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larrywww

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Reply with quote  #1 


I have been looking at alternative investments and comparisons between alternative investments---given my lack of enthusiasm about the current real estate market.

This was a graph created by an accountant at the end of 2016 to compare various returns (the website is called the Wealthy accountant):

[image]

There was also a Kiplinger article that made the following comparisions:


Earnings for All

https://www.kiplinger.com/article/investing/T052-C000-S002-earn-6-to-8-with-high-yield-bonds.html\

Given that I feel the market is very very inflated, I am not at all sure where to place funds at this point.  I don't really think that there are very many markets that are obversely correlated with real estate prices----that offer any kind of opportunity in the current market.

One can also invest in other things like:

1. Buy trust deeds (though what I see online frequently tend to be 2nds not 1sts and they are prone to the same asset inflation as current real estate)
2. Become a hard money lender
3. Investigate out of state investments (trust deeds, tax liens, etc)
4. Invest in real estate developments
5. Invest unsecured financing (I have never tried peer to peer lending)
6. I'm not enthusiastic about cryptocurrencies, but that is another possibility.
7. Invest in a business (but this would require some active management, not highly favored)
8. Investigate other licenses (one can try for an insurance license, though some investment type licenses require sponsors).





Do any of these investments make particular sense in the current market?


kaihacker

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It is hard to read the image's fine print but it looks like it says that for the sake of simplicity it does not take leverage or rent income into account.  That is a pretty major omission.  

Simplicity would not be my primary concern if one is really trying to create a fair comparison.  

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Jeff

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I personally don't see how ANY other investment can create the kind of returns that real estate does.  Right now my houses have a return on equity of 6.87%--and that does NOT include appreciation.  That is pretty much the floor.  If you factor in appreciation, then ROE jumps (some years) to 20% or even 30%. 

2017 was a particularly good year for me with ROE of well over 50%.

Trust deeds, hard money lender, trust deeds, tax liens, unsecured financing, peer to peer lending, and cryptocurrencies, all appear to me to have HIGHER unknowns and risks than a plain vanilla single family home portfolio...and nowhere near the potential upsides.

Am I missing something?


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Jeff

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BTW...

None of the comparisons I have seen between real estate and the Dow, or between real estate and any other investment...have fairly represented real estate's powers of leverage and tax benefits.  (or taken into account that the Dow of the 1920s is NOT the Dow of today...so saying that the "Dow" has gone up 6%...or 10%...is at best misleading)

The only way to make the comparisons close (it seems) is to handicap real estate.

For example...

_________________________________________________________________________________________

Reliable data on the value of real estate in the U.S. is murky before the 1920s. One inflation-adjusted value index between 1928 and 2012 placed the annual rate of appreciation for real estate prices at just 0.2%. The peak for real estate growth occurred between 2001 and 2005.

The inflation-adjusted appreciation on the Dow Jones Industrial Average (DJIA) over the same 84-year period was 1.6% per year. Compounded over time, that difference resulted in a fivefold greater performance for the stock market.

There aren't many investors with an 84-year investment horizon, though. Take a different time period: the 38 years between 1975 and 2013. A $100 investment in the average home in 1975 - as tracked by the House Price Index from the Federal Housing Finance Agency (FHFA) - would have grown to about $500 by 2013. A similar $100 investment in the S&P 500 over that time frame would have grown to approximately $1,600.

___________________________________________________________________________________

 

I don't like the example above (a $100 investment in the average home returning $500) because that is not how real estate works or how people invest in housing.  A more realistic example would be if you assume a 10% down loan on a 100k rental, and if you assume that the original rent pays for the mortgage (not unreasonable for 1975).

38 years later you would own a 500k house and have an income stream of 2k-3k a month or around 30k a year.  The return on your original investment would be enormous.   Your original 10k is now 500k (not to mention the 30k a year income).  That isn't, as the comparison above suggests, a 5 fold increase.  That is a 50 fold increase.  And if you add the 30k a year in rent that you have been putting in the bank for the last 8 years (having paid off the mortgage), you now have a 240k MORE money or about 740k...which is about a 74 fold increase.  

A similar 10k investment in the S&P 500 over that same time period would have grown to approximately 160k--and NO income stream.

740k vs. 160k.  Huh.

THAT, my friends, is a more "fair" comparison...and in any "fair" comparison, real estate has the edge.


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SFL

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Reply with quote  #5 
Quote:
Originally Posted by Jeff

A similar 10k investment in the S&P 500 over that same time period would have grown to approximately 160k--and NO income stream.

740k vs. 160k.  Huh.




"Everyone is entitled to his own opinion, but not to his own facts.”
      - Daniel Patrick Moynihan


Stocks do provide income streams, they're called "dividends" and they have historically been a major component of total returns.  

The below site calculates total return of the S&P 500, with all dividends reinvested:  

https://dqydj.com/sp-500-return-calculator/

For the period 1/1974 - 12/2013, the total return (including reinvested dividends) calculated by this site is 7,736%.  This means that your $10K would have grown into $784K (not $160K).

