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Valyooo (99.63)

Stocks versus real estate

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August 17, 2010 – Comments (19)

I never considered real estate before, so somebody who knows more about it, please correct me....

 

If I put 40,000 down on a $200,000 house...with mortgages as cheap as they are, and I use the rent money to more than cover the mortgage (and never pay off the mortgage, due to inflation and arbitrage of mortgage costing less than rent), won't I make a ton of money?  If the price of my house were to double in the next 10 years (thats a big if), it would be worth $400,000...but all I put into it was $40,000. Thats a ten-bagger.  On top of that I use the excess rent to take care of the house. 

That seems like a really great return, can the s&p still beat that?

19 Comments – Post Your Own

#1) On August 17, 2010 at 3:00 PM, TMFBabo (100.00) wrote:

I've never done it before either, but it's not quite that simple.

You have to pay property taxes.  You have to find tenants, make sure that the place is maintained, receive calls 2 AM if a pipe bursts and water's dripping out of the ceiling, etc.  You might not have the property occupied 100% of the time in between tenants.

On the plus side, if the property is solely an investment, you get tax advantages.  The main one, I believe, is that you can depreciate the house much like companies depreciate factory equipment. 

I think the rate of return is better than with simple hard assets (or just average real estate prices), but the headaches are DEFINITELY there.

It sounds to me like commercial real estate would be less a headache than real estate, but it's still not something a novice should just get into without learning the ins and outs.

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#2) On August 17, 2010 at 3:08 PM, Valyooo (99.63) wrote:

Well even if you don't rent it out, you can buy a bond that pays a higher after tax yield (safe ones too) than current mortgage rates, so you would still be making money.

Since you are top fool I ask you, why have you spent so much time learning about investing in the stock market but not as much in real estate considering these abnormal returns?

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#3) On August 17, 2010 at 3:16 PM, TMFBabo (100.00) wrote:

Wait, how would you make money if you don't rent it out? The only other way to make money then is to flip the house.  I'm not seeing the bond angle that you're talking about.

I don't see the abnormal returns.  Sure, you can buy houses for cheap and either have someone rent it out or flip it, but you can try to buy stocks on the cheap too.  You said maybe the house could double in 10 years, but you yourself said that's a big if.  I also forgot to mention closing costs in the above under the cons.

Having to come up with $40,000 down is no small feat and would take most of us years.  Also, a house is the most leveraged investment most people make in their lives.  I personally believe a house is a great place to live and that the investment aspect should be a minor bonus if it's even there.

There are a lot of hidden costs and headaches associated with real estate that I'm not sure you're seeing.  It's certainly profitable if you do it right, but it's a lot of work and I'm not sure it's massively profitable like you're saying.

I'm going to hope Donnernv or someone else who's actually owned real estate jumps in, because I'm not qualified to answer your questions much further.

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#4) On August 17, 2010 at 3:27 PM, davejh23 (< 20) wrote:

"There are a lot of hidden costs and headaches associated with real estate that I'm not sure you're seeing.  It's certainly profitable if you do it right, but it's a lot of work and I'm not sure it's massively profitable like you're saying."

I'd agree.  Being a landlord is more work than many seem to believe.  Your maintenance costs will not be limited to minor touch-ups between tenants...unexpected problems come up just like they do with your car.  The odds that the investment will be cash-flow positive are slim when you consider taxes, maintenance, etc...  Also consider that rents are falling in many areas...it should be much cheaper to rent than to own, so an imbalance that makes it look like a good deal now could be corrected and derail your plans.  In addition, I'd say that there is zero chance that the home appreciates 100% in 10 years.  In fact, there's a good chance that interest rates could double and the house could be worth far less than $200K in 2020.  Even if we see high inflation near-term, stocks will rise (probably not as fast as inflation), but housing could stay steady as any appreciation due to inflation could be negated by rising interest rates.

