What would you do (asset diversification)?

[SmallCityDave]

First and foremost I understand I need to diversify but here is my real world situation.


My question is keep investing in rental real estate or in my 401k?
Real world numbers over my last 5 or so purchases:


When I buy a home and fix it up my out of pocket cost is $100k, the home is worth $150k.


My $100k investment returns $1625 per month, my "take home" portion is 70% after property taxes insurance, repairs and vacancy so that equates to $1125 per month or $13,500 per year.


I'm in real estate and these opportunities don't present themselves too often, these investments are certainly not passive but all in all I can't complain with the time and effort I put into them.

 

[jazz4cash]

You have to figure out a way to do both. Maybe not all at the same time but do as much as you can each year. Does your 401k have a match?

 

[OldShooter]

Well, as @jazz4cash implies, you should absolutely be taking advantage of any match.

You should also be diversifying. That is the cardinal rule of investing; no asset class is so good and so reliable that it is suitable to be anyone's sole investment.

FWIW, your return of 13.5% is a bit of a mirage too. First, you spend time taking care of these properties, doing bookkeeping, etc. So part of that $13.5K is really payment to you for doing the manager job, not return on your investment. As a SCORE small business mentor I run into this all the time. I tell clients that a business owner should be getting two kinds of return. First, a market rate salary for the work he/she performs. Second, a return on the investment he/she has made in the business. When thought about this way, then the P&L accurately represents the business. When the profit just equals the market rate salary, we say that the owner has "bought themselves a job" since he/she is getting no return on investment. So, for example, if building management fees in your market run 7% then your return on your investment is 6.5%.

As long as you are happy to do the management job, then there's nothing wrong with banking the 13.5% but it is not all return on investment.

Finally, is that $150K "value" a net amount after selling costs? If it's a gross number you are misleading yourself. And who will manage, what will happen to the properties when you die? This kind of real estate is a poster child for illiquidity.

 

[RunningBum]

Could you or one of the mods please make the thread title less generic? Something like the question you ask in the second line?

 

[SmallCityDave]

Well, as @jazz4cash implies, you should absolutely be taking advantage of any match. -- I'm self employed, it's only matched if I match it.

You should also be diversifying. That is the cardinal rule of investing; no asset class is so good and so reliable that it is suitable to be anyone's sole investment. -- Agreed

FWIW, your return of 13.5% is a bit of a mirage too. First, you spend time taking care of these properties, doing bookkeeping, etc. So part of that $13.5K is really payment to you for doing the manager job, not return on your investment. As a SCORE small business mentor I run into this all the time. I tell clients that a business owner should be getting two kinds of return. First, a market rate salary for the work he/she performs. Second, a return on the investment he/she has made in the business. When thought about this way, then the P&L accurately represents the business. When the profit just equals the market rate salary, we say that the owner has "bought themselves a job" since he/she is getting no return on investment. So, for example, if building management fees in your market run 7% then your return on your investment it a 6.5%. -- While I agree with you to an extent I'm not sure I'd call it a mirage. I'm already "out in the field" my time is worth $100 per hour (to me) and I doubt I have much more than 10 hours "working" on these homes per year (I spent more time and effort this year researching FA's and 401k's). Would I do this for someone else for a $100? no, would I have someone else doing it for me for $100? no I wouldn't trust anyone in this stage of my life.
As long as you are happy to do the management job, then there's nothing wrong with banking the 13.5% but it is not all return on investment. I'm not sure I'm happy to do it but it appears to be the highest and best use of my resources, I do wish I had a great alternative that I understood and believed in as much a real estate.

Finally, is that $150K "value" a net amount after selling costs? If it's a gross number you are misleading yourself. And who will manage, what will happen to the properties when you die? This kind of real estate is a poster child for illiquidity. It's FMV at the end of the rehab, I'm not misleading. We just had this conversation, the homes would be sold off at the end of each lease.

See above.

 

[Aerides]

Could you or one of the mods please make the thread title less generic? Something like the question you ask in the second line?

added "(asset diversification)" to the question. Hope that helps.

 

[OldShooter]

See above.

OK; My standard warrantee: All opinions guaranteed worth price paid.

Re "FMV at the end of the rehab" then you probably have to deduct 5-10% in selling costs to estimate your net. $100K to get $135K or $140K net is still pretty good, though.

