uncle Sam's money invested in the building. I also get to depreciate the new building, and that shelters the current income partially (fully in the early years). Then when the building is sold the bill comes due - unless you exchange it again into more or bigger buildings.

Current income - I get $1,000 to $2,000 a month from it. Currently I am managing it myself and getting $2000 per month, but I could have a professional property manager manage it and get $1,000 a month from it. Also, I mostly pick the hours to work, and how much to hire out versus do myself. Of course, one has to continously make that decision, time or money. But the point is that the decision is there, it is yours to make, and you are working for yourself if you chose to do the work. I spend a lot more time out hiking, biking, etc. than I did when I had a 50-60 hour a week computer job.

Long term appreciation - not much to say here, real estate seems to have gone up with small exceptions over the years I am aware of. Yes there is talk of a bubble, and some areas have gone up and then come back down some...but the overall trend is up. Very little new land is being made, and that new land is very expensive (see Japan for details).

Inflation protection - you are collecting rent, and paying utilities, taxes, etc. But since they all go up with inflation, and the rent is greater than the costs, the profit or cash flow goes up with inflation (or faster if you have fixed debt service (aka mortgage) costs).

I have friends that invested in larger buildings several years ago, and the cash flow from their investments replaced their salaries....they are now retired early.

So yes, there are risks - but there are a number of offsetting paybacks. Especially since I can paint, hammer nails, fix doors, floors, etc. I have ways to cut costs if things get tight, and can relax more if they don't. For me it seems to be an ideal investment. I still have more $$ invested in bonds and stocks (both individual and funds). Just one investment vehicle is risky...

Wayne

[MRGALT2U]

For me, real estate is also the answer assuming that
I wanted to work that hard. If I was ever forced back
into some sort of gainful employment I am sure it
would be real estate investment. The biggest
downside for me would be illiquidity. I have dabbled in real estate my whole life, but never really got
into it in a big way. Now, it no longer fits with our
"dream", a slightly different version of Dory36. Speaking of this, I just returned from a week in Florida
where I mostly looked for a place to reside and keep the
boat. Think we have it narrowed down to central Fla.
near the St. Johns River, or near the Panhandle Gulf Coast.

[Michael]

Low cost REIT index funds have about the same inflation protection, and an income stream roughly comparable to what you would get if you hired a professional property manager to manage your property for you. Since I have no desire to manage a building myself, a REIT index fund would seem to me to be a better choice for me, since it offers much greater diversification and liquidity than an individual building. I may not understand all of the benefits of owning a building directly, but this is my thinking for now.

[wzd]

I've looked over the REIT's and they seem to have a lower cash flow than a managed building. They are also open market stocks, and the value goes up and down with the stock market. Owning a building or part of one directly doesn't have the 'already bid up' component of stocks.

But that is not the main attraction for me. I can switch on extra income by managing it myself, and it is pretty much a self directed job where I set my hours and contract out as little or as much as I want. I consider it as similar to reducing expenses during a bear market as mentioned on some other boards here. I still have young kids, so spending time on MY schedule is important. I suppose it is like a job, but I am the boss....

The other advantage is that the income is largely tax sheltered by depreciation, so the equivelent return is about 16%/year.

Wayne

[MRGALT2U]

Wzd, you have thought it through well. Me too!
I see deals (mostly real estate) all over the place that
kick in my entrepreneurial juices. When I first retired,
I had to pull myself back from the brink several times.
In short, I think it's the way to go for me and probably
always has been, if I wanted to be actively employed. Not at this stage of my life though. I'm just hanging on until SS starts up .

[John_T]

Short tidbit before I leave. Real estate is a great investment for the long term indeed if one has the money to pay cash for purchases and don't rent them. I once rented a house and managed it myself for 10 years and the aggravation I encountered during that time dealing with renters was definitely not worth the capital gain. I carried a mortgage on it and socked away funds for repairs from the rent profit. Sure I had a nice tax shelter but not much usable income. But real estate is an appreciating asset but it takes time to realize. Dealing with the renting public is not for me though, especially not at my age. Just my 2 cents.

Nice discussion,

I too have thought many times of jumping into the Carlton Cheets lifestyle. There are many positives of using real estate as an investment vehicle and for every positive experience there is a negative one out there.

My experience shows that the rewards of real estate are in the increasing of equity over the years. It hits you when you wake up 25 years later and find your property is now worth 100s of thousand outright and your mortgage just about paid off. Lots of blood, sweat, and tears in the interim and if you don't mind that I believe this investment vehicle is great.

Since I can't stand dealing with smucks , I'll keep my money in stocks and bonds. Best of luck to those that go this route.

JS

[MRGALT2U]

If you know how to avoid dealing with smucks (real
estate or no) I would like to know your secret. Years
ago, before I abandoned the "Carlton Sheets"
idea (which had been bouncing in my brain for years)
I would get into a discussion where someone would ask
"Isn't that (real estate investing) a lot of work and bother, what with the temants and all?" Well of
course it is. But, in spite of all the ways to make money,
the "free lunch" is still pretty elusive. Most of us just
have to choose our poison and hope we get lucky.

[Barnstormer]

John,

I avoid schmucks by being an island and keeping relatively to myself and my family (who I must say married into some schmucks) . Your points of poison was very true and the fact that there is no free lunch.

My sister and husband bit the Sheets bullet and own 2 rental properties with a total of 11 units. I can say it is a struggle for them and the schmucks are everywhere. A lot of headaches for sure. Hopefully it'll work out well for them.

As for me I'm happy with my measerly gov't pension which enables me to sit around all day and complain about the gov't. What can be wrong with that?

