Real estate investing con artistry

[BladeRunner]

It is a shame in some ways, but the trend of new physicians to seek hospital employment removes them from one opportunity for investment diversification beyond stocks and bonds. Buying or building your own office can be a way of forced savings that can be an important resource for retirement income or funds years down the road. There will be no more transparent financing and no more reliable tenant than yourself or your group. Paying off a multimillion dollar mortgage over a 15 or 20 year career and then collecting rent as income or selling your portion of the building to the remaining partners can be a very significant income stream for retirement..

With 4 kids, and no WCI training, I had no extra income to put money into a taxable account for many years. However, I paid down that monthly mortgage on our office buildings for 15 plus years and it has turned out to be my best investment, better than the S+P 500. The downside, and it is not insignificant, is that you cannot simply pull up stakes and leave your practice. You are committed to making it work.

[AlexxT]

Zaphod wrote:

As with any kind of leverage play, it works great until it doesnt.

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Indeed.

Leverage is what allows you to go bankrupt.  I know of several developers who have gone bankrupt over the years.  Perhaps that's why I'm reluctant to delve into real estate.

The biggest, most famous developer in  Manhattan in the 1950's and early 60's was William Zeckendorf.  I know about him because a family member had worked with him.   He went bankrupt in 1965.  Check him out on Wikipedia.  Lots of other famous real estate bankruptcies out there to read about.  Canary Wharf in London, several in Toronto.

It's all good until it isn't.  Be careful out there.

[Complete_newbie]

This has more to do with greed. Personally I see it no different then losing money in stock market. Easy leverage plus higher base price leads to more risk and at loss capital in RE.

as mentioned, following KISS principle of index investing works fine.

[Dont_know_mind]

AlexxT wrote:

Complete_newbie wrote:

Please tell me how it practically matters in terms of long term, boglehead style investing where you buy and hold.

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Actually, liquidity matters because with index funds you can get as much or as little cash flow as you wish.  If I want no cash flow, I reinvest the dividends.  If I want more, I sell some shares.  This is important in retirement, when I will probably be selling shares.  With real estate your cash flow is more or less fixed, dependent on your expenses and rent.  If I need more money than I’m getting in rent, I either sell an entire property or have to use a line of credit or mortgage.

CREGuy wrote:

Can anyone else please point me to the investment that allows you to write off significant non-cash expenses against income?  More importantly, can anyone point me to the other investments that allow you to defer any tax liabilities on the sale of the investment if the proceeds are transferred into a similar vehicle?

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True, but index funds have no expenses, so no need for a deduction.  As for the deferral of liabilities, index funds don’t have any tax liability until they are sold, ( except for capital gains rate on the dividends, amounting to about 0.6% a year for the total market fund )  and I have no reason to sell them until the step-up at death.  Correct me if I’m wrong, but the only reason you would want to do a 1031 exchange is to keep getting the depreciation allowance after the 26.5 years have gone by. But with index funds, I have no depreciation, so no allowance.  Also, no repairs, no maintenance, and no property taxes.  Plus, they can also provide tax deductions through  tax loss harvesting.

But none of that is important.  What’s important is the bottom line.  So  I would appreciate it if the real estate investors in this thread could tell me what their actual overall ROI is, including appreciation, both before and after the depreciation deduction, if you know it.   I would be curious to see how that total  return compares to the total return of the S&P 500.  I realize that this can vary widely, but if you know yours, and are willing to share, I would love to see some hard numbers.

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Real estate is very local but on average (averaged nationwide) is probably on average 1-2% below stock index LT return but the difference is made up by leverage. From my own limited sample size of experience, my net return on commercial CAGR has been 10%, residential 8%, vacant land 18%. The difference between commercial and residential has not been significant for me because the rental yield on commercial is not as tax efficient as CG on residential or vacant land. The holding cost of vacant land is about -2% pa.

It's all active investing. The problem is that people get some success at what they do and extrapolate too much. The residential investors become overconfident that houses only go up over time, the commercial real estate fans become overconfident in the safety of their cash flows and the land bankers overconfident that the future will pan out.

