case study: 7-year investor, 34% gain, no profit

Spoke to someone about all the real estate na-sayers. The repsonse was that these people must be fairly young on average, and that cash was a sure fire losing strategy over time as opposed to real estate which over time will go up, if not today then tomorrow.

Inonada, I may be reading this wrong, but am I right thinking that if your friend had not done the cash-out refi the investment would have paid off far better?

Also, based on calculations I've done for tax-abated properties, the tax rate seems really high at The abated taxes I'm seeing in that price range would total about $4500 over seven years, less than the annual $5,285 and change. $440.47/month doesn't seem abated to me, although I am not really looking in Manhattan so this might be the issue.

Just asking for my own edification, not trying to challenge your figures - this is really interesting info, and I appreciate your post!

One wonders if the average person properly considers points and recording tax when advertising refis..
Tons of brokers, just rattle off 2% and it works.

Inonada, you need to incorporate mortgage interest tax deduction in your analysis.
Also the $20k in insurance seems really high.

Evnyc, the abated taxes were on a 10-year schedule (i.e., 10% of full taxes in the first year, 100% in the last year), and this is at the tail end of the abatement (i.e., 7 years ago was not at 0%). The current taxes are $665.

I do agree that things would have worked out better without the refi. Problem #1 is that $16K wer paid. Problem #2 is that $17K of interest on the extra amount ($110K) would have been saved. Problem #3 is that the refi was at a 1.5% higher rate than the original (5-year neg am ARM into a 10-year ARM), and things would have worked out better to the tune of $22.5K from that. So altogether, maybe $55K better had there been no refi.

Now I'm not privy to the reasoning behind the refi or the cashing out. On the cashing out, it could very well have been the case to reclaim / provide buffer on upfront costs paid and negative carry. Or it could have been simply to increase the leverage on the investment.

Not that it matters much, but this is not a friend, more of an acquaintance: I try to avoid poking around the finances of my friends...

downtownsnob, this was an investment property, so there is no mortgage interest or property tax deduction. I agree, though: if this had been owner-occupied, the picture would have been nicer to the tune of $70K.

Insurance is one of the things I had to guess at. I used $2800 a year on a $835K condo. What do you think is correct?

Purchasing a single-unit dwelling for investment purposes has almost always been a bad idea. Even in the height of the market, people were cautioning against this. Very few people are ever going to rent something for more than it would cost for them to buy the same thing, and the ones who will are often not desirable tenants.

If you already own an existing property and it makes financial sense for you to rent it out, that's one thing. But buying a new property to make money renting it is almost always asking for trouble.

Good points and interesting analysis. I buy property only to live in, so these numbers don't mean much to me. Of course, an investor in the DJIA at the end of 2003 would have lost money as of today.

I assume that this is a doorman 1 bdrm given the average rent is under $3K and common charges around $750. I am not sure that $625 was a much of a good deal for a 1 bdrm in 2003.

"Purchasing a single-unit dwelling for investment purposes has almost always been a bad idea."

Huh? It was a great idea for much of the 1990's. Prices were 1/3rd of what they are today, rents were only 30% less, and mortgage rates were 30% higher. I think it would have made fine sense back then. It hasn't been a good idea for just about a decade now.

Well if they took cash out, it went somewhere. One could argue the risk free rate on that cash out should be added to the profit. I suspect the cash went toward something other than profitable investments, but we should account for it anyway.

Great post nada - on the one hand fascinating and on the other obvious with hindsight. To summarize, the guy lost ~$100K on monthly cash flow because rent did not cover the sum of interest, common charges, property tax and insurance and another ~$100K on transaction costs coming and going (and refi-ing mortgages) that added up to something approaching 15%.

On the entry, and echoing nyc_sport, I question the presumption that he bought at a good price. I looked for several months earlier that year and ended up buying in the summer of 2003 and I recall rent vs. buy (admittedly after-tax, which makes my owner-occupied situation different from the example) being pretty much a push in those days. Here, the investor's rental income fell 30% short of total carrying costs, which just seems like a lot if we are working on a "625k was a good price" assumption. My 2 cents.

