Long Term Rental Properties

When a new real estate investor sits down and looks at one of our cashflow analysis for the first time, she usually has a puzzled look on her face. And it’s understandable – Here she is looking at a financial projection where she invests $30,000 of her hard earned capital for an annual return of $3600-$4500 per year. Sure, 12-15% cash on cash return is nothing to sneeze at but in the end $4k per year won’t exactly change your life. It isn’t the lucrative, rich overnight image projected when people speak of real estate investing. It’s not the sexy buy-renovate-resell-double your money kind of strategy. So inevitably, the question comes up: Wouldn’t it make more sense to purchase a home to flip with that capital and earn much more money in a very short term? This is the part where I smile.

The debate over the merits of flipping homes versus investing in real estate long term is not even a close contest. As a matter of fact, they don’t even belong on the same debate stage and in this post I intend to show you why.

Our starting point is a look at the real math of flipping homes. Let’s look at the facts: even if you were able to acquire the property low enough, by the time you pay selling costs, closing costs, holding costs, rehab costs and Uncle Sam, your true return on investment isn’t exactly what you expected even in the most optimistic of scenarios. But let’s assume you are reasonably successful and don’t make any major mistakes. In normal times, reasonably successful flips take 100-150 days to complete  – purchase to resale. So, assuming that you’re not running multiple crews (which most new investors don’t) you could complete two to three flips a year and make $35k-45k per year after tax. That’s if none of those flips end up being break even deals or worse, money losers. In a perfect world with no market downturns that wipe out more flippers than a Japanese tsunami, you could make $350k to $450k in a ten year period. No income. If you want to take a break from flipping homes, the money flow grinds to a halt.

Now let’s look at a similar situation where the investor executes a long term investment strategy instead. The investor methodically acquires nine investment properties in great locations with high tenant demand over 36-48 months. On our advice, she opts to go for capital growth first and income later. So, she grows her capital by aggressively paying down the mortgages on her properties according to our Domino Strategy using positive cashflow from the properties themselves and her job income. All in all, she invests $300-340k of her capital and ends up with a free and clear portfolio in 10-12 years. This portfolio is worth $1.2M without a penny in appreciation over that time frame. In addition, her portfolio provides our investor with over $100k in annual income thereafter. So let’s do some arithmetic: From $300k to $1.2M in 10 years is $900,000 of capital growth or $90,000 per year. And on top of that there’s $100k of annual income to boot? And you didn’t have to deal with contractors for 10 years of your life, nonstop?  And you can take off to your favorite island for a month or two while income still flows to your account regularly? As I said, not even close.

Mitchell Joyce via Compfight

Sometimes people become real estate investors on purpose: They have a clear goal, they plan for it, analyze investment opportunities then pull the trigger on the option that better helps then achieve that goal. However, at times one can become a real estate investor by inertia. The property could be a former residence that got converted to a rental once they moved up in house. Or it could have been student housing for their children while they were going to college and became a rental once they graduated.

In the end, it doesn’t really matter that much how one comes to own an investment property – it matters how that property is performing and whether it is propelling that investor towards the fulfillment of that goal. So in that spirit I want to ask those inertia investors a Dr Phil question: How’s that been working out for you?

Certainly, there are exceptions as there are with every rule. But in the overwhelming majority of cases, the property is underperforming as a real estate investment. It might be breaking even or even costing the investor some money every year. But it’s easier to continue that inertia “trend” then to do something about it and right the ship. It feels that way because the opportunity cost of sticking with an underperforming property isn’t readily apparent. So allow me an illustration.

Jim Investor owns a property worth $130k with a $85k remaining balance on the 5% 30 year mortgage with 16 years left on it. Currently the property pays for itself most years except when repairs exceed the “normal” range. So Jim sees no reason to fix a situation that’s “not broken”. Let’s take a quick look at the numbers. Jim has $45k in equity in the property. Best case scenario, his return on that equity is the amount that goes to principal from his mortgage payment or $1959.54. That’s a 4.3% return on a best case scenario! What happens when the AC has an issue and needs a major component replaced? Rhetorical question.

