BiggerPockets

Not sure I buy the 5% annual appreciation number, if you factor out the recent bubble, but we'll go with it. Inflation over that period has averaged 4.07%.

After 30 years of averaging 5% appreciation per year, a property will be worth 4.32 times its initial price, in nominal terms. However, during that time, assuming 4.07% inflation, inflation has made overall prices 3.31 times what they were at the start of the time. So, in real terms (real means inflation adjusted, that's, what you can buy with the money), the property is worth only 1.3 times its initial value.

The calculation is down as a power function in Excel: Power (1+rate, term) where rate is the appreciation rate (5%) and term is the number of years (30).

There's not quite enough information to fully answer you second question, so I'll make a few assumptions. Say you purchase a house for $100K with a 30 year loan at 6%. You put down 20%. Your payment is $599.55. After 30 years, in nominal terms (i.e., the price you would sell it for in current dollars) would be $432,194. The total of your payments would be $215,838. So, in nominal terms, you would have just about doubled your money. To apply the rule of 72, you've doubled you cash in 30 years, so your return was 72/30=2.4%. Pretty crummy.

Another way to consider this is to compare it to putting the money in CDs. I don't have historical CD rates, so lets back into the equivalent rate. Say instead of buying the house you used the $599.55 to buy one CD a month for 30 years. What rate would you need to get to end up with the $432K? 4.275%.

Now, of course, with a property you don't just pay. You have rent coming in. My rule of thumb is I assume 40% for expenses because I manage them myself, and I'm not looking for monthly cash flow. So, if I could rent this house for $1000 with this payment, it would meet my bare minimum criteria. I have an asset that's (at least in nominal terms) increasing in value and I'm not out of pocket anything.

If I bought one house a year at $100,000, put nothing down, got a loan as above, and rented it for $1000 a month, then after 30 years I'd have total equity of $5.1 million. The properties themselves would be worth a total of $7 million, but I'd have $1.9 million in debt.

Note that most of the value is in the earliest purchases. If I just bought one a year for 10 years, then waited for 20 more years, I'd have a worth of $3.2 million and only $270K in debt.

Now that's all in nominal terms, and if you want real comparison, you have to convert to real terms. If you adjust for inflation, the one house a year for 30 years gives you the equivalent of $1.6M in todays dollars, and the one for 10 years and wait 20 gives you just under $1M in todays dollars.

Again, I don't buy that 5% is the right number, so what if we use the same 4.07% for both inflation and appreciation. In nominal terms I end up with $4.0 M in the 30 house scenario and $2.5M in the 10 house scenario. In real terms, I have $1.2M with 30 houses and $760K with 10 houses.

Either of those would make for a decent retirement. In fact, I'd have to say that's pretty much my plan.

Thanks Jon. You keep making the comment of "in real dollars after inflation, etc, etc etc". Please find me one single other investment that you can compare to stay ahead of inflation. I can't do it.
I used to speak at seminars and before the recent crash, the actual annual rate for the last 59 years was 6.34%, which would certainly have made the #'s much higher.
Also, you have to assume some benefit for the depreciation and taxes saved.
On the second question, your rent would've caused a negative scenario in early years, then a break even situation and then positive cash flow for later years. This would cause the "crummy" return would not be so crummy.
Mike oh- I think you're still using an earlier example from a different post. That is a starting point that most investors would not want to begin at, imo.
Thanks to both respondents. Newbies should be able to see the benefits pretty easily. Time plus initial investments will eventually lead to free and clear properties and real wealth, imo. Rich.

- The monthly payment on an $80K amortized over 30 years at 6% is actually $480 (not $599). So, the total amount paid over 30 years is $172,800. Add to that the $20K down payment and the total investment is $192,800;

- If the value of the property after 30 years is $432K (as Jon calculated above), then the nominal ROI is:

$432,000 / $192,800 = 224%

- Your annualized ROI is:

224% / 30 = 7.4%

- As Rich mentioned, I'm not sure that calculating ROI with respect to inflation is meaningful, as no other investment returns are calculated this way, and therefore it would be difficult to compare the result to any other options.

- Also, keep in mind that the $192,800 is not paid all at one time, but is instead paid over 30 years. So, the ROI is actually much higher, as the average investment is actually much lower. The best way I can think to approximate it is to take the average investment amount over the entire time (plus the initial down payment), which is:

$192,800 / 2 + $20,000 = $116,400

- Using that, the nominal ROI is 371%, and the annualized ROI is 12.3%. Those numbers are probably much closer to accurate than the ones above (though without using a differential equation, not completely accurate).

- The only other thing I would point out is 5% appreciation per year is probably too high of a number to use. If you assume real estate tracks inflation, then 4% annual increases would have made the property worth $324K (not $432K).

- This would put your nominal ROI at 278% and your annualized ROI at 9.2%.

