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Return on investment for residential real estate

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  • Avatar fev1 
    Participant
    Status: Physician
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    Joined: 12/30/2017

    Hello,

    I have been doing some research on whether residential real estate investing would be a good fit for me. In particular, I’m trying to decide whether it would make sense for me to purchase properties to rent out versus simply investing in REITs.

    I recognize that there are geographic variations, but are there average values on return on investment on real estate? Excluding maintenance costs/property management expenses, how much rental income does one typically expect per year relative the the price of a property? I wonder whether I can compare this to a REIT’s dividend to help me decide if it is worth the time and effort to directly invest in real estate myself.

    Thanks!

    #221379 Reply
    jfoxcpacfp jfoxcpacfp 
    Moderator
    Status: Financial Advisor, Accountant, Small Business Owner
    Posts: 7503
    Joined: 01/09/2016

    Hello,

    I have been doing some research on whether residential real estate investing would be a good fit for me. In particular, I’m trying to decide whether it would make sense for me to purchase properties to rent out versus simply investing in REITs.

    I recognize that there are geographic variations, but are there average values on return on investment on real estate? Excluding maintenance costs/property management expenses, how much rental income does one typically expect per year relative the the price of a property? I wonder whether I can compare this to a REIT’s dividend to help me decide if it is worth the time and effort to directly invest in real estate myself.

    Thanks!

    Click to expand…

    Let’s just cut to the chase and say go with REITs. You did not mention personal time involved, lack of liquidity, or lack of diversification. Yes, you will easily be able to find off the grid stories of incredible success, and they are out there. But they are anecdotal and not the norm. If you want to concentrate on what you’re good at and put your investing on auto-pilot, go with REITs. Over the long term, you’ll be happier and less stressed. But your investments may be a little less exciting.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #221396 Reply
    PhysicianOnFIRE PhysicianOnFIRE 
    Moderator
    Status: Physician
    Posts: 1516
    Joined: 01/08/2016

    The 1% Rule is a decent rough guideline dictating whether or not it might make sense to buy and rent out.

    Passive Income MD is a good source for real estate investing.

    Bigger Pockets, too.

    Good luck!
    -PoF

    40-something anesthesiologist and personal finance blogger @ https://physicianonfire.com [Part of the WCI Network] Find me on Twitter: @physicianonfire

    FIRE. Financial Independence. Retire Early.

    #221399 Reply
    Liked by fev1, ENT Doc
    Avatar PreCancerDoctor 
    Participant
    Status: Physician
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    Joined: 01/06/2018
    Splash Refinancing Bonus

    Dude, I have been researching this EXACT topic. Warning, long post ahead.

    My understanding is, you might expect 1% of the value of the property (purchase cost + fix-up costs) per month as gross revenue.

    Then you cut that in half to account for repairs, vacancies, and other expenses.

    If you had to finance, then interest payment would also take a chunk out of the profits.

    So you might expect 6% per year as a cash-on-cash return (if you purchased the property outright) plus whatever appreciation of the property. A balanced stock-bond portfolio might give you 7-8%. To me, that’s not enough extra profit to justify the risk/hassle of real estate.

    I view it as chickens laying eggs.  Stocks don’t lay many eggs (low dividends), but the chicken grows really fast. Real estate lays lots of eggs (rental income) but the chicken doesn’t really grow much.

     

    I know a lot of people love real estate, and what I am learning is:

    – you can make more money if you purchase the property well below market value (good luck to us first-timers)

    – you can keep more money if you handle all of the work yourself (but my hourly wage is higher than someone who earns $50K/year)

    – you could make more money if you leverage and borrow from a bank, but I don’t see many pointing out the risk of being leveraged.  Sure, if housing prices and rents rise steadily it would be great.  We all recognize that stock investing on margin is super-risky, but so many never question a 20% down rental purchase.

    – people say it requires minimal work, but even 1 hour per week of my free time is worth $300 (to me at least), and I don’t see me making enough profit to justify that. An extra $1200/month of profit? I wish.

    – a lot of people say: buy 1 property, then buy the 2nd, then now you have 10 or 20 properties and a stupendous income stream.  It’s the “rinse and repeat” part that concerns me.  That presumes no housing crashes, liquidity issues, hurricanes, bad tenants, eviction proceedings, neighborhood blight, municipal mismanagement, etc.

    – if the point is to build up enough assets to where you can stop paddling the surfboard and just ride the wave, it seems like it would be easier to do that by hoarding stocks and bonds (ie the annual growth of your portfolio > your annual savings), which many already own.

    – I am wary of crowdfunding, etc.  Generalization: hospital-employed physicians often make less than self-employed, because the hospital has to to take a cut of the profits.  I don’t see anyone addressing the fact that the suit-and-tie folks arranging these crowdfunded or consolidated investments HAVE to be taking a cut, and HAVE to prioritize their own exit strategy above yours.  It’s not personal, it’s just their business. Not yours, dog.

