By Dr. James M. Dahle, WCI Founder
John T. Reed
Usually when I review a book on this site, I like to throw up a bunch of links to the book on Amazon and I make a few cents if readers choose to buy the book through that link. More recently, I've been reading a self-published book that I'd like to review on the site. Unfortunately, you can't buy it on Amazon, Ebay, or Barnes and Noble. The author, John T. Reed, who is most famous for “debunking” Robert Kiyosaki's Rich Dad, Poor Dad enterprise (you'll be very disappointed to learn there probably is no Rich Dad I'm sure), is a long time real estate investing author who sells all of his books only through his website.
I originally sent him an email asking for a discounted copy to review on the site (usually 146,000 page views a month are enough to get a free copy of a book), but after receiving no response after a couple of weeks, I went ahead and ordered a few books anyway since I liked what I read on his website. His books aren't the cheapest at $30-$100, but they're still a solid value. He sells this one for $29.95 plus shipping.
The “Big Picture” Real Estate Book
Best Practices for the Intelligent Real Estate Investor is an obvious play on Benjamin's Graham's “The Intelligent Investor” (also highly recommended by the way) that Reed says took him over 40 years to write. Essentially, he argues, it is easier to write about narrower subjects such as taxes or property management than to write a “big picture” real estate investing book. This is his “big picture” book, and as such, I recommend it to anyone thinking of getting into real estate investing. For those of us who are already real estate investors (whether by choice or by inability to sell our home in the last few years), the book is still recommended, but you may find some of his other titles just as useful or more useful.
Best Practices for the Intelligent Real Estate Investor Is Different from Most Real Estate Books
Frankly, I agree with Reed when he argues that most real estate investing books are crap. According to Reed, in 1980 the real estate investing information business was taken over by a bunch of shucksters such as Robert T. Allen (“Nothing Down”) and now there are so many books written by these guys, usually coupled with expensive seminars and “mentoring” services, that someone just looking for some honest information is severely handicapped. Reed, while definitely opinionated, and far more negative and curmudgeonly than most investing authors, tries for the most part to stick to the facts with solid analysis as he debunks common misconceptions about real estate investing. His books are absolutely packed (205 8 1/2 x 11 single-spaced pages) with high-yield, actionable information. He minimizes fluff and rapidly disabuses you of any “get-rich-quick” ideas you may have brought to the table. In fact, after reading his book, I suspect most physicians will probably decide real estate investing really isn't for them anyway.
John T Reeds Big Ideas
There are four significant themes in the book. The first is that you can't actually hire a property management firm. Not only is it expensive (8%-10% of gross rents in my experience), but the managers have no incentive to maximize your profits. Maximizing the gross rent would increase their pay, but not by enough to act on, and they certainly don't care about your net operating income. Like mutual fund managers, their goal is to increase assets under management. They get paid far more to manage 100 properties poorly than to manage 50 properties well. To make matters worse, you would hope that by hiring an expert property manager that they would be able to get you a great price on the best contractors to work on your place. Instead, they hire those who provide them the biggest kickback. Unfortunately, I have to admit that Reed is spot on in this analysis as I've had the same experience in my limited time as a real estate investor. If you want to be a real estate investor, you're going to have to be a property manager or at least supervise your own employees very closely as they do it.
His second big idea is that real estate investing needs to be actively managed. This is a real bummer to me, since I am mostly a passive investor. Don't get me wrong, I'm well aware that real estate investing is part investment and part second job. For Reed, however, the goal of real estate investing is to make money “on purpose,” not from speculation/pure luck. He defines pure luck as holding on to real estate in hopes that prices will go up, which is honestly how most real estate investors (including me) approach the process. Instead, he says there are really only three ways to make money in real estate “on purpose.” The first is by doing a “bargain purchase.” That means buying something for at least 20% less than it is worth (remember that 10% disappears in transaction costs so you need a 20% discount to make it worth it). The second is by “upgrading.” You basically buy something you can upgrade inexpensively and make it worth much more than the upgrade cost. The final method is by buying a property in a rare moment when it has “double-digit cap rates”, which never persist long. But even after you do one of these three things, he suggests you then sell the property and capture your profits rather than relying on luck for further gains. If you want to be a passive, buy-and-hold, real estate investor he suggests you buy the Vanguard REIT Index Fund (which I also hold) rather than individual properties.
The third theme in the book is that you can no longer buy real estate for cash flow purposes. He notes there was a change in real estate investing starting in about 1970 when investors quit trying to get cash flow for most of their return and started banking on appreciation. After a few decades of that, it is now nearly impossible to buy real estate for cash flow. Despite our ultra-low interest rates or 2013, you simply cannot buy most property with any kind of reasonable down payment and get positive, much less good cash flow. Since most residential property is sold at cap rates of 3%-5%, most properties don't become cash flow positive until the loan to value ratio gets close to 50%.
The math is easy to see. Let's say you have a $300K house with gross rents of $21,818 and a net operating income (NOI = ~ 55% of gross rents) of $12,000, giving you a 4% cap rate. You've got to put 25% down, so your mortgage is $225,000. At 4% for 30 years, annual mortgage payments will be $13,000. You now have negative cash flow. Even if you put 50% down, your annual mortgage payments are $8,674, leaving you only $277 in monthly cash flow on an investment of $150K. That's a yield of 2.2% on your huge downpayment. It's pretty hard to get excited about that. Even with tax benefits and amortization of the loan, you're still hugely reliant on appreciation to get any kind of decent return.
The final theme is that when you calculate your return, you have to include the value of your time. That's no big deal when your other job is working the counter at the 7-11. When you're a physician, however, spending a few hours or days dealing with real estate issues involves an extremely high opportunity cost.
Talked Out of Being a Real Estate Investor?
When you combine his four themes, it essentially eliminates this notion I had of what real estate investing is. I'd prefer to minimize the “second job” part of real estate investing and maximize the investment part. I'm interested in solid returns and low correlation with the rest of my portfolio. My idea of real estate investing is spending a little time looking at properties, buying a few at a decent price, and holding on to them for a few decades as they get paid off and the cash flow situation improves. Then in retirement I can live off the cash flow or sell the properties and annuitize the money. I have little interest in property management, going through the buying and selling process frequently, or in upgrading properties. I have a job where I can trade my time for money at a very high rate. I certainly don't need to trade it (or my free time) for one where I exchange time for money at a lower rate. If the main themes of the book didn't talk me out of that, I think the chapters on litigation and dealing with bad tenants (imagine your worst patients living in your investment) did.
Should You Read Best Practices for the Intelligent Real Estate Investor?
