I picked up a book " The Wall Street Journal Complete Real estate investing guidebook." Looks good so far, but I am trying to wrap my head around some math in here. If anyone could please break this down for me.
When evaluating if buying a property is the best use of money the author states
"Do the math: If you buy a $300,000 house with a 95 percent loan at 6 percent, and the house appreciated at 5 percent annually, you're just treading water."
6% of $300,000 = $18,000
Those are the specs I can pull out from this statement. Very confused on how the would be owner is treading water. If anyone can break this down for me, thanks! I am assuming the 6% interest may be the annual cost of interest on the loan... Thanks for the help
They are referring to the interest the bank gives on the loan which is 6%.
No investor is getting 95% bank financing. Investors have to put down 20% + closing costs for all conventional bank loans.
That makes sense, however the way it is depicted it sounds like the loan was approved. It is the numbers that are causing the investor to tread water, which is what I am trying to puzzle out.
Treading water may be a euphemism for "breaking even". If something is costing you 6% per annum and you are only making 5% per annum, you are barely breaking even.
There are some great resources on this site for helping you to analyze property deals. See the "analyze" tab and also the "resources" tab where you can look under "file place" for some great spreadsheets.
I've spent a few hours this weekend learning real estate math and I'm feeling very empowered. Its a great tool. When you've seen 20 houses, you don't remember the details. Putting the numbers in a spreadsheet so you can compare them side by side takes aesthetics out of the equation and focuses you on the numbers and the investment potential of a property.
This is speculation and not considering the inflation I may not even go for the deal. You would see investors say that speculation cannot be timed and it's always look for great cash-flow. If you principal appreciation that's icing on the cake.
Without more explanation I do not know specifically what they are talking about. I haven't a clue what the 6% is because the loan as described would be $285,000 with total interest of $17,100 interest in the first year.
I am guessing they mean
- You are paying out $17,100 the first year in interest
- The house is going up in value $15,000 the first year.
- That is a theoretical loss of $2,100 the first year.
This is a ridiculous analysis. This doesn't take into account the full effect of appreciation, or amortization, and doesn't even mention the effect of rents. It assumes you paid $300,000 for the property but what if it was worth $350K when you bought it? What if it had and had $3,000 a year positive cash flow?
There is a lot more that goes into a deal evaluation.
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