     

    if anyone has better numbers or can address these concerns, please chime in

    #221402 Reply
    White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 783
    Joined: 02/06/2016

    When I was a young doc, I did invest in the stock market with vanguard index funds through my 401k, 403b, tIRA, SEP-IRA, and 457b.  With other money I made some small down payments on investment real estate.  The real estate cash flowed, and the mortgages got paid down and are now paid off.

    So I now find myself in a high tax bracket, with all my properties paid off, and I earn about 5% in tax free income each year on the value of the real estate portfolio.  I spend an average of 1 hour per month for my six figure annual income tax free real estate income.  In total, I am sitting on a few million in real estate equity.

    I have not really formulated an exit plan.  The depreciation deductions that shelter all of this real estate income from income taxes are starting to run out.  I will need more depreciation deductions in the near future to shelter this income.  So I am starting to consider selling my smaller properties to roll over the proceeds in a 1031 tax free exchange to then purchase a larger multifamily property with a professional manager on site. The return on the right multi-family property would likely be significantly higher.  And I cannot cash out without paying massive capital gains and depreciation recapture taxes.

    I probably should buy something in the 5 to 10 million range.  But I haven’t spent the time to learn this commercial real estate market and I need to engage a bit more to begin to learn and become an educated investor.  I feel that the advantages to this approach would be some generous tax free retirement income to balance against the highly taxed RMDs from my multimillion dollar tax deferred accounts.  And if I roll over the real estate into a worthwhile investment that will have another 2 or 3 decades of depreciation deductions, this could either pass to the heirs at a stepped up basis, or be donated to charity with a favorable tax deduction if the estate tax issues become too onerous.

    I tried doing some reading on the real estate blogs but have not learned too much so far.  If anyone has recommendations for books or blogs to enhance learning in this area, please send along your recommendations.

    #221426 Reply
    Liked by hatton1, fev1
    Avatar StarTrekDoc 
    Participant
    Status: Physician
    Posts: 1798
    Joined: 01/15/2017

    1% is a pipe dream in california.   Other places it’s realistic.   Real estate is all things local; so if you’re doing something individually, it WILL take time and energy and essentially a separate small business if you don’t farm out the management portion — so be prepared.  It’s not JUST investing.    If you’re not into the work and/or risk/reward — go REIT or syndicated route.

    That said, direct real estate investing is a world of opportunity and great ways of passive income once setup and diversification of resources.  Of our Net worth; 50% is involved in Real Estate over primary residence + 4 residential properties.   We grew these over 10 years and then 5 years ago paid them off and Free and Clear on them.  It will take energy and time.

    #221428 Reply
    Liked by Hank, fev1, G, StateOfMyHead
    Avatar G 
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    Status: Physician, Small Business Owner
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    I am actively trying to get out of directly owing real estate.  I absolutely hate it.  I see a text/caller id/email from tenant (or prop mgr) and my stomach drops; kinda like when one of the nurses comes up and says “So, Dr G, remember that kiddo that you sent home yesterday….”  Seriously, every time it is like a kick in the breadbasket.

    I freely admit that I probably have developed an irrational response because I know that others love this stuff.  These tend to be the folks with a large number of properties who run it like a business.  (To be fair, some people actually enjoy jumping out of airplanes.)  I don’t need another job.

    Finally, don’t get me started on the 1% rule.  Not in my city, at least this century.

    #221435 Reply
    Liked by jfoxcpacfp, CM, fev1
    Avatar StateOfMyHead 
    Participant
    Status: Advanced Practice Provider
    Posts: 81
    Joined: 01/01/2019

    If you are interested and willing to do the leg work and monitor I feel real estate can be a valuable mechanism for diversification. I keep a significant portion of my portfolio in residential rental properties. Over 25 years I have estimate about a 6% rate of return. It isn’t passive but it doesn’t take a large amount of time either. I know the neighborhoods, am comfortable rent and resale values will continue to rise which has happened consistently with the exception of a re-sale correction about 10 years ago. There was no difficulty with renting during that time and sale prices have since recovered. If things should happen to take an irreparable dive I will sell early. With minimal mortgages I can sell for a low price to unload if push comes to shove. Real estate is not liquid however the properties will always be worth something and moderate priced homes continue to sell regardless of the climate if the price is right. I don’t plan on major calisthenics to avoid taxes upon selling as at that point the rental income will have more than paid for the property itself and the proceeds will simply be considered extra.

    #221437 Reply
    Liked by fev1
    Avatar fev1 
    Participant
    Status: Physician
    Posts: 3
    Joined: 12/30/2017

    Thank you for your responses! I’ve enjoyed reading your replies.

