Recently, I received a few questions about my real estate holdings – how they have been performing and what our goals are for the investments.
We own our primary residence plus 8 rental properties. Today I’m going to analyze 3 of the properties, which I will cleverly call Property 1, Property 2, and Property 3.
For each property I’ll run through how much we paid for it, what our actual cash investment has been, what the cash flow was for 2017 (since I don’t have data for all of 2018 yet), and what our total return has been for each property.
Goals for our rental properties
The reason we bought these properties was not because we thought we’d get better returns than we’d get in the stock market (although that’s been the case), but because we were looking for diversification, income, and an inflation hedge.
Diversification – real estate is a great way to diversify your stock holdings, as the returns from real estate tend to be completely uncorrelated from equity returns. Adding uncorrelated assets to an existing portfolio lowers risk and reduces volatility.
Income – I’ve never had any CD or bond investments, as I find their returns to be uninteresting. However, I knew I wanted to start transitioning some of our portfolio to more of an income-focused tilt. Real estate was a way to provide income but with more upside than CDs and/or bonds.
Inflation – during the Great Recession the Fed was providing an unprecedented amount of stimulus to the economy in hopes of avoiding a full on depression. My concern was (and still is) that it’s much easier to start stimulus than it is to end it. History has shown the the Fed usually errs on the side of too much stimulus for too long, which tends to lead to inflation and/or the next bubble.
Real estate tends to be a very good hedge against inflation (better than equities, in fact). The hope was that buying these properties would provide some defense in case inflation started getting out of hand.
Property 1
We purchased Property 1 in December of 2014. The purchase price was $149,900, and our total initial investment (down payment + closing costs) was $43,045.60.
When we purchased the property the projected rent was $1,295 – $1,395/month, and we put a tenant into the property at $1,295/month.
In 2017 this property provided $2,920.06 in cash flow. This is a 6.78% cash on cash yearly return on our initial investment.
The total return (cash flow + payment on the mortgage + appreciation) has been $76,587.70. That is about a 30% annual return.
Obviously this property has been a great investment – I’ll take 30%+ annual returns anytime. In addition, it’s provided a very solid yearly cash flow of 6.78% per year.
Property 2
We purchased Property 2 in April, 2014. The purchase price was $118,900 and our total initial investment was $30,821.45.
The projected rent was $995-$1,095/month and we found a tenant at $1,095/month.
In 2017 this property provided $3,349.81 in cash flow. That’s a 10.86% cash on cash yearly return on the initial investment.
The total return has been $63,257.80. That is a 30% annual return.
This has been another great investment for us.
Property 3
We purchased Property 3 in May, 2014. The purchase price was $122,900 and our total initial investment was $42,772.14.
The projected rent was $1,150-$1,250 and we found a tenant at $1,195/month.
In 2017 this property provided $1,040.72 in cash flow. That’s only a 2.43% cash on cash yearly return on the initial investment.
However, despite the low cash flow in 2017 (due to some repairs), the total return since purchase has been $72,714.12. That’s a 25% annual return.
This investment hasn’t been quite as good as the others, but it’s still been a great investment.
Additional details
If you want the gory details on the income and expenses for a property, here they are for Property 1:
Income
- Appreciation: $62,195.00
- Rent: $60,292.52
- Total income: $122,487.52
Expenses
- Property taxes & insurance: $17,008.32
- Mortgage interest: $19,257.09
- Property management: $7,345.59
- Repairs: $2,087.17
- Total expenses: $45,698.17
Profits = $122,487.52 – $45,698.17 = $76,789.35
Observations
First, for this property the appreciation was a bit higher than the rental income. For the other two properties the appreciation was a just a bit less than total rental income. I think this surprises a lot of people – people tend to think that profits from a rental property come solely from rental income.
Second, the reason the profits look so good is because of leverage. For Property 1 we spent a total of $43,045.60 to buy a house worth $149,900. That means we put down just 28.7% of the cost of the house, which puts our leverage at 3.48x. This means that if the rental property increased in value by 5% a year, we were getting 5% * 3.48 = 17.4% annual returns just from appreciation. Add on another ~10% annual return on cash flow and you’re looking at a pretty sweet investment (and that’s 10% on our initial investment, not the value of the house).
Third, the reason we were able to get such great appreciation is because we bought when home prices were undervalued. We haven’t purchased any real estate since 2014 because I don’t think there are screaming deals on real estate any more.
Conclusions
The annual returns on these 3 investments ranged from 25% – 30%. Since April, 2014 (when the first property was purchased), the S&P has returned 12.4% annually.
I do not think that these types are returns are easy to find in today’s market. We aggressively purchased rental properties when prices were low. In retrospect, I wish we’d bought even more properties than we did.
Similarly, at some point in the not-too-distant future we’ll be able to find screaming deals on the stock of high quality companies. And when those deals are available, you’ll wish you had more cash available to buy stocks on sale.