Despite real estate ranking second to last in my Passive Income Rankings, don’t worry real estate fans, real estate still is my favorite asset class to build wealth.
One of the reasons why I love real estate is because of the utility it provides. I don’t buy real estate for rental income or capital appreciation. I buy real estate for improving my lifestyle first. If the property so happens to appreciate in value while I enjoy the place over the years, fantastic. If not, it doesn’t matter because I’ve derived tremendous satisfaction from all the property brings: location, view, amenities, and memories. Capital appreciation is just a bonus.
Money earned is best spent on improving your lifestyle. It may be fiscally prudent to hoard as much cash as possible for a rainy day. You might grow your wealth faster by buying multiple rental properties while you rent a piece of crap place to save money. But I find that to be a waste. There has to be a better balance when it comes to spending money. If you can spend money on an asset class that provides a better lifestyle and a chance for capital appreciation and rental income, you’re hitting triples and home runs!
DESIRABLE REAL ESTATE FEATURES
There are several real estate features I, along with plenty of buyers covet:
1) An open gourmet kitchen with a large peninsula or island
2) A walk-in closet
3) A luxury master bathroom with deep soaking tub, separate rain shower, and enclosed toilet stall
4) Peace and quiet
5) A room or two with a view
As someone who spends a lot more time at home now after retiring from Corporate America, my appreciation for nice amenities has gone up. I’ve got to imagine it’s the same thing for many stay-at-home spouses. This post is a discussion about point #5, recognizing value, and figuring out what the future holds in real estate.
FINDING A ROOM WITH A VIEW
When I was in my 20s, I’d always face the dilemma of paying up for a room with a view or getting an inner courtyard room with no view for half price while on vacation. It always felt silly paying $400 a night for a view when I could just walk outside the hotel and have the same view for free. So, I never did.
I began obsessing about ocean views once I moved to San Francisco in 2001. In 2003, I was able to buy a condo with a view of the park. It was a lovely view that transported me away from the busy city, and into a jungle every time I sat down on my living room sofa. I loved the tranquility of a park view. It was as if I had a huge backyard that needed no maintenance. In fact, nine years later, the city spent $10 million dollars renovating the park with an amazing playground, huge walking paths, a dog park, and two pristine tennis courts.
Two years after purchasing the park-side condo, I longed for something else: a single family home. Condo living is fine, but I wanted to have more freedom with my living space. So, I bought a house that I lived in for almost 10 years, but it had no view. My obsession with having a room with a view kicked in five years after moving in. I found myself climbing up to the roof once a month, wondering whether it would be worth the money and the hassle to expand one floor up in order to catch a glimpse of the Golden Gate Bridge in the distance.
Knowing how difficult it is to build upward in San Francisco, I decided to do nothing. Instead, I biked down to the water’s edge and watched the sailboats float by Alcatraz during sunset as consolation.
TIME TO GO LOOK ONCE MORE
Who doesn’t love shaggy green carpet and wall paper?
After 10 years in the viewless single family home, I was itching to explore a different neighborhood or relocate to a different city altogether. I had a mobile business after all, so why not go on a new adventure?
There was no need to commute downtown five days a week anymore, which is a relief since downtown San Francisco feels like congested Manhattan nowadays with 100,000 more people employed than five years ago, and 55,000 more people employed than the height of the dotcom bubble according to the California Employment Development Department.
Going back to Honolulu was also at the top of my list for its incredible weather, beautiful beaches, emphasis on family, and kick back lifestyle. If only I could bring Hawaii to San Francisco, I kept thinking to myself. Buying property in San Francisco is less risky due to the plethora of high-paying jobs.
Then one Spring evening in 2014, I found my existing home by accident. It was a fixer that was poorly marketed on the Multiple Listing Service by an out-of-town agent. He didn’t have a single picture online, despite marketing the house as having “panoramic ocean views.” Talk about bad marketing. I had to check it out for myself.
When I stepped inside there was gross green carpet everywhere (picture above). The paint was falling off and the bathrooms and kitchen hadn’t been updated in over 60 years. But all the interior ugliness disappeared once I saw the view. The view was to die for and I was willing to pay 50% more than the $1,250,000 asking price just for the view alone.
But instead of paying $1,074 a square foot for my house, I paid $716 a square foot. I knew I would have to put around $100,000 into rehabilitating the home with a new roof, new outside and inside paint job, new floors, new kitchen, new bathroom, new 200 amp electric panel, and new electrical wiring. But that would still be $525,000 less than the $1,875,000 I would have paid.