If you always wanted a real estate mentor to pass down the secrets of what he's learned over his career in real estate, this book is for you. It is very different from the typical real estate book. If you couldn't tell that from the first 22 chapters, the last one, on ethics, will reveal it. John T. Reed is one of the “good guys” out there, and you'd do well to read his advice, even if you choose to ignore some of it. I highly recommend you read Best Practices For The Intelligent Real Estate Investor before getting in to real estate investment.
Looking for other book recommendations? Check out our list!
What do you think? Have you read any of his books? Comment below!
“it is now nearly impossible to buy real estate for cash flow.”
Worth clarifying: it’s easy to buy real estate for cash flow, as long as you’re not ALSO using leverage.
I agree but is the return for personally owned real estate in cash basis worth the risk.
We are getting 10-30% returns on residential properties we purchased in 2010. We bought them for cash using friends and family money and have recently leveraged them in a package deal at about 50% LTV but a very low interest rate. My spouse now manages them full time. We have a couple peers who had the same approach during the down-turn. Point is that if you’re willing to hustle, the returns are out there, even now (still buying). What I’d like to understand is how to get these returns on bigger properties – retail, industrial or multi-family. Have you found any useful reading on commercial investing?
Is the 10-30% return AFTER subtracting out a reasonable salary for your spouse?
Did you see the recent post on fractional investing?
Regarding buying properties for cash flow, I suppose you could buy a cap rate 3 property with all cash for the cash flow, but it doesn’t seem very smart to me. There’s no doubt though, that real estate is a relatively inefficient market and deals can be found out there. But if you could find a place that is truly a cap rate 10 property, then your returns may be better selling it at a cap rate 5 price than holding on to it for the cash flow. I think that’s the point Reed is trying to make when he says you don’t buy them for cash flow any more.
As an active Real Estate investor I have a lot of things I’d like to say about this review and the comments. I apologize in advance for “highjacking” the thread but I think there are a number of serious errors here which in the end damage both the investing public’s perception of “my” asset class and, as a result, cause many investors to walk away from what has historically been one of the most dependable methods of building wealth over time.
First, as opposed to the stock market the real estate market is magnificently inefficient. The failure to understand this difference is at the heart of most real estate failures. Key among the implications is that it is possible (and for the investor essential) to find real “bargains” in the real estate market in a way that is almost impossible in the stock market. Finding a bargain stock (a la Graham) is these days a tremendously complicated task and one best left to professionals or those who are willing to spend a lot of time pouring over company financial statements.
This is why it is difficult for an individual investor (or even most mutual fund professionals) to “beat the market” for any significant time.
In contrast “beating the market” in real estate is relatively easy if one simply stays away from the common wisdom, buys bargains and looks for niches that are “working” at any given time.
“Staying away from the common wisdom” means focusing on the fundamentals of the business and avoiding most of the “guru” strategies that are either 1) outdated or 2) about to be overcrowded because some guy is out training 500 of your competitors every weekend.
That said, We are currently buying residential real estate with annual cash returns over 30% of our non-leveraged acquisition price without any rehab costs. While management in the first 60 days or so is pretty intensive the resulting 30 years of cash flow makes up for it.
I agree the real estate market is extremely inefficient. I think it is unfair for you to claim returns of 30% where you are not calculating in the value of your time. You’ve got to include that. Yes, the longer you hold on to the property the more time you can spread that expense over, but it’s still a very real expense.
We also need to keep in mind what 30% means. If you’re really making 30% on your money, that means that a physician who saves $50K per year will have half a billion dollars after 30 years. If you can manage that fantastic return over the long run you should be giving Donald Trump lessons. If I could guarantee myself 30% returns, I could retire within 4 years. I’m sorry, but that is a “get-rich-quick” scheme. Might you find some deals that pay 30% for a while? Sure. Might you average 15% long-term? Sure. But 30%, reliably over the long-term while calculating in the value of your time? I don’t buy it.
Great review of an area that some might have had opinions based on biased information. The truth will set you on the right course and alternative views can be evaluated against each other.
Any thoughts on commercial properties (ie office, warehouse, etc)? It seems the cap rates are higher 7.5 to 8.5%, less tenant turnover, and tenants take better care of the space– they’re trying to run a business out of it. The discussion always seems to focus on residential properties, but I’m not sure why.
If commercial cap rates in your community are 8% and residential cap rates are 4%, there’s a reason, and that reason is that the commercial properties are considered riskier. Higher risk of going down in value or having vacancies or whatever. Inefficiencies can exist however.
I think that there is a mis-perception here and it is one that raises its head from time to time throughout this thread. The reason cap rates on rental SFR’s is lower is NOT that they are less risky. The reason is that they tend to be bought by amateurs and there are plenty of amateurs in the market place. (More investors chasing product, lower returns) This is also why most of the advice from real estate gurus is wrong, especially for professionals who are the target market of WCI.
For most moderate income investors (say, less than $50,000 per year of job income). SFR’s are probably the best real estate asset class. That’s because they can be self managed and they can be leveraged. The problem is that those two criteria are exactly what high-income investors should avoid.
But if you are in the business of selling real estate “get rich” books or seminars there are a LOT more $50,000 wage earners than there are $150,000 wage earners so you want to target those folks as the market for your book. This means that the few (none?) advisers who are peddling appropriate advice for the WCI type investor get drowned out in the hubbub over the “No Money Down” scheme of one type or another. Since nobody has a financial interest in saying “I’m sorry but the advice I am selling is inappropriate for investors in your income bracket. You should look elsewhere.” investors do not get the message that the real estate business is incredibly diverse and that what you buy should be a function of your life position as well as the market.
The other mis-perception here is that Real Estate is “risky” and that it is risk that drives the boat and that higher rates of return are inherently risky.
For the most part Risk in Real Estate is a function of two things– either separately or jointly. Leverage and construction.
A SFR bought with 95% borrowed money is a lot riskier than one bought with 50% debt. And a rental house purchased with no leverage (i.e. all cash) is incredibly safe although without a lot of searching its also not going to produce high cash flow. (But with a lot of searching it may– the return is a function of whether you found a bargain– not how much risk you took. See my comment above on the inefficiency of the real estate market).
Likewise building a new shopping center is a lot riskier than buying one that is 5 to 10 years old in a good location with existing tenants. But that leased-up building is going to mean a 6% cap rate where the ROI on the development project is going to be much higher (if it succeeds).
It follows, then, that the riskiest Real Estate ventures tend to have both high leverage and construction.
These are not the best investments– the best investments are found by searching out low-risk bargains and structuring the financing of those bargains appropriately.
Again, this is in contrast to the efficient stock market where bargains are hard to find, the market moves more quickly thereby increasing volatility risk, and for the most part investors do not buy for dividend return.
For most people, residential real estate is not profitable and is very painful. If you buy enough duplexes or single family homes, hold them for 30 years and pay off the mortgages then they can replace your income in retirement. That is 30 years of your life with an uncompensated or poorly compensated job. These properties are always one vacancy away from negative cash-flow. I started in residential real estate, but for many of the reasons listed in this article, I no longer buy residential.
