Let’s take a look at some of the actual returns for a small apartment building investment over a period of five years. Whenever you are making projections into the future concerning investment returns it is always necessary to make some assumptions. In this case we will keep our assumptions very conservative and well in line with historical averages.
Also, I will be using as an example an eight unit apartment building with a purchase price of $300,000.00. I want to use a smaller property with smaller numbers because I believe that just about anyone, who properly prepares him or her self with the proper education and preparation beforehand can realistically purchase, manage and profit from an apartment building this size. There are many methods for securing the money for a down payment that I discuss in my course but I don’t have the time right now to list and explain them all.
The purchase price for our eight unit apartment building is $300,000.00. We are using a bank loan for 75% of the purchase price and we are making a down payment in the amount of $75,000.00. The Net Operating Income of the building is $27,750.00. Our annual mortgage payment on the property is $19,952.76 based on our 25 year bank loan with a fixed interest rate of 7.5%. After paying our mortgage payment the building’s cash flow is $7,798.00. This cash flow gives us a cash-on-cash return of 10.4%. (the cash flow of $7,798.00 divided by the down payment of $75,000.00.)
Let’s take a look at what happens to your returns after five years. We will assume that the building’s income has grown by 3% a year. We will also assume that the expenses have increased 3%. The fixed rate mortgage payment remains the same for the life of the loan.
The Net Operating Income has increased from $27,750.00 to $32,169.86.
The new Cash Flow for year five is:
The new Net Operating Income of $32,169.86
-
The mortgage payment of $19,952.76
_______________________________________
= $12.244.00 Cash Flow at Year Five
The cash-on-cash return has increased from 10.4% in the first year to 16.3% in the fifth year.
In the mean time the actual value of the building has increased by 3% each year to $347,782.00. And increase of $47,782.00 after five years
In addition, the mortgage balance has amortized. The principle amount of the 25 year fixed rate loan has decreased by $20,106.76. The remaining loan balance is now $204,893.24.00.
Putting aside the income returns seen from the Cash Flow every month for 60 months and just looking at the appreciation and loan amortization you have a total return of $47,782.00 + $20,106.76 or $67,888.76. That is a whopping 90.5% cash-on-cash return for a period of five years.
These kinds of returns for many investors who are stuck in the stock market might seem too good to be true. But, remember that we only used one real assumption and that was a growth rate of 3% which is well within historical average norms.
Article Author:
Ted KarschTed has written 60 articles for us.
Visit Ted's Website: http://www.apartmentbuildinginvestor.com
Joshua Dorkin
Charles Feldman
Ted Karsch.
{ 11 comments… read them below or add one }
I like the article, useful calculations, thanks very helpful.
Are there any sites that offer similar calculations for property deals?
Nice plan you have put together here, yes this is the problem with real estate it takes time for it to increase, but the profits are crazy. I think it’s much better then putting your money in the bank, and I don’t think that there is that much risk in real estate.
I don’t know where you are – but in my area there is no way to purchase an eight unit building for $300,000. Can you point me to where such properties are available?
“Your site is very informative n helpful .. thanks…..keep it up” .IndiaSurfer is social news submiting site.submit your posts get more traffic to your site.vote for best stories.
http://www.indiasurfer.com
I’m confused, what about taxes, insurance, other expenses? Do you factor these into your calculation?
Great question. Taxes, insurance and other maintenance expenses are subtracted from the Gross Income to give us the Net Operating Income, which is the figure we are working with above.
Great article thanks for posting –
One question based on this statement:
“We will assume that the building’s income has grown by 3% a year. We will also assume that the expenses have increased 3%.”
If the expenses also increased by 3% how did the NOI jump to $32,169.86 ?
Matt, 3% of the expenses is less than 3% of the rent. You’ll see a net gain with the numbers given.
I was confused like Mike. I’m glad he asked his question.
It’s pedantic (because it really doesn’t matter from the investor’s point of view), but the rent really isn’t going up in real dollar terms. It’s flat. That 3% increase is just the inflation protection that real estate enjoys and few other investments do. The Fed can inflate the supply of money, but it can’t inflate the supply of land.
First of all, thanks for a great case study Ted. I have been buying shopping centers for years and I wish we had a few more good tools for commercial real estate in general. I just found your site for the first time…great site by the way! I added you to my bookmarks!
Thank you for sharing with actual numbers. That really helps to understand visually as to what you are talking about.