Not to hate on real estate, but just another perspective:

If you have a $400,000 property and net $2,000/month, that’s only a 6% return.

Seems like real estate money is made off leverage. Same risk is available with options in the market.

 

You’ve demonstrated the ability to do math while simultaneously demonstrating a misunderstanding of how one invests in real estate.

 

It is good to look at multiple perspectives. Your math is correct for one year of cash flow which is one component of real estate.

Other components for consideration:
-Depreciation deduction on residential property of that valuation would be $12,000 per year which defers the tax liability on half of the annual income.
-When the tax bill comes due in the form of depreciation recapture it is at a lower rate than income tax (25% vs 37%)
-Annual rent increases bump up cash flow. On the example property Year 2 should be $1,000 higher.
-Appreciation on real estate provides long term capital gains that compound tax deferred until sale.
-Exercising a 1031 exchange can defer the gains even longer.
-As part of an estate, the long term gains become tax free via stepped up basis.
-6% is a low net return on all cash real estate.

You are correct about leverage being a huge factor in real estate returns. Consider the following:
-Real estate leverage is typically for 5-30 years vs weeks or months in options. The long term risk is not the same.
-Typical 75% leverage on real estate turns 3% inflation into 12% capital gains.
-Cash on cash return for the hypothetical investment remains near 6%
-Loan amortization provides additional return in the form of principal reduction.
-Depreciation on the larger amount creates passive losses that more than offset income and in some cases can offset earned income.
-Refinancing after several years provides a tax free return of capital for portfolio expansion.

The first year or two of real estate investing isn't all that impressive. A few years of rent increases followed by a cash out refi, sale or 1031 exchange is eye opening. A third generation of the original capital starts to look like a snowball that was rolled to become the base of a snowman.

The below is typed in a non abrasive, inquisitive font.
I'm curious if the perspective is one of theory or experience. How much time have you spent investing in real estate and/or trading options?

 

I have 0 personal experience in real estate investing. I would make a terrible candidate for this type investment:

-In my personal residence, I am 3 out of 3 for just breaking even after expenses. HOA fees, real estate commissions, property tax, repair, yard maintenance, etc have all been a drag on the small paper gains. This doesn’t factor opportunity cost or cost of capital.
-Real estate has poor liquidity
-Emotionally I couldn’t handle tenants. This involves late night repair calls, tenant damage, and late or no payment. I have no desire to run the eviction process after relatives that have been landlords have shared their stories. This includes one tenant that poured concrete down the toilet. Another wouldn’t leave after 6 months of non-payment. Even though the water was shut off, they just used a bucket for a toilet. That same family was finally evicted and the family’s kid badmouthed the landlord’s family to all the kids in the shared high school. Property management helps, but erodes returns. Your state’s eviction process may vary, mine favors the tenants.
-2008 Great Recession is still fresh in my mind. Have too many friends that bought their rental property in Destin, Pensacola, Gulf Shores, etc that overpaid for a dream condo that had over-extended neighbors not pay their HOA and leave the solvent few with giant assessments. The non-payers walk away, the payers burden the 6-figure roof repair.
-I also recall 2008 investors defaulting on strip mall after strip mall due to lack of tenants or non-payment by tenants. Had acquaintances that had it all and lost it all.

YMMV- In the nicest, most non-judgmental font, real estate is not for me. Love hearing about how it works for others! I have been satisfied with my brokerage account and extra time devoted to the occasional green slip. For those that make it
work, I hope I can get a ride in your Ferrari!

 

My experience echos yours. Tenants, finding competent trades, getting caught in a tax squeeze with local property tax/regulations, wild swings in insurance, unexpected expenses...the list goes on.

That said, in GF's defense, there are essentially three ways you can handle real estate:

Go all in with personal management. If you try to do one or two rental properties, or try to hold a property for investment value, there is a high probability you could get clobbered. Non-homsteaded property taxes have spiraled upward along with property values, making it very hard to raise rents in conjunction. Random changes in local laws can burn you. For example, a municipality where I had a property randomly instituted VERY punitive fees for "non-long term rentals" (AKA AirBNB, etc) because it was eating into the local hotel revenue. Almost no warning. Everyone who was into property for that reason got clobbered or got very ugly legal letters when they didn't pay (or weren't paying attention).

You really need a critical mass of properties to amortize the rental costs, taxes and insurance. You also need a critical mass of properties to have a good relationship with trades with wholesale costs. If you are on a "call as you need them" basis with trades and paying retail rates, you WILL get creamed with expenses and spend all your free time dealing with them or the tenant(s). There are also random liability concerns. This can be mitigated, but thats $$ as well.

Go with a property manager. Removes the tenant hassle, removes "off the top" revenue, mitigates SOME of the MX costs if you have a quality manager, but again, you need a critical mass of properties to make it worth the bother. 1 or 2 properties makes it a cash flow/break even proposition for tax purposes or to mitigate costs of holding as an investment. A variation of this is to "just get big", and hire professional staff to run your properties. That might as well be a second job

Go with the "real estate syndicate". Buy into scheme that invests solely in RE. You really need to do your DYODD and results vary.

For the less-that-experienced, RE can be a quagmire even in good times. If the market turns, it could be a really bad deal. You really need to make it a primary focus, second job level of involvement over the course of several years to make it a reliable investment.