If you still owned this investment at the end of June 2018, it would have grown further, and would have been worth $1,296,300.

Inflation-adjusted, average annual compounding during this (1975 - current) time period would have gone down from a bit under 12% to a bit under 8%.

The current dividend return on the S&P500 is only 1.80%, so that $1.29 million would be yielding $23.3K in dividends per year at this time.  In other time periods, especially while markets have been depressed, dividend yields have been much higher.
  
I agree that there are issues with stock market indexes (especially the DJIA and especially way back when), but there are lots of issues with RE indexes as well.  How many of the houses in today's RE indexes existed 84 years ago?  Fact is that most of the houses have been torn down, replaced, and/or been subject to ongoing renovations and repairs over this time; as well as to real estate taxes and a whole host of other expenses.  Have these been taken into account in calculating RE index returns?  If so, how?

Averages don't tell you much about specific regions or about specific investments in those specific regions.  A nice middle class home in San Francisco has appreciated more than a nice middle class home in Detroit over the past 50 years - probably by orders of magnitude.  As Minh has pointed out, there are always opportunities.  However, one has to be careful and selective.  Sometimes those opportunities are all over place, and sometimes they are much rarer and much more difficult to find.  

Regarding the original topic of this thread, all of those return statistics are backward-looking and tell you nothing about what to expect in the next five years.  One has to have some understanding of what one invests in, and what the factors are that influence results.  Many people on this board have a pretty good understanding of real estate but don't have any familiarity with most of the other of the asset classes listed.  It almost always makes the most sense to stick to what one knows and to be careful and selective within one's own area of expertise.





Jeff

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Quote:
Originally Posted by SFL

Stocks do provide income streams, they're called "dividends" and they have historically been a major component of total returns.  


I will defer to you on this point...as you clearly have more experience in this area.  It was my understanding that SOME stocks have dividends, and some do not.  In general, dividends are not typical for stocks.

Rental property, in general, always pays "dividends."

 

Quote:
Originally Posted by SFL


The below site calculates total return of the S&P 500, with all dividends reinvested:  

https://dqydj.com/sp-500-return-calculator/

For the period 1/1974 - 12/2013, the total return (including reinvested dividends) calculated by this site is 7,736%.  This means that your $10K would have grown into $784K (not $160K).

If you still owned this investment at the end of June 2018, it would have grown further, and would have been worth $1,296,300.

Inflation-adjusted, average annual compounding during this (1975 - current) time period would have gone down from a bit under 12% to a bit under 8%.

The current dividend return on the S&P500 is only 1.80%, so that $1.29 million would be yielding $23.3K in dividends per year at this time.  In other time periods, especially while markets have been depressed, dividend yields have been much higher.
  
I agree that there are issues with stock market indexes (especially the DJIA and especially way back when), but there are lots of issues with RE indexes as well.  How many of the houses in today's RE indexes existed 84 years ago?  Fact is that most of the houses have been torn down, replaced, and/or been subject to ongoing renovations and repairs over this time; as well as to real estate taxes and a whole host of other expenses.  Have these been taken into account in calculating RE index returns?  If so, how?


 

 

It does not surprise me that you do not like the comparison in my post above...as I presented it as a BAD example of how the comparison between real estate and stocks is typically made (in this case by https://www.investopedia.com/ask/answers/052015/which-has-performed-better-historically-stock-market-or-real-estate.asp)

I am a little shocked by your counterexample.  Why would investopedia present such a relatively poor case for stocks when there was a better one to be made?

And, as far as counterexamples go...here is one I like:

I personally purchased a house in Clairemont in roughly 1974 (4901 Gaylord Drive, 92117) for roughly 50k...putting only 5% down.  I since sold it...but if I had kept it as a rental, and rents had covered my mortgage...I would be sitting on a goldmine.  That same house is now worth 750k...and would rent at $3,300 a month or almost 40k a year.

A 750k return on an original investment of $2k is about a 375x increase, and if I had used the same 10k you used in your example to buy 5 houses, I would have roughly 3.7 MILLION in real estate equity, and an income stream of roughly 200k a year.  If I had saved the roughly 200k a year in rents the 14 years or so that my mortgages have been paid off--that is another 2.8 MILLION or  6.5 MILLION.

6.5 MILLION vs $1,296,300.

Income stream of 200k vs. income stream of 23k.

I STILL don't see how any "fair" comparison of real estate to any other investment results in anything but real estate far in the lead.

 

 

 

 

 

 

 


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SFL

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Reply with quote  #7 
Quote:
Originally Posted by Jeff

It was my understanding that SOME stocks have dividends, and some do not.  In general, dividends are not typical for stocks.