On the other hand, direct fractional ownership of commercial multifamily real estate provides bigger, more consistent returns and you do NOT have to become a landlord. The reason commercial beats residential comes down to Economies of Scale. This concept is so important, I wrote two articles about it on my website.
I would like to read more about this topic from your website. What is the website that you’re referring to? Thanks
Dennis has retired from medicine and now does real estate full time. You can read more about his business here: http://nesteggrx.com/
Always enjoy reading your reviews especially about investment real estate. I found the book however boring and repetitive. There was no great insights here and the information reed espouses is readily available from many free sources on the web. On a personal note I found the web page of reed to be amateurish attacks on some well known and respected authors; it all seemed to be very self serving and downright contentious. reed is not someone I would recommend to your readership. I wonder why he is so angry?
I’m curious what web sources you use for investment real estate. Are there forums, blogs, or sites that you find particularly helpful?
Inc Magazine, Zillow, Dataquick, NYT, WSJ, youtube,joe McCall,
The BEST, by leaps and bounds, source for Real Estate info on the web is biggerpockets.com. No hype, no bs, it’s a phenomenal resource.
Is there any thing specific that he is written that you think is incorrect? I haven’t read much of his stuff and I’m not super knowledgeable when it comes to real-estate, but I have yet to read something of his and think that it was wrong. In contrast, I would say the majority of real estate (or other) investment books have several pieces of wrong/bad advice.
The enormous content of his webpage has many gross and subjective inaccuracies too numerous too mention; as do many real estate review pages of this nature (welcome to the www:-).
Don’t buy their stuff but you should buy mine, is a common self serving strategy for profit but not a very smart one.
The real issue however is the intent and purpose of his reviews. The anger at competition reveals much about him and can only lead one to one conclusion.
Note: I found some interesting comments about him here:
http://www.ripoffreport.com/r/John-T-Reed-John-Reed/Alamo-California-94507/John-T-Reed-Aka-John-Reed-Aka-Jack-Reed-The-truth-about-John-T-Reed-Alamo-California-65784#comment_1
Not exactly damning evidence in the link. But my post isn’t about his website so much as the book. Let’s try to keep comments focused on that.
Agreed, but a wise man once said “always consider the source of the information you utilize”
I can’t say I’ve read all the books Reed criticizes, but I’ve read a few, and his criticisms are spot on for those few. If you don’t see him as an expert, that’s fine. After reading some of his books, he’s close enough for my purposes.
Thanks for your kind comments about my book. It is one of the more accurate reviews. A couple of points. You say my books cost $30 to $100. $30 to $40 is the correct range. I have no books over $39.95. You also pick four points and perhaps leave the impression that those are the four main or only points in the book. I would have said the focus compared to my other books was on risk management. Another chapter is on minimizing transaction costs which are absurdly high in real estate compared to, say, eTrade. The best way to see what the book covers is to look at the table of contents which is on my web site.
I rarely send out complimentary review copies any more. I have been doing this for 37 years. I long ago learned that publishers get a zillion requests for free books and that few are wise to agree to. I have not yet seen if your review sells any books, but I do not remember your request because there are so many. Given the nature of real estate investment and the minimum dollar cost of entry into the field, I am skeptical of readers for whom book price is a factor. Ultimately, in your case, you appear to be a real investor and as such you bought the book because as a true investor you have trouble passing up a $30 book that might increase your return.
Always nice to see authors on the site. Perhaps the four points discussed would be better described as my takeaway points from the book. The “$100” figure comes from the books sold as 3 parts such as Real Estate Investment Strategy Part 1 ($40), Part 2 ($30) and Part 3 ($30) for a total of $100. And I agree $100 is a cheap education in real estate. Here’s a link to the table of contents for this book to readers: http://www.johntreed.com/bestpracticesforintelligentrealestateinvestor.html
I am currently enjoying Aggressive Tax Avoidance for Real Estate Investors and anticipate reviewing it in the future. I like the “aggressive approach” to taxes you espouse, with or without the real estate specific points.
Mr. Reed
I read the White Coat Investor weekly and because of this review I bought your books Succeeding and How to Get Started in Real Estate. 🙂
Thanks for the kind comments about Aggressive Tax Avoidance… That was my first full-length book and first self-published book. It has sold over 100,000 copies and used to be the salient thing people remembered about me. My guru-rating page has replaced it which I wish were not true, but you can’t control what looms largest in people’s minds.
John Church’s comments are unique and are precisely the sort of thing I was writing about in my article “On trying to hurt the feelings of public figures” which is at http://johntreed.com/headline/2011/01/30/on-trying-to-hurt-the-feelings-of-public-figures/
The way I found your review is I get a daily Google alert on all new postings that mention “John T. Reed.” Sounds like you provide a valuable service for your readers. Keep up the good work.
Mr. John Reed – do you employ cost segregation in your aggressive tax avoidance approach? If so, I’ll buy the book ASAP! I need to master this area. Thank you.
Your site provides such great info!
I wanted to get your opinion about renting vs. buying a house for my mother, who will be moving from another country and completely dependent on me financially. I’m looking at either buying a house a few blocks from ours (she does not drive) for around $300-350K vs. a rental property for probably around $1000/month. The houses nearby often has a basement which can be rented out for $500-700 (althouhg I expect vacancies certainly). We live in a well thought-after neighborhood in Salt Lake but the houses are also older. Otherwise financially we have a two-physician income, maxed out on all the tax-advantaged plans and have fairly high savings in taxable accounts, and still with enough cash flow to afford either the mortgage or the rental costs. Just trying to figure out what is the better option given the discussion regarding real estate investment above? Our time horizon is staying at least for 2-3 years but a move is possible but not planned for after that.
I’m not the Sage White Coat, but this showed up as a reply to my thread and I have been in your spot before.
Rent, don’t buy. I purchased a home for my mom 7 or 8 years ago, when she was between a rock and a hard place – not through any bad decisions of her own (or drugs, etc), she lost her job after being hurt at work.
About 3 years later, she passed away and I got slaughtered on the sale of it and lost 20-30%. If it was a rental, that would’ve never happened. Additionally, I ilke the thought towards covering some expenses by renting out the basement, but that is also a very high risk situation I wouldn’t put my mom into. With the potential prospect of moving in 2-3 years, this detail also makes me thing owning 2 homes is not the best move. Just my .02. It’s nice you’re there for your mom – too many people are consumed in themselves and don’t do what’s right for their parents.
You can pay for a lot of months of rent for $300K. Even if you only consider the transaction costs (5% to buy and 10% to sell) you’re looking at $45K. That’s almost 4 years of rent payments. If those are your choices, I’d rent. One possible option that is common in SLC is to get a place with a “mother in law apartment” in the basement. Then your mother is close, but still has a separate place to call her own. At any rate, whether it’s a place for you or a place for her, it’s not smart to buy a place for only 2-3 years.
