[Editor's Note: This is a guest post from Eric Tait, MD, MBA, a practicing internist and a professional real estate investor. After having a few lengthy arguments with Eric on the Sermo forum, I invited him to write up his story for publication here. A few months later, I received this in my email box. I think you will find it inspiring. We have no financial relationship. Enjoy!]
My story begins with a wide-eyed first year medical student who was trying to figure out how he was going to invest his eventual millions (isn’t that what all doctors make?). My world had just been rocked by a book that would become the best-selling personal finance book of all time – “Rich Dad, Poor Dad” by Robert Kiyosaki. This book called into question all that my middle class upbringing had taught me about money. Because I had graduated from Morehouse College as a Biology major, I had no experience with business or finance; but I have always had an entrepreneurial spirit. It was this spirit that led me on a quest to find the most effective ways to invest my money. Leaving Atlanta to attend Baylor College of Medicine in Houston, Texas, afforded me the chance to join a newly created dual degree MD/MBA program, and I jumped at the opportunity to learn the language and principles of business. This experience would further push me down the investment road less traveled.
Eric Tait MD, MBA
It was the summer of 2000. I was finishing my first two clinical rotations at the same time I was entering the world of business school at Rice University. My first class, Financial Accounting 101, introduced me to the language of commerce. As Latin is to medicine, the income statement, balance sheet, and cash flow statement are to business, and I loved it. My sister, a Columbia University Business School graduate and portfolio manager at J.P. Morgan Investment Bank at the time, would speak to her friends in “back of the envelope” calculations that made my head spin, and now I was going to be able to join those conversations. One of our first class assignments was to dissect the balance sheet of one of the most beloved companies in Houston and a darling on Wall Street. As I tackled the project, I realized that this company, despite much hype and promise, so many glowing reviews and praise about its innovative business model, had raised many questions for me, a second year medical student, one month into business school. Later that summer, this company’s stock price would hit a record high of $90/share until it eventually faded into the dust bin of history taking many of my neighbors’ 401K and IRA account balances with it. You see, this company had not generated any profits from its core operations in over three years, even as its stock price soared. This was pivotal for me, and I began in earnest to find alternative ways to invest that were outside the traditional stock and bond markets.
I knew that I loved medicine. My great-grandfather was a country physician, his son joined him in practice, my uncle was an oral surgeon, and so I was the 4th generation in my family to enter the profession. Yet, I now had a desire to incorporate my new area of study into my future career. As they say, medicine is a jealous mistress, and as such, I knew that my investing life would have to center around assets or industries that would not require me to be a full-time operator of a business.
Introduction to Real Estate
So I looked around and asked myself, where have most of the world’s millionaires and billionaires either made or held a large percentage of their assets? The more I researched the question, the more I kept coming back to real estate as the answer. With this knowledge, I devoted the rest of my time in business school, medical school, and residency training to reading, researching and practicing how to own real estate effectively.
I got my start investing in real estate with the condominium that I lived in during medical school. I purchased it for my own use, but later became an “accidental landlord” when I left Houston to travel 50 miles south to the Gulf of Mexico to attend the University of Texas Medical Branch at Galveston for my Internal Medicine residency training. Before leaving, I researched the rental rates of apartments and condos in my area and realized that after factoring in my mortgage and condo fees, I could lease my condo to another medical student and still make a cash profit every month; so that is what I did. I had no formal plan or training at the time, just a simple understanding of taking in more rent than it cost to own and operate the property. In retrospect, it was more luck than skill that allowed my plan to work, and I warn would-be investors from taking this approach.
Investing the Attending Earnings
When I returned to Houston three years later to join a mentor in private practice, I decided to add to my growing real estate portfolio. I loved the fact that I was being paid passively while someone else was paying down my mortgage. I was receiving a cash dividend, acquiring capital gains through price appreciation and I was in control of the asset. Oh, and as an added benefit, the cash flow that I was receiving was not being taxed because of a thing called depreciation. In my mind, I had found the holy grail of investing.
So I set off to educate myself on how to effectively buy real estate so that I could duplicate my accidental success. I took on-line training courses and joined a few local real estate investing clubs in Houston. I talked with successful real estate investors and listened to their advice. I did not try to do it on my own, I found mentors and followed their successful leads. I encountered difficulty only when I thought I was smarter than my mentors.
In the summer of 2007, my wife and I bought our first property solely for investment. It was a foreclosed single family home in a northern Houston suburb. We purchased it for around $45,000. [Welcome to Houston-ed.] It was a 3 bedroom 2 bath, 2 car garage home of approximately 1500 sq. ft. At the time, Houston had not experienced the economic downturn of the recession, so foreclosed homes were not common. We purchased the property using a hard money loan, which allowed us to buy the property, renovate it, and then refinance into a 30-year fixed-rate loan with no money out of our pocket. We continue to own this property today and it generates after all expenses around $400 a month in passive income and is currently worth around $95,000. In 2008, we decided to purchase a small dilapidated apartment complex that had 10 rental units. We purchased the property for $180,000 and invested around $60,000 of our own money to purchase and renovate it. This property generates between a $12,000 – $30,000 cash return annually depending upon the capital improvements we make to it each year. We have used this as a training property as we begin the process of purchasing larger apartment complexes.
The Empire Expands
From 2009-2013, we continued to purchase single family properties as the Great Recession took hold in Texas. This included nine more single family homes for our own portfolio. It was during this period that a few colleagues approached us about joining us in our property investments. We placed five of our single family homes into an Investment Fund and offered investors the opportunity to purchase bonds based upon the rental revenues from the homes. Because of the Federal Reserve’s low interest rate policy investors could not find attractive yields on fixed income investments that paid out monthly cash flow, so we created our own to satisfy the demand. That was our first investment fund and it allowed some of our physician colleagues to participate in the debt side of real estate investing with us. In 2012, my mother decided to retire, so I had her liquidate one of her 401K plans containing around $70,000. We purchased seven single family rental homes in Houston, which generate around $3000 a month for her in retirement and has captured over $280,000 in equity/capital gains. We have also purchased several rental homes for other family members, as well. In total, we have 21 single family properties along with our apartment complex that have been purchased, renovated, repositioned, and are currently rented. My wife and I are closing on another single family property in the coming weeks for our own personal portfolio.
Going International
The Great Recession was a wakeup call for us about having all of our holdings within in the United States, tied to one economy and fixed to one currency. Although we invest primarily for cash flow, and that cash flow actually increased during the recession, we realized that we were heavily levered to the United States and real estate prices transiently declined here for several years. So we decided to diversify our real estate holdings into international markets and search for the highest-yielding asset class within buy-and-hold real estate. Our research showed that hotels have the highest return on capital within real estate. We found an experienced real estate developer from the United States who had previously developed hospitality properties internationally and was preparing to build the largest resort development in the history of Ambergris Caye, a Caribbean Island in Belize. The developer had already partnered with the largest land owner on the island as well as the top-producing real estate broker in the country. Because of our real estate investing experience, the developer asked that we put together an equity partnership to bring in current and new investors for this project. We now lead an investment group that owns six rental units in this development. We expect to earn between 8-15% a year in cash returns on these units without the use of any debt.
Rags to Riches in 8 Years
Collectively, our personal holdings and investments (exclusive of properties bought for family members) went from a negative $250,000 in net worth coming out of residency in 2007, to close to $2,000,000 in net worth and around $5-6,000 in semi-passive monthly income. Generating this income has required some time, dedication, and focus. But it has been manageable, even minimal over the years.
And although I am still a full-time practicing Internist, through real estate my wife and I have been able to amass the wealth that we have in a relatively short time. I am asked all the time by colleagues why I still practice medicine. The answer is, because I love it. And I love it especially because I can practice in a manner that is consistent with keeping the patient the focus of my time. I am not beholden to medicine to generate an income to live the lifestyle that I want to live and can afford to give my patients the time they need. My goal is to continue to build the passive income streams for both my family and investors to a point where we can all retire, if we choose to. In the meantime, my wife and I have two young daughters who factor heavily in our planning. Over time as they grow older, they will be added to the business as owners of the corporations in which we hold our property. Our children will eventually inherit our portfolio outside of our taxable estate, and in this way we will use real estate as a way of estate planning as well. However, I have no intention of stopping the practice of medicine.
I hope this brief look into my journey as a real estate investor prompts you to begin to research how you too can add direct ownership of real estate or real-estate backed debt as a way to diversify your investment portfolio. I look forward to sharing with you what I know about how to effectively invest directly in real estate in future columns.
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Great story! I have connected previously with Dr. Tait and have enjoyed his like-minded spirit and camaraderie.
Our stories are very similar. I began investing in residential real estate in Texas in 1980 while in my first year of dental school. I had no MBA – it was all learned “on the streets” and via very good mentors.
I was able to walk away from private practice dentistry over ten years ago thanks to my real estate portfolio.
Did it take some work in the early years? Yes. But well worth it.
Congratulations Dr. Tait! You are an inspiration!
Hey Dr. Phelps,
Great to hear from you again, thank you for the kind words.
Interesting article and kudos to Dr Tait for his successes and the inspirational story.
There are some significant points that are unaddressed that would be worthwhile for anyone thinking about embarking on this strategy:
1. Significant upside potential, but the risk of problem tenants? Imagine one problem tenant in any one of the few properties that a physician owns – not only would this be a significant time suck, source of stress but how well are physicians typically equipped with interfacing with our legal system?
2. Legal liability – in the event someone has a fall, bad outcome on the premises etc, a large lawsuit could be disastrous to a physician? Sure there are insurance policies and umbrella policies but with physician net worthy typically upwards of often upper limits of these policies, there is a real risk to one’s nest egg
3. Returns – is it possible to achieve similar returns via alternative real estate investment vehicles eg REITs where the individual physician doesn’t have to take on as much personal risk and getting involved in the intricacies of tenant related issues? On a risk adjusted basis, how much more return is a physician garnering by holding a portfolio of properties rather than investing through a REIT?
I have limited RealEstate experience but the above thoughts make me hesitant to pursue further. A single bad outcome of any of the above have the potential to ruin one’s retirement plan but more importantly months and years of sleepless nights.
1) Yes, real estate investing has components of a second job, and that second job is providing a place for people to live/work etc. Serving your customers successfully is required to be successful.
2) You can buy pretty big umbrella policies and you can also place each property into an LLC to isolate it from your other risky assets as well as the rest of your financial life. Not that big a deal.
3) While it is certainly possible to become very wealthy using mutual funds (my first million all came from just saving my earnings and investing them into mutual funds) there are certainly some benefits of being a direct real estate investor like Dr. Tait, especially if you work hard and are skilled. It’s not unusual at all for these investments to have long term returns similar to or slightly better than stock market returns, especially when applying a reasonable amount of leverage.
I don’t known anything risk free , do you.
Lastly, the environment in which Dr Tait has generated significant returns has been 2009-2013 where we are really at a unique and unprecedented time in history – super low interest rates, limited credit and a significant upswing in property value as we come out of the housing market crash and subprime fiasco.
At least two of these three factors promise to change over the next 1-2 years and significantly affect the real estate investment outlook for someone getting involved now.
My point isn’t that this is a bad strategy, my point is that this is a strategy that has significant risks and downside scenarios – it takes a particular persona, personality and nack to do this successfully. before embarking on this path it’s paramount that any physician clearly understands the nature of risk they are taking.
You are right. There is significant risk there.
S. Rathi – Your other comment was so eloquently answered by the editor and Dr. Phelps I will let those stand. My goal is to publish a series where I go into the actual mechanics of single family real estate investing and show you how to mitigate your risks and find properties in an up trending and down trending market. As interest rates rise, prices fall in real estate, the same as happens in a bond fund, so there is always a state of equilibrium, to allow you to purchase the cash flow stream that you are happy with.
As with all “investing” there are risks, but it is never in isolation, it is always “as compared to what”? When done effectively, I feel that this is the safest way to generate investment returns for the amount of risk taken. Remember, I trained in business school on how to “invest” in the stock market, and I have chosen not to pursue that route, it’s not because I do not know how, it is because I have found a better alternative.
Your questions are good S Rathi.
One can be either passive or active – a choice that needs to be made in advance. Most professionals should NOT be involved in active rental portfolio management – that’s a business – so either you decide to go into “that business” to manage your investments (which means you hire others to do the work), or you outsource the management – usually the downfall of most “accidental landlords.”
Legal liability – liability insurance is cheap – that’s the first line of defense. Second is to isolate properties via proper entity selection. Slip and falls can happen, but they can happen at your office as well. Insure against it – it’s part of life.
Returns – active participation with proper education will almost always produce a higher return than passive. With passive, you are paying for someone else to manage. Probably a good idea for most professionals who value their time.
There are many ways for one to invest in smaller residential real estate without owning the property outright. Options, secured note receivables, hard money lending. Many ways to control without ownership.
I can relate to Dr. Tait because I also took a very active participation in my financial future – I think that is the exception today. The majority want “easy investing” – I tend to go against majority thinking.
Education and finding what kind of investment best fits your personality type is very important. Best of luck!
In real estate, I agree there is room to add value with active management. In stocks, I think the data is quite clear that passive investment is the way to go.
Great article! We are interested in Real estate investment as a pathway for providing affordable housing for people and for personal financial independence. We have had a SFH as rental for 6 years now, close to finishing a BRRR duplex, and just acquired another SFH to convert to a triplex. What are your personal recommendations on limiting liability? Do you place all different buildings in separate LLCs? Thank you!
We use an asset protection firm who created an integrated plan that took into account our Wills and created Trusts and LLCs to hold different assets based upon their risk profile.
Because we are in Texas we can use Series LLCs to separate our real estate assets, and if we didn’t I would likely group a few homes and make sure that they have a good amount of leverage on them as another asset protection precaution.
Thank you Dr Tait! That’s very helpful advice
I’ve been contemplating RE investing for some time now. It’s clear WCI has been too. What are people’s book recommendations on this topic? I’d love to have the Jack Bogle or William Bernstein equivalent for RE investing.
I’d start here:
https://www.whitecoatinvestor.com/great-real-estate-investing-book/
https://www.whitecoatinvestor.com/best-practices-for-the-intelligent-real-estate-investor-a-review/
Thanks
Great article. I have been thinking about this as an investment vehicle as well. Agree with the above comments about the potential for downside risk.
That said, Dr. Tait – could you expand on how you operate day-to-day? Do you have a property manager? Do you do maintenance yourself? Do you hire people directly or have a prop mgr do it?
I worry too about the “time suck” and I agree that one problem tenant can cause a lot of issues. To the poster above re: liability, I think that you can be effectively protected by placing the assets under an LLC. Not too difficult of a process in that respect.
Great article, great ideas. Thanks so much for sharing.
Hello Ryan,
Thank you for the questions, so I used medical school, business school, and residency as my time to study how to effectively invest in real estate. Part of being effective is creating systems that lessen the time burden. That includes creating a team of professionals around you that you delegate tasks to i.e. real estate brokers to find you property, contractors to renovate and maintain them, a subscription service to do background checks in less than 2 minutes (the key to having great tenants), having at least 2 people in each trade (plumbing, hvac, electrician etc…) on text message, training your tenants on the do’s and don’t’s of living in one of your units.