According to the first line of the below article, 422 out of 500 S&P 500 stocks pay dividends.  So I'd say it is pretty typical!

https://cabotwealth.com/daily/dividend-stocks/highest-paying-dividend-stocks-sp-500/

It is correct that some stocks do not pay dividends.  Some of these are in opportunity-filled industries where the managers feel the shareholders get a better long-term return through the reinvestment of 100% of the profits into expanding the business, rather than forking over some of the profits to the shareholders.  Others of these companies are in trouble and can't afford to pay out anything.  Generally, well-run companies in mature industries have excess cash which they distribute to shareholders in the form of dividends.  

Failure to account for dividends by an investment professional constitutes gross incompetence.  Non-professionals can be forgiven for this, of course.  But seriously, an intelligent adult ought to know at least a little bit about the main asset classes!

Quote:


Rental property, in general, always pays "dividends."



Stocks generate dividends and rental properties generate rents - provided of course that they are not vacant and that the tenants are not deadbeats.  

Most of the comparisons I have seen show returns on equities over time to be not terribly dissimilar from returns on rental properties.  Usually unleveraged equities are a bit ahead of unleveraged real estate.

You can leverage anything you want, as long as someone lends you the money.  In 1929, people were allowed to borrow 90% of the cost of buying stocks.  They did, stocks shot to the moon, then stocks went the other way and leverage didn't look so smart anymore.  This ushered in the Great Depression.  

About 12 years ago, pretty much the exact same thing happened with real estate, for pretty much the same reasons - inadequately secured excessive leverage.

The secret of leverage is that whatever you buy with the borrowed money has to appreciate by more than the cost of the loans - you're in great shape if you get a 7% loan and whatever you bought goes up at a rate of 10%.  This is what happened during much of the 1970s.  

However, you're in terrible shape if you get a 7% loan and whatever you bought goes down instead of up - especially if it goes down a lot.  This is what happened about 12 years ago.  
 
It would be great if we all could go back to 1974 and, with the benefit of hindsight as well as the benefit of a loose 2005-era banker buy up entire California neighborhoods.  Unfortunately, we can't. 

The question which concerns both you and me now is the following:  Can we borrow money using fixed-rate self-amortizing loans at rates which are sufficiently low to with 100% certainty be able to purchase investment real estate today which easily will yield more than enough to pay off those loans and leave us with a nice profit?

I don't know the answer to that question.  Are you sure that you do?

In any case, I'm glad that you're having a good year!  

Jeff

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Reply with quote  #8 
Quote:
Originally Posted by SFL

The question which concerns both you and me now is the following:  Can we borrow money using fixed-rate self-amortizing loans at rates which are sufficiently low to with 100% certainty be able to purchase investment real estate today which easily will yield more than enough to pay off those loans and leave us with a nice profit?

I don't know the answer to that question.  Are you sure that you do?

 

 

F#ck no!

 

...

P.S.  Thanks for the lessons...my intent was never to say that I know what I was talking about...only that I have never seen what I consider a "fair" comparison of houses vs. stocks as investments.  I have seen plenty of bad comparisons though.  Do you know of a good one?


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Jeff

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Reply with quote  #9 
Quote:
Originally Posted by SFL


Most of the comparisons I have seen show returns on equities over time to be not terribly dissimilar from returns on rental properties.  Usually unleveraged equities are a bit ahead of unleveraged real estate.

You can leverage anything you want, as long as someone lends you the money.  

Yes unleveraged vs. unleveraged seems to indicate that stocks are better.  But that is like trying to answer the question "Is a man faster or a horse?" by running a race where both contestants are required to have their feet tied together.  Yes, the man will win that race...but that is not how horses run--and such a race will not tell you anything meaningful. 

Maybe stocks can win the "unleveraged foot race"...but that is not how people invest in real estate--and such a comparison, imho, does not tell you anything meaningful.

Perhaps there is a comparison to be made allowing BOTH stocks and real estate to take full advantage of leverage.  THEN see who wins THAT race.  That might tell you something meaningful. 

Once again I will defer to your greater experience...but it is my understanding that:

1.  Houses can be leveraged 20 to 1 or higher

2.  Houses can reliably produce enough income to cover the costs of leverage (and other expenses)

3.  Houses do not have a "call" during bad years.  You can keep your leveraged investment as long as you make the payments (which should be easy--see number 2)

4.  There are significant tax benefits to holding leveraged properties

On the other hand (here is where you can correct my errors):

1.  Stocks can typically only be leveraged 2 to 1

2.  Stock do not reliably produce enough income to cover the costs of leverage (and other expenses)

3.  Stocks DO have a "call."  One bad year can wipe out ALL of your gains--and even put you into debt.

4.  There are no significant tax benefits to holding leveraged stocks

 

...

Once again it seems as if real estate has a significant lead as an investment vehicle compared to stocks.

I respectfully await your lesson.

 

 

 

 

 


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SFL

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Reply with quote  #10 
Quote:
Originally Posted by Jeff

Perhaps there is a comparison to be made allowing BOTH stocks and real estate to take full advantage of leverage.  THEN see who wins THAT race.  That might tell you something meaningful. 



