By Dr. James M. Dahle, WCI Founder
Many physicians will own rental property at some point in their investment career. However, they often fail to analyze it properly before making the purchase. Applying five rules of thumb will help ensure a favorable investment outcome.
Rule 1: You Make Money When You Buy
Experienced real estate investors know that the secret to making strong returns on real estate is to buy a property at a fair price or, better yet, at a discount. You simply cannot pay “retail” and expect a good return.Retail is the price at which an inexperienced home purchaser would purchase the property to live in, and can easily be demonstrated using recent sales of comparable properties in the area. That means you cannot shop for a property using the Multiple Listing Service (MLS) and expect outstanding returns. By the time a property hits the MLS, the most experienced investors in the area have already taken a pass at that price. That doesn’t mean you cannot purchase a property listed in the MLS, it is just that you need to pay 10% to 20% less than the retail price listed there.
When you buy a house to live in, there are a lot of factors that go into it. Do you like the neighbors? Are the schools good? How long is the commute? How will your furniture look in the house? Can you see yourself growing old there? These and a dozen other issues come into play.
But when you buy an investment property the purchase is all about the money. What kind of a return will you get on your investment? You do not care about the color of the carpet, only about how soon until you will have to replace it. You should not care about the school district or the distance from the hospital, only about what you can get for rent.
Rule 2: Use the 55% Rule to Determine Your Net Operating Income
Perhaps the most important number to know for a rental property is its net operating income (NOI). This is the amount of money you get after all expenses, except financing costs like principal and interest payments. You don’t actually need to know all the expenses a property may have in order to estimate this.
A seller obviously has a great incentive to report that the expenses are very low, but very low reported expenses may mean that you have some large expenses coming up, such as replacing the roof, air conditioner or windows. A good rule of thumb is to multiply the gross rent for the year by 55%. Approximately 45% of the gross rent will go toward vacancies, insurance, maintenance, property taxes, snow removal, lawn maintenance, repairs, and management costs (whether you pay them to someone else or use your time to avoid that expense).
Rule 3: Use the Capitalization Rate to Compare One Property to Another
The capitalization rate (cap rate) can be used to compare one property to another. The cap rate is figured by dividing the NOI by the value of the property. This is also the “cash-on-cash” return if you simply purchase the property outright, without a mortgage, or will be your cash-on-cash return once you pay off the mortgage.
If you purchase a property for $100,000 and the gross rent is $1,000 per month, or $12,000 per year, then your NOI is $12,000 x 55%, or $6,600, and your cap rate is 6.6% ($6,600/$100,000). As a general rule, a cap rate of 6% to 8% is pretty good, a cap rate of 3% to 4% is not good, and a double-digit cap rate is excellent. Your cap rate is heavily affected by the purchase price. If you had purchased that same property for $140,000, your cap rate would be just 4.7%. If you were able to purchase the property for $80,000, your cap rate would be 8.25%.
Your cap rate is the equivalent of a stock dividend. While the property is likely to increase in value at about the rate of inflation as you are able to increase the gross rents, the net operating income is really what is going to provide most of your investment return, both as cash flow and as amortization on any mortgage you may have on the property.
If you buy a 6% cap rate property for cash and the property appreciates at 3% per year, then your return will be 9% per year. You may also be able to get some significant tax breaks as you depreciate the property; but if you sell the property prior to your death, that depreciation will mostly be recaptured.
Rule 4: You Must Put Down a Significant Down Payment If You Want Positive Cash Flow
Consider again our $100,000 property with $1,000 per month rent. If the NOI is $6,600 per year, then your financing costs must be less than that in order to be cash flow positive. That means you cannot spend more than $550 per month on mortgage payments.
If you put nothing down and take out an interest-only loan at 5%, your payments will be $417 per month and you will have positive cash flow. However, you will not have any amortization of your loan; after 15 or 30 years, you will still owe $100,000 on the mortgage.
If you actually want the property paid off in 15 years so it will provide significant income in retirement, that same 5% mortgage payment will run $791, and your cash flow will be a negative $241 per month. In order to be cash flow positive on a 15-year fixed mortgage, you will need to put down over $30,000, a 30% down payment. The truth is that most traditional lenders will require a 20% to 30% down payment for investment property, anyway.
