Report finds residential real estate underperforms other assets

[calmloki]

Exactly ... the "sell decision" is in that calculation. Especially if you believe the run-up of the last decade will not continue.

Calmloki,

Hows your return on investment ((profits from rents)/(current market value)). Trying to see if the west coast results mirror the east coast.

Thanx in advance!

I suspect there's going to be some variation depending on location and type, but we just did a report for the tax lady Friday, so:
NOT including any depreciation for the year, and using what I think are pretty realistic projected sales numbers, also, F&C properties, so no interest expense:

a 1972 16 unit in town of 18,000: 9.23%
a 1945 8 unit in a town of 150,000: 9.2%
a 1915 3br/1ba in a college town of 8,000: 5.789%
a 1945 3br/1ba in a town of 18,000: 5.09%

The above figures also do not put any value on our management or my repair time, OTOH, the rentals buy our computers and most of my tools. OTOH, I doubt we would own a $450 drain snake (rarely used 'cause I hate using it) or a couple commercial rug machines (used about 5 times/month) if we just owned stocks and bonds. If I subtract 10% of rent for management and my labor, which is probably modest,

the 1945 3br made 4.404%
the 1915 3br made 5.05%
the 1972 16 unit made 7.777%

I figure over the long haul that appreciation matches inflation - at least that's what we tell ourselves. The past 5 years are anomalistic in my opinion.

My current favorite tool, BTW, is my Kwikset rekeying kit - that was an outstanding use of $90 - allows me to rekey and master key our locks so I can carry around 1 key instead of a box full.

Edit: just back from a showing and realized I had taken 10% of the profit as a management/labor figure. Corrected to use 10% of the gross rents as a management/labor figure.

Another interesting unit is a 3br/1ba, maybe 1955? in the same town as the 1915 house. We bought it, re-roofed, redid the bathroom, lots of yardwork and a full in/out repaint, then borrowed at 6% on a 7 year int only ARM the purchase price and the entire amount of the money we had invested. We could pay it off in full, but I'm resisting my natural impulse. That one looks like it returned a whole 1% after subtracting 10% of gross rent as a management/labor fee. So there we are (hopefully) tracking inflation and making 1% on $0! Wait a minute - that doesn't seem right....

 

[al_bundy]

i think it depends when you first buy in. if you bought a first home in the mid 1990's then you made out like a bandit almost anywhere in the US but when you factor in interest and taxes the return is not that good. on the other hand i work with someone that bought into a nice NYC suburb back in the late 1980's and was upside down until a few years ago.

 

[chinaco]

For some reason, I do not think home ownership is a simple asset investment. It seems to me that (for a primary residence) it is my home first and an investment second. The article paints a very one-sided picture. I wonder what it would look like if one compared a home with another asset of similar risk and took all expenses and gains over a twenty or thirty year period and cashed out what one would net. It would not be quite fair to compare a house as an investment against another asset class that carries much more risk (i.e., apples and oranges).

A couple of things that would need to be considered is if one rented a similar dwelling for the 20 or 30 year period (an added expense). Of course, owning real-estate requires real-estate taxes to be paid, however for most houses (below $500k) I do not think you would have tp pay long-term capital gains when the house was sold.


I suspect that for most people, a house winds up being a more realistic investment than other investments that have similar risk. By that I mean... I cannot live in a Bond! That said... I have not run the numbers.

 

[haha]

Comparing returns on a primary residence to any other market is always gonna be an apples to oranges comparison. People over improve and/or decorate to thier taste.

I've got nearly 20 years of MS money data on the units I keep. So I can run these numbers to the penny. For years my return was in the 6-7% based on only rental income (compared to CURRENT market value).

T, is this return after a sinking fund amortization for infrequent expenses like sewer assessments, new roofs etc that would be considered capital expenses for tax purposes, but are in fact necessary for you to continue renting the asset?

If so this is an excellent real return, comparable to a MLP GP yielding similarly, or a good bank when it can be bought at a similar current yield.

Ha

 

[tryan]

Ha,

No sinking fund is in those numbers ... just pure expenses. Did have new roof in the last year and and new sewer line dug (as the existing was rooted).... and the year before there was the water main break. Just comes with the territory.