So I manage all of my and my extended family’s single family units, I have a my own property manager for our apartments, and our hotel/resort project will have 3rd party professional hospitality management in place.
If you notice something, as I have progressed in my own investing and with my investors, we have moved up the value chain of real estate (single family to apartments to hotels) and my involvement in the day to day operations becomes lessened. That was by design, so that I could first learn with my own money on smaller properties, and as we became more and more proficient, we could bring others along with us with confidence.
So to give you a sense of time commitment, I spend maybe 1-2 hours per month on the single family homes, 2-3 on the apartments. When we are in acquisition mode, this amount of time goes up because of due diligence, but right now we are not acquiring anything in these asset classes.
The hotel project is a bit different because I am raising capital in different investment funds for that, so I normally spend my free time in cigar bars, and in restaurants anyway, so I now spend it with potential investors, but it is a part of my lifestyle and I do not consider it work, and technically I do not have to do it, but I enjoy meeting new people.
That last line is key to how most very wealthy people become that way- they actually enjoy work to the point where they view it as fun. A hobby that pays you.
I read Rich Dad, Poor Dad about 14 yrs ago and didn’t like it.
I was always weary of borrowing money to invest.
They say, “Duh, it is so easy to borrow money from the bank to buy a house that you can rent and never come out of pocket”.
Maybe I have been listening to Dave Ramsey for too long.
If you can’t buy it cash, don’t buy it.
This story made me cringe as I was reading it.
A little too good to be true for me.
No downside. I doubt it.
I am hoping WCI has a guest post that isn’t so rosy.
I know they are out there.
+1
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-1 😉
+4. Was surprised with such a large portfolio of real estate that net worth was just 2M. Would love to know more details of amount of leverage and if (hopefully) 2M net worth related only to his real estate investing and not his total financial picture.
Dr. Mom, thanks for the comment, I will break it down for you as best as possible and let you in on a little secret.
Networth totals don’t really matter in life. What matters is CASH FLOW.
Wealth is measured in time, not dollars (especially not U.S. dollars).
Wealth is the amount of time you can maintain your current standard of living without spending your savings, selling your assets, or touching your principle.
I could care less about my networth, what I care about is how many productive assets I own in my portfolio that pay me cash every month or every quarter. Assets whose price and cash flow rise with inflation.
My networth total quoted is real estate and personal residence (not an asset), bay home (not an asset), cash, cars etc…minus the debts on all of that. The usual measures that a banker would recognize. It does not account for some operating businesses that I am an investor in that generate income but have no hard assets, I did not do valuation on those cash flow streams.
Our strategy in our U.S. purchases was to focus on work force housing, the type of housing that the average one income earner could afford in good times and in bad. We are in Houston in the State of Texas, so those homes are only worth between 100-150K apiece, and Texas is not a high price appreciation state, so that explains the relatively low total dollar amount for the # of units. I also tend to be conservative in my estimate of price as it helps to keep me out of trouble.
The whole “cash flow is all that matters” argument is kind of silly in my view. Net worth is convertible to cash flow and cash flow is convertible to net worth. Some people make the mistake of not including your caveat- “assets whose price and cash flow rise with inflation.” There are lots of ways to get cash flow but without a rising asset price and inflation-indexed cash flow. That’s a problem. Think junk bonds. Yes, the yield is high, but the asset value goes down over time.
But if I have $1M in a stock market index fund, it generates a cash flow of something like $20K a year. My total return may be $80K a year. I can use it to buy a property that provides me $60K a year of cash flow, and a total return of $80K a year. I can also leverage it up and buy 3 properties. My cash flow will then probably be lower than $60K a year, but my total return may be quite a bit higher (or, if leverage cuts the wrong way, quite a bit lower.)
At any rate, I see income and net worth as being two sides of the same coin. Interchangeable. Centuries ago, Europeans described a rich man as worth “80,000 francs a year” rather than a “millionaire.” It’s all the same.
You and I always disagree on this point, but just to clarify, when I say cash flow I am absolutely talking about cash flow that is above the real rate of inflation and is inflation adjusted.
Now let’s talk about high grade bonds, bonds held to maturity are not an issue because even if interest rates rise, once you receive your principle back you can just reinvest it again in bonds with higher yields. Junk bonds are a different animal and they have massive counter party risks, so they would be more speculative then a true investment and they need to be bought in groups to mitigate their risks of default.
I do agree that equity and cash flow COULD be related, but for most people they are not, and in an zero percent interest rate world real returns on equity are actually negative for many people. The average investor if using paper assets cannot get a positive real cash return without being in something like junk bonds which puts investors principal at real risk of default.
An instructive exercise for everyone reading to do is to take your networth and add up how much cash flow your portfolio produces because this is an actual return of your capital, capital gains are just price movements until you sell. Most people will have less than a 0.5% return on their own equity. That is what you are actually REALIZING out of your portfolio.
I assume you mean return ON your capital, not return OF your capital.
That would be a pretty interesting portfolio to only have a 0.5% return considering the yield of the US stock market is 2% and most bond yields are in the 2-4% range.
There is an underlying but not quite spoken argument you’re making. That is that the value of a “paper asset” portfolio can take some massive dive or even disappear completely. Let’s think that through. If the price of a stock market index fund drops 90% for no apparent reason, and stays down, what do you suppose that is going to do to the real estate market? No effect whatsoever? That’s bizarre. Also, if it drops 90% with no change in earnings, it’s yield just went through the roof and it is now a fantastic investment. It’s almost like you (and by you, I am referring to all those who think “paper assets” are an insane investment but real estate is somehow incredibly safe) see no connection whatsoever to the price of a company and the actual, real value/earnings of said company. There is a connection. Is there volatility as the market tries to figure out the true value of that company? Sure. But that doesn’t mean the value is zero. It’s a silly argument.
Real estate pricing can be just as volatile-it just isn’t marked to market each day. It’s like when you go to sell a condo- you think you can get it under contract within 90-180 days for $100K. Well, on days 1-37 it’s worth $0. There are no buyers. On Day 38, it’s worth $100K. Sure, on days 1-37 you could probably have found someone to buy it at a firesale price if you were desperate. But that doesn’t mean that’s what it’s value is. In 2008, you could buy a lot of companies for fire sale prices.
These assets are not so different. All of them represent a going enterprise with real earnings and make worthy additions to a portfolio.
Please correct me if I am wrong in my very simple big picture thought process… If my “paper” assets which are unleveraged drop to zero, then I am at zero and I start all over. But if my leveraged real estate portfolio drops to zero, then I am restarting far in the hole.
I’m not sure either of those are really realistic anyway, so why bother thinking about it, but your principle holds true even for a 50% drop, which is obviously very possible as it happened in both assets classes around 2008. Those who stuck with their plan (didn’t sell out of their index funds and those who could service their reasonable real estate debt) did just fine, especially if they continued to buy at firesale prices.
I guess my point is that comparing the returns of an unleveraged paper portfolio to a leveraged real estate portfolio isn’t really comparing apples to apples. Below Dr. Tait discussed his views on the return of a single unleveraged property. I am really most interested in the behavioral side of this discussion more than the math. If I leveraged my paper portfolio to the point of his real estate portfolio the returns look more similar. But as I do not want to do this with my paper why would I want to do so with real estate? Is there something inherently different about real estate? For me, the answer is maybe, as we have considered adding real estate (more than just REIT’s) to our portfolio. So then comes the discussion of how much leverage are we comfortable with for the risk. Dr. Tait’s risk tolerance seems much higher than mine. As always I learn and enjoy the most from your site when getting the views of others that vary from my own. So thanks again Dr. Tait and WCI!
Yes, the leverage is not callable. That’s a serious advantage for real estate.
You missed the argument I was making, it was a recognized return argument. The scenario is take how much cash your portfolio generates that you actually receive in your hand as a realized gain and divide it by the total amount of equity you own in your life. That is what I was referring to, realized gains vs. your total equity.
As for the argument about public market equities going to zero, I am not making that argument. But though not common, it can happen. How many of the companies in the Dow Jones 100 years ago still exist? Yes, you could by an index fund to capture a diversified basket, but then you are just capturing GDP growth for all intents and purposes, it cannot MAKE you wealthy, it will just protect your purchasing power. I do agree with you buying beaten down paper assets of great companies with great dividends at market bottoms is a good use of spare cash.
As for real estate during downturns, there was only 1 prolonged period in U.S. history where real estate prices nationwide declined in price and we just lived through it. So let’s take a look at what happened because it is instructive.
I owned and purchased property through the Great Recession, and I had no qualms about doing it because of 2 things, I knew the value of the properties relative to their cash flows, cash flows that were increasing as the price was falling, and I knew what the input costs (a.k.a. replacement costs) were for the assets.
You could not rebuild that exact asset for the prices that we were paying for them, it is hard to lose money when you do that. So we were paid very handsome cash returns while we waited for prices to rise again.
It is the same thing that Value investors try and do in the public markets, the difference is we control the timing of distributions, there is no worry about the dividend being cut because if the rental market is turning to the point that rents are falling it is bc tenants are becoming homeowners and that means there is demand for the asset and we can sell it for a capital gain.
It’s a heads I win, tails I will situation.
Or it means that prospective tenants are moving to another town, state, country etc.
“Or it means that prospective tenants are moving to another town, state, country etc.”
That is why following the jobs, population, and retirement trends are so important. But that is not hard to do. You will very likely do well in large Sunbelt cities in the U.S., especially in Texas, Florida, Arizona, Georgia, North Carolina, and Tennessee.
Thanks for your reply and for writing your post. It is very instructive to see how you think through your investment portfolio. Would you mind telling us big picture of total assets minus total liabilities that gets you to your 2M net worth? I suppose I am really getting at how much you are leveraged and your thought process as to why you are comfortable with it. Did you ever consider investing in real estate without the leverage, i.e. just paying for the properties as you go? You said you are not currently looking for more properties, so are you letting your current portfolio start to pay for itself and decrease your overall leverage? If so, why not just keep the amount of leverage you started with or did something change in your though process or risk tolerance?
So Dr. Mom, I will take your earlier comment and answer that here as well.
“I guess my point is that comparing the returns of an unleveraged paper portfolio to a leveraged real estate portfolio isn’t really comparing apples to apples.”
You could theoretically invest in either of these assets so it is a valid comparison.
I say this because there are myriad investment options in the universe for your capital, you just referenced 2. But there are characteristics within both that make them better or worse investments.
The fact of the matter is you could not get a bank or lending institution to lend you 70-80% of the price of paper assets that you wanted to buy. You can with real estate because of the nature of the asset.
The reason you leverage real estate is because other people are going to reliably pay off the mortgage for you, so you can take the capital that you would have used to buy a whole property outright and now you could conceivable purchase 5 of those same properties if you were so inclined. (assuming 20% down on each property) Each of those properties will pay you cash, and possibly go up in price, now you have 5 assets working for you instead of just 1.
The good thing is that since the great recession banks are going to limit your ability to borrow against investment property to really no more than 80% of the market value (and that is generous), and even then they are going to make sure that you have a debt coverage ratio of 1.20 or higher. (meaning the cash flow after all expenses have been paid is at least 20% higher than the mortgage payment).
Now to answer your questions from the second comment –
When we initially purchased many of the properties the market was depressed so we would get loans for 70-75% of the then depressed market value of the property. As prices have risen and debt has been paid off, we are somewhere around 55-60% of the current market value of the properties on average. We are actually torn about whether or not we should sell, but the problem is where to put the capital?
We are not looking for more property in this market because prices have risen above the value that we want to pay to get the returns that we expect. So we have turned our sights abroad to find value and are part of a group developing a hotel/resort in the Caribbean. This project is unleveraged, but after 12-24 months of operations the plan is to place leverage on the property and pull all of our invested capital out and return it to investors. That would be at around a 70-75% loan to market value. In commercial real estate the market value of a property is largely determined by the cash flow that it generates, this is not the case in single family homes. So no, we still believe in using leverage in real estate because it is one of the characteristics that make it such a powerful investment vehicle.
You read my mind, cringing at the thought of all that debt…
I have one rental property, tried managing it ourselves and I can’t stand the thought of owing money on a house that I would never even consider living in unless it was an absolute necessity.
Props on the hotel investment in Belize though, thats a great idea, I would love to invest in something like that! WCI can we get Eric to follow up with a guest post explaining that process?
Hey Razorback –
The debt is not all that big a deal, we are usually at 70% of the market price of the property or less and we make sure that the rental payment more than covers all of the expenses even assuming a 10-20% drop in rental rates.
Interestingly, I have had people cringe at the thought of investing in Belize, calling it absolutely risky, but have no problem investing and taking on debt.
What I have learned is that everyone’s definition of risk is very personal.
And if you want to invest in the Project I am a part of in Belize you most certainly can, (as long as you are an accredited investor). I have many of my physician colleagues and friends who are in one of our 3 funds.
Just look me up on linkedin. (not sure if it’s against the rules to post my contact information in the comments)
There should be a link to your site at the beginning of the post for those who wish to contact you.
Once I get my rental property sold I suppose I could share the numbers. I guarantee they aren’t so rosy. Just buying real estate doesn’t guarantee great outcomes, you actually have to be good at it.
Theres a lot of truth in what you say but too much of any one view isnt a good thing nor jives with reality. Now, I dont typically think of RE as part of net worth but then again I dont have a full portfolio of it either and I get both sides.
On the buying cash side, there is really no good reason to buy your personal house or especially rentals (beyond the amount needed to capture income/tax sweet spot). Due diligence will keep you from the majority of predictable bad situations. A mortgage is dirt cheap and gives you options, lots of options. There is an opportunity cost to everything and financially wise people often times take on debt they dont have to/need for just this reason. Options both in liquidity and putting that money to work elsewhere.
I try to think of any purchase/investment within the context of my global life financial strategy, nothing is absolutely independent of it so its thought of that way. It helps to clear up things by aligning longer term issues, math, and personality. Math usually wins.
Hey GatorDMD – Thanks for your comment, I would love to answer some of your concerns. I love that you references “Rich Dad, Poor Dad” as Robert Kiyosaki is one of my mentors. If you remember back to the first chapter of the book, what did he say?
It was that the rich don’t work for money. Which means that their money and their assets work for them. That is why the bulk of the worlds millionaire’s and billions either made or hold their wealth in real estate. As a good reference article:
http://www.yourhoustonnews.com/woodlands/living/what-you-should-know-about-real-estate-investing/article_061196d5-ede0-5bbb-9090-3807adf6de7c.html
The only asset that a banker will consistently lend you 70-80% of the purchase price is real estate and there is a very good reason for that, and that is because it is self collateralizing.
