Gyroscopic Investing

Posted: **Thu Mar 13, 2014 4:28 pm**

I am intrigued by the concept of owning rental properties, using mortgages as leverage. One can expect to make about 9.5% per year with the PP, so a $1 million portfolio would yield around $95,000 per year, historically. But if you take $1 million and use it as 20% down payments to buy rental properties, you can buy $5 million worth of properties. Assuming a lender would be willing to do this and assuming that each property has a 10% cap rate (ROI) after all expenses, then $1 million will earn you $500,000 per year in rental income/ROI. You then have to subtract the cost of the mortgages, themselves. I think a good amount of money would be left over. Does anyone know how this works and how much would be left over?
Also, I would only buy lower income properties to make them more recession proof (but not slums). How SHTF-proof are they? What happened to lower income properties in an economic crisis like Weimar Germany or the more recent collapse in Iceland?

Posted: **Thu Mar 13, 2014 5:29 pm**

jason,

I love the PP, but I wouldn't use 9.5% for a portfolio containing the following:

1) A stock market with 4.5% and 5% earnings yield for the last 10 years and 1 year, respectively.

2) A bond portfolio yielding <4% for 20-30 years.

3) A bond portfolio yielding <.2% for 1 year.

4) A yellow metal that has historically, long-term stuck pretty close to CPI.

Like I said, I love it, but just digest those numbers a bit. This isn't the 1980's any more

.

Further, make sure your cap rate includes ALL expenses, including some measurement of the value of your time and/or a management company, having very robust insurance protection, utilities, vacancy, MAINTENANCE (try to be very honest with yourself about this... it's so huge when using leverage to get CF's right), and if residential, look at laws that could leave you responsible for housing dead-beat renters with no income.

And I would NOT put all your eggs in that basket, no matter how many of those answers come back favorable. Never. Just me

.

Lastly, make sure there's an out for your family. If you die, what happens to all this property? Do they have to sell all of it? At fire sale prices? Is there some way to pre-arrange a buy/sell and have a partner who would take your share, and have funding for it? What if you get sick or have a long-term care event? Do you have someone who can manage operations lined up?

Also, do you have a lot of your wealth in tax-qualified accounts (IRA or Roth)? Would you have to pull a bunch out in one year?

Remember, this stuff can go below zero. If you're taking on 80% loans to get 10% and comparing it to a 9.5% (even though I disagree with this number) PP, you really can't compare the two. Leveraging in with an -80% bond portion (debt), and 180% real property portion, and comparing it to an insanely robust portfolio is a bit crazy (in the least offensive way

.)

Even if you went in all cash, that's 10% on a completely un-diversified investment. Not horrible, but definitely not the whole pot.

Just my thoughts. Hope I didn't kill too many dreams.

I'm sure other dream-killers will be right behind me!

Posted: **Thu Mar 13, 2014 7:26 pm**

moda0306 wrote:
Further, make sure your cap rate includes ALL expenses, including some measurement of the value of your time and/or a management company, having very robust insurance protection, utilities, vacancy, MAINTENANCE (try to be very honest with yourself about this... it's so huge when using leverage to get CF's right), and if residential, look at laws that could leave you responsible for housing dead-beat renters with no income.

And I would NOT put all your eggs in that basket, no matter how many of those answers come back favorable. Never. Just me .

Lastly, make sure there's an out for your family. If you die, what happens to all this property? Do they have to sell all of it? At fire sale prices? Is there some way to pre-arrange a buy/sell and have a partner who would take your share, and have funding for it? What if you get sick or have a long-term care event? Do you have someone who can manage operations lined up?
Just my thoughts. Hope I didn't kill too many dreams.

I'm sure other dream-killers will be right behind me!

property ownership tends to be more of a job/carrier than an investment, if you find a top notch management company (which is a cost ) that you trust (which you still must keep an eye on) you may be able to be semi hands off but you still need some knowledge of buildings (does that leak really mean i need the new roof that they want to sell me? or is patching the better choice?, and what factors go into making the best long term/short term roof decision?) and tenant law skills, plus all the above stuff moda mentioned and likely a bunch more.. i wouldn't let all this discourage me from making a building VP play.. but i would be very inclined to view it as a new full time carrier more than a passive investment

Posted: **Thu Mar 13, 2014 11:53 pm**

moda0306 wrote: jason,

I love the PP, but I wouldn't use 9.5% for a portfolio containing the following:

1) A stock market with 4.5% and 5% earnings yield for the last 10 years and 1 year, respectively.

2) A bond portfolio yielding <4% for 20-30 years.

3) A bond portfolio yielding <.2% for 1 year.

4) A yellow metal that has historically, long-term stuck pretty close to CPI.

Like I said, I love it, but just digest those numbers a bit. This isn't the 1980's any more .

