Diversification through rental property?

[krldrummerboy]

Was just speaking to a co-worker (we're in the bay area) who recently sold his local rental property. To avoid capitol gains he bought 2 rental properties in another state. He chose FL believing it would generate immediate cash flow (the bay area would not) after the 20% mortgage down payment. While he is working his plan is to put the returns back into the mortgage so that it's paid off by retirement (he's 38). The purchase was done without ever traveling to FL through a turn key type outfit that also manages the property. He did some due diligence and used a friend of a friend before investing and seems happy (although it's only been ~6mo).

I know many of the folks on this board mention rental property as part of their retirement income. Given that all of my assets are in my own home and the stock market, is doing the above a recommended method of diversification?

If yes, where do you start the research and what are the pit falls? I obviously am nervous about the thought of trusting someone like this (even if they turn out to be reputable):

BTW- I am 10-12 years from retirement. I would not buy rental property in the bay area (too expensive).

 

[exnavynuke]

I briefly considered rental properties and then dismissed the idea as I don't want to tie up that high of a percentage of my portfolio in one asset class and in such a specific manner. I figure my primary residence is already an investment in real estate. As such, when I look at my "total" portfolio, before even picking up a rental property my "diversification" already includes a significant percentage in real estate (primary residence value/total investment value). It can work out great, and it does for a large number of people. I'm just not comfortable with it. If I had won the powerball last night and had 130 million sitting around to diversify, then I'd most likely put 1-3% into real estate investments (rentals likely). For me, however, a single house in one city is a significant amount of a portfolio to put in one specific place. If you have a $1 million portfolio and own two $250k homes, then you've got 1/3rd of your net worth in a single, non-liquid, asset class. As Detroit and many other places have taught us, real estate is far from a guarantee, so I'll get my diversification elsewhere.

 

[COcheesehead]

A benefit of rental property is that someone else pays off your mortgage.
So if you have a long enough time horizon, you end up with a paid up property that should cash flow at a high rate.
The downside is do you want to mess with the property? I own a commercial building and the tenants are paying it off, but I still have to screw with things from time to time.
I would not even entertain a property out of state and I wouldn't put a management company layer in place because that just sucks even more money out.
The time for buying real estate for most of the country was 5-9 years ago. Someone smart told me that money in real estate is made when you buy, not when you sell. I believe that.

 

[laurence]

Our threads posted just now are like matter/anti-matter collisions. If somebody else is doing the management, a large part of your cash flow goes with it, but it can work. I just think the market is a bit played out right now. But in general you want your rental local. Mine is 15 minutes away and it's still a pain to go over to fix something (or hand over the new parking permits the HOA mailed me instead of them - they are sitting in my front seat right now!). My parents paid off their rentals and have income stream from them now in retirement which is why I was willing to take the plunge. The leverage you gain by putting only a down payment on the place and letting renters pay the mortgage can definitely juice your returns, but if the market turns down...

....I'm always suspicious of anyone selling anything with "immediate cash flow". If the returns are so great, why do they need small time nobodies like us to invest? They'd have been acquired by Buffet by now.

 

[calmloki]

We've had rentals since the eighties and they have been our primary source of income for decades. I would not do what your fried did, no way no how.

Some do well with remote management; it just makes me twitch. This morning I got off the phone with the guy caring for our places 1000 miles away while we play snowbirds. The shower valve he has put 4(!) hours in on still leaks. The carpet guy didn't install the carpet with the curve we asked for in the livingroom/dining interface. The new formica is being installed - correctly? I know I could have handled those things efficiently were I onsite. But I'm not.

 

[Meadbh]

Over the past decade I have done something similar to what your friend is planning. Without going into too much detail, I have invested about $100k, and now have about $400k in equity and $100k in outstanding debt. My three remaining mortgages have interest rates from 2.19-2.59%. I adjust the mortgage payments to keep total cash flow neutral. The properties are professionally managed and I have been on several of the boards, so it is not a high yield investment, nor an entirely passive one (though it can be if you wish). As each mortgage is paid off, cash flow improves in a stepwise fashion and the surplus can be used to pay remaining mortgage debt faster, to invest in an additional property or as an income stream. Refinancing can generate cash not subject to taxes (at least where I live) but resale profits are subject to capital gains tax. My goal is to finish paying off all the mortgages within the next decade, which will leave me with a dependable income stream that should cover about 25% of my expenses and reduce the withdrawal rate from my other portfolios. This is definitely a long term strategy and is not for everyone. But if you consider that an initial investment of $100k will ultimately generate sufficient income to cover a quarter of my expenses, then it will have been worthwhile.

 

[Bruceski44]

I looked into a big property management company in Memphis, but could never get my analysis to match the numbers they were giving me. They weren't willing to dive into the numbers to reconcile the differences, so I chose not to proceed.

Your initial workload is doubled, because not only are you vetting the location and properties, but you are also performing due diligence on the property manager. Even after you've been involved for a while, you must still expend significant effort managing the manager. It may be just a phone call, but you must stay closely involved. It isn't a hands-off type of deal, although your manager might tell you it is because that makes it simpler for them.

