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Can you increase rents approximately with inflation?
Posted: Sat Sep 06, 2003 11:50 am
by therealchips
Ben said
But you ignore the fact that rents should increase approximately with inflation.
I seriously considered buying a small apartment building in Southern California twenty years ago. In analyzing the investment, I postulated increasing the rents approximately with inflation. My real estate broker was aghast at the idea. He said "That's a sure way to bring on rent control!" (I made a low-ball offer of the property which, fortunately for me, the owner rejected.) So, raising rents with inflation may or may not be possible, depending on local economic and political conditions. Your tenants know that the interest you pay on the mortgage does not rise with inflation, even if your other expenses do. FMO is in the enviable position of not having to worry about rent control laws. I never had that luxury.
Posted: Sun Sep 07, 2003 5:15 am
by BenSolar
therealchips wrote: So, raising rents with inflation may or may not be possible, depending on local economic and political conditions. Your tenants know that the interest you pay on the mortgage does not rise with inflation, even if your other expenses do. FMO is in the enviable position of not having to worry about rent control laws. I never had that luxury.
Hmm, very true. Rent control is a real issue in places, I guess. On the other hand, if the following years haven't seen rent control in your area, then maybe your broker was overly concerned with the possibility.
In my area rent control has never been seriously considered, to my knowledge. We do have a fairly onerous housing code within the city limits of Asheville that is an additional expense at times. Of course the same people who keep adding requirements to the housing code are the same ones who complain that housing is too expensive here.
Rent control is a fact of life in NY city, I guess. Is it any where else?
Rent Control
Posted: Sun Sep 07, 2003 9:36 am
by therealchips
Hi, Ben,
Short answer: Rent control has passed in these California cities -- Los Angeles, Santa Monica, San Francisco, San Jose and Berkeley -- and at least 125 municipalities in New Jersey.
Long answer: From the 1997 source I quote below, I have just learned that my impression of rent control is colored by my sixty years living in my native city of Los Angeles, California. (Here in Nevada, some people call our neighbor
The People's Republic of California.) Even left-leaning Vermont has, or has had, a constitutional prohibition on rent control. So, I could have invested in income property in another state, and I considered that too twenty years ago. The problem for me was that, if I did that, I couldn't see the property personally except at considerable transportation expense. Anyone who prudently distributes his income property investments geographically faces the same problem. Maybe that's an argument for income property in Hawaii, so you can deduct the cost of visiting the place. :D
http://www.heartland.org/Article.cfm?artId=864 During the 1970s, it appeared that rent control might be the wave of the future. Boston and several of its surrounding suburbs imposed rent control during the inflationary years of 1969 to 1971. President Richard Nixon imposed wage and price controls in 1971 on the entire country, freezing all rents in the process. Many cities retained rent controls, eventually making them permanent, after wage and price controls expired. Washington, DC, for example, still has rent regulations from this period, as do about 125 municipalities in New Jersey.
In 1978, California activist Howard Jarvis promised during the Proposition 13 anti-tax campaign that tenants' rents would be reduced if the proposed state constitutional amendment lowered property taxes. In the midst of an inflationary period, the rent reduction failed to materialize, frustrating many tenants. Berkeley and Santa Monica, two smaller cities with radical political cultures, led the state in imposing very strict rent control ordinances. Ten cities--including San Francisco, Los Angeles, and San Jose--eventually adopted rent regulation. More than half the state's tenant population were governed by rent control ordinances. One major California city, San Diego, bucked the trend, rejecting rent control by a 2-to-1 margin in a 1985 referendum.
By the mid 1980s, more than 200 municipalities nationwide were living under rent control ordinances, affecting about 20 percent of the nation's population. This proved to be the high tide of the movement. As inflationary pressures eased, the agitation for rent control subsided.
Some cities have remained strangely immune from the rent control temptation. Chicago, with one of the largest proportions of renters of any American city, has never seriously entertained proposals for rent control. Philadelphia, Baltimore, Cleveland, and other eastern cities outside the Boston-New York-Washington axis have never experimented with this policy. In the major cities of the south and southwest--Atlanta, New Orleans, Dallas, Houston, Phoenix--rent control is simply not an issue. During the 1980s, a reaction set in among southern, western, and rural states. Some 31 states, as diverse as Idaho, Florida, Texas, and Vermont, adopted laws and constitutional amendments forbidding rent control.
Posted: Mon Sep 29, 2003 8:35 am
by howdydoday
TRyan wrote: I have a few single families that are returning 6-8% (annual rents minus all expenes divided by current market value). It gets taxed as ordinary income (28% federal; 5% state) so that leaves ~ 4.6% ... minus inflation to get a "real return". Wow, not much left !
I guess it's all about the property appreciation.
Hi TRyan,
How to you decide if a piece of real estate is a worthwhile investment before purchasing? I guess my mind gets cluttered when it comes to real estate-I mean, if the money coming in is more than the cost of the property(taxes,repairs...) how could it be bad?
Hope this isn't an ignorant question...
