Written by David Lowrey, Owner of Stress Free Property Management
About eight years ago, I attended a real seminar and ended up having dinner with several the speakers. The topic of the hedge funds and private equity buying up tens of thousands of single family homes came up. As an owner of a Tampa property management company and an active real estate investor, I had strong opinions on this subject. Everyone was going around the table giving their opinions of this and how we thought it was going to work out for these new players.
The consensus was we thought the hedge funds and private equity were crazy and paying too high of prices. We also thought they were ill equipped to manage all these assets in so many different markets. This was right in the middle of the Great Recession. As a Tampa property manager, I personally felt they lacked market knowledge and were paying too high of prices and were going to get crushed managing these single-family homes. It turned out we were 100% wrong!!
The only person who didn’t feel like they were crazy was an investor in his late sixties. He explained
that time will tell, but the behavior of these groups paying higher prices reminded him of his life. Thirty years ago, he spent an enormous amount of time trying to find the best deals. He would pass on single family homes that were listed for $20,000 because he wanted to buy them for $17,000. Thirty years later those same houses are worth $125,000.
He looked at us and asked, was it worth paying a higher price thirty years ago? Obviously, it was. Of course, this sort of growth is incredibly unlikely in todays more connected economy. Just buying a house at retail and hoping for that type of growth in 30 years is silly in the extreme. However, I do believe its reasonable to expect houses to triple in values on average in 30 years.
This doesn’t mean you’ll have three times as much money in 30 years, if you paid cash for them, because of inflation. However, if you use responsible leverage, and have the tenants pay off the mortgages, you will have a lot money. In other words, paying cash for properties and waiting 30 years is not a good strategy to wealth, but getting great financing and buying quality assets is an overlooked option. The key is the tenant’s rent must be able to pay all the costs of ownership (taxes, insurance, repairs, and management) and put a little money in your pocket.
If you do this, does it really matter if you pay $100,000 or $110,000 for a rental property? I’ve never forgotten that brief story he told us. Now when faced with buying an investment property, I first see if I’ll make some money after all expenses, and the asset is decent and in a reasonable location. Second, I’ll consider how much to negotiate the price down. But at the end of the day, I won’t always walk from a cash flow positive property, even if the price is 5% or 10% above my ideal purchase price.
In 30 years, that slight bit of money will mean nothing. This doesn’t mean I buy a ton of these types of properties. The best scenario is to invest when others are fearful as Warren Buffett famously says. However, I will pick up the occasional property if I like it and can see myself holding it for 20 or 30 years. I just don’t want to have negative cash flow. Negative cash flow will eventually destroy you if you add too many properties that don’t make you money in the beginning. But, if you can buy a decent property that gives you a slight profit after all expenses, it is worth considering, if you can keep it for long period of time.
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