I think with any active investing, most people will make mistakes. It seems very common that people at some stage are faced with things moving against them to the tune of something they find hard to cope with. My worst year I made mistakes that cost me 2M. With actual losses I had to take of 750k.

I had contact with a fellow I knew from 10 years ago. He was investing in RE since his early 20's. Like me, he is in his 40's. He has fallen on tough times and is down about 500k this year. It looks like his portfolio has been bleeding for a few years. He said he was thinking about consolidating his portfolio back to 1 property that he lives in. It would be quite depressing to only have the house you're living in after 20 years of active real estate investing. He has actually invested in quite a bit and done various seminars and read a lot. I think a lot of people go through a tough patch like that where they wonder whether they can regroup or give up. Leverage, overconfidence and buying at the wrong time in the cycle are mistakes that most people make.

A good thing about index investment is that you can potentially make very few mistakes and if you do this, you're more likely to do better than the average active investor.

I still think the core of active investing in real estate is to see the potential of the future. I saw this for the first time when an airport was announced near where I lived. Within 10 years the area had completely transformed from paddocks. For me that is where I see the best returns from real estate investing. The same applies for individual stocks. If you can cultivate the ability to see and buy an apple or google with a significant portion of your wealth and hold it for 10 years or hold land in an area that develops rapidly then that is an amazing thing. You only need to do this once or twice in your life to do very well as an active investor. Not many are able to do it but some do. In retrospect was it luck or skill ? It's hard to know.

[AlexxT]

Dont_know_mind wrote:

Real estate is very local but on average (averaged nationwide) is probably on average 1-2% below stock index LT return but the difference is made up by leverage. From my own limited sample size of experience, my net return on commercial CAGR has been 10%, residential 8%, vacant land 18%.

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Great post!  Thanks for that.  It would make a good blog post for WCI.

[StarTrekDoc]

The current laws favor real estate speculation.  One can quickly go from rags>riches>rags if not properly structured and leveraged.   Look at our President.  He saw the entire cycle and the first time around a single improperly structured deal can expose the entire organization--that's why corporations and he have thousands of lawyers to make these complex deals work --- for the speculation piece and rewards of those deals.

Now, for the smaller angel investors?  That's a lot harder to climb and leverage those amounts, but the concepts are the same regardless it be home, SBO office, commercial prop or residential rental.   Leverage and isolate each with LLC-like protection.

[Dont_know_mind]

Kamban wrote:

Dont_know_mind wrote:

If I had 1m, I think buying a vacant property and holding that would be less risk than buying it and putting another 2M in to build a building. To me the less risky thing is to sell the land to a guy who wants to build a hotel than to buy the land and build a hotel. The holding period for buy and hold land is longer but the ROI is higher, without the risk of much debt. You have to be able to identify real opportunity though and if you buy something on a single rationale like the example you citied, it might well be wrong. if it doesn’t work out you can always use it for storage or a cucumber farm or just sell it. I haven’t had a dud yet that I had to sell at a loss. It could be that I’ve just been lucky.

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It looks like you have specialized in this strategy and been disciplined and lucky.

I don’t think I have that much luck predicting with 90% certainty the future use and value of land. So the only option is to use it to generate an income. No one will buy a land + hotel from you unless you show a 3 year plus negative to positive returns ( most new ones don’t become profitable until end of year 2 of operations).

But buying land alone does not make it a certainty. A land next to a highway was held for 5+ years by a person but he could not continue to pay the loan’s “interest only” repayments and it went to foreclosure. The bank was left holding the land and they do not want to be a empty land owner. It does not generate any income and they hate it. By chance the VP knew my boss and mentioned it. We were willing to buy it at discount only if they finance the loan for building a hotel. They had no other choice and agreed if we could get the agreements in place. We have done that and the land closed a month ago and the hotel loan will close in the next 3 months. Luck certainly plays a part, but so does knowledge and shrewdness and a game plan to see it through.

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Perhaps I overestimated my ability to predict there and am guilty of overconfidence. Maybe it is more like 60% confidence (although it may feel like 90%), 40% of the time I'm wrong.