Any way you look at it, it's clear that for this example of a leveraged real estate purchase, the returns look pretty good.

Thanks to both Jon and J Scott. I think the answers were excellent. On the question as to rent in 30 years, it is impossible to know. However, it is easy to look back 30 plus years.
My wife and I rented a 2 bedroom appt when married 30 years ago in La Habra, Ca(orange county) for $110 per month. I remember, because it was raised to $120 and we questioned how we were going to pay the increase! That apt would probably rent for $1000 today. That is 10 times the original rent! I guess if you used Jons' #'s of questioning whether $1000 might go up triple compared to mine going up 10 times, and take somewhere in the middle (6-7 times increase) it might be close.
If you take ANY of the above annual potential rates of returns; 7.4,9,9.2,12.3, or 14.65-you'll be VERY happy in 30 years.
Again, thanks for the posts and I wish the newbies would be reading this post, thinking about it and asking more in-depth questions about it. Good replies by Jon and J, imo. Rich.

For those with a portfolio of properties, Is it your goal to eventually have them all free and clear?

YES! The cash flow greatly increases when they're paid off!

The downside is that your cash flow is negative for the first 12 years, at which point you have $56K out of pocket. Your cumulative cash flow remains negative until year 28.

I'm not a big believer in the theory that rents always go up. I'm even more skeptical in the theory that the cash flow improves as time goes by, for the simple reason that expenses also increase and are certainly likely to increase as fast or faster than rents in the future. In addition, if anyone thinks that interest rates will stay this low, I've got a bridge to sell them. That will affect anyone that refi's for any reason and anyone that has an ARM. At any rate, I certainly would not buy a property that was bleeding cash and assume the cash flow would increase over time. I'll just be happy if I can keep my $100 per unit per month over time.

If a property bleeds cash today, it will likely be bleeding cash at least until it's paid off!

Mike

Great discussion, gentlemen! I'm kinda late to the party (just back in town), but if I might add a couple of pennies' worth...

Using the numbers from J Scott's post, we've got the property purchased for 100K originally, and appreciating at 5% pa for 30 y, to 432K. Loan payments plus the 20K down pmt bring our total cost up to 192,800.

With that fact set, our overall ROI is (432,000 - 192,800) / 192,800 = 124.1%. Equivalently, it's the 224% calculated previously, less 1. The previous calculation didn't first deduct the cost. It's like investing 100 today, and cashing out for 110 in one year. It's true that 110 / 100 = 110%, but clearly the ROI was 10%.

Since most investments assume at least an annual compounding, we should do likewise in "annualizing" our ROI, to give us a decent apples-to-apples. And further, as J Scott points out, only 20K of the cost is paid up front, with the remainder spread linearly over 30 years.

Running those numbers, the annual ROI on this hypothetical comes in at 4.4%.

Instinct immediately says something's wrong...if the property's appreciating at 5% a year, how can the overall ROI be less? The fly in the ointment is the financing. We're assuming a cost of money at 6%, against a property that's appreciating at 5%. Borrowing 80K at 6%, and putting that cash into an investment that grows at 5% has a slight negative return effect on the overall results. Had we simply paid 100K cash up front, no financing, our ROI would have been precisely 5% per year.

But of course, this is relying solely on the appreciation as our return source. Throw in the rent income and it's a whole 'nuther game. And of course, this is all pre-tax stuff.

I'd finally add an agreement that nearly all asset classes are quoted at nominal (pre-inflation), rather than real (post-inflation) returns.

Thanks for listening, guys. Cheers!

Nope, and I'm glad you brought it up, 'cause it's a huge factor, and although I mentioned it near the end of my post (along with the "pre-tax" caveat), I'm afraid it might be overlooked.

I was just playing off of the original tenor of the thread, which looked primarily at the return generated by the property's appreciation, and I just made a couple of tweaks to those calcs.

Bringing the rent revenue stream into the mix is gonna juice up the ROI nicely. As a side note, I'd advise letting Excel (or your favorite spreadsheet weapon of choice) do the heavy lifting. That'll let you play plenty of "what if" games with assumptions regarding rent escalators, property expenses, taxes, etc.

Regards, PDC

Oh, I can't say a word...if I had a nickel for every one of my "calculator faux pas", well, I'd need a piggy bank slightly larger than a Volkswagen.

Mike oh- I agree that the chosen one will screw everywhere he ca, IMO, if he does that, all items will increase in price and home const, hence rentals will have to march right along with everything else, no?? Rich

It amazes me of how a thread like this gets such little attention from the newbies. Notice only 8 people have posted, and arguably most of those are the most experienced ones. I hope the ones that could benefit from threads like this are at least reading them , even if they don't post on them. This is the nuts and bolts to investments, imo, and that is why I started the thread... Rich.