You buy a brand new 3/2/2 house (1,500 sq. ft or less) that cost $150K in a good class B neighborhood that has appreciation potential. You also have a 15 year mortgage and you are able to rent the house out for your mortgage payment which includes insurance, taxes and some maintenance added in. You are going to rent the house at your monthly break-even cost.

Fast forward 15 years,...you now have paid off mortgage that your tenant(s) have paid 90% of (the other 10% you had to pay during a vacancy) . You also have a house that has appreciated in value but only at the rate of inflation being 1%-3% but that is still better than nothing.

Does this house buying strategy make sense assuming you don't need the rent money for your personal needs?

Well, you just said in your other post the other day that being financed is leveraged and is stupid, so I'm assuming your question is hypothetical?

Don't forget about all your rehab costs during turnover as well. Plus in 15 years you're going to be starting to replacing mechanicals and other facets of the property.

Your figure of 1% - 3% inflation is a government average, and one with specific purposes in mind. You are probably thinking about Consumer Price Index for UrbanWage Earners and Clerical Workers (CPI-W), the Bureau of Labor Statistics consumer price index measure of the "average change over time in the prices paid by urban consumers for a market basket of consumer goods and services". That market basket doesn't really reflect YOUR actual cost of living, and it certainly doesn't reflect the appreciation in cost of residential real estate.

You may have noticed that the CPI for seniors (governing cost of living for social security recipients) was recently changed to reflect how seniors MIGHT POSSIBLY change their purchasing habits to better suit retirement income. That means that seniors who may have been accustomed to Ben & Jerry's ice cream, with retirement income may need to re-accustom themselves to Safeway plain vanilla. There are a lot more statistical quirks involved. Basically, the CPI reflects how much the government is willing to pay for cost of living adjustments, rather than the actual rate of inflation.

Residential real estate goes up with supply and demand. Thus, CA real estate, for example, has gone up so extremely profitably, because so many people move there. The stock market goes up and down also with supply & demand, but the supply & demand is artificial. In the pandemic environment, toilet paper and cleaning supplies have been in short supply and costs have risen enormously, perhaps never to return to what we used to call normal.

You need to ascertain the ACTUAL prospects of real estate in your area to determine potential appreciation prospects. If they are not excellent, you may want to consider other investments.

Real Estate is supposed to be a leveraged investment, putting around a 20% down payment and working with the Bank's money.

I would never buy a rental for appreciation. To me that is not investing.

Investors want cash flow appreciation is a bonus but doesn’t alway happen. As, N.E. Stated you have repairs maintenance, taxes and insurance increases.

As Dave mentions, taxes. Not sure about Alabama, but in PA, new construction's assessment is set at the max valuation right out of the gate.

So it's tough to appeal down because everything is brand new.

Age, health and beneficiaries play a factor in the

equation.

Surely, this is a hypothetical question for a friend.

Depending on what your goals are, I think the question we should be asking is what is the optimal choice among many investment alternatives?

Let me up the stakes for you a bit and see if it help clarify the issue: let's say you could buy a $5 million piece of commercial property and rent it for just enough to cover the costs of ownership on a 15-year lease purchase. We will further assume that the economy of the local town would remain stead enough so that all the property would do is appreciate equal to inflation.

Would you do it?

I never bought a similar property. I do know several people who do and it seems to have worked out well.

These investors have signed up with property management company from day one. It’s appeal to my acquaintances is an income stream in the future that funds a bump in retirement lifestyle. I should point out that these individuals have significant assets but not enough income.

So you are breaking even at current rents. What happens when they decide to quit paying rents for a few months? Maybe even trash the place while you are trying to get them out? Why take such a risk?

This is not hypothetical. I have met people at Mr. LL conventions and they have told me they use this strategy as a means of creating paid off assets when they retire from their day job. In retirement, they can continue to rent the house or sell it and get their money back. It is like investing in the stock market but someone else (tenants) is buying your stocks for you.