If you use the same amount of leverage at the same terms and conditions (interest rate, closing costs etc.) for two investments; and one investment yields 8%/yr unleveraged and the other yields 9%/yr unleveraged, then the 9% investment will provide a better overall return.  Actually, a much better return.

Here's why:  Suppose your leverage in this example costs a fixed 6% and (for the sake of simplicity) that there are no closing costs and there is no amortization, but that you are using 100% leverage and the loan needs to be repaid in ten years.

Here are the investment results for $10K invested under the above scenario:

8% investment  (interest differential is 8% - 6% = 2%)  

Total after 10 years = $10,000 x (1.02)^10 = $12,190, for a profit of $2,190

9% investment  (interest differential is 9% - 6% = 3%)

Total after 10 years = $10,000 x (1.03)^10 = $13,439, for a profit of $3,439

Under this scenario, the profit from the 100% leveraged 9% investment is 57% higher than the profit from the identically leveraged 8% investment.

If both of these assets keep up with inflation and the loan is not inflation-adjusted, then the benefits of leverage are even greater.  


As mentioned, you can leverage anything you want, as long as you can find someone to lend you the money. 

Real estate financing is the most attractive long-term financing available to the general public.  The rates are fixed, the terms are up to 30 years, and the loans cannot be called as long as you're making the payments.  These are extremely attractive characteristics in a loan.  

If you are starting out with nothing, then the only way of taking advantage of real estate financing is to buy real estate.  

However, if you have plenty of equity in your home, there is nothing to prevent you from mortgaging (or re-mortgaging) your home and using the proceeds for any investment your desire.  (Lots of people have financed businesses this way). 

Investment interest is deductible, and if you are using the proceeds from the home refinancing for a business or a basket of stocks, it is deductible.  

Here are the rules:

https://turbotax.intuit.com/tax-tips/investments-and-taxes/what-are-deductible-investment-interest-expenses/L9TeFQAf9

Whether an "average" house or an "average" stock has done better historically is not a particularly useful argument.  In a scale business - say large apartment complexes - the expected returns can be expected to be similar to those of a basket of stocks, because at that scale all capital assets are in competition with each other.  

The biggest advantages in real estate are conferred on people buying a home for their personal use, because they not only get the best financing and a place to live, but also are eligible to take a $250K capital gains exclusion every two years.  The people best able to take advantage of this are flexible, energetic, handy and have a feel for how to buy low, add lots of value using their own labor, and sell high.  These folks can in theory make $250K every two years without paying a penny in taxes.  These are the people who can take full advantage of the fantastic opportunities available in real estate that are not available in other asset classes.  However, the vast majority of people don't have the skill set, the energy, the motivation, the understanding family, and the geographic stability required to take full advantage of these great opportunities.  

Quote:


...it is my understanding that:

1.  Houses can be leveraged 20 to 1 or higher

2.  Houses can reliably produce enough income to cover the costs of leverage (and other expenses)

3.  Houses do not have a "call" during bad years.  You can keep your leveraged investment as long as you make the payments (which should be easy--see number 2)

4.  There are significant tax benefits to holding leveraged properties



1.   You probably have more knowledge than I do regarding the extent to which a house can be leveraged.  The general rule used to be that 20% down was required, but for primary residences this might well have been reduced to 10%, 5% or even 3% under certain circumstances.  I don't have this information.

2.   I would disagree with the use of the word "reliably", and would feel more comfortable using the word "often".  The lower the leverage, the more that can go wrong without getting into trouble.  

3.   It is correct that typical mortgage financing cannot be called as long as you are making the payments.  This is a tremendous benefit of such financing.  Regarding the "this should be easy" part, sometimes it is not easy at all.  As you well know. 

4.   Tax benefits of interest deductibility are available for all investments, not just for real estate investments.  


Quote:


On the other hand (here is where you can correct my errors):

1.  Stocks can typically only be leveraged 2 to 1

2.  Stock do not reliably produce enough income to cover the costs of leverage (and other expenses)

3.  Stocks DO have a "call."  One bad year can wipe out ALL of your gains--and even put you into debt.

4.  There are no significant tax benefits to holding leveraged stocks



1.   The easiest way to leverage stocks is by keeping them in a "margin account" and incurring "margin debt".  The initial "margin requirement" is 50%, so if you want to buy $100K in stocks, you have to come up with at least $50K in cash.  

The brokerage firm may allow your stocks to decline somewhat without making a "margin call", but if they decline too much you will get a "margin call" and have to figure out how to come up with additional cash immediately.  Not only that, but if you are in breach of the margin requirements the brokerage firms have the right to sell your stocks in order to cover margin debt even without calling you first, should they feel the need to do so.  Here are the rules on margin borrowing:

https://www.sec.gov/reportspubs/investor-publications/investorpubsmarginhtm.html

However, there is nothing to prevent you from using some source of financing other than margin loans to finance purchases of stock.  As mentioned above, a very safe way of getting a long-term non-callable fixed rate loan for this purpose (or any other purpose) is by refinancing a home. 

