Hey 2Million,

I'm just looking over your networth updates. The only thing I can say is: good job.

Best,

James

Posted by James | February 14, 2007 12:44 PM

Great site 2million! I’ve always enjoyed reading your page. You recommended a book called Automatic Wealth a few months ago and I absolutely enjoy this book. One of the key points he discusses in building wealth is increasing your income, having a business (or side business), and owning investment property. I’ve purchased investment property, of courses out of state since I’m in California, and this has helped immensely in boosting my net worth.

I think you’ll find the same since your property is below national medians and you are cash-flowing already. Good luck and I look forward to your continued progress!

Dr. Housing Bubble
http://drhousingbubble.blogspot.com

Posted by Dr. Housing Bubble | February 14, 2007 12:47 PM

I guess I'm about the only person in the world that can't seem to get excited about rental real estate. The house, with perfect circumstances, generated a net worth increase of about $4,500 (including tax breaks). The cash flow was only about $2,300 (includes tax breaks but excludes mortgage paydown). Maintenance this year was very low at ~ $800; but, roofs, A/C, furnaces, etc. etc. etc. need to be replaced; I've read that a house will generally cost around 2.5% of its cost in maintenance and repairs. On your house, that's about $4,000 per year. So, taken in this light, over the long run with no vacancy your house will just about break even. Sure, I'm ignoring appreciation. But I don't think it's realistic to expect real estate (especially single-family rental) to increase at more than the general rate of inflation. However, just about all risk-free (and hands-free) asset classes perform the same as inflation.

In my analysis, residential rental property in today's market generates a non-cashflowing yield approximately equal to inflation, which I find very unattractive. The same is also true for other asset classes right now, such as farmland. Maybe I'm just crazy. It is tax season after all.

Posted by CPA1298 | February 14, 2007 6:35 PM

Hmm... You're anticipating a loss of >$2000. Are you sure you can deduct that loss? Uncle Sam says you cannot offset active income (salary and investments) with a passive income loss (rental income is typ. defined as passive.) So you may not get the deduction you are hoping. The only way to take that deduction is to declare yourself a "Real estate professional". The qualifications for this are no small feet including that you have to spend somthing like > 50% of your annual working hours in the RE profession. But once you are categorized as a RE professional, the *real* tax benefits kick in such as accellerated deduction on an SUV, etc... The only way I've been able to make it work for me is to have my stay at home wife (mother of 2) take that on as her "career".

It'd be interesting to see the rest of your numbers on the property. I'm always interested in this stuff as I have a couple rentals myself and never get to see much of what other RE investors are experiencing. My first was my primary residence that I moved out of when I got married. (That was an interesting decision comparing the cost to sell plus the capital gains tax hit versus investment opportunity cost and highly leveraged investment.) Then my wife and I purchased a multi-unit building. We're currently considering a beach property as well...

To the other point about RE market appreciation rates, the historical nation average for housing is 6% annually. Sounds high but that is the number. And then you need to factor in the fact that your mortgage likely makes your RE investment very highly leveraged, ie if your $40k equity in the property is only 10% of the actual market value, then even a conservative 4% appreciation on the $400k property value is $16k per year increased equity when you only put $40k into the investment... A much nicer return.

But beware the appreciation rate is very different from region to region and changes with the times. And IMHO it also varies per type of structure (single/multi-family) as well.

JP

Posted by Jay | February 14, 2007 9:22 PM

Thanks for the comments JP. Sorry I should have specified that I actively participate in this investment and that the losses qualify under the rental loss $25k limit since my MAGI is less than $100k.

Posted by 2 million | February 14, 2007 9:57 PM

in response to CPA's post...

if you are only putting down 0% or 10% on rental properties and able to break even year after year or turn a profit, there is no reason it is not a good investment. with a $100,000 house, 10% down is 10k. if you can net 2k after expenses, you have made 20% ROI. add in a few thousand in tax savings and a few thousand in equity and you have a darn good investment. pay your mortgage biweekly or throw in some extra payments here and then and you have your rentals paid off in 15-20 years. thats when the big numbers come in. now you no longer have a mortgage to pay and your rental income is only offset by taxes, insurance, and repairs. if you have 10 - 100,000 houses, you now have an additional $1,000,000 net worth throwing off probably $100k+ net cash flow. multiply the numbers for a bigger idea. theres no other investment where you can gain from this many angles.

JP - real estate losses can be deducted up to $25k in one year.