Despite people telling me how much cheaper these homes in Golden Gate Heights were five years ago, I didn’t care. The properties I own rode up with the market as well, and it was just unbelievable to think that I could finally find not one room with a view, but five rooms with a view of the ocean.
I would have paid 50% more for this view
VALUE IS SUBJECTIVE UNTIL THE RUSH
There are plenty of people who couldn’t care less about a view. They would rather have a larger size room or bigger home instead. That’s fine because if everybody wanted a view, I wouldn’t have been able to afford my house. The key is to be a little contrarian with your desires. A room with a view is a pretty common desire. But buying property in Golden Gate Heights hadn’t really caught on yet because it is five miles west of downtown San Francisco.
I surveyed over 100 people during my property hunt and less than 10% knew where Golden Gate Heights was. One 28 year old woman jut the other day said she lived one neighborhood over all her life and had never heard of GGH. Perfect. Everybody is focused on Pacific Heights, Noe Valley, Hayes Valley, Russian Hill, and The Marina where property prices have gone ballistic already. It’s costly to go with the crowd.
Instead, look ahead and see whether there’s a possibility others might see in the future what you see today. Research public transportation expansion plans and buy property close to those respective stations. Research whether new restaurants, stores, or buildings will be built that will attract more demand. Those who are willing to spend lots of money expanding have surely done their due diligence as well. Take advantage!
If you can successfully look ahead, you’ll be able to save a lot of money now or develop a lot more wealth in the future. And even if the future price never materializes, remember the point about buying property for a better lifestyle first.
To be able to see the sunset every evening is priceless to me
THE REAL ESTATE MARKET IS EFFICIENT
Here’s what I wrote in my post on the best place to buy property in any major city published on June 6, 2014:
” The majority of prime real estate in San Francisco is closer to $1,100-$1,500 per square foot if we exclude the $3.4 million “outlier” mentioned above at $2,200/sqft. But even at $1,500/sqft, that’s still cheaper than the $2,000 – $3,000 per square foot in places like Hong Kong, London, and Manhattan. San Francisco is turning into a major international city before our eyes with all the cranes downtown due to the profitability of tech firms e.g. Facebook is set to pull in over $10 billion in revenue and $2.5 billion in net profits in 2014. Revenue and earnings are estimated to grow in the double digits for years.
I see the average Golden Gate Heights view home reaching well over $1,000/sqft by 2019 if not sooner as long as the economy remains stable. Let’s just hope local residences discover Golden Gate Heights before foreign buyers do. From what I know and hear, Chinese and Russian buyers are buying prime properties around the nation in droves, sight unseen.”
My prediction was that GGH homes selling for only $700 – $800 / sqft in 2014 would rise by 30 – 40% over the next five years. After only eight months, I’m surprised to say my prediction has come true. Almost every weekend I go for a one hour hike around my neighborhood to exercise, visit open houses to get a pulse on the market, talk to realtors, and find inspiration for design.
See the listing below. It’s closer to a fixer, than a remodeled home.
A two bedroom, one bathroom, 1,174 square foot home on a healthy 4,599 sized lot (half of it is majorly downward sloping) just sold for $1,350,000 from a $975,000 asking price. That’s $1,149.91 per square foot! I went to check out the house after it sold and it does have an equally amazing panoramic view of the Pacific Ocean and the Farallon Islands. There’s a possibility for expansion potential as well if the new owners build out about 15 feet to get that extra bedroom and bathroom.
Living and dining room area with view of the Pacific Ocean
A luxury kitchen w/ linoleum flooring to go with the $1,350,000 price tag
WHAT WILL THE FUTURE HOLD?
Besides the example of 2001 14th Avenue selling for over $1,000 / sqft, I’m seeing other examples of GGH properties now selling for over $1,000 / sqft (199 Quintara and 2219 12th Ave). It is crazy how efficient the market is, and now I’m wondering what’s next? If you go to any big city in the world, ocean views trade at huge premiums, except for in San Francisco for some odd reason. If you can find ocean view homes for less than $1,000 / sqft, buy all you can.
