Sunday, January 01, 2012

Real Estate Investment Musings

There is a lot about simple finance that ought to be taught in high school, but it isn’t. It irritates me to hear the phrase “paying rent is throwing your money away.” That phrase has sold a lot of real estate in California when in actuality renting in our area is cheaper than owning.

The basic thing that never enters the question on home ownership is the cost of money. You borrow money to buy a home from the bank. After 20 years the home is paid off and you have no more payments, Right??? You’re wrong. Take a paid off home financed for 200K. Figure interest rates at 6% not the ridiculous current 2 percent. The interest generated by 200k at 6 percent is about $12,000 a year. This is what a paid off homeowner’s hidden costs are. The cash in his home is not paying him $12,000 a year, that’s his cost of ownership plus $2,000 in taxes plus about $2,000 in upkeep. So the paid up home owner is paying about $16,000 a year for the privilege of living in that home. Divide that by 12 and you get monthly “rent” payments of about $1334 a month. Everybody pays rent.

40 years ago you might have heard the phrase, “A home is the most worthless investment you will ever make, but a necessary one.” The reason being, it was a savings plan for young people starting a family and a long term hedge against inflation. Plus it had always been cheaper to own a home than to rent. Renters paid more for the freedom to pick up and move. The real estate bubble trashed that well tested concept and replaced it with two new ones, “Real estate always goes up,” and “Buy now before you get priced out of the market.” Everyone that ever wanted a home bought one and now this bubble has collapsed leaving our government (you and me) holding the bag.

Rental real estate may again become a viable investment option in certain parts of the country. A single family home purchased for 100 times its monthly rental, should have a very nice return. For investor owned real estate, the banks want 20 percent down. A 100k home, that can be rented for $1,000 a month, will cash flow nicely. Figure a down payment of 20k plus 6k in closing. If bought right, you could take $200 a month off the top for 20 years and then after that, you’d get a retirement check of $1,000 a month as long as you own the house. One thing to realize, landlords don’t set rental rates, the market does—the higher the rate, the more months the unit sets vacant.

Don’t go to Las Vegas and buy a home in one of those 4,000 house developments that has only 4 families living in it. The current tenants are probably busy recycling the copper and appliances out of the other 3,996 homes.

Fannie and Freddie ought to be offering some good deals in the coming year. The extra dollars they give you for buying a stripped out house, you can shop Craig’s List and buy back the water heater, furnace and dishwasher.

Cash held in the bank right now is taking a real beating. As a rule of thumb, a home is the equivalent of 150 ounces of gold. Not only that, it provides shelter, is a hedge against inflation and the banks will loan you 80% of its value as an investor, more if you decide to live in it. Maybe the investment tip for the New Year is; “Buy and hold things the government can’t print.”

So in the coming year if you have an extra 25k rotting in the bank, do you buy a new car or dabble in a rental? In 10 years, your wheels will then be worth $500 or you could have had 50k in tax deductions depreciating your rental. A lot of people in this country work full time for the car industry without even knowing it. So investing 20K and waiting 20 years, do you have the time to spare? At age 65 I keep asking myself, why didn’t I buy two instead of just one when I had the time?


Anonymous said...


I just spoke with a mover who is located in Sarasota, FL.
He said that business is brisk. Investors are buying 10 or more homes at 50¢ on the dollar and renting them out.

Like you, I am in my mid 60s and at this point it won't work for me. If only I was forty!

Anonymous said...

60 year olds. Don't be dismayed. Home prices will continue to drop. They'll go down another 10-30% because there are so many more foreclosures coming and unemployment statistics. Then prices could flat line for years. This is what happened as a result of the 30's depression (15 years of flat line). Matter of fact if you're 60 you may never see appreciation in single family homes again in your lifetime.

Anonymous said...

Careful investors...all the news reports are going on and on about how strong local rental markets are, but if programs get put into motion where the banks start renting out their REO holdings, you'll get stuck holding the bag...again! Check out this article about selling out the nation's landlords:

Jim in San Marcos said...

Hi Anon 3:36

I agree there is need for caution. I don't see the banks going for the rental program, but Fannie and Freddie could give it a try. As with all government programs, they will overrun on costs. Renters are mobile and homeowners underwater are not. There is a very good possibility that prices could go a lot lower so you really need to know your market.

Figure most homes of about 1800 square feet cost around 80k to build. Anything below that price has to be a good deal. Buying one won't hurt you, but buying 10 could.

The key is management. If you are easy on the renter and cut him slack, he isn't going to move out unless it is job related. I don't see management companies cutting any slack, they are hard asses and it pisses off a lot of renters and they vote with their feet.