Leverage can be very beneficial to the real estate investor. Both appreciation and depreciation are magnified by leverage. If a property increases in value by 10%, but you only put 20% down, that appreciation is worth a 50% return on your money! Likewise, you depreciate the entire building on your taxes, not just the percentage equivalent to your down payment.
However, remember that leverage works both ways and comes at a cost. In a real estate downturn, a highly leveraged investor can lose far more than his original investment. The more you leverage a property, the more dependent you become on appreciation, tax benefits and amortization of the loan for your property, since the financing costs will consume your cash flow.
Rule 5: Minimize Transaction Costs
One of the most significant downsides of real estate investing is that the transaction costs can really eat into your return. Spending 5% when you buy a property and 10% when you sell it is not unusual. That means it would cost about $15,000 roundtrip in transaction costs for our hypothetical $100,000 property.
Those costs may very well consume five or more years of appreciation. They can be especially costly when you are highly leveraged. For example, if you only put down $30,000 on a property, and rapidly buy and sell it, fully half of your investment may go toward the transaction costs. This is one reason why many people hold on to their starter homes as investment properties. They get to avoid the transaction costs upon moving out. Plus, they often get the lower cost of financing available only on owner-occupied properties. Minimizing transaction costs will boost your returns significantly.
Following these five rules, physician real estate investors can use investment real estate to supplement the rest of their portfolio without taking on undue risk. If you want to learn more about real estate investing I would also recommend checking out our No Hype Real Estate Investing course. It will give you the foundation you need to learn about all the different methods of real estate investing.
What other rules would you add to the real estate vetting process? Comment below!
[This article was originally published at MDMagazine.]
Great advice. 2 books I recommend are “HOLD: How to Find, Buy, and Keep Real Estate Properties to Grow Wealth” and “Flip: How to Find, Fix, and Sell Houses for Profit”.
Great article, I’ve been buying and holding investment properties for 15 years and have not heard anyone explain the vetting process so clearly. Well done!
That’s a nice thing for a guy who owns 200 units to say to a guy who owns one!
That is a real good article, I appreciate it. Since most physicians are in this situation, would you be able to write an article on if you are deciding to sell or rent out a starter home/condo from residency before upgrading as an attending. I currently live in a condo that I owe 135K, bought for 168K; property tax $4200/Yr; association fee $250/month and can likely get 1400-1500/month rent. Mortgage rate is 5.37 on 30Yr. P+I $850/Month and with property tax in mortgage I pay $1250 or so per month. This condo is in the area I want to buy, but still considering a property manager since a pretty busy physician. Looking long term to try to establish some passive income streams. Thanks in advance…
One big advantage of using a starter home as an investment property is you already own it- thus no transaction fees. Plus, you have owner-occupied financing, which is a better rate. This is one reason I have an investment property. The other being I couldn’t sell it for any reasonable price. But I basically had zero equity in it after transaction costs if I were to sell, and it was making me money even though it was cash flow negative. So I still have it.
Your home, with rent of $1400 and a value of $168K, has a cap rate of 5.5%. Not incredible, but not bad. You’ll probably be cash flow negative, since the 5.37%, 30 year mortgage is probably something like $785 a month, the HOA fee is $250, and the property tax is $350. There’s your $1400 right there and we haven’t even considered vacancies, repairs, maintenance, insurance etc. That doesn’t mean you aren’t making money, but it does mean you’ll have to plan to feed the beast for a while. Another alternative is put another $50K into it and refinance it (preferably before you move out.) You might then have a rate of 3% on a $100K mortgage, which really changes the cash flow situation.
If you expect to hold the property long-term, it would be wise to refinance it before you begin renting it and before you move out. There’s a decent chance you can save a good amount of money. Even if you’re underwater or short on equity, you might be harp eligible.
Do you have recommendations on asset protection as a physician if you have rental properties? I had heard that physicians should set up a separate business entity, but never explored the details.
The usual recommendation is put each property into its own LLC.
This practice is good for a couple of single property llcs that are cash flowing well.
It becomes a nightmare when there’s a turnover or the owner needs to deposit funds for a large, unexpected repair.
