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  • Real Estate as an Investment-Cons

    In my blog post this week (https://www.whitecoatinvestor.com/re...ncial-advisor/) I discuss the cons of owning small amounts of real estate compared to just being invested in public stock markets. There are certainly individuals who do well with real estate-and they are usually those that buy a property every year or two over twenty plus years and do much of the work themselves. As in my post, those families that buy one or two rental properties invariably sell them later with a poor return. I did not discuss syndicated funds but I am very skeptical of giving money to developers who then promise to develop/manage properties and then hand me a nice profit. Public large REITs seem a better option as they are liquid and have more scrutiny and public disclosure.
    Today's guest is a physician turned financial advisor. Here are financial recommendations from his decades of experience and observations.

  • #2
    So you don't like real estate. That's good as it is less competition out there for purchasing income producing property for those of us that do like real estate. There are too many $ out there pursuing property driving up prices into realms that won't cash flow. They will eventually fail leaving "blood in the streets" for those of us prudent enough not to overpay so that we can then pick up the bargains. It's definitely a seller's market.

    Comment


    • #3
      Good review article for financially successful doc consumption with its broad strokes. Stay in stocks. Individual real estate is for a small portion of people fraught with risk; so tread carefully.

      The overall thrust of the article appears -- docs have big shovels and low risk of retirement wealth, even with SOR. Docs primary issue will be wealth transfer and tax efficiency for those who want it for now and into the future.

      All true and good general advice. I do think there's a larger portion of folk (including docs) that aren't so financially secure for either a spending issue (common) or worry about single sourcing retirement income.

      This is were both bonds and individual real estate both help diversify the income stream and wealth preservation. Bonds may underperform stocks long term but they do provide steady income because the doc is now the bank making the loan and earning the income stream and steady during fluctuations of equities. Real estate clearly goes same for primary residence: own vs rent equation but even more magnified -- even fewer people who own primary houses should engage in investment real estate. When chosen correctly, real estate appreciation will modestly beat inflation. Magnify that during growth phases with leveraged loans (70%) you turn a 1-2% appreciation to a 2-6% appreciation and maintain a cashflow neutral position. Over time, that turns into a solid cashflow position naturally. Of course, it's not a passive investment, so have to fit there too -- an for many -- not so.

      Comment


      • #4
        Let me make a case for investing in the REIT index vs Syndications/Private RE Funds. To be clear, I have never invested in a syndication or private fund and rely only on what I have read.

        1. REIT Index time commitment. Almost none. I believe that private real estate investing takes A LOT of time even if you are investing in diversified funds. I do not believe that this time is compensated monetarily.
        2. REIT Index returns. 12.1% annually over the last 20 years per NAREIT. I would say this is consistent with my REIT index returns. Does an entire portfolio of syndications/funds outperform this total return? If so, by how much? Is the extra return worthwhile given the time it takes...time that could be spent earning money as a physician or golfing etc?
        3. REIT Index diversification. No comparison. To be fair, the REIT index is a different RE market than syndications but the index is way more diversified in it's space.
        4. REIT index and volatility. It has been said that values of the REIT index are much more volatile than syndication holdings. I am not sure this is true but let's assume it is. Is volatility a bad thing? If you believe in DCA (which I do) you will have lower average prices on your purchases. If you believe you can time the market (which I do not) you can load up when the index is undervalued.
        5. REIT Index and the liquidity premium. I believe it exists but think it is over done. If I invest $500 k in the REIT index and $500 k in a syndication portfolio and they both have an annual total return of 10%/year over 10 yrs, how has the premium hurt me?
        6. REIT index and costs. The individual REITs in the index need to buy, sell and manage property. These costs are not in the ER of the index but embedded in the REIT expenses and may be comparable or less than those same costs in syndications. I believe that the REIT index has less cost vs syndications when it comes to pooling capital, creating feeder funds, promoting etc.
        7. REIT Index and taxes. Right now the REIT index yields about 4%. Call it a cap rate. How is it taxed.
        - 30% of this yield is a ROC(return of capital) and not taxed as income. It will reduce the cost basis of the index shares just like depreciation does in syndications. If I hold my REIT index shares until I die, my heirs get a "stepped up" cost basis just like in syndications.
        - 70% of this yield is taxed as regular income(37% for most of us). BUT, with the 2017 Tax and Jobs Act, this portion of the yield is reduced by 20%(Bringing this rate down to 29.6%)
        -So for example, if I made $4k on a $100 k investment over 1 yr. I would be taxed(initially) 0.7 x $4000 X 0.296=$828. My effective tax rate then would be $828/$4000=20.7%. If I keep these share until I die, I will not pay the capital gain recapture. This seems reasonable to me BUT I REALLY WANT TO HEAR FROM THOSE WHO HAVE INVESTED IN MANY SYNDICATIONS. IS THE "ZERO TAX" BENEFIT OF DEPRECIATION REALLY AN AUTOMATIC WITH SYNDICATION INVESTING? If so, is it easy to do a 1031 exchange and not get dinged with capital gains recapture every 3-7 years when the syndication comes full cycle?