I’m in total agreement here. Lets do the math. You can rent a house for $1,000 per month= $12,000 per year. On the $350,000 house that means an annual return of 3%– and that’s probably high because the rent will include the property taxes and maintenance and if you purchase you will have to pay them yourself.
There is one other point– assuming you are in a 35% tax bracket and that you could manage to make the interest on mom’s house deductible on your return then a $350,000 purchase fully levered at 5% interest would cost about $17,500 in mortgage payments but yield $6,000 per year in tax benefit. Which would bring your cost down to around $12,000 per year before property taxes and maintenance.
Now, if you can find a bargain on that house and buy it for $250,000 then the monthly payment is $12,500 the after- income tax cost around $8,000 and the market value when you are done using it around $350,000 then that is a pretty good deal. But if you buy the $250,000 house at market and there is no “bump” on the back end then the transaction costs when you are ready to get out will eat you alive.
If mom is capable you might put her on the “find a bargain” hunt and let her get familiar with the neighborhood while real estate agents chauffeur her around but at “list” the best deal is the rental apartment.
Everything seems so high risk now. Real Estate investment used to be a safe bet, but with the housing market struggling to find its bottom, I’m not so sure anymore
Are you suggesting it was better to buy when the housing market was struggling to find it’s top in 2006?
The best opportunities are found during market chaos and downturns. I have learned to be profitable in both up and down market cycles, but my best deals have always come during market downturns.
Contrarian investing has always served me well. When the masses are selling, I am buying…..when the masses are buying, I’m there to sell to them. 🙂
Excellent review of Reed’s real estate volumes. I purchased John’s books decades ago and as you found, his advice is overall very solid. Unfortunately, I have never had the opportunity to meet him, so difficult to comment on what some say is his negative comments or bashing of others (yet he is correct that many who espouse the “get rich in real estate schemes” have not a clue).
Fortunately, I found very good mentors of Mr. Reed’s caliber early in my investing career. I purchased my first investment rental in 1980 while first year dental school in Dallas. Was the best move that I have ever made outside of a great 20-year run in private practice dentistry. I never looked back and continued building my investment portfolio and concurrently running my practice – not exactly the way I would do it or recommend doing it today….but I did learn a tremendous amount about how to invest, what to invest in, how to manage etc.
There are many myths and misconceptions regarding real estate investment. It is an asset class that mesmerized me from day one and I have never stopped studying and learning while investing.
In short, it was real estate that set me “free” in 2004 when my only child, a daughter, faced life-saving liver transplant (after surviving high-risk ALL as an infant and years of uncontrolled epileptic seizures). Without my foundation in real estate, I would have been hard-pressed to leave the profession and spend the time that I needed with my daughter without severe financial constraints.
The problem with any of us who are relatively “high income earners” is just that fact. Our income is derived from our labor….stop producing and the income stops. Real freedom comes from capital assets…and real estate, in particular, single-family, has been the absolute best that I could have ever imagined. With real estate, I do not have to work at all today, however, I will never retire….I enjoy too much what I am able to do today.
Candidly, I am not in the stock market at all…..left completely in 2005, having only a modest amount of investment capital up to that point. To me, the market is a pure gamble, completely manipulated with the individual investor as the “retail buyer” who takes it on the chin every time. Not so with real estate, which as Jim accurately stated, is an ‘imperfect’ market and that is why it makes it a ‘perfect’ investment asset – very difficult to manipulate, notwithstanding our government interference today in all markets.
I understand the typical lay concerns about management and “working a 2nd job” for less hourly, etc…..from the outside, those concerns are valid. Today, I can earn about 4 X what I ever netted in a very productive and profitable dental practice with much less risk, liability and the best part? I do it on my own time, my own terms. No schedule owns me. Do I work? Absolutely…but I enjoy what I do and the people on my team are much more cohesive and fun to work with than the old days of dental practice and staff management, insurance quagmire, OSHA and everyone else wanting to put their hand in my back pocket or interfere with my productivity as a dentist.
TIME is the most important commodity and true freedom, which I define as “doing what I want, with whom I want, and when I want to do it,” is my mantra.
Had I known what I know now, I would have left full-time dentistry much earlier. While I love the profession and what I could do to help people, I won’t stay in a regulated industry trading time for fewer and fewer net dollars.
This is a great site and I promise to be a more frequent visitor and commentator. Jim Dahle, you have done an outstanding job bringing together the best of the best and facilitating with firmness and diplomacy.
For any of you interested in talking more about how real estate investment can be done as a busy professional without dealing with time, tenants and toilets, or outside management companies, with stability and long-term predictable income and returns, I am happy to discuss.
@David Phelps,
David,
Thanks for your comments. I’m only a few years into my career in medicine.
I’ve already made some terrible mistakes in stocks of the last two years (facebook and THEN apple).
I am reading as much as I can about real estate investing and really interested in the tax saving strategies and cash flow.
I am currently buying a property in Texas with a rent to value ratio of 1.2% (1,200 rent/month for $99,000).
I think cash flow is still very possible in some markets. (not in California or New York…or anywhere along the coasts).
I would love to hear from you how you got through the various real estate market cycles. I think we are currently at the end of the a very “good” cycle for investors (if started investing after 2008).
I’m currently finishing “Equity Happens” by Helms and Gray which is a very pro real estate investment book.
I would love to what you have done in terms of setting up LLC for asset protection but also about the real tax saving possibilites. For example, I’m trying to get my stay at home wife to become a “real estate professional”. I am actively seeking a good CPA who can help me in this arena.
Thanks again for your comments.
joe
Hi Dr. Kim,
We’ve all made investment mistakes….don’t think you are alone! The fact that you are making a conscious effort to study and learn is the way to fastrack. You have found a great community here at White Coat Investor…..so many well-thought topics and discussions. Secondly, you are young and time can be your friend if you remain disciplined and continue to be as active as possible in your investment management and decisions.
Real estate is very local….yes, there are areas where cash flow is still very positive. I have been fortunate to have lived in Texas since 1979 and therefore, the majority of my holdings are in this region where we have always enjoyed very good cash flow ratios. We have also not experienced wide valuation fluctuations during market cycles…..there have been four major such cycles that I have experienced since 1980 and I have had no issues during any of those cycles for a few main reasons:
1. I don’t use institutional financing – if you are going to be building a substantial portfolio over the years, learn how to acquire and leverage your investments without the banks….doing otherwise can trap you during market cycles of when the banks decide to limit credit (which will happen more and more as we go forward). I use private funding, seller equity financing, or on specific occasions, take title subject to (no assumption) of existing financing or any combination of those three.