If you’re in the same situation, here’s how to tell whether you should stick with the status quo or make a move to improve it. Answer this question: If you didn’t own that property, would you go buy it today as a pure investment property? If the answer is no, there are much better opportunities for that equity capital within that property. You could sell the underperforming asset and trade to purchase a newer property in a better location with higher rent demand than the current. And your rate of return would be 4 times the best case scenario mentioned above. Isn’t it time to take control and be intentional about your investing?

If you’re in this situation currently and would like to do something about it, call my cell at 713-922-2702. I will show you step by step how we can go from “inertia” to “on purpose”. 

Aftab Uzzaman via Compfight

Sometimes people become real estate investors on purpose: They have a clear goal, they plan for it, analyze investment opportunities then pull the trigger on the option that better helps then achieve that goal. However, at times one can become a real estate investor by inertia. The property could be a former residence that got converted to a rental once they moved up in house. Or it could have been student housing for their children while they were going to college and became a rental once they graduated.

In the end, it doesn’t really matter that much how one comes to own an investment property – it matters how that property is performing and whether it is propelling that investor towards the fulfillment of that goal. So in that spirit I want to ask those inertia investors a Dr Phil question: How’s that been working out for you?

Certainly, there are exceptions as there are with every rule. But in the overwhelming majority of cases, the property is underperforming as a real estate investment. It might be breaking even or even costing the investor some money every year. But it’s easier to continue that inertia “trend” then to do something about it and right the ship. It feels that way because the opportunity cost of sticking with an underperforming property isn’t readily apparent. So allow me an illustration.

Jim Investor owns a property worth $130k with a $85k remaining balance on the 5% 30 year mortgage with 16 years left on it. Currently the property pays for itself most years except when repairs exceed the “normal” range. So Jim sees no reason to fix a situation that’s “not broken”. Let’s take a quick look at the numbers. Jim has $45k in equity in the property. Best case scenario, his return on that equity is the amount that goes to principal from his mortgage payment or $1959.54. That’s a 4.3% return on a best case scenario! What happens when the AC has an issue and needs a major component replaced? Rhetorical question.

If you’re in the same situation, here’s how to tell whether you should stick with the status quo or make a move to improve it. Answer this question: If you didn’t own that property, would you go buy it today as a pure investment property? If the answer is no, there are much better opportunities for that equity capital within that property. You could sell the underperforming asset and trade to purchase a newer property in a better location with higher rent demand than the current. And your rate of return would be 4 times the best case scenario mentioned above. Isn’t it time to take control and be intentional about your investing?

If you’re in this situation currently and would like to do something about it, call my cell at 713-922-2702. I will show you step by step how we can go from “inertia” to “on purpose”. 

Aftab Uzzaman via Compfight

At some point or another, every real estate investor has experienced temptation. You could be the new real estate investor just getting started that gets his head turned by an obscene cash on cash return rate. Or you could be well on your way after purchasing several quality assets and questioning your direction when you see higher cap rates or lower prices elsewhere.

Analytical minds love simplicity. I know because I’m the proud owner of one. We hate ambiguity, it’s “maybes” and “it depend”s. Instead we seek factual benchmarks, hard statistics that show what’s what without a shadow of a doubt. It’s simpler that way: A cap rate of 9 is better than 6 or a cash on cash return of 20 is better than 13.

The problem is long term real estate investing is much more complex than that. When you try to reduce in depth analysis down to the myopic perspective of an indicator or two, it leads to wrong answers.

Ceteris paribus – all else equal – a higher cap rate and cash on cash return is better than a lower one. Thing is, all else is rarely equal. Higher returns on paper typically reflect a higher level of risk. Think about it this way. In order to acquire a property in a great location you will generally have to pay more than if you were to acquire the same in an inferior location. In addition, properties priced lower tend to have lower property taxes, insurance costs and HOA dues. When you pay less to acquire the same income stream, your rate of return on paper increases substantially. So it follows that to get off the chart returns you have to settle for lower asset quality. Since the property “picks” the tenant, that leads to lower quality tenants which leads to higher vacancies and turnover and lower actual returns. Defeats the purpose, doesn’t it?

So when you read that pro forma income and expense statement the question you should ask yourself is: Am I looking at a paper tiger? Because in the end, the only returns that matter are the ones you get to keep.