Many people feel the same way that you do concerning debt, but you know that there is a difference between “good debt” and “bad debt”, good debt generates income and other people pay it off for you, that is called leverage, bad debt is debt used to purchase things that do not generate income.
Now, are there ups and downs in real estate investing, absolutely, do tenants sometimes pay late? Yes, (and they pay a fee for the privilege), and I actually had my first eviction from a single family home ever 2 months ago, I lost 2 months of rent and had to make repairs to the tune of a few thousand dollars to the property. But the tenant had been living there for over 2.5 years, paying me $500+ a month. So even when there are down times, you can still be profitable. The apartment business model calls for more frequent evictions because of the nature of the population you are serving, but it is built into the business model and investment return assumptions.
The reason my story is what you say is “rosy” is because I educated myself on how to do this effectively, there are a ton of stories out there of people who watched some HGTV or Flip this House show and thought that they could just go out there and do this. Just as we all became professionals in healthcare, it takes some training to learn how to do this effectively. But it takes no where near the amount of time that professional education takes and it can be so much more lucrative.
I absolutely agree with that last line.
I agree with Ryan and the other posters—I would love to hear more details. My biggest concern with real estate is the time commitment associated with dealing with the tenants and other problems.
Great post. Passive income is what we are all shooting for, right?!
I’m happy to see someone else learning from Mr. Kiyosaki’s writings. Those of you that have no read Rich Dad Poor Dad I strongly encourage it. We appreciate his writing so much that a colleague of mine published a blog on the 3 core concepts Kiyosaki teaches (Debt, Taxation & Creating a Business). If you haven’t read the book maybe this would be a good gatway into it….
[Link deleted. As you have previously been warned, keep any links to subject matter about infinite banking/bank on yourself/nelson nash etc etc etc solely on posts that deal directly with that subject. The manner in which you post links feels an awful lot like spam/advertising. It’s getting to the point where other readers are calling you out on it even before I do.]
It’s amazing how a salesman can find any post to drop an add for permanent insurance policy schemes such as infinite banking. There is not one person who reads this blog interested in what you are selling with your high fees and low returns. Post infinite banking schemes in the blog posts that discuss them or go back from under the sleezy take advantage of other people rock you came from.
Is that too harsh? [No, but your next sentence was so it was edited as an ad hominem attack.]
I don’t even remember what I wrote that was so harsh. These guys really tick me off. Trying to literally steal money from anyone they can get their hands on.
Sorry to soil you blog with that ad hominem attack. I will keep it cleaner in the future.
I just don’t want some unsuspecting first time reader to fall prey to these tactics.
Hey Sleeze,
It is frustrating that the “life insurance sales industry” that you refer to has personified my attempt at teaching Austrian economics as a sales pitch. For that I have no answer. The blog I referenced was a tie in to two authors (Kiyosaki and Nash) and their books. Not a sales pitch.
As far as stealing money goes there is enough of that going on as is. I’ll leave that up to the professionals (and biggest thieves in the world) who take it from us in taxes. Funny how the highest tax rate is much higher than my commission rate…As a medical professional likely earning in the top 5% of American families, you should understand this concept best.
In the mid-1800s French economist Fredric Bastiat wrote an essay entitled The Law. If you read, check it out sometime. Bastiat identified “legal plunder” as:
“Quite simply: see if the law takes from some persons what belongs to them, and gives it to other persons to whom it doesn’t belong. See if the law benefits one citizen at the expense of another by doing what the citizen himself cannot do without committing a crime.”
I challenge you to actually try and think about what Bastiat is describing in the above quote on “legal plunder”. You can purchase The Law on Amazon or even better download it free from the Ludwig von Mises (he’s an Austrian economist, too) Institute. I would link it, however I don’t want to come across as a “salesman”. Enjoy.
Not a sales pitch? Have you read the blog? It’s a sales pitch. In fact, it is extremely difficult to find anything on the internet about Nash that ISN’T a sales pitch.
I know, but I delete their ad hominem attacks (daily, I’ve got 4 more today), so I have to delete yours too.
Reading Dr Taits story, I realized how similar it is to WCI. Both of them worked very hard initially and spent a lot of time to learn and make it better. No one came and did it for them, they did it themselves. If they didnt do it, it wouldnt get done.
During Dr Taits time , indexing was not a major player. Since the last depression, indexing has become very popular and taking money away from active managers. People have realized they dont have to take the risk of Enron and actively be bothered to keep looking where to place their “millions”. Hence a lot of things have changed since Dr Tait did his MBA.
Dr. Tait’s time is basically the same as mine. Indexing works just fine. Real estate investing, when done properly, works just fine. Either works alone. They can also work together.
Interesting read, except for the Rich Dad Poor Dad??!!
John Reeds assessment of RDPD,is more factual
http://www.johntreed.com/Kiyosaki.html
While there probably is no Rich Dad, and Kiyosaki’s book has plenty of flaws, it isn’t that there is nothing useful in the book. There are some useful concepts there. Not much practical information, but a few useful concepts.
I actually went to one of the seminars he had, the ones at the hotels etc. I liked the book enough, but once I saw how his business model worked I knew he wasn’t into real estate anymore, he was selling his product. I’m sure he makes loads more money teaching others what they should do, than doing it himself.
Like you said,some useful concepts, but remember he is selling.
What did the seminar cost? Do you remember?
It was during residency, the seminar was free, which should have been the first clue, and it wasn’t actually him that showed up, but his “right hand man” was there. (Read that in the fine print after the fact.) But, for $109 of you hurried to the back you could pick up a tote with a book, lots of investors information and a special thank you for the first 10 people that signed up. Left a sour taste in my mouth.
Honestly I don’t remember much about it now, but my buddy and I thought it was a waste of time. Sales pitch for him and his books, not so much for real estate.
Like I said, his book was interesting, and got me really thinking about how money can work for me, which was good as it started me thinking about what my dad did wrong and what I wanted to change. The whole “many roads to Dublin” applies to real estate and many other areas of finance.
You can learn a lot from Kiyosaki about marketing, no?
I went to that same seminar coming out of residency, and took my wife. That was the best thing that came out of the Kiyosaki real estate seminars from those times. She learned to mantra of passive income and buying real assets.
As Larry Swedroe always say “Don’t confuse strategy with outcome”. Probably in this case outcome with strategy.
Eric was fortunate with timing of his investment and ZIRP policy of fed. If he had started couple of years earlier (2004-2005) with the same strategy, results would have been far different. I would love to see the comparison of 60:40 mutual fund or for that matter passive real estate fund with the same money invested at the same time.
That is comparing apples to oranges, how do you compare a 60.40 passive mutual fund to a active second job? What value do you give to the time he spent on the job and learning about it?
Author clearly states that “Investing the attending earnings”.
Any investment should be compared with the alternatives and risks involved. There are dime a dozen so called “investors” licking their wounds here in florida
Srini –
People make the classic mistake of thinking that speculating is investing, and they are not the same thing. Florida was full of real estate speculators, not investors.
Buying low to sell high is speculating, deploying capital to generate long term income is investing in my book.
We have never purchased real estate in the hope that it goes up in price, we have always purchased where we knew what the rental income was for the given market, best and worst case scenarios involved. If we could purchase the property, rehab it, and rent it and still make a return that we were happy with we would purchase the property. If we could not we passed. We never try to force a deal or buy when things are not undervalued for the cash flow that they produce.
Thanks for your reply.
In the world of finance demarkation between investing and speculating is blurry.
So called investing in tourist rental resort in Belize with leverage is speculating. It has lot of country, currency, liquidity risk.
Even in your example what makes of think future cash flow isn’t already priced in rental real estate you are purchasing. You are basically extracting liquidity premium.
What I don’t understand is that you were attracted to real estate investing because of Enron disaster. Have you ever considered the probability one of the SP500 going bust vs individual real estate buyer with leverage?
Srini –
Let me take your assumptions 1 by 1 so that you can see my thought process in investing.
“So called investing in tourist rental resort in Belize with leverage is speculating. It has lot of country, currency, liquidity risk.”
So the Project in Belize is actually all equity – There is no debt on the Project whatsoever. There is a quirk in Belize that makes construction financing nearly impossible to get, this problem is what created the opportunity for us to build the largest resort on the Island of Ambergris Caye (the #1 Island on Tripadvisor for 2013 and 2014). The Island runs at an 85-90% occupancy year round currently and there has not been a new hotel built on the Island in 14 years. The ADR (average daily rates in hospitality parlance) has increased $50-100 a night over the past 3-4 years, anyone who knows hospitality knows that this is unheard of. There are approximately 1900 rentable rooms on the Island (down from 2000 in 2012) while tourism to the Island itself is up over 60% from 2011 (the highest recorded level in history was 2011 to give the baseline). There are over 2000 NEW passenger seats a week going into Belize over the past 12 month, with 70% of the people spending some time of their trip on the Island. The metric in hospitality is for every 1.6 passengers you need 1 hotel room. So the Island needs around another 1000 rooms just to keep up with demand, there are less than 50 on the drawing board not counting what we are doing. So you may think it is risky, but I know things about the market that most outsiders do not, which gives me an advantage, and that is basically the only time I like to invest, when I have an advantage.
As for country risk, Belize is a stable democracy and a British protectorate, same as Hong Kong was, the Falkland Islands, British Virgin Island etc…. The basis of law is British Common law and land is owned with fee simple title insured by the government. There is no foreign restriction on ownership as there is in countries based on Napoleonic law, which is most of Latin America.
As for currency risk, Belize has its own currency and there is a unilateral 2:1 US dollar peg. So as the USD resumes it’s slide to oblivion, an American would not lose their purchasing power in Belize. But if the US dollar were to fall off a cliff, it takes the signature of 2 cabinet ministers to unpeg the Belizean dollar from the USD.
“Even in your example what makes of think future cash flow isn’t already priced in rental real estate you are purchasing. You are basically extracting liquidity premium”
Because we in the real estate world know that the market of information is asymmetric, we were buying property when the price was falling but the rental rates were increasing. People often mistake price for value, value is determined by cash flow, price is determined by the market. I buy for value, not price. There was no way the future cash flow was priced in, because the price was falling. As for a liquidity premium, it is not a concept I personally give any credence to, liquidity is often antithetical to wealth, we buy projects with the anticipation that we may need to hold them for 20 years, so we need to be OK with our purchasing decision, the ability to get in and out of an “asset” can sometimes give people a false sense of security that if they make a bad decision or a speculative decision, they can quickly get out of it. We do not take that approach, wealth is built and maintained on your assets generating income, with very little proportionate need to reinvest capital in said asset to maintain the returns. (low capex spending).
We look to capture cash flow streams, not make new ones.
“What I don’t understand is that you were attracted to real estate investing because of Enron disaster. Have you ever considered the probability one of the SP500 going bust vs individual real estate buyer with leverage?”
I am not exactly sure what you are asking, but for me when you look at all of the academic research done on public market investing, the individual investor gets hosed at every turn. Secondly, I did not want to be a trader and have to be tied to the whims of the market with my wealth (cash flows), change in real estate markets are glacial, Detroit’s decline was 20 years in the making, it’s like a slow moving train, but if you are a student of history, after the great depression the public equity markets languished until WWII, 2000-2014 was a lost decade, that can absolutely happen again. I would be ok with my real estate not going up in price, as long as it continued to pay me month after month, year after year at rates that far exceed inflation.
You are good sales man, I will give you that.
It is pretty simple, any extra returns you might get is tied extra risk you are taking.
Belize is not Hongkong both geographically and trade wise. Currency pegs are meant to be broken, see recent example of Euro-Swiss.
I don’t get individual investors get hosed comment either. Looks like it is pretty standard line from real estate and kiyosaki crowd.
I am not your target audience also. I am not an physician (I do have MBA from top 10 business school), it is pretty funny to see most of my physician friends are attracted to real estate.
Good luck with your project.
Sorry, gotta correct the facts from your last paragraph about stock investing. Real estate investing is good enough on its own, you don’t have to talk badly about stock market investing to make it look good.
Many would argue the end of the great depression was the start of WWII. Thus, there were no “languishing market returns” in that infinitely small time period. Actual stock market returns in the 30s and 40s, however, are very easy to look up.
If you start in the depths of the Great Depression stock crash (let’s use Jan 1, 1933 for a starting point) and go through the 1937 crash (-32.11%) all the way up to Jan 1, 1942 (shortly after Pearl Harbor), the average annual return of the S&P 500 was 11.85% per year (annualizes to 8.10%.) Hardly languishing. Even if you add on the Great Depression market crash (let’s start with Jan 1, 1929) you get an average return of 1.88% and an annualized return of -2.28% per year, and any investor who was continuing to invest throughout that time period did much, much better (although I don’t know that there were very many to be honest!) So, if you’re going to start in 1929, I’ll give you the word “languish.” But come on, it was the great depression for crying out loud!
The lost decade claim is way off for many reasons I’ve written about before. Let’s start, however, with your claim that 2000-2014 was a lost decade. That’s actually 15 years, and it was far from being lost. The S&P 500 averaged 6.07% (annualizes to 4.20%) over that time period. Value stocks, small stocks, international stocks, REITs etc etc. all did better than that. And again, any investor who continued to add money throughout that time period (like me) did just fine.
Your comment also fails to discuss “lost decades” in real estate. There are plenty of them out there, but just looking at people who bought properties in 2006 ought to provide sufficient evidence that real estate is not immune to price declines. And it’s not like rents are somehow immune to declines (although they are admittedly far more stable than home prices). For example in my home state of AK, properties rented for more on a real basis in 1980 than they did in 2000. Real estate is all local.
Besides, it’s fine to say “I don’t care what the price of my properties is” but many real estate investors actually do plan to sell or exchange their properties at some point. Price certainly does have a huge effect on your return at that point.
You like to cherry pick what an ideal investor in stocks COULD have been in to make money during down periods, but let’s look at the research of what the average investor does in the market, and all the research shows that individual investors almost always under performs the market. And in doing so, does not even beat inflation in terms of returns.
Dalbar research is your friend:
http://blogs.wsj.com/moneybeat/2014/05/09/just-how-dumb-are-investors/
Again, just because someone doesn’t follow the advice to purchase real estate for cash flow and get appreciation as a prize, doesn’t make the strategy risky or wrong. I would like to make a million dollars on every Project, but that is not always possible, so I take what is possible. Buying real estate for cash flow and tax advantages works, but people consistently ignore it. I know of no easier way to make money besides maybe what you are doing here on the net.
Dalbar data is flawed- in a rising market the “investor return” is always less than the “fund return” even with perfect behavior. Vice versa in a falling market. The investor looks brilliant, but it’s just from the trend.
At any rate, if we’re going to talk about how the average investor in stocks does, we’d have to talk about how the average investor in real estate does. I’m sure it’s no prettier.
I can’t let you get away with saying that Dalbar’s data is wrong without some real evidence as to why that is. They are a respected research firm, and their data sets take into account up and down markets.