2.  I agree with the use of the term "do not reliably", and it is my view that the same term should be applied in the case of real estate investments.  

As an aside, lots of people in recent years have been speculating in stocks with borrowed money.  A few stocks yield a lot more than current interest rates, and Interactive Brokers in particular is known for having (or having had) very low margin rates.  Of course, these stocks are to some extent being propped up with borrowed money by speculative buyers, and this poses risks and potential buying opportunities in the future.

The most gambling-inclined people are busy speculating with stock options, which provide a huge amount of leverage without any meaningful margin requirement.  This also poses systemic risks.  If we have a major market crash, stock options and the hidden leverage lurking behind them will probably have something to do with it.  

3.   Yes, margin debt can be "called" as mentioned above.

4.   This is incorrect.  Margin interest is deductible, as is interest on any other kind of loan used for buying stocks.  


A typical problem in the real estate industry is that people get addicted to debt - they just take every loan that someone will give them, and assume that everything will work out.  This was one of the things pointed out by Sam Zell in his book (recently mentioned in a thread or two).  When an astute investor has calculated that the market will bear, say, one new apartment building; and when you the following year notice that there are six new apartment buildings going up and not just one, it should be obvious that there will be way too many apartments in the market and that the only way for the capacity to get absorbed is by drastically reducing rents - which leads to the 90% mortgages not being repayable and a bunch of real estate investors going belly up.  

This happens all the time.  

The best opportunities in real estate tend to occur after these guys have gone belly up, and the reason the opportunities are so good is that everyone who has experience already is either broke or in debt up to their eyeballs, and in either case not able to act on these wonderful opportunities.

So here are two reasons not to use too much leverage:

1)   You sleep a whole lot better; and

2)   You retain the ability to take advantage of the great opportunities that become available at the precise times when most of the other experienced players are out of the game.  




Jeff

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Reply with quote  #11 

First of all, I want to thank you for sharing your knowledge with me.  I find this topic is very interesting and relevant…but I have been a little negligent in my “continuing education” lately.

So thank you.

Having said that…I have some comments…


Quote:
Originally Posted by SFL



If you use the same amount of leverage at the same terms and conditions (interest rate, closing costs etc.) for two investments; and one investment yields 8%/yr unleveraged and the other yields 9%/yr unleveraged, then the 9% investment will provide a better overall return.  Actually, a much better return.

Here's why:  Suppose your leverage in this example costs a fixed 6% and (for the sake of simplicity) that there are no closing costs and there is no amortization, but that you are using 100% leverage and the loan needs to be repaid in ten years.

Here are the investment results for $10K invested under the above scenario:

8% investment  (interest differential is 8% - 6% = 2%)  

Total after 10 years = $10,000 x (1.02)^10 = $12,190, for a profit of $2,190

9% investment  (interest differential is 9% - 6% = 3%)

Total after 10 years = $10,000 x (1.03)^10 = $13,439, for a profit of $3,439

Under this scenario, the profit from the 100% leveraged 9% investment is 57% higher than the profit from the identically leveraged 8% investment.

If both of these assets keep up with inflation and the loan is not inflation-adjusted, then the benefits of leverage are even greater.  


As mentioned, you can leverage anything you want, as long as you can find someone to lend you the money. 

Real estate financing is the most attractive long-term financing available to the general public.  The rates are fixed, the terms are up to 30 years, and the loans cannot be called as long as you're making the payments.  These are extremely attractive characteristics in a loan.  

If you are starting out with nothing, then the only way of taking advantage of real estate financing is to buy real estate.  



I didn’t exactly start out with “nothing”…but no bank in their right mind should of loaned me, a complete investor newbie, well over 2 million dollars to buy houses all over the country.

God bless America.

Quote:
Originally Posted by SFL



However, if you have plenty of equity in your home, there is nothing to prevent you from mortgaging (or re-mortgaging) your home and using the proceeds for any investment your desire.  (Lots of people have financed businesses this way). 

Investment interest is deductible, and if you are using the proceeds from the home refinancing for a business or a basket of stocks, it is deductible.  

Here are the rules:

https://turbotax.intuit.com/tax-tips/investments-and-taxes/what-are-deductible-investment-interest-expenses/L9TeFQAf9

Whether an "average" house or an "average" stock has done better historically is not a particularly useful argument.  In a scale business - say large apartment complexes - the expected returns can be expected to be similar to those of a basket of stocks, because at that scale all capital assets are in competition with each other.  