In terms of vacant land - it may not be completely vacant for tax purposes, there might be a small house there yielding 0.5% rental return or something. To me it is about seeing opportunity but also making sure you aren't hurt if you turn out to be wrong. 3 steps which are not easy:

1. Being able to see a high opportunity situation when you come across it.

2. Finding the balance of putting a significant amount of your wealth into what you think is an exceptional opportunity but not so much that you're hurt if it doesn't pan out.

3. Holding that well beyond where most people would have sold it because you see the potential runway.

The other parts, funding, being able to cope with negative cost of carrying, minimising tax are important but the critical aspect is being able to see opportunity and making sure inevitable mistakes don't hurt you too much.

Or you could hit to first base consistently over an extended period and achieve the same thing.

The way taxation is set up currently with capital gains concessions, even with land taxes/levies, I favour the capital gains route. But there are certainly other methods that are profitable for other people and perhaps it is lower risk That is just what I have seen and what has worked for me so far.

 

[Complete_newbie]

Dont_know_mind I think those numbers on ROI are probably true. Ability to project RE , to me, has been easier than to spot the next Netflix. Your airport example is great, I'm in midst of something similar.

Any successful venture has skill, effort and some luck. I try to minimize luck. Doing all this increases my skill. I keep making money despite losing some so I do it. Stock market goes up AND down. What do people do when it's down? Hold on.

In RE its greed. If you go for deals you can't service and it has no cash flow when you want you are stuck. Then people try to leverage their way out which is horrible. That's your friend story.

Anyways, all of these are just assets making money. I don't care what does what but there are non financial benefit to doing g RE or other ventures as I mentioned.

[Kamban]

StarTrekDoc wrote:

Leverage and isolate each with LLC-like protection.

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This is the key. Isolation of each property or set into separate LLC. Works for mega developers who can get loans that does not require personal guarantee from the main developers. The mid sized ones and lower end ones do not have that luxury. We are very careful when we buy land and build. We make sure that projections state that the income post routine expenses will at least cover the mortgage.

[Zaphod]

Complete_newbie wrote:

Dont_know_mind I think those numbers on ROI are probably true. Ability to project RE , to me, has been easier than to spot the next Netflix. Your airport example is great, I’m in midst of something similar.

Any successful venture has skill, effort and some luck. I try to minimize luck. Doing all this increases my skill. I keep making money despite losing some so I do it. Stock market goes up AND down. What do people do when it’s down? Hold on.

In RE its greed. If you go for deals you can’t service and it has no cash flow when you want you are stuck. Then people try to leverage their way out which is horrible. That’s your friend story.

Anyways, all of these are just assets making money. I don’t care what does what but there are non financial benefit to doing g RE or other ventures as I mentioned.

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In everything you mean.

Its the same no matter stocks, real estate, etc....you have success, you project out your own agencies role and downplay luck/etc...go in big, and....then comes the big failure.

Its nearly inevitable and hard to not do since we are so so so so very good at tricking ourselves into believing how we are different and have things under control. On the hand you have to take some risks, or you get little.

[Ghetto]

BladeRunner wrote:

It is a shame in some ways, but the trend of new physicians to seek hospital employment removes them from one opportunity for investment diversification beyond stocks and bonds. Buying or building your own office can be a way of forced savings that can be an important resource for retirement income or funds years down the road. There will be no more transparent financing and no more reliable tenant than yourself or your group. Paying off a multimillion dollar mortgage over a 15 or 20 year career and then collecting rent as income or selling your portion of the building to the remaining partners can be a very significant income stream for retirement..

With 4 kids, and no WCI training, I had no extra income to put money into a taxable account for many years. However, I paid down that monthly mortgage on our office buildings for 15 plus years and it has turned out to be my best investment, better than the S+P 500. The downside, and it is not insignificant, is that you cannot simply pull up stakes and leave your practice. You are committed to making it work.

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This is so true. I also see the trend of new physicians moving away from solo and group private practice into employment models decreasing their entrepreneurial and investment diversification opportunities.

The lamented illiquidity of real estate can be a boon if it essentially forces one to invest in the class over a long period of time. My building is an investment, yes, but it’s also my place of business so it serves dual purposes and I’m not going to get spooked and roll out of the investment at the drop of a hat like securities investors will often do. Your house is fairly illiquid as well but few complain about that as they need a roof to keep the rain off their head. And over time, both your house and commercial building can appreciate significantly. The only difference is that my building will keep sending mailbox money after I retire.