Management companies like people that move, they charge the owner for repainting and re carpeting. A rent turn over can cost the landlord $1,500 plus two months down time.

Being a landlord is not for everyone, you need to be a bit carefree and relaxed otherwise the stress will drive you crazy.

Jim in San Marcos said...

Hi Anon 11:28

It still might be a good investment for you to pass on to your kids.

I might just live to be 85. My son could enjoy the added income when he is 40.

Anonymous said...

Really Jim? $80K to build a 1800 sq foot house?

Maybe out of toothpicks and the cheapest drywall made in china!

I've see kitchen remodels with quality materials and cupboards run close to $40K. Hell, Ikea kitchen remodels can run $20K easy!

My insurance companies insures my $400K 1950s home for $280K replacement cost.... I'd say that's much more accurate to replace my home.

Hell a new roof alone cost $10K minimum! Mobile home for $80k maybe...

Anonymous said...

80k to build an 1800sf house out of mud bricks and salvaged wood and parts like an adobe maybe.

Jim in San Marcos said...

Hi Anon 4:20

There is a point at which home building completely disappears, thats when resold homes hit 80k, like they have in Detroit and some areas of Florida. 80K would be the builders costs figure a 40k markup and 30k for the land and 15k for permits and services hookup. Right there you are at 165K per home.

Rebuilding a home that has been destroyed is not easy. Have you got the original plans? Can you build that same house and be up to code? Homeowners policies typically cover the contents up to 50% of the home value.

I'm pretty much discussing homes built 20 years ago that will be valued a lot lower than your typical new build.

I've seen people in California spend 80k just upgrading their kitchen and IMHO, they didn't get even one third of what they paid for.

Some home costs are like trying to buy a new car at the parts department of a dealership. It will cost you double or more.

Anonymous said...

Home prices will continue to drop and once at the bottom will flat line for years. All you have to do is look at the macro economic pic to know that. Real estate investors will not be figuring appreciation into their projections any more. Just cash flow and tax breaks (but the tax breaks will go away soon too and property taxes will go up too). Real estate may not even be considered a worthy investment in another 5 years or so. This is what happens in a depression, right Jim?

Jim in San Marcos said...

Hi Anon 9:45

I do think that housing prices have a lot further to fall to get in line with rentals.

With the present interest rates, rentals make a lot of sense if you can buy one for 100 times the monthly rental. I figured it out once and I believe that the return at that ratio is about 20%. That sure beats what the bank is paying.

The unexpected thing we have to contend with is the excessive amounts of dollars that have been spent by government in lieu of taxation. That has to be very inflationary (IMOH).

The next step in the 1930's was easy to call, very little government debt. Today we are in an unknown grey area with the massive government debt.

It doesn't look good.

Anonymous said...

One note on depreciation.
When you sell, the IRS collects
"recapture of depreciation."
So if you depreciate the house by $100,000. you owe taxes on that gain, even though it was not money paid to you.

Jim in San Marcos said...

Hi Anon 11:17

The first rule of real estate is to never sell, borrow on it maybe. Of course, you can't do that if you paid too much for it unless you're Donald Trump.

Let your relatives inherit and the capital gains from depreciation drop off.

dearieme said...

"Let your relatives inherit": not hereabouts - inheritance tax is 40% in the UK.

Anonymous said...

Put your rental properties in a CRT (Charitable Remainder Trust).

Jim in San Marcos said...

Hi Dearieme

Welcome back

Tax laws vary from country to country. I imagine there is a way to avoid inheritance taxes. It has become an art over here. We have 1031 exchange programs that allow you to sell one rental property and buy another with the proceeds and avoid tax and at the same time you get to depreciate the new investment for another 27 years. Living Trusts are another. Some farmers have very large insurance policies on them and when they die, the non taxable death benefits pay the probate taxes.

Just reading about your 40% inheritance tax rate had me trying to think of ways to avoid it. It certainly doesn't sound very fair.

In my case, I'll have to get rich first, before I worry about estate taxes. With my luck, I'll win the lottery at age 90 and the grand kids will be mixing antifreeze in my Gin and Tonic.

Anonymous said...

As my first post to this thread, I just wanted to say that there is more to home ownership than just $, especially for a first purchase. I bought a home, and because of that, I started reading your blog. There has to be some intrinsic value there. :)

Many renters would not read your blog. They have no idea what is coming up next, unless you are talking television lineups.

Sell Real Estate Note said...

Real estate investing needs a long term vision. As individual investors we save money, purchase real estate and try to increase our portfolio over time, hoping that by the time we retire, if not before, the cash flow from the investments might pay for college for our children and then pay for a comfortable retirement.

Jim in San Marcos said...