You really have to stay up on recent trends at this point of the cycle to determine if you should get involved. The news today said that single-family homes have been selling at the fastest pace in recent years. That's just a single data point, but it may signal the end of the strong single-family rental market, or at least that the strong rent growth we've seen may be slowing down because more people are buying.

 

[rayvt]

Rental property is not so much an investment as a business.

I've never had sone of my stocks call me on Sunday morning to complain that the kitchen sink overflowed all over the floor (because they had been pouring cooking grease down the drain after frying fish).

If you want to run a business, go for it. Bur to me "retired" doesn't mean having a part-time job managing a bunch of rental houses.

 

[Texas Proud]

I always wonder what kind of real return rental property returns...

As some have mentioned, it is the gain in RE value that is the big thing... but there are many places where RE does not even keep up with inflation....

And if a property is cash flow negative, then it is a loser IMO...


So, what is an all in 5 year or 10 year return on a RE investment portfolio... and if you are managing it yourself, how many hours have you put into that portfolio over those time periods since I believe that you need to factor in a salary for those hours....

 

[Luck_Club]

I love rentals. They provide steady predictable cash flow, with minor output of effort. I started in my early 30's, and several which had a few hundred a month cash flow when purchased are close to being paid off.

Evaluating a good vs bad deal can be done on the back of an envelope, and lots of rules of thumbs can be applied.

1 months rent time 100 should be your purchase price or less. This way you have covered taxes and insurance.

10% net. If you paid all cash you should net a 10% return. rents-(taxes+insurance)=1/10 of the cash invested.

Needed to be successful:
Basic handyman skills
Good BS detector
Zero tolerance for excuses.
If the rents don't throw off a few hundred after mortgage and taxes forget it!
My mantra is ability to pay, willingness to pay and the wisdom to know the difference.

If you call a plumber when the toilet clogs; don't do it.
If you can't replace a broken light switch; don't do it.
If you pay a painter vs do it yourself; don't do it.
If you aren't willing to treat contractors like an hourly day laborer; don't do it.

Over the years I've had "low skilled" contractors ask for well over $100 per hour for labor.

Septic installation prices ranged from $100,000 to about $7,000. Knowing and being able to determine what is the correct rate is the biggest challenge. $100,000 guy wanted me to sell 4 neighbors on upgrading their systems and get a variance from the 5th for him!

Any contractor that asks before giving me a quote, "so what do you do for a living" is really asking how much can I get away with charging you.

 

[laurence]

I always wonder what kind of real return rental property returns...

As some have mentioned, it is the gain in RE value that is the big thing... but there are many places where RE does not even keep up with inflation....

And if a property is cash flow negative, then it is a loser IMO...


So, what is an all in 5 year or 10 year return on a RE investment portfolio... and if you are managing it yourself, how many hours have you put into that portfolio over those time periods since I believe that you need to factor in a salary for those hours....

Yes it's a high paying part time job!

 

[Luck_Club]

I always wonder what kind of real return rental property returns...

So, what is an all in 5 year or 10 year return on a RE investment portfolio... and if you are managing it yourself, how many hours have you put into that portfolio over those time periods since I believe that you need to factor in a salary for those hours....

My total time is heavily weighted to tenant turn over. During a turnover (about every 2 years at "market+ rates") I invest about 30 hours all in. This includes painting, fixing little crap, and screening tenants. That is about 1.5 hours per month for a $300-500 monthly positive leveraged cash flow.

I've dramatically cut that down recently by having the previous tenant show and discuss the rental with potential tenants, only meeting to take the physical application and collect the deposit.

I typically throw them about 1/4 month rent for helping me out.

What I'm willing to buy will be throwing off between a 10% and 15%, if I paid cash. Below that I walk away.

Example:
$200,000 duplex Leveraged
Down payment =$50,000
Improvement =$14,000
Time=80 hours (general improvements)
Rents =$2150
Taxes=$350 month
Insurance=$125
Mortgage payments=$900 @6%
Total monthly cost=$1375
Free cash flow=$775 per month
Annual free cash flow=$9300
Annual return on cash=14.5%

Out of that you have continued maintenance and lost rents. However, I'm now below market and having no issue holding long term or turning over quickly.

 

[Another Reader]

"1 months rent time ten should be your purchase price or less. This way you have covered taxes and insurance."

I don't think this is what you meant. If you can find properties like this, they would be in burnt out sections of Detroit.

Most people that invest in paper assets have no business investing in rentals. It's a business that requires a lot of skill. You can be a very involved landlord, or take a lower return and call plumbers, electricians, roofers and the handy man or woman.

Return can be from cash flow and/or appreciation. I do not bet on appreciation except over the very long term.

Turn key companies exist to make their principals money, not you.

 

[Another Reader]

My total time is heavily weighted to tenant turn over. During a turnover (about every 2 years at "market+ rates") I invest about 30 hours all in. This includes painting, fixing little crap, and screening tenants. That is about 1.5 hours per month for a $300-500 monthly positive leveraged cash flow.

I've dramatically cut that down recently by having the previous tenant show and discuss the rental with potential tenants, only meeting to take the physical application and collect the deposit.

I typically throw them about 1/4 month rent for helping me out.