"Of course, an investor in the DJIA at the end of 2003 would have lost money as of today."

Not really. DJIA was at 9800 back then, it closed at 10406, and it paid 1560 in dividends. So a return of 22.7%.

"I assume that this is a doorman 1 bdrm given the average rent is under $3K and common charges around $750. I am not sure that $625 was a much of a good deal for a 1 bdrm in 2003."

The holding period was 80 months, not a full 7 years (84 months), and it went into contract very late 2003, closed very early 2004. Average rent was $3350, square footage is ~950. It also transacted at $630K in 2002. All said, I don't think it was a very bad deal either, as evidenced by the in-line-with-market 34% rise since then.

"On the entry, and echoing nyc_sport, I question the presumption that he bought at a good price. I looked for several months earlier that year and ended up buying in the summer of 2003 and I recall rent vs. buy (admittedly after-tax, which makes my owner-occupied situation different from the example) being pretty much a push in those days. Here, the investor's rental income fell 30% short of total carrying costs, which just seems like a lot if we are working on a "625k was a good price" assumption. My 2 cents."

I don't actually think the two pictures are very different price-wise. The deductions are worth close to $10K a year (around 25% of carrying costs), and between OP fees and some empty months spent finding tenants / closing a sale, I think simply that makes up the 30% shortfall between what this is and what you had. Perhaps 6 months of price gains also account for a little...

walterh7, you make a fine point. On the other hand, I didn't charge anything for the down payment or the upfront costs or the cost of the negative carry over the years. In some sense, the down payment was mostly tied up for a few years, and then he pulled most of that capital out, a good fraction of which was used to replenish the hole?

Fair points nada. I think you are on to something on the 6 months of price gains. At the time it felt like we bought in a bit of a lull and that the market started to take off almost as soon as we signed the contract, but I am cautious about presenting that as fact lest I be accused (or in fact guilty) of making up a narrative to validate our decision to purchase.

I am missing something because it would seem that it was an awful investment from the start as it seems total rental collected was lower then actual expenses every month. Maybe some of it is the interest rate paid after the refi.

Also from a tax perspective, you are assuming no benefit of the tax loss, but you have not given figures for where he ended up. For instance he sold for $835k, but it looks like it nets down to $766k and he paid $625k, however he would have been depreciating for tax purposes and had $140k in depreciation over the 7 years assuming i beleive a 29.5 year life. that means that its value was $485k and that he actually had a gain of $281k and he would then recapture the losses not taken over the years, of at least the depreciation and then the remainder of the losses. Either way it would seem that your friend actually did not do well at all because he has to pay tax on the gain on the property. Assuming any left after the losses.

But seriously though you said he owned 80 months, the $3500 does not seem even close to covering monthly costs.

inonada, this is a great post. I think it really emphasizes how distorted the real-estate-as-investment philosophy got during the bubble and makes it clear that owner-occupied property is really not an investment.

If you're going to buy property with the purpose of renting it out for profit, you simply cannot approach it in the same way as you would buying a home. To me, that means all cash or at least mostly cash - if you look at the major dings on his profit, two of the biggest ones are interest paid and mortgage tax. Now obviously, not everyone has that much cash on hand, but that's exactly why real estate investment should not really be a money-making venture for the average joe (and apologies to the non-descript Josephs out there). When you put 10% or 20% down and borrow the rest, why in the world would you expect a huge profit 7 years down the road?

I am new on this board, but let me try this. His basis is 625+37=662. He had a negative cash flow of 99 over 7+ years. If he were actively in rental business, this 99 plus depreciation would offset his tax on ordinary income. If he were a passive landlord, the rental loss plus depreciation would be deferred until he sold the property and would offset his ordinary income. The depreciation portion would be recaptured when he sold the property, so that the portion of gain eqaul to depreciation would be taxed as ordinary income (whether or not he was actively involved or not), so depreciation would give him tax benefits only if he were an active landlord, but only to the extent of the time value of money. Now, the net amount realized is 835-69=766, so he had a capital gain of 104, which would be taxed at 15% for federal (but I think no difference for state and local). He had a cash on cash return of 5 (which probably would have been higher but for refi), but he was getting a tax benefit, which would be at least about 20 (tax rate differential of 35% minus 15% on 99), assuming that he had 99 of ordinary income. Not sure if this is a good enough return or not, but certainly there is more than 5 gain from this investment.