It tried the 1 property to llc approach for awhile and burned out on it. It’s incredibly cumbersome and a paperwork headache. I now keep 3-4 paid off units in each llc, as an effort to compartmentalize my risk. Setting up an llc, with your attorney as the only named person of the LLC is a great advantage as well. Sure, in my state, for $50 I could get my own, but then my name is listed for everyone to see. I pay my attorney $250-300 per llc for this and it has been very beneficial.
The best first move is to never put the property in your own name.
I recently talked to a lawyer that I’m friendly with. He’s an abulance chaser, er, I mean, injury lawyer. He advised me to have good insurance and a solid personal umbrella policy on myself and my spouse. It’s on my list to do, but for around $400 a year, you can get 1 mil in coverage, which the lawyer said, is money well spent.
Lastly, some people strongly advocate using trusts, to offer a level of asset protection and owner anonymity. Anonymity, yes. Whether it offers worthwhile, added liability protection is disputed from lawyer to lawyer.
Thanks for sharing that. Never thought about listing an attorney as the only LLC member. Not sure how you then own the property though. I guess if you had the attorney be all the listed officers, maybe your state doesn’t require the members to be listed, dunno.
Sorry for the lack of clarity. My attorney is listed as the registered agent for the LLC. I would still sign purchase docs, etc. However, when someone goes to the state’s web page to research llc ownership, all they would see if the attorney and his contact info.
From a liability standpoint, having 3-4 properties per llc also doesn’t make every home you own show up when someone enters in a specific llc trying to see what each one owns.
The liability benefit of LLC’s is actually pretty limited. Unless you are having regular meetings of the directors, a minute book in which you record the discussions, etc. the odds of a plaintiff in a serious liability case penetrating the corporate veil is actually pretty good (though it will shield you from minor “nuisance” claims).
Besides the liability in a LLC drops out to the manager– again, unless you are willing to spend some bucks on a manager that’s going to be you anyhow.
The only real protection against liability claims is liability insurance. Have a $1,000,000 limit on each property and a $10,000,000 umbrella.
These are lessons learned the hard way, after a fire in which the infant died, the father became a paraplegic and the mother spent weeks hospitalized with lung damage. Sued me for $10,000,000 Insurance company said, “If this thing goes to trial we don’t think $10,000,000 is going to be enough, the jury is going to want to throw money at that woman.”
Don’t count on your LLC shielding you from liability, have insurance. If you want to save money on insurance have a big deductible– I get $20,000 when the insurance company will let me go that high.
Mark,
Thanks for sharing your story. I know many landlords, but few/none that have been on the bad end of a massive liability suit. Can you tell me who your umbrella policy was with? If you’re able to share any details as to why you were deemed liable? Were the utilities off? Smoke detectors? I’d like to think there had to be something they were trying to attach negligence too – just trying to learn from others. Thanks in advance, glad you go through this grind!
Actually in the end they settled for my $1,000,000 primary policy. I was never held liable and, in fact, as the Insurance company attorney said to me: “If this case gets tried on its merits we don’t think you have any liability at all. But we don’t think it is going to get tried on its merits. They are going to put that woman on the stand, she is going to cry about her dead baby and the jury is going to want to throw money at her.”
I didn’t have an umbrella, which is why I have advised one ever since. Fortunately in this case, a greedy lawyer (theirs) weighed the cost in his time against the possibility of collecting the overage from me and took the primary policy without a second thought.
Now, had I been a “rich” MD with easy-to-find assets he might have weighted that equation differently.
Part of the point is that your liability in the modern system is not a function of what you did or didn’t do– these “tenants” were effectively squatters at the time.
The building was a renovation we were in the midst of and these tenants were the last to leave. We had reached an agreement for them to move out, they had done so. We boarded up the building. Unknown to us that night they broke in and moved back into their old apartment. However they failed to tell her “brother” that they’d come back and that night he torched the building out of revenge over some perceived slight. I had done nothing wrong except to fail to board up the building good enough to keep them out after they had agreed to move.
So, I did nothing to contribute to their loss. Hence, legally no liability.
