The Rate of Return from ONLY Principal Paydown

Andrew Syrios · 2021-06-30T14:14:32-07:00

I was curious on what the rate of return would be on real estate from nothing more than principal paydown alone. Turns out it's not that shabby. Using my trusty CCIM Institute financial calculator, if you get a 80% LTV loan with a 20 year amortization, then break even for 20 years while the property gains nothing in value (which never happens over 20 years), the rate of return is still 7.18%. Yes, it's not a "cash return," it's just "equity and no, it's not incredible by any means, but nothing to sneeze at. The historical average for the stock market is about 10%. (https://www.nerdwallet.com/.../average-stock-market-return) And this is just principal paydown. It doesn't include the appreciation (like the insanity we're seeing now), tax advantages cash flow or the other advantages of buy and hold: https://www.biggerpockets.com/... It would also be a lower return if you paid it off early as the early payments are mostly interest, but it still shows the power of buy and hold real estate. Overall, another reason to love real estate.

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

5y

Originally posted by @Matt Nico:

@Joe Villeneuve

Joe what are you not getting about this? This guy is running a hypothetical scenario where if he put 20% down on a rental and it cashflowed $0 and his tenants only payed down the mortgage and capX what his return would look like.

Use a $300,000 purchase price as an example. He puts up $60k + say $10k for closing codts so he is in for $70k. Over the next 30 years his tenants pay his mortgage down to $0.

He now has a $300,000 house fully paid off by someone else for a gain of $230,000.

If you don’t understand this then Im not sure what to tell you…lolol

No, what he is saying is he's taking his cash to pay down the mortgage.

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Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

5y

I went back and read the posts here again. Somehow I got confused (I think) and I apologize. Somewhere I interpreted the paydown we were talking about as coming "out of pocket" and not exclusively coming from the normal mortgage payment that's paid by the tenant's rent money. Of course mortgage paydown is a gain, if the money comes from the rent and not the cash flow or the REI's own personal cash.

As a result, I fired my proof reader (that would be my body double).

12 Reply

Andrew SyriosPro Member

Moderator

OP

Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes

5y

Originally posted by @Jonathan G.:

@Andrew Syrios

Why would you “buy” equity when cash flow can make you more money. For example, if you Invest 100 dollars into your “equity” each month get all that money back in 10- 15 or 20 years, you actually lost money because of the time value of money.

1200 dollars per year x 20 years =$24000

1200 dollars per year INVESTED X 20 years = just over $69,400

Now let’s just say you’re really motivated and you wanna invest those $24,000 into your equity right now, well in 20 years, it would probably would be be equivalent to less than $10,000 when compared to the current years purchasing power.

Equity is dead money that’s not working.

If I had the choice between cash and equity, I would choose cash. But with a bank loan, you don't get a choice. You have to pay down the principal of the loan as well. The point above is simply that principal paydown (on a property that at least breaks even) is a major benefit IN ADDITION to the other benefits of real estate investment (appreciation, cash flow, tax advantages, etc) that is often underappreciated.

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Andrew SyriosPro Member

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Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes

5y

Originally posted by @Jenning Y.:

Nice post @Andrew Syrios , this is exactly what I have done in the past 10 years. I have invested out of state, bought properties at market prices, and have break-even cash flow, still increased my equity (thus net worth) by 24 folds. Since I am heavily leveraged, I also pulled out a large chunk of equity(about $0.4M) as cash reserve in the last two years. It worked perfectly for me.

That's great to hear Jenning! Of course buying at market isn't ideal by any means, but even so, real estate can be a very powerful investment as you've shown.

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Andrew SyriosPro Member

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Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes

5y

Originally posted by @Joe Villeneuve:

I went back and read the posts here again. Somehow I got confused (I think) and I apologize. Somewhere I interpreted the paydown we were talking about as coming "out of pocket" and not exclusively coming from the normal mortgage payment that's paid by the tenant's rent money. Of course mortgage paydown is a gain, if the money comes from the rent and not the cash flow or the REI's own personal cash.

As a result, I fired my proof reader (that would be my body double).

No worries, I figured that's what the miscommunication was. Send my regards to your proof reader.

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1 Reply

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

5y

Originally posted by @Andrew Syrios:

Originally posted by @Joe Villeneuve:

I went back and read the posts here again. Somehow I got confused (I think) and I apologize. Somewhere I interpreted the paydown we were talking about as coming "out of pocket" and not exclusively coming from the normal mortgage payment that's paid by the tenant's rent money. Of course mortgage paydown is a gain, if the money comes from the rent and not the cash flow or the REI's own personal cash.