The biggest advantages in real estate are conferred on people buying a home for their personal use, because they not only get the best financing and a place to live, but also are eligible to take a $250K capital gains exclusion every two years.  The people best able to take advantage of this are flexible, energetic, handy and have a feel for how to buy low, add lots of value using their own labor, and sell high.  These folks can in theory make $250K every two years without paying a penny in taxes.  These are the people who can take full advantage of the fantastic opportunities available in real estate that are not available in other asset classes.  However, the vast majority of people don't have the skill set, the energy, the motivation, the understanding family, and the geographic stability required to take full advantage of these great opportunities.  



1.   You probably have more knowledge than I do regarding the extent to which a house can be leveraged.  The general rule used to be that 20% down was required, but for primary residences this might well have been reduced to 10%, 5% or even 3% under certain circumstances.  I don't have this information.



…and MY information is old.  However, there was a time about 15 years ago where 100% financing was relatively common.  I, myself, purchased all of my rentals using 100% borrowed money.  You could argue, I suppose, that my leverage ratio was infinite…and that my ROI was likewise infinite.

All that changed after the crash of course…but 10% down loans are coming back, as well as some 5% loans, and I just read an article about 3% down loans for first-time buyers.  I recently did a cashout refi on two homes in SLC…and the bank didn’t care that I had more than 10 rentals, and even allowed me to do to 90% LTV on a rental.  90% on a refi of a rental!  You couldn’t do that 5 years ago!


Quote:
Originally Posted by SFL


2.   I would disagree with the use of the word "reliably", and would feel more comfortable using the word "often".  The lower the leverage, the more that can go wrong without getting into trouble.  



Nothing in investing is guaranteed…but I think that we, as competent investors (or lucky in my case), can relatively easily find a house in a market somewhere in America that will cashflow. 

Do ALL houses cashflow?  No.  But I am not making that claim.

As for lower leverage being “safer”…I get what you are trying to say, but lower leverage has costs/risks too.  Lower leverage leads to lower returns, fewer purchases, and more missed opportunities.

Also, when mudslides or earthquakes hit your 10 houses, and they are not covered by your insurance, do you want to have owned them outright or had 100% loans on each of them?  High leverage actually minimizes some risks.

Quote:
Originally Posted by SFL



3.   It is correct that typical mortgage financing cannot be called as long as you are making the payments.  This is a tremendous benefit of such financing.  Regarding the "this should be easy" part, sometimes it is not easy at all.  As you well know. 



You said it brother!

Quote:
Originally Posted by SFL

 

4.   Tax benefits of interest deductibility are available for all investments, not just for real estate investments.  



I thought it would be obvious that I wasn’t talking about interest deductibility.  Spending a dollar to deduct a dollar from your income is no way to make money…and certainly not a “significant” tax savings.

Real estate investing has the significant and meaningful advantage of taking depreciation (which costs you nothing, zero, nada) off of your taxable income.  This is essentially free money from the government to subsidize your investment.  Do leveraged stocks offer that?  I think not.

Quote:
Originally Posted by SFL


1.   The easiest way to leverage stocks is by keeping them in a "margin account" and incurring "margin debt".  The initial "margin requirement" is 50%, so if you want to buy $100K in stocks, you have to come up with at least $50K in cash.  

The brokerage firm may allow your stocks to decline somewhat without making a "margin call", but if they decline too much you will get a "margin call" and have to figure out how to come up with additional cash immediately.  Not only that, but if you are in breach of the margin requirements the brokerage firms have the right to sell your stocks in order to cover margin debt even without calling you first, should they feel the need to do so.  Here are the rules on margin borrowing:

https://www.sec.gov/reportspubs/investor-publications/investorpubsmarginhtm.html

However, there is nothing to prevent you from using some source of financing other than margin loans to finance purchases of stock.  As mentioned above, a very safe way of getting a long-term non-callable fixed rate loan for this purpose (or any other purpose) is by refinancing a home. 



With either the margin account, or the refinancing your house technique, are your dividends going to pay for your carrying costs separate from your appreciation/return?  To my inexperienced mind, that doesn’t seem likely.  I am interested to hear your experience on this matter.

Quote:
Originally Posted by SFL



2.  I agree with the use of the term "do not reliably", and it is my view that the same term should be applied in the case of real estate investments.  

As an aside, lots of people in recent years have been speculating in stocks with borrowed money.  A few stocks yield a lot more than current interest rates, and Interactive Brokers in particular is known for having (or having had) very low margin rates.  Of course, these stocks are to some extent being propped up with borrowed money by speculative buyers, and this poses risks and potential buying opportunities in the future.

The most gambling-inclined people are busy speculating with stock options, which provide a huge amount of leverage without any meaningful margin requirement.  This also poses systemic risks.  If we have a major market crash, stock options and the hidden leverage lurking behind them will probably have something to do with it.  

3.   Yes, margin debt can be "called" as mentioned above.

4.   This is incorrect.  Margin interest is deductible, as is interest on any other kind of loan used for buying stocks.  



We seem to disagree here about what constitutes a “significant” tax advantage.  Please see above.
 