As for the argument of the average stock investor vs. the average real estate investor, it is a bit of a straw man argument. Relatively few people set out to actually invest in real estate (buy for long term cash flow) vs. the number of people who end up as accidental landlords, try and flip properties, or try real estate development. So there is no way to really judge.
But we can ask the question how many people became wealthy buying public market stocks where their actual investment gains made them wealthy, not their ability to save large amounts of money over time and place it into the public markets vs. those people that did it through real estate investing. I think we all know which avenue creates more millionaires.
I have been watching this exchange and find points on both sides. I think both have their idea of what they are comfortable with, but the last sentence you said about which creates more millionaires is silly. I do know quite a few millionaires, and non of them are in real estate. In fact, the few dozen I know that are invested in real estate aren’t even paper millionaires, although they have great cash flow. It’s the leverage that works for them. Now you have more chance to make a killing in RE than index funds, but will every killing, there are always hundreds more casualties along the way.
It is pretty easy to settle the argument.
You sounds like a professional investor. Why don’t you post audited statement of your real estate return and then we can compare with REIT mutual fund from the same time period.
Absent of that you are another snake oil salesman with nice suit (or whitecoat).
Since you mentioned that you started buying property in 2009, I literally changed the date in M* page to 2009 till today.
Unless you present the average individual real estate purchaser performance Dalbar study is apples to oranges to comparison. You also just cherry picked Enron debacle to make your case, even though individual real estate purchase can be as and probably more riskier than buying SP500 company. Enron debacle can easily solved by purchasing an index fund.
I actually said 2008, but it’s of no consequence. As I stated in an earlier post, there is no way to quantify what the average real estate investor returns, so it is a straw man argument.
Real estate is painted as a risky endeavor so most investors do not do it. But the public markets are painted with a brush of inevitability and that you are crazy if you do not participate, I am just trying to give a counter narrative to that. I just think that the public markets lull people into a false sense of security and makes people not truly examine why it is they are placing their capital where they actually place it.
Are there people who fail at investing in real estate, of course, but most of those people are speculators, trying to buy low to sell high, not actual investors who buy for the cash returns that come almost from day 1.
Successful real estate investors get educated. But most stock and bond investors do not, they cannot accurately value a business, and if you cannot accurately value a business you have no business buying it, that is an incredibly risky thing to do.
There’s more to investing in real estate than just buying real estate. I know you know this, but lots of people do not. The ability to look at an “income statement” etc is actually relevant when buying a business, which is what any property is.
However, one great shortcut is just buying all the businesses. Will it do as well as just buying a great business? Maybe not, but you will at least get market returns, and historically, those have been “good enough” to meet the financial goals of anyone with a reasonable savings rate and a reasonable amount of time.
Eric Tait on April 10, 2015 at 4:27 pm said:
“I actually said 2008 ..”
From your original post:
“The Empire Expands
From 2009-2013, we continued to purchase single family properties as the Great Recession took hold in Texas.
Srini
My 2008 comment was not from the original article, but in response to your posting of a Vanguard REIT, where you were looking at it’s returns from the depths of the recession.
Srini –
If you will pay for it and me for my time for gathering the information I will gladly take you up on your offer. It will take me roughly 4-5 hours to gather up the materials I’ll give you a discount of $100 an hour for my time. I know that my CPA charges roughly $65 an hour for bookkeeping work and he has all of the tax returns for our corporations.
If you are serious, just let me know and I will give you wiring instructions.
Since you mentioned 2009-13, I just went back 6 years from the day you posted. If you look at the chart it is from 04/08/2009 till 04/07/2015
Nice try.
I am not the one who came here to raise money for the fund, boast 58% yield, claim Real estate investing is the best since slice of bread and bash other form of investing.
As any investor who does due diligence on manager performance, manager needs provide proof of their superior performance. If you can’t cherry pick your own best performing properties and beat average REIT mutual fund risk adjusted then what is the use of your [post? Bear in mind Srini that he was invited to post here as I felt he had an interesting story-ed.]
Srini – your comment
“If you can’t cherry pick your own best performing properties and beat average REIT mutual fund risk adjusted then what is the use of your”
What I quoted you was the average across the single family homes. If wanted to cherry pick, I would pick the properties that I actually have an infinite return on with no money in the property whatsoever.
Example:
We purchased a 2098 sq ft. 4 bedroom 2.5 bath home in a Houston suburb for 55K. We then put around 15K in the property for rehab and renovation. That has us at an all in price basis on $70,000. I purchased that property using a line of credit. I then went to Wells Fargo and to do a cash out refinance of the property at 70% of the appraised value. The appraisal came in at $120,000 after our renovation. So they gave is 100% of our invested capital back, and the property cash flows around $450 a month.
That is what we call an infinite return. Now, would I have led with that in an article, no.
Is that common? More common than you may think, but it is not the norm. So when you say I am cherry picking, trust me, I am not.
I’d be happy to send you the HUD statement and the appraisal if you like.
Eric:
“So they gave is 100% of our invested capital back, and the property cash flows around $450 a month”
It is not a new concept for equity investors. For example if some one bought REIT etf’s or mutual fund, after 100% gain sell your initial investment back then ride the investments and collecting the dividends. Better yet buy the calls and roll up until the momentum dies. (if you haven’t realized i am an optiontrader).
We have a second home and an rental, so I am familiar with real estate pretty well.
Getting back to raising money for your funds. You are pushing the legal boundary in some cases, outright violation of regulation in some. I did check your state regulator and you are not registered with securities regulator. It does not matter you are raising money from accredited investor, you need to be registered. Giving out specific future performance of like 8% return with 50% occupancy to raise money in public form SEC will certainly question. Even claiming 58% yield crosses the line.
If anyone complains to regulators, they do not hesitate shutting down websites. There are few blogs which i follow, whitecoat is one of them. I think Vectorgrader.com ran into similar issue last year and he finally stopped updating the site.
Srini –
Please be careful about what you are accusing people of. Also, please learn something about Securities law while you are at it before you misinform the readers of this website.
I never said that I was raising equity capital for single family homes or looking for investors for single family homes. If you read some of my comments you would know that was the case.
Also, we have raised debt capital on single family homes, as our first foray into creating a fund a few years ago, you can find that on the SEC website here:
http://www.sec.gov/Archives/edgar/data/1532607/000153260714000003/xslFormDX01/primary_doc.xml
Now, what you may be trying to speak about is our Fund that we are raising for our Project in Belize. You can find that on the SEC website here:
http://www.sec.gov/Archives/edgar/data/1639023/000163902315000001/xslFormDX01/primary_doc.xml
To give you a quick lesson in Reg D 506 (c) – we have elected to use general solicitation for this Fund, which means that we can advertise and speak publicly about the Fund but we must verify definitively that the investor is in fact accredited.
So to set you straight on the law, there is no “registration” for an exempt offering. “Registration” is what companies do who want to sell stock to the public, they are usually S1 Registrations and that is what Google, Facebook, Xerox etc… did to “go public”
For Private Funds like ours there is “notification” of the SEC and the exemption that we have preempts State Blue Sky laws.
Now in our first 2 Belize investment funds which you can find here:
http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=%201580926%20&owner=include&count=40
and here
http://www.sec.gov/cgi-bin/browse-edgar?action=getcompany&CIK=%201591439%20&owner=include&count=40
we used a 506 (b) offering where we had to have a prior relationship with the investors in some capacity and could not generally solicit or advertise.
I hope this clears up your misconceptions.
I am familiar with debt capt financing from friends and family.
I was referring about your Belize fund. General solicitation about fund is fine. But i do think it crosses the line with this statement about future performance in a public forum “with only operational risk …If the price of our property in Belize does not go up one cent in 20 years, and all we do is collect an increasing cash flow stream I would consider it a great investment. We project from an 8% cash return at 50% occupancy to over 16% cash returns at 85% occupancy without any leverage”
I will file the complaint with the SEC, let them sort it out.
If you care about my opinion, I’d really rather not hear from the SEC.
Emergdoc:
I respect you and your blog too much to further proceed. I have appreciated posts from your early boglehead days.
I would like to unsubscribe from future posts here before i get worked up by another equity bashing post from Eric. Real estate investing just another form of investing like others.
http://i.imgur.com/a999CVV.jpg
Before i go just want to point to ironic fact that the same $70,000 invested in April 8th 2009 (6 years back from the date of his first post) would have grown 40,926*7 = $286,482 (link above chart )instead of his $120,000. Investors like him could have taken out their initial investment along the way.
Eric is getting $450 month rent or about $5400 which equates 7.78% yield on his initial investment. VGSLX TTM dividend is about $4.221. Initial unadjusted price is VGSLX $36.97 on April 8th 2009, that gives me 11.4% yield on original investment.
Tax benefit is a wash, if you take into account maintenance, property tax, closing cost for buying, selling & refinance, accounting, vacancy rate, default, legal etc.
So best of the best property manager in a most real estate friendly state could not beat an average real estate fund.
I’m going to miss your contributions. I’ll work with you on unsubscribing via email.
[Unnecessary comment removed.]
In any event, what you think about crossing or not crossing a line doesn’t actually matter in this case, it is what the law says that matters. So for your edification and for the rest of the message board I will quote the SEC code section for you.
Under Rule 506(c), a company can broadly solicit and generally advertise the offering, but still be deemed to be undertaking a private offering within Section 4(a)(2) if:
The investors in the offering are all accredited investors; and
The company has taken reasonable steps to verify that its investors are accredited investors, which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like.
I could absolutely if I wanted to pay this website as an advertiser place an ad for that specific fund and it would all be perfectly legal. It’s funny, I only spoke about the Fund in response to you trying to denigrate me and my thought process, the irony in that is hilarious.
Srini – You can attack me personally, I am ok with that I can take, but I do not want to let your bad analysis languish on the message boards.
I will take apart your arguments one by one for the benefit of the message board so that they can see both sides.
To start with, you again cherry picked the bottom of the market for that fund, if you go back just a bit you will see that had someone been invested in that fund it dropped in price over 68%. I wish we could all market time as well as you pick your entry prices to make your points, we would all be wealthy. So since behavioral theorists have proven that most people sell at the bottom and buy at the top, that is a much more likely scenario for the average investor. And if one is invested in an index like fund, the whole point is to ride out the dips, so at the bottom they would not have had that 70K with which to start, their investment nest egg would have been less even if they were dollar cost averaging in.
“that the same $70,000 invested” –
I think you missed my point, the 70K was removed within 3-4 months and placed into another investment. There was no invested capital in this projected. It is what is known as an infinite return.
Had an investor done that in the fund you quoted they would not have ended up with the amount that you stated at the end because they would have sold some of their principal (the 70K that we are discussing) that was compounding. – So that is logical fallacy #1
“Eric is getting $450 month rent or about $5400 which equates 7.78% yield on his initial investment.” –
No, see above. That money has no denominator to it to figure out a yield. It is what we like to call free money in our business. Logical fallacy #2.
Also, the $450 quote is what we make with debt on the property, it would be closer to $800-$850 a month if we were unlevered in that particular property.
“Tax benefit is a wash, if you take into account maintenance, property tax, closing cost for buying, selling & refinance, accounting, vacancy rate, default, legal etc”
The $450 a month cash flow that we quoted takes into account maintenance, vacancy, property tax, and insurance. The closing costs (where refinancing happened) were in the original acquisition price. – knowledge fallacy #1
Depreciation on this property will cover most but not all of the cash flow because of the high rental rates in our market right now, but just so the message board can understand.
The depreciation schedule for residential rental real estate is a straight line 27.5 year schedule. In this example it breaks down like this.
The property is worth 120K, some proportion of that is allocated to the structure (usually 80%) and some is allocated to the land. (the remaining 20%). You cannot depreciate land.
So to make the math simple let’s say that we use 100K for the depreciable amount of this property. (it would actually be the initial purchase price that is broken down 80/20, but the math is easier this way)
100K/27.5 years = $3,636 in income that can be sheltered from taxation. So if we make $5400 we would subtract $3636 from that total for a taxable income of $1,764 instead of $5400.
In the 39% tax bracket that is a savings of $1,419 dollars a year, multiply that by 10 other properties and you almost have enough for a down payment on another single family home. That is how you multiply your wealth using the tax code.
So as you can see the tax benefit is not a wash – knowledge fallacy #2
So let’s now look at the actual returns that this property has generated over the 4 year period in terms of capital gains, cash flow, principle paydown, and money kept through depreciation.
Capital gain – the $120,000 appraisal was in 2011, we also bought the property that year so let’s just take it from there. Assuming a 5% appreciation (and that is low for Houston over the past 4 years) that would give us a value of $145,860, the all in purchase and rehab price was around 70K.
Cash flow – $5400 x 4 years = $21,600
Principle pay down – Approximately $4,151. (we actually have a line of credit on this property and pay simple interest, but for the example I used a 30 year loan at 5% interest)
Depreciation tax savings of $5,676 that you kept in your pocket and could do with what you want.
I hope readers now get a more accurate accounting of the returns on the real estate side of the ledger.
Careful with the “house money” theory. While you got your equity out, there was more equity you could have taken out by selling, so that is what your return on equity going forward should be calculated on, and that’s the return that matters.
WCI – what you are referring to is ROE or return on equity, what I was speaking about is ROI, or return on investment or invested capital.
I use ROE as a measure of how effectively my total equity is in generating a cash return. How much does my networth generate? That is what I am referring to when I was saying that most people have a less than a 0.5% realized return on their total equity portfolio.
Whereas ROI is used as a measure of the return (cash and possibly capital gains) vs. the total amount of money that has to be invested out of pocket. We use it to compare different investment options against one another.
In real estate, your ROE tends to go down over time, (appreciation and principle paydown) that is why refinancing out your equity, or 1031 exchanging the equity to higher yielding property is important.
I know the difference, but I think it’s important to be a little more explicit. If you put in $70K into a property, and it appreciates a bit such that you pull out your $70K and still have $50K in there on a $250K property, it’s not an infinite return on that $50K in equity you have, and that’s the return that really matters outside of cocktail parties. That money sitting in equity has an opportunity cost, and if your return isn’t outperforming it, it isn’t a good deal, no matter how infinite it’s ROI is.
WCI –
I think that you are letting the equity tail wag the dog a bit. You cannot get the equity in any asset until you first make the decision to invest some amount of capital out of your pocket. The initial decision to make that investment is not driven by the potential equity (because it does not usually exist until the investment is made), it is driven by what the return will be on your INVESTED capital.
In the example that we are talking about, the 70K was the initial investment capital that allowed us to purchase an asset with a specific return criteria. The potential return on investment of that asset is why we chose it over any other asset in the universe of assets that were out there. This decision was based upon the ROI calculation.
It just so happened that what we did to the asset over a 3-4 month period allowed for a capital gain/equity gain. So we pulled the initial investment capital out of the asset tax free (the transaction costs were part of the financing and covered by the equity in the property) and rolled that 70K into other assets.
So we had a 50K gain in the price of the property from our initial investment of 70K, but the return was ON the 70K that is no longer in the property. Yes there is an opportunity cost of the equity left in that property but the equity cost us nothing to acquire, also there is no opportunity cost on the initial 70K because it is out working in other assets.
