I started writing a new book on your principal residence as your only real estate
Posted by John T. Reed on
In the course of writing my principal residence book I made a discovery that I did not realize before.
The path I took was to buy apartment buildings as fast as I could starting when I was 22. The path I SHOULD have taken was to buy only principal residences one at a time and devoted the down payment money and time I devoted to dealing with rentals to my principal residence instead. The principal residence would have take infinitely less of my time. I would have been sued about real estate not at all. I would have avoided a lot of travel to Texas and long-distance phone calls which cost extra then.
I show the real estate I owned in the book and convert the rental properties to one principal residence, which is just an arithmetic exercise. The list of all the properties I owned is at my web site. I put it there years ago to contrast with all the get-rich-quick real estate investment gurus who refused to give the address of a single property they owned.
https://johntreed.com/pages/john-t-reed-s-real-estate-investment-background
As you would expect, instead of living in a normal house and owning two rental duplexes and a triplex, as I and my future wife did, the principal-residence-only approach would have had us living in one of the most gorgeous houses in the nicest town in our area. I converted the 1975 prices of the properties we owned by simply looking up what those same properties are worth today. I turned 29 that year and entered Harvard Business School that September.
I added those amounts to one current property. All four of the buildings we owned in 1975 when we got married are worth about $1.35 million today. So I found a house in Haddonfield, NJ now selling for that: 120 Gill Road, gorgeous house with four bedrooms, four baths, Pennsylvania-stone, three story in a great school district and neighborhood. In the Philadelphia area, the Pennsylvania-stone, slate roof house is the Main Line gold standard.
One of the main benefits would have been NO TENANTS!! In my management book, I show that owning rental properties takes about 3.6 hours per unit per month. We had seven rental properties then which was a part time job of 3.6 x 7 = 25.2 hours per month.
All that is about what I expected. But as I continued collapsing all the rental units I bought into one house I found that when we had our current house custom built for us in 1983, when I was 37, we COULD have acquired what today would be a $4 million house. I roughly expected that when I started writing his book.
Surprise conclusion—to me—when you are buying a $4-million home, you probably have to custom build it.
Actually, we came to that same conclusion back in 1983 when buying our current $1.7 million house. We could not find what we wanted at all, so we designed it and had it custom built in our neighborhood where almost all the homes are custom built by the same builder. That is even more true when you are spending $4 million.
All the regions had about the same median price in 1970 when the Realtors® starting publishing median existing home prices. Now, the West is way ahead. By definition, that means the West had high appreciation. The Northeast also had a lot of appreciation.
Furthermore, there is a structural reason. Those are blue states which have extreme land use regulations that make it extremely difficult to build or overbuild there.
It is possible that appreciation rates in the West or Northeast may decline in the future. But it would take a sex-change type transformation of the U.S. Supreme Court and their overturning the 1926 Village of Euclid, Ohio v. Ambler Realty Co., 272 U.S. 365 decision that said zoning was constitutional. It is not. It violates the last 12 words of the Fifth Amendment.
One chapter in the book is about all the ways in which principal residences are favored miles more than any other asset category in finance, tax law, bankruptcy law, landlord tenant law, environmental regulation, homestead property tax discounts, and so on.
Another part is regional price variation where I say you may need to start in a low price area to “get on the train” but that you would generally need to move to the higher priced regions because if you succeed, most markets would not have expensive enough houses for you move up as often as you should.
My book has the longest discussion of home prices around the US in the last 130 years that I am aware of.
All the regions had about the same median price in 1970 when the Realtors® starting publishing median existing home prices. Now, the West is way ahead. By definition, that means the West had high appreciation. The Northeast also had a lot of appreciation.
Furthermore, there is a structural reason. Those are blue states which have extreme land use regulations that make it extremely difficult to build or overbuild there.
It is possible that appreciation rates in the West or Northeast may decline in the future. But it would take a sex-change type transformation of the U.S. Supreme Court and their overturning the 1926 Village of Euclid, Ohio v. Ambler Realty Co., 272 U.S. 365 decision that said zoning was constitutional. It is not. It violates the last 12 words of the Fifth Amendment.
One chapter in the book is about all the ways in which principal residences are favored miles more than any other asset category in finance, tax law, bankruptcy law, landlord tenant law, environmental regulation, homestead property tax discounts, and so on.
Another part is regional price variation where I say you may need to start in a low price area to “get on the train” but that you would generally need to move to the higher priced regions because if you succeed, most markets would not have expensive enough houses for you move up as often as you should.
