When I first started investing in real estate I didn’t know anything. When I purchased my first duplex, I had no idea about the numbers really. I just wanted to buy a duplex. So I bought one and I kind of figured it out a long the way.
Then I got a little smarter and I only invested in properties where I could earn double in rent than what my mortgage payment was. This seemed to work well at the time.
Now fast forward to today with twenty years under my belt, I am much wiser than I was when I first started investing in income producing real estate. However, the market has really changed.
Now more than ever there is more competition from investors. Not just normal every day investors like myself, but big institutions with lots of capital to deploy. Mortgage interest rates are higher. There is less inventory. All costs between taxes, insurance, and maintenance have all gone up significantly. Deals just don’t look like they used to look.
I am not saying there aren’t deals to be had, but I personally don’t have the time or expertise to buy way undervalued and distressed properties and then get them back to market value and condition. That just isn’t my lane. Back in the day a value add was carpet and paint. Nowadays, who knows it could be a total rehab or a lot more invasive rehab than I am capable of doing right now. It’s just different.
Nowadays instead of just looking at the numbers I used to calculate, these numbers just don’t happen anymore. You can’t get double in rental income a month on a property than your mortgage payment. Unless you want to put a whole lot of money down. And then your cash on cash return is impacted significantly.
In all reality if you want your numbers to be a certain way, you can manipulate them to make them however you want. But it will cost you more money on the front end or on a monthly basis.
I personally still want my deals to cash flow. But they don’t cash flow like they used to. I now calculate these two things into my deals.
Debt pay down and appreciation. It could be rental income appreciation or property appreciation. Or both.
These calculations don’t allow you to look at deals in the short run. You have to think long term. Everything I buy I plan on holding forever in my mind. But at least ten years. Ten years is probably ideal on most deals.
Let’s look at a scenario.
Let’s say you buy a house for $150,000 dollars.
You put down 20%. That would be $30,000
You do a 30 year mortgage. And your interest rate is 7%.
Your monthly mortgage payment on this deal is $1045.20.
I want to keep this concept simple for you. I don’t want to complicate it by estimating how much you could rent this house for. I have done those calculations before on here, but for the sake of this scenario I don’t want to add that in. But I will say, you would be able to rent this house for more than the mortgage. At least you you should be able to. Check out the post here to learn more about rents and rental growth.
After five years of making this $1045.20 payment. You would have paid $62,760 roughly in payments on this house. Of the $62,760 you paid it would be basically half would have paid down your debt and the other half would be towards interest.
It looks like this.
monthly_payment = (principal * interest_rate) / (1 – (1 + interest_rate) ** (-loan_term * 12)) debt_paydown = monthly_payment * (loan_term * 12)
principal = 120,000
interest_rate = 0.07
loan_term = 30
monthly_payment = (principal * interest_rate) / (1 – (1 + interest_rate) ** (-loan_term * 12))
monthly_payment = (120000 * 0.07) / (1 – (1 + 0.07) ** (-30 * 12)) monthly_payment = 1045.2
debt_paydown = monthly_payment * (loan_term * 12) debt_paydown = 1045.2 * (5 * 12) debt_paydown = 31380
At the end of five years you would now have a principal of $120,000-$31,380 = $88,620 left. And hopefully your tenant or tenants paid down all of that debt for you.
Secondly. Let just say this house of $150,000 appreciates at 5%, which history tells us this is easily doable.
appreciation_rate = 0.05
future_value = original_value * (1 + appreciation_rate)^number_of_years
future_value = 150000 * (1 + 0.05)^5
future_value = $191442.23
At the end of these five years the $150,000 dollar property is now worth $191,442 dollars.
Now you can see between the debt pay down and the appreciation of the property you are ahead right? But by how much?
Well, how much money do you have in the deal? Your money?
You put $30,000 in the deal. Maybe you had to put some money in it over the five years. But again for the sake of this example. Let’s assume you didn’t.
What is the return on your $30,000?
future_value = 150000 * (1 + 0.05)^5
future_value = 191442.23
debt_paydown = 31380
profit = future_value – debt_paydown – 30000
profit = 191442.23 – 31380 – 30000
profit = 90062.23
return_on_investment = (profit / 30000) * 100
return_on_investment = 41.2
((191,442.23 – 30,000 – 31,380) / 30,000) * 100 = 41.2%.
So you now have an asset you own that is worth $191,442 dollars. And you only owe $88,620 on it. And you only have about $30,000 of your own money in the deal.
If you believe the numbers here, would you do this deal?
My answer is yes. How many times can I do it?
I welcome any insights you might have on my calculations here.
Also, check out the post here to learn about how to calculate rent and rent growth.
To your success and your future.