But the loss was horrific. And Juries want to try to make people who have had horrific losses whole. “After all,” they rationalize, “its just insurance money, that’s what its there for.”
Surely none of this is news to Doctors, who live with this sort of nightmare all the time.
Oh, by the way. Nothing in the above should be read as advice not to set up separate entities. And to keep up the formalities of the organization (minute books, regular meetings, annual reports, etc.)
I should tell the counter-argument story. We were being sued (on a suit that got dropped relatively quickly) on another property and the attorney for the other side, in an early attempt to see if he could pierce the corporate veil asks our attorney for a copy of the Corporate records.
“All of them?” asks our attorney.
“Yes, all of them.” Demands the other side.
“Well, Ok but you are going to have to spend somebody over to copy these. no way I am spending that much time at the copy machine.”
“What are we talking about here? How many corporate minutes can there be?”
“I think they are on Volume Seven.” says our attorney.
“Never mind, I don’t need copies of the corporate minutes.”
Shortly thereafter the suit got dropped.
The point is that anybody that doesn’t have good “formalities” has to worry that the corporation is going to fall apart under scrutiny.
And that anybody that has monthly corporate board meetings with minutes, etc. is going to be a lot harder to take apart.
Well done article! Jim, you always bring a well-researched and unbiased perspective on the subjects for which you write.
I don’t disagree with any of your points from a general investment perspective – that which most busy docs and professionals, readers of WCI, view real estate as an alternative investment vehicle. (Full disclosure – real estate investment is what set me free from practice when I needed to leave due to a family health crisis – 34 years after my first property investment. I am very biased as to the merits of real estate investment IF done in the right way).
As has been stated before, most well-intentioned buy and hold investors who are active professionals with a day job, become embroiled in the moving parts of property rehab, maintenance, tenant turnover and repair….a 2nd job for most in this category. They don’t have any systems in place for tenant recruitment or management and usually end up paying retail contractor prices for repairs and maintenance or, end up doing the work themselves….this is NOT investing!
The initial acquisition and financing of the property is also a key area where most make mistakes and later regret….all of which often give real estate investment a bad name.
“You do not care about the color of the carpet….you should not care about the school district or the distance from the hospital, only about what you can get for rent.” I will kindly take the opposite view on your position here, Jim, and where I see a classic mistake for most novice investors.
One of the biggest headaches and expenses that most investors face is management and turnover costs. And I would agree with you that for the average investor, a 45% expense ration is pretty accurate. That number can be reduced by 5-10% by being more careful in choosing the specific type of house and its location….3 or 4 bedroom, 2 bath in good neighborhoods with good schools, close to churches, hospitals, shopping and access to jobs. Why? The house and location will dictate your tenant pool. Don’t overlook this!
I’ve invested in the full gamut of properties. Starting out at the lower end, lower priced properties that ON PAPER, would show a much higher rate of return (cash flow relative to investment), however, in reality, the turnover frequency and costs thereof, combined with a much higher degree of management due to the tenant who is attracted to this class of property, quickly changed my modus operandi.
Instead, invest in a higher quality property as described above in a neighborhood where families want to live. The turnover, management time and expense will decrease exponentially. An additional bonus is that this type of property will appreciate much more with inflation than will the lower priced, “higher cash flow” property.
On the acquisition and financing side (leverage), I completely agree. A couple of points to add; as you said, most new investors go where everyone goes….MLS and local realtor. While there were good deals here between 2008 and 2012, that arena has dried up and lazy investors are bidding these properties up without regard to sound economics again. Another bubble is beginning to build in some geographic areas. It is far better for one who truly wants the benefits of real estate NOT to try to do it solo (which is hard to do for doctors and professionals who are very wise, well-educated, and can’t stand to let anyone do something that we think we can do better). The problem is that it’s about the value of our time).
Since leaving full-time practice nine years ago, I have built a team-on-the ground with full blown direct mail marketing as a lead gen mechanism….we don’t rely on MLS or HUD property sales to find our deals and therefore find cash deals at 30-50% of current market, or deals on seller finance terms that are extremely generous and don’t require that we use any institutional or bank financing….another trap for the novice investor!