Buying real estate for capital appreciation is like buying a growth stock. But none of it really matters if you never sell. I don’t plan to ever sell my current primary home, despite a 50% increase in comparable prices because I enjoy my home. I honestly don’t care about a realistic $250,000 – $350,000 gain (20% vs. 50%) after remodeling because if I sell, where would I go if everything else has also moved up in price? Even if the property takes a big dive, like my Lake Tahoe vacation property did during the downturn, there’s only a psychological impact.
For those of you who live in more reasonable priced markets, real estate is a much better investment for rental income instead of capital appreciation. If you can get net rental yields of greater than 8% (~4X the risk-free rate of return) after putting down 20%+, you’re probably going to do pretty well. In markets like San Francisco or New York City, you’d be lucky to get a net rental yield of 4%.
The more I think about it, the more I believe most of us should just buy a home to enjoy. Chances are high that if you like your home enough to buy it, others will too. Save your money while enjoying your home, and when the time comes for you to make a change (family, empty nester, change of scenery), you can rent out your home and buy another. If you can start this real estate empire building process by age 30, by the time you’re 60, you’ll be able to comfortably amass three to four properties with probably a decent amount of capital appreciation, rental income, and fantastic memories to boot!
Related: To Get Rich, Practice Predicting The Future
Wealth Building Recommendations
Explore real estate crowdsourcing opportunities: If you don’t have the downpayment to buy a property, don’t want to deal with the hassle of managing real estate, or don’t want to tie up your liquidity in physical real estate, take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible. For example, cap rates are around 3% in San Francisco and New York City, but over 10% in the Midwest if you’re looking for strictly investing income returns.
Sign up and take a look at all the residential and commercial investment opportunities around the country Fundrise has to offer. It’s free to look.
Less than 5% of the real estate deals shown gets through the Fundrise funnel
Shop around for a mortgage: Check the latest mortgage rates online through LendingTree. They’ve got one of the largest networks of lenders that compete for your business. Your goal should be to get as many written offers as possible and then use the offers as leverage to get the lowest interest rate possible. This is exactly what I did to lock in a 2.375% 5/1 ARM for my latest refinance. For those looking to purchase property, the same thing is in order. If you’ve found a good deal, can afford the payments, and plan to own the property for 10+ years, I’d get neutral inflation and take advantage of the low rates.
Updated for 2019 and beyond.
Sam – I’m posting this here hoping some people will comment, but have you or anyone else had any experience with the Zillow For Sale by Owner feature as a way to avoid realtor fees?
I’m disappointed in Zillow. Look at every industry on Earth and what happened to fees and commissions once the internet took hold. Now look at the real estate industry, insisting on charging 5-6% selling commissions! Zillow could have reduced costs, but they didn’t b/c they make a lot of money from realtors.
Depending on your local market, you may luck out with zillow fsbo, however I believe that you will probably need to be MLS listed (to get on the MLS and major realty sites – realtor/yahoo/redfin/trulia etc) and offer buyers agent commission of at least 2.5%. I listed a property that way for a short time, however all the calls I got were from agents who wanted the listing! In my case one of the agents showed me a comp listing with prices and buyers agent percentages (ranging from 2-3%). One agent recommended paying a minimum of 2.5% rather than 2% buyers agent commission. As she said – agents are in it for the money, if you pay 2% many agents will avoid your listing. If you are trying to save money and will do the leg work, pictures, showings, open houses etc, find an MLS listing for fee service (carefully! dont use byownerMLS – a zillow partner – for example). I found one that charged $75 for the MLS listing, charged at COE. Then set your buyers agent commission at say 2.5% (You can set it at 2%, but I believe you will get more agents interested at 2.5% – yes really). You will have substantial savings over a traditional listing, but will get much more exposure, calls, etc this way. I’m fortunate in having a semi retired broker friend who has advised on offers, contracts, terms, RE forms etc. Yes there are a lot of disclosures, forms etc that are definitely required and not obvious, so you should consider that also. After going this route, we’ve had a constant stream of calls from agents, showings, etc. I will almost certainly go this route in future, not free but about half the traditional cost. just be careful who you select for the listing service.
Great post! My wife and I are thinking about doing something similar: probably building a 3 story property in the Dominican Republic after we retire from Corporate America with a few apartments for renting to tourists. That’s less than 4 years away!