On the surface, this strategy appears brilliant. Even if the house did not appreciate at all, you still have a free and clear income producing asset that someone else paid for!!!

There is no on-size fits all answer to this.

As RB said, "Age, health and beneficiaries"

If you are 65 years old with no W-2 income or real retirement assets, this probably isn't a good strategy. Most of us would look at that 65 year old and say this wasn't a good program for them - they'll be lucky to still be on this side of the dirt when they pay off.

NE,

You are missing the entire point here. I used the example of 'new house' since the maintenance cost (roof, hvac, etc) would be low for the first 15 years. Yes, you would have some repairs during vacancies, but that is not the point I am trying to make here.

I have been successful in buying either breakeven or negative income homes. The tenant is paying all or a huge percentage of the cost and as a landlord you end up owning the property.

Your rents should also follow the same 1 - 3% annual appreciation rate. So in 15 years time, your rents should be up 25 - 50%, your home has appreciated 25 - 50% and, since your largest bill is your fixed mortgage, your gross cash outlay should be appreciated at a lower percentage. As Robert stated, your rate of return would be based on your initial cash outlay and not the $150000 purchase price.

Roy, I don't think you like a lot of the answers you get to your questions. Someone may be doing it because the math works for them. Many people don't do it because the math doesn't work.

Is this for you or someone else to do?

I personally wouldn't borrow on a break even, zero cash flow property. Makes no investment sense. (To me.) I'm in this for cash flow and instant equity.

You buy a brand new house, you are MAXED. Maxed on material costs, labor costs, land cost, taxes, etc., because you are buying retail.

You buy an older house for pennies on the dollar, rehab and rent it out for 50% ARV with a 15 year loan. 9 times out of 10, you have instant cash flow, instant equity, built in sweat equity, possibly appealed taxes, discount labor, discount materials and on and on.

Seems simple to me.

Right on, Razorback.

Cheers !

of my 80 original purchases only the first was with cash (never again). All others were for 90 to 100% owner financing (VA foreclosures)

You could create a housing ladder of 15 units and have one of them pay off year. You could do then do cash refi's on the one place that got paid off that year.

That would get you a years worth of cash free income in one shot. Can you do that with a new home at a $150K price point based on current rents - not around here.

It is possible at the 70K price point and even give yourself 20K of additional improvements. I can't speak to AL, but NE is correct how they tax new construction homes in Pa. A solid 30 year home makes more sense here. You mileage may vary

Jim in OC (CA)

Thank-you for your answer. You have actually done this! You and I are now on the same page here.

Now, would you recommend this break-even or negative cash flow situation to anyone else here? And if that $125K house had never appreciated (some houses do not appreciate), would you have sold the house sooner or kept it or what?

Actually, the important thing, here, is NOT the issue of initial breakeven price and operation. As for any other investment, the real issue is potential for the future.

Even if you buy with an initial position of breaking even regarding mtg, upkeep, taxes, maintenance, etc, you will be spending your time to act as landlord. In exchange for what? What compensation will you receive, now or in the future?

If your acquired property does not appreciate, including rents, then it is all for nothing. Any other investment should be expected to do at least 10% per year (mot uniformly). Real estate in particular will appreciate in fits and spurts as vacancy rates adjust to population changes. If your catchment area does not support such development, then it is not particularly a good investment.

Here's how I'd look at it, in very simplified terms:

Assume you put 20% down, or $30k. Assume that management costs are pretty minimal because you have a great screening process and lease. When the house hits the 15 year mark, you sell it for the 150K you put into it so you don't have to replace the roof, furnace, etc as they age. Assume that the inflation appreciation covers the sale costs.

Those are a lot of assumptions, but if they hold true, you've made $110K on your $30K investment over 15 years. That works out to a 24% rate of return over the 15 years. I'd say that's pretty darn good. I think what the others are pointing out is that you have to be very careful, because if even one of those assumptions is wrong then you could be in hot water.