2. I buy and hold. I have flipped only a few houses and only because I saw a “good deal” but not for a long-term investment. Flipping, or buying, fixing and retailing is a business….not an investment….and that business, while it can certainly be profitable, is also very susceptible to market cycles and of course, available financing.
3. Buying the ‘right’ property – right neighborhoods, right number of bedrooms and baths, right price or terms – buying the right property establishes the “who” …….who will want to occupy your properties….your tenants. Good property attracts good tenants and that makes all the difference in your management (whether you do it or someone else does it), your returns (because your turnover is much reduced with stable tenants), and your better houses not only hold value, they will appreciate and rents will rise during times of inflation.
There are many other ‘plays’ in residential real estate that can be fun and profitable….and require very little in your active management.
Lastly, while we as veteran investors have had a great run since 2008, don’t fret and believe for a second that the best opportunities are gone. Only the “low hanging fruit” has been taken by amateurs who have a very limited lead generation funnel, usually limited to MLS listings or HUD foreclosures. Marketing, or lead generation is everything on finding the best deals. I joint venture with others who are very active “boots on the ground” by providing mentorship and often, capital to invest with them. I can take either equity or debt positions, all secured, of course, in those investments if I like and know both the person and the property deal.
Keep studying and come back to this site to ask questions and tell us how you are doing. Sharing with each other is the best way that we will all survive the marketplace turmoil and the issues that all of us face in our chosen healthcare profession.
Keep
The reviews trashing John Reed are garbage. As an active real estate investor, I’m very familiar with the “guru” circuit and have seen and read extensively about the nonsense they push and peddle to people. Some people do have success, but the majority of gurus pitching programs are shady. For one person to go to ripoff report and post a negative remark in 2004 – that’s meaningless. I generally agree with a lot of the person specific positions that John Reed takes. He’s respected in the field, I know this, having read and spoken with a decent amount of people that have reviewed his info.
The more modern gurus – Th4n M3rril to name one, charge $30,000 for their training and have a highly evolved snake oil selling program. I went to their 3 day training and had to walk out on both of the days I attended, including their “advanced” sessions. It’s all hype and BS to the max, with people pretending to be in it, “to help others.”
It can all be done without these types, but I would still consider scooping up good content on Ebay when it comes available for pennies on the dollar of the original cost.
Started to buy 4 years ago with the goal of securing my retirement. Just closed on our 20th last month – as of today all units are rented, all been cash flowing from the first month with 20% downpayment.
All of them were bought as foreclosed properties with some significant equity in them to start with and all went up in price tremendously within the last year or two. Rent been going up yearly, tax incentives are still there, with the way things are going we are planing to pay of mortgages in around 10 years or sooner – what else do U want?
My oldest just turned 13 and I decided to teach him the value of hard physical labor – we just cleaned the house after a messy renter – U should see expression on his face – he was shocked to learn how some other families live. Not to mention that he got a chance to learn how to replace the door lock and re-program garage door opener – priceless ))
At the end of the day I should live comfortably being a rentier and pass those houses down the road to my kids. And being anesthesiologist makes management of those real easy – all contractors are just a phone call away. Having wife as a CPA does help tremendously with all the paperwork, but after being up in arms against rental business on the site she had changed her mind 180 and loves it.
Its hard for me to figure out what is actual return on the investment, but dont U want to diversify your income and real estate does just that.
Fantastic Ajbolit! Did anyone ever say that managing one’s money or retirement account should take little or no time? Not if you want to take control….and that, of course, is a choice.
Too many docs that I see have taken the passive path, handing over their entire life’s work to a CPA, financial planner, or “money manager” who ironically, are all working stiffs and haven’t figured out how to go “free” themselves. One of my early mentors told me, ” take advice from those who have already gone where you want to go.” In 1986, some six years into my real estate investing plan, I had a well-known CPA to dentists tell me, “Be careful with this real estate investing….you can lose a lot of money.” Ignorance. Plain and simple. People know what they know and should either become educated in areas for which they want to give advice or leave it alone. Needless to say, he’s still “working at his firm” and I am no longer shackled to any schedule that is not of my own desire.
Equity and cash flow can be made from all real estate investment classes, but my favorite is single-family houses. Perhaps I’ll take the time to write an article and submit to WCI for consideration. The issues that many complain about, e.g. management, are simply not true. No matter what asset class one invests in, someone has to manage it….investments don’t manage themselves. The point is, there is a management cost somewhere…..would you rather control it (I didn’t say “do it”), or would you rather just turn that factor over to a fund manager, REIT or syndicator. Not a right or wrong answer…..simply a consideration that needs to be made before attempting to compare apples to apples.
Returns on single family have never been better over my 33 years than they are today, depending upon the leverage factor used. In what other market can you buy the asset at 30-40% under retail? Stocks, bonds, gold? Nope…you pay market price and “hope” the value increases.
I use NO institutional or bank financing….a steadfast rule….that’s where speculators and novice real estate investors can get hurt when the market cycles and credit becomes scarce. I don’t go there. I control what I can control and don’t let my portfolio be susceptible to the whims of governmental interference.
Finally, as the previous poster, Ajbolit, well-stated, there is no better way to teach a young person financial discipline and responsibility than having them help with the real estate portfolio on an appropriate level….so much great education here.
“I use NO institutional or bank financing”
What do U use? Thought that historically low interest rates were actually an added incentive to finance houses. Btw – totally agreed in regards to single family houses – best return – my rule was to anticipate double the expenses in rent payments: basically if your mortgage plus taxes, plus insurance was $600 a month U should anticipate at least $1200 a mont in rent – that ration only getting better on the old properties, but is unachievable with the current real estate market. Are U still buying new properties?
That’s an interesting and valid point: “historically low interest rates as an incentive to finance houses.”
No question, it is the availability of financing that increases demand and more times than not, increase in housing values (just look back and the housing bubble that burst 2006-2008 – due to the ease of financing, causing speculation among both homeowners and speculators, and resulting in a crash when the financing was cut off to most).
Other than one’s own home, and assuming that home will be lived in for at least 5 years, I would NOT use bank or institutional financing, regardless of the interest rate….and here’s the reasons why:
1. The banks own you….read the fine print if you haven’t done so last time you signed personally (personal recourse) on one of those bank loans.
2. Once you sign on the line for a federally-insured loan, you have a very high standard to meet in terms of fraud. Fraud? Wait a minute…..how am I committing fraud by taking out an investment loan? It’s your application. If you leave one iota of information off of that application or do not completely disclose every aspect of your financial life, assets and liabilities, and the Feds want to take you down, they’ve got you. Again, personal knowledge of a number of these situations that has happened to very good people.
3. The banks can call your note even if you are not in default on the payments. Yep, hard to believe, but that’s a fact, and I have personal knowledge of that very occurrence with well-established professional practice owners. The banks (and therefore the bankers employed by same), have zero control today. The government and the Fed owns the banks….would you put your investment assets into the hands and control of the government?