Hello,
I am a college student studying business and entrepreneurship, I do not have a business idea yet. Although I have owned and operated a promotions company for clubs and bars in the DC metropolitan area and did fairly well. I am now invested in stocks and mutual funds with a personal financial advisor, they are low fee funds that have performed fairly well. I don’t know what area of business to pursue, but my ultimate goal is to create wealth, I invest in myself everyday with reading. But I want to know what will help me find what business idea to create or “reinvent” as Josh Linkner says. I need help I just wanted to ask you if you had to start all over again, what would you do differently? And what advice could you give me as a 20 year old. I only have a net worth of $16,340 but I have zero debt. I would be ecstatic and very grateful to hear from you Sam, anything will help.
Thanks,
Zev
Hi Zev,
Welcome to Financial Samurai.
I had two options upon graduation: Go to China and be an entrepreneur, or go work in finance and I chose the later for 10 years before coming up with my own idea: this site.
I would try and work a stable job and moonlight on your idea at night. I thought about it in 2003, but didn’t start until the financial crisis. That was a mistake. Start early and often, while gaining work experience and Savinfs.
Congrats on a 16k net worth at 20! That’s great!
Sam
Sam,
Have enjoyed your articles for a long time. I live in SF and own an investment property as well.
Do you have any reservations regarding the stability of California real estate market given the potential impact of the drought? There are more and more people moving here (more homes being built), and less and less water to support everyone. It’s not something anyone really talks about, everyone turns a blind eye to water problems, but I think 3 years into the drought and another dry winter behind us, it may be time to diversify my real estate presence to other areas like Seattle.
Good question. I’m not, but perhaps if this goes on for 10 more years, we might have a problem.
Hopefully ocean saliniation technology will improve by then.
I’m more interested in finishes and the quality of the space than I am the actual size of the space itself. I’d much rather have a 500sqft home modeled completely to my tastes than a 2000sqft cookie cutter.
But yes, as a design nerd, having a properly designed home is pretty necessary for my happiness. Views and location definitely do make a difference. If it’s somehing you want, it’s likely a bunch of other people will want it down the road should you decide to sell or rent it out.
I completely can’t understand how some landlords (usually accidental or purely investors) barely make their spaces presentable and go with the cheapest finishes. One should take pride in it. I would never rent something that I wouldn’t love to live in myself. With that, I am completely agreeable to your point of view and how you’ve built your real estate empire thus far :)
You’re rather lucky to have bought when you did in San Fran. I envy your location and returns.
Then you would enjoy renting one of my properties! The labor is what’s expensive, and it’s relatively fixed. You can pay $10,000 in labor to install $5,000 in finishes, or $15,000 in finishes, it’s all the same. Hence, I always gravitate towards the nicer things. Better bang for your labor buck. Furthermore, a home is where I’m willing to spent my money more freely since I get to enjoy it.
I agree that buying in SF is lucky. I wish I bought a 2/2, 1,300sqft, double balcony place on 21 between Park and Madison in 2001 for $799,000. It’s more than doubled. Crap!
Hi Sam,
Thank you for your resource rich site that is both informative and inspiring. I just quit my job of ten years (sure wish I had found your book prior to quitting -damn!) and my wife and I are going to travel Europe for 6 months. We own our condo in SF and we’ve seen about a 300k appreciation (bought in SoMa in 2010), but we are nervous to rent. How do you weigh in the tenant laws in SF, the potential for squatters etc, (the place does not have rent control) when considering what to do with your home? Right now we don’t know whether to sell our place or rent? At age 39 – should we take the 300k and run or rent?
DAMN! I sure wish you did too, as 10 years is a GOLDEN duration. Anyhoo, life moves on.
I would keep your property for as long as possible. Forever, if you can. That’s how you are going to best build your fortune. Landlord have rights too. Don’t fret!
Peruse through my real estate section for more advice.
Thanks for the encouragement! I’ve found many great articles in your real estate section and I am continuing through many more.
Thanks again for an amazing resource site
Most condos are NOT under rent control in SF. Why do you think yours is? Also, if it’s built after June 1979, no way no how is it under rent control. Also, rent to upwardly mobile people who don’t plan to live in your unit forever and ever. Every smart landlord has been doing that for years now.
Owning property in SF is like printing money. Almost a guarantee that it will be worth ALOT more 10 years from now. So I definitely wouldn’t sell. So many accidental millionaires were created in this city by people buying ONE property and keeping it for a couple of decades! This thing could be your retirement plan, don’t screw the pooch with short term thinking!
Good luck.
In my area, rental real estate is all about income. Prices appreciate on average with inflation, so if you are looking to get rich through price appreciation, you best bet is to look elsewhere.
