BiggerPockets

People talk about the advantages and disadvantages of real estate investing as oppose to stock market investing.

Everyone tries to compare risk, long term appreciation rates, leverage...etc between the two.


But I wanted to bring up a specific scenario and see how it plays out. For simplistic reasons lets assume 100% financing at 6% for a 250k house.

If you take out a 30 yr, fixed rate for 250k the total amount you have paid during that time is 540k.So even if you sold your house for 550k and had your loan paid off it essentially nets our with everything you paid. There wasn't really anything gain during those 30 yrs was there? Am I way off?

Don't you really need to outpace the rate of interest + inflation rate during your hold just to make any profit?

Now you know why a principal residence is a liability and not an investment. Given that, with the exception of the recent bubble and short term (a few years) oscillations, house prices have just matched inflation, you can't win.

I really think you have to do the math on the rent vs. buy decision. When people talk about buying investment (rental) property in LA that sells for $500K and rents for $2000 a month, it seems very easy to be a tenant. You'll have a payment pushing $3K a month with taxes and insurance and a $100K down payment. Not to mention maintenance and the need for improvements sometime over the course of 30 years. You'll put in over a million dollars of payments, plus the down payment. The rental would still amount to $700K plus, and would be likely to go up over time. But that's $400K, plus earnings, difference.

You do get to stick up pictures wherever you want, though, and get to knock down walls if you wish.

We're talking about apples and oranges here. As Jon said, a home to live in is NOT an investment - it's a liability.

However, if you buy a rental right (and most people don't), then a rental can be a great investment.

Let's examine a typical little $50,000 market value SFH that I buy here in Ohio. I typically will buy those for $25,000 from a desperate landlord. So, when I close on the deal, I have an instant $25,000 equity. Consider that almost every rental I've bought has been with 100% financing, but very low LTV (which is more difficult in the current environment), then my cash on cash return is infinite.

Let's look at the numbers on one of these rentals:

Gross rents: $550
Operating Expenses: $275
NOI: $275

Mortgage (30yr, 7%, $25K): $166

Cash flow: $109

So, over 30 years, I've made $39,240, just on the cash flow.

In addition to the income (cash flow), the tenants have paid the $25,000 principal over the 30 years.

Moreover, I get to depreciate the building over 27.5 years, so there's another $17,000.

Add that all together and over 30 years and that comes to $106, 240 for a property that I put nothing into. Now, multiply that by the number of properties you have and this could be significant. For example, if you only had 50 of these silly little houses, you would "make" $5,312,000 over 30 years and assuming that you spent all the cash flow, you would still have a net worth of at least $2,500,000 at the end of that time IF THERE WAS ABSOLUTELY NO APPRECIATION. Throw in some appreciation and you might be talking real money.

Now, take none of your own money, put it into the stock market, and see how much you have at the end of 30 years. My guess is ZERO!

Mike

Excellent explanation guys, I have to do this to everyone that overhears me talking about real estate investing.

So many people think their house is an investment and ironically these are the same people that discourage you from investing in real estate (outside of owning your own home). I tell them that they actually have it backwards, but by that point they are too belligerent to listen :( Ohh well, more opportunities for me!

Originally posted by Dave Kennedy

When you think about it quickly you see that you purchased a house for 250k and solid it for 550k. In your mind you are happy because you made 300k appreciation over 30 years. But it really isn't the case.

Even thinking about it that way is misleading. Even if you were to pay cash, and you buy a house for 250K, live in it without making any essential improvements, and sell it 10 years later for $1,000,000, you've more than likely gained nothing. If the market price for that type of house in that area is now $1,000,000, then you're only going to be able to buy the same type of house you just sold. On the other hand, if you move to another area, you may be able to buy a better house for a million, but you would have been able to buy that same house 10 years ago for 250K. Obviously this is overly simplistic since there are other things to consider, but it's essentially true.

The only way you gain with a principal residence is if you look at it vs. paying rent for your residence, since part of the money you pay each month goes towards principal. Growing equity in your principal residence however, is a myth.

Thx. My question -depreciate the building over 27.5 years, so there's another $17,000.
how you get that $17,000?

Shouldn't lost rent be part of this equation?

It seems to me that the rent you would otherwise pay if you didn't own needs to be factored in there some where. IE: A $1000/mo rent today = $360,000 over 30 years. And rents do go up unless you are going to live on the streets.

So if you buy a home and it costs you $2k/ mo, you are not paying the $1k/mo for rent your so your net cost is $1k/ mo to own.

I didn't factor in maintenance because I figure that any good landlord will get that out of you in raised rents if he is going to survive as an REI pro.
Riley

Yes of course!! A house is always going to be beneficial to the owner. The price can go up to a mark where even if owner sell the house he will be benefited by thousands or even millions of dollars. Its a fact and we all are witnessing it.

By "investing" in the home you're $540k ahead of where you'd be if you rented. How is that not a good investment?

There's a cost for shelter, and you can pay it in rent or in mortgage payments. You're assuming the mortgage payments are investment costs when it fact they're living expenses in the case of your residence.

If I'm able to save $5,000 this year from my investments but spend $5,000 for food during that same period (big eater), have I just broken even? Of course not. One is a cost of doing business (profit) and one is a living expense. They have nothing to do with each other.