4. With about 15 Trillion dollars in “lazy or anxious” private capital sitting on the sidelines in low or non-yielding accounts, there is no need for me to go through the institutional financing maze and traps. I would much rather share in some of my profits with REAL people, people that I can and do have long-term relationships than a bank or banker often only temporary and with no control. Access to money is never a problem IF one has a good deal and a good track record and has taken the time to build real relationships.
My only dealings with banks are to make deposits….they do not have my financial information and I do not make application to banks for any form of financing….period.
Do I buy new properties? Only if they cash flow with a minimum 8% cash on cash return. The ability to cash flow properties is very local…..I have read a number of posts where single-family investors are having a difficult time due to the market tightening up and good deals seeing multiple bids. I believe this is only a temporary situation….months to maybe a year….there is no way that the current economic fundamentals can long-term support a long housing rebound. Cash flow, cash flow, cash flow. That’s the most important. And those deals are out there as they are in every market….but the low-hanging fruit has been picked off for the most part. Lead generation via multiple channels continues to produce solid acquisition inventory for us regardless of the general market conditions.
8% cash on cash return?
Price of the house was 160k, we paid 32k down, our monthly expense is $785 and the rent is $1700 a month. So the way U calculate it is 32k down and $915×12 =$10980 in positive cash flow a year – 35% cash return? Am I calculating it right?
The easiest way to calculate cash on cash return is to first get your net operating income, easily estimated at around 55% of gross rent, so in your case, $1700*0.55*12 months = $11220. Then subtract out your principal and interest payments. On a 30 year 5% fixed mortgage of $128K, that should be about $687 a month, or $8244 a year. $11220-$8244= $2976. With $32K down (remember to add closing costs to that) you have a $2976/32000= 9.3% cash on cash return.
Hope that helps.
Why do U subtract principal and interest payments twice? Thought U did it at the beginning – 55% gross? My net operating income is around $955 a month – thats including principal of $178 a month with positive cash flow of $777 a month. I am still confused with terminology, and the way U calculate it – sorry.
And yes – I am a little of – apparently we paid 38k at the table with 32k downpayment and 6k in closing costs. With the positive cash flow for a year at $9324 and 38k down it should be 24%? And if U include principal – $11460 a year – 30%?
The 55% is what’s left after everything ELSE. The property taxes, vacancies, maintenance, repairs, insurance etc. You don’t include principal amortization in a “cash on cash” return. You would include it in total return. You would also include appreciation (or depreciation) and the tax benefits in total return.
55% expense allowance is actually very high for the average Single Family assuming the tenant pays utilities. 25% is probably acceptable. We use 50% in Chicago in apartment buildings where we pay the heat.
“Cash on Cash” is the most deceptive ratio in real estate. You can always improve the Cash on Cash with more leverage– but you are disproportionately increasing your risk and your Cash on Cash loss in the event of vacancy.
Response from WCI: I agree 55% is high for expenses. The 55% rule is the NOI, so the expenses are 45%. If you can get your expenses down to 25% of gross rents, I think you are a particularly adept property manager, extremely lucky, or are deferring maintenance that will come back to bite you or whoever you sucker into buying the property.
You are absolutely correct, Ajbolit! I was using the most conservative “all cash” model for establishing return without any consideration for leverage or equity capture (buying at market discount) simply to prove the point that carefully purchased and well-managed single-family residential real estate provides excellent market returns….with a solid inflation hedge….and without the roller coaster cycles of other markets that are mass-traded.
The use of leverage, when utilized safely, will easily multiply one’s returns as your example so well portrays. Your numbers, by the way, are very much in line with what I have found, year after year, for over 33 years……about 40% total expense ratio…..well done!
And if U consider that according to Zillow the price of that house went up 130k to 290k as of now, and tax advantages of owning real estate rentals – the return is up there with the best performing stocks or better. Not all of the houses did as good of course, but some did even better )
I’ll put my house portfolio against a stock portfolio any day….there is no comparison. Period.
I completely replaced my dental, labor-produced income in 15 years via real estate, had to rebuild it after a divorce in 6 years….I could never do that with a stock portfolio….no way.
Today, I work when I want to, live a very comfortable lifestyle, and pay far less in tax than I did when I was actively working in my practice.
It’s important to recognize that your real estate investments require much more work than buying a few stock index funds. The value of that work is not zero and needs to be recognized when calculating your return.
No question about it, WCI. I made a conscious decision while in undergraduate school that I would be an active manager of my future…..and being active does require a term of sacrifice, just as the years of education that we each put in to gain our degrees and license to practice.
For me, the active component in my early years (the sacrifice) has made all the difference in my later years…..I have real freedom. I know very few who made that happen through a stock index portfolio. It’s a choice and you are correct that in order to compare apples to apples, the amount of TIME that must be devoted must be counted.
There are also numerous portals of real estate investment that do NOT require active participation and very little active management (similar to a stock index), but in my opinion and experience, with much greater control, less risk, and higher predictable yields.
In contrast to my labor-produced dental income, my real estate income continues to produce 24/7, whether I decide to actively work or not. While I was able to eventually create a practice that was not dependent solely on my production (a real business), it could never come close to what I was able to leverage through real estate investment.
I’m not saying it still doesn’t work out great when you include the value of your time, just that to be fair, your time should be included. Most docs are able to trade time for money at a fantastic rate, far higher than most real estate investors, and that should be factored in. Just because you prefer working in real estate to working in a dental clinic doesn’t mean it isn’t valuable time you’re spending there.
We agree. My premise is freedom. If I can honestly say that what I do everyday, at least 80% of the time, is spent on activities or ‘work’ that I enjoy, then that is where I want to spend my time. If that is practicing medicine or dentistry, then so be it. But if it is all about the money and lifestyle at the expense of my freedom, the choice is easy for me. While I enjoyed certain aspects of clinical dentistry, the regulations, insurance oversight, risk and liability reached a point where I said “no more.”
By becoming knowledgeable in the real estate market during my practice years, I was able to very easily segue out of practice and today, I earn at least 4 X per hour what I did in a very successful dental practice. My real estate peers (not newbies) are able to easily out earn (and wealth build) my colleagues in medicine or dentistry. It’s a completely different mindset than that from which we graduated school….I’ve walked both walks.
The majority of physicians, dentists, chiros, vets, that I speak to today would walk away from their professional practice if they could….unfortunately, most cannot as they have become accustomed to a lifestyle that is dependent, as you said, on trading time for dollars. How dependable will that income be and for how much longer? That’s the question I would be asking today.