Sam,
I agree, your view is worth every penny. Great move buying your place.
Your comment about buying where there is planned public transportation really hit the mark for me. I purchased a new build home in the south bay near the BART extension and have already seen the price of my model home (in this community) increase by nearly 10%. My house won’t even be ready till September! I bought the place because I love the design and the ability to totally customize it as a new home, but the appreciation is a nice perk.
Sam, what an incredible find! I live in West LA so the housing stock and buyer profile are probably similar to S.F. Although I’ve enjoyed incredible appreciation in my primary residence (bought in 2003), I switched my real estate investment strategy to apartments last year. For the same price that one could pay for a single family home in West LA, one can buy a 12+ unit building in Long Beach or neighboring cities. You probably wouldn’t want to live there but the buildings can cash flow (even after deducting property management costs) whereas a single family home would be impossible (assuming a similar 25% to 30% down payment).
Since I’ve recently started my journey on self-employment/unemployment/retirement, the ability for a property to cover its costs is paramount. Hopefully the appreciation between apartments and single family homes will be similar as well. However, since apartment valuations are driven by rental income, I have more control over appreciation by making improvements, screening tenants and raising rents.
I’ve come to the sad realization that any property where I would actually want to live probably wouldn’t cash flow.
What would your advice be to a first time home buyer in this market ? I’m 29 and can afford around 415k in Los Angeles area which would not get me much at all in terms of lifestyle. This would also suck my retirement funds. I’ve been staring at home prices for a few years and the 2013 runup was devastating for me to watch during my saving years. It seems like those who do well today have reaped the rewards prior to the runup in 2000 and feasted on the collapse in 2009-12. With interest rates to rise how does this not affect home prices when the median wages aren’t in line with median household prices based on previous non bubble years ? I seek value in the first purchase because it’s getting a good foot through the front door . I imagine with subsequent purchases the price matters less with the substantial amount of equity built in the first home which would dominate the income of any entry level buyer. I will strive to follow your plan of purchasing a property every 5-10 years . I just struggle with the first.
A bull market is terrible for those who lack assets. During the downturn, we were all like $8 billion richer relative to Warren Buffet b/c that’s how much he was down! Now, he along with others are blowing us out of the water.
Check out this post: The Best Time To Buy Property
wow … and I consider anything over $100/sq ft. to be an extravagance. I guess there is the price of the land and the price of the place. Guess this is why I will never live on coasts near a big city. I have my spot picked out in Washington, 65 acres, no house, $250k. Great views, and perfect for what I want.
Do you think Californians and other people who live in more expensive areas should go to Washington and buy up the land first then? $250K is cheap. Maybe we should!
It is a free country.
Awesome. I was afraid that there’d be some defensiveness or territorial issues. Californians have been buying property in Nevada, Wyoming, Arizona, and Texas. There might be a huge flux of Washington and Oregon buyers in the coming decade that might drive up prices for locals, but still will remain cheap to expensive state residents.
Sam, you probably covered this somewhere already, but what % of your net worth do you feel it is appropriate for your home to be? Does that % change when you take the leverage of a mortgage out of the equation?
Check out the charts in: The Recommended Net Worth Allocation By Age
I have never invested in real estate (from the outset) but I have accumulated two rental properties simply by not selling my homes when I traded up. Fortunately, I bought cheap places in very desirable neighborhoods that have seen significant capital appreciation. Neither are producing great income – in fact neither are cash flow positive. Though one at least covers the carrying cost (interest, taxes, and insurance). I am losing money on the other one – a lot more now that property taxes have significantly increased – but I have more than made up for it on the capital appreciation side (on paper at least). I could sell one or both and pocket the gain, but the tax hit and the realtor fees (if I used one), would really cut into both.
I look at them both as a s forced investment vehicle. With a little bit of investment in them, I could rehab both to secure more rent. But at this point, I’m willing to let them be. I’m bullish on Texas (where I live) and bullish on real estate here. I doubt I’ll see the gains that I have seen in the past 4 years, but I think I will do well with them.
I was fortunate to buy my residence during a market lull a few years ago, and it has since appreciated significantly.
All my properties are in very deseriable locations, and that is the key for me. I sacrificed “newness” for location – and I think that has paid dividends (on paper again).
