Tuesday, May 13, 2014
Investment Properties, Indexing, and Use Value
Along with an unseasonal amount work, a new project has been keeping me busy lately. The missus and I are in the process of buying our first rental property, the cutest little single family home a couple could ask for. We are working through a turnkey company, which basically finds a potential rental property, renovates it, sells it to an investor (at a profit), finds a tenant, and then acts as the property management company (for a percentage of the rent). We learned about this type of investing from FI Fighter, one of the really good dudes in personal finance blogging, and we're drawn to the light touch approach. Why would a frugal DIYer outsource all of that? The main reason is that Phoenix property values have skyrocketed since 2011, and the numbers look better elsewhere. The rub is that I have no interest in flying out to other parts of the country a half dozen times to find a rental, or in managing a long distance renovation from Arizona. In steps the turnkey company, and we get our one-stop shop.
Still, the process has not been without its snags. I negotiated hard on the first property, getting concessions on price, closing costs, and waiving fees for putting tenants in place. But then there was an issue with the title, and the deal fell through. A new property was suggested, but it only had one bathroom. We were set on a three-and-two, so we went back and forth on how to put in a second bath, and how much of the costs we should bear. After finalizing that, it turns out the taxes were re-assessed, and they doubled, due to it now being an investor owned property. Problems abound, and we haven't even started being landlords yet.
All that said, we're still moving forward with the deal as we think it will still provide good returns. But I was driving home from my mother's this past Sunday, a dull six hour trek from the mountains in California into the desert of Arizona, when I got to thinking. Why is it that I'm so set on owning rental property in the first place? We are basically index investors. We buy index mutual funds because they're diversified, they have low fees, and the strategy is bound to beat active investing over the long haul. We can dollar cost average to avoid trying to time the market. We can rebalance regularly to keep in line with our asset allocation. The strategy of index investing acknowledges that we are not so smart. When it comes to actively picking particular stocks, and when to buy or sell them, I'm subject to a variety of logical fallacies. The way to win at active investing is to not to play in the first place. So why is it that I'm actively investing in real estate?
Buying a piece of property is a bit like buying a single stock. One house is unique from every other, so you try to buy the best value or best performing one. As such, a house or a condo is not diversified: you are not buying the neighborhood or the market at large, but a single asset you're hoping outperforms the other choices available. The process of evaluating a property looks a lot like the fundamental analysis of a company stock: you look at its historic value, the property's costs and predicted revenues, and make predictions about future returns. Worse yet, there might be a little timing of the market involved, too, as we try to buy while the local housing market seems well priced (ignoring the possibility that prices may drop in the near future). We can't dollar cost average since, well, we can't afford to buy a new property every month or two. We can't rebalance, either, since we can't sell off just a piece of the house to bring us back into our desired asset allocation.
Considering all these contrasts with our core investment approach of indexing, I've got to ask why we'd buy rental property at all. Or if we like the idea of real estate being part of our portfolio, ought we just buy a REIT index like VGSLX?
Mrs. Done by Forty points out though that owning property provides some important things that paper investments do not: they give us something tangible. No matter how poorly the property investment turns out to be, we (or someone) can always live in it. In other words, a home has a use value and an exchange value, while paper investments only have the latter. Besides the fact that you can sell it for money, a stock investment doesn't have any real use or value. A home has tremendous use value: it gives shelter from the elements, a place for children to play in the yard, space for a garden, and all the other comforts of home. It's hard to quantify that use value in dollars of course, but we'd do well to remember the benefits of having a roof over our heads. On top of that, there's the fact that we intrinsically want to own property, so we will save at a greater rate to achieve that goal. On the other hand, I have to twist Mrs. Done by Forty's arm to invest in the stock market at all. So there's some unknown (but real) delta between the scenario in which we save because we really want something (a cute house we can rent), and when we save because we know we ought to (investing in index funds for retirement).
As usual, I have a question more than I do a point. What do you readers think? Are we being inconsistent with our investing behavior? Should we just avoid the headaches of owning property, the negotiations and lending hoops and never-ending problems that landlords must deal with, buy a REIT, and be done with it?
*Photo is from krystian_o at Flickr Creative Commons.