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A new topic but maybe of the greatest interest to JAFO31 and I...

Broad principles here. More or less prove true using history but history is no guarantee of the future.

Assume a person wants to retire with a passive income in 10 years time. They want 50K gross income.

They buy 1 home a year for 10 years.
Each one costs 50K
Homes (on average) double every 7-10 years
Rents double (on average) every 7-12 years

In the homes were bought with interest only loans and there were NO down payments. 100 leverage so no equity to start.

If the numbers work as they have on average then the first property will have doubled in 10 years. Pay off the mortgage (50K) by taking out a new 100% mortgage and you have 50K left over. Use this to live on.

Comments, ideas, ways to improve the model?

Yes there are possible issues. Most can be dealt with if you wait longer, buy a few more, use less leverage, etc. Try to just consider the model and how it might work and how it could be improved so that the risks are contained.


Why am I posting this? There are people who are starting to realize that they have 10-20 years to retirement and they do not have any real savings or pension. If they work at finding one good deal a year for 10+ years they just might improve their lot in life. The reason this works better then just savings is the use of leverage and the fact that a tenant will cover the running costs. Certainly more work and potentially more risk then putting cash into a mutual fund. Well, maybe not as much risk as the stock market over the last 3-5 years.

Bring on all possible comments. Interesting and constructive ones are the most welcome.

John
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I wonder where you would get houses, in safe areas, that people would actually want to live in, and which you wouldn't have to spend a fortune maintaining for $50K. I'm just saying.

A friend of mine is doing this. First of all, to make it work, he buys duplexes, which means finding one of the few safe areas in the New Orleans area that have nice duplexes at a reasonable price. Otherwise, you get into suburban slums where crack is openly sold in the streets, people don't pay their rent, blah blah blah. You have to be really picky. But anyway, you find the duplexes, and they really all have to be in the same neighborhood. Which is close to YOUR neighborhood, where you actually live, so you can manage them, pick up rent, etc. without giving 10 percent or more to a management company which does nothing but pick up rent and doesn't catch on if a crackhead boyfriend moves in with that nice middle-aged teacher or what-have-you.

The reason for buying duplexes, in case it isn't clear, is that rents are not high enough to cover the mortgage plus property tax plus costs and still leave room for profit for most single family dwellings. This is just our area, yours may be different.

A lot of older people who still rent are alcoholics. It is a fine line to walk. He has to find people who are stable enough to pay the rent, yet not quite "together" enough to ever get a house down-payment together. At least when they move out because they bought a house, they are not bitter and they don't trash their old apartment up as a going-away present to the landlord.

That said, my friend is making money. But it is no walk in the park. And even though New Orleans is cheap as far as cities go, there is no way he could have bought any $50,000 houses to start. The condition of the houses and the neighborhoods would make it impossible to get decent tenants who pay the rent on time or even at all.

Not sure if my input will help, but maybe it will spark a few ideas?
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Homes (on average) double every 7-10 years

I would assume homes grow at the rate of inflation over the long term. It really has to be this way on average- if residential housing grew even 1% faster than inflation, in a couple of decades homes would be impossible to afford. This assumes wage and price levels grow at the same rate.

So at 3% inflation, your nominal home price would double every 24 years or so. On an inflation adjusted basis, it would never double.

Nick
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Oh one more thing. I can't emphasize the neighborhood enough. Because you need to get the houses close enough together to handle them efficiently when you are a landlord, you REALLY have to guess right about the direction of the neighborhood. Otherwise you'd be wiped out. My friend picked a neighborhood that he knows very well, where members of his own family still live, and which is on the way up. But if you guess wrong, you're screwed, so this is not necessarily a risk-free retirement plan. (What is, right?)

We know tons of people wiped out or who lost substantial assets by buying into condos and other cheaper properties, including his dad, so he was very careful to choose a neighborhood where people maintain their lawns, plant flowers, etc. Lots of landscaping in the front yard is a good sign -- if you have a choice between two neighborhoods, and the houses look just the same and just as suburban, the one without any landscaping in front, that is the neighborhood where crack and other substances are sold. It becomes annoying when some crackhead literally steals your plants out of the ground -- really, I had this happen way back in the when. Flowers and landscaping are an indicator all out of proportion to the amount of money people spend on them.

"Gates" mean less than you think. His dad's condo village was gated, but when the crack cookers moved in, they shared the code with their friends as frequently as it changed. In the end, the decent people had to abandon the place at a substantial loss, his place sold at about half of the original cost -- ugh.
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activeREinvestor:

"A new topic but maybe of the greatest interest to JAFO31 and I...

Broad principles here. More or less prove true using history but history is no guarantee of the future.