Location, location… ? 2012 to now is a major bull market, after the crash…bottom was finally in, not quite as crazy as 2003 -2005 (about doubled), but a substantial rebound. this year they were predicting 1% or leveling off – i’m seeing much stronger market and gains though here in so cal. I have property purchased in 2009, that perhaps is $500 cash flow positive, but has been going up in value by $4k /mo for the last 3 years. I dont expect it to continue at that rate, but we have been recovering from the bubble/crash – and I do expect it to appreciate above the inflation rate. the overall roi is hard to beat.
I live in LA with a view, purchased just 8 months ago, moved in after major renovations a few months later. My neighborhood is up at least 20% since I purchased, which is pretty insane. I would say I purchased at a fair price in a competitive market, maybe a little bit under market.
Re: buyers wanting a fixed up home esp. higher priced home buyers… I think there’s also something else at play, people can afford their x downpayment and don’t have that liquid cash to fix it up so they just want it done and are willing to pay for it to be perfect. I think often these perfect houses still need a lot of work when you really look at them.
I consider my home, not as a potential money making asset – but just that – my home. I have several investment properties and I’m only interested in the money they make me for however long I decide to own them. In my mind, I just don’t correlate the two. All my investment properties I purchased under market value, and with a strict criteria. The family home I live in, I paid market value, and it’s exactly what and where I want to raise my family. I didn’t consider myself an investor when I was looking for it, or thought I had any sort of insider edge or experience when buying it. In fact, there were homes in the same area that are arguably in better condition and with higher value on a per sqft basis. It just can’t be a commercial purchase in my opinion.
We live in Europe, and we just bought our third rental. Capital appreciation is great, but we dont plan on ever selling a property. We just buy for rental income.
I would love to be able to move to another place, but we rent out part of our house as an airbnb, and so the house pays for itself. Because of that we cant just move. We would be losing part of our income.
Interesting. Where in Europe are you from?
How about just airbnbing the entire house and buying another to live so it is completely compartamentalized?
I haven’t gotten over the hump yet to have strangers live in my home yet. Perhaps if I build my extension downstairs.
Hi Sam,
The reason ocean view properties dont sell at a higher rate as opposed to other cities with the same type of view is because the fog blankets the view of the ocean quite often in the GGH neighboorhood. Love your articles. keep them coming.
Stephen
Ah, good thing there was that perception last year, and there’s still that perception. I’ve lived here for 10 months now, and the fog is no different from anywhere else in the city I go (except for The Mission). Maybe it’s global warming, but I see the sunset 80% of the time. And if I don’t see the sunset, it’s b/c there are a lot of clouds over the Ocean or it’s foggy.
What I discovered in SF is that everybody is prejudice against anybody living an inch west of them. Yet, nobody bothers to go West to explore. I didn’t bother for 13 years either! It’s like never experiencing the West Coast, living on the East Coast. Once you check it out, it’s hard to go back.
My brother just sold his house for slightly under asking because he had to relocate out of state. But the real estate market where he is in rural Pennsylvania is very different than what you’re seeing in San Francisco. I live in LA and totally agree with your viewpoints. And love your view!
Bummer about your bro’s place. Could he have held on and rented it out? I’m really biased for buying and holding RE forever, especially with commission rates to sell still so high.
Beautiful view. I agree with your philosophy on real estate. I just bought my third property and it will be a primary residence. I just enjoyed a nice mountain bike ride out my front door followed by an evening in front of my fireplace looking at the sunset over the mountains. 10 minutes from skiing and 25 to work. It is a fixer upper, too, but there’s no other way I could get in this location without being willing to do some work. The great thing about buying for a personal residence then converting to a rental is that you can typically get better mortgage rates. The bad thing is that you miss out on free capital gains if you were to just sell rather than hold and rent. I suppose you could hold it forever, too. But flipping after the 2 year hold period for capital gains then reinvesting in something with a better yield is a good alternative.
Missing out on the $250-$500k in capital gains is definitely a bummer for not selling within 5 years of moving out. That said, I think one can always move back in or have no tenants for 2 years and claim primary residence to requalify, so long as the rule is intact!
A special rule enacted in 2009 limits the $250,000/$500,000 exclusion for homeowners who initially use their home for purposes other than their principal residence, such as a rental or vacation home. The rule requires you to reduce pro rata the amount of profit you exclude from your income based on the number of years after 2008 you used the home as a rental, vacation home, or other “nonqualifying use.”
Source:
Thanks RJ for the link and highlighting nonqualifying use.