So we received a free 50K in equity, purchased and still own the WHOLE 120K asset (the 70K does not get subtracted from the price of the asset so it can still compound on the whole 120K), but none of our money is in the asset. Oh, and the property generates around 5K a year in cash, gives tax benefits etc…
That is free money and an infinite return on the initial 70K, the 50K in equity was just a by-product, albeit a nice one.
I’m just saying ROI is a silly measure once you pull some equity out. You can do the same thing with a stock. If it goes up 50%, you take your original investment out and now your ROI is infinite! Woohooo! Except that what really counts is what you are earning on the money still in there.
WCI –
I think this where you and I get our signals crossed when talking about investing. I will not begin to assume that I know what your investment philosophy is, you do an eloquent job of explaining yourself, but for the sake of the readers let me give insight into mine as it speaks to your comment about ROI as it relates to an infinite return scenario.
“I’m just saying ROI is a silly measure once you pull some equity out.”
We are actually pulling out the initial investment capital, not equity in this scenario, but that is a minor point.
I use ROI as a litmus test for where I allocate capital. Most wealthy individuals (I am not one yet but I like to model after them) have a minimum return level that an investment has to have a reasonable expectation of achieving for them to place their capital into it. For the wealthy that I know it is in the 10-15% per year range in some combination of cash returns and capital gains.
For the example that we are referencing it was not an accident that there was an infinite ROI, as we have had at least 3 single family properties where we have done that. It was the reason that we allocated capital to those assets.
Ken McElroy who I referenced earlier, his business model in apartments is to purchase projects that will allow him to return his investors capital back to them while still owning the apartment project, it is a basic part of the investment strategy.
Likewise our Belize Project is designed to do the same exact thing for our investors. It is a part of the business model. (whether we pull it off or not remains to be seen, but that is the plan)
So using that as a bench mark we can then use the post-refinance ROI calculation to see how well we achieved our goals. Let’s assume I only pulled 60K out of the property instead of the full 70K. That would have left 10K as our invested capital in the asset. We could then figure out how well we are doing with our money.
Cash on cash return of $5400 in rent on 10K invested is a 54% cash ROI per year
Capital gain return is 60k on 10K invested creating a 600% ROI in terms of capital gains.
That is why the post refinance ROI is meaningful, because even if you fall short of your infinite return goal, it will give you a good measuring stick to decide where to allocate your capital.
So if I have the choice between an investment that is going to generate a 10% return a year for 5 years and one that is going to pay me 7% a year for 1-2 years and then return all of my capital to me in year 3 while the asset continues to produce returns, I am personally going with option #2.
The problem with paper assets is that you cannot model that type of outcome, you cannot do anything personally to effect that outcome. In paper assets you would have to get a 100% gain in price to be able to pull out all of your initial invested capital. And then your investment base has been eroded in that particular asset.
You have to be one hell of an individual stock picker to do that, and most likely it will be a small or mid cap stock (with the exception of Apple over the past few years and the fact that we are coming off of recession era lows in stock prices). If you are an index fund investor, it is even less likely to happen because we know that the average return in most indexes is like 7-9% a year (and we also know that the individual investor rarely see that in their portfolio). Then there is the tax cost if the stock/fund is sold if it is in a taxable account.
Maybe it is because I do not have an automatic withdrawal of my money into savings vehicles like 401K and IRAs on a monthly basis, but I sit and really have to analyze where I personally write a check as it relates to investing. (and before I get hate comments, I am not saying people who have automatic withdrawals do not do this as well, I am only speaking from my perspective)
The ROI target on investment entry as well, as well as exit, for the initial invested capital is one of the most important metrics that I look at when making an investment decision.
As Roy Rogers once said “Don’t talk to me about return ON my investment until you tell me about return OF my investment”.
You have an interesting definition of wealthy. A $2 Million net worth doesn’t qualify for you? 🙂
You don’t seem to get that most of what you can do with real estate you can do with stocks. It might not be as good of an idea to do it with stocks, but you can do it.
For example, let’s say I borrow $100K out of my home equity at 4%. I also take 25K of cash I had in my checking account and I buy $125K worth of stock. The stock goes up 20% in value. There is now $150K in stock. I sell $25K of it. I’ve got all “my money” back. My ROI is now infinite since I no longer have anything invested. Woohooo!!!! Infinite returns! Yippeeekaiiyaaaa!
But in reality, I’ve still got $125K invested and I owe somebody $100K. If the investment outperforms the debt, then I’ll do well. If it doesn’t, then I won’t. But the appropriate measure at this point that any reasonable investor would care about is the return on that $125K. That’s because there are alternative uses for that $125K. I could pay off the home equity loan. I could invest in real estate or a mutual fund or whatever. There is opportunity cost there. So you can’t just pretend it is house money. That’s my point. Pretending it is house money is a way to sell to a financially unsophisticated investor. If you truly believe that equity isn’t yours, then you’re being financially unsophisticated yourself.
Plus you can’t ignore the time value of money.
For example, if you put your $50K into a real estate project and then a year later it is refinanced and you get your $50K back but still own part of the project. Now you run around bragging that you got your money back and now your return is infinite and talk about what a great model it is. Well, that’s not entirely true due to # 1 inflation and # 2 the time value of money. $50K now just isn’t worth what $50K a year ago was worth. This also, of course, ignores the risk that your $50K could have disappeared just as easily as being available for withdrawal.
At any rate, I think ROI is not a very useful measure EXCEPT right when you buy the investment. After that, you need to always be comparing to the alternatives you could do with your equity.
WCI –
Remember, wealth is measured in time not money, I could not stop working a 9-5 job and maintain my current standard of living from my assets alone (without touching savings or principle). So no, I am not wealthy yet.
Now let’s break down your example to show that while it can be done with paper assets, it does not really further the same goals and there are some holes in the analogy.
“let’s say I borrow $100K out of my home equity at 4%.”
#1 – It assumes that you own a home
#2 – It assumes that you have any equity in your home to borrow against.
#3 – You are not using paper assets to perform this maneuver you are using real estate to do it. (and that makes me smile)
“The stock goes up 20% in value. There is now $150K in stock. I sell $25K of it.”
The stock went up in price, not value, and if you sell within 1 year, then you will get hit with ordinary income tax and not have the full 25K back.
“I’ve still got $125K invested and I owe somebody $100K”
You are the one stuck paying back the 100K, not a tenant, so your material standard of living has just gone down because you must now devote some portion of your income to servicing this debt. Now maybe you chose a stock to buy that has a 5% dividend yield (AT&T maybe), but you will still be taxed at ordinary income rates on that dividend and you will still be negatively geared in relation to your borrowing costs. You will get a slightly higher mortgage interest deduction in the process, but it will probably not wipe out your tax liability on the dividends.
” So you can’t just pretend it is house money. That’s my point. Pretending it is house money is a way to sell to a financially unsophisticated investor.”
And that is where we differ, I go in with the expectation that I am going to be playing with house money in a relatively short period of time, because accomplishing that is the highest and best use of my capital. There is nothing else that I would consider investing in at the time that is yielding higher, even if we are not able to pull all of our initial capital out, the returns will still be higher than most of what is out there, so the opportunity cost argument is moot.
“For example, if you put your $50K into a real estate project and then a year later it is refinanced and you get your $50K back but still own part of the project. Now you run around bragging that you got your money back and now your return is infinite and talk about what a great model it is. Well, that’s not entirely true due to # 1 inflation and # 2 the time value of money. $50K now just isn’t worth what $50K a year ago was worth. This also, of course, ignores the risk that your $50K could have disappeared just as easily as being available for withdrawal. ”
Now this is interesting, the time value of money and inflation work hand in hand, but they effect all portfolios equally, so it not a real factor in this instance. While the 50K is in the property it is generating a return that was the best at the time, once it comes out it will move to another investment that offers the best returns at the time for our goals. All of those returns are above the rate of inflation as well.
To be able to pull the entire investment capital out of a property on a 70-75% LTV the property would need to go up in price around 33% in round numbers.
Now how can we make that happen? Well we could make sure that we buy at a discount to current market price thereby making sure that we will capture that equity. So the fear of the 50K going away is mitigated by buying correctly when it comes to single family homes, in commercial property all you have to do is increase the income of the property to get an increase in value.
So the entry price is key, you are not buying paper assets at a discount to the market price, you are buying at market price by definition. What you are hoping is that you are buying under value and that the “market” realizes it and gives you some price gains in the process, but this is a hope and a wish.
So we will agree to disagree on the house money concept as I am putting forth, but I bet if we polled people and gave them an option as to how they would like to invest, I am pretty sure the house money concept as we have discussed it would be very popular.
Sure, and if we made a poll asking whether people would like Santa Claus to fly over and drop bags of money down their chimneys it would be a very popular concept too.
And yes, I agree that if you can buy something worth $100K for $75K, you’re going to do very well. You should do that as often as you can.
There are transaction costs to getting your money out of real estate as well. Last I checked, neither selling real estate nor refinancing it was free. And STCG rates apply to real estate just as much as anything else. And of course, this whole discussion only talks about the awesome use of leverage in assets that only increase in value.
And the fact that you can’t live on the income from a net worth of $2 Million is a reflection of your spending preferences, not your level of wealth. 🙂 But it’s a vague term and I suppose you can assign it any meaning you wish. “Enough” is an elusive concept but one worth spending some time pondering.
WCI –
“There are transaction costs to getting your money out of real estate as well. Last I checked, neither selling real estate nor refinancing it was free. And STCG rates apply to real estate just as much as anything else. And of course, this whole discussion only talks about the awesome use of leverage in assets that only increase in value.”
Yes, but in the example we are talking about the refinance transaction costs were paid for in the equity gained in the property, we did not pay out of pocket so no more investment capital had to be paid in to unlock the initial investment.
STCG and ordinary income tax rate is the same thing, we do not sell properties within 1 year, that would be flipping. Debt refinancing is a tax free transaction.
And like I have been saying from the beginning, with the way that we invest in real estate we do not need the property go up in price to make a return, we can live off the returns that the rental income gives us alone as a sufficient yield to be happy with the investment, capital gains are just a bonus. If prices happen to fall for a year or so, it wouldn’t matter.
Sure, you can live on that return, but you can’t “take your money out for an infinite return” without amortization or appreciation.
The funny thing about the word “speculating” is that it is usually used by one investor to refer to another investor where the second investor typically has a much higher risk tolerance and certainly invests in a different way than the first.
If you don’t invest the way I think best, you’re a “speculator.”
The bond investor calls the stock investor a “speculator.”
The index fund investor calls the real estate investor a “speculator.”
The real estate investor calls the individual stock purchaser a “speculator.”
I’m not sure the world will ever agree on a definition of speculating with respect to investing.
That is just not true.
Speculation is very easy to define.
Buying something that you need to sell later at a higher price in order to make your money is speculating.
Buying a dividend paying stock whose long term prospects to maintain the dividend is not a speculative investment.
Buying a bond and holding to maturity is not speculation.
Buying a stock fund that does not give you any dividends or cash returns is speculating.
Buying a piece of property to flip is speculating.
If you need the price of the “asset” to go up for you to receive your return you are speculating.
Like I said…everyone has a different definition of speculating. Some think buying property in Belize is speculating. Others think buying an index fund is speculating.
I think you are conflating speculation and risk, they are not the same.
All investments have risk, but not all investments are speculative.
Our Project is going to tap into a known cash flow stream and demand curve that is rising. We are not trying to create new cash flow streams that do not already exist and we do not have to outperfom the market for it to be a great investment.
Our RISKs in the beginning were labor costs, materials costs, import duties, cost overruns etc…. All of those have already been handled, our current RISKS are operational in nature, can the 3rd party hotel management company operate the project as effectively as the other 4 star resorts that are 90% occupied? That is a risk, if the market was not performing the way that it is and we thought we could outperform the market and we needed that to happen for us to make money, that would be speculation.
If the price of our property in Belize does not go up one cent in 20 years, and all we do is collect an increasing cash flow stream I would consider it a great investment. We project from an 8% cash return at 50% occupancy to over 16% cash returns at 85% occupancy without any leverage. I will take those risks any day with what we know about the market. (plus when we bring in leverage at a 10 cap we will be able to pull of our equity out of the project and still be able to own it and the cash flows)
It cuts the same with stocks, if you buy AT&T for that 5% dividend, you are not speculating in AT&T, you are buying it for the cash flow, and if you are happy with a 5% dividend, then you do not really care if the stock price increases, it is nice, but it is not necessary for you to achieve your investment objectives.
That is the difference between speculating and investing.
Ricky,
It of course depends on where you sit, Owning your own business and real estate are the fastest way to get to the million dollar plateau. I know quite a few millionaires as well and most of them are in real estate, and all of the ones I know who are less than 50 years of age are in real estate.
Again, it is easy to have a high income job and save your way to a million dollars, it is not as easy to INVEST your way to a million dollars using the public markets.
But this discussion is not about that, it is about opening peoples eyes to the possibilities of other ways to allocate their capital.
I’m personally insulted. Maybe I should send you a copy of my book. It took me 7 years out of residency, no real estate required. LOTS of docs have done the same. As I mentioned before, real estate can stand just fine on its own. It doesn’t require you to put down other successful methods of investing to make it look better.
Seriously though, there is some selection bias here. Go by the Bogleheads board some time. About half of them are millionaires. The vast majority did it simply by working at a decent paying job they either liked or didn’t, saved a reasonable percentage of their income, and invested it in boring old index funds in a 401(k) or Roth IRA. It works just fine.
“8% return with 50% occupation with only operational risk” on Foreign, hospitality industry with only operational risk involved.
I have heard this argument before. Just replace “Belize” with “Nigeria” and “Resort” with Mining industry” when gold price was roaring.
Have you considered Cuba opening up? on second thought never mind
WCI – I meant no offense, but if I am not mistaken you are an ER physician, (please correct me if I am wrong). All of my friends who are ER docs make between $175-250 an hour. With a 12 hour shift, 15-20 shifts a month that is on the low end 31,500 a month before taxes, or a gross or $378,000 gross a year on the low end. That is more than my internist wife and I make from medicine combined. If you happen to be married and your significant other works then that is possibly even more income. So my point about having a high income job and socking away a good bit of money while still being able to maintain a pretty affluent lifestyle still holds true.
I’d like to see how many internists/pediatricians/FP’s were able to put away a million dollars 7 years out of residency in 401K’s and IRA’s? I know if I was using that strategy there is no way that I could have and I live below my means.
The sad part of this is I know quite a few older physicians who have not done this and they are up a creek without a paddle in terms of retirement.
My average salary those 7 years was ~$180K. I was in the military for 4 of them ($120K a year), an employee for 2 more years, and then one year as a partner. There are many roads to Dublin. A physician salary + a solid savings rate + an optimized financial plan = millionaire in less than a decade. Maybe a little more if you have to start out $3-400K in the hole.