        -I believe the individual REITs in the index may be more adept at the 1031 exchanged than I am.
        8. REIT Index and tax reporting. Multiple state returns and complexity have a real cost to syndication investing.

        Please poke holes in my logic. In all honesty, what I have written has prevented me from investing in syndications even though I enjoy looking at deals and suffer from FOMO. The prospect of not having my time well compensated however bothers me.

        Glen

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        • #5
          We've had good fortune with our SFH rental, but prices were low then, and high now. I've debated selling but it's almost paid off and cash flows well, and both bond and stock prices are very high, no good alternatives.

          I wouldn't say individuals invariably sell with poor returns. The profit is made on the buy. Get a good price ie 100x rent, and you'll probably do ok. Get a bad price, ie 200x rent, and you won't.

          Comment


          • #6
            Glen: You are correct that effectively investing in real estate is not a passive activity and it does require self education to do well. I read and learned over a 2 yr. period before I first pulled the trigger 15 yrs. ago. In addition to the investment property I personally own I have set up 3 syndications with other docs as the passive investors. I have only taken 1 "full cycle". It was a 4 yr hold and we had an 18% IRR pretax including capital gains and cash flow. I was able to do a 1031 exchange with my proceeds but I knew how to do it and the investors just paid their capital gains as needed. With the taxes REITs are best held in a qualified account. Do real estate investors make mistakes, you bet. You learn from them and move on and don't make the same one twice.

            Comment


            • #7
              “There are certainly individuals who do well with real estate-and they are usually those that buy a property every year or two over twenty plus years and do much of the work themselves. As in my post, those families that buy one or two rental properties invariably sell them later with a poor return.”

              It may be that those individuals who buy a property every year or two for 20 years and do much of the work themselves talk a lot about it and their success with it, because it’s such a large part of their lives. And those individuals who buy one or two rentals and sell later at a poor return talk a lot about because it was such a negative experience for them and people tend to be vocal about negative experiences. There are no doubt people out there who invest in real estate as part of their overall portfolio, it doesn’t take over their lives, generates a good return, they are satisfied with it, and you don’t really know about that facet of their lives.

              Comment


              • #8
                The first thing I thought of when I read the post is that the author is an AUM-based financial advisor. Thus, he has pretty much zero incentive to recommend that his clients invest in real estate, apart from REIT index funds.

                Doesn't mean he's wrong or dishonest, but the bias should be acknowledged.

                Comment


                • #9
                  I am an aum based financial advisor-but that does not change the history and experience I see routinely. The cases of poor real estate experiences by the over 100 physician families we deal with are legion. I have no issue with having a nice home (within reason, a lifestyle choice-not a financial one) or owning one's office (often a good choice). But, we almost never see a financial outcome from real estate that is "worth it" in terms of making money or time involved. The same is true outside the medical community-our friends and clients that try to own real estate as a part time endeavor do not come out well. Heck, most of my real estate transactions have not come out well!

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                  • #10
                    real estate is for the birds. you look like liam neeson in the article photo.

                    Comment


                    • #11
                      Originally posted by StarTrekDoc View Post
                      When chosen correctly, real estate appreciation will modestly beat inflation.
                      Just a note here regarding real estate appreciation and intrinsic value--buildings fall apart, they are depreciating assets. They are made of wood, dry wall, appliances, shingles, and perhaps brick or stone, among other things. None of that becomes more valuable with time, quite the contrary. Most buildings are eventually razed.

                      The value of the land may change. Detroit was a dynamic city in the 1950s, but it has declined and its land has lost value. Silicon Valley has been dynamic more recently and its land has appreciated. When you expect real estate appreciation, you are really speculating in land value.

                      Now that's not to say that you can't purchase well and realize a gain because you paid less than intrinsic value. Many did that in 2009 and 2010. You can also earn a good return from real estate despite the slow depreciation of the building.

                      However, I think it's incorrect to say that real estate appreciation will modestly beat inflation. I think that idea comes from Shiller who published a series showing home prices rose about 1% real over time in the US. His series tracked the repeat sale price of individual homes over time. However, his series did not track all of the improvements made to those homes between sales.