Assume a person wants to retire with a passive income in 10 years time. They want 50K gross income.

They buy 1 home a year for 10 years.
Each one costs 50K
Homes (on average) double every 7-10 years
Rents double (on average) every 7-12 years"


50k does not buy much home in alot of markets. Also, I am less sanguine about price increases; you may not know, but I lived through the 1980s Houston real estate market and the related S&L busts. While Houston real estate has geenrally recovered, I know some submarkets that still have not returned to 1982 prices! Not only did the property not double in value in 22 years, it is still down from peak pricing 22 years ago.

"In the homes were bought with interest only loans and there were NO down payments. 100 leverage so no equity to start."

Debt service would worry me; without adeqaute reserves, a vacancy could be a killer.

"If the numbers work as they have on average then the first property will have doubled in 10 years. Pay off the mortgage (50K) by taking out a new 100% mortgage and you have 50K left over. Use this to live on.

Comments, ideas, ways to improve the model?

Yes there are possible issues. Most can be dealt with if you wait longer, buy a few more, use less leverage, etc. Try to just consider the model and how it might work and how it could be improved so that the risks are contained."


Owning and managing rental real estate is a business; I would not consider myself retired if I had to do so. If I contracted management and leasing out, then a substantial portion of my "profit" would be paid in these additional fees.

For those who have the time and and inclination, including DIY repair skills, this may be a feasible plan. For those who do not, I am much less certain.

Regards, JAFO


Why am I posting this? There are people who are starting to realize that they have 10-20 years to retirement and they do not have any real savings or pension. If they work at finding one good deal a year for 10+ years they just might improve their lot in life. The reason this works better then just savings is the use of leverage and the fact that a tenant will cover the running costs. Certainly more work and potentially more risk then putting cash into a mutual fund. Well, maybe not as much risk as the stock market over the last 3-5 years.

Bring on all possible comments. Interesting and constructive ones are the most welcome.


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I wonder where you would get houses, in safe areas, that people would actually want to live in, and which you wouldn't have to spend a fortune maintaining for $50K. I'm just saying.

Add a zero.

By focusing on the example when compared to NO you have come up with only negative rental examples. Assume person wants 100K to live and therefore is buying 100K homes each year. Or 500K and 500K each year.

Use the rough model but focus on areas that are not so negative. It can be done as every city has a reasonable neighborhood and therefore an average house price for that area.

John
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Nick,

So at 3% inflation, your nominal home price would double every 24 years or so. On an inflation adjusted basis, it would never double.

Fine point.

To compensate is you can multiple the number of homes upward to compensate. In the specific example you are using (3%) then go for 3.4 properties a year.

Another way it so stretch the program out 24 years as you have shown with 3%.

I think you would find that homes do better then double every 24 years.

More importantly is the model can be adjusted to compensate. At least that is my challenge to the other fools willing to discuss.

John
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JAFO,

Many good points.

I too like good areas and do not go bottom fishing. If an area is very expensive I look for a different city where the prices are more reasonable compared to average incomes.

I always assume a property manager and the associated costs when running the numbers. You have to as you never know when something might happen and you can not longer directly manage the property. I have directly managed and have used property managers for many years.

If we take the view that at retirement property management is not something one wants to do then a sale of all the property would make sense. A more creative way is to structure a deal with an investor still on the way up. They take on the management and get an option to buy the property at some attractive price. You get a graceful exist with no selling costs and the other person runs the property while building the equity to buy you out.

OK, the creative exit has risks. If you have built a large portfolio you will know how to set up a smart deal and not take unreasonable risks.

John
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John,

What you're talking about will take a lot of time, there will be a fair amout of risk, and it will be a full time job, but if you're lucky it may work out in the end.

It's the same with starting any business. If I say to you: "I'm going to open a cafe. It will earn $20K. Each year I'll open another cafe and after 10 years I'll retire. Will it work?" The answer is: "Sure it might."

Nick
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A few years ago I read an article (I can't remember where) about the demographics of the home supply (the actual buildings, not the homebuyers). As I remember it there was curve very similar to the baby boom of homes built after world two. There is a major problem with this in that as houses age they keep getting more expensive to maintain until there are no longer economically viable to maintain and will generally either be torn down or abandoned. Some houses will be exceptions to this like nice upscale houses in a good areas(like the ones on “This Old House” on PBS) but your typical suburban tract house will be past it economically useful life in something like 60 to 80 years (as I remember the artical). If anyone knows more about this it I would welcome more information.

I would be very cautious about buying something like a 50-year-old tract home to rent because it may be nearing the end of its useful life and even if the housing market in general continues to appreciate, that specific house may loose value becasue of its age.