Quote:
Originally Posted by SFL




A typical problem in the real estate industry is that people get addicted to debt - they just take every loan that someone will give them, and assume that everything will work out.  This was one of the things pointed out by Sam Zell in his book (recently mentioned in a thread or two).  When an astute investor has calculated that the market will bear, say, one new apartment building; and when you the following year notice that there are six new apartment buildings going up and not just one, it should be obvious that there will be way too many apartments in the market and that the only way for the capacity to get absorbed is by drastically reducing rents - which leads to the 90% mortgages not being repayable and a bunch of real estate investors going belly up.  

This happens all the time.  

The best opportunities in real estate tend to occur after these guys have gone belly up, and the reason the opportunities are so good is that everyone who has experience already is either broke or in debt up to their eyeballs, and in either case not able to act on these wonderful opportunities.

So here are two reasons not to use too much leverage:

1)   You sleep a whole lot better; and

2)   You retain the ability to take advantage of the great opportunities that become available at the precise times when most of the other experienced players are out of the game.  



My addiction to debt has been solved by the fact that I can find no bank that will lend to me (so far…can you hook me up?). 

Otherwise I would definitely be looking to score some more.  It’s a very sneaky and insidious addiction.


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brycewheeler

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Reply with quote  #12 
WOW!!!  Thank you Jeff and SFL for a great in-depth analysis of real estate versus other investments.

Just goes to show you that we have some of the "smartest guys in the room" on this Chat Board.

Bryce
taddyangle

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Reply with quote  #13 
Quote:
Originally Posted by Jeff

I personally don't see how ANY other investment can create the kind of returns that real estate does.  Right now my houses have a return on equity of 6.87%--and that does NOT include appreciation.  That is pretty much the floor.  If you factor in appreciation, then ROE jumps (some years) to 20% or even 30%. 

2017 was a particularly good year for me with ROE of well over 50%.

Trust deeds, hard money lender, trust deeds, tax liens, unsecured financing, peer to peer lending, and cryptocurrencies, all appear to me to have HIGHER unknowns and risks than a plain vanilla single family home portfolio...and nowhere near the potential upsides.

Am I missing something?



Jeff,

I love real estate and for us, it has in fact been life changing.  

I think it is important to note that the 6.87% return you are currently earning is not the floor.  When the next down turn occurs and housing prices go down, you must also account for rents going down and therefore the ROE will also go down.

We have not as much success with other investments when compared to real estate.  So we stick with what we know.  Our focus now is to pay off the loans we have in preparation for the next downturn.  It allows for us to have comfort in our investment strategy. 


In our particular example:

if we pay the following towards principal  > this is the savings in interest.

extra Principal paid >   Interest Saved

$10  > $21k
$25k > $47k
$50k > $76k
$75k > $95k
$150 > $115k  (what is needed to pay this loan off)

As I work this out, it seems to me that paying off the loan may not be the best bet to maximize ROI, but it may be more advantages to pay down a few different loans.  All dependent on interest saved.  Monthly cash flow is not an issue, so I will not factor that in as part of the decision making process. 

Seems to me that a extra payment of $25k will yield a savings of $47k, this is almost a 100% return on my money.  Am I missing something in my logic?  


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SFL

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Reply with quote  #14 
Quote:
Originally Posted by Jeff
As for lower leverage being “safer”…I get what you are trying to say, but lower leverage has costs/risks too.  Lower leverage leads to lower returns, fewer purchases, and more missed opportunities.

Excessive leverage can also lead to lower returns and missed opportunities.  If it were possible to accurately predict returns, then leverage could always be optimized.  Since this is not possible, there is much to be said for moderation.


Quote:
Also, when mudslides or earthquakes hit your 10 houses, and they are not covered by your insurance, do you want to have owned them outright or had 100% loans on each of them?  High leverage actually minimizes some risks.


This is an interesting point.  Shifting the losses to the financiers could work if the loans are non-recourse, which may be the case with purchase-money mortgages in some states.  I don't think this generally holds for refinancings or any other with loans aside from purchase-money mortgages, but I have not researched this in the past decade or so, and may be wrong.  


Quote:
Real estate investing has the significant and meaningful advantage of taking depreciation (which costs you nothing, zero, nada) off of your taxable income.  This is essentially free money from the government to subsidize your investment.  


Depreciation is not a concept exclusive to real estate; it applies to any property used for business which has an expected life which is not infinite but which does exceed a year.  In the case of rental housing, the standard depreciation time appears to be 27.5 years.  

It does cost you something to be able to deduct this depreciation - first you have to buy the asset!!!  The fact that you are doing this with borrowed money does not alter the fact that you own an expensive asset which you only can write off over 27.5 years.  Note that only the house can be depreciated, not the land underneath it.  Land is assumed to have an unlimited useful life.  

There are two additional relevant issues:

1).  In the case of real estate, this depreciation is often at least to some extent fictional.  Most housing does not actually lose all of its value in 27.5 years.  The problem with this is that the depreciation gets "recaptured" when you sell the property and this fiction is exposed.  So when you sell the house, you have to repay the government for taking the excess depreciation.