Not sure where you are assuming he got a tax benefit. His income was over $150k according to this scenario so he got no tax deduction for the loss, all it did was offset the gain at the end of the day. but based on your calcs also that means he walked away with 5k assuming no other figures we are missing that could make that 5k a loss. Either way this was an awful investment and probably was from the moment the idea was formed.

And to think I almost purchased a pied a terre coop in Brooklyn. $600,000 + $70,000 renovations. Maintenance $1500 + assessment $230. Add insurance, cable/internet, utilities. Thank you to the coop board for rejecting us because we would be part time occupants. We could stay at The Ritz and probably come out even for the average 5 nights a month we would be there......unless one assumes a 20% annual increase in real estate values. Not.

I am not a tax professional, but the loss is from business, which is ordinary. This would not go on Schedule B, which would be subject to limitations. I think the 99 loss over the 7 year period or at the end as the restoration of passive activity loss would directly offset income on 1040. In any case, this may not have been an investment I would have made (definitely with the refi).

wtf inonada? If you keep this up, I'll have no morez lemming meat. I needs lemming meat with a side of mash!

UWS77? I paid $5K for a kid to wash my boat, fix the tiller and keep an eye out for it.
kid = $0 investment, 20 hrs total "work"?,
mini-trump=$662K at risk, leveraged, I bet a lot more than 20 hrs of work, countless hours tossing and turning, inability to get it up during weekly family budget time for 7 years.

NOT ALL $5K gain is the same, no?

w67th, not sure I actually want the answer to this question, but why do you need to "get it up" during family budget time?

bjw, my wife gets really really randy when I see how much money we accumulate every month renting.... if the stars align properly, (i.e. no call weekend, women issues, etc)... budget week sex is No Ka 'Oi!

Yes, but think of the children!

Hell, I know what I'd do if I was 18 and had an empty sailboat.... : )

I AM thinking of the children... she wants ONE MORE! She doesn't know I'm shooting blanks.... ; )

depreciation against passive loss? 150 income limit? what?

Renting kids (uncle) is so much easier and cheaper.
Still get the benefits of owning (they look like me, share the same surname and genes) but can move out anytime I want.

On depreciation and losses talked about by UWS77 and Mikev, here's how I think it plays out. Beyond the standard disclaimer of "I am not a tax professional", let me add that I dug up the rules on this stuff when putting together the above scenario, so I have little experience with it. If someone can illuminate further, it'd be appreciated.

The rental unit had $241K in revenue (rent), minus $377K in costs (interest, common charges, insurance, property taxes, mortgage taxes, points, etc.). This amounts to a $136K loss. Additionally, fraction of the $625K purchase that can be attributed to the building (as opposed to the land) can be depreciated linearly over the 6.7 years of ownership. Let's assume $500K is depreciable, which works out to $18K per year, or $121K overall. Altogether, there were $257K of losses.

Putting aside rules for RE professionals, you generally cannot deduct losses from passive income (such as renting out property) against regular income. However, a special exception for up to $25K per year is made for rental properties. This exception is fully phased out at incomes above $150K, so for the actual investor here it didn't matter. That's the calculation I did above.

Had this individual been able to deduct $25K a year ($175K total over 7 years), it still would have amounted to pretty much nothing. Below $100K (where the exception is in full effect) or even $150K (where it is reduced), federal tax rates are either 25% or 28%. Let's call it 28%. What this means is that you'd get to reduce your taxes by $175K * 0.28 = $49K in the years you're experiencing the losses. However, the $175K you got to deduct is kept around and reduces the tax basis of the investment so that you later (at sale) have to pay capital gains on the $175K you deducted. The capital gains tax rate on this $175K is not the standard 15%, but rather a special 25%. So, at the end you'll have to pay $175K * 0.25 = $44K in extra capital gains because of the $49K you got for your losses. In the end, you'd only net $5K.