Calmloki,

Thanx for sharing! Nice to see the multis doing so well. Gave all mine up for single families years ago. Too much bitching between tenants.

Also did not pay myself in my numbers if I did the returns would be lower. One thing for sure, hired management will turn a positive cashflow into a negative one(been there done that!). Much better off doing the management myself . 8)

 

[Craig]

BTW, if we're going to factor in interest on residential real estate returns, then shouldn't we factor in some margin interest on equity returns ...

Or, simply look at the returns cash-on-cash ... probably the fairest comparison. Residential real estate can look pretty good in that real world measure.


Clearly, timing, and location-location-location are important factors.

 

[BarbaraAnne]

We've owned residential real estate in AZ, OR, CA, TX and TN. All but TX showed us very clearly that residential appreciation can far outstrip inflation. AZ showed us returns far in excess of the S&P 500. At least for the periods we owned.

TX was pitiful ... a function of high real estate taxes, and huge amounts of private land available.

Very true...in addition developers are out of control and there is no balance between supply and demand. The only folks making money are the developers, builders and realtors!

We have a 12 year old house and need to put quite a bit of money into it to resell it! If you don't, buyers won't look. There are too many new houses in new developments for sale!

However, on a positive note, the homes here have a lot of nice features and finish-out that are only available in other parts of the country in much more expensive homes. When we move, we will be giving up a lot of amenities that we have here for a similarly priced, if not more expensive, home. In addition, we are close to 2 major airports, several excellent hospitals and great restaurants, recreation and sports venues. Our home may not be a great moneymaker for us, but it sure is conveniently located.

However, we are ready to try somewhere new for retirement!

 

[calmloki]

BTW, if we're going to factor in interest on residential real estate returns, then shouldn't we factor in some margin interest on equity returns ...

Dunno what margin interest is, but most of the places I used were free & clear.

"Or, simply look at the returns cash-on-cash ... probably the fairest comparison. Residential real estate can look pretty good in that real world measure."

Reasonable, but cash spent 15 years ago to buy a place for a paltry sum in today dollars would mask real return - I like Tryan's use of current property value - though it dawns on me that maybe we should use estimated sale price minus guesstimated taxes when trying to see how real estate would compare to a CD. That is, if the property sells for $300k, but after the tax man takes his bite you would only be left with $225 to buy CDs with then it seems that the return from a rental property is even better than thought. If Tryan's formula is revised to (profits from rents)/(current market value - (tax + cost of sale)) then our old 1915 3br/1ba making 5.05% (after factoring a cost for self management) would be making 6.73%. In other words, we would need to find an investment that made 6.73% above inflation in order to match the return of the rental. Holy cwap! And I want to bail out of the darn things!

"Clearly, timing, and location-location-location are important factors."
Clearly!

 

[tryan]

If Tryan's formula is revised to (profits from rents)/(current market value - (tax + cost of sale))

Weeelll, I didn't deduct taxes because - for the sake of comparison to other assests - Uncle and the states get the same cut (be it RE, stocks, bonds, or be3ver cheese futures). But transaction costs definately vary (RE is higher ... but by how much ? 5%??)

 

[Craig]

By margin interest I meant loans on brokerage accounts, secured by the stocks, used to buy stocks. I don't understand the perspective that somehow mortgages are bad ... it is an advantage we can so easily leverage real estate investments, taken in moderation.


Also note you can 1031 out of real estate into other real estate. Nice.


There are many advantages to real estate investments, and most folks that build a nice nest egg benefit at least a bit from some real estate investments along the way. Frankly, while I recognize Fidelity's motives, I think it is pretty rough and foolish to ignore this asset class, but to each his own.

 

[Nords]

Reasonable, but cash spent 15 years ago to buy a place for a paltry sum in today dollars would mask real return - I like Tryan's use of current property value - though it dawns on me that maybe we should use estimated sale price minus guesstimated taxes when trying to see how real estate would compare to a CD. That is, if the property sells for $300k, but after the tax man takes his bite you would only be left with $225 to buy CDs with then it seems that the return from a rental property is even better than thought. If Tryan's formula is revised to (profits from rents)/(current market value - (tax + cost of sale)) then our old 1915 3br/1ba making 5.05% (after factoring a cost for self management) would be making 6.73%. In other words, we would need to find an investment that made 6.73% above inflation in order to match the return of the rental. Holy cwap! And I want to bail out of the darn things!

