Real Estate: Fundamentals

[OldTrader]

Quote from Sparohok:

OldTrader,

Interesting stuff. Thanks for sharing your experience.

I personally have nothing against buy and hold investing in real estate or anything else. When I see sufficiently attractive valuations, I have no problem tying up capital in a long term position. I just find it interesting that the wide derision for buy-and-hold stock and mutual fund investors among many traders doesn't seem to translate over to real estate.

Martin

I'd say that most of the traders don't understand real estate. Let me give you an example. The basic formula I have used over and over is to buy a property that requires fix-up...sometimes signficant fix-up. Not just paint and carpet. I pay cash for the property. Cash for the fix-up.

At this point I could resell the property for significant profit. This is true because I pencil all this out before I ever make an offer. I make my profit in essence going into the deal.

In my market though, I am able to rent for signficant profits as well. And therefore, I have tended to choose this route, because over time the rent makes more profit than selling. Further, if I keep for a while I can do a 1031 exchange which defers any tax I would have due.

If I need my cash back out of the property to do another deal, I can always refinance all of my cash back out without problem, because I bought the property so cheap to start with.

When I was first starting I used partners at times, so that they put the cash up and we would split the deal in accordance with an agreement.

I think the difference is that stocks fluctuate. In real estate on the other hand the rent is consistent, and growing over time. Equity builds in the property whether there is appreciation or not, through loan pay down.

Completely different than stocks. Not unique to me either...this basic formula was one I read in a book. Buy a property in disrepair, fixup, either sell or rent. Refi your cash back out. Trade up. etc etc.

It's always a question of value. But understand, I don't buy a property at retail value. I buy at significant discounts to retail, such that when fixed up I am still under retail. What you're talking about is trying to time the real estate market...something I have never done. I buy under market routinely because the house needs so much repair, the normal mom and pop won't buy the property.

OldTrader

 

[OldTrader]

Quote from Sparohok:

Virtually all first time home buyers are already renters. When they choose to buy a house they are inherently comparing what they're renting today with what they're buying tomorrow. For that matter, you can barely open the real estate section of the paper without finding an article comparing buying with renting. Who's it written for if nobody compares buying with renting?

The reason appraisers don't use an "income approach" is because their job is to determine market value. Whatever the market would pay, it's their job to report, no matter how far it is from net present value.

Martin

The income approach applied to a single family home is patently absurb to begin with. The vast majority of homes are not rental houses...they are owner occupied. And therefore, the rental value per se is almost irrelevant.

If you believe that people decide to buy based on some type of comparison to rent...I think you're mistaken. I have sold many, many houses over the last 30+ years, and never once did I see a single buyer look at some notion of what rent was. Instead, they looked at the decor, the yard, the neighborhood, though about whether it would serve their family, etc etc. They would look at the payment, but not against rent, but against what they felt they could afford.

Wall Street consistently tries to predict real estate prices based on things like rent. It's never worked even once. Maybe it will this time. Wall Street does not understand real estate in essence. Hell, Wall Street does not understand stocks, why should they understand real estate?

OldTrader

 

[Sparohok]

Quote from OldTrader:

I have sold many, many houses over the last 30+ years, and never once did I see a single buyer look at some notion of what rent was.

That's because you were selling the house, not renting it. As you said, your buyers were comparing it against what they can afford. But they also have alternatives, and they are also comparing those alternatives against what they can afford. They look at the rental down the street, they look at the decor, the yard, the neighborhoood, whether it would serve their family, etc. They are also, as you have pointed out, taking into account the advantages and disadvantages of ownership versus the advantages and disadvantages of renting. And then they make a decision based on relative cost, relative value, relative tangibles and intangibles, and of course, ultimately, what they can afford.

Do you really think that they will buy your house if the nicer house down the street is renting for a third of what their mortgage will cost on your house? If they can afford the rental but can't afford the mortgage?

Finally, even in your alternative universe where no home buyer ever considers renting as an alternative, house prices and rents will still have a long term market equilibrium, and there is no better illustration than your own post:

In my market though, I am able to rent for signficant profits as well. And therefore, I have tended to choose this route, because over time the rent makes more profit than selling.

Your action increased the supply of rentals because it was profitable to do so. If it hadn't been profitable, you would have increased the supply of homes for sale instead. You are, by your own example, the exact market force which brings about the equilibrium between house prices and rents, an eqilibrium whose existence you deny!

Martin

 

[Retired]

Marty:

Like stocks, you need to pick and choose your real estate targets carefully.
If you choose some cheaper areas, such as Phoenix or Houston, you will come out ahead much sooner than the 10-15 years you calculated for the Bay Area.

In fact, for most locations in US, the buyer would come out ahead of the renter in 1-5 year's time, because your monthly payments go toward building up your own equity, not your landlord's pocket.

SF Bay Area and NYC are not your typical locations. Do you use GOOG's stock price to say the stock market is over-priced, or no one can afford it, or there is no more money to be made from the stock market? You would be an idiot to say that.

But that's the kind of statement you are making about real estate.