Instead of trying to do it all yourself, find good joint venture partners with whom you can co-venture in individual single-family real estate investments, fully-secured and leave the lead generation and acquisition negotiating, property rehab and tenant management to someone who does this for a living. The time, frustration, and mistakes that you will give up are far worth taking a “piece” of many such deals vs trying to build your own rental portfolio on your own….and you can learn as you go, becoming more active in any aspect as you wish.
Leverage is a double-edged sword and that is why I do not use bank institutional financing – period. Many scoff, stating the low interest climate in which we currently operate. Banks are a trap….get in bed with the banks at your own risk…full documentation, financial statements, full recourse and if you for any reason become a target, finding some place on your financing application that is not 100% correct is very easy to do….and that equals fraud.
Because of the credit and financing crisis, which, thanks to the overreaction of our government through the Dodd-Frank Consumer Protection Act, will continue to leave a void in homeowner financing. The perfect opportunity exists for private financing, either debt or equity (equity being the safest), to acquire as much real estate as one can handle without the negative effects of bank financing. Also, by not using institutional financing, one does not have to tie up any specific down payment amount in order to have significant cash flow.
Because we market and lead generate to many who have homes with high equity, we are very good at getting the seller to participate in financing…with interest rates very low and quite often, at zero interest….now, that’s leverage!
Buying and selling of real estate (the business of flipping) does carry transaction costs. So my point would be, why sell? If you buy right, finance correctly, and don’t need the profit or gain in order to fund your lifestyle, what’s the point? If I have a tenant who wants to buy a property and can qualify (using lease options as a management tool), I can exchange my equity gain via 1031 exchange and pay no tax on the gain and my transaction costs are very minimal. It’s more about whether you are a retail investor or a wholesale investor. There is a difference.
Finally, the absolute best leverage is through options…no downside, no recourse, no management, no owner liability. Options are perfect for self-directed qualified accounts. Many don’t know or understand how to use options in real estate. A very powerful tool!
I agree that skill and experience in acquisition, financing, and management can improve returns.
However, I think you make the “find good venture partners” part of your advice sound pretty darn easy. Perhaps it is, and if so, I’d love to see a blog post about it. But finding good venture partners sounds a whole lot more difficult, risky, and time-consuming than “buy into a syndicated real estate deal” or even “buy a REIT Index fund.”
Easy, risky and time-consuming? Are we looking for the ‘easy’ button? I thought that the premise behind WCI was that taking charge of one’s financial house required some level of active participation? At least some study – yes? What about building a secondary business with tax advantages and the security of another income stream? If “it was easy,” everyone would be financially free at a very early age.
For me, it is a matter of control. And yes, to exert that level of control over my investment portfolio does require an investment in time. However, unlike my early years of trading time for dollars, this time investment pays dividends over and over again, compounding over time.
Your network is your net worth. I have accomplished many times more in life through synergistic relationships than I ever could on my own. Your blog posts, your articles and your new book….profitable at the same rate as your physician services? No, but there is a greater purpose in what you do. You enjoy it for one, you are creating a second business income, and building new relationships which I promise you will become financially invaluable as time progresses.
Don’t discount the short term payment for the long term payoff. For myself, I enjoy the art of deal negotiation, financial structuring and joint venturing. It is a skill set not taught in school and is a profitable and satisfying passion that allows me to live my life as I please.
Thanks for providing a platform for great discussions.
I’m not saying it isn’t worth it, but there are lots of highly-paid professionals who are not looking to exit their careers, simply to make their money work as hard as they do. If they’re working 80 hours a week at something they love, and they don’t particularly love something like real estate investing, doing something like you’re doing isn’t going to be very appealing to them.
I have a condo that has a 230k mortgage on it at 4% ARM, $790 condo fees (yes extremely high) current rented out @$1750/month.
Our expenses are 2190/month – 1750 income = (negative 440/month)
We’ve held onto the property b/c the market has been poor but I really just want to get rid of it at this point since we are losing month every month.
Would you just sell the condo at a loss (we’d pay $15-25k at closing if sold at an aggressive after fees) or continue renting despite it being a monthly loss in come?
Both situations aren’t ideal but curious to see what other’s opinion of this situation is.
