Rental home investment thoughts
Housing as an investment, be it personal or business - be it your personal home, or a rental home or a rental portfolio, is a lot more complicated and nuanced than we’ve been led to believe.
I mean it’s accepted wisdom that buying real estate is a good avenue to wealth building, and anyone who bought pre-2020 might actually have that idea bode well for them, but over all, over time, now that I’m 25 years into playing around with real estate, it’s evident to me that while it has its advantages, it certainly isn’t the end all be all.
My friend George at our hometown bank has been keeping track of me through my blog and decided to contribute to my pancake production process (PPP) when Lucas Petersheim has 15 friends over with a gallon of Maple Syrup. That's George saddled up to the bar at our annual Christmas party (picture below), waiting for a ginger ale or beer - note, not his shot glass!
On owning a home for a family - a personal residence - I’m not sure there is a worse investment in terms of pure ROI $$$. Monthly utilities, yearly taxes and insurance that are no joke anymore, upkeep and maintenance, mortgages and interest, things that break and the itch to improve leave the math pretty lacking even if you do see a steady appreciation, which is no lock. Even the real estate fee of 6% to get out of it in the end impacts the value of the investment.
I mean the math is simple - buy for $500,000, pay $35k a year in the above costs (without the costs of projects and improvements), and 10 years later you have $850k or more in it. Few periods of appreciation keep up with that cost of ownership. And since people can’t do math, a 25% appreciation over 20 years isn’t 25% APR.
Rent and save that $100,000 down payment and $20k a year in operating costs, and you can see the wealth-building diversion between the two. It’s a little bit like the college vs non-college tracks - that the community college and get to work track leaves that person hundreds of thousands of dollars ahead by the end of their 20’s in many cases where the person pursues intelligent ready to go positions whereas the ROI on the cost of college and the course of study pursued never really pays off for lots of people.
What owning a home does do, for a country of mostly financially illiterate people, is turn a home into a forced savings program - money losing, but forced savings, with a tangible nest egg over a lifetime. The 30 year mortgage leaves you with a nice little chunk of change.
Dave Ramsey the personal finance guru is always hating on whole life insurance as an investment but is always high on owning your own home. But I think all things being equal, they both are pretty lackluster as investment vehicles. But I like and own both, since they serve a purpose, and it might not be solely or even primarily a pure financial return on investment (ROI). They both provide security, they both are sort of outside the chaos of the day to day, and they both can be cashed in an emergency.
But of course, that just looks at housing in investment terms, which of course it is not. It’s a place of safety, creativity, security (for many people) and something you can call your own, improve as you wish, etc… Even if there would be a trend to rent over buying and the stigma of renting over buying would be erased, in most parts of the country the rental stock variety doesn’t nearly parallel the options on the purchase track, meaning less options in less areas. When you buy, you can really dial into what you want - area, house style, property type - it’s rare to have the same choices, unless you are in a city or urban environment.
But the point of this post is more investment than personal real estate. I’ve been messing around with rentals for 13 years, as it seems the dream of progress - to own several pieces of real estate, a real marker of professional success and growth.
What I’ve learned, and I’m sure this is not local but national, single family rentals are hard to make money at, and if the home is older, or if you are holding a mortgage on it, geez, good luck with that. Squeaking out a few hundred dollars a month at best if everything goes well, waiting on questionable long-term appreciation, hoping none of the inevitable happens.
Non-paying tenant squatting in your home for 6 months as you try to evict. Damage to the unit. Improvements to units. Maintenance to the Units. Increasing taxes and operating costs. Tenant management. Collecting rents. Legal costs.
Above, My Playstation 5 boxer I created named Upper Cutt. Almost as clever as my PGA golfer named Hole Inone - he's from Hawaii.
There is literally nothing passive about owning a rental portfolio. It’s a ton of work, and it’s 24/7. My first foray was a condo in Miami, and 2 older homes (like 100+ years) in the Barryville and Eldred areas. All with mortgages. All with modest at best rental prices. They were money losing, though you don’t really realize or notice it month to month, especially if you have another business where most of the cash flow juice is coming in from. Tough learning curve, made more difficult cause it was in the height of covid when I was messing around with the houses in SuCo and we were too busy to begin with.
I transitioned into new homes when we really started making money - sometimes on purpose, sometimes by accident. I’d be building a home in a good spot, and our sales would be good for the year, and I didn’t want to book another and would decide to test the rental market. Also, I personally used to loan the company lots of my profits, so to square up Catskill Farms would gift me a finished house to pay back and square up the loan. Currently we have 8 I believe. Four in PA, 1 in St Petes, 2 in SuCo, and one in Rhinebeck. They all show a profit, but less than you would think, given there is no debt involved. Any debt would make the purpose of the exercise questionable, and the monthly expenses eat up the cash flow.
But if you are playing with cash, it’s a great way to diversify, and not be all-in on the stock and bonds game. It’s a great tax savings vehicle, with real returns juiced with the impact of basis/cost depreciation. In the end, all things considered, we are seeing a 5-6% return on these homes - I read or see about some sages say don’t do it unless you can get 10% cap rate, but I literally have never seen a route for a 8-10% cap rate, or annual ROI. 5-6% is pretty good, long-term, with some long term appreciation helping those returns hopefully.
And this is with an existing business infrastructure and staff that sort of does a lot of the portfolio management as part of their daily job scope. We are pretty good at vendor acquisition, book-keeping and accounting and a lot of the day to day is marginal in the whole scheme of our related business activities. If you’d have to hire someone, or pay 20% to a management company, that changes the equation. If your existing business or line of work has little to do with construction, real estate or rentals, that increases the lift too.
Absolutely nothing passive about real estate investments, and I think my takeaway is the only time it makes sense to get involved in real estate investment is when you’ve built some wealth in some other fashion, and real estate investment is a hedge in a large portfolio, or you are in real estate in some fashion already.
Our recent St Pete’s purchase will breakdown like this - $800k purchase, $20k annual expenses, $60k in rent. That’s a 5% cap rate. Add in the depreciation tax savings of $30k (27 years divided by purchase price) and that cap rate climbs to 6.6% with the help of $30k of depreciation (the savings of not paying $13k in taxes) - though using depreciation is not commonly used in cap rate formulas, but it is useful for a real study of the ROI.
If there's ever been an example of the endless expense of tinkering with a house, it's mine - though I think most people would define what I'm doing over the last 7 years as a bit more than tinkering.