I love watching those home renovation shows where investors buy a run down crackhouse, bring in their demolition crew, and sell the property a three-times the original purchase price. Amazing eh? We know these situations are the exceptions, but how good is real estate for building wealth?
I’ve certainly zero experience in the rental or the buy-and-hold markets. The only real estate I deal with is my own home (which I sunk a foolish amount of money into fancy kitchen appliances) and a REIT fund that’s losing money in my IRA. Is real estate an investment vehicle that I hope to venture in one day? Sure. Everyone else including my mother-in-law dabbles in it and is convinced that it will be the savior for my retirement.
I believe that the financial freedom advocates are divided in their opinions of real estate. There are plenty of early retirees who are convincingly opposed to owning any home—I think several have written manifestos against property ownership. Whether or not their math is sound, the opponents to home ownership are typically the ones who basically spend their days traveling the world and country hopping.
Sure, but what if I wanted to stay put? Is it worth sinking in a chunk of change to own a piece of America? Let’s see:
Scenario 1: Upper East Side Manhattan Co-op
This unit is in a prime location on Park Avenue in the Upper East Side of Manhattan. You can run to Central Park and exercise every day if you’d like. I wished that I lived in a place like this. This is a 1000 sq. ft unit on the market for $1.1 million. This is more than twice the size of my apartment rental in NYC! This is actually a reasonable price per square foot. Let’s look into some statistics:
Prewar building with an HOA of $1,582 a month! If you owned this unit outright, you’d still be contributing about $2000 a month for HOA and utilities! The property tax on this unit will run about $90,000 a year. So all in, your annual upkeep on this co-op will be about $114,000! Oh yeah, don’t forget that it is also customary to tip the doorman during the Christmas holidays too. A look at the Zillow pricing history shows that the pricing for this unit has been relatively stagnant over the past few years. So much for appreciation of this property’s value:
In fact, a recent report by the Eliman Group shows that Co-Op sales in Manhattan for Q3 2016 has been declining:
Let’s suppose that you are looking at this property for investing in cash flow. I’d say that the unit could command perhaps $3000-$3500 in monthly rent as a one bedroom unit given its great location and building amenities (read: doorman).
How can one possibly get positive cash flow on this unit?
Answer: You can’t.
The rental income wouldn’t even be enough to pay for the taxes, let alone the doorman’s salary through the HOA fees. This is the sad truth of about the NYC real estate market. Many of the owners are either holding companies or longstanding owners who bought the units decades ago at the fraction of the price. Fortunately with the prime location of this co-op, the value of this property will not diminish significantly over time.
Lesson learned: If you have a huge chunk of change that needs to be parked somewhere, New York City isn’t a horrible place to put it
Scenario 2: Condominium near the University of Indiana Campus in Bloomington
I arbitrarily picked a college town in a relatively inexpensive city. Consider that you’re trying to find a unit near the university to rent to graduate students. A quick find shows that there is a condominium within walking distance of the campus:
This is a two-bedroom, two-bathroom unit for $105,900! Modest amenities, great location, and in a relatively good complex. I would be great for two graduate students or a small family. Further details show that the unit does have an HOA of $245, which I am not thrilled about in a small suburb, but not the end of the world:
How can I get cash flow out of this property?
With a downpayment of $20,000, one could probably negotiate a 30-year mortgage to cost a little less than $400 a month. If you include the HOA fees, you’d be paying about $600 a month at the minimum to maintain. I think that one could rent out each bedroom for $500, or the entire unit for $950 a month.
Let’s say that you rent out this unit for $950 a month, and your costs are $650 a month for mortgage, HOA…etc. Assume that you only get to rent this unit for 11 months of the year. With $300 of ‘net-profit’ per month for 11 months of rent, you get about $3,300 per year. With an initial downpayment of $20,000, you’re actually getting a 15% return annually. Not bad!
This amount is not going to fund your doctor lifestyle, at least it’s positive cash flow. Let’s say you buy five or ten of these units and rent them all out. You hire a maintenance person or even a property manager. You suddenly have $10-15k a year of extra cash flow for owning approximately $1 million worth of properties that you’ve leveraged with a little over $100,000 in parked costs.
Not bad, eh?
How have you used real estate to fund your cash flow? What suggestions to you have for me to get started with real estate?