What I'm willing to buy will be throwing off between a 10% and 15%, if I paid cash. Below that I walk away.

Example:
$200,000 duplex Leveraged
Down payment =$50,000
Improvement =$14,000
Time=80 hours (general improvements)
Rents =$2150
Taxes=$350 month
Insurance=$125
Mortgage payments=$900 @6%
Total monthly cost=$1375
Free cash flow=$775 per month
Annual free cash flow=$9300
Annual return on cash=14.5%

Out of that you have continued maintenance and lost rents. However, I'm now below market and having no issue holding long term or turning over quickly.

That's one percent of your all in cost per month. More likely what you can find in a decent area. For multis, you look for closer to two percent per month. Tenant quality is generally lower, turnover more often, and appreciation generally follows rent increases in stable markets.

 

[wolf]

Also live in Bay Area. Bought my rentals many years ago. Location, Location,
and Location. Now paid for. Good rents and appreciation. However,real estate is not a straight line. It does go up and down.

Have 2 friends who did the same as your friend. Sold/traded, local Bay
area rentals for out of state. Reasoning. Can buy multiple units, diversify
the rents, used property mangers.

Short version: Big mistake. Paying property managers very expensive.
Repairs, costly. (if local, you could do yourself).
Tenant turnover, high. (if you manage your own rentals
you are more careful). (property manager's have no
incentive, to try and find long term tenants).

One friend, said, never again. The other, I have not talked to recently.

 

[Luck_Club]

"1 months rent time ten should be your purchase price or less. This way you have covered taxes and insurance."

I don't think this is what you meant. If you can find properties like this, they would be in burnt out sections of Detroit..

Correction 100 times 1 months rent.

 

[COcheesehead]

As some have mentioned, it is the gain in RE value that is the big thing... but there are many places where RE does not even keep up with inflation....

...

Gain in value is a bonus. Having someone else pay the mortgage until free and clear is the real value. Then the cash really flows.

 

[COcheesehead]

Correction 100 times 1 months rent.

Average rent in Denver is about $1500. By your formula you need to buy a $150,000 place. Ain't no way someone is dropping $1500 on a $150,000 place. That would be a Tuff Shed in someone's backyard.

 

[Bamaman]

My buddy was CEO of a mid size company--well to do guy. He told me the other day that every wealthy person he knows had one common investment--rental properties.

But like was just said, Location-Location-Location is the most important part of it.

Many local people have properties on the Gulf of Mexico--either Gulf Shores, AL or Destin, FL. And few are seeing big positive cash flows every year. But sales prices are coming back up from the big downturn in 2008.

I personally would want to live close to any rental properties. I've never thought expensive management companies are capable of maintaining property at the lowest cost. Nothing beats being to see your assets with your own eyes.

 

[Luck_Club]

Average rent in Denver is about $1500. By your formula you need to buy a $150,000 place. Ain't no way someone is dropping $1500 on a $150,000 place. That would be a Tuff Shed in someone's backyard.

https://www.zillow.com/homes/for_sa...,-104.270554,39.510927,-105.440598_rect/9_zm/

Offer 30% below asking move on to next, Rents are roughly $1250 a 2 bedroom.

May take 20-30 places before you find the right one.

 

[COcheesehead]

https://www.zillow.com/homes/for_sa...,-104.270554,39.510927,-105.440598_rect/9_zm/

Offer 30% below asking move on to next, Rents are roughly $1250 a 2 bedroom.

May take 20-30 places before you find the right one.

You don't understand this market at all. You don't offer less, you offer more.
Which is why your formula is off and why rental RE today in Denver is a fools game.
They will get 3-5 offers and sell around $200,000 or more. My wife is in RE she sees this everyday. Denver RE is on fire now.

 

[moneyviking]

I would be hesitant to make your first venture in rental properties an out of state adventure. you will want to drive past (ie stalk) your first baby in a market you are at least a little familiar with.

The turnkey out of state is for when you are more comfortable with the whole process. IMO.

 

[Luck_Club]

You don't understand this market at all. You don't offer less, you offer more.
Which is why your formula is off and why rental RE today in Denver is a fools game.
They will get 3-5 offers and sell around $200,000 or more. My wife is in RE she sees this everyday. Denver RE is on fire now.

Don't claim to know Denver at all. Real Estate is an inefficient market at best, which is why you can usually make money in it. If it is on fire, if you buy today another sucker will pay more tomorrow, until it crashes.

 

[COcheesehead]

Don't claim to know Denver at all. Real Estate is an inefficient market at best, which is why you can usually make money in it. If it is on fire, if you buy today another sucker will pay more tomorrow, until it crashes.

Like I said up thread. The money was made buying 5-9 years ago... when no one would touch RE.

 

[Another Reader]

Like I said up thread. The money was made buying 5-9 years ago... when no one would touch RE.

Absolutely right. I'm selling one rental now that's not been a top performer and if prices continue to go up, I may sell another I originally planned on keeping or the other marginal performer at the end of the lease. Going to use up stored depreciation from the early years to avoid paying tax on depreciation recapture and the capital gains. Pay off some mortgages and put away some cash for the next downturn.