Your point is well taken, but I am able to text or call at almost anytime while in the hospital, and I am yet to experience real emergency in my real estate empire)). I do usually go and see what am I buying, and wife does have to go to closings and occasionally to court – can be painfull, but rewarding at the end – and does give you different experience that I hopefully never need.
I still consider that a passive income since my involvement is minimal – time-wise is much less than what typical stock investor spent on doing research, watching MSNBC or following your blog ))
I think a spouse as a real estate guru is a great option. I haven’t managed to talk my wife into getting a real estate license yet.
Ajbolit and WCI – couldn’t agree more, and I’m the spouse! Helped my wife open her wellness/chiropractic center in the mid-2000s. Left my marketing gig as the center grew and have one rental property. Looking to add 3-5 more over the next 8 years, hopefully pay them off, and then give her the choice to walk, or drastically cut back hours. So, reading your site/blog has been very helpful, and inspiring.
An active spouse in real estate can help you overcome the passive loss limits of (I think) 25k per year, which can be quite beneficial when leveraging depreciation, especially accelerated depreciation techniques.
Why any md would manage their own units or do any labor is beyond me. A high earning MD my wife knows is shedding time prepping a unit for rental. The opposing end of highest and optimal use of time in my book.
A great, top notch resource on the web is biggerpockets.com. It’s totally free and I know they operator personally. There’s no gurus and no bs, just the biggest community of like minded re investors.
I’ve spent a little time on biggerpockets.com. It’s not Bogleheads, but it’s not bad.
I dont do manual labor unless I choose to – mostly when I want my kids to learn whats are alternatives out there for the guy without degree. And it does work for my kids – they are shielded from that kind of experience in our house. At the end of the day – few years down the road, I might not be so eager to do that and sell those out or hire management company, but its definitely fun for now
Interesting that today Obama made remarks about reining in mortgage subsidy giants Fannie and Freddie. http://www.nbcnews.com/business/obama-urges-shutting-down-freddie-mac-fannie-mae-6C10860677. Sounds like a conservative position – yes?
Whether he would actually follow through on such a quasi-free market proposal is yet to be seen. But suppose he and Congress move forward on this plan and move a greater percentage of home mortgage lending to the private sector…what will that mean? What opportunities lie ahead under this scenario? Obstacles? Potential political fall-out (they’d never let that happen, would they?).
While I am a proponent of free markets and against government regulation, interference and subsidies, this plan would, in my opinion, reduce the availability of credit financing for housing, lowering home ownership, putting a damper on the current so-called “recovery,” and could cause a new housing downturn. Rents (cash flow), on the other hand, would at least hold steady (depending on the overall economy and local conditions) and could increase (as we saw in the 2006-2008 collapse).
Would private investors, without the backing and purchase of mortgage backed securities by giants Fannie Mae and Freddie Mac, even consider making fully amortized loans of 10, 20 or 30 years without some form of indexing? I think not. Far too much risk. We would be back to short-term, variable rate loans which would destroy home ownership in this country.
Our economy is too dependent on housing to allow this to happen (and one of the reasons I am long-term bullish on single-family house investments).
Therefore, I don’t see this happening…at least not in its pure form.
Other thoughts?
Dr. Phelps – I’d like to talk with you off line, if possible, regarding getting becoming a full-time going as a real estate investor. My wife is a chiropractor in Seattle. Good income, but it’s dropping each year due to insurance dependence.
Regarding Mr. Reed’s books, I’ve purchased Succeeding and the protect your assets from hyperinflation/depression. The material is helpful, well researched and provides well-thought out and substantiated positions, even if you don’t agree with all of them. I give him a thumbs up.
Thomas, Seattle
Off topic, but not sure where to post: we have several financial people telling us to cash out and kill our 401Ks now and do anything else with the money.
That, because of the business and then deductions for mortgages, we’re in a low tax bracket. So, might as well pay the taxes on money while we have deductions rather than being taxed in retirement. They did say to fund to the minimum amount that our corporation matches.
So, we’ve socking away $10K-$12K (whatever the max is) in a SIMPLE IRA for each of us, each year, for the past 5 years. Fearful, and completely ignorant of the market, the money is sitting in a Schwabb cash account at 0.01% yield! Crazy, I know!
Anyway, would appreciate your thoughts on 401k’s or a redirect. Between funding the retirement account and additional principal on our mortgages, it’s about $3,000/mo. And we’re thinking of redirecting this into single family homes.
I just can’t shake concept of leverage of real estate; the thought that as long as we have cushion for the rough patches (although we’ve never had a month’s vacancy in the 7 years holding our current rental), we own 100% of the interest in a property that someone else is paying for.
To buy a stock requires 100% of the stock price at the time. To buy real estate, you only put a fraction down, but someone else (tenants) pay for the asset.
Would really appreciate your thoughts. Thanks, Thomas, Seattle
So, as long as it’s break even, to me at least, we’re not losing even if property values drop. Someone else, in essence, is buying the house for us. Then we have the deductions and depreciation.
You’re addressing a lot of issues here. Just a few thoughts-
1) Leverage works both ways. You can certainly buy stocks in a leveraged manner.
2) I’m not a big fan of “cashing out” of 401Ks. If you’re in a low bracket now compared to what you expect later, use a Roth 401K, Roth IRAs, or do Roth conversions. Not only do you avoid the 10% penalty, but you still have the money growing in a tax-protected manner. Most advisors recommending you get out of a 401K completely are trying to earn a commission on whatever else they are planning to get you into.
3) SIMPLEs are often not the best option. https://www.whitecoatinvestor.com/simple-iras/
Let’s compare the use of leverage when buying stocks vs real estate. I’m not an expert in using leverage to buy stocks, so I need your help here. As I understand it, if you buy stock on margin and the stock price drops to a certain point, you get a margin call and have to cough up the difference.
With real estate, I can leverage today with long-term, 30-year fixed rates at under 4% (taking title subject to existing financing with no personal liability) or I can use private capital and again, structure non-recourse financing with very solid cash flow returns.
If I buy to hold real estate, I can withstand market value fluctuations with no capital call and no personal liability. Since 1980, I have experienced four major down cycles in the real estate markets and I lost no properties during that time and suffered no cash flow deficits with the property that was leveraged. I did not have to sell.
Those real estate investors who got into trouble use institutional short-term financing with super leverage and speculated that they could continue to flip their properties during the up-market. They simply got caught with a poor gameplan.
Oh I’m with you that it’s far better to leverage real estate than stocks, but to pretend that an unleveraged stock investment should have the same return as a leveraged real estate investment probably isn’t a good idea.
Hmmm….not sure where you thought I was attempting to compare unleveraged stock investments with leveraged real estate. My intent was to compare and contrast leveraging in both markets.
I would fire those investment advisers quickly before they really screw something up. The best thing about the 401 k money is that it is not easy for you to get to and fritter away– especially if you are in a low bracket.
