nothing in common, but the relationship between them is a graphic way of demonstrating the impact of value appreciation and price increases due to inflation.
This analogy is one that I first heard from my friend David Campbell of Hassle Free Cash Flow Investing. I liked David’s analogy so much that I have adopted it. Prior to becoming a real estate investor, David was a teacher, and like many good teachers, is better at explaining complex concepts than us long-time Real Estate Junkies.
So lets begin the analogy with a description of the current market. In my home town of Anchorage, Alaska, you can buy a modest but decent house for about $250,000. Since the cost of a new Toyota is about $25,000, we can say that “a house is worth 10 Toyotas”. Assuming a 90% mortgage loan to purchase the house means that the down payment is one Toyota.
Now, lets fast forward 10 to 15 years and assume that the same house now sells for $500,000. If in the same time period, the price of Toyotas has increased to $40,000, the house is now worth 12.5 Toyotas. That is an example of value appreciation.
However, if the price of Toyotas has risen to $50,000, the house is still worth only 10 Toyotas. That is an example of price increases due to inflation.
But, here is where things get interesting, and is one of the reasons that I believe Now is the Opportunity of a Lifetime to Buy Real Estate.
Remember that you can finance 90% of the purchase price of the house with a 30 year
fixed interest, low interest rate mortgage. That means you can live in the house, while waiting for the price to double, at a cost less than rent, or you can rent it for enough to let the tenants pay the mortgage for you. Now lets look at what happened to your one Toyota investment (down payment) under both scenarios.
Value Appreciation: If you sell the house for $500,000 and you payoff the $225,000 mortgage ($250,000 – $25,000 down payment) you will have $275,000. (For sake of simplicity I have assumed that mortgage amortization over 10 to 15 years offsets sales cost). With your $275,000 you can now almost buy 7 Toyotas ($275,000/$40,000 = 6.875) This means that your initial investment of one Toyota down has grown by 587%!
Price Increases Due to Inflation: Even if the price of your house is still worth only 10 Toyotas, with your $275,000 you can now buy 5.5 Toyotas at $50,000 each. So, even if there is no real value appreciation, your initial investment of one Toyota down, has still grown by 450%!
I HOPE THAT THIS ANALOGY WILL HELP CONVINCE MORE FOLKS, THAT NOW IS THE TIME TO BUY REAL ESTATE!
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