As a result, I fired my proof reader (that would be my body double).

No worries, I figured that's what the miscommunication was. Send my regards to your proof reader.

He understands, and was pretty mellow as he walked out the door. LOL

1 Reply

Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

5y

Originally posted by @Andrew Syrios:

Originally posted by @Jonathan G.:

@Andrew Syrios

Why would you “buy” equity when cash flow can make you more money. For example, if you Invest 100 dollars into your “equity” each month get all that money back in 10- 15 or 20 years, you actually lost money because of the time value of money.

1200 dollars per year x 20 years =$24000

1200 dollars per year INVESTED X 20 years = just over $69,400

Now let’s just say you’re really motivated and you wanna invest those $24,000 into your equity right now, well in 20 years, it would probably would be be equivalent to less than $10,000 when compared to the current years purchasing power.

Equity is dead money that’s not working.

If I had the choice between cash and equity, I would choose cash. But with a bank loan, you don't get a choice. You have to pay down the principal of the loan as well. The point above is simply that principal paydown (on a property that at least breaks even) is a major benefit IN ADDITION to the other benefits of real estate investment (appreciation, cash flow, tax advantages, etc) that is often underappreciated.

I agree. I like cash better than equity, however here's some food for thought. I consider equity to be a form of cash (not to be confused with "real" cash), that the property owns. I control the property, so if I sell the property, I now own the cash. Until I sell the property, the equity form of cash can't be used in any cash related (CoCR, etc...) formulas.

The paid equity had a 5 to 1 ratio of PV to Cost. The free equity (paydown from rent and appreciation), has only a 1 to 1 ratio. The beauty of equity is when it grows to double what the paid equity started out as (when the free equity matches the DP), you can sell the property and double your pleasure, as in double the PV and cash flow. Repeating this process is the best way I've found to scale up.

3 Reply

Dan DiFilippoBusiness Member

Real Estate Broker · Fayetteville, NC · Member since 2020 · 251 posts · 244 votes

5y

@Andrew Syrios this is really good, but I don't think anyone's discussed interest rates, which determine the concavity of our curve, and therefore our return.

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Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

5y

Originally posted by @Andrew Syrios:

Originally posted by @Joe Villeneuve:

There is NO return from principle paydown...zero. You are gaining equity equal to the amount of money you are spending. In other words, you're buying the equity at face value. Where's the gain?

From the original post, "Yes, it's not a "cash return," it's just "equity."

Equity is still a gain even if it's not measured as cash until you sell. And this assumes 1) you get an 80% loan and 2) your rental income covers all expenses but there is no cash flow above that. Basically you pay off your loan over 20 years and that return is 7.18% (minus the costs to sell if you realize that gain by selling)

this is why neutral geared west coast rentals can make people rich.. you have some gain according to your math but the asset doubles or more over the same amount of time compared to a market which asset price tends to follow rental returns only.

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Russell BrazilBusiness Member

Moderator

Real Estate Agent · Washington, D.C. · Member since 2012 · 17k+ posts · 30k+ votes

5y

Originally posted by @Andrew Syrios:

Originally posted by @Jonathan G.:

@Andrew Syrios

Why would you “buy” equity when cash flow can make you more money. For example, if you Invest 100 dollars into your “equity” each month get all that money back in 10- 15 or 20 years, you actually lost money because of the time value of money.

1200 dollars per year x 20 years =$24000

1200 dollars per year INVESTED X 20 years = just over $69,400

Now let’s just say you’re really motivated and you wanna invest those $24,000 into your equity right now, well in 20 years, it would probably would be be equivalent to less than $10,000 when compared to the current years purchasing power.

Equity is dead money that’s not working.

If I had the choice between cash and equity, I would choose cash. But with a bank loan, you don't get a choice. You have to pay down the principal of the loan as well. The point above is simply that principal paydown (on a property that at least breaks even) is a major benefit IN ADDITION to the other benefits of real estate investment (appreciation, cash flow, tax advantages, etc) that is often underappreciated.

Spoken like a true single person. After you get married, you're going to prefer equity, because your spouse can spend that cash but not the equity.

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Arn CenedellaPro Member

Rental Property Investor · Greenville, SC · Member since 2008 · 786 posts · 1k+ votes

5y

@Andrew Syrios

Respectfully, your analysis ignores the money spent on mortgage payments over 20 years.