Wow! That’s quite an HOA fee. $20K/$440/month = 45 months. If you think you’ll get significant price rise in the next year or two, it may be worth it. But it seems that in most areas we’ve seen most of the dramatic recovery we’re going to see to me, so I wouldn’t count on much rise from here, at least any higher than the rate of inflation. It doesn’t seem like a great investment, at best a cap rate of 5 (probably lower given that condo fee). That’s a lot of negative cash flow, even for a doctor. I think mine works out to $1-200 a month, including unforeseen repairs.
How much goes towards your principal each month? You need to consider that in your analysis as this should count as savings.
Are you depreciating it as a rental? This may allow some of your eventual loss (if any) to be absorbed by Uncle Sam.
If you are actually negative by around $5,000 per year, which you probably are not once you consider the amount going towards the principal, then you have 3-5 years before you get to your predicted loss that you will have if you sell it and pay $15-20k at closing. Then ask yourself if it is worth the gamble.
Sorry, should read “$15-25k at closing”.
I bought a condo during residency, and couldn’t come up with the cash to bring to closing in order to sell it. Therefore, we’ve been renting it for the past few years. I read a book by Frank Gallinelli in which he described the 4 ways to make money with income property – cash flow, loan amortization, appreciation, and tax shelter. My cash flow has been negative with the condo fees, property management fees, and mortgage all adding up. Loan amortization hasn’t been too great lately because I was upside down on the condo for awhile. I’m finally getting into the black and so at some time, I might recoup some money there. Appreciation – ha! Tax shelter – sure, a bit. My salary is low enough that I can deduct my losses from my other income and so that provides a bit of money.
Anyway, one can certainly make a lot of money in real estate. I just think that most physicians are looking for passive ways to make extra money. I think to do well in real estate, you have to be quite active. If you invest in the local utility company’s stock, they aren’t going to call you in the middle of the night if the power goes out.
I love Gallinelli’s book and have reviewed it here:
https://www.whitecoatinvestor.com/great-real-estate-investing-book/
Amortization makes you money even if you’re in the read. You’re less in the red every month.
I agree that most docs are looking to be pretty passive.
Great article, Jim. Please do not construe anything that follows a criticism of the core points/logic but I do think there are a number of “tweeks” that might be helpful”
1). There is more than a little platitude here (not just with rule 1) and I really have trouble with platitudes. “You make your money when you buy” is only partially true. The premise is that you must buy a “bargain” in order to profit. The problem is that its very hard to define a “bargain” and it may not be as necessary as you think. “10% to 20% off list may or may not be a bargain– Most listed properties are over-priced by 10% so getting a 10% discount means nothing. Many are 20 to 30% overpriced. The key is not to get a discount to List but a discount to Market– i.e. the price at which other similar houses have sold for.
Likewise a bargain is not always necessary. There is always the alternative– add value after you buy. Whether that value is added by renovation, new landscaping, getting a premium rent in some way or whatever is irrelevant– Finding a bargain is only one side of the game. You do not always make your money when you buy. Sometimes you make it via good management afterwards.
2) The 45% expense rule is misleading. This is a rule of thumb. My investment properties have had expense ratio’s from over 50% to very close to 0%. While the rule of thumb is useful you must keep in mind that exceptions are frequent. Otherwise you end up prescribing Tums for a heart condition because the “rule of thumb” is that burning sensations in the upper abdomen is usually heartburn. Yes, usually but not always and the exceptions are critical.
3) If I had my choice I’d use the cap rate and forget all the other rules. Problem is that it is often not explained well (unlike your excellent summary) or it is forgotten in all the excitement over the possibilities of leverage.
4) Rule 4 is patently false. It is corrected by improving the bargain when you buy or by getting a premium when you rent. Not that a big down-payment is a bad idea or even paying all cash. Depends on a larger view.