    I must admit that some of my interest in directly investing in real estate stems from the potential pride in ownership of a (literally) tangible asset. However, this should be separate from criteria that defines a good investment.

    It would be great to hear from other users and their experiences with real estate investing.

    #221440 Reply
    Avatar G 
    Participant
    Status: Physician, Small Business Owner
    Posts: 1544
    Joined: 01/08/2016
    real estate can be a valuable mechanism for diversification.

    Click to expand…

    I used to feel the same way, but my opinion has changed.  I think partly because I’m financially secure without real estate.  If anything, real estate just opens up liability.

    I’m open to hearing the contra view, however.

    #221460 Reply
    Avatar Grizzle 
    Participant
    Status: Physician
    Posts: 7
    Joined: 12/24/2016

    I follow the snail real estate model. Buy the best located property you can find at the best deal and live in it for 5-6 years, when you outgrow it, buy another property that suits you better but rent the first one out. In 10 years, do it again. Now you have 3 homes and maybe a 4th if you do this for your retirement move. You get tax deductions which are gold if you are W2 in your main gig. You have homes that you can put up adult children in if they can’t fly on their own, or can manage professionally as their career if they don’t have another calling. Lastly, if things go sideways, liquidate the biggest ones and live off the proceeds in the smallest house.

    This also keeps your new purchases in line so you don’t buy too much house  if you need to sell the first to get the second, you are overreaching  or you live in CA

    If if jack reed is right and we are headed for hyperinflation, the tangible assets are a hedge against that too.

    I wouldn’t do this at the expense of equity investments, but it’s a good hedge if you buy well located properties.

    #221465 Reply
    Liked by StateOfMyHead
    jfoxcpacfp jfoxcpacfp 
    Moderator
    Status: Financial Advisor, Accountant, Small Business Owner
    Posts: 7503
    Joined: 01/09/2016
    I have not really formulated an exit plan.  The depreciation deductions that shelter all of this real estate income from income taxes are starting to run out.  I will need more depreciation deductions in the near future to shelter this income.  So I am starting to consider selling my smaller properties to roll over the proceeds in a 1031 tax free exchange to then purchase a larger multifamily property with a professional manager on site. The return on the right multi-family property would likely be significantly higher.  And I cannot cash out without paying massive capital gains and depreciation recapture taxes.

    Click to expand…

    Two best options are 1031 exchange and passing through your estate with heirs getting a stepped-up basis (don’t know how long you’ve been a “white beard” doc, so this may not be a feasible option for you). I’m sure I’m not telling you anything new, but other readers may be interested.

    Actually, an FLP (Family Limited Partnership) might be feasible, too.

    Johanna Fox Turner, CPA, CFP, Fox Wealth Mgmt & Fox CPAs ~ 270-247-0555
    https://fox-cpas.com/for-doctors-only/

    #221526 Reply
    Avatar StateOfMyHead 
    Participant
    Status: Advanced Practice Provider
    Posts: 81
    Joined: 01/01/2019

    real estate can be a valuable mechanism for diversification.

    Click to expand…

    I used to feel the same way, but my opinion has changed.  I think partly because I’m financially secure without real estate.  If anything, real estate just opens up liability.

    I’m open to hearing the contra view, however.

    Click to expand…

    Excellent points and I agree with you at this stage in my life. When I was younger and trying to rapidly increase my assets on a modest income investing in properties that needed work and either living in them while rehabbing or updating and renting similar to @grizzle‘s experience worked quite well for me. I would continue to recommend it for those who are realistic and interested. At this stage it is much easier to put my money in VTSAX. I still like having something I can lay my eyes/hands on so my RE portfolio is sort of a place card for a lower return more secure fund. For now the plan is to continue to invest more aggressively in the market than usually recommended for my age due to having the properties as a perceived diversification and back up.

    #221528 Reply
    White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 783
    Joined: 02/06/2016

    I still like having something I can lay my eyes/hands on so my RE portfolio is sort of a place card for a lower return more secure fund. For now the plan is to continue to invest more aggressively in the market than usually recommended for my age due to having the properties as a perceived diversification and back up.

    Click to expand…

    I agree with you.  Having real estate returning tax free rental income feels somewhat similar to a tax free municipal bond with a significantly higher return.  In economically diverse cities, people always need a place to live.  When the real estate market crashed, I had to limit rent increases, but I have never had any issues with vacancies, even in the crash of 2008.

    #221537 Reply
    Liked by StateOfMyHead
    White.Beard.Doc White.Beard.Doc 
    Participant
    Status: Physician
    Posts: 783
    Joined: 02/06/2016

    Actually, an FLP (Family Limited Partnership) might be feasible, too.

    Click to expand…

    How would an FLP work exactly?  (sorry Fat Little Pig, this isn’t for you!)

    #221538 Reply

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