If you invest $20,000 and nothing for 20 years and then get $80,000; the return might be 7.8% but your chart ignores all the monthly payments for years 1 thru 20 - that’s 240 payments you have not accounted for.

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Andrew SyriosPro Member

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Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes

5y

Originally posted by @Russell Brazil:

Originally posted by @Andrew Syrios:

Originally posted by @Jonathan G.:

@Andrew Syrios

Why would you “buy” equity when cash flow can make you more money. For example, if you Invest 100 dollars into your “equity” each month get all that money back in 10- 15 or 20 years, you actually lost money because of the time value of money.

1200 dollars per year x 20 years =$24000

1200 dollars per year INVESTED X 20 years = just over $69,400

Now let’s just say you’re really motivated and you wanna invest those $24,000 into your equity right now, well in 20 years, it would probably would be be equivalent to less than $10,000 when compared to the current years purchasing power.

Equity is dead money that’s not working.

If I had the choice between cash and equity, I would choose cash. But with a bank loan, you don't get a choice. You have to pay down the principal of the loan as well. The point above is simply that principal paydown (on a property that at least breaks even) is a major benefit IN ADDITION to the other benefits of real estate investment (appreciation, cash flow, tax advantages, etc) that is often underappreciated.

Spoken like a true single person. After you get married, you're going to prefer equity, because your spouse can spend that cash but not the equity.

😂🤣😂🤣

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Andrew SyriosPro Member

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OP

Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes

5y

Originally posted by @Arn Cenedella:

@Andrew Syrios

Respectfully, your analysis ignores the money spent on mortgage payments over 20 years.

If you invest $20,000 and nothing for 20 years and then get $80,000; the return might be 7.8% but your chart ignores all the monthly payments for years 1 thru 20 - that’s 240 payments you have not accounted for.

The analysis assumes the rental income covers all property expenses including the mortgage but brings in no positive cash flow above that.

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Andrew SyriosPro Member

Moderator

OP

Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes

5y

Originally posted by @Jay Hinrichs:

Originally posted by @Andrew Syrios:

Originally posted by @Joe Villeneuve:

There is NO return from principle paydown...zero. You are gaining equity equal to the amount of money you are spending. In other words, you're buying the equity at face value. Where's the gain?

From the original post, "Yes, it's not a "cash return," it's just "equity."

Equity is still a gain even if it's not measured as cash until you sell. And this assumes 1) you get an 80% loan and 2) your rental income covers all expenses but there is no cash flow above that. Basically you pay off your loan over 20 years and that return is 7.18% (minus the costs to sell if you realize that gain by selling)

this is why neutral geared west coast rentals can make people rich.. you have some gain according to your math but the asset doubles or more over the same amount of time compared to a market which asset price tends to follow rental returns only.

That's how my dad did it, with west coast (student) rentals.

Podcast Guest on Show #121

1 Reply

Andrew SyriosPro Member

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OP

Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes

5y

Originally posted by @Dan DiFilippo:

@Andrew Syrios this is really good, but I don't think anyone's discussed interest rates, which determine the concavity of our curve, and therefore our return.

Low interest rates certainly help a property cash flow, and if you can get the property to cash flow over and above all expenses (which should be the goal) then your return will be even higher (add in appreciation and it's exceptional). But this analysis was just to show the power of principal paydown alone and therefore I tried to make it as simple as posssible and just assume a break even.

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1 Reply

Andrew SyriosPro Member

Moderator

OP

Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes

5y

Originally posted by @Joe Villeneuve:

Originally posted by @Andrew Syrios:

Originally posted by @Jonathan G.:

@Andrew Syrios

Why would you “buy” equity when cash flow can make you more money. For example, if you Invest 100 dollars into your “equity” each month get all that money back in 10- 15 or 20 years, you actually lost money because of the time value of money.

1200 dollars per year x 20 years =$24000

1200 dollars per year INVESTED X 20 years = just over $69,400

Now let’s just say you’re really motivated and you wanna invest those $24,000 into your equity right now, well in 20 years, it would probably would be be equivalent to less than $10,000 when compared to the current years purchasing power.

Equity is dead money that’s not working.

If I had the choice between cash and equity, I would choose cash. But with a bank loan, you don't get a choice. You have to pay down the principal of the loan as well. The point above is simply that principal paydown (on a property that at least breaks even) is a major benefit IN ADDITION to the other benefits of real estate investment (appreciation, cash flow, tax advantages, etc) that is often underappreciated.