You guys are about to send me back into spreadsheet hell.

Bought in 1989... major improvements made as a primary residence... rented out '94-97... moved back in for more primary-residence improvements and paid off the mortgage until we found a better residence in 2000... rental since then with then even more improvements and a new mortgage.

At least it's all in Quicken and the tax returns.

 

[lets-retire]

My experience has shown me that house ownership is profitable. The worst deal we've made was our first house and we still made a couple thousand. We did not do much maintenance on it and IIRC the place cost about the same as the townhouse we lived in after including utilities. I could go into the specific numbers for each house, but I don't have the desire to sit here and go through the past records. Our best one was the one we just sold. We owned it for a little over three years and walked out with about 60 or 70k profit. The mortgage was less than a similar house for rent just down the street, so in real terms we walked away with much more. Most of our houses were purchased with the thought of selling in a rather short time period, and we would not buy anything we thought we could not sell at an increased price in the short term.

 

[Craig]

BTW, I believe I saw somewhere an estimate of 1% to 2% annual repair costs.

Our home was purchased for $315K ... that would mean we're supposed to spend between $3,150 and $6,300 per year keeping it up. No way.

I can see spending that much on upgrades. Not just repairs and maintenance.


Perhaps the 1%/2% was based upon older homes ... not a well built home today, IMHO.

 

[tryan]

If Fidelity wants to compare ONLY primary residences ... it's a real diservice to ignore the fact that sale proceeds are TAX EXEMPT.

That alone puts all other assets at a 20-30% disadvantage (depending on your tax bracket).

 

[HFWR]

BTW, I believe I saw somewhere an estimate of 1% to 2% annual repair costs.

Our home was purchased for $315K ... that would mean we're supposed to spend between $3,150 and $6,300 per year keeping it up. No way.

I can see spending that much on upgrades. Not just repairs and maintenance.


Perhaps the 1%/2% was based upon older homes ... not a well built home today, IMHO.

I would think that would include longer-term maintenance, like the eventual HVAC, appliances, roofing, etc. replacements. You might not actually "spend" that much each year, just like the full cost of driving your car is not reflected in the price of fuel.

 

[haha]

BTW, if we're going to factor in interest on residential real estate returns, then shouldn't we factor in some margin interest on equity returns ...

This would definitely be true if we could get long term fixed rate loans against stocks. But we cannot, so advantage goes to RE on this dimension.

Ha

 

[Billy]

charles

BTW, I believe I saw somewhere an estimate of 1% to 2% annual repair costs.
Our home was purchased for $315K ... that would mean we're supposed to spend between $3,150 and $6,300 per year keeping it up. No way. I can see spending that much on upgrades. Not just repairs and maintenance. Perhaps the 1%/2% was based upon older homes ... not a well built home today, IMHO

HFWR

I would think that would include longer-term maintenance, like the eventual HVAC, appliances, roofing, etc. replacements. You might not actually "spend" that much each year, just like the full cost of driving your car is not reflected in the price of fuel.

We wrote a piece for The Motley Fool called Cost of Working: http://www.retireearlylifestyle.com/cost_of_working.htm where we discussed the cost of home ownership. We cited a current Wall Street Journal article that said "Almost every house, no matter how recently or expertly built, is a money pit."

I suppose in the end it's a matter of priorities and approach.

We have readers who were thrilled with the recent past's uptick in real estate and planned on selling their house to buy another cheaper one in a different state. They went traveling for 6 months, came back home and the market went soft. Now they have a 'ta-hoo-ma' (ta hoom I gonna sell this?) in one state and another home they are upgrading in another. Their (retirement) time is spent driving uhauls from one state to the other and repairing the 'new' place to suit them while they are hoping their other home sells.. meanwhile, the wife went back to work... ?

Again, I suppose in the end it's a matter of one's priorities and approach to housing.

Akaisha
Author, The Adventurer's Guide to Early Retirement