Quote from Sparohok:

I actually did run the numbers on a 30 year fixed mortgage for a property in the SF Bay Area, assuming that both home prices and rents stay constant in terms of 2005 dollars. I accounted for taxes, tax breaks, transaction costs, maintainance, insurance, everything. At 10 and 15 years the renter was ahead, but after 20 years I think buying was a little cheaper. So, it's not necessarily as clear cut as you think, at least not in the most overheated markets.

Martin

 

[ElCubano]

Like OLDTRADER said not in exact words but more or less ( or maybe he didnt say it i dont recall)....you make your money on the purchase not on the sale...ooooooh so true.

 

[mschey]

Quote from Sparohok:

I actually did run the numbers on a 30 year fixed mortgage for a property in the SF Bay Area, assuming that both home prices and rents stay constant in terms of 2005 dollars. I accounted for taxes, tax breaks, transaction costs, maintainance, insurance, everything. At 10 and 15 years the renter was ahead, but after 20 years I think buying was a little cheaper. So, it's not necessarily as clear cut as you think, at least not in the most overheated markets.

Martin

Why don't you share your model with the group here, and lets take a hard look at your assumptions.

 

[AAAintheBeltway]

Quote from Sparohok:

I actually did run the numbers on a 30 year fixed mortgage for a property in the SF Bay Area, assuming that both home prices and rents stay constant in terms of 2005 dollars. I accounted for taxes, tax breaks, transaction costs, maintainance, insurance, everything. At 10 and 15 years the renter was ahead, but after 20 years I think buying was a little cheaper. So, it's not necessarily as clear cut as you think, at least not in the most overheated markets.

Martin

You assumed away the biggest reason people are in a panic to buy, namely that prices will far outpace inflation. Maybe prices are in a once in a lifetime bubble. Maybe not. I have seen markets that appeared insanely overvalued get even more overvalued. I have also seen people get their heads handed to them in California and Texas property. When the exit door shuts in real estate, it shuts hard and they lock it. But that's what you're dealing with and no amount of discounted value calculations can capture it.

 

[Sparohok]

Quote from Retired:

Like stocks, you need to pick and choose your real estate targets carefully.

But I live where I live. For personal reasons, that's more important to me than owning a house or becoming a landlord.

SF Bay Area and NYC are not your typical locations. Do you use GOOG's stock price to say the stock market is over-priced, or no one can afford it, or there is no more money to be made from the stock market? You would be an idiot to say that.

That's why I haven't said any such thing.

I was quite careful not to generalize to all real estate markets in the US. I might have been a little loose once or twice but it gets old writing "in my neighborhood" or "on the coasts" or "in overpriced markets" all the time. I thought the point was crystal clear on enough repetitions, but apparently not.

The only generalization I would make is that, if real estate valuations revert quickly in some markets, it's likely to have some negative effect even on fairly priced markets.

In 2000 and 2001, the stock market correction was led by the vastly overpriced tech stocks, but even the most conservative value plays got caught up in the selling.

Martin

P.S. I'll be the first to grant that real estate is more fragmented than the stock market; it was your analogy not mine.

 

[AAAintheBeltway]

Quote from OldTrader:

I've owned rental real estate for most of my adult life...I'll be 60 in June. I've also traded for most of my adult life, from about 20 on with a few years off for the Army.

First let me respond to your comment "I'm earning far more by trading my capital than I could hope to earn by investing it in a house."

I've bought any number of properties where I eventually refinanced all of my cash out of the property. I then held the property with none of my cash in it, and collected rent while the tenants in essence built my equity by paying my loan down.

I've bought a number of properties by assuming existing loans with little to no cash out of my pocket.

So the bottom line here is that when you say that you're earning "far more" with your capital, I'd say that if you were educated in real estate your statement would be incorrect.

Eventually what happens over time is that the properties kick out cash flow without a great deal of effort. I don't work on the properties for instance...I hire people. So that I could say that I spend hours glued to my monitors to trade, whereas with the real estate it runs itself. If we get a repair call, my wife sends the repair man.

My original goal with real estate was to create a secure source of income. I have never viewed trading as "secure". Perhaps you do. I did not buy real estate with the idea that it would appreciate...although it has. I think making money in real estate has been stable, and relatively simple. For the effort expended it was a superior investment to trading. Again, the reason for this is that it took little effort.

At this point I own considerable real estate, much of it is owned free and clear. It kicks out income monthly regardless of what I do. It will be an excellent retirement if and when I ever stop trading...which at this moment I don't plan on. It will also provide excellent income for my wife if something should happen to me. And believe me, she does not have the patience or tolerance to sit at a monitor all day.

OldTrader

Great advice everyone should pay attention to. I know a number of people who have done the same thing with similarly satisfying results. It takes a lot of foresight and patience when you're younger and starting out to invest in real estate, but over long periods of time, nothing has come close.

 

[Sparohok]

Quote from AAAintheBeltway:

You assumed away the biggest reason people are in a panic to buy, namely that prices will far outpace inflation.

Yes, intentionally so. I have no desire to incorporate an assumption that all the evidence tells me will not persist in the long run.

I have seen markets that appeared insanely overvalued get even more overvalued.

Sure, it could happen. I don't mind waiting.

Martin