I plan to just buy, hold on forever, and buy another place every 5-10 years.
Well, I hate to be the bearer of bad news, but the rule changed a bit starting January 1, 2009. It used to be that the $250,000/$500,000 exclusion applied so long as you lived in the home for any 24 months of the 5 years preceding sale. Now there’s an exception to the exception to the rule in section 121(b)(4). (Note: it’s the second subparagraph (4) under subsection (b)–apparently the legislature mistakenly enacted two sections called (b)(4).) The IRS chomps away at the $250k/$500k exclusion amount based on a proration of the amount of time that you’ve held the property as a rental since January 1, 2009 (note that it goes back more than 5 years now to look at the use period). The one oddball exception to that (under (b)(4)(c)(ii)) is that if you lived in the home for 2 years during the past 5, and held it out as a rental AFTER you move out, that period is still counted as qualified use.
I mapped this out once about a year ago before selling my residence-turned-rental condo, and determined that it wasn’t worth moving back in to try to recapture a proration of the exclusion amount.
So let’s assume you lived in the house for 2 years starting January 1, 2009, and then converted it to a rental for 2011, 2012, 2013, 2014, 2015, and then moved back in for 2016 and 2017 and then sold it January 1, 2018, you would have owned it for 9 years total and lived in it for 4. You would be able to exclude 4/9 of $250,000, and that’s it. Better than nothing, but if you’re reaching for the full amount of the capital gains exclusion, it’s not as generous an exclusion as it was before.
Fantastic heads up an example. Thanks for the reminder and clarification.
San Francisco is an incredible city and it’s getting almost too crowded. You are lucky you found a gem.
The property market doesn’t show signs of slowing in SF and supply is low on single family homes. They are building way too many condos but people are still paying a premium even with more and more condos coming on the market.
That view is really fantastic. I love real estate investing although I don’t like all the hassles come with it so I am a solid reits investor and prefer to live close to work so that I can walk to work. Haha Thanks for sharing amazing posting as always.
BSR
“The more I think about it, the more I believe most of us should just buy a home to enjoy.”
Great point. The more I learn about investing, the less I look at my house as a way to increase my net worth. Owning rentals later in life are ideal for me, considering rent is tied to the cost of living, so I can basically guarantee my own food supply. But I’ve come to believe that my primary residence is not an investment decision. It is a value decision. A relaxing space combined with friends and family through the years is the recipe for a beautiful life.
Sounds like a great deal you picked up. People usually run away from fixers, but that often is where the great deals are. Are you going to hold your other properties for the foreseeable future?
I am contemplating doing a full remodel of townhome in Los Angeles It really is time as the appliances are all at the end of their useful lives and the flooring is done. It is a little hard to spend this kind of money without a direct return like I get on my rentals, but I think it is the thing to do. I am pretty sure I’ll get the money back on sale or at least most of it.
I may rent the extra room some on Airbnb to help pay it off when I am done.
Hi Matt,
The thing is, the property at 2001 14th avenue in this post is a fixer as well. All it received was a cleaning and a paint job before it was listed.
I plan on keeping all my properties forever, and keep adding one property to the portfolio every 10 years.
Good luck w/ the remodel!
Here in Tulsa OK, most properties are appreciating close to the rate of inflation. I bought new construction home that has done fairly well over the last 5 years, but still not major appreciation.
Everything I buy here is purchased for long term cash flow. It is fairly simple to buy quality properties with 9% to 11% cap rates. It is getting a bit harder in the past 12 months as it seems everyone is wanting to become a real estate investor.
I also bought a small mini storage complex in 2014 that was roughly a 13% cap rate. Again, not much potential for huge appreciation, but the cash flow is hard to beat.
Yeah, high cap rates are definitely great for the MidWest and non-coastal cities. I’ve definitely considered buying MidWestern properties for cash flow as well. But, my order of reasoning for purchase is lifestyle.
I’m not sure if it’s just me, but I get MUCH more excited with capital appreciation than rental income. It’s the same analogy of getting much more excited with a growth stock that performs well vs. receiving a dividend payout. Perhaps this is because I know how to make a steady income stream already.
How do you feel about rental income vs. capital appreciation?
Personally, I get much more excited about rental income. Perhaps I am biased because rental income is strong in the area where I am from and capital appreciation is not super strong.