Of course, there are other advantages to the setup: you defer the taxes, and you get to make use of the capital in the meantime. Nevertheless, all this was not an option for this particular investor because their income is above $150K.

truthskr10, although it might make sense to have kids, and it's downright great to borrow kids, it's not a good idea to lend your kids out. How ever will you find people who are willing to lend their kids out, unless of course, we are in the midst of a kid bubble?

I'm with UWS 77 - I'm assuming that if this guy has a $1 mm first mortgage so the mortgage on the investment place isn't tax dedctible, then the nominal monthly losses on this place are being used to generate larger schedule E losses which are shielding his ordinary income. Similarly, expense items like the property taxes are going to generate deductions, no?

ali r.
DG Neary Realty

My family is in a constant bubble state.
You know those jewish grandmothers.....the biggest developers ever.

FP, how would mortgage interest on an investment property ever be eligible for the mortgage interest deduction, regardless of the $1M issue. This is not a second home.

On deductibility, as I outlined above, I don't think he gets them because of the $150K income thing. Even if he did, it would mainly serve to defer the tax liability, plus maybe a 3% reduction in taxes from the aggregate amount of losses.

true enough, passive losses are not deductible in any quantity with high income. However, they do not disappear and can be used against future passive gains. So, there is a retained asset there.

I think you guys will teeter back and forth between what could be and should be which is fair, but what NAda presents is hey, here's a real story.
And though in a perfect world the picture might be a bit better (no refi,etc) but that's the point is real life is not the perfect world, and purchase errors can be heavy. A lot heavier then rental errors.

I don't follow the cash analysis. Why isn't it initially -125k for the purchase and +whatever for the cash-out refi and +whatever for the net sales proceeds. You seem to mix cash costs with transaction totals, and fail to recognize loan proceeds.

Also, zero return on zero net equity investment (cash out refi) is really not so surprising, is it?

I agree with you, gcondo. In this case, I offset the retained asset (the $257K of passive losses -- $136K from negative carry and $121K from depreciation) against the later liability (the $141K of capital gain, plus the $121K from depreciation recapture).

The biggest value of the whole thing, it seems to me, is to be able to take the $25K against income each year, yielding $7K. If you like-kind exchange from one property to the next indefinitely, you can push out the day of reckoning for a long time. In the end, however, you will end up owing the $7K in taxes back. However, you are effectively getting a 0%-interest loan on that $7K for many years.

I believe many professional RE investors who should have known better got caught up with their positions trying to avoid the day of reckoning. I.e., even though they knew paying 2006 prices was a bad idea, the like-kind exchange clock was ticking and they just didn't want to have to pay the IRS bill.

I think for this person, he could use the PAL when he sold the property, as he owned for more than 2 year. I also think that given his income and this paricular property, he probably was able to claim that he could rely on material participation in rental business, so he deducted the rental loss on a current basis. (I was told that the PAL applies to those who own lots of rental property and engage a management company to take care of rental business.) I am not sure about 25% capital gain rate. I did not know about it. Where should I look to find it out?

PMG, consider the $125K cash as margin posted to put on the trade. If you'd like, you can change the lines:

-$625K purchase price (put down $125K, borrowed $500K)
+$835K sale price (5% below $879K ask)

Into:

-$625K purchase price
+$500K proceeds from initial loan

-$500K repayment of loan
+$610K proceeds of second loan

-$610K repayment of second loan
+$835K sale price

The investor put $125K in at the beginning, removed $110K in the middle, and removed $225K at the end. They netted (before other costs), $225K + $110K - $125K = $210K. Alternatively, you could ignore what happened on the money in terms of when it was in the hands of the bank vs. the investor and just look at the price at the end minus the price at the beginning: regardless of who put the money in and who took the money out and when they did it, there was still $210K of netted between the sale price and the purchase price regardless of anything else.

