monkeys, as I´m sure many can attest, RE is hot right now, I am continuing to get inquiries from clients wanting a piece of the action but since my answer seems to be the same every time, I wonder if I'm missing something. here's an example of the type of deals being pitched to my clients
$1mm property value
12.5% gross rents or $125k/yr gross
20-30% property management, assume the midpoint of $31,250
$10k maintenance costs
$83,750/yr before debt service (assume 4% int so $40k/yr)
leaving you with $43,750/yr income or 4.375%
while this is a higher yield than the DJIA or SPY gives you, it's still not all that compelling to me when you consider the illiquidity of it. if I add in potential price appreciation, 10y case shiller returns are in the 7.5% range versus SPY of 12-14% and longer term (30y) is more like 4%, so still inferior to stocks.
what am I missing? with numbers like this it doesn't make any sense for an LP to invest in real estate if they're purely looking at CAGR. I suppose if the stock market scares them or they like to "touch" their investments, there's that, but I cannot seem to bring myself to be "for" investing in RE unless it's something you mange yourself (avoiding management costs) or you buy at a deep discount.
thoughts?
On your math that’s like a 15ish percent cash on cash assuming 70% leverage, which is a huge return. Think you’re just thinking about the wrong metric here as an individual cares about how much cash is coming in compared to how much they’re outlaying. This is the perfect Example of the power of leverage you can get on real estate.
And because of the underlying assumption that the leverage won't ever blow up in their face it's a safe investment. I'm starting to get it, appreciate it. Maybe it's my aversion to using leverage full stop that's put a mental block on my understanding, I prefer to be 100% long only, no leverage
Numbers seem a wonky (20-30% PM, assuming these are fees and not other operating expenses, are egregious). But ignoring that for a second two main things to consider:
Leverage is fundamentally what makes the asset class attractive for a lot of people, especially on post-tax basis for the income (Mort Interest + Depreciation deduction). I would argue most companies you are buying on the public equity side are levered, maybe not 70% but still use debt, so unless you are intentionally buying companies with no debt you will always have some exposure. Best thing here is maximize leverage relative to blow up risk, i.e. always enough room to be in compliance with loan covenants on a down cycle.
GP/Operator is likely the most important part of the deal in these small private syndications. Not sure how involved you are here but I would recommend your clients really only invest with experienced operators/those who have a track record or people they know/trust. Who is signing for recourse/carve-out guaranties, can they survive without transaction fees/promotes coming in the door, etc.
Lot of grifters these days raising money on twitter and elsewhere just given the demand for private syndications but highly doubt their ability to navigate a down cycle. Most people are charging ridiculous fees in the non-institutional space. Tenants leave, shit breaks or burns down, you trip a loan covenant - you need somebody who knows their head from their ass so your clients are not getting capital calls left and right.
As always diversification is king, across asset types (industrial, multifamily, etc.), across GP/operators, and number of deals. Depending on how cheap REITS trade over the coming months I would just increase allocation there and save the hassle/illiquidity.
I think you misspelled "Grant Cardone"
This - you're deducting costs for debt service but not accounting for the benefits of the leverage that comes with it.
not sure if I understand the question/premise.... nobody claims real estate "outperforms" stocks.... it's a yield driven real asset. Most institutional investors hold for the consistent yield (like actual cashflow) that it generate to cover actual liabilities/expenses of the investor. The fact real estate can appreciate, grow income, even with capex makes it an effective growing perpetuity. So, from a risk spectrum comparison, it sits somewhere between bonds and stocks. Since correlation is generally much less than 1 with stocks (this is difficult to really parameterize given the infrequency of "trading"), it will usually improve any efficient frontier calculation... hence why all institutional investors have been increasing their real estate allocations for decades.
also thebrofessor, your example with leverage doesn't make sense. You charge interest (apparently on $1m million on debt), but don't adjust for actual equity invested as a result (which in your example would be zero, so now infinite returns by calc). If you did 70% leverage (at 4% interest only), debt service would be $28k, so cash flow (before tax) would be $55,750 for a 18.58% yield ($55,750/$300,000).
What a try hard with that second decimal
As others are pointing out, you're subtracting debt service without actually giving the investor the benefit of the leverage. Lets say it's a 70% LTV loan. $28,000 in d/s a year (keeping it interest only for simplicity's sake). That's $55,750/yr, over an equity investment of $300,000, so your returns are more like 18.6%
And even that doesn't tell the whole story, because you should be able to structure your deal to take advantage of depreciation (I guess it depends on how much real estate investing your client is doing), which juices your returns still further by offsetting tax liability. Now, I have my questions about the assumptions in this deal (which I understand are not "real" and just for the purpose of discussion), but I think that qualifies as roundly outperforming the stock market.