Greg
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Nick,

I disagree. Strongly disagree as a matter of fact but that is not on topic.

It has never been a full time job for me. I have had positions where I spent more time flying between meeting then I did looking or managing property. Other years I had more time but never was it that time consuming.

I have worked in investment banking and in Silicon Valley most of my life. Always on the technology side. A lot of the time is overseas from where the property is located. Hence It is not hands on or full time. Right now I spend 30 hours every three weeks on a plane. I do not spend that much time on my RE investing.

I definitely agree that running a business can produce similar results.

In Silicon Valley they talk about creating equity so you can cash out with an IPO or trade sale. Real estate is similar. You want to invest time and effort plus OPM (other people's money) so you can build equity and then cash out (of some sort).

John
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What you propose is very similar to what my Dad did about 15 years ago. He bought houses as quickly as he could find deals. At the time he had started buying, a refinery had just closed down, and the the other refinery in town was threatening to close down as well(they were the two biggest employers in town). This was in a small midwest town, with very low cost of living (and correspondingly low real estate values). So he was buying houses cheap (<50k), and his vacancy rate was high.

He would buy them as close to zero down as he could, and in his case the mortgage payments worked out to be lower than the rent. The extra money was reinvested in the properties.

He decided to buy twice as many as he wanted to keep, wait 8-10 years, then sell half to pay off the rest. That sorta worked...

Others have said you need to be a do-it-yourselfer and do most of the repairs yourself. Anyone who isn't a do-it-yourselfer, shouldn't consider rental property investments on a large scale, because there will be times when the vacancies get to high to have adequate cash flow. When (not if) this happens, it is challenging to make it though even if you can limit expenses. Even if you choose not to do everything yourself, you need to have the option to.

There are also a number of things that are a much greater concern to a landlord than the standard homeowner. For example, about 10 years ago, we had softball sized hail that destroyed most of the roofs in several counties. That was a separate insurance claim (and deductible) for each roof.

You would also have to decide how you will deal with bad tenants. At my Dad's peak (about 45 units), he was in court nearly once a month. He was able to do this because he did his own legal work. Small claims and even district court are not a big deal if you have the nerve to handle it yourself. The good news is, most people who will rip off their landlord will also lie to a judge. If you have a very strong lease, document everything, and don't show what you've got in court until they've already lied to the judge, it isn't hard to represent yourself. Since his rentals are in a small town, the landlords get reputations. If your area is small enough to get a reputation, you need to be known for going after the deadbeats.

A thorough reference and credit check is a must, but will NOT keep you from getting ripped off. You can get set up with the credit check companies and do your own credit reports on people for $5.

Oh, and have a non-refundable “application fee” for processing an application. A few people will be be concerned that if you turn them down, they won't get the application fee back. Even if you don't find bad stuff on the credit reports, their guilty conscience says a lot...

-Joe
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Add a zero.


OK, I guess I just assumed you had a certain amount of credit to work with.
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Joe,

All good advice. Some of which I had already applied over the years so I know what your dad faced.

I prefer to price in using a property manager and a handyman for all management and repairs. This way if the numbers stack up I have a choice as to how I actually handle things. You can never tell when the bus might hit you and someone else is left trying to deal with things.

I must admit that some folks find this model scary. Hence there will always be deals that someone passes over because it seems like too much effort or too complex.

I am assuming that you dad has done just fine. What are you plans if you do not mind me asking?

John
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I am assuming that you dad has done just fine.

Yes, sometimes better than others, but overall very well.

What are you plans if you do not mind me asking?

I grew up working on Dad's rental houses, so my plan since I was very young was get an education so I could work inside where it's cool in the summer and warm in the winter :)

So far, I haven't had time to deal with real estate investments if I wanted to. A couple weeks ago I finished my thesis so I'm finally done with my Master's degree (in engineering). Now I have to finish remodeling my own house, and a list of other things.

I'm 25, and am fortunate to be able to invest a substantial portion of my income. So I don't need to take on the risk and lack of liquidity associated with rental property. Someday I may buy rentals, but for now I'm content with REITs for my real estate exposure.

-Joe
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Joe,

Thanks for sharing.

Sounds like a plan that works for your father and a plan that works for you.

I would expect his allows for greater growth while yours provides the benefits you are looking for (warm or cool office work). Every person is different their needs sometimes change over time.

Well done!

John

PS. Also an engineer but older and in software. Mostly management these days as I have no useful skills as a programmer any more.
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>>I would expect his allows for greater growth while yours provides the benefits you are looking for (warm or cool office work).

Joe's career path certainly involves far less risk than his father's, and a higher quality of life.