                      Just about every house is renovated over its lifetime. This increases its value, just not as much as it costs to make the improvements; homeowners lose money on renovations (though they may think they capture the remaining value in quality of life). Shiller's series also doesn't separate land appreciation or depreciation from the price of the building that sits on it.

                      Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

                      Comment


                      • #12
                        Just read the article.

                        "We see better bond returns only in the periods in which interest rates have dropped steadily and significantly (as during the last two decades."

                        Rates have been falling for about 4 decades.

                        "The attorney will relate dozens of issues that the physician must consider in a contract and explain everything that can possibly go wrong to “cover” any blame after the fact. However, they frequently fail to address the most important issues that really matter for a physician such as — restrictive covenants, partnership options and path, and what happens in the event of a practice sale. "

                        This has been true in my experience as well. I used attorneys to review contracts early in my career but no longer.
                        Erstwhile Dance Theatre of Dayton performer cum bellhop. Carried (many) bags for a lovely and gracious 59 yo Cyd Charisse. (RIP) Hosted epic company parties after Friday night rehearsals.

                        Comment


                        • #13
                          Originally posted by Steven Podnos MD CFP View Post
                          I am an aum based financial advisor-but that does not change the history and experience I see routinely. The cases of poor real estate experiences by the over 100 physician families we deal with are legion. I have no issue with having a nice home (within reason, a lifestyle choice-not a financial one) or owning one's office (often a good choice). But, we almost never see a financial outcome from real estate that is "worth it" in terms of making money or time involved. The same is true outside the medical community-our friends and clients that try to own real estate as a part time endeavor do not come out well. Heck, most of my real estate transactions have not come out well!
                          Intrinsic bias may be creeping in there as well as some selection bias to begin with depending on how you market your practice.

                          This forum tends to run in the 3 fund portfolio retirement investment and heavily in equities for overall investment. Even a significant portion hold the rent vs buy primary house as a long term living situation. That said, we find more than a few successful direct real estate folk that will range from active managers to completely passive with full use of a property manager -- and be quite successful at direct RE.

                          CM - yes real estate is an asset that needs replacement. As you know, most properties do not need full replacement over 27.5 years unless something dreadfully wrong occurs; yet one gets to fully write this off during that time; then rinse/repeat with a 1031 if desired. That's crazy, but this is the way of our tax code.

                          Double down on the depreciation works on the top earning tax bracket of many higher earners and is also a built in type of tax-deferred tax shelter in cash flow in later years is one simply keeps the property.

                          Another direct RE benefit would be that one get leverage x3 the working capital which cannot be done with any other sector of investment.

                          One still needs to make the right choice of properties. One just can't pick any property within one's city -- just like picking the right individual stock choice out of the ~5000 available.

                          Comment


                          • #14
                            Originally posted by CM View Post

                            Just a note here regarding real estate appreciation and intrinsic value--buildings fall apart, they are depreciating assets. They are made of wood, dry wall, appliances, shingles, and perhaps brick or stone, among other things. None of that becomes more valuable with time, quite the contrary. Most buildings are eventually razed.
                            To me, real estate investing is at its core about land speculation. The building/rental income is like the bond part of your portfolio, to help you hold. It’s quite unnecessary for the return and can subtract from it.

                            I came to the conclusion that for the same return it was more capital efficient to just buy land. This can occur in many forms. You can buy an apartment in a small set that can be demolished to build 50 times more and achieve a 10X return from this. Or you can buy acreage that gets rezoned. There is risk and it is obvious, which I prefer.

                            Comment


                            • #15
                              Originally posted by Steven Podnos MD CFP View Post
                              In my blog post this week (https://www.whitecoatinvestor.com/re...ncial-advisor/) I discuss the cons of owning small amounts of real estate compared to just being invested in public stock markets. There are certainly individuals who do well with real estate-and they are usually those that buy a property every year or two over twenty plus years and do much of the work themselves. As in my post, those families that buy one or two rental properties invariably sell them later with a poor return. I did not discuss syndicated funds but I am very skeptical of giving money to developers who then promise to develop/manage properties and then hand me a nice profit. Public large REITs seem a better option as they are liquid and have more scrutiny and public disclosure.
                              I guess it depends on your sampling.

                              Real estate investments have been very profitable for me.

                              If I include every hour I have spent thinking about real estate investing, reading about it, looking at RE deals and attending to real estate investments:
                              I calculate that my return from real estate investing has been around $5000 per hour.

                              I bought my first property 25 years ago.

                              The excess return from exchange traded equity investing over that time period has been negative compared to index funds, hence why I am this site and moved to indexing.

                              So in comparison, my return from active exchange traded investing if I take into account every hour I have spent on it is probably in the order of -$50 per hour.

                              Thank goodness I have the real estate investments to fall back on!

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