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#5) On August 17, 2010 at 3:33 PM, SockMarket (63.07) wrote:

  If the price of my house were to double in the next 10 years (thats a big if), it would be worth $400,000...but all I put into it was $40,000. Thats a ten-bagger.

no because you have to pay off the mortgage. I don't know the payment schedule but I would guess that you will probably wind up paying $185k ish in mort costs along the way. So ignoring rent income, etc. you should be able to make $215k net, or about a 5 bagger on initial capital. 

 

anyway, it is never that simple, you always have to decide what is a good investment and what is a good value. 

I have never invested in re (obviously). A couple of viewpoints:

1) if a house is a good investment buy it. You may not be cash flow (CF) positive for some time, so you should be sure that your income will be able to cover this until such time. However, over time rents rise and the property value follows suit. You will make money. period!

2) only buy a house if you believe that it is a good place and can earn you 15% cash on cash immediately. 

#1) is a brilliant fellow who retired at age 38 on his real estate income. He has been set for life twice, lost the money both times (he is a miserable stock investor) and has recouped the money with real estate

#2) is an excellent real estate investor. although he rarely buys in I do not believe he has ever lost money on a deal.

obviously it is quite a bit more complex (what constitutes a "good" investment/place is hardly quantifiable) but that at least is what I have heard.

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#6) On August 17, 2010 at 3:42 PM, catoismymotor (38.90) wrote:

Val,

You may want to look at this blog by checklist34.

http://caps.fool.com/Blogs/commercial-real-estate-as-an/359217?&mrr=0.20

Cato

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#7) On August 17, 2010 at 3:49 PM, Melaschasm (65.13) wrote:

Buying a REIT is like buying a stock.  Buying and renting a house is like starting a business.

A rental property business can be a great business, but it requires much more work, and a bigger cash cushion than investing in stocks.

If you can do the repairs yourself, that will help you make more money.  If you are good at reading people, that will help you avoid evicting bad renters. If you live close to the house you are renting, that will help you keep an eye on the place.

I bought a duplex a few years ago, and I am doing okay despite the market crash destroying my equity.  If you are going to make such an investment, you need to be committed to owning that property for 10+ years.  With a 20% down payment, you are going to be putting additional cash into that house, unless you have found a really great deal (and there are some out there).

 

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#8) On August 17, 2010 at 3:53 PM, GNUBEE (26.83) wrote:

I'd say best bet it could be a 3+ bagger in 10 years.

$40K down, another $10K in closing costs, 1% yr in maintenance, $4K/yr in property and school taxes

Assuming you see 4%/year appreciation, your house is worth just south of $300K in 10 years.($296K)

So you paid $40K + 10K at closing- $50K and it cost another 2K/year in maintenance ($20K) $4K/yr taxes ($40K) or $110K

You will pay 6% comission to sell or $17K, so your $296K house now brings in $279K, less the $110K, your return could be $169K or 3.38x investment--and you have to wait 10 years.

But as others mentioned, you need to be responsible for the habitability of the house, repair damage from renters, and make sure you always have renters

(sidebar..like when my brothers $250K new construction investment townhouse was being used by his renters as a brothel, and his tenants were evicted, necessitating him paying rent while a new tenant was found, and replacing all the carpeting, painting and repairs to said house),

Another big "also" is hoping that property taxes and school taxes do not increase and eat up your margin, and lastly complicating your annual taxes to account for this investment. It's not always such and easy proposition.

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#9) On August 17, 2010 at 3:57 PM, MyunderratedLife (87.96) wrote:

Have you ever thought of owning a franchise?

That is something I've looked into in lieu of starting my own business.  Having worked at these jobs while going through highschool and college I can tell you there's definitely some untapped profitability.

The initial requirements are somewhat 'higher' than $40,000 but the profitability - from what I can gather is amazing.  McDonalds publishes the financial information of its franchises and the most backwater McD franchise on the planet (including kiosks, and untraditional non-standalone mcdonalds) brought in close to 400k revenue.