[Ghetto]

CREGuy wrote:

Man, there is a lot to respond to in this thread, but here are the main comments I have that jump out at me perusing the thread…

1. There is a clear disconnect that you see with the two camps of RE investment.  The truth is superior returns can be attained through real estate investment, however, to realize those returns, one must spend time and effort in both learning the nuances and developing the skills required to execute what’s learned.  So the disconnect is that for those who have a desire to put in the time (and quite frankly many people who are active in this arena have a passion for it, even if it’s not their main source of income), RE is an area where an enormous amount of wealth creation can be had.  However, for those who don’t wish to dedicate the time or effort and are seeking something completely passive, have no desire to learn about the nuances, etc. – those folks will do one of two things – either delegate to a third party (syndicator, crowdfunding, etc.), which eats into the returns as those people have to be compensated for filling that role that’s been vacated, OR they will simply jump into an investment without the proper knowledge, background, insight, and skills, and typically those deals are a coin flip on how they ultimately turn out.  In short, direct RE investment is a hybrid of a business and an investment.  If you are unable or unwilling to do or learn the business side of it, then other assets are probably better suited for your capital.

2.  Vacant land speculation is the worst way to invest in RE.  Buying vacant land that produces zero income, while at the same time bleeding you annually for property taxes (and worse interest if you’ve financed it) is a recipe for disaster.  Unless you have a clear, concise purpose in mind for the property (i.e. you’re going to develop it in the near future), you’re simply banking on someone, someday, coming along to pay you significantly more than what you paid for it originally.  You’ve done nothing with the property, and therefore have created no value.  Can you get lucky and have the area around it explode with new development that drives the value of your parcel up significantly?  Sure, but you’re relying on outside forces that you have no control over, that may or may not happen.  Honestly most land speculation deals aren’t even great investments if they do appreciate in value.  Your property taxes are going to eat up 5% a year or more in most places, so you need 5% in appreciation just to break even.  The real killer is that all that capital you have sitting around in the dirt, producing zero income for a long period of time (I think the poster who mentioned this had a 20 year timeline!).  That’s just crazy.  Your true break even on a 20 year timeline on a vacant parcel is going to be somewhere around a 250% gain, based on 5% property tax, and a modest 4% cost of capital, and that’s before you take into account the time value of those property tax payments.  That’s not to say nobody makes money on vacant land.  Everyone has heard a story of someone who bought a chunk of land for next to nothing and someone comes along with a big project and pays them top dollar for it, but those stories are the needle in the haystack of land speculators that would have been far better off shoving the money under their mattress.

 

3.  One thing that’s often never mentioned in the RE discussion is control.  If you own a piece of property, you can do whatever you want with it (within the bounds of zoning, lease constraints, etc.).  See a property that’s being underutilized?  Buy it, unlock it’s potential and reap the rewards.  See a stock that’s undervalued, perhaps because their execution on the operations side is lackluster?  You can buy it, but unless you’re a majority shareholder, you’re just along for the ride.  Your hope is that they correct those inefficiencies and it’s ultimately reflected in the share price, but you have zero control or say in those actions.

4.  The biggest wild card in the discussion of RE however, is the tax advantages.  Anyone who fails to take these into account when analyzing RE shouldn’t be taken seriously.  Can anyone else please point me to the investment that allows you to write off significant non-cash expenses against income?  More importantly, can anyone point me to the other investments that allow you to defer any tax liabilities on the sale of the investment if the proceeds are transferred into a similar vehicle?  Depreciation and the 1031 exchange are the tools that really drive significant returns to direct RE investment.  The depreciation allows you to shelter large portions of your income from the property annually.  There’s no depreciation fairy that you’re writing a check to.  In most cases the property is actually appreciating.  Now on it’s own, depreciation is simply a slight deferment of tax liability, as eventually if you sell the property, you have to recapture all that depreciation and pay Uncle Sam his share.  However, then we get into the 1031 exchange.  Sell that property that you’ve depreciated for a huge gain?  Go ahead and roll it over into another property (bigger? better? different location? more secure? more passive?) and there goes that tax liability on the capital gains, the depreciation recapture.  You don’t owe one cent to Uncle Sam, and you get to keep that money working for you and in your “pocket”.  Then it gets even better.  Just keep doing that until the day you die and you can pass it on to your heirs, they get a step up in basis, and you NEVER pay Uncle Sam his cut.  Again, if anyone can point me in the direction of other investments that can claim these same tax advantages and provide the same returns available in RE, I’m all ears…  These advantages don’t mean that direct RE is the end all be all for everyone.  Obviously if you’re the latter person in section 1, the tax advantages may not be enough to overcome the added work, poor returns due to lack of experience/knowledge, etc.  Even with the tax advantages, most of the time those folks are going to be better off putting their money elsewhere.