Further, make sure your cap rate includes ALL expenses, including some measurement of the value of your time and/or a management company, having very robust insurance protection, utilities, vacancy, MAINTENANCE (try to be very honest with yourself about this... it's so huge when using leverage to get CF's right), and if residential, look at laws that could leave you responsible for housing dead-beat renters with no income.

And I would NOT put all your eggs in that basket, no matter how many of those answers come back favorable. Never. Just me .

Lastly, make sure there's an out for your family. If you die, what happens to all this property? Do they have to sell all of it? At fire sale prices? Is there some way to pre-arrange a buy/sell and have a partner who would take your share, and have funding for it? What if you get sick or have a long-term care event? Do you have someone who can manage operations lined up?

Also, do you have a lot of your wealth in tax-qualified accounts (IRA or Roth)? Would you have to pull a bunch out in one year?

Remember, this stuff can go below zero. If you're taking on 80% loans to get 10% and comparing it to a 9.5% (even though I disagree with this number) PP, you really can't compare the two. Leveraging in with an -80% bond portion (debt), and 180% real property portion, and comparing it to an insanely robust portfolio is a bit crazy (in the least offensive way .)

Even if you went in all cash, that's 10% on a completely un-diversified investment. Not horrible, but definitely not the whole pot.

Just my thoughts. Hope I didn't kill too many dreams.

I'm sure other dream-killers will be right behind me!

Regarding the PP, I'm not sure that the 9.5% days are over. The PP performed pretty well during the 10 years from 2003 to 2012 (around 9.3%). I wouldn't mind spending the time on dealing with rental properties if the financial reward was there. While I feel real estate is a lot less safe than the PP, the income from real estate is far more predictable, in most years. I have seen rental properties being offered with a true 10% cap rate, including all expenses (of course, that doesn't necessarily include major, one-off repairs like a new A/C or a new roof). Plus, with leverage, I can get a much higher return than the PP (I think). For example, let's say, hypothetically, I take $1 million and I use it as a down payment to buy a $5 million house. And I rent out the $5 million house at a cap rate of 10% (I would sooner buy 25 $200,000 houses, but this example using one house makes the math much easier). A 10% cap rate means my income from the house is $500,000 per year, after expenses (barring any major, unforseen repairs) minus the cost of the mortgage. According to a mortgage calculator I found online, a $4 million loan ($5 million house with $1 million down payment) at 5% interest has a monthly mortgage payment of $21,472.86. That comes out to $257,674.32 per year. When I subtract that figure from the $500,000 in rental income/cap rate, I get positive cash flow (yearly profit) of $242,325.68, which is a 24.2% annual return on my initial $1 million investment. Plus, I am building equity (after 30 years, the mortgage payments will stop and I will own the house outright), plus, historically, real estate has averaged an increase of about 4% per year in value, so I would get the appreciation as well. And even if there is an economic crash and real estate drops a lot in value, I will still have my tenants paying rent. Yes, if there is high unemployment, I could have to deal with a lot of evictions, but I am thinking that if I buy rental properties that are appropriate for people in the lower end of the income spectrum (upper working class/lower middle class), it will be easy to fill the units so would be fairly recession proof (I would not buy luxury properties, and I would not buy slums where I would feel unsafe when visiting the property). Rents typically don't drop during an economic crisis, do they? I wouldn't put all of my money into real estate - maybe 50%, while leaving the other 50% in the PP. Does anyone see a problem with my math and with the 24.2% ROI figure I am up with? Am I missing something? What is the worst case scenario for this investment (within reason)?

Posted: **Fri Mar 14, 2014 12:13 am**

jason wrote: plus, historically, real estate has averaged an increase of about 4% per year in value, so I would get the appreciation as well. And even if there is an economic crash and real estate drops a lot in value, I will still have my tenants paying rent. Yes, if there is high unemployment, I could have to deal with a lot of evictions, but I am thinking that if I buy rental properties that are appropriate for people in the lower end of the income spectrum (upper working class/lower middle class), it will be easy to fill the units so would be fairly recession proof (no luxury properties). I would not buy slums where I would feel unsafe when visiting the property. I wouldn't put all of my money into real estate - maybe 50%, while leaving the other 50% in the PP. Does anyone see a problem with my math and with the 24.2% ROI figure I am up with? Am I missing something?

i cant really speak to your numbers, but there are definitely ebbs and flows in occupancy that you have to deal with, and if tenancy drops you must have cash to pay the bills and debt or look at taking higher risk lower quality tenants or both, it may be far easier than you appreciate for a upper working class/lower middle class building to slide into a lower class poor building (not necessarily a slum by any means but much higher work load and bigger headaches)
as i said before if you take it on as a carrier and learn the ins and outs you will likely still be fine and do well over all, but its far from passive investing or sitting comfortably waiting for checks to arrive the mail

