by Call_Me_Op » Thu Feb 02, 2012 8:27 pm
Actually if you put 20% down on a property your leverage is 100/20 or 5 to I. If it appreciates at the inflation rate +!% your annual real return is 5% not 20% of your original investment as you claim. Simple math. The problem is that you borrowed 80% of purchase price, let's say your loan was at 5%, higher than current rates but much lower than long term average mortgage rates. That costs you and additional 4% of purchase price (.80 X 5%). Therefore your real annual return after paying for mortgage is 1% (5% -4%). Over the long run maintenance costs and insurance costs will be at least 1%, meaning your real return after all outflows is 0%, plus you get the deal with renters, plumbers, electricians, contractors, etc.. It doesn't look like an attractive deal to me.
1% is not the average inflation rate. The past decade has been 2.3%, and the 90s was 3%. Use 2% and you get 10% appreciation on your money. The mortgage is irrelevant because it is paid by renters. Any decent rental will provide you 2-3% over the market mortgage payment (P+I) on average with your rent increasing with inflation, but your mortgage payment staying constant. Capital expense on a residential rental will be 1-2% annually, so you are net 1-2% on the rent including capital reserves (i.e., 5% to 10% cash on cash) going into the deal, and your rent/mortgage spread just goes higher and higher the more rents increase. After 10 years, inflation adjusted, your rental yield should be about 5% higher than your mortgage payment, and 20 years later about 10% higher.
100k - Purchase price
80k - Mortgage
20k - Down
7.5k - Rent (gross rent circa 12k, costs circa 4.5k)
-5k - Mortgage (4k interest, 1k principal)
-1.5k - Capital reserve
Net rent: 1k (5% on your cash)
Appreciation: 2k (2%, 10% on your cash)
So you have 15% in the first year.. let's do the math 10 years from now assuming just 2% inflation:
120k - value
64k - mortgage balance
56k - equity (~11% compounded before rent)
9k - Rent (gross rent circa 14k, costs circa 5k)
-5k - Mortgage
-1.8k - Capital reserves
2.2k - Net cash
You earn about 16k rent in the 10 years.... so bottom line:
Compounded rate: 16.5%
This is just on an average deal.. as stated above, it's really not hard to find good deals in real estate, it's actually surprisingly easy. It is entirely realistic to find something for 90% of market value. Pay cash, refinance at 20% loan to value after 6 months of seasoning, and then you are in for 10%. Run the #'s at 10% leverage and the returns are ridiculous.
* Real estate growth is non-linear. This would be an average over 10 years
* The more your mortgage is paid down, the less return you get, so it's necessary to refinance every 10 years or so to get your cash out to maintain high returns. Or don't worry about cashing out and just let the tenant keep paying off your loan so you have an investment that is more stable than a bond with a huge cash on cash return from your original principal.