Thanks
howdy
Still trying to figure out a good asset allocation at age 22
Posted: Mon Sep 29, 2003 9:17 am
by ben
Howdy,
it is a good question! Answer is simply that it is a question of risk/return evaluation. If the real estate only pays 1% in return per year after all costs - then why would I not just put the money in a bank account or MM-fund and thereby avoid (almost) all risk?
Or; if I was willing to take the real-estate risk level - could I create a diversified portfolio (bonds/stocks/reits/gold/timber/whatever) that would do BETTER than the 1% with same level of risk?
Now; HOW to evaluate the return on investment on real estate is hard, and the risk even harder to evaluate. (A mortgage is actually a gearing of your invested capital, the tenants might destroy the place, the area might go downhill, the costs/taxes might go through the roof, tax deductions on mortgage an income? Etc.).
The way I evaluate is very basic: purchase value of property divided with rental income after all costs. I leave the mortgage/loans out of the equation initially.
Posted: Mon Sep 29, 2003 10:18 am
by wanderer
Ben is right: it is a good question! maybe the essential question.
Ben has walked you through the idea of cost of capital. Not only should it return what cash does, but it should accomodate the higher transaction costs, management expense (imputed or otherwise), lack of liquidity, and so on. On the other hand, we give directly held real estate points for asynchronicity with many other asset classes, reduced 'agency' concerns (no $6,000 bath curtains), tax efficiency, etc.
Since we can invest in VWEHX or VGSIX and reasonably predictably get 8%-10%, the return needs to be higher than that.
Since, overall, directly held real estate offers more concentrated risk (compared to actively traded indexes), we go into real estate transactions only if it looks like we can reasonably make 20%-25% per annum and only if we believe we can hold the property for 10 years or so.
*****
very nice to see you again, ben. you are one my investments that has yielded a very tidy return.
hope you have been well.
Posted: Tue Sep 30, 2003 8:56 am
by howdydoday
Hey guys,
I am definitely still confused
Very Basic Example (all hypothetical):
Cost of the House is $150,000
Rent received for the year less expenses: $10,000
If I flat out purchase the house for $150,000 my return on investment for the year is about 6.66%-(This seems to be how ben analyzes the cost and return).
However, if put down the standard 20% I only have 30k invested and the return jumps dramatically since the money is borrowed.
-At some point when enough equity gets built up in the home I can see where the investment would no longer be worth my time but in the beginning it seems good.
Is my logic flawed in this example? Am I forgetting something?
Thanks guys
howdy
Posted: Tue Sep 30, 2003 10:22 am
by therealchips
Am I forgetting something?
Maybe $7200 annual interest cost on your 6% mortgage as an additional expense you would not incur if you bought outright?
Posted: Tue Sep 30, 2003 10:44 am
by JWR1945
howdydoday, you are right.
FMO addressed this problem back in March. Read these two threads that he started in the order shown.
FMO thread about
Decisions Decisions on Wed, Mar 19, 2003 dated 4:33 pm CST.
http://nofeeboards.com/boards/viewtopic.php?t=676
FMO thread about
Real Estate Proforma Spreadsheet dated Sat, Mar 15, 2003 2:56 pm CST.
http://nofeeboards.com/boards/viewtopic.php?t=657
The first thread confirms your thoughts about leverage. The second provides you with an excellent calculator.
Have fun.
John R.
Posted: Tue Sep 30, 2003 11:13 am
by TRyan
Thanx John (I was looking for the same FMO posts).
Howdydoday,
I use a VERY basic qualifier .... Make sure the mortgage, taxes and insurance payment is 50% the rents or LESS. This allows:
Maintenance (averaging around 15% of rents)
Water (5%)
Vacanacy (5-10%)
Liability Insurance (2%)
PROFIT (return on deposit and sweat/blood/tear)
Problem is, at today's prices my qualifier is hard - if not impossible - to meet (without a VERY large deposit) so I've been a seller since 2000.
Hope this helps, TRyan
Posted: Tue Sep 30, 2003 11:55 pm
by ben
As I said; I leave the whole loan/mortgage thing out of the calculation initially (as if bought cash) - that will show you if the investment is good (compared to risk/alternatives) seen by itself.
The financing side/loan/mortgage/tax deductability of interest etc. is simply a gearing(like my margin loan at my broker) of your initial downpayment in my book. I.e. if the area/building goes to the dogs due to gang fights on your doorstep - you STILL owe $120000K or whatever the loan says.
Wanderer: Maybe my English has deteriorated but pls clarify:
you are one my investments that has yielded a very tidy return. hope you have been well.
I have been well - but travelling a lot. long live VPACX!
Posted: Wed Oct 01, 2003 4:53 am
by TRyan
The financing side/loan/mortgage/tax deductability of interest etc. is simply a gearing(like my margin loan at my broker) of your initial downpayment in my book
... but the mortgage interest rate can make or break the monthly cash-flow (when your only squeezing a couple hundred bucks per month out of the unit). That's also why I won't buy on margin (stocks).
Posted: Wed Oct 01, 2003 5:39 am
by wanderer
have been well - but travelling a lot. long live VPACX!
travelling 'haha' or traveling 'strange'?
i think veiex has more legs but god bless vpacx, too, we'll need it. and god bless the keiretsus and the chebols, too!