My book has the longest discussion of home prices around the US in the last 130 years that I am aware of.
Amortization of the mortgage is well known to be tiny. I have written a million times about how rare positive cash flow is. Also rare is an investor who admits he has negative cash flow.
I had positive cash flow on my first duplex, which cost me 61 times monthly gross when I bought it in 1969. That multiplier soon after that became unheard-of low. Since 1969, gross rent multipliers on such small apartment buildings went up way over 100 times.
Thereafter, I generally had to settle for break-even cash flow in duplex and triplex type properties. Then I hit upon the formula of buying waiting-list buildings where I could raise the rents after I purchased—about 30%. That gave me positive cash flow.
Then there were no waiting list buildings. Then I got run over by the S&L Debacle in Texas and had negative cash flow of $35,000 a year on one property then $35,000 negative cash flow on the other. I gave both back to the lenders as described in my book Distress Real Estate Times.
https://johntreed.com/collections/real-estate-investment/products/dret
https://johntreed.com/collections/real-estate-investment/products/dret
When the Debacle hit, income property values fell by something like 50% in TX, OK, AK. But single-family houses across the street from those buildings only went down much less at the same time.
TX and OK and AK were overbuilt in the 1980s. CA and the northeast would have been also except that land use regulation makes it hard to overbuild in blue states.
My thesis in the new book is supported by overwhelming evidence of structural change in America since WW II in terms of land-use law, landlord-tenant law, and mortgage finance rules and practices.
One of the 14 risks in owning and managing your own rental property is political risk. That is the risk of new laws that are averse to earning an attractive return on the asset category in question.
The Tax Reform Act of 1986 was horrible and is still extant. The spread of rent control is like like a bubonic plague that only attacks residential landlords. Security deposit laws are so bad in MA that many lawyers tell landlords there not to get one.
In virtually every state every year, tenant groups demand and get, anti-landlord legislation. In NJ, landlords have to tell the tenants the name and address of the lender. Why? The tenants demanded it figuring they would give it up in negotiating. But they did not have to. They did not even want it.
There came a time in Germany when the Jews needed to leave. Financially, I think that time is past in many US states with regard to landlords staying in the business. The left is killing landlords financially by using the boiling frog or salami slice method—doing it so gradually that the landlords do not realize what is being done to them.
It used to be principal residence mortgages were 20% down and 30 years. Income-property mortgages were 30% down and 20 years. Now, virtually all income property mortgages have balloon payments which I am totally against agreeing to, not to mention another dozen or so adverse changes to income property mortgages. That alone would have me advising no income properties.
A facebook reader asks: I also thought I remembered you talking about how you built your home and purposefully didn't move because of the stability you wanted for your kids. Have you changed your mind on that, or are you just giving the best strictly financial strategy here?
I discussed that at length with my three sons yesterday. They were not impressed with the stability. Dan noted they did not experience anything else as I did as a kid. Steve more or less said that our current home being sold would not bother him in the slightest. Mike is following my advice right now on moving up to a more expensive house.
I am giving the best strictly financial strategy here. In the book, I will have a chapter on the non-financial considerations.
I suspect the general tendency is to overvalue the non-financial considerations. I suspect there is a mindless inertia justification that excuses resistance to moving up.
The devil you know—current home—is preferable to the devil you don’t—a new home, neighborhood, school. That is not correct. Careful selection of the new home can generally make sure it is better in all respects than the cheaper one you are leaving.
Ending up with a four-million dollar house is better than ending up with a $2 million house which is better than ending up with a $600,000 house. I have no idea why that is not self evident or arguable other than people who did not do it when they could now have to deny it was a mistake to protect their egos.
I wanted to be an apartment building owner—big time—in my young adulthood. And I did. Then I lived 50 more years and experienced markets in the Northeast, TX, and CA and wrote about the whole U.S. for 43 years.
Amortization is trivial at first when you get a new mortgage. Negative cash flow is the rule in rental properties. I have often written that real estate investors do not realize that the negative cash flow is a sort of Christmas Club saving program and not a great investment.
It did not occur to me that my figuring out that your residence is a better investment than beleaguered, more outlawed by the year, landlording and sharing my mistake and the better path in a new book would trigger landlords into going into a defensive crouch an attacking me to save their egos.
My book Best Practices for the Intelligent Real Estate Investor has a chapter on how to calculate your true return.