JS

[Barnstormer]

I guess I'm signed in on one computer and not the other.

[Barnstormer]

BTW,

Our local book club will be reading Altas Shrugged this summer so I'll be reintroduced to this John Galt guy.

JS

[MRGALT2U]

Re. "sitting around all day and complaining, etc.", it's
a tough job but someone has to do it .

Atlas Shrugged is a tough read for most people. Guess I've read it a dozen times at least. As far as "reintroduced", you
are corresponding with the real life John Galt, just
not as good looking and a lot more cynical.

[Barnstormer]

Well in that case...it's a pleasure Mr Galt. And don't sell yourself short, you're a tremendously looking gent. And cinisism is all relative.

I agree it is a tough read, but IMO well worth the effort. After all most people don't get, but could benefit greatly, from understanding that A is A.

Nice to meet you.

JS

[MRGALT2U]

One of the arguments for real estate investment
(or common stock for that matter) is that your money will show long term appreciation.
I no longer have a "long term" to work with.
It's not all gloom and doom though, as knowing this
helps me to eliminate a bunch of potential investments
that I might have considered 20 years ago. In that
sense, getting older is a real time saver, along with
all of the stuff you can no longer do physically. Like other changes which we must reluctantly accept as time passes, many can be a blessing if viewed from the
proper angle.

[wzd]

I hear you on the shmuck factor....I can put up with it for a while. 15 years ago, I first went into rental real estate with 2 4-plex's with 2 other couples(for 10k each). We managed it hands on for a couple of years (till the cash flow turned positive - we got in at the worst time!), and then we had a management company run it. I traded my share of that for a 20 unit building a few months ago. My goal is to put up with the shmucks for a while, but if I get sick of it, I can turn it over to a management company earlier. I'm viewing it as a part time job for now.

Hoping it can push me and my portfolio over the hump to fully retired with the income I want.

Wayne

[MRGALT2U]

Well, I may yet be back in the landlord business. After
trying a FSBO (I had little patience for this and am basically lazy anyway) and going through 2 realtors
(neither all that sharp), I am seriously considering
just leasing our house when we head south. It's a
great location (for Illinois) and we can take some pressure off the timing of our "escape". So...................
think we will find a place to live in the south first, then finish liquidating our
"stuff" and move at our leisure. We had an offer on the house which we accepted. Buyer got buyer's remorse and backed out. I was relieved because we only had 60 days to get out and I almost had a nervous breakdown
trying to cram everything to be done within the 60 days.
I have crunched the numbers on a lease and have a
good chance to do better financially than if we sold.
The key, of course is finding the right tenant as we will
be living 1000 miles away.

[wzd]

My sister tried the long distance landlord thing. It does have it's pitfalls, but she does ok. Since it will be in an area you lived in and know people in, you will have contacts in the area. Despite that, I strongly suggest setting up people to help you before you leave. Someone you know who will watch the property, and is responsible enough to deal with any emergency - like no heat. The person should also have keys to the property. A general contractor or handyman you know would also be a good bet to have an arrangement with.

You know my view - owning some real estate is a good investment to complement traditional investments. Single family residence is not the best cash flow rental investment but I think it has more potential for appreciation.

The other issue to look out for is the tax one. I know there are tax breaks for selling your primary residence, and I don't know if you lose them if you rent it for a number of years before selling it. I fear you might and you really should check that angle out closely. It can be a lot of dollars! Especially if you have owned the place a long time.

Wayne

[JWR1945]

I know that there are some special rules about renting out your old house while you are trying to find a buyer. The general idea hinges upon whether collecting rents is just a interim situation or whether you have decided to convert the house permanently to a rental.

Be careful. Big bucks are involved.

Have fun.

John R.

[MRGALT2U]

Hi John R.

Here is my set up. The house is owned by a small company which I own 100% (leftover from my
"Captain of Industry" period). So, I rent it from myself
in a manner of speaking. Thus, my little company gets
to deduct depreciation and a lot of other stuff, while
I have a friendly landlord. Also, once we become
snowbirds, a reasonable number of trips back here
will also become deductible by the corp. If I owned
the house directly, I would lose more than I would gain,
especially since in my scaled down condition I always
take the standard deduction on my taxes. That alone is a major plus as I hate recordkeeping of any kind.
I want to be out having fun, not paying bills and filing.

[wzd]

Hi John -

The downside of what you are doing (other than the tax man possibly frowning on the setup) is the loss of the exclusion on capital gain on sale of personal residence. As hypothetical examples:

Using a holding/management company:
purchase in 1980's $50,000
depreciation $40,000
adjusted basis $10,000
Sale price - 2003+ $150,000
proceeds subject to tax $140,000!!!!

Holding it in your own name and living in it:
purchase in 1980's $50,000
Sale price - 2003+ $150,000
proceeds subject to tax $0!!!

The proceeds alone will push you up to a high tax bracket. You do get to use uncle Sam's money (via depreciation) in the first scenerio, but the payback is quite severe.

When you do get ready to sell it, I suggest you have a tax advisor look over any options. There is a loophole, called a 1031 exchange(see http://63.123.136.2:28122/index.htm for some info), which can be used to defer the taxes due, and there are investment companies that facilitate exchange into their products (see www.myips.com for an example of one local to me). It takes some w*rk to find a good company, assuming you are inclined to go that way.

There may also be a way to salvage the personal residence exclusion - you should check with a competent tax advisor if you are interested.

As John R says, there are big bucks at stake. Do the research and planning first, as you can easily get stuck with a big bad tax bill.

Wayne