Posted: **Fri Mar 14, 2014 1:25 am**

l82start wrote:
jason wrote: plus, historically, real estate has averaged an increase of about 4% per year in value, so I would get the appreciation as well. And even if there is an economic crash and real estate drops a lot in value, I will still have my tenants paying rent. Yes, if there is high unemployment, I could have to deal with a lot of evictions, but I am thinking that if I buy rental properties that are appropriate for people in the lower end of the income spectrum (upper working class/lower middle class), it will be easy to fill the units so would be fairly recession proof (no luxury properties). I would not buy slums where I would feel unsafe when visiting the property. I wouldn't put all of my money into real estate - maybe 50%, while leaving the other 50% in the PP. Does anyone see a problem with my math and with the 24.2% ROI figure I am up with? Am I missing something?
i cant really speak to your numbers, but there are definitely ebbs and flows in occupancy that you have to deal with, and if tenancy drops you must have cash to pay the bills and debt or look at taking higher risk lower quality tenants or both, it may be far easier than you appreciate for a upper working class/lower middle class building to slide into a lower class poor building (not necessarily a slum by any means but much higher work load and bigger headaches)
as i said before if you take it on as a carrier and learn the ins and outs you will likely still be fine and do well over all, but its far from passive investing or sitting comfortably waiting for checks to arrive the mail

According to my calculations (I'm not really sure I know what I am doing when it comes to calculating these figures), even if I have 25% vacancies, my investment income would be 75% of $500K, which is $375,000. When I subtract the mortgage payments from that, I get a positive cash flow of $117,325.68, which is an 11.7% return on my initial $1 million investment. A 25% vacancy rate seems really terrible and unlikely, and probably could be considered a worst case scenario, within reason, no?

I acknowledge this is not passive income, but if it's done on a large enough scale, I could afford to hire a property manager to handle everything for me. If he or she does a good job, then I can be mostly hands off. That is a big "if", though.

Posted: **Fri Mar 14, 2014 9:16 am**

You'll need some bigger inflation numbers.
That's the key.
And your best day will be the day you sell.
Keep us posted..

Posted: **Fri Mar 14, 2014 10:40 am**

jason wrote: According to my calculations (I'm not really sure I know what I am doing when it comes to calculating these figures), even if I have 25% vacancies, my investment income would be 75% of $500K, which is $375,000. When I subtract the mortgage payments from that, I get a positive cash flow of $117,325.68, which is an 11.7% return on my initial $1 million investment. A 25% vacancy rate seems really terrible and unlikely, and probably could be considered a worst case scenario, within reason, no?

I acknowledge this is not passive income, but if it's done on a large enough scale, I could afford to hire a property manager to handle everything for me. If he or she does a good job, then I can be mostly hands off. That is a big "if", though.

(if i am just pointing out the obvious sorry) but i tend to look at property from a practical consideration angle because that is the side that i am most familiar with , 25% is probably not quite as rare as you think but it depends on a lot of real world factors like, building size, is the neighborhood in decline or gentrification or static? and can you pick out the difference by looking? can you spot the big ticket items coming like roofs and water heaters and AC units? and there are hundreds of little and big details like these that contribute to success, and they start when you are looking to buy. I am perpetually amazed at how much murphy's law apples to buildings and even more at how much the corollary of "things going wrong at the worst possible time" applies, these are things that if over the course of your life you have bought sold and dealt with buildings you can handle easily, if not then you need CEO skills, if you can find and hire people that do the work and have the knowledge then the larger scale approach may work very well, you still need to understand the business you run and be familiar with many of the details but you can rely on your ability to hire the right people more.. as for your numbers, any percent return is going to be based in part (and possibly large part) on the quality, skill, knowledge and work of the owner/management and the quality location and condition of the building you own..

property management isn't a bad idea, i would be inclined to buy buildings myself if i had the means. i do have my doubts about it being mostly hands off and profitable at the same time. I must admit i don't know as much about big property management company's who (may) handle large chunks of the work for you than a smaller scale company. this might allow an owner to be hands off more than i realize.... you will have to research it to find out...

Posted: **Fri Mar 14, 2014 11:07 am**

jason wrote:
moda0306 wrote: jason,

I love the PP, but I wouldn't use 9.5% for a portfolio containing the following:

1) A stock market with 4.5% and 5% earnings yield for the last 10 years and 1 year, respectively.

2) A bond portfolio yielding <4% for 20-30 years.

3) A bond portfolio yielding <.2% for 1 year.

4) A yellow metal that has historically, long-term stuck pretty close to CPI.

Like I said, I love it, but just digest those numbers a bit. This isn't the 1980's any more .