I’m sure his returns have been quite good given the limited time he has been doing it and his relatively low physician income as an internist. Of course, to be fair, you would have to subtract out the value of his time since much of what he is doing is really a second job. But the point is that he worked hard, acquired some knowledge and skill, applied it and found success. Fortunate timing the last 5 years? Sure, but the same could be said of a stock investor.
Interesting read, however having 5-6k in passive income would clearly not be enough to replace a salaried position. Also, having 5-6k in passive income on 21 properties is not really that great…….strictly speaking investment/cash flow wise…………that’s WAYY too much work managing 21 properties and it’s more of a side-job/2nd job than just a ‘passive investment.’ Thoughts?
That was my thought. If each property is 100K, then that’s about 2.1M in either debt, or opportunity costs. At even a 3% withdraw rate, 2.1M generates between 5 and 6k a month, and that’s completely passive income.
Granted, the homes should appreciate which is an added benefit, but some of that get eaten up in recapturing if he sells and doesn’t re-invest it in another property. Overall I like the idea of real estate, but it would be a second job, and I feel I can make that money up pretty easily by working more at my main job.
I am intrigued, but not sold yet.
Ricky,
Traditionally that is how people view real estate, the mathematical relationship that you just put forth, the problem is the assumption is not correct. I did not save my way to 2 million dollars, I invested my way to that. That is the beauty of real estate and leverage. The average person, even a very high income earning M.D. is not saving 2 million in 5-7 years, and still be able to live what is the usual M.D. lifestyle (I am not passing judgement on whether the lifestyle is good or bad, just stating it). If you have a decent home in a decent neighborhood, kids in private school, a vacation home etc…. It’s not easy to create 2 million of investable equity that quickly for most people who go to work everyday in a place not called Wall Street.
As for selling property, I have not done that yet, and I would probably 1031 exchange the property into larger property to avoid any tax consequence, unless of course I decide to roll more down to Belize which I am seriously considering as I do not see very good value in the Houston market right now.
I wrote this as an introduction, most of the people who invest with us are not trying to have a second job, they want the passive returns and the tax benefits of direct investment, not to manage the whole process themselves. But there are a select few who absolutely want to learn how to do it themselves and I would like to give them a road map in upcoming articles.
Whether you wish to invest in real estate, stocks via index mutual funds, bonds, or whatever else- if you do not carve out some portion of your income to invest you will probably never get wealthy.
What you call “investing my way to $2 Million” should probably be called “working and investing my way to $2 Million.” That’s like saying I invested my way to a $100K a year passive income from this blog. Sure, I “invested” a lot of time and labor, but most people call that “working.”
It’s all semantics, of course, but I just don’t want doctors taking from your comment that they can have a big fancy home in a fancy-schmancy neighborhood, 3 kids in private schools, and 2 homes and somehow become multi-millionaires in a decade just by choosing to “be a real estate investor” of some type. Time or money, it takes one or the other to make money. Since most docs are already busier than they wish to be with work, they had best carve out a significant chunk (I recommend at least 20%) of their money to invest in some passive way (and real estate is just fine.)
P.S. Let me clarify,
I am only counting the 11 single family properties, and the apartment property in that 5-6 K a month (and taking out potential maintenance and vacancy in that estimate). The other 10 single family properties I bought for family members and manage for them, I do not count those cash flows which are around another 4K a month on the conservative side. Also, in our resort project which opens later this year we are projecting to gain another 5K a month over the course of the year (initial ramp up period, but the market has a 85-90% current occupancy, so we expect a fast uptake).
As I replied in an earlier post, since we are no longer acquiring in the Houston market, I spend 1-2 hours a month of the single family homes, 2-3 on the apartments. It is all about the systems you have in place.
For a few years now I have been considering getting into real estate, and every time I think about it and do research on a single family home, I realize that I will be bringing in only a few hundred bucks a month at best. Even the mortgage payments would affect very little of my principal. While at the same time I pull in thousands a month practicing medicine. The last thing I want to do is maintenance on rental property or dealing with tenants for a measly $200 or $300 a month. Obviously over the coarse of 10-30 years that $200-$300 a month will grow especially as more and more principal is being paid off. Then you add in owning more and more properties as Dr. Tait did and you will find some very nice cashflow. I know that you have to start somewhere and that to build an empire you need to lay down your first brick. I just can’t get myself to lay that first brick especially when it will take away some of my very precious free time. And early on that time is not cost affective.
Another item that holds me back is that real estate investors recommend finding homes with CAP rates of greater than 5%. Historically a 60:40 stock bond portfolio has returned 8.7%. With that in mind, why would I put in any extra time and energy into a market that returns less than just holding a few index funds?
This analysis is for single family homes. I think the real money in real estate is multi family homes or commercial properties. That is when your CAP rates can start to hit double digits and can outperform index fund returns.
Remember that your have other sources of return other than cash flow- appreciation, deprecation/tax benefits, amortization of the loan etc.
There are a number of ways to minimize your involvement in the investment as well:
Hire a property manager
Only buy net-net-net properties
Syndicated deals
REITS
etc.
But you’re right that you don’t want to trade a $200 an hour job for a $10 an hour job. You have to be very careful and deliberate to avoid that.
I want to be a real estate tycoon –
So I completely understand your point of a few hundred bucks a moth, but it is really more about learning a skill set and learning how to generate income not using your labor. You change as a person when you get passive income checks, how you view money and what you do with your money really comes into focus.
Also, just to be clear, time is my most important asset, and I understand that building my passive income portfolio has given me more time to do the things that I want to do while still being able to expand my lifestyle without having to work harder in medicine. I choose when we will be making acquisitions, or when I will have contractors come to my office etc…. It is about control over your own time.
Now you say something about an 8.7% return in a paper asset fund, that is capital gains not cash flow. Right now you can purchase single family homes in my market for an 8-9% cap rates, but you don’t buy property unleveraged, so your returns will be way higher than 8-9%. Now counter-intuitively, multi-family and commercial cap rates are now around 6-7 and lower in first tier markets. So single family actually has higher returns historically, but single family homes are not completely passive unless you have property management.
What commercial properties and multifamily properties can do is you can force price appreciation by increasing the cash flow the property produces. You cannot do that with single family homes, because they are sold based upon what other single family homes are selling for in the immediate area.
Author states that he started collecting properties from 2009-2013.
Here is the Vanguard REIT performance from 2009.
http://i62.tinypic.com/2akfhjq.jpg
300% return in a passive mutual fund with out worrying about tenants. 5k-6k passive income on a $2 mil portfolio with all the hassle of managing them is not great either. It is about 3 to 3.5% yield. Guess what is the yield of Vanguard REIT 3.53%.
You are over simplifying if you think 5-6K of income is the only return on his investment….That is actually the minority of the return on his investment.
Well my chart above shows capital appreciation of 300%. In one of his example $45,000 property is worth of $95,000 now, appreciation of slightly more than 100%.
So he is under-performing his direct benchmark. What else did i miss, other than dealing with bad tenants and wasted hours?
My point is his effort is quite commendable and can be a good water-cooler topic. How is this a guest post in this esteemed blog? In fact, it is pretty risky strategy in the current environment.
Srini –
You have made a classic mistake that many people do when they are trying to figure out the returns real estate investor receive.
Because we use leverage that 2 million dollars was not saved it was created from investing. Our actual out of pocket, at least on the single family properties was between 10-20% of the total amount.
To give you rough numbers, our average acquisition basis on our single family properties was around 50K, lets just say we put 20% down on each property (we did not, and in some cases we actually put no money down) that would give us 10K x 11 properties for a total cash outlay of $110,000. The bank gave us the rest of the money to acquire and rehab the property. We are all in for around 60K per property and each on average is worth around 100K. So we have 40K in equity over that time frame you stated giving us $440,000 in capital gains.
Now the cash flow is between 5-6K a month so 60-72K a year.
Let’s do the math – on cash flow of 60K on an outlay of $110K that gives us a 54% return on cash per year. (At 72K it is 65%).
Now let’s turn to Capital gains – $110K out of pocket for a capital gain of $440,000 is also a 300% return
So we have a 216% cash on cash return over that period and 300% capital gain.
We have not even begun to touch the returns of principle paydown (mortgages being paid by the tenants), depreciation, and appreciation. (Imagine a 5% increase across 11 properties each worth 100K, that would be another 55K in appreciation)
This is the math of investing in real estate directly.
I posted date issue in of my reply above.
In any case, since you mentioned you started buying property in 2009 I literally changed the dates in M* to 2009 till today.
Regarding you are getting yield greater because your purchase price was low, same is the case for investor who bought mutual funds at lower price in 2009. I remember junk bond was yielding more than 20%.
Regarding leverage, it works both ways. If anyone had conviction pouring money to individual real estate, they could have used cheap leverage in market much more efficiently. Implied interest rate are far far lesser than anything you could get at the bank. Cheap call options on real estate ETF in 2009 blows anything you earned.
Regarding market volatility you should know better. Just because individual real estate market is not marked to market daily, it does not mean prices are stable. Real estate and commodities price are momentum plays just because use of so much leverage. Any leveraged individual real estate player who could not make payment had to default or sell at fire sale prices. Atleast mutual funds have liquidity to sell.
So I actually started buying in 2008, so let’s go and look at that Vanguard fund, not at the bottom of the market and it’s long march upwards, but at it’s height and then its’ fall, THEN it’s climb back up from the point that you decided to choose.
http://quotes.morningstar.com/fund/VGSLX/f?t=VGSLX
So if we do some analysis we see that this Fund reached it’s peak on 1/31/07 at 17,679.
From this point it marched its way down to a low of 5,620.88 on 2/28/2009, So if you held that Fund you lost 68% of your capital all the way down. A 3% yield will not compensate you for that loss or purchasing power or opportunity costs.
See my response below to rest of your comment.
Great post!
My plan has always been to invest in real estate once I have the capital. Used to be 9/10 millionaires (when that term meant something) found their fortunes primarily in real estate. My father is a commercial real estate developer and my close friend’s family holds over 100 residential units. While it’s a lot of work and risk, they are in control over their assets and they make their own success.
Even without Enron, the stock market scares me because I am so far disconnected from my investment dollar and the control and valuation of the underlying asset. If Greece suddenly stops paying their bills, I could be out half of my savings in an instant. Even if the economy collapses, the real estate is still there. If all the tenants move out and there’s literally zero demand, chances are the financial market is doing no better.
That fear of market volatility (both temporary and permanent loss) is a frequent driver behind many real estate investors’ heavy preference toward real estate investing over stock investing. While I think their fear is often at least a little overblown, real estate investing certainly promises much higher returns than the 20% stock/80% bond portfolio that an investor with that much fear of capital markets might otherwise hold.
Is Greece really that key to your portfolio?
Touche! I’ve just been reading too much wsj lately. 😉
But seriously, that’s part of my point. I’d guess that most American portfolios aren’t particularly leveraged with Greek assets, but a few months ago the S&P500(an American index) was ticking substantially up and down after statements by the ECB, German bond holders, Greek election results, president Tsipras, etc. The euro is at a 12 year low right now, and if Greece defaulted on their obligations (which they have recently been within days of doing) it would wreck the euro and take much of our market with it.
But do I think Greece will default? No, not really. Do we have any control? No. Are there many other similar things that can happen, through no fault of our own, on the other side of the world, that could devastate our portfolios? I believe so.
Don’t get me wrong, I believe in the capitalist system, but betting the bulk of my holdings on the whim of market it is another story.
Craig –
Thanks for the kind words. You hit the nail on the head, I am just starting to dip my toe into Development and it is riskier than buying residential tenanted property. But even with that, the premise behind our development is holding for long term cash flow, so we do not need a market buyer to come along to take us out so that we can make money, and that is what often gets builders and developers into trouble.
As for the stock market, I try to avoid the real estate vs. stock market thing, but I do not know anyone who buys public market stocks and becomes wealthy from doing that, at least not within a 10 year time frame. And by wealthy I mean no longer having to work a 9-5 job to maintain their standard of living and not selling your assets and spending down principle.
That’s a lot of caveats on wealthy. That’s like saying:
I don’t know anyone who buys real estate and becomes wealthy from doing that… And by wealthy I mean never collecting any rent from their properties or ever talking to a lender.
What I am talking about is trading time for dollars. 9-5 working hours.
I do not collect rent from tenants, they deposit it into the respective corporate accounts, if I need to speak to a lender it is when I want to do it.
Being wealthy is being in control of your time, is there some maintenance work, of course, but that is true for people who are 65 and on social security and drawing down their 401K.
But if I am 40 and all I have to do to maintain my standard of living is spend 1-2 hours a week dealing with my investments, I will take that all day long.
“Being wealthy is being in control of your time” – you nailed it, Eric.
I love what I do today…I also enjoyed most of my twenty years in private practice…but not close to the enjoyment that I have today because I have real freedom.
As you stated, I still “work” – but the work is fun – because I choose who I work with and delegate the rest. I choose when I work. I am not “on call.”
Like you, I can’t name anyone in my personal network who has achieved the same in the financial markets…but I can name many who have done so in real estate.
Have you considered that there are people who would rather practice medicine, put 20% of their income into index funds, and spend the rest of their time with their family, hobbies etc? Figuring out a way to do what you love is one definition of “financial freedom,” “retirement” etc. If someone hates medicine, real estate is a great career/exit strategy. If you actually like what you do, and it provides more than enough income to meet all your financial needs/goals, it’s perfectly fine to do that.
What you described may be call “happiness or contentedness” but it is not financial freedom. If you have to trade hours at work most days of the week, most weeks of the year to maintain your standard of living you are not financially free, it doesn’t matter if you love what you do.
Not everyone’s goal is to be financially free at an early age, I get that, but I want to at least give people a window into the possibility, and while single family homes is probably not going to get a high income earner there alone, it may start the journey for someone who then looks at other asset classes in real estate where you can invest larger sums of capital to achieve economies of scale.
As I stated in the article, I would be bored out of my mind if all I did was collect rent checks, there is nothing intellectually stimulating about holding a passive income portfolio. Of course there is exhilaration, fear, trepidation, and elation when purchasing a real estate asset. But after it is up and running it is like watching paint dry.
Good investing is boring investing.
Eric,
I was in Galveston (The Rock) for at least 1-2 of the years you were (med student). Glad to see you are doing well. What strikes me about this post is what I have realized from reading the WCI posts. Physicians, if they invest the money they make wisely, can go any number of different routes and do very well. Too many don’t take any interest in the money they make and what to do with it which creates problems. Although I’m sure your MBA has helped you, it sounds like much of your education came from practice as it relates to real estate. It also sounds like you continue your education in Real Estate to this day. WCI is very similar, just in slightly different area. I think it is more difficult to become a skilled real estate investor, but I do think that they payoff can be quicker than a “lazy/coffee house portfolio”. Either way, I think continued education, savings, and investment are key for physicians wanting financial independence. Which area you choose to invest your time an money may be less important that the acutal investment tool. Thanks!