It seems like a nice way to generate income from a reliable source -  

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#10) On August 17, 2010 at 4:14 PM, JaysRage (90.49) wrote:

Unless you plan on become an expert in McDonalds operations, you'll have to pick a different franchise, but the overall idea has merit. 

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#11) On August 17, 2010 at 5:13 PM, EnigmaDude (98.06) wrote:

Wow - I am surprised at such naivete from the CAPS community when it comes to real estate investing!  One of the biggest disadvantages that nobody so far has mentioned is that you will have to pay income tax on all that rental income.  That is in addition to the property taxes.  So if you can afford a mortgage of say $1200/month (including taxes and insurance) and you receive $1600 in rent, you will have $400 gross profit which you will have to pay toward maintenance, repairs, advertising (when the renter moves out), etc.  But you will pay taxes on the full amount of rental income minus depreciation and other costs mentioned above.  Sure it can be profitable if you can find a great deal on a house in a desirable area at a good price and you are able to find good tenants to rent to.  But obviously there are lots of risks involved as there are in any other investment alternative.

Good luck to you, whatever you decide!

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#12) On August 17, 2010 at 5:25 PM, outoffocus (23.59) wrote:

It sounds to me like commercial real estate would be less a headache than real estate, but it's still not something a novice should just get into without learning the ins and outs.

That is most certainly not true.  I don't know where to start.  The contracts, the tenants, the increased scrutiny over rents, state commerce laws, required inspections, required property financial statements and annual appraisals.  Lets just say if you decide to invest directly into CRE you better know what you are doing.

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#13) On August 17, 2010 at 5:35 PM, Donnernv (< 20) wrote:

It's simple.  A house rents for 6% of its market value annually.  An office building rents for 15% of its market value annually.  I know; I own one.

And the building tenant often pays for routine maintenance.  Moreover, the differences in the hassle-factor are enormous.

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#14) On August 17, 2010 at 6:57 PM, Valyooo (99.63) wrote:

What does the inflation rate have to be that you never pay off the mortgage? I know plenty of people say to not pay off your mortgage, because inflation makes the amount you owe easier over time since youre using cheaper dollars to pay off more expensive ones.  Whats the equation, is it just when inflation > mortgage rates?

Also, isnt a 3-bagger in 10 years around 21.6% compounded interest, which is more than buffet makes?

Alllllso, yeah you have to pay taxes on it...but you have to pay taxes on stock too, and you can't use any part of stock as a write off

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#15) On August 18, 2010 at 3:45 AM, TMFBabo (100.00) wrote:

A 3 bagger in 10 years is a 200% gain.  That comes out to a compound annual growth rate of 11.6%. 

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#16) On August 18, 2010 at 3:52 AM, BSCWatchlist (< 20) wrote:

Unless you plan on become an expert in McDonalds operations, you'll have to pick a different franchise, but the overall idea has merit. 

Worked there every summer since I was 16 (currently 21 going on 22).

I made shift manager this year :D 

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#17) On August 18, 2010 at 4:47 AM, BearishKW (< 20) wrote:

Also, as the interest (tax-deductable) and principal gets paid off by your renters, you are then allowed to refinance at low interest rates and receive cold hard cash that CANNOT be taxed as income.

Property ownership and income properties are great investments because of the tax advantages.

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#18) On August 18, 2010 at 11:58 AM, GNUBEE (26.83) wrote:

you are then allowed to refinance at low interest rates and receive cold hard cash that CANNOT be taxed as income.

Bearish, a cash out means you are not making money, but borrowing it. You could make money only as long as the fees and avoided taxes do not exceed the extra cost for borrowing, then it makes sense.

Again, all of this assumes the lender will grant you a cash-out refi, and rates remain the same or are lower in the next 10 years.

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#19) On August 18, 2010 at 4:32 PM, BearishKW (< 20) wrote:

True, this is all assuming all of the what if's...renters, lender refi, low rates, etc...but at the end of the day, if you have renters in the place, they're paying off the loan, not you.

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