Further, make sure your cap rate includes ALL expenses, including some measurement of the value of your time and/or a management company, having very robust insurance protection, utilities, vacancy, MAINTENANCE (try to be very honest with yourself about this... it's so huge when using leverage to get CF's right), and if residential, look at laws that could leave you responsible for housing dead-beat renters with no income.

And I would NOT put all your eggs in that basket, no matter how many of those answers come back favorable. Never. Just me .

Lastly, make sure there's an out for your family. If you die, what happens to all this property? Do they have to sell all of it? At fire sale prices? Is there some way to pre-arrange a buy/sell and have a partner who would take your share, and have funding for it? What if you get sick or have a long-term care event? Do you have someone who can manage operations lined up?

Also, do you have a lot of your wealth in tax-qualified accounts (IRA or Roth)? Would you have to pull a bunch out in one year?

Remember, this stuff can go below zero. If you're taking on 80% loans to get 10% and comparing it to a 9.5% (even though I disagree with this number) PP, you really can't compare the two. Leveraging in with an -80% bond portion (debt), and 180% real property portion, and comparing it to an insanely robust portfolio is a bit crazy (in the least offensive way .)

Even if you went in all cash, that's 10% on a completely un-diversified investment. Not horrible, but definitely not the whole pot.

Just my thoughts. Hope I didn't kill too many dreams.

I'm sure other dream-killers will be right behind me!
Regarding the PP, I'm not sure that the 9.5% days are over. The PP performed pretty well during the 10 years from 2003 to 2012 (around 9.3%). I wouldn't mind spending the time on dealing with rental properties if the financial reward was there. While I feel real estate is a lot less safe than the PP, the income from real estate is far more predictable, in most years. I have seen rental properties being offered with a true 10% cap rate, including all expenses (of course, that doesn't necessarily include major, one-off repairs like a new A/C or a new roof). Plus, with leverage, I can get a much higher return than the PP (I think). For example, let's say, hypothetically, I take $1 million and I use it as a down payment to buy a $5 million house. And I rent out the $5 million house at a cap rate of 10% (I would sooner buy 25 $200,000 houses, but this example using one house makes the math much easier). A 10% cap rate means my income from the house is $500,000 per year, after expenses (barring any major, unforseen repairs) minus the cost of the mortgage. According to a mortgage calculator I found online, a $4 million loan ($5 million house with $1 million down payment) at 5% interest has a monthly mortgage payment of $21,472.86. That comes out to $257,674.32 per year. When I subtract that figure from the $500,000 in rental income/cap rate, I get positive cash flow (yearly profit) of $242,325.68, which is a 24.2% annual return on my initial $1 million investment. Plus, I am building equity (after 30 years, the mortgage payments will stop and I will own the house outright), plus, historically, real estate has averaged an increase of about 4% per year in value, so I would get the appreciation as well. And even if there is an economic crash and real estate drops a lot in value, I will still have my tenants paying rent. Yes, if there is high unemployment, I could have to deal with a lot of evictions, but I am thinking that if I buy rental properties that are appropriate for people in the lower end of the income spectrum (upper working class/lower middle class), it will be easy to fill the units so would be fairly recession proof (I would not buy luxury properties, and I would not buy slums where I would feel unsafe when visiting the property). Rents typically don't drop during an economic crisis, do they? I wouldn't put all of my money into real estate - maybe 50%, while leaving the other 50% in the PP. Does anyone see a problem with my math and with the 24.2% ROI figure I am up with? Am I missing something? What is the worst case scenario for this investment (within reason)?

In 2003, the stock market had just finished a three year drop, with earnings ratios similar (it looks like) to today (I'll call that about equal from a pricing perspective), treasury bonds ranged from 1%-5% rather than 0%-4% (1% difference from today's range, about), but the big difference was gold, which would have to be over $5,000 a decade from now to get similar returns, which are about 13% CAGR since 2003.

So you'd need something to adjust for 50% of your portfolio earning about 1% less, which means either stocks or gold will have to beat their last decade by 2%.

Obviously, this is taking a pretty narrow approach to measuring PP performance, but over longer periods, for at least 3 of the assets, it's earnings/interest that really drive the RoR.

Posted: **Fri Mar 14, 2014 1:28 pm**

As others have pointed out (Melveyr, specifically), the PP has a nearly constant real return (i.e. inflation adjusted, as opposed to absolute) - of about 4.5%. See Melveyr's blog at http://www.stableinvesting.com/2011/04/ ... html.  The upshot is although you shouldn't count on an absolute 9.5% CAGR going forward, you probably can count on a real return of about 4.5%.

Gyroscopic Investing

Rental properties for VP

Rental properties for VP

Re: Rental properties for VP

Re: Rental properties for VP

Re: Rental properties for VP

Re: Rental properties for VP

Re: Rental properties for VP

Re: Rental properties for VP

Re: Rental properties for VP

Re: Rental properties for VP

Re: Rental properties for VP