Posted by bryan | February 14, 2007 10:24 PM

You can offset other income with passive rental income losses as long as you're considered an "Active" Participant in the management of the property. So as long as you don't hire a property manager, you usually qualify. In addition, you have to make less than $150k. As a result most people qualify. It's a nice tax break. While I don't agree with the Koyaski of the world, I think rental real estate is important part of portfolio of someone who doesn't mind managing those properties. Alot of people don't like managing a rental property, and if have to end up paying a property manager and forgoing the tax benefits - it's not worth it as there are better assets to have at that point.

Posted by Dong | February 15, 2007 11:43 AM

Maybe everyone else lives in a different rental market than me. In the small Midwestern city I call home, a $100,000 house would rent for about $550 per month. Unfortunately, the principal and interest payment on a $80,000 loan costs about $525 per month. Then, there's insurance of $500 per year and taxes of $2,000. Plus, repairs of $2,000. For a hypothetical:

Rent $6,600 ($550 x 12, no vacancy)
Mtg. Pmt. (6,300) ($525 x 12; $80k at 7%)
Insurance (500) actual cost in my area
Taxes (2,000) actual cost in my area
Repairs (2,000) 2% x $100,000
Appreciation 4,000 4% x $100,000
Tax Benefits 1,000 (tax loss of $6k x 15% ave rate)
Net Income $1,200 (includes tax benefits)
ROE 6%
ROA 1.2%

That to me sums it up; you have an investment where the best case ROE is virtually the same as holding CDs. As the mortgage gets paid down, the ROE declines to the point of the ROA.

I still think either I'm missing something, or I'm losing my mind.

Posted by CPA1298 | February 15, 2007 11:56 AM

For CPA1298 - Only 4% appreciation? Wouldn't perhaps 6% - 'true inflation figures' be closer?

I know one of the property investing "guru's" over here suggests the following as a good idea for Prop Investing:
Problem + Solution = Profit.

For a passive investment - Property is pretty lacking... For an active / semi active investment - Property has some benefits. (ie - a new coat of paint might cost $5K and add $15K to the value of your house... You can't make upgrades like that to shares/bonds/funds/etc.
Only running your own business offers more opportunity for YOU to personally increase the value of your investment...

Posted by Rob | February 15, 2007 8:08 PM

You are having someone else pay off the mortgage and creating equity. Nice work, any positive cash flow is a plus.

Posted by Marshall Middle | February 15, 2007 8:23 PM

cpa- your analysis is about dead on. you are correct, where the numbers vary from your market to mine are in the rental income. Everything else looks fairly close to the prices around here in NJ. Where you can only charge $550 in rent for a 2 bedroom house, I could charge $775-850 here. the extra $300 a month adds $3600 to the bottom line each year

Posted by bryan | February 15, 2007 11:38 PM

My bad, as I did forget that the $25k deductibility is there but is phased out between $100k and $150k. The RE professional status covers without limit and makes things a bit more interesting.

As for the profitability, validating the market will support the numbers is critical. My three family averages $1025 monthly income per unit and cost $115k per unit to purchase. While I was searching for an investment property I realized that the increased market demand and rent from 3 bedroom units over 2 beds far outweighed a slight increase in purchase price.

My biggest challenge is how active you need to be to support the properties. The tenents in this building are not big earners,come and go more often, and are high touch. And the building requires regular maintenance.

On the other hand my single family rental in the Boston area draws double that per month, retains tenants longer and requires much less effort. That's a big consideration. Lots of interesting lessons throughout both experiences.

The downside to the single family is that the equity in that property is considerable, so I am stuck trying to decide if that is the best place for all that equity to be sitting. I could refinance, to get some out which, would dip into the cash flow but increase my leverage...

Who knows? I would like a program that determined the bottom line return on cash invested after taxes and compare that to alternate investment choices...

Posted by JP | February 16, 2007 10:05 PM

JP - is the $1,025/unit gross rent, or net income? If it is gross rent, that would seem kind of tight, as I assume the monthly mortgage payment is around $3k. And, as you mentioned, you suffer from high turnover, maintenance, and 'touch'. Is the building profitable?

Marshall - I don't doubt that a 1,200 sq. ft. house in Jersey would rent for more than one in the MidWaste. However, I also doubt that $100k would buy nearly as much house in Jersey as it would here.

Posted by CPA1298 | February 19, 2007 1:49 PM