"Also, zero return on zero net equity investment (cash out refi) is really not so surprising, is it?"

For an investor looking to make money, it is worse that what was expected. Even if you borrow all the money for making a risky investment (with the understanding that you are on the hook for losses as well as the gains), you are doing so with the expectation of a positive return. Why else would you take the risk?

Inonada,
Just stay all cash
-125k
+110k
+225k
It's much clearer that there is near zero equity.

Just because someone takes risk by signing mortgages (here it's mostly the bank's or American taxpayer's $$$ and the buyer's credit rating) doesn't guarantee them a positive return. My point is that zero $$$ equity is not a recipe for economic gain. In Atlantic City maybe, but not in capital investments like property. I think if you say in the beginning of the thread that the investor had zero $$$ equity invested, no one would really care to crunch the numbers, nor would they be surprised by your conclusion.

WOW! Can you imagine the NOLs this ninny could've gotten if not for the greatest RE BUBBLE in nyc's history!!!????

truthsk.... my kids are "no cat food" insurance policy.... but seeing them fight to be first to press the elevator button, makes me think I should save more....

I am lost by your argument. Someone with income above 150K bought an investment property in Manhattan with negative cash flow and ended up with no return on a 0 investment? this is the most stupid case study I have ever read.Can you restate your point and what is your conclusion?

PMG, I don't see how -$125K + $110K + $225K means near-zero equity. I don't understand your math.

On day 1, the investor put up $125K and borrowed $500K for the purchase of a $625K asset, in which he had 20% equity. He then paid $21K out-of-pocket in buy-side closing costs. At this point, he still had 20% equity. He then proceeded to pay $14K negative carry for about 3 years until he refinanced, at which point for the sake of argument let's say the place was worth $1M. During this entire, he only had a $500K mortgage, as the equity grew from $125K to $500K. His out-of-pocket costs grew from $125K to $188K. Then, he paid $16K out-of-pocket to refinance with a $610K mortgage, pulling $110K out. At this point, his equity in the condo became $390K, and his net out-of-pocket costs became $94K. Then, over the next 4-ish years he paid $14.25K negative carry, or $57K total, and his out-of-pocket costs became $151K by the end. Meanwhile, the price dropped from $1M down to $835K, and his equity dropped from $500K down to $225K. He then sold with $69K in selling costs, bringing his out-of-pocket to $220K. After paying off $610K on the mortgage, he was left with his $225K equity. Netted against his out-of-pocket costs of $220K, he netted $5K.

So, during the entire period his out-of-pocket costs (your seemingly preferred metric) was always at least $94K and averaged $140K. His equity was always at least $125K and averaged $340K.

How exactly do you figure this guy didn't have any money on the line at any point in time?

007: please read my last post if you want the details. The summary is that PMG's assessment of "zero equity" is based on a misunderstanding. The investor bought with 20% equity, all the while keeping at least that much equity in the property (and at times 4x that for a 50% LTV, and with the cash-out refi 3x that for a 61% LTV). The out-of-pocket cash at all times was at least 15% of purchase price and averaged 22%.

The point here is that here is a case of a guy with a 7-year holding period that started well before the peak of the bubble. He saw a 34% gain on the asset price, which he had levered up 5x with a 20%-down investment. Despite the simplistic-viewed 168% gain on that 20% downpayment (i.e., $125K became $335K), the reality is that the gain was nothing.

sls: "Fair points nada. I think you are on to something on the 6 months of price gains. At the time it felt like we bought in a bit of a lull and that the market started to take off almost as soon as we signed the contract, but I am cautious about presenting that as fact lest I be accused (or in fact guilty) of making up a narrative to validate our decision to purchase."

Well, I think Miller Samuel certainly paints a picture of high rates of appreciation in 2003 & 2004: average ppsf was $639 in Q1 2003 and $910 in Q1 2004.

Was it an interest only loan? If not, wouldn't he have paid down the 610K 2nd mortgage by about 25K-30K over those final 4 years?

did this person overpay for the property? I thought Manhattan real estate appreciated a lot more than by 34% over this 7 year period? 34% over 7+ years is less than 4% per year on a compounding basis. what am I missing here?