It's interesting to hear the difference between your dreams of property investment and Joe's reality. In your model, home prices grow at a steady 10% per year, the business requires little effort to run, and you can hire people to do all the dirty work and still make a healthy profit. Joe's reality was incessent lawsuits, summers spent fixing roofs and leaky pipes, and "I'd rather choose a professional career, thank you very much".

Nick
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I do not think rental real estate is a bad investment, only that there are a lot things to consider before getting into it. And that the costs/benefits of it don't currently make it worthwhile for me.

For those with the time, ability, desire, to improve the properties, I think it is a good investment. It is hard earned money, but fairly safe money. As willingness to invest personal time in the property goes down, so do the potential profits.

A great candidate for investing in real estate is someone with a modest income and skills in remodeling. This person probably has more time than money, and with real estate can use someone else's money to build far more equity than they could otherwise accumulate.

Another great candidate is someone who does remodeling as their business. This is what my brother does (has his own remodeling business, and has been buying rental houses). He has made some very impressive quick profits buy purchasing rough houses and doing a few weeks worth of repairs, then selling.

-Joe
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Nick,

You jump too soon.

I have 21 years of experience investing in property.

I am a working engineer like Joe only I no longer work full time. Something about being over 40 and not needing to.

It is not all roses but it is not a lower quality of life. Homes in multiple countries, travel, taking on projects based on if I like working with the people. Properties that I can afford to have someone else do the maintenance.

Each person has to follow their own path. Many are not what you think based on common wisdom.

John
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>>>"Joe's career path certainly involves far less risk than his father's, and a higher quality of life."<<<

Different risks certainly, not so sure regarding "far less risk". Risk is in the future so we can only speculate. "Office work" as an engineer creates dependencies on others, the benevolence of a corporate employer - my experience has been highly variable. Most engineers I know have re-located more than the average bear and/or travel a ton. All real estate is local, and the buck stops in the mirror.

Quality is a relative term. The "value" of features and benefits are in the eyes of the beholder. Some will value air conditioning more than others. Others will prefer independence more than others.

If you are saying that over the next x years, an engineering skillset will trade at a premium to real estate values, maybe so. Of course, it will depend on the engineering specialty vs. the specific location and type of real estate.

We each have unique temperments, abilities, and thresholds for risk - and that's a wonderful thing!

11


by the way, if the "thrill of property management" is what irks you, raw land investment/development opportunities could be considered. The dirt is generally well-behaved ... never once called in the night)-

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Different risks certainly, not so sure regarding "far less risk". Risk is in the future so we can only speculate. "Office work" as an engineer creates dependencies on others, the benevolence of a corporate employer - my experience has been highly variable. Most engineers I know have re-located more than the average bear and/or travel a ton. All real estate is local, and the buck stops in the mirror.

**************************

This really nails the crux of it. Directly held rental RE isn't a passive investment like other vehicles. In reality, it is a business, whether it is a small time thing you do on the side or a full time effort. Some people are born entrepreneurs, others are happy as employees. Some can/will cross the divide. Personally, I have always been an employee, while my dad has always been an entrepreneur, and we both do OK. I'm not really interested in having a small business on the side, so the current state of the RE market doesn't tempt me to invest there (there is money to be made, but you have to work at it). If market conditions were to change, I might be a RE investor, but given my preferences there would have to be some pretty juicy low-hanging fruit. Others are happy running their own RE operations regardless of the state of the RE market. Different strokes.

Just remember that directly held RE is more like a business than a passive investment in most cases.
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Different risks certainly, not so sure regarding "far less risk". Risk is in the future so we can only speculate

I think borrowing a million dollars or so and operating a highly leveraged business will always be more risky than selling you labor. You only have to look at personal vs small business bankruptcy rates to see that.

Certainly, real estate can be an excellent way to make your fortune. My beef was more with John's naive (in my opinion) assumptions regarding everything from appreciation rates to the effort involved. You have to make conservative assumptions when modelling something like this- otherwise you end up with negative cash flow properties.

Quality is a relative term. The "value" of features and benefits are in the eyes of the beholder. Some will value air conditioning more than others. Others will prefer independence more than others.

Ok, that's true. Some people enjoy working outdoors, or with their hands more than office work.

If you are saying that over the next x years, an engineering skillset will trade at a premium to real estate values, maybe so

On a risk adjusted basis, an engineering job should pay more than acquiring cheap houses and renting them, since it requires more education/skill. Given the best possible outcome (high rents, high property appreciation, low interest rates, no vacancies, low maintenance) the real estate investor should wind up with more money. But I think the expected (average) outcome should be lower. More sophisticated real estate investing, like starting a REIT, might pay better.

Nick
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