Stages of wealth

[corn18]

• • 
    #24.1
    TexasHusker commented
    Today, 12:23 PM
    Actually I am a fan of REITs for dependable income that is usually a multiple of CDs. But there is added risk with that income. Do your homework.
    
    With REITs however, you miss out on most of the magic of real estate - leverage.
    
    Here is an example: 18 months ago, I bought my dad a vacation rental for $182K, for income to pay for his care (he has Alzheimers). He paid cash for the house, but for a moment let's presume that he financed 70% of it.
    
    That would be a $54,600 initial investment, and let's toss in $5600 for closing costs and prepaids to make it an even $60K.
    
    Assuming 5.5% @ 30 years, the monthly debt/principal repayment is $728.
    
    His yearly expenses would be as follows:
    
    $8736 P&I
    $900 Property taxes
    $1200 insurance
    $4500 utilities
    $2500 repairs and maintenance
    
    Total rental income is around $32,000.
    
    Net yearly income is $14,164.
    
    That is a 24% return on investment per year. Remember, the amount invested is $60,000. And I am not factoring in the added income from depreciation if I chose to take it, OR the principal that the renters are steadily paying back. The real rate of return might well approach 30% a year.
    
    Just as a nice bonus, due to a tremendous price appreciation, it appears that my dad's cabin is now worth around $227,000. So toss in another $45,000 in profit potentially, after just 18 months.
    
    Hopefully this helps delineate the difference between REITs and a direct real estate investment.
    Last edited by TexasHusker; Today, 12:28 PM.

The real magic happens when you multiply this x5. $60k x 5 = $300k invested generating $70,820 of annual income. You would need $1.77M in a portfolio to generate that kind of income @ 4% withdrawal rate.

[TexasHusker]

That's true. What I have done is this: As my equity in each property grows - due in part from renters paying down principal, and due in part to price appreciation, I have done "cash out refinances" to fund additional Great Clips franchise locations. In fact I am in the process of doing that right now with a fourth location.

So I will have four locations, but no business debt per se - all of my debt is collateralized with income producing real estate.

There are many ways to save and invest - I've just discovered this particular way as I my niche.

[TexasHusker]

Here is my dad's cabin that I bought for illustration purposes. You can see the $182,000 that I paid for it last year, and what it is presumed to be worth today.

[james.hendrickson]

Here is my dad's cabin that I bought for illustration purposes. You can see the $182,000 that I paid for it last year, and what it is presumed to be worth today.

Oh - its really nice. Totally worth $182,000.

For what its worth, when I was living in DC, I had a good 3 apartment units out there - every couple of years I was able to take out $30,000-$40,000 from the portfolio because the appreciation was so strong in that market.

Owing lots of cash producing real estate isn't a bad way to go at all.

I guess the only thing I'd add here is to follow up on the point about real estate being able to deliver better long term returns. I *think* the returns to the asset classes are comparable.

Here is a conclusion from a NBER's study looking at the aggregate returns of various asset classes for the last 145 years. It basically says that equities and real estate both give you about 7%.

"Arguably the most surprising result of our study is that long run returns on housing and equity look remarkably similar."

Source: NBERs,

[TexasHusker]

If are you paying cash for real estate, I agree that the returns would be comparable. The study doesn't take into account leverage, which is the attractiveness of real estate.

A friend of mine ("John") builds nice, but affordable housing. For each house, he goes to the bank and puts down around $30K to start the project and the bank finances everything else until finish. John sells his houses for $175-200K, depending on amenities and finishes. It takes him about 60-90 days to complete a house. He pockets around $20K per house, and has to pay some interim interest over that 75 days. So his total investment might be $32K, but he makes $20K profit in 75 days. He can do that 4 times per year per house, which means he's using around $36-37K as leverage to produce $80K a year in income.

Stocks can't do that.

[corn18]

The key to examining real estate is really the cash flow. I can artificially inflate a RE rental investment by getting a VA loan with 0% down on a duplex and rent out half as owner occupied. If I generate $1 of profit, my return is infinite. Not sure why RE investors try to compare RE rental income to stock investment returns. Doesn't make sense. The income is what matters and RE can generate a lot of income on a lot less investment, and that is what is powerful. I would not want a portfolio of RE that generated 30% annual returns but that 30% only equalled a few thousand dollars of income.

[disneysteve]

Well technically you can leverage your money with stocks by buying on margin but it's an incredibly risky way to go about things. Buying RE with borrowed money is a far more common and accepted practice (and much lower risk generally).

[TexasHusker]

That is correct and it is very risky. That's because there is no hard asset as collateral, besides the share value. With real estate, you have a hard asset that presumably will never be worth $0, though I suppose anything is possible. I have had stocks that I thought were quite worthwhile investments quite literally drop all the way to zero (bankruptcy). I hope that never happens with my RE but it could!