Wednesday, September 26, 2012

Real Estate can be a much better retirement plan than traditional passive investments

Rental Income Produces A Better Return Than Wall St.


Let's face it.  The times of gradual yields from a typical stock have faded into the pre-mortgage melt down days.  Private equity firms are offering much higher yields for purchasing percentages of certain securities of their unwanted assets, claiming up to a 19% return.  If that sounds too good to be true... it more than likely is.  Aside from that, S&P's 500 is offering typical returns of 2% to 6% for their average junk bond.  Across the map, stock investing is less than average based on its averages.

Current trends are shifting to more tangible assets.  Primarily, real estate.  Specifically, rental property.  Buying a distressed property such as a foreclosure or short-sale at a significant discount can offer "hard to believe" returns in comparison to any typical investment vehicle offered on Wall St.  

Let's say you purchase a property from someone like OCWEN, BofA, Fannie Mae, Freddie Mac, or any other bank that has a massive amount of REOs.  More than likely, you can purchase that property for nearly half of it's after repair value.  After repair value is exactly as it states... A fair market value equivalent to it's comparables in updated marketable condition.  Typically, another 15% to 20% of that after repair value will be applied to repair the distressed asset.  With that added into the equation, the average investor is left with about 30% to 35% equity capture.  If the property's after repair value is $200,000.00, that leaves you with around $60,000 to $70,000 in equity.  
A standard rule for rental averages in the DFW marketplace typically allow for a property to have a rental rate of 1% of it's after repair value.  Using the previous example, the property would rent for around $2,000 per month.  If you were to cash out what liquid assets you have placed into the property with a mortgage,  your PITI (principle, interest, taxes, and insurance) payment would be near the amount of $1400 per month. That leaves the investor with what is called "cash flow" of around $600 per month.  

The strategy is to hold the investment until the mortgage placed on the property is completely paid off.  Since the investor has a tenant paying rent, the mortgage is paid by the tenant and the investor is simply profiting each month the difference of the rent minus the mortgage.  Once the mortgage is satisfied, the investor can choose to sell the asset.  Because the property has seasoned for the term of the loan (typically 15-20 yrs), there will be appreciation to factor into the value.  Using conservative appreciation at 2% of the term over 20 years, the value will have increased to just shy of $300,000.  

Obviously, there will be some renovation costs and some un-forseen instances.  Assume costs of 30,000 are to be subtracted from the selling price along with realtor fees and closing costs of an additional 20k, this investor will walk from the closing table with around $250,000.  Keep in mind that your passive income of $600 a month from this property over 20 years have not been accounted for.  Tax benefits are also unaccounted for as well, but that is for another blog.

This is one of my retirement plans, and it is proving to be an extremely profitable one.  I have others, but those are for different blogs as well.


  1. Im all for the real estate investing but with the current government I have concerns that this market and the future of real estate is unclear. The inventory is my main concern now, there seems to be a lot less...but I know that there are just as many distressed sellers out there, where is it all going and is there going to be a second drop in prices after the election...?

    1. I agree that there is an overwhelming amount of uncertainty within our current executive and legislative governmental condition. While I'd rather remain ambiguous as to my stance in political issues, I have seen some progress in the direction our nation has been driven in the past 4 years following one of the worst economic states our nation has come to see. By no means am I in agreement to every piece of legislation passed (and I'd rather not get started as I tend to get a bit heated on the topic), but there has been some good and there is evidence to support it. I think the decrease in inventory you are noticing is not necessarily a miraculous improvement of our economy. My observation (atleast in the DFW marketplace) is a staggering increase of short sales as well as loan re-mods through the HAMP (Home Affordable Modification Progam) which are effecting the "decrease" in foreclosure activity. Although some financial reports would advise differently, there is still a massive amount of shadow inventory containing defaulted assets. My guess to the improvement of the bank's financials is that there have been multiple amounts of massive purchases from private servicing companies, hedge funds, and more recently REITs. I would say that overall there is still plenty of "inventory" for the average investor to go around and then some. While I can't speak for the national marketplace (aside from what I read), I can say that I personally have purchased nearly 200 single family properties in the DFW marketplace alone this year.

      As for a second drop in prices after the election, I don't personally see why there would be. I have seen double, triple and even quadruple dips over the past 4 years in particular marketplaces across our nation. As of recent I have seen slight economic job growth and a common increase in values across the board. I think the answer to that question lies solely on the candidate elected and their economic agenda.