I agree. I like cash better than equity, however here's some food for thought. I consider equity to be a form of cash (not to be confused with "real" cash), that the property owns. I control the property, so if I sell the property, I now own the cash. Until I sell the property, the equity form of cash can't be used in any cash related (CoCR, etc...) formulas.

The paid equity had a 5 to 1 ratio of PV to Cost. The free equity (paydown from rent and appreciation), has only a 1 to 1 ratio. The beauty of equity is when it grows to double what the paid equity started out as (when the free equity matches the DP), you can sell the property and double your pleasure, as in double the PV and cash flow. Repeating this process is the best way I've found to scale up.

I think we're in agreement although I'm more fond of usually refinancing instead of selling. I don't like selling very much.

Podcast Guest on Show #121

2 Reply

David M.

Morris County, NJ · Member since 2020 · 5k+ posts · 2k+ votes

5y

@Joe Villeneuve

Glad you fired your proofreader! :)

Yeah, some people forget about building equity with opm when looking at investments. People get so focused on cash flow and the very low valued property/markets that they forget how leverage works in a real property situation.

3 Reply

Tom DegroodtPro Member

Evans, GA · Member since 2016 · 122 posts · 65 votes

5y

I look at the IRR for principle pay down as fodder, when people tell me why RE investing is bad. If there is cash flow and principle reduction you have locked in a higher average rate of return than the stock market for 20 years. Add to that tax advantage and appreciation and....

Also I find it easier to identify a house that is on sale over a stock that is on sale. If you can add 5% equity at the start of the equation it starts getting even more exciting.

0 Reply

Jonathan G.

Investor · Marietta, GA · Member since 2015 · 382 posts · 258 votes

5y

@Andrew Syrios

Funny! Everyone here is making "money " or "equity ". Different strokes but eventually , everyone is getting paid. Gotta love REI.

2 Reply

Llewelyn A.

Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes

5y

I use IRR exclusively because it allows me to calculate all the multiple ways of making profits in Real Estate.

To re-word the OP's scenario in a NON-IRR way, it can be as follows:

Let's say you buy a property for $1 Million with ZERO down.

Said property's Rents pays for ALL expenses for all of the months for 20 years.

20 Years later, you sell the House. BOOM..... you are a Millionaire without having to put in a dime.

While my scenario isn't exactly like the above, in my case, I buy NYC Properties generally at Break Even Cash Flow but with Million Dollar Mortgages.

I have been holding properties starting from 1997 when I bought my first Investment.

I now have 9 small multi-family in various stages of Principal being paid by the Tenants.

This portfolio has made at least 6 Partners who own the Portfolio Millionaires.

Is it a strategy for everyone? NO. Does it work? YES! Is there proof? You are looking straight at him.

3 Reply

Robert TinkerPro Member

Rental Property Investor · Round Rock, TX · Member since 2019 · 251 posts · 159 votes

5y

@Joe Villeneuve Perhaps the return is it's your tenants who paid it down.

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Joe VilleneuvePro Member

Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes

5y

Originally posted by @Robert Tinker:

@Joe Villeneuve Perhaps the return is it's your tenants who paid it down.

This is referring to what?

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Mike Dymski

Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes

5y

This is a thread about attribution. Some attribute the rent or the resident to paying down the mortgage. Others attribute the owner or savings paying down the mortgage. Cash inflows to the owner increase property returns and cash outflows from the owner decrease property returns. Period. It does not matter whether we net certain cash flows (net monthly cash flow) or look at them all gross (rent, expenses, mortgage)...the attribution is just noise, not math. The amount and the timing of the cash inflows and outflows determine the IRR.

A principal payment largely generates a rate of return equal to the interest rate on the debt. I say largely because we have to factor in the time value of money in the IRR calculation.

2 Reply

John Thedford

Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes

5y

This is why I love buy and hold and practice it 24/365.

2 Reply

Marcus Auerbach

Investor · Milwaukee - Mequon, WI · Member since 2010 · 5k+ posts · 7k+ votes

5y

I like to look at it this way; here is a simplified example.

You buy a 100k asset with 20% down, which is 20k. You are financing 80k over 30 years and are paying it off using rental income. That is on average a rate of 3% per year (less in the beginning, like 2.1%, more later, of course) on the 80k loan - but based on a 20k investment.

You are leveraged 4:1 and so is your average ROI on your down payment 12%? Not quite, because your downpayment is not compounding, it's still 20k even after years.

That is the reason why it makes sense to extract equity via a refi and buy another asset.

So in conclusion, yes, principal pay down alone is pretty good. Now you add appreciation - currently about 10