Oh, and what about the original 500K loan? Was that paid down? Probably would be about 18-20K over those first 3 years. So when refinanced for 610K the payoff wouldn't be 500K. More like 480K and when sold, the payoff wouldn't be 610K but more like 582K. Another 48K +-.

Bob420, the first loan was IO with 110% negative amortization. The second loan was regular. I don't know how much principal was paid (or neg am capital) was taken out. To first order, it doesn't matter though. The $218K interest paid is just that, interest. I just assumed no principal was paid on, say, the $500K mortgage; I assumed $500K was paid at the end. If $20K principal was paid in addition to the interest, the final balance would have been $480K, and $500K total would still be paid. So it doesn't really matter.

Arguably, the interest paid would be lower by 2-3% if the principal was being paid off. Similarly, if the IO feature was being utilized on the first loan (good assumption -- why pay the higher rate for IO if you're not going to use the feature?), then the interest paid would be 2-3% higher as the loan balance increased. Given that one was IO and the other was not, I assumed the two offset and called it a push -- constant loan balance throughout.

UWS77, this was a 6.7 year period. Sale closed Jan 2004 and will probably close Sept 2010. Using Q1 2004 to Q2 2010 Miller Samuel data, 34% (4.4% anually) is very much in line.

Alternatively, does an 80% increase followed by a 25% drop sound any better? That gives you a 35% increase.

-$ 50K broker's commission
well thats nearly 1% a year, investor must refuse to pay this 6% (other places do it for 1.5%-2.5% at the lower end of the market and less at they high end)

PMG, I don't see how -$125K + $110K + $225K means near-zero equity. I don't understand your math.

inonada, don't take the net selling proceeds into account when looking at equity invested. Take the down payment $125k, and subtract the cash out loan $110k for a net equity investment of $15k on an real estate asset bought for $625K. Forget counting closing costs, loan fees or transfer taxes as equity. The investor in effect put down 2.4% equity ($15k/$625k). That is what I mean by zero equity. Listen inonada, I mean no disrespect, but when an investor has 2.4% equity in Real Estate the carry charges are going to exceed the fair market rent. It doesn't take a rocket scientist to understand that breaking even is actually a lucky result because it requires obtaining a higher sales price. Maybe you saw too many "no money down" real estate infomercials but this example is not shocking to me. No investment equals no return in 7 years. They were lucky they didn't hold on and continue to lose money on the carry.

I re-read your responses inonada and you said the investor at all times had 20% equity. You, like the banks that once marketed HELOC loans based on appraised values have a notion of investing that I don't agree with. The banks may have been foolish relying on appraised values but they were bailed out by the Fed. The rest of us might not be so lucky. A conservative investor looks at transaction values. A conservative investor doesn't do cash out transactions within a few years of a purchase. Perhaps, I look at this as 2.4% equity because I never saw the wisdom of using leverage in a bubble.

Makes sense. I didn't look at the complete breakdown at the beginning to see that you were only adding interest paid and not a possible total mortgage payment.

Interesting calculation, I'll have to go through it in more detail. Are all of the tax matters accounted for?

sixjaydee, yes they are accounted for. This is an investment property, so no homeowner deductions; with them the picture would have been much better. Loss & deterioration did not come into play here (no loss limitation exception due to income level), but I don't think they would have mattered much for other than tax deferal (i.e., the spread between income tax rate and special recapture rate is de minibus). All is discussed, and any corrections would be appreciated.

PMG, you make no sense. Can you point to a time when there was less than $125K, even based on your preferred metric of transaction values? No, and it averaged $340K. Can you point to a time when the investor had less than $94K net cash out of pocket in this investment? No, and it averaged $140K. Yet you insist there was only $15K equity.

