Midnight Ravings Pt. 1

Good evening, friends.

For the inaugural Black Cypress blog post, I felt it'd be helpful to summarize as best I can our current investment strategy, and a bit of the reasoning behind it.

Part I - The Basics

When considering how best to allocate capital, we look at the following:

• Return

• Risk

Pretty simple. See you next month!

Just kidding. Let's break these basics down into their components.

Return

What actually makes up our Returns when it comes to Real Estate investing? We can boil it down to 4 components:

• 1. Cash Flow: Net profit from owning an asset (after expenses) that hits our bank account each month.
  
  Example: We own a 2-family home. Each side rents for $5k/mo. The total mortgage (including taxes & insurance) is $8,500/mo. Let's assume the tenants pay the utilities, so we don't have to worry about those.
  
  Let's also assume we'll have 100% occupancy (we won't but it keeps the math simple) and we put 10% of the rent aside for Capital Expenditures (CapEx - Costs like a new water heater, etc), so our $10k/mo becomes $9k/mo. This is our Income.
  
  After paying our Mortgage, our Cash Flow is $9k - $8,500 = $500/mo. 

• 2. Appreciation: The value a property gains during our ownership.
  
  Example: We own a $500k property for 5 years, and then sell it for $630k. That $130k gain comes to us as profit, though we will need to pay long-term capital gains tax on the gain (so 15-20% of that $130k increase), and remember to factor in closing fees (typically 6-8% of sale price).
  
  Note that appreciation is not guaranteed. Shockingly, neither is cash flow... The reality is, no investment is guaranteed.
  
  
  

• 3. Debt Paydown: Other people are paying off our debt on the asset. In the example above, when we sell, we've also got less debt left on the asset than we did initially. This increases towards our total profit upon sale.
  
  
  

• 4. Tax Savings: Owning real estate allows for significant tax advantages, which come in the form of depreciation. We can go into detail in another newsletter but this is essentially a cherry-on-top that makes owning RE even better.

All of these pieces add up to our total Return.

With me so far? Good - In a future newsletter we'll cover the Metrics we use to measure Return (Cash On Cash return, Internal Rate of Return, Return On Investment, Return On Equity, etc.) as well as Debt / Leverage, and how MASSIVELY important it is.

Let's move on to...

Risk

Here's a fun topic. Off the top of my head, here are some of the risks I'm thinking about when it comes to buying and holding real estate:

• Your strategy becomes illegal - You have a STR in a town that bans STRs. This is a trend that has been playing out for the past 5+ years as Airbnb has become more popular

• Major Capital Expenditure (CapEx) costs come out of nowhere - The roof caves in and the water heater explodes! Our pets heads are falling off
  
  

• Market goes down and the property is now worth less
  
  

• Competition is too good and your property underperforms
  
  

• Someone gets hurt at your property and sues
  
  

• Squatters refuse to leave your Multi-Family apartment and you lose rental income for a year. Your $500 cash-flow is now negative $4,500 plus lawyer fees. They trash the place when they leave and put a burning bag of shit on your porch. You stomp it out and your wife calls it "Poop"
  
  

The list goes on and on.

Realistically, some of these risks are going to happen, no matter how well prepared we are.

More importantly, all of these risks are mitigatable, and none are disastrous, so long as the approach considers them and errs conservatively. To quote Warren Buffett,

"Risk comes from not knowing what you are doing."

At the end of the day, there are a million reasons not to do anything worthwhile. I'll spare you the IG inspo post here, but in all seriousness, it's risky to work your W2 for the next 35 years and hope you make it to retirement. As they say, "Choose your hard".

We believe in the benefits of owning quality real estate long-term. Since the dawn of civilization, the wealthy have owned the property and the land, and the poor have rented it from them.

Over a 10+ year time horizon, we believe real estate is inherently low-risk. Take a look at the inflation-adjusted data on US home prices since 1900:

We buy real estate, just like the noblemen of Ancient Rome 2,500 years ago, and the wealthy Mesopotamians thousands of years before them. 

Keep in mind, "Risk" is subjective. We're not talking about bullfighting here:

We like to keep things simple.

The question is - How do we get the best of these Return components, while at the same time minimizing Risk?