 

[pb4uski]

It looks to me that you are making $50k on selecting the house and fixing it up and your annual return is not 13.5%, but more like 9% ($13.5k/$150k). IOW, after the fix up the house is worth $150k and rather than flip it, you chose to operate it and that brings in $13.5k on what could have been $150k in cash. (Ignoring sales costs).

The issue that I have with real estate is concentration risk. If your particular little corner of the country goes to hell in a hand basket, not only is your livelihood impacted because you are in the real estate business there, but your portfolio of properties is dinged as well.... meanwhile, the rest of the country might be doing fine. For example, our neighbor at the end of our road owned a commercial building in Flint, MI and took a bath on it when the SHTF there.

It looks like your sweet spot is identifying good values, buying them and fixing them up. Your sweet spot might be buying properties, fixing them, leasing them and selling them after the one-year LTCG period is over and then investing the proceeds in your 401k so you are less geographically concentrated.

Or in short, do both!

 

[Another Reader]

I think it depends on what is going on in the real estate market and the paper asset markets. When you diversify between very different asset classes, I prefer to look for what's "on sale." If you can still find those deals, in your shoes, I would keep accumulating properties.

I would also keep some cash and other short term reserves to carry you through slow times in the real estate business and a major downturn where rents go down, evictions happen, and vacancy goes up. The two things are likely to go hand in hand, so I would be heavier in cash than most cyclical business owners so I could wait out the downturn comfortably.

Anytime I had cash that wasn't needed for reserves and there were no good deals, I would load up that 401(k). If the paper asset markets go on sale, and you have sufficient savings to get through a major recession, I would throw all extra money there.

One thing to remember is that rents don't always correlate with values. When the SHTF in 2009-2012, single family prices were going down while rents were going up in many markets. You have to look at what's happening at that point in time to decide where your money is best invested.

I like pb4uski's idea as well. It does not work in a market full of hungry flippers and HGTV addicted millennial buyers with money, but it might work well in a more balanced market.

 

[Nature Lover]

It looks to me that you are making $50k on selecting the house and fixing it up and your annual return is not 13.5%, but more like 9% ($13.5k/$150k). IOW, after the fix up the house is worth $150k and rather than flip it, you chose to operate it and that brings in $13.5k on what could have been $150k in cash. (Ignoring sales costs).

The issue that I have with real estate is concentration risk. If your particular little corner of the country goes to hell in a hand basket, not only is your livelihood impacted because you are in the real estate business there, but your portfolio of properties is dinged as well.... meanwhile, the rest of the country might be doing fine. For example, our neighbor at the end of our road owned a commercial building in Flint, MI and took a bath on it when the SHTF there.

It looks like your sweet spot is identifying good values, buying them and fixing them up. Your sweet spot might be buying properties, fixing them, leasing them and selling them after the one-year LTCG period is over and then investing the proceeds in your 401k so you are less geographically concentrated.

Or in short, do both!

This is what I'd do. Very well said!

 

[SmallCityDave]

It looks to me that you are making $50k on selecting the house and fixing it up and your annual return is not 13.5%, but more like 9% ($13.5k/$150k). IOW, after the fix up the house is worth $150k and rather than flip it, you chose to operate it and that brings in $13.5k on what could have been $150k in cash. (Ignoring sales costs).


My ROI is $13.5k per year and my investment is $100k but regardless we are saying the same thing.


The issue that I have with real estate is concentration risk. If your particular little corner of the country goes to hell in a hand basket, not only is your livelihood impacted because you are in the real estate business there, but your portfolio of properties is dinged as well.... meanwhile, the rest of the country might be doing fine. For example, our neighbor at the end of our road owned a commercial building in Flint, MI and took a bath on it when the SHTF there.


I agree about the risk.


It looks like your sweet spot is identifying good values, buying them and fixing them up. Your sweet spot might be buying properties, fixing them, leasing them and selling them after the one-year LTCG period is over and then investing the proceeds in your 401k so you are less geographically concentrated.


I've done this to build capital to buy more properties now it's a lot harder to find homes with margin. Right now my focus is on income so that if we want to retire early we can.


Or in short, do both!


That's my thought process, do both until we have about 10 homes after that most everything into the 401k.

See above.