Hi Anon 10:26

You are right, There has to be some intrinsic values in owning a home. The walls don't have to be painted white, the carpets don't have to be light tan, and you can plant trees, build a greenhouse, or a barbecue pit.

With a rental, the owner can tell you to move if he wants to sell the home or move back in it.

It's still way cheaper to rent in California. That could change in a couple of years.

For a lot of couples, home ownership is a retirement savings plan, that is an unplanned accident. Which is a good thing.

Thank you for your comments.

Jim in San Marcos said...

Hi Sell Real Estate

Your description describes my life.

We still rent in California, but between the rental I have had for 25 years and what we save renting over owning, our son will comfortably make it through Berkeley 4 years, fully financed by the wife and I.

Your recipe for investment works just fine.

Anonymous said...

I've built or remodeled or purchased over 8 homes. Never lived in one of them. Sold them for profit. I'm 60. My wife and I have always rented, never lived in a house we owned. Don't like being stuck in a location;;; refuse to pay ridiculous interest (people wind up paying 2-3 times the cost of the house by the time they finally pay off their 30 year mortgage, banks are smart, people are stupid, how insane is that?);;; no property taxes, no insurance;;; no maintenance and repair costs;;; no wasted time cleaning or doing lawn work;;; if you don't like your neighbor or what is going on in your vicinity you can pack up and move;;; you don't need furniture if you rent furnished (more depreciating stuff you didn't have to pay for and don't have to worry about or haul around with you);;; but the most important benefit of them all is all the money and time saved so that you can do things for YOU (like education, health programs, hobbies, business activities, etc. etc.);;; in other words renting raises the quality of your life.

Anonymous said...

Right. You may have been one of the "fortunate ones" and bought and later sold a house after wild appreciation. (But even that is not a real gain. The higher "value" is just nominal and a result of inflation and demand that is artificial.)

Setting up "The American Dream" of owning your own house and making it so important and having the government take an active role is assiting you to own a home is and was just a ploy created by bankers and all the other devious groups that want to stick a hose in you and suck the money out of you throughout your whole life.

Debt serfdom. No thanks.

Jim in San Marcos said...

Hi Anon 9:56

I have to take exception to you blaming the bankers. No one pointed a gun a people buying homes like crazy. It was consumer greed.

My neighbor owes one million in real estate loans and has a 30k per year job.

The banks paid the sellers real money and now hold the loans that the new owners are walking away from. You have every right to be mad at the banks for a different more real reason, it was your savings that they loaned out.

Anonymous said...

The banks didn't pay the sellers "real money". The banks created the money out of thin air with the widespread use of fractionalized reserve lending. You know that. The money was created by just punching out some digits on a computer keypad. Banks are allowed to loan out up to 9 times what they have on deposit. There is no real loss of wealth when someone doesn't pay back their mortgage, other bank loan or credit card. There was no money in the first place. This needs to be stopped. Everyone should default on their loans and pull their money out of the big banks and brokerages. That would take their power away and put an end to their raping and pillaging of America.

Anonymous said...

When home prices reach the bottom after another 20-30% or more drop (which will happen gradually or possibly quickly, could take another 5 years) then they'll be some great deals for buying and owning single family residences as rental/income properties. Altho they aren't very good investments. Much better to own a small apartment building. Aptmt rentals will be in high demand from this point on for many reasons. People losing homes, baby boomers retiring and downsizing, unable to qualify for loans, the new generation entering the work force, etc.

Jim in San Marcos said...

Hi Anon 2:21

Banks can't create money out of thin air. Congress has that ability as does the Federal Reserve in conjunction with the Treasury.

Fractional Reserve lending is a method used to explain how the money supply increases and decreases.

The banks can loan out about 90 percent of deposits, not 9 times.

The money in the bank is real and belongs to someone, like you and me.

Our government is covering all of these losses with printed dollars. and the total is added to the national debt.

The question you need to ask, is do you want to be paid in IOU's or gold? The way the law is written, dollar bills are legal tender. You won't get gold.

Our government has borrowed all of the money in the banks. The banks are not the problem, its the government.

Anonymous said...

Banks are loaning out money that doesn't exist. If everyone wanted their deposit money back the banks wouldn't be able to deliver. This is an unfair and corrupt activity. Banks loan money that they don't have. The Fed Reserve creates money out of thin air and gives it to banks for zero or little interest. Banks make money on the interest spread. Another unfair and corrupt activity. There is not enough money to back up all the credit that has been extended. This is no different than counterfeiting which is a crime. People are paying high interest to banks for money that doesn't even exist. Robbery.

Jim in San Marcos said...

Hi Anon 11:52 AKA 2:21

Your statement "Banks are loaning out money that doesn't exist." is false. The statement "If everyone wanted their deposit money back the banks wouldn't be able to deliver" is true and rather obvious. Thats why the Federal Reserve was created, to keep banks from going broke when there was a run on the bank.