Moshe,

I agree with you. It has more to do with the unknown future than anything else. In my example though, even if no appreciation happened, you would still have a $150K house that was paid for by someone else. That 'could be' worth the hassle of being someone else's LL.

If this type of investment worked everyone would be buying a $150k rental and telling the banker all I have to do is break even every month and my rental will be paid off in 15 years and I will sale at market, pay income taxes and pocket the rest.

I think 2006 -2008 took care of those investors.

The only person I think this investment would remotely work is someone with a high income position and didn’t need the rent income.

Roy - Any sound investment is based on minimizing the risk.

You assume the house will appreciate. Was that the case in the 2008 RE downfall?

You assume rental rates will rise to satisfy the break even, maybe in some areas but not most areas.

Consider this - A break even number for a 15 year pay off, at today's rate, would require the rent to be about 1500. A little high for most areas of the country, but not all. Maybe in some parts of the country where RE has extreme highs and lows. CA or FL - buy full retail on the low end of the RE cycle may work, but full retail when the RE cycle is high as it is today????

The recent - Lowest Offer - post was about strategies most LL used to purchase units at the lowest possible price - not full retail.

To much risk for me.

Roy,

How do you address the breakeven point of your plan when banker questions why the DCSR isn't 1.2?

Ray N PA,

This is not my plan. It is actually someone else's plan which I am just trying find the logic that supports it, if there is any logic to it. I would assume someone would need a 6 figure day job to make this plan work, especially if you have several houses in your inventory.

I have known people with plenty of money, who will buy houses and just let them sit empty. They hope that long term appreciation will produce a profit someday. Their rationale is that buying houses is a better place to park their cash instead of in a bank at 1% interest.

I also know people who buy Blue Chip stocks that pay little or no dividends. And there is no guarantee that any of these blue chip stocks will ever appreciate in value. Why do people do this?

JB,

Roy I would never recommend this to ANYONE who is weak and thinking "get rich quick". Financing to the max on every deal from 1986 to 2001 is not for everyone. Two men I mentored brought 6 of my property's. Almost all nothing down to them. What a disaster. After a year one mans wife said when the heck we gonna make some money? I told her maybe 7 or 8 years she flipped out. Her statement was NO FREAKIN WAY!!!!! 6 weeks later they were at my door handing me 6 deed in lieu of's. They had put on new roofs, new carpeting new HVAC's man oh man they had no concept of budgeting RE.

So directly I would not suggest this to anyone with heart problems or in old age. It's the time value of money program for me and my family.

Several people in the local REI group have done a similar plan.

Their plan was to buy as many houses as they could in their 20's and 30's using 30 year mortgages.

Most of the houses they bought were nice houses (class b and c) in good school districts.

They focused on tenants with young kids who might want to stay in the house for many years.

They set rents at the lower end of the market and did not raise rents very often. Many of the tenants stayed for decades.

Over the past 30 years, the profits were put back into the properties.

30 years later, they quit their W2 jobs and are paying houses off every month.

MMIT,

" I also know people who buy Blue Chip stocks that pay little or no dividends. And there is no guarantee that any of these blue chip stocks will ever appreciate in value. Why do people do this? "

Just to keep the record straight, the Fidelity Blue Chip Growth Fund has averaged growth of 13.23% since the beginning of the fund in 1987. This growth rate is compounded for long-term shareholders and if the shares are held in a ROTH IRA, then they are entirely tax-free. If distributions are re-invested, then the growth rate is even further compounded. Maybe that's why do people do this.

By the way, over 15 years, that's 645% on $30,000 (20% of $150,000) = $193,500. And its liquid plus tax-free, and no plumbing calls. And it can keep on growing for more tham 15 years.

RentsDue

Roy, #22 MO builds new rental single family houses. Maybe he will jump on this thread and share some of the finer points of this business model.