5) On the one hand it is never a bad idea to reduce costs of any kind. But your concentration on avoiding transaction costs is short-sighted. One way to avoid transaction costs is to hold onto the property for a long time, thus amortizing the transaction costs over a longer period and reducing their effect. But transaction costs are part of a larger picture. I am in the midst of a series of transactions where my transaction costs in the first 6 months are up to 50% of the acquisition price– Much larger than your 15% “norm”. Why am I willing to pay such high cost? Because my acquisition price is enough of a bargain to absorb these costs. As a function of my sale price the transaction costs (in and out) are only about 10% of sales price. It would be a shame to miss those profits because I was stingy with transaction costs. The other factor here is that my purchases in these transactions are small- since transaction costs tend to have a minimum they look larger as a percentage in a small transaction than in a big one.
More importantly than reducing one-time transaction costs are reducing ongoing operating expenses. At one time I specialized in buying apartment buildings with high expense ratio’s. I’d figure out why the expenses were so high, make the appropriate adjustments and have a building worth considerably more than we paid. Reducing transaction costs by $5,000 or $10,000 matters less than reducing operating costs by $5,000 because the operating costs are an on-going year-after-year expense. The $5,000 operating reduction adds $50,000 or more to the value of the building. This returns to the cap rate discussion above.
6) The other critical point for high-earners is not to trade high-rate labor for low-rate labor. Do not manage property yourself unless you have maxed out all the hours you can bill in the practice. Better to be a $100 an hour doctor than a $50 dollar an hour plumber. I agree with Phelps regarding finding good help even if it means taking on a partner.
The problem with rules of thumb are there are always exceptions, and you point out many of them. However, just because there are exceptions doesn’t mean rules of thumb should never be written or used.
It’s like when your foot starts hurting the rule of thumb is you can wait a couple of days to get in and see your primary care doctor. However, sometimes it is necrotizing fasciitis and that wait will kill you. That doesn’t mean that every time your foot hurts you should run to the ED demanding STAT IV antibiotics.
Rules of thumb have their uses, but once you have an advanced understanding of a topic, you don’t need them. The article wasn’t written with an audience of professional real estate investors in mind. 🙂
Absolutely agree, and again didn’t intend my comments to say that the “rules of thumb” are wrong, in so far as they go.
Leverage is a good example. For a low-income earner the benefit of leverage is great, he can control a larger property with a small amount of his own money. For a high earner or high net worth individual the benefit of leverage drops dramatically and the risk (in terms of personal liability) increases.
But the high earner also gains tax advantages via the leverage so there is at least the possibility that in the right circumstances he’d want to lever up a property that then has almost no cash flow.
Lots of variables and my point is that Real Estate offers lots of opportunities that go beyond renting out the starter house.
I looked at your recent “what’s your problem?” poll and see that for most of your subscribers the opportunities and risks of are sufficiently enticing that a more sophisticated approach to the topic might be warranted.
BTW, was at a real estate investors meeting this evening and this site came up. The MD in the group was effusive in her praise and the admiration your post has among her colleagues. Thought you might like to know that you are a topic of conversation.
Mark
Hi WCI,
What real estate books do you recommend for someone whose only real estate experience is owning ht primary residence? I’ve browsed your bookstore and saw Gallinelli’s and Reed’s books. Do you recommend any books that focus on duplex/triplex or small apt buildings? Thanks.
JS
My family has owned rental properties for four generations and today my mother, wife and I co-own and manage about 100 units. For me the three most influential books we’re the Rich Dad, Poor Dad series by Kiyosaki. I’d likely start with the first book and if you like his style, then move through the style. I think so much about being a landlord/investor has to do with savings and making sound decisions, I’d reccommend The Richest Man in Babylon and the Millionaire Next Door. These last two are really more fundamentals of thought on saving, investing and lifestyle, but I’d argue that without those fundamentals, you’re likely to fail long term, regardless of how real estate educated you are. Good investing!
The Rich Dad, Poor Dad books are heavy on inspiration and extremely light on implementation, aside from the fact that there isn’t actually a rich dad.
I don’t have a recommendation at this time aside from those by Gallinelli and Reed. Let me know if you find a good one and I’ll consider adding it to the list.
The link for the article has gone dead…anywhere else I can find it?
Currently researching the common question in the comments “should I sell or rent my residency starter house now that I am an attending?”
Thanks.
The usual answer is sell. I’ll work on recreating these articles. I have copies of all of them, but I’m a little frustrated those guys just killed the link. Oh well, guess I won’t be sending them traffic to dead links.