Your quote "The Fed Reserve creates money out of thin air and gives it to banks for zero or little interest" is wrong again, they give over night loans to banks that need capital advances because of an accounting screw up or other glitch and they charge enough that the bank would rather avoid the charge by correcting the problem.

Your statement "There is not enough money to back up all the credit that has been extended" has some merit if you phrase it a different way, "not everyone is going to pay back their debts."

The banks are not the villain. The credit card companies charge high rates for borrowers, but they aren"t stupid. Not everyone is going to pay, so they charge accordingly.

Personally, I wouldn't loan you a dime, Your remarks give me the impression that you are just rationalizing why you won't pay for what you have already borrowed.

Your view of the banking sector has just enough truth mixed into it in the wrong places, to limit your future success. Take the time to learn what a bank does and what services it offers. They don't print money, but knowing what they can do to you if you don't have your wits about you is a different thing. I've seen people refi a home three times in two years, and they haven't got a clue that they have been ripped off.

Anonymous said...

I don't have any debt so there is nothing for me to rationalize or justify about.

You've got it wrong. It is even in the WSJ. Banks borrow from the Fed Reserve for less than 1% and then buy long term treasuries and profit on the spread. One of the little tricks that is done by the government and The Fed to help the banks out (cronyism and plutocracy).

I've read books and seen DVDs explaining the banking system and the Fed Reserve. They don't agree with what you are telling me.

You should watch "The Money Masters" and "Money As Debt" and read "The Creature From Jeckyll Island".

The big joke on everyone is that... there really isn't any money!

Anon 11:52 AKA 2:21

Anonymous said...

Everybody who existed prior to the installment by the power elite of The Federal Reserve in 1913 is dead. We were all born into it and raised with it. We know of no other way, which is why no one can think straightforwardly about it. This country's framers did not plan for a private independent corporation controlling our money, printing money and meddling in our economy. Jefferson fought the idea. Jackson fought the idea and won. That viral ilk kept coming back and trying and trying again to get into the position where they controlled the currency. The 16th Amendment, bringing in the Fed Reserve and income tax, was one of the last nails in our coffin and has brought us to where we are today.

Banking is no longer banking. The corruption is horrendous. The leveraging is horrendous. Loaning money that you don't have is unconscionable.

We can never have sound monetary or fiscal policies as long as the power elite have their fangs (The Fed Reserve) in our jugular artery.

Jim in San Marcos said...

Hi Anon 11:52

Now you are making sense.

Right now the banks have our savings and no one to lend it to. Hardly anyone qualifies for a loan.

Japan was able to salvage their banking system by paying zero interest and investing in American Treasury's for 20 years. It worked out OK for them.

So our banks borrowing from the Fed short term and investing the proceeds in long term treasury, will probably help the bank meet payroll and pay interest to depositors, but that's not going to make anyone rich.

Normally the banks write a loan for 100k and sell it to a private investor and manage the loan for a half percent. So if you can turn that 100k over 20 times in a year, you generate about 10 percent interest on the 100k. In todays market, buying long term Treasury's at 3 percent and holding them isn't much of a deal. The bank is more likely to write a 100k loan at 7% and hold the mortgage on the books.

You are right about the money being gone. Everyone is sitting on their dollars in the bank. But if everyone was to go out and try to spend them, the shelves would be bare. There are too many dollars and too little product.

Anonymous said...

You are making rentals out to be a sure bet. There are many things that can go wrong along the way. Even if everything goes as planned financially, the owner still might lose. Stress, lost opportunities, time sink, interactions (situations).

as an aside,
Ask those who bought in Detroit 10 years ago how they are doing.

Anonymous said...

Jim --

The "rise of dark inventories" has been getting alot of play this week

I was wondering if you had an opinion on this topic?


NewYorker said...

Before considering real estate as an investment in a rental market study the actual experiences of landlords in the area. In many places you might have a terrible time trying to evict a tenant for non-payment of rent. My next door neighbor moved to Florida and rented his house. After 15 months of living in the house without paying any rent the tenant moved to Puerto Rico leaving my neighbor with no money and a filthy house.

Anonymous said...

The part of the country you live in makes a difference. I live in Wisconsin and real estate values did not bubble much, nor collapse much here. There are numerous foreclosures, but they have more to do with long term unemployment. Still your reasoning is sound, although our taxes are a sky high burden here.

Anonymous said...

I can see viable arguments for both ways when it comes to renting vs owning. I suppose it depends on where you are living, your budget, and where you plan to be in 5, 10, & 20 years.
-Jon @ real estate investors