Moreover, I think liquidity concerns can be a little overemphasized. Sure, you have 300k locked away, and you probably need 30+ days to access it in some form or another. It's also hard to imagine someone wealthy enough to make this kind of investment who doesn't also have access to other forms of liquidity. And it's not like liquidating equities doesn't come with it's own form of punishment in the form of taxation, even if it's deferred for some months.
You use leverage, you get rents, and you refinance tax free. You get your money out of the deal by refinancing. No money in the deal and you still get rent and money from refinancing.
If you’re in stocks, you can never really get your money out of the deal in the same way. Best you can do is lever the fuck up with portfolio margin (risky), buy 8% yielding dividend funds, refi the margin loan with box spreads, and maybe squeak out 10% with a lot of risk. Even in that case you’d get your money back in 10ish years. SPY’s great until it crashes 40%. NASDAQ was underwater for like 15 years after the dot com bubble burst.
It isn’t SPY and it isn’t dividend funds. Real estate has its own unique features that make it a good investment to hold along with SPY and a broadly diversified portfolio, not in place of it.
For a development, you can invest in a deal and get your entire investment out in 2-3 years and still have the income coming in. Good inflation protection and tax benefits. Over ten years with a development a significant portion of your income is coming in through refi’s so your effective tax rate on that cash income - not just a number in your brokerage account - is 8-12%.
This is a great thread. I think real assets are back and any advisors who ignore all together will regret their advice to their clients. Comparing the last 10 years in real assets to the SPY is not fair truly
what is a P/E of SPY currently? I know AAPL and MSFT have 30+, AMZN has 50+. this translates into E/P (yield) of 2-3%. so, I'd take 4.375% instead.
also, real estate is a basic necessity. people will pay rent the first thing. if the rent it growing, they'll cut their purchases on Amazon and decide not to buy the latest iPhone, but they'll still pay rent. real estate will grow forever because people will always need to live somewhere and the world population is growing. Apple, for example, might very well shrink because we're coming off of the pandemic where everybody upgraded their home offices and bought new laptops and PCs but may not buy new ones in the next several years. also long-term AAPL products are getting worse every year (many bugs that never existed before). I personally got the latest iPhone with 3 cameras and I think the quality of photos is worse than on my old iPhone of 2 years.
same with Amazon. everybody subscribed to them during pandemic, but now coming off of it, people will purchase less and might unsubscribe. also there are Amazon workers protesting all over the country all the time, so I won't be surprised if there will be some regulations or unions formed which will cut Amazon's profitability.
and in general, businesses in US now are lobbying government heavily and are enjoying incredible regulatory favors. however, there is a growing interest in democratic socialism with higher taxes on businesses, and more regulations, and higher minimum wages. all that can easily drop the market very significantly. however, with the minimum wage increases, landlords will be able to increase rents.
Real estate bois are maybe the most insufferable demographic of finance hardos/scam artists. Normal people are just trying to find places to live and then you have these clowns jacking up prices and hyping up the asset classes trying to convince people to “iNvEsT bRo”
Don't you have a powerpoint to format?
Just wanna shout out how helpful of a thread this is for understanding accessible RE investing basics
Been looking for a breakdown of this math, leverage, depreciation, etc for a bit
OPM, it’s that simple. Leverage plus so many other things like tax advantages through depreciation, built in inflation hedge, pull money out through refi tax free, bonus depreciation, step up in basis, promoted interest, and on and on.
Gotta make an add-on... A lot of people are talking about the "virtues" of leverage, and yes.. they are all correct (given that even individual investors can get 80% financing routinely is amazing, no doubt!). BUT, at core, you don't need to use leverage to justify real estate as an investment in a diversified mixed asset portfolio. The income and appreciation is plenty and many institutional investors use little to zero leverage.
In fact, go look at the NCREIF returns (just google it, publicly available), they are all on a unlevered basis (they de-lever any leveraged funds/properties in return calc). That is the basis of comparison. You can then add your own "leverage assumptions" to NCREIF to approximate that return if you want.
Also, stock equities are often internally "leveraged" as well (they use bonds/bank loans. etc.). So if you want to truly compare, you would need to "de-lever" the S&P 500 or whatever index you are using as your equities index for a fair comparison (i had an investment valuations course with my MBA where we did that with stocks and indices, was actually very interesting).
Just felt that need, leverage can be return enhancing (and risk enhancing of course...), but that isn't what makes real estate worthwhile by itself!!!
Glad you mentioned appreciation as that's a big part of it too. Seemed overlooked on the thread.
That's a huge return in RE, can you share the listing lol?
To answer your question you also get depreciation, tax write offs, can 1031 exchange it to roll the equity tax free, and can leverage your equity to the max. Lots to like about the re game
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