However – this is why I am excited about rental income: I am presently 30 years old. I have total investment real estate worth about $800,000 and a personal residence worth about $240,000. I am on track to have all of my investment real estate paid off around age 38-40.
At that point, I’ll have no real need to work for money any longer. I plan to begin building a side consulting business this year that hopefully can generate $50k per year on an extremely part time basis within the next 10 years (about 10 hours per week at $100 per hour).
At that point, all of my living expenses will be more than covered by my real estate investment portfolio. The (hopeful) consulting income can either be used to enhance my lifestyle, investment in more property, stock, etc. or for whatever I want at that point. Primarily I am planning on building that business because I cannot see myself completely quitting paid work at age 40, but it would be very nice to have complete control over my time.
Sure, I’d love to buy a property and have it increase in value by several hundred thousand dollars. However, I’d much rather own free and clear properties that generate all the cash I need to live so I can quit working about 20-30 years quicker than most people.
I like the plan! And I think you will get there!
The funny thing I’ve found is that once you get there so early, it’s impossible to not work.
https://www.financialsamurai.com/its-impossible-to-stay-retired-once-you-retire-early/
https://www.financialsamurai.com/what-does-early-retirement-feel-like-the-positives-and-negatives/
You’re right. It’s hard to enjoy your stock, but it’s easy to enjoy your home!
Hi Sam, my market in northern Colorado has gone up 30 percent in two years and I am still buying. I have 13 rentals now and they all make good money. I agree it is very tough to buy rentals for income in big cities with high prices.
My personal investing strategy is to buy for income and keep building that income every month, not hope for appreciation. I am up to $7,000 a month in income from my rentals after I get number 12 fixed up and rented.
I would add the real estate market is not efficient. That is why you can buy real estate below market value. The house you bought was a deal because it was marketed poorly and needed work. If the market was efficient like the stock market those factors would not have mattered, because everyone would have still known the value based on what the market prices were for that exact house. The fact that every house is different, every seller has different motivations, every house is marketed differently makes the market inefficient. I buy all my houses 20 percent below market which helps my cash flow and is great for my net worth. Like you said, it is a paper gain unless you sell or refi.
I think the market catching up within 10 months is pretty darn efficient for real estate.
This is a great perspective on real estate investment. So many people focus on the downfalls of REI. In reality, if you live in the home first, you know its quirks, its potential problems and how to weed out tenants who realistically can’t afford to live there. It’s easier to market. Currently renting out my first home that I lived in for one year first and I consider it my best investment yet. It’s still “my house” and I made wonderful memories there, but now it’s making me money, so I love it even more!
Good stuff Michaela! I hope you continue to have good tenants!
The transition from “home” to “money maker” is a peculiar one. It’s hard to late go at first, but it gets easier over time.
I think you got a steal of a deal on that place! Obviously hard work and timing, but also the willingness to pay for renovations and remodeling must have played a pretty big part. I think a lot of buyers in higher priced markets are less willing to buy places that need fixing. Maybe it’s because they’re working so much, or maybe it’s because people think a house with a price tag in the high 6 to low 7 figures should come move in ready.
I like the strategy you recommend of buying houses to live in and then renting them out when you move. It’s definitely a great way to build a real estate portfolio while also enjoying improving living conditions. This is our current strategy with the house we recently bought.
I’m wondering how well this strategy applies to vacation property. A dream set up would be to have property in vacation spots across the US that are rented out, but that you can use for your own get aways. How has this worked out for you with your property in Lake Tahoe?
Hi Joshua,
It’s true, there’s less a desire to remodel by wealthy buyers because their time is more valuable. Hence, if you’re willing to roll up your sleeves and put in the time and effort to remodel/expand/renovate, the returns are even greater as wealthy buyers are more willing to pay a premium.
The crazy thing is the comparable that I highlight in this post (2001 14th Avenue) is not a remodel. It will likely go through $50,000 – $100,000 to remodel the kitchen, bathroom, roof, windows, etc. And even if that’s done, it’s still only a 2/1 with under 1,200 sqft of space. But its view is worth over a million bucks alone imo.
A second home or a vacation property can be a nice combo if you can get the combined mortgage under $1 million for deduction purposes, if you absolutely love the vacation area, and plan to utilize it a lot. But for the most part, buying a vacation property like I did is NOT a good financial move. It’s nice from a lifestyle perspective though.
I’ll write more about vacation property buying in an upcoming post.
Thanks, I’ll look forward to that post.