 

Three words: Commercial Real Estate

It’s a business, it takes some work and effort. It’s not passive income. BUT…it certainly doesn’t have to be a full time job. A couple hours a week. The benefits are all the things Gunfighter says. It really is amazing…if you do your due diligence.

I had zero experience in real estate investing. Four years ago while I was not getting used on reserve, I was bored and started watching YouTube videos on commercial real estate investing. I had about $70k to invest. Four years later I own an office building worth $1.2M. This is after just one generation of the process (see Gunfighter’s comments). And it wasn’t that I got lucky, I bought an office building 4 months before Covid! The first year was dicey. But I did my due diligence and am happy with the results. I just put the property back on the market this week. I expect to net close to 7 times my original investment in just 3-4 years. And if the property doesn’t sell right away, it’s cash flowing $5k a month (that’s cash in my pocket before taxes). YMMV, but it really is incredible to see how it works. I would encourage everyone to at least read a book or watch a video about the basics.

 

Very happy for you! Genuinely curious about your specifics because it sounds too good to be true:

You paid $70k for an office building and 4 years later it’s worth $1.2M?
Or you used $70k as a down payment and the bank still owns it?

Is that $5k/mo gross before expenses?
Or do you have to subtract out loan payment, property tax, utilities, repairs? How much per month is property tax and utilities?
Who pays for when the roof leaks or air conditioning breaks? You or tenant?

 

#1 Learn how to value property. This is where books and videos come in.

#2 Formulate a plan. How do you intend to make your money? Stabilize a distressed property and sell it? Cash flow for years? Have an exit strategy.

#3 Be patient and wait for the right property that fits your plan. Don’t buy on emotion or out of impatience.

#4 Figure out how to close the deal. Don’t be afraid to get creative here. Put financing together. There are a million ways to acquire a property. It’s not what you’re familiar if you’ve only bought houses.

I’m happy to share the details of my experience with this particular property. I bought it for 575k with 70k down. I got financing through a big bank but they wanted 35% down. So I had to seek private financing for the rest of the bank’s requirement (see #4 above). I paid that off as soon as I could because it was costly. But I needed it because I knew this was the right property.

The property has 6 offices and was about 35% vacant by square footage…which is a lot. This affects the NOI (see #1 above), which in turn affects property value. So I got a good property, albeit financial distressed, for a low price. My game plan was to make some small cosmetic improvements and patiently wait for the vacant spaces to get leased, all the while bending over backwards for the existing tenants to make sure they stayed. Once I got the spaces lease up…it took more than two years…and with rent increases, the NOI has almost tripled, which results in a current value of around $1.2M, of which I owe $340k to the bank.


The $5k a month is cash flow. This is after all expenses (utilities, repairs, property taxes, insurance, etc) and debt service (loans). Like I said, money in my pocket, before income taxes…different subject. But I will say in addition to depreciation, your own children under 18 as employees are gold mines.

Property taxes are $14k a year. I challenged the assessor’s value last year and won. Most property owners pay an attorney to do this, but I did it myself. It was easy. Utilities around $1k a month, depending on season. I pay for almost all exterior repairs. But you can structure new or re-negotiated leases however you want. For example, this property went through a rash of broken windows (vandalism) that I kept paying for. So the next time I negotiated a new lease I made sure it had the tenant responsible for windows. The world is your oyster when it comes to leases…as long as you can get a tenant to sign it.

It’s not necessarily easy money, there have been plenty of frustrations. But I have learned a ton, it’s been moderately enjoyable, and the return is unreal. Seriously, look into it and don’t be afraid of the unknown.

 

Awesome write up. For those first two years while you were being patient trying to get it leased, were you making a loss? Did you find the property online or through a real estate agent or something? (I haven't done a ton of research on this topic aside from casually browsing loopnet occasionally, so I apologize for my ignorance )

 

It was cash flowing, but just barely. Around 1k a month, which I saved in the property’s own bank account (it’s an LLC, always put an investment property in an LLC). I was a little worried that when I did get new tenants to fill the vacancies, they would want tenant improvements (TI), which I wouldn’t have the cash to pay for. But like I mentioned, everything is negotiable.

I found this particular property on LoopNet, which is kind of like Zillow but for commercial real estate. However in the CRE realm most deals are made off-market, which means by the time a property gets advertised on LoopNet, it’s already been passed over by those in the know. I did luck out with this one, every once in a while you’ll find a good deal on there. But it’s a great way to see properties in your market at a glance. I would highly recommend building relationships with as many people as you can in the industry. Befriend property brokers, lenders, insurance brokers, etc. I’m a total introvert, so this was difficult for me, but I try. This is how you find those off-market deals. You want to be at the top of their list (or as high as you can get) when they hear about a property that might be for sale. I have also just driven around neighborhoods looking for apartment buildings that looked like they weren’t being taken care of. I look up the owner on the county assessors website and cold call them. Haven’t had success with this approach yet, but it’s just a matter of time. This is the way to really find those good deals. You want to figure out how to solve the owner’s problem. Maybe they’re old and not interested in owning property anymore. Maybe they moved out of state and are trying to manage it long distance. Make it an easy decision for them to sell you their property. Good luck!