However, it is my impression that the following holds true:

a) you have the benefit of using these depreciation credits until such time as the depreciation is recaptured, often years or decades later; and

b) you can continue postponing depreciation recapture as well as capital gains by 1031:ing into something else, over and over if necessary; and

c) you can continue avoiding these taxes forevermore if you die while still owning the post-1031 assets, thereby benefiting from the step-up in tax basis.  Or rather, thereby benefiting your heirs through the step-up in tax basis.  (Alternatively, you may be able to benefit your favorite charities through gifting - or part-sale part-gifting - such assets to such charities)

2) If you are holding the real estate directly (rather than through a non-pass-through entity), then the depreciation will show up on your personal tax return rather than on that of the non-pass-through entity.  This can be very useful if you have a high income that you need to offset.  (You still have the recapture problem, but you may be able to postpone that problem by decades, and you may be able to take deductions in high-tax years and save the recapture for low-tax years).


Quote:

With either the margin account, or the refinancing your house technique, are your dividends going to pay for your carrying costs separate from your appreciation/return?  


Generally not in the short term.  Perhaps in the long term.   Companies generally only distribute a portion of their earnings to shareholders, retaining the other portion in order to finance growth and other priorities.  Therefore, dividends often rise over time.  So you'd generally (but not necessarily always) have negative cashflow in the short term if you attempted this.  In many cases you'd have positive cashflow in the long term, but there is no guarantee that this will occur, either.

Just like there's no guarantee that your rents always will continue to rise faster than your expenses, etc.

I am not a CPA or tax attorney, and nobody should rely on anything in this thread without double-checking it.


SFL

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Reply with quote  #15 
Quote:
Originally Posted by taddyangle


We have not as much success with other investments when compared to real estate.  So we stick with what we know.  Our focus now is to pay off the loans we have in preparation for the next downturn.  It allows for us to have comfort in our investment strategy. 


In our particular example:

if we pay the following towards principal  > this is the savings in interest.

extra Principal paid >   Interest Saved

$10  > $21k
$25k > $47k
$50k > $76k
$75k > $95k
$150 > $115k  (what is needed to pay this loan off)

As I work this out, it seems to me that paying off the loan may not be the best bet to maximize ROI, but it may be more advantages to pay down a few different loans.  All dependent on interest saved.  Monthly cash flow is not an issue, so I will not factor that in as part of the decision making process. 

Seems to me that a extra payment of $25k will yield a savings of $47k, this is almost a 100% return on my money.  Am I missing something in my logic?  



The textbook answer is that you should pay off those loans that bear interest at higher rates than the investment returns you can make through the reinvestment of that money, taking into account tax effects.  

So if you're borrowing at a fixed 7% but only can get a 3% return; pay off the 7% loan rather than re-investing at 3%.

But if you're borrowing at a fixed 3% and with absolute certainty can get a 7% return, reinvest at the 7% return rather than paying off the 3% loan.  

Of course, the textbook assumes many things, including that there is such a thing as certainty, and that there is no such thing as being either more or less comfortable with one's financial situation.

My personal preference is to be quite conservative with leverage, and I would generally lean towards getting rid of debt even if there were to be somewhat higher returns available in the marketplace.

One caveat though.  For people who are able and experienced RE investors with a long-term commitment to their field and a good feel for the marketplace, and who are able to get low interest self-amortizing long-term loans, I think there still may be some good long-term opportunities out there.

The Federal Reserve has been pushing as hard as it can to attain 2% inflation, and I suspect that at some point it will probably succeed in this, at least.  

If one still can get a 30-year loan at 4%, and if we have a steady 2% inflation in the future, the real rate of the loan would only be 2%.  If inflation ends up being higher, than the real rate would be even lower.  If such a loan were to be used to finance a well-selected, well-located property which is intended to be kept for the long term and where rents are satisfactory now and likely to rise at least along with inflation, then this could work out very well.








taddyangle

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Reply with quote  #16 
Thanks for responding.  

We are selling (should close next week) a CA property and trying to figure out best way to invest the proceeds.  

As far as the text book response, I get it, very often it seems the text book response does not apply.

Right now I am inclined to "invest" $75k in paying down the mortgage. 

I am really looking for a logic check here.

$75k paid now allows for the loan to be paid off in 10 years (otherwise 26.5 yrs).  Once the loan is paid off the $900 payment goes away.  This saves $100k in interest.  So we save $10k a year for 10 years and on the 11th year the loan is paid in full.  Of course the monthly loan payment stays the same, but that seems like a worthy trade off to me.

We looked at doing the same thing with a property we have owned for 13+ years with the original loan, but a little more than half the payment is towards principal, so no where near the savings.  We have a few other fixed loans less than 3% so those will stay, as they too make no sense to pay off.  





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