I agree. Many roads to Dublin and all that. One area where real estate is really useful is in applying leverage. So if you can get a Cap Rate 6 property that also appreciates at 3% a year, that’s 9% a year. Basically a stock return. However, if you leverage it up a bit (say 67% loan to value) you can boost that return to say 12-14%. Since that investment takes more work than an index fund portfolio, you have to subtract out something for your time. But even if you reduce your return to 11% (vs our hypothetical 9% index fund portfolio return) the difference between 9% and 11% over 30 years is huge. On a $50K a year investment, that’s a difference of $7.4M to $11M. A little extra return is worth a lot.
But you have to enjoy it and you have to be good at it. That’s what has kept me out of diving head first into it so far. I neither enjoy it, nor am good at it! I enjoy the WCI thing far more. In 4 years, without investing any significant sum of cash, I have basically built a passive income (meaning if I quit even logging into WCI more than once a month or so) of probably $100K a year.That seems a pretty good use of MY time. But I could be investing that same amount of time and effort into real estate and probably could have done well at that too.
I would argue that the internet is actually a MORE effective way to invest your time than even real estate. Much more scalable for much less money, so you absolutely correct. You have the platform now, and with folks willing to give free content, and you having sponsors, your work load is fairly minimal now. You can then outsource content writers and as long as you are adding great value (which I hope I am contributing to now) to your readers this has the ability to grow infinitely large with very little additional input from your labor. I applaud you.
I wish my work load were fairly minimal now. I need to figure out how to keep quality high while becoming the well-oiled machine your acquisition team is.
You have to kiss alot of frogs, and every couple of years you have to take them out back and shoot them to put them out of their misery because eventually they all go lame, especially contractors. But once you get a reputation for actually doing deals and projects in your area, people seek you out, I have more contractors and the like calling me and we are not even buying anything here now.
I want you to well oil this website so it becomes automated for you, because it is a much better use of your time than learning how to invest in real estate yourself, you need to know enough to evaluate a good operator/sponsor and then invest with them through syndication.
I’m just hesitant to work with only one operator/sponsor/syndicator, and I’m not looking forward to evaluating multiple. It really is a lot more work than just buying every company trading on a public exchange via a couple of Vanguard index funds. Worth it? I hope so.
You can spread across multiple operators, I can personally introduce you to Ken McElroy and his team. He is the person who ACTUALLY does Kiyosaki’s apartment real estate investing. Super nice guy, and his team puts investors first. His issue is that he has too much money right now and not enough projects to satisfy the demand.
Just like you buy a basket of stocks or indexes. You place your money in multiple syndication projects across a wide geographic area. The interesting thing in real estate operators is that past performance does often have a bearing on future returns.
Napoleondynamite –
Thanks for the comment, you are absolutely correct that as high income earners we would all be able to save enough money to be financially independent over the long run. The road I took is because I want to be financially independent when I am 40, I have 8 more months to do it, but even if I am off by 6 months, it will create an amazing sense of freedom.
Also, I am a firm believer that fee for service will be leaving sooner rather than later, and I want to be able to help my specialty colleagues turn their investment portfolios into cash flow streams to lessen the blow of declining income, especially anyone that has more than 10 years to practice to reach “retirement”.
First, thank you for writing a guest post Eric. You are a good, clear writer and have an interesting story. I admire your background. Awesome that you became financially literate early and got the MBA too.
That said, there is no way I want to do what you are doing. People lose money in real estate too. It is just too much of a time suck + risk to worry about. It has become clear that keeping it simple will work out just fine.
One final thought: I didn’t catch if you are doing any “typical” investing via 401k/IRA. Do you select real estate funds there too? Just wondering if you are going “all in” here.
PS Let me know if you have a rental in Belize open.
I agree that keeping it simple will work out just fine.
I also agree that everybody can’t do what Eric does, not only because they don’t possess the desire, drive, and skill to do so, but simply because we can’t all own 100 housing units while only living in one or two. Direct real estate investing is nowhere near as generalizable as index fund investing, but that doesn’t mean it won’t work for some of us, nor that it won’t work very well.
Like you, I am surprised when I see “real estate guys” pass up on 401(k)s, Roth IRAs etc. I see no reason, even for a diehard real estate fan, not to do both.
I find that fascinating, mostly in that even though its not all or nothing, a very large percentage of the RE crowd detest stocks. Always something about paper versus a real tangible asset..
Even like Erics story of being soured by learning about Enron, etc…didnt make sense. He had the financial know how and did recognize when things didnt add up, but still isnt about it.
Im much more into doing both. Currently pretty happy having REITs as part of my retirement plan, but will get back into hard assets soon as well.
I will tell you why we don’t play with stocks once we become proficient real estate investors.
It is because when you know that you can definitively make a dollar doing something, you put all of your dollars there. In the stock market, no one can say that they can definitively make that dollar (except the guys on wall street skimming their fees), so instead you are told to diversify and most people do.
We know how to make a dollar in real estate, actually we know how to make a dollar 5 different ways (6 with multifamily and commercial real estate) and stocks cannot do that, they only have 2 ways to make you a return.
Full disclosure, I just recently bought some gold bullion for the first time ever, with all of the major central banks debasing their currencies, I am more scared for the future of fiat currency than I have ever been and I want to have some real money if asset prices collapse to be able to buy more real estate and other hard assets at the bottom.
Hmmmm….sounds speculative. 🙂
It’s actually insurance.
The average person thinks of gold as an investment, it is actually a currency. The oldest surviving currency there is. And buying it is portfolio insurance against fiat currency and central banking fiascoes.
What most people do not realize is that value of gold never changes, its purchasing power has remained constant for millennia. What changes is the price of the currency that it denominated in over time. So if heaven forbid we have a currency collapse in the U.S. dollar, the price of gold denominated in US dollars will rise. I hope this never happens because I hate allocating my capital to a shiny non-productive rock, but I think it is prudent to do so at this juncture.
Joseph –
The great thing is that you don’t have to do this. With the JOBS Act finally being implemented you will have the ability to invest in Funds that do this, not as a REIT, but as a direct equity investor. Then you will be able to take advantage of the tax advantages as well, unlike when you invest in a REIT.
I do not invest in paper assets, and I do not use 401K’s or IRA’s. I believe in being in control of my money at all times. And I do not want to be locked in until I am 59.5 to get at my money. Also from a tax perspective let’s say that you invest in a something that has a long term capital gain, when you actually access the money, that gain will now be taxed as ordinary income.
Also, there is no way that after working 30+ years that my income should be less than when I was younger, so there is no real benefit to me to use those vehicles. Most of our income from real estate is tax free so I can compound that wealth while still having it under my control.
The 59 1/2 rule isn’t a big deal:
https://www.whitecoatinvestor.com/how-to-get-to-your-money-before-age-59-12/
If you truly expect more income in retirement than during your peak earnings years, then Roth IRAs, Roth 401(k)s, and Roth conversions should be very attractive to you. That is a fairly unusual situation, but certainly not impossible for someone in your position or for super savers. Most docs will see a significant arbitrage between their marginal tax rate at contribution and the effective tax rate at which they withdraw the money from a tax-deferred account.
Heck, you can even buy direct real estate in a Roth IRA if you want. Seems silly to pass up on free tax benefits.
This fear of turning a long-term capital gain into a fully taxable gain ignores the value of decades of tax-deferral. Are you suggesting that deferral is valueless? It’s not, it’s worth quite a bit…that why real estate investors try to defer it as long as possible. The whole pay taxes later thing. The higher your returns, the more deferral is worth.
Real estate income is only tax-free if you are periodically exchanging and never actually sell. If you sell, the depreciation shielding that income is recaptured, although perhaps at a rate lower than your marginal rate.
Remember, I can make returns far in excess of what is available in the public equity and debt markets. So putting my money in a vehicle that limits my ability to have flexibility in my investments has no appeal for me.
From a purely investing standpoint I have actually already surpassed my W-2 wages with investment income. One of those investments requires me to still practice medicine so I do not count it, although it is still passive in nature. And I expect to surpass my W-2 income from real estate alone within the next 24 months. So I most certainly will have more income in “retirement” than I do now. Remember, retirement is not an age, it is when you passive income exceeds your monthly expenses, no need to wait until you are 59 1/2 or whatever time someone else deems that to be.
As for tax deferral, that to me is very speculative in the public markets, the assumption is that those dollars will be there in the future, or there at the level that you need to maintain your standard of living. No one can guarantee that, so I will take my chances controlling my money in hard assets that are needed and wanted by others.
As for the tax free income, depreciation covers the rental income for 27.5 years in single family real estate, so you do not have to periodically exchange it to realize that yearly tax savings. If you sell the property and do not exchange it, then yes it can be recaptured, but if you exchange it just once you will get 55 years worth of potential tax free income.
If your rate of return, minus the value of your time, of your real estate investments reliably exceeds that available in other investments, then who can blame you for going home on the horse you came in on. Warren Buffett says the same thing about paying dividends- he doesn’t believe there is much of a better use for your money out there than keeping it in Berkshire.
If flexibility is more important than the tax and asset protection benefits, then a taxable account makes sense. Just realize that isn’t the same for everyone. I’ll gladly give up some flexibility in exchange for those.
I’ve been reading the comments in list order–not chronological–and I wish I had hit this comment sooner. All the best to Dr Tait, but owning no “paper assets” and not lowering my tax liability by $50k+/yr is not part of my strategy. We’ll have to agree to disagree on how to get rich. Some of us drink RE Kool-aid, some of us Boglehead Kool-Aid.
I enjoy my rental property income (landlord by necessity after the crash) and it is now painless (I have a great property manager). However, I was a millionaire without counting property well before 40 and I have enough boring index funds now that I see exponential growth–without leverage. (n.b. It seems I have an income twice that of Dr Tait.)
G – Thanks for the comment.
Like I said to Dr. Mom earlier, the million dollar mark is really immaterial in my book. It is mark to market accounting, it is all just prices moving up and down on a ledger board. What I want people to understand is REALIZED returns that actually improve your standard of living.
It really boils down to what do you expect your excess capital to do for you? I expect it to add to my material standard of living every year and decrease the need for my physical labor to support me. Every year, I should make more income in less hours worked, and that is what I have done. It does not mean I will stop practicing medicine, it just means that in the near future I can do so if I so choose and my standard of living will not decline.
As for taxes, I haven’t even TOUCHED on the tax benefits that I receive from being an active real estate investor. Trust me, tax deferred investment accounts cannot begin to touch the breaks that I receive. Just suffice it to say that my wife and I combined SHOULD be in the top marginal tax bracket based upon our total income (medicine + Investment income), but we are routinely in the teens in our effective tax rate because of real estate.
I disagree on the bit about realized returns. Even once you realize a return by selling an asset, you either spend the money or you are reinvesting it, at which point it is either not growing very quickly or again has risk for loss. In fact, realizing a gain just to realize it is not a particularly tax-efficient way to invest.
WCI –
That is my point as it relates to real estate, the realized return of the investment is tax free if done correctly and does not impair the underlying assets ability to appreciate in price or to send you another realized return in the form of cash flow the following month.
You can choose to save the cash flow from your real estate and reinvest it, or you can spend it, it is completely up to you, but at least you have the choice.
If the market price tanks, it is ok, because you have been receiving a realized return along the way. And while your networth may take a hit, your cash flow doesn’t and the actual cash yield on your original invested capital (even if it has now dropped in price) has not changed.
That’s a weird phrase for what you’re using it for. Most people use “realized return” to refer to realized capital gains. You’re just talking about cash flow.
WCI –
That is what I mean about the financial services industry brainwashing of investors. (harsh I know) Language is key, a realized return on your investment is just that, you have received a return (in this case cash) on the investment capital that you placed in an asset.
For me it is the reason why you invest, to realize a return. That is why I invest in things that generate cash flows at a rate I am happy to have as a real rate of return.
Capital gains can be illusory and fleeting, while getting a cash return monthly or quarterly is real. Capital gains are not real until the asset is sold and while you may have a gain and still own the asset, what happens when the price goes down?
People rarely factor in the opportunity cost of lost principal.
A 50% decline in prices requires a 100% increase just to get back to even.
A 75% decline requires a 300% increase just to get back to even.
Then there is the cost of lost time that your assets were not growing.
If it takes 5 years to get back to the top of the previous high, that was 5 years your portfolio was not compounding its value.
But if you had a portfolio that was generating a 5-10% cash return, at the end of 5 years you would have had at least a 25-50% return on your initial portfolio value and then you are back to even in terms of principal price. That is why realized cash flow is so important.
Real usually means “after-inflation” when discussing investing, not “actual.” But I get what you’re saying. I get that you think investing in “paper assets” is not wise for various reasons. I just happen to disagree with you.
Cash flow is great, as long as you can shelter it with depreciation where the recapture is indefinitely deferred. Otherwise, I’d rather have the capital gains than cash flow- far more tax-efficient. I can “declare my own dividend” at any time. The only way to do that with real estate is to refinance.
Good post and comments. Sounds like I share the same thoughts and reservations as others with regards to RE.
I feel like I’m at a stage (similar age to WCI with $3m NW) where I should be looking into RE for diversifcation, apart from holding REITs and my principle residence. However, I adhere to the KISS principle and still love my daytime physician job (which pays very well), so I don’t want to make RE a 2nd job.
My plan is to make a cash purchase of a newly constructed townhouse/condo in the next yr. No mortgage. Newly constructed, so ? less maintenance, no renovation. Rent it out. Hold for long term. That’s it. Nothing fancy.
I view it like a bond fund – pays out rent/interest every month, with relative stability of the principle. The rent that I collect (minus expenses), I just put back in my REITs. My plan going forward, is to hold 1/3 stocks, 1/3 bonds and 1/3 RE (including my principle residence, REITS and rental property).
Seems straightforward. Am I missing something here?
REPadawan
Not having a mortgage doesn’t save the hassle factor. It seems to me you might be more interested in some of the lower hassle ways to invest in real estate.
REPadawan –
You are not missing anything, but I will tell you unleveraged residential real estate that is rented monthly often does not give you a high enough return to justify the work and effort involved. You return on equity in quite low.
One of the reasons to use real estate as an investment vehicle is because of the leverage you can gain. Imagine you were buying a town house that cost 500K, lets say you make 20K a year from owning that property unleveraged.
Now consider you buy 5 townhouses with 100K down on each, you may make only 5K per property a year but you still end up with 25K a year in cash and now you have 2.5 Million in property that if it appreciates 5% you just added $125K to your networth. As opposed to 25K if you bought the one property without debt.
This is enlightening. “Leverage” seems to be the differentiating factor between the return you can get in RE hard assets Vs buying REITs.
It is a bit more nuanced than that.
REIT’s use leverage as well, and just like for individual investors it can be a double edged sword.
General Growth Properties was the 17th largest corporate bankruptcy in history in 2009, and because many REITs are publicly traded, they are constantly getting inflows of money that has to be put to use. In an upmarket like we have now, bad deals can get a green light, but it is when there is economic stress that the issues can occur. An individual investor can make the decision to stop buying when prices become too high to purchase the property and still make a cash profit that you are happy with.