At the end of the day, like everything, it all comes down to personal circumstances.  There is no one size fits all when it comes to allocating capital.  For one person, index ETFs make the most sense and will provide them with the best returns.  For another perhaps a heavier allocation to direct RE makes more sense.  In the end, we must all decide what makes the most sense for our own personal circumstances.  Everyone should keep this in mind when having discussions such as this one.  Speaking in absolutes for either side can be misleading.

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I’m sorry to quote this wall of text, but I cannot recommend this post highly enough. I completely agree and appreciate the control and tax advantages that RE provides.

Also, I agree that holding vacant land is not the best strategy. It has a negative cash flow due to taxes and the nonproductive nature of dirt. Commercial development provides a steady stream of rents that pay down your mortgage, and if you’re doing triple net leases, your taxes as well.

[Complete_newbie]

Sure.

But people take no risks. Or like group risk. Not right or wrong but then they attribute someone who took risk and made it to luck. Nope. Not luck, its effort, smarts, calculated risks and luck. They downplay the work that went in and ability to opportunity grab.

[Dont_know_mind]

AlexxT wrote:

Dont_know_mind wrote:

Real estate is very local but on average (averaged nationwide) is probably on average 1-2% below stock index LT return but the difference is made up by leverage. From my own limited sample size of experience, my net return on commercial CAGR has been 10%, residential 8%, vacant land 18%.

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Great post!  Thanks for that.  It would make a good blog post for WCI.

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I think it would be great if WCI could interview crazyroadtodublin. I really want to know how he did it.

I think WCI once told him off for not having a reasonable portfolio. He has net 20-30m in stocks, with a highly concentrated portfolio in mainly Apple from what I remember and 30-65% leverage. I think he said his portfolio went down 80% during the GFC but then it increased 10 fold since then. That is a real outlier.

https://www.whitecoatinvestor.com/forums/topic/a-crazy-counterpoint/

 

[Zaphod]

Dont_know_mind wrote:

AlexxT wrote:

Dont_know_mind wrote:

Real estate is very local but on average (averaged nationwide) is probably on average 1-2% below stock index LT return but the difference is made up by leverage. From my own limited sample size of experience, my net return on commercial CAGR has been 10%, residential 8%, vacant land 18%.

Click to expand…

Great post!  Thanks for that.  It would make a good blog post for WCI.

Click to expand…

I think it would be great if WCI could interview crazyroadtodublin. I really want to know how he did it.

I think WCI once told him off for not having a reasonable portfolio. He has net 20-30m in stocks, with a highly concentrated portfolio in mainly Apple from what I remember and 30-65% leverage. I think he said his portfolio went down 80% during the GFC but then it increased 10 fold since then. That is a real outlier.

https://www.whitecoatinvestor.com/forums/topic/a-crazy-counterpoint/

 

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From what I recall CRTD (who apparently was at the conference and I didnt see!) sells naked puts on stocks he would like to own or rather wouldnt mind owning. Obviously this is profitable most of the time but can be savage and blow up your portfolio that one time (see Feb 5th for many in the volatility space).

The only issue I have with selling puts is that if said event occurs (and obviously depends on your chosen delta and instrument of choice) you usually wouldnt rather own those puts. Having recently been put to for the exact amount I was totally fine with owning just reinforced this to me. Verticals or covered calls are less profitable but more defined.

I think you know all about how futures and options can go.