Lots of investors like real estate. And sometimes for the average person it’s hard to understand why.
One of the biggest reasons for that disconnect is the way people view their return on investment (how much money you make on an investment).
Let’s help you grow a wealth of understanding as we take a look at how an average person would see a real estate deal and how an investor would look at it.
Example Property: Single Family Home in Dallas, TX.
4 Beds / 2 Baths / 1,872 sq.ft.
Down Payment: $37,000
Mortgage Loan: $148,000
Closing Costs: $5,000
Initial Investment: $42,000
Monthly Rent: $1,575
Monthly Mortgage: $706.58
Additional Expenses (vacancy, property management, taxes, insurance, repairs & maintenance, etc.): $783/mo
These are the details of the property.
And here’s where people view the deal differently.
The average person takes the income (Rent: $1,575) and subtracts the expenses (Mortgage Payment and Additional Expenses: $1,489.58) to equal their return on their investment.
$1,575 – $1,489.58 = $85.42
The average person would look at this and say,
“$42,000 invested will give me $85.42/mo or $1,025.04 a year.”
It would take something like 41 years to recoup the investment.
Your “Cash on Cash” return is 2.4%
That’s not a great return.
Granted, it’s 240x better than what you’ll get in a savings account right now, but there’s more risk involved.
For the most part, that’s where ordinary people stop looking at the numbers. They only measure what comes into their wallet or their bank account; they only measure tangible return.
The average person only measures what comes into their wallet
However, an investor thinks differently. They don’t just measure the money you get paid that you can touch; they’re also measuring things like Appreciation (how much the value of the home will rise), Equity (how much of the house you own), Rental Growth (how much rent will rise), and Tax Incentives (either deductions or write-offs that they can use to reduce their tax bill).
So where an average person sees 2.4% return, an investor sees 10x that.
Appreciation: 3.8% ($7,030 in Year 1)
The house value rises even while the bank co-owns it with you, but you get to keep all the growth.
Loan Pay-off: $2,600 in Year 1
Your renters are paying off the mortgage for you, which helps to grow your equity (the portion you own).
Rental Growth: 3% (538.65 in Year 2)
Even though your mortgage (expense) stays the same, you can continue to raise rent every year or two by a small amount (2-4%) which locks in more profit.
Tax Incentive: $1,292+ in Year 1
The interest portion of your mortgage can be a tax deduction. In the first year of loan repayment you’ll spend close to 68% on interest ($5,873) to the bank. That’s a write off. Other repairs, improvements, and costs can also be written-off so that you reduce your tax bill.
The investor then, would add up everything above (including the cashflow from rent) like so: $1,025 + $7,030 + $2,600 + $538 + $1,292 = $12,485
The investor looks at all this and says,
“$42,000 invested will give me $12,485 of value (not cash).”
Which is a 29.7% return.
In less than 4 years you’ve doubled your investment value.
In 5 years you could sell the house and your $42,000 investment would let you walk away with $80,993 cash.
But few people see that. Mostly they see a measly thousand dollars a year.
Train your eyes to see value differently.
Start looking like an investor.
-Wealth Of Understanding
BONUS! If you want to learn more, check out these links:
Gerald Peters: Ran through a similar scenario pointing out the different thinking between average people and investors. His language is NSFW.
Roofstock: Brokers rental properties for sale. Best part, they show projected financials to help you understand how an investor looks at a deal (doesn’t include tax incentives).
BiggerPockets: One of the best forums and websites for real estate investors. Start with the free account.
NerdWallet: Great recommendations, blogs, and calculators. This post will help you understand how Mortgage Deductions work.
Legal Disclosure: Investments carry risk. But doesn’t everything in life? Be smart about what you do and work closely with professionals who have your best interest in mind.
Sincerely, the Wealth of Understanding legal team.