REITs also by law have to pay out 90% of their cash flows, the problem is that if the business cycle changes and you want to hold capital to shore up operations, or look for other opportunities you cannot retain earnings within the company.
Lastly and most importantly to me, is that you get none of the personal tax benefits of owning real estate if you own a REIT, those distributions are fully taxable as ordinary income most of the time. Whereas an individual owner in real estate can shelter most if not all of his/her rental income with depreciation if structured correctly.
there is risk in real estate. You are leveraging most of the time (can work both ways, if interest rates go up, you can only increase your rent so much due to rent control) and you are putting all your money into one asset class. But the biggest headache is the time. Maintenance, problem tenants, and you’re limited in what you can charge in rent due to rent control. Yes you can get a property management company and all that but then they are skimming your profits and you still have to pay for any big repair items. Better to buy a good collection of dividend paying stocks that increase their dividends yearly or a basket of ETFs.
Agree that leveraging is a double-edged sword. Used “the right way” (we could have another discussion on this subject), there is no faster way to build equity, net worth and wealth convertible to cash flow on demand.
Using leverage to speculate with variable interest rates is often the demise of many and is what caused many “investors” major problems during the last housing, credit and financial collapse. As a long-term investor, loss in property value did not affect my cash flow – I wasn’t a seller. Today, the very same properties that had lost 15% are back up at plus 15% and cash flow is also way up. (I don’t invest in rent-control areas).
Time value – many have also commented about Dr. Tait’s many hours of time that he obviously has had to invest to create his portfolio – the difference is that once he creates the portfolio, he can effectively have it managed by others at a much lower pay grade (and not necessarily a “management company”). That portfolio will continue to produce income and build equity through amortization and appreciation whether he actively works “in” it or not. Far different than his day job which is 100% transactional – he has to get up and go do it again the next day to create the income. And where’s the equity in a system that goes home at night?
Dealing with tenants and contractors or other time consuming activities on a personal level is voluntary – if you feel that you must control it all yourself because no one will do it as well as you, then you are self-limiting. I pay and empower many people to assist me in my real estate endeavors. I don’t look at that as a “cost” – it is an investment that allows me to further leverage my skillset, knowledge and experience. In this case, the word “cost or expense,” in my opinion, is a scarcity mindset.
A lot of really great points on this thread – I respect all. Thanks for the opportunity to exchange values and experiences.
A lot of that risk can be mitigated by investing in fewer, higher quality properties or avoiding residential altogether.
Craig –
This is one of those things that sometimes catches people about real estate investing, it is often counter-intuitive.
In residential real estate there is a sweet spot between cash flow and appreciation. We could go and buy a bunch of A class property, and there would be little to no cash flow so higher “quality” does not necessarily equate to higher cash flows. Since we buy primarily for cash flow (if we cannot find it, we just do not buy in that particular market) and because we target “work force” housing to mitigate our risks during a recession we prefer B properties in B class neighborhoods.
As for avoiding residential, that is why we have moved into Hotel property. Hotels actually have the highest cap rates of all real estate classes, and you bring in professional management to run the place.
I have historically avoided commercial property like strip malls and office buildings because I am not sure how many jamba juices the world needs, I think we have some very tough times ahead of us as a nation, and I want to see how the United States fiscal house shakes out. Now if someone comes to me with a great commercial project in a high traffic area, with a national credit anchor tenant where I can make at least a 10% return on my equity I may look at it.
But Amazon has a less than 2% return on equity, brick and mortar stores cannot really compete with that, so I am still concerned about the future of brick and mortar retail in the types of property that we as smaller (non-REIT) investors will have access to.
Not all cities have rent control. I’m surprised that real estate prices are as high as they are in some rent controlled cities. John T. Reed has a whole diatribe about San Francisco in one of his books.
Actually it is because of the rent controls that prices are so high.
It is a classic unintended consequence of regulations. Because properties are rent controlled, there is a cap on the amount of money an investor can make. Because of that cap, older buildings whose cost basis is low become more valuable but there is no incentive for the owner to make capital improvements because they know that they cannot charge more rent when they do. So you often see the worst slums in places where rent control is prevalent.
Then someone like me as an investor wants to come in and build new housing stock, but because I cannot charge market rates I cannot make that investment pencil (the returns are not great enough to justify deploying capital), so no new housing stock gets built so the prices of what IS available goes up. (pure supply and demand)
Also, areas with rent control tend to be more liberal and also tend to have more restrictive zoning and land use ordinances, this restricts even more new building. It is a vicious cycle.
Sure, the price goes up, but not the value- since that asset still can only generate so much revenue. At any rate, I agree rent control is a bad idea. A similar idea is a big part of why the US health care/insurance system is so screwed up.
You have it EXACTLY right, that is the absolute worst time to put your money to work in any asset class.
That is the case for the U.S. equity market right now, prices are up way above values because of the world’s central banks money printing. 4+ trillion dollars looking for yields, pushing up prices while top line revenue growth in most firms not named Apple is stagnant or declining. Most of the gains in the U.S. market is from corporations buying back their own stock, in the short term that is great if you are a shareholder, but long term you are starving the business of capital to grow and innovate. It will come back to haunt people.
Great post Eric. I appreciate the time you put into it. I am sure you enjoy every minute you spend on looking up properties and reading about improving your real state skills. What some people do not understand is that more than a second job, it could be a hobbie. And it needs to be done with passion. The argument of “putting time and effort in real state investing is not worth it” is a silly one. Of course you need to work hard and spend time and effort to achieve your goals, otherwise what is the difference between you and the next door doctor? I guess as always at the end it is a matter of your personal desire to “work”, risk tolerance and investing goals.
JC –
It is actually not that time consuming once you have learned how to effectively do it. Right now, we are not buying anything in our local market. We are just maintaining what we have. When we were buying I had a veritable army of agents, brokers, and wholesalers looking for property for me. They would send them to me by e-mail and within 1-2 minutes I could give them a yes or no answer. They knew our buying criteria, so they sent only those properties that fit into our “box”.
Once I found one that looked promising, I would drive to the property either after clinic or on a Wednesday when I don’t see patients. (usually 25 minutes to and from) and walk it with my contractor. I would then go home, the contractor would send me his bid my email or text, and I would give the broker/agent a price that we would be willing to pay. Once the contract was accepted, my agent would come and pick up the earnest money check and we would set up a courtesy close at my office that happened 3-4 weeks later.
The closing takes about 30 minutes, and then my contractor would come by my office and pick up a lock box and keys to the newly acquired property. I would call to get the utilities turned on and then not go back to the property for 2-3 weeks until the contractor finished the renovation.
In the meantime, I would put the property on craigslist and get a list of potential tenants lined up. The first and usually only showing, would be my walk through with the contractor for the punch list or final cleanup, list.
There would be 3-4 families that would come and I would tell them that its first come first serve, bring your deposit and application fee. So I would go to the property maybe two-three times in 30 days. The family that gets approved gets the lock box code and the keys and I send out a remote locksmith to change the locks. Total acquisition time 5-6 hours that month with phone calls from prospective tenants, closing, walk throughs, lease signings, etc….
6 hours acquisition time is a ridiculously well-oiled machine. I think your comment underestimates the time and effort it took to set up that machine.
Exactly, that is what I used my training for in medical school and business school, and residency. The book the E-myth by Michael Gerber was a great help as well.
Like anything that you want to be good at you have to put in the time. I cannot tell you how many hours it took me to become proficient (not 10K I can assure you). But instead of listening to music in the car all the time, I would listen to podcasts, I went to a couple of weekend seminars. This was pre-Facebook, so there were no real time sucks like there are now.
I can tell you this, if someone committed 2-3 hours a week to learning how to effectively manage single family homes it would take them no longer than 3-4 months to get REALLY good at it. Again, this is not for everyone, I am just trying to show people what is possible.
Eric, do you have a list of books you recommend for real state investing? Are you planning to set up a blog with your ideas?
Hey JC –
I have thought about writing a blog, but in my mind I am not saying anything new or original that cannot be found in a million other places on the web or in books. So my assumption is that no one would really care or read it.
As for books, yes. I just went to my book shelf for you and will give you my picks.
I am an unabashed Robert Kiyosaki Disciple, so we start with the triumvirate. This gives you the why, which to me is more important than the how –
1. Rich Dad, Poor Dad
2. The Cash flow Quadrant (this is probably the most important book he has written in my opinion)
3. Rich Dad’s Guide to Investments. (Teaches you what the wealthy really invest in)
Moving on to the tactical books on how to purchase and manage –
1. Equity Happens by Robert Helms and Russell Gray
2. Real Estate Investments and How to Make Them – Milt Tanzer
3. The ABC’s of real estate investing – Ken McElroy
4. Insider Secrets to Financing your real estate investments – Frank Gallinelli
5. Rental Houses for the Successful Small Investor – Suzanne P. Thomas
6. The ABC’s of property management – Ken McElroy
This will get you very far down the road to learning how to effectively invest in single family homes. Also, join your local Real estate investing club (to find it look at the National REI website) and if you can, find a local investment mentor who is willing to guide you as well.
Don’t be afraid to ask someone for help, as a lot, I find that successful real estate investors are more than happy to pass on their knowledge because someone did it and continues to do it for us.
I’d go with Gallinelli over Kiyosaki anyday. Much more practical.
WCI – absolutely,
But they do different things, Kiyosaki is much better on the big picture of the why you would want to do these things, he is not tactical and he will be the first to tell you that. But he has his tactical people as his advisors. So all of the people in his universe are actually his partners, Tom Wheelwright is his accountant, Ken McElroy does his real estate investing, Mike Mucelli is his oil and gas guy. So he makes sure you can get that tactical information within his sphere of influence.
Eric, thanks a lot for the list and advice. This is great! There is nothing more sweet than a good book as a starting point. Just with your post and answers here you have helped a lot of people.
I go back and forth on this topic. On one hand, I’m a big believer in the wisdom laid out in WCI’s book – emergency fund, adequate insurance, index investing, maximize pre-tax retirement, backdoor Roth, college savings for my kids, paying down moderate to high interest on personal debt etc.
On the other hand, while I do mostly enjoy my job, I desire the option to leave it if that is my wish….the freedom to make that decision without really sacrificing my standard of living. I’m not sure how I could reach that point other than via real estate. The ability to generate cash flow while having debt paid down by another coupled with the ability to purchase an asset at a fraction of its value appeals to me.
So, I’ve made sure to do the things in the 1st paragraph. Over the past year, I decided that I’d rather pursue real estate than place money in a taxable investing account. We now have two SFRs (single family rentals) whose returns are below (2015 is projected based on cash flow to date and likely higher expenses).
2014 2015
Property 1
Equity Investment $20,000.00 $-
Cash Flow $2.68 $1,224.00
Mortgage Paydown $1,556.04 $3,253.00
Cash on Cash Return 0.0134% 6%
Total ROI (excludes appreciation) 8% 22%
Estimated FMV $88,000.00
Purchase Price $80,000.00
Amount Owed $64,000.00
Equity $25,556.04 $28,809.04
Return on Equity (excludes appreciation) 6% 16%
Property 2
Equity Investment $26,000.00
Cash Flow $2,400.00
Mortgage Paydown $1,385.00
Cash on Cash Return 9%
Total ROI (excludes appreciation) 15%
Estimated FMV $118,000.00
Purchase Price $107,000.00
Financed Amount/Amount Owed $85,600.00
Equity $33,785.00
Return on Equity (excludes appreciation) 11%
It’s a start. I’m happy with those returns (especially when you couple debt paydown with cash flow), perhaps I would’ve done better with index funds in a taxable account. I’ve enjoyed the learning process that has gone into investing in these two properties and I enjoy the deal analysis and calculation of returns.
I absolutely agree with WCI that it is entirely feasible to utilize both strategies, they are not mutually exclusive. I hope to continue to grow my real estate portfolio just as I will continue to grow my index investing portfolio.
Sorry, the formatting for the returns got messed up and it’s a little hard to read.
It’s important to point out that using a mortgage does not allow you to purchase a home at a fraction of its value. You own the whole thing baby; you just used borrowed money to buy it. If it appreciates, you get all the appreciation. If it depreciates, you lose it all. Now, if you’re not referring to a mortgage but actually did buy a house at a fraction of its value, then good on you. That’s part of the skill of being a good real estate investor.
Congratulations Justin!!!!
I am curious about how you feel having done this?
Can you describe if you had any revelations or epiphanies?
Dr. Tait,
I’ve started individual family real estate investing as well (we’re purchasing house number 3 now). You mentioned in your article that you did a lot of online courses on real estate investing – any particular recommendations? Likewise for the investing clubs.
Thank you for putting together this great piece, and Jim (or WCI) thank you for putting it up! You guys are both doing phenomenal work and I’m just following behind trying to learn from your wisdom.
Sincerely,
Neil
WCI, your site was referenced on another site I frequent and I find the content enlightening despite the fact I work in commercial real estate. I think the majority of successful people, regardless of profession, could stand to learn more about personal finance. My company develops, owns, and operates senior housing properties. We are a small company. We use our own capital to get deals off the ground and then we bring in outside equity. At the construction loan closing we repay ourselves the initial development costs which are then used for the next deal. Aside from our own deals, syndicated deals, primarily market rate apartments in the northeast, come across my desk from other developers. They typically have great track records promising returns higher than those contemplated above. Obviously there is risk associated with these deals but I guess my point is I think the vast majority of people would be better served focusing on what made them successful in the first place and investing passively in Real Estate through other vehicles. The author has been successful but I agree with your reminders throughout the comments that the ease with which it appears he has grown his portfolio would be hard to replicate.
Yes, there are really two things being discussed here- investing in real estate passively and running a real estate investing company as Dr. Tait has done. Both have their place, advantages, and disadvantages. The former can be done by most physician investors as part of their portfolio. Few docs have the ability, knowledge, and desire to do the latter, although it will certainly work very well for a certain subset (and badly for some as well.)
Really interesting post, Dr. Tait.
I’ve kicked around the idea of jumping into the real estate game and based on my fairly limited research, I concluded that the best things to invest in were lower income (relative to most around here) housing (mobile home parks are great, but so are the kinds of properties I think Dr. Tait is investing in) and hotels. So it sounds like I may not have been too far off of the mark, based on this post.
However, I never really invested the time to figure it out. Throwing stuff in indexed funds is easy and I have moved around a lot in the last 15 years (which is not an insignificant obstacle for something like this). I know it would take a long time/significant effort to get good at it. I’m doubtful that I’ll ever pursue it, but it’s nice to read an inspirational story of how it can be done.
The only criticism (if you want to call it that) I have is that you make it sound too easy. I suppose when you achieve a level of expertise in something, then that something becomes easy to you, and certainly comes across in your writing. I’d estimate that it’s certainly easier than being a good internist, but it’s certainly not trivial.