I’m from a family of real estate entrepreneurs and investors.
As a result, I’ve literally been involved in real estate for the rest of my life, so I felt it was natural to buy a rental property when investing.
I bought the first one at the age of 18, and I still remember that number.
It was a German condominium. It was for sale for around 38,000 euros, I was able to negotiate it up to about 33,000 euros, and its expected rent was about 400 euros per month. I also had access to cheap debt to increase equity returns.
On the surface, this was easy.
Equity returns are over 20% per year, even before explaining future rises.
I thought that even a conservative estimate would be a much more attractive return than making money on the stock market.
But I was wrong!
Then I started working in private equity real estate, and I soon realized that my calculations were quite far apart.
And I’m not the only one to make these mistakes.
In fact, I argue that the majority of rental real estate investors greatly exaggerate their returns by miscalculating them. Revenues may be attractive, even after all costs have been properly accounted for, but in most cases they are inferior to REITs (VNQ), And in addition to taking a much greater risk.
Show it to you:
Calculation of rental property revenue: 101
Here’s a simple calculation that everyone is doing:
Rent + depreciation-interest expense / down payment = return on equity
With this calculation, you can often earn more than 30% annual revenue.
But even fairly new investors will find this to be widely misleading.
Taking it one step further, investors usually replace rental income with net operating income. This removes real estate costs such as utilities, taxes and insurance.
Net operating income + depreciation-interest expense / down payment = return on equity
Earnings are already starting to decline significantly here. If all real estate costs are properly accounted for, net operating income is typically only half of rental income.
So let’s say your revenue drops to more than 20% a year.
It’s still pretty good, isn’t it?
Well, we haven’t yet explained the most important costs … it’s often forgotten by investors.
Calculation of Rental Property Revenue: Continued
Some investors may include refurbishment reserves in their net operating profit calculations, but in most cases they do not cover or at least properly consider major repair costs that are rarely incurred.
Occasionally you will have a bad surprise. This is literally unavoidable and should be taken into account when calculating returns.
Going back to my first rental property, I could have lost years of rental income with a single repair fee. Imagine, for example, that your apartment was flooded and severely flooded. If you’re lucky, your insurance may cover a few things, but probably not all. Repair costs can easily be several years or rental income.
But there are other negative surprises. It’s not just a property repair, it’s like a tenant who refuses to pay rent, throws the place in the trash, or sue you.
To give another example, let’s say a tenant decides to sue you when he learns that his rental property is moldy due to poor ventilation and has developed asthma.
You will have to hire a lawyer to protect yourself, and this will cost you a lot of money (and time … more later on that) and will be in court for months or even years. You may be dragged into.
The point here is that bad surprises are inevitable, very costly and need to be considered in the return calculation.
Now let’s look at the previous calculation again.
Net operating income + depreciation-interest expense-unexpected reserve / down payment = return on equity
So now your return drops to, for example, 15-20% each year.
But this is where things get really annoying, as we haven’t yet explained the value of your own time and work.
Buying and managing a rental property is more like running a business than making a passive investment. It’s a daunting task and your time is not free. You can also work on another job and earn a salary, so you need to account for this cost.
First, we need to estimate how many hours a month you will work on your property. This depends on many factors, but assuming you own some of the properties you manage, it can be as long as 15 hours a month. This quote also includes all the time spent acquiring the property. For a few months, you work 30 hours. Other months will only work 5 hours. We spend an average of 15 hours.
Next, you need to understand the value of your time. This also varies from person to person. If you’re doing a normal job, let’s say your value is $ 25 an hour.
Therefore, the cost of working on a rental property (rather than a regular job) is $ 25 x $ 15 = $ 375 per month.
Net operating profit + depreciation-interest expense-unexpected reserve-work value / down payment = return on equity
Currently, revenue can drop by nearly 10% annually.
Still, that’s not a bad thing, but we’re far from the 30% or more discussed early on, and our estimates are still pretty conservative.
Now suppose you are a lawyer and the time is worth $ 300 an hour.
In that case, the monthly cost of spending time on the rental property is $ 4,500.
Is your earnings high enough to justify this cost?
No, it’s not. It’s much better to spend your time doing your main job and investing that money in passive investments like REITs.
The more likely your income is, the worse your return will be if you properly explain the value of your time.
In most cases, why REITs get higher returns than rental properties
Some studies have shown that listed REITs get higher returns than private real estate investments when all costs are accounted for.
Three of these studies are:
How can this be done?
I’ve listed 10 reasons you can read in the last article click here..
- 1) REITs distribute investment to compounds faster
- 2) REITs can enter real estate-related businesses and increase returns
- 3) REITs can develop their own characteristics
- 4) REITs can sell and leaseback
- 5) REITs enjoy a significant economies of scale
- 6) REITs enjoy stronger bargaining power with tenants
- 7) REITs employ the best talent in the real estate industry
- 8) REITs have a total return approach
- 9) Most REIT managers work well with shareholders
- 10) REIT investors do not pay transaction costs
This is REIT’s Realty Income (O) Since the IPO in 1994, we have been able to achieve an average annual revenue of over 15%.
And if you are an active REIT investor and can choose the best opportunities and further improve your returns.
That’s what we’re aiming for on High Yield Land Road. Invest only in the best REIT opportunities to maximize returns.
This has historically had even stronger results for us. We are profiting with compound interest of over 15% per year and higher dividends with an average yield of 6%.
After all, this is why I stopped investing in rental properties and started investing in REITs instead.
They allow me to earn as much or more than I rent, but importantly, I can earn these revenues with much lower risk and less effort.
I’ve done a lot of work in advance to make the right choice, but beyond that I simply monitor my investment, raise income, and patiently wait for long-term gratitude.