Joe Investor calls me up on a wonderful Monday morning and says that he has $50,000 sitting in the bank. He wants to get rich one day so he is looking to invest the money. He is currently renting and is fine with that - he really just wants to put the money into an investment account and forget about it. He figures he can get a 10% longtime average (he is very sharp.) He has received my mailers talking about what a great investment real estate is, so he is curious as to what return I can get him.
So, in an optimistic voice I tell him that the average appreciation for real estate is about 5% per year (it is a bit higher, but no harm in being conservative.) The phone goes silent on the other end before he stutters that he can get double that by just putting it in an investment account!
The above reaction makes sense at first glance. I often run into people that has a similar percetion of real estate - especially now that the short term appreciation has slowed drastically most places. So, how can real estate be such a great investment? Can you make money over the long term, even if the short term prospects are dim?
I love numbers, so to see what is going on let's make a quick comparison: how would the stock market do versus the real estate market over, say 1, 5, 10 and 25 years?
First, let's put the money in an investment account with an average yearly return of 10%.To keep things simple, let's just do simple interest and add it to the principal every year.
Year 0:
$50,000
Year 1:
$55,000
Year 5:
$80,525.50
Year 10:
$129,687.12
Year 30:
$872,470.11
Pretty impressive! Over 30 years he made over $800,000! Dang, one could retire with that! Of course, there is such a thing as inflation, but we'll ignore that for this comparison.
So, to get the gain for the real estate investment (giving 5%) we'll just halve that to $400,000 then and declare the stock market superior to real estate. Case closed?
Not so fast - leverage is a homebuyer and real estate investors' friend.
Leverage in this context means that we spend a little to get control of and the appreciation of a lot. By taking up a mortgage on a house and just putting in part of our own money, we get control and the appreciation of the full investment (as opposed to just the money we invested from our own pocket.)
So, if Joe Investor spent his $50,000 as a down payment on a house and paid for the rest with an 80% mortgage, he would in essence have the equivalent of a $250,000 investment (and a home to live in.)
He would in this case have a $200,000 mortgage that he would owe interest on - at 7% interest over 30 years. Mortgage payment would be $1,330 per month.
Year 1:
Initial Investment: $50,000
Home Value: $275,000
Paid in interest+principal: $16,320
Outstanding Loan: $197,968.38
Net value of investment: $60,712
Year 5:
Initial Investment: $50,000
Home Value: $402,627.50
Paid in Interest + Principal: $97,920
Outstanding Loan: $188,263.18
Net value of investment: $116,443.82
Year 10:
Initial Investment: $50,000
Home Value: $648,435.62
Paid in Interest + Principal: $179,520
Outstanding Loan: $171,624.77
Net value of investment: $297,186.08
Year 30:
Initial Investment: $50,000
Home Value: $4,362,350.57
Paid in Interest + Principal: $505,920
Outstanding Loan: $0
Net value of investment: $3,856,430.57
Yes, you read that right. The $50,000 initial investment grew into $3,856,430.57 (Now that's a retirement!!!)
Of course, there are additional expenses to owning a home. But, on the flip-side, I have not included the tax benefits when owning and when selling (as opposed to stocks), the savings of not having to pay rent and so on. Also, few people put down 20% these days - 5% is far more common. So, even with few of the other benefits accounted for, owning a home seems to beat putting the money into the stock market to smithereens!
Would the same hold through for an investment property? Absolutely - the numbers would be even better for the example above as you would get rent to offset the amount of principal and interest paid. Basically, over the long run the rent income should more than offset the $505,920 spent on principal and interest. There are tax implications with investment properties, but with the right planning the taxes can be greatly reduced.
So, it is easy to see why people love to own real estate - in the long term it is a fantastic investment! Give me a call and I'll help you find a great home to invest in!
(of course, past performace is no guarantee of any future returns - that goes for the stock and real estate market both)
Comments(0)