” because of the business and then deductions for mortgages” would seem to imply that you have your own business. Consider starting a solo 401 k similar tax treatment much better opportunities to the Simple IRA.
There are a lot of very smart people involved on this site, so take my advice only as far as it might fit your situation (which obviously I don’t know). My belief today, is that when the government hands us a “carrot,” that carrot can very easily be taken away (retirement plans, 401K’s, IRA’s).
I terminated my 401K plan a number of years ago for that very reason. In a confiscatory, redistributionist environment, I don’t want to be “the low hanging fruit” when they want to start stealing more of our money and assets to fund the debt and continual overspending in Washington.
While I do manage a number of self-directed IRA accounts, I maintain indirectly, absolute control over those accounts and where the money is….not in the custodian’s hands, I assure you. I believe, however, that the tax benefits of all of these retirement plans will soon come under income limits and for many of us, those benefits will be lost. Anyone counting on social security?
You know my preference for real estate – I love the control, the leverage when wealth-building, plenty of tax benefits (1031 exchanging being a major benefit) and the fact that I can be very diversified.
Most who look at real estate only go one layer deep – what I would call very traditional investing. While that works, it’s far from where those who are well-versed and savvy can go – and you won’t find much in books on those topics.
Glad to speak to you offline, Tommy Coburn. Email me at [email protected]
I’m not sure I understand what you’re suggesting the government is going to do. Are you saying they’re going to take your tax-deferred 401K and make you pay taxes on it? That’s pretty much the definition of tax-deferment. Or just take the money? I don’t see how investing in real estate in a self-directed IRA protects you from that. A government can take a house just as easily as an IRA.
I also think it is unlikely that Social Security will disappear. It is one of the most popular programs out there.
Good morning. The simple fact is that our government is unable to rein in spending. We have a national debt fast approaching $17 Trillion and unfunded liabilities of over $90 Trillion. The country and economy is on the precipice of major default. Where do you think the money will come from to continue the spending and service the debt? From those deemed the “evil capitalists,” those who have worked hard, managed to save and invest for their future.
When they decide to take your retirement funds, it won’t be for you or me to pay taxes….it will be for the government to throw into another slush fund with the promise that they will “take good care of your investment capital.” The tyrannical nature of this administration and the rhino conservatives who only give lip service to pushing back will do whatever it takes to stay in power.
Remember Rahm Emmanuel’s now famous quote “never let a crisis go to waste.” All we need is the next “financial crisis” to give them the reason to make a move. And 50% of the country’s citizens will applaud (those who have been bought off by welfare, food stamps and all of the other entitlements that we pay for). Financial accounts, 401K’s, IRA’s etc are the low-hanging fruit and most easily accessed and taken by the government, to hold and “manage” for the account holder’s benefit and protection, invested and distributed on the basis of need as assessed by government agencies.
Yes, all property is subject to confiscation, however, I believe that financial assets will be the easiest and simplest for them to take. There are means to protect real estate assets from outright confiscation, notwithstanding a full collapse of our economy and then of course, all bets are off.
Social security? I wouldn’t bet on it…not if you are a “wealthy person” by government definition. Means testing will most definitely be in place before any of us will see any return on that ponzi scheme.
John reed’s web site has a fair amount of interesting information, and his books are a fair deal, if you wish to buy them. He is one of few decent web resources worth reading IMO. Having said that, he has some serious blinders on when it comes to different RE markets, as its not one size fits all. RE is extremely micro and what works in TX will NOT work in CA; matter of fact it may be polar opposite.
For instance, he dismisses appreciation as pure speculation or luck. Well, no. I have been investing in San Francisco RE for almost 20 years. The appreciation has been tremendous, and has given me flexibility in using cash from refinancing to: buy more properties, for personal expenses and money to improve and add value to existing projects. SF is a very expensive market, and obtaining positive cash flow here is counterintuitive and tricky. I finally obtained that in significant fashion the last three years, as my asset base has gotten substantial enough. BUT, I have been able to use appreciation beforehand as I mentioned above to live off of, and to acquire more properties.
The crux of the matter is that varying local markets behave radically different, and Reed glosses over that, and it’s a big hole in his knowledge base. The particulars of your local market will drive most investment decisions. Just compare and contrast SF to TX to get an idea: In my case, I buy properties that I do major changes to (add a unit, develop a basement space, convert to condos, lots splits, etc.) It is only after that work is done when they get to cash flow. We have prop 13 in CA so my property tax base is low and it’s protected. Rents are strong and continue to soar in SF due to the influx of the tech market. SF is a gateway city, and while it is very expensive, many want to live here and rents are high and it is easy to rent out almost anything. Plus we are one of the few cities that have rent control. Most investors run away! But smart SF investors know how to use that for their advantage. Rent control is complicated and laced with Byzantine local politics, but lets just say that it creates tremendous market inefficiencies, and that is always good for a savvy investor. I know a lot less about TX RE investing, but I do know that: immediate cash flow is critical, prop taxes are high, they always keep building in new areas, and that there is (mostly) little appreciation (it’s a cash flow play.) SF is surrounded by water, is tiny, crazy local politics and as a consequence has had little development take place for many years.
Moral of this story- understand the subtle (and not so subtle) dynamics of your local market!
WCI and Dr. Phelps – Thanks for your replies. Your information was very helpful. We’ve been on extended holiday and just getting up and running again.
* Still debating dumping the 401Ks. We setup the SIMPLE IRA’s because of the employees and our tax attorney told us to do so about 7 years ago. Haven’t looked at the setup since and are pretty ignorant about retirement accounts. But are finally at a place where we can start saving more heavily after paying for multiple six figure TI office build-outs during the past 7 years. I’ll read the link on the SIMPLE IRA you provided. Thank you.
SFInvestor: Thanks for your post, too. Yeah, you’re definitely right about the local markets. The whole 1% rule of rent vs purchase price DEFINITELY doesn’t fly in Seattle, or the surrounding areas. I mean, renting a room in a house is about $700 and studio apartment, even in a rundown neighborhood, is $1,000+/mo. In the city, you’re looking at $1,500 for a studio… if you can get one.
I’m trying to make sense of this area because it’s very expensive. And, with all the tech boom still going on (about 50,000 tech jobs are moving into downtown between Amazon, Google, Facebook and Microsoft), this market is only getting pricier. Makes it more challenging for investing.
So yes, localization of markets is important.
Last April, I went on a mission with Frank McKinney who builds mansions on spec for the ultra wealthy. He started out in single families in the 80s and still holds a few properties, I believe. Anyway, he don’t me not even to bother studying the national real estate trends. Sure, look at interest rates and what the government is doing. But he suggested that if you’re going to be a local investor, studying the area within 5 miles, up to 20 miles (if you have to go that far), of your target area and master that. So that’s where I’ve been spending my time. Thanks again.