It seems to me you are only looking at half of the relevant cash flows: you are completely ignoring the money put into this investment outside of loan-related capital. That's just wrong.

inonada, frankly, you are rude. When you look at the transaction value which is the purchase price the asset is valued at $625k. When you look at the deposit money less the cash out it is $15k. If you want to look at the negative carry costs as equity, you are confusing matters because these are only high because the equity of $15k is so small. Get it? See you don't need to have Ivy league degrees in engineering or business to understand. It's really quite easy.

inonada, using your logic, if the investor put 100% equity down, the carry would be positive. Would this positive rental income reduce the equity investment? No. That would represent the RETURN ON INVESTMENT. It's no different because it is a negative return in this case. Just because this purchase cash doesn't mean you call that cash equity. IT'S A LOSS ON INVESTMENT. There is your lesson on the basics of investing for the day. I'm out.

just because this purchase EATS cash doesn't mean you call that cash equity.

can someone opine on the insurance costs? $3k/yr sounds very high for a one bedroom, especially because there wouldn't have been any contents insurance. For my 2 bed co-op, without the contents and riders, the insurance is well less than 1/2 of that. I don't know how it works for a condo, though I would assume that a portion of the common charges go towards insurance for the structure, so that the individual unit owners only pay for what's inside their apartment - cabinets, appliances, etc. I stand to be corrected.

Also, when buying a property which is initially CF negative, such as this one, isn't the idea that as rent rises it hopefully becomes CF positive? Not that you cash-out refi to keep it CF negative - either he did that intentionally to keep it CF negative for some tax purposes, or it was just a foolish move. The transaction costs of that cash-out were mindboggling - he paid 15% to get that $110k - quite a vig.

I just bought a condo and my insurance part, ignoring building coverage paid through common charges, is $350 per year.

Mikev and printer, I stand corrected then to the tune of $15K or so overall.

The refinancing was probably more motivated by the expiring ARM, I believe, not cashing out (about half of the $110K could have been pulled out simply from utilizing the negative amortization of the original loan). At the time of the refinancing (mid 2007, 1.5 years before ARM expiration), the loan was due to reset to 1-year treasuries (5%) plus a 2.7% spread, so 7.7%. The refinancing was probably an attempt to lock in a lower rate in face of what seemed to be looking like 7.7%. Of course, had he simply waited, the rate on the original loan would have simply rest to 3.3% in 2009 and 3.0% in 2010.

PMG, I believe I now understand what is in your mind. I believe it is wrong and misguided (not attempting to be rude, just stating how I see it).

My view of equity in this instance is $125K downpayment, plus the $21K in closing costs, plus about $56K in capital buffer put aside to deal with the expected negative carry. Remember the Stuy Town deal and how the buyers had allocated capital to a fund separate from the purchase price to cover the expected negative carry? That money had to come from somewhere, and they were not free to use it for any other purpose, and it had to cover the shortfall. You'll note that this investor always had between $100K to $200K cash out of pocket invested in the deal.

As to the cash-out, they had a gain of $375K and equity of $500K. Say they wanted to realize a small fraction of their gains ($110K) now rather than later. How is that any different than realizing gains by having paid cash and getting monthly positive flow? It is simply realizing a portion of your gains while keeping yourself invested cash-out-of-pocket at $100K-$200K.

If you want to take a picture of equity or cash-out-of-pocket at the start and use that as the basis of ROI, that's one thing. This is my preferred picture.

If, on the other hand, you want to use some continuous and changing version (as you seem to prefer), that's another valid way to look at things. However, if you do this, it's a mistake IMO to count only the cash-outs along the way and ignore the cash-ins. This is what I believe you are doing.

PMG, I'm curious how you'd account the following. FWIW, I don't think there's one correct answer, I'd like to know how you view it.

Suppose you buy $10K of S&P 500 futures, and you post your $1K margin. Over the first year, the price goes up 30%, so you now have a $13K future with $4K in your margin account. You decide to take $2K out of your margin account, leaving it with $2K. Over the second year, the price is flat, and you still hold a $13K future with $2K in your margin account. You sell, putting a total of $4K in your pocket.