.
https://johntreed.com/collections/real-estate-investment/products/best-practices-for-the-intelligent-real-estate-investor
.
If you apply it to the typical investor who brags about his investments positive cash flow, it would reveal that the guy is piling money earned in his other life as an employee or business owner into a negative-cash-flow rental property for which he overpaid.
If you pay down the mortgage with money from other sources, and hold on long enough to experience leveraged appreciation and come out ahead of where they started. But the result is akin to what you would get if the negative cash flow went into a savings account instead.
I wanted to be an apartment building owner—big time—in my young adulthood. And I did. Then I lived 50 more years and experienced markets in the Northeast, TX, and CA and wrote about the whole U.S. for 43 years.
Amortization is trivial at first when you get a new mortgage. Negative cash flow is the rule in rental properties. I have often written that real estate investors do not realize that the negative cash flow is a sort of Christmas Club saving program and not a great investment.
It did not occur to me that my figuring out that your residence is a better investment than beleaguered, more outlawed by the year, landlording and sharing my mistake and the better path in a new book would trigger landlords into going into a defensive crouch an attacking me to save their egos.
My book Best Practices for the Intelligent Real Estate Investor has a chapter on how to calculate your true return.
.
https://johntreed.com/collections/real-estate-investment/products/best-practices-for-the-intelligent-real-estate-investor
.
If you apply it to the typical investor who brags about his investments positive cash flow, it would reveal that the guy is piling money earned in his other life as an employee or business owner into a negative-cash-flow rental property for which he overpaid.
If you pay down the mortgage with money from other sources, and hold on long enough to experience leveraged appreciation and come out ahead of where they started. But the result is akin to what you would get if the negative cash flow went into a savings account instead.
The mythical positive cash flow comes from ignoring transaction costs, ignoring expenses other than PITI, ignoring negative cash flow drawing in money from other non-real estate investment activities, ignoring the value of the investors’s time, and ignoring a sort of clinical trial of the rental properties on the one hand and the principal residence on the other.
The dishonest positive cash flow claimers also ignore what is a whole chapter in the forthcoming book: use value. That is, you live in it. That gives you, in effect, cash flow in the amount of the rent you do not have to pay. Treating tenant rent as a source of cash flow or amortization, but ignoring rent not paid on your home and thereby treating that valuable annuity in kind that is worth thousands a month as being worth zero is illogical and incorrect.
Your true return on rental property is explained in my Best Practices book. Condensed version:
1. subtract the amount you would have been paid to manage someone else’s building from your return attributable to the building (3.6 hours per unit per month time number of units times hourly pay rate for property managers).
2. After you remove the income attributable to what you could have earned doing the exact same type and quantitative of work for others without risk, you are ready to calculate how much money the property actually made.
3. Subtract the rental income from your Schedule E
4. then subtract your operating expenses from schedule E
5. then subtract all of your capital expenditures made that year
6. then subtract your mortgage payments
7. Then divide that amount by your investment including non-recurring closing costs of acquisition as well as the value of all the time you spent acquiring the property.
8. The quotient is your ROI. After the first year, divide by your current equity in the property.
Wanna fight about the capital expenditures? You might wanna read that Best Practices chapter first.
The dishonest positive cash flow claimers also ignore what is a whole chapter in the forthcoming book: use value. That is, you live in it. That gives you, in effect, cash flow in the amount of the rent you do not have to pay. Treating tenant rent as a source of cash flow or amortization, but ignoring rent not paid on your home and thereby treating that valuable annuity in kind that is worth thousands a month as being worth zero is illogical and incorrect.
Your true return on rental property is explained in my Best Practices book. Condensed version:
1. subtract the amount you would have been paid to manage someone else’s building from your return attributable to the building (3.6 hours per unit per month time number of units times hourly pay rate for property managers).
2. After you remove the income attributable to what you could have earned doing the exact same type and quantitative of work for others without risk, you are ready to calculate how much money the property actually made.
3. Subtract the rental income from your Schedule E
4. then subtract your operating expenses from schedule E
5. then subtract all of your capital expenditures made that year
6. then subtract your mortgage payments
7. Then divide that amount by your investment including non-recurring closing costs of acquisition as well as the value of all the time you spent acquiring the property.
8. The quotient is your ROI. After the first year, divide by your current equity in the property.
Wanna fight about the capital expenditures? You might wanna read that Best Practices chapter first.
Share this post
0 comment