I think we all agree that there was $3K profit here. However, what would you consider the equity? Is it the $1K initially put up? Is it the initial $1K put up, minus the $2K taken out in the middle, leaving you with $-1K?

overall nada, an interesting case. what it highlights is that even a decent period for real estate (4% annualized returns) can't bail you out of the foolishness of CF negative property bought with a neg-am IO mortgage, which you then take a hefty cash out re-mortgage on.

If it were a 'more typical' transaction, and you didn't have the $55k (your number) of extra costs associated w/the re-mortgage, and corrected by $15k for the insurance, you'd be looking at a gain of $75k on the $202k of equity (your number), which would be a gain of 37% over 6.7 yrs, or a compounded return of about 4.8% - not great, but not horrible. And this on a short-term holding with substantial transaction costs which was negative cash flow during a period when the asset appreciated nicely, but not wildly (4% or so - CPI (which many think understates true inflation) over that time was around 2%)

"Well, I think Miller Samuel certainly paints a picture of high rates of appreciation in 2003 & 2004: average ppsf was $639 in Q1 2003 and $910 in Q1 2004"

Im sure has a lot to do with invasion of Iraq and capture of Saddam.
(Invasion March 2003 / Capture December 2003)

Printer, I agree with what you are saying. I was surprised that a 34% nominal gain on a $615 base did not translate into much profit (corrected to $20K after applying the $15K insurance change).

I don't actually think the financing was the issue here, though. Had the investor been "conservative" and gotten a 30-year mortgage on the $500K and without a refi and/or cash-out, the mortgage paid would have been $226K, $5K higher than the $221K that was actually paid. (Conforming was 6% back then, and this would have been jumbo + investor, so it'd have been something like 6.75%.) So, something like $11K would have been saved ($16K in costs for the refi, minus this $5K). On the other hand, he would have needed another $100K in capital cushion, bringing the total cash-in closer towards $260K by the final sale.

I.e., I don't think it was the financing. Had the investor gone "more typical" in the sense of a fixed 30-year mortgage upfront without a refi, he'd have netted $10K, but with the caveat of needing another $100K in cash. The $55K is what would have happened had the investor not refinanced. However, refinancing is the "more typical" choice there. Put yourself back in 2007. You have a 5.125% ARM that is set to reset to 1-year treasuries (then yielding 5%) plus 2.7% in a year-and-change. You're looking at a reset to 7.7%, and long-term rates are at historical lows. Inflation is running amuck. Do you refinance to lock in a low rate? I think so.

Can someone just bullet point this case study. Seems to me its not adding up. Did he rent out the property, what amount was it rented for over the 7 years. Also aren't you allowed to depreciate investment property by 1/38th of purchase price from your taxable income?

And if he used it as a second home or primary home without renting it out - shouldnt we be factoring in the use and enjoyment of the property? Living rent free in Manhattan for 7 years and netting zero return is not bad.

The original post contains all the details, the only thing that should be amended is that insurance was probably $5K not $20K. Everything else remains.

On rent, it's already in there at $241K received in rent. About $3K a month.

On depreciation, you only get it if you make less that $100K or $150K, which was not the case in this instance. Even if it were, it would have been of little value because whatever you depreciate (in this case at a 28% marginal tax rate, I believe) would have been taxed on the way out at a 25% tax rate.

There are no bad investments, only bad prices...

Same thing could've been written about stock investor..

in regards to the mortgage tax, NY allows ammended and restated loan docs so the mortgage tax is NOT paid twice.

Lance1, in this specific instance the tax was paid twice. CEMA requires cooperation from the first lender, who may not have any incentive to do it especially if they are getting a fat rate from a loan whose LTV has dropped since underwriting. You figure the owner would have done it if they could have as it would have only cost $2K instead of $12K+.

What if instead this person bought shares of Sprint instead?

If he had sold this today after 8 years, he'd have out a bit more negative carry and would have gotten a slightly lower price, ending up with a profit of $0K more or less.

If he had bought Sprint with the cash & buffer put into this purchase of $200K, he'd be down by $157K.

If he had bought Apple with the $200K, he'd be up to $10M!

If he had simply bought SPY, he'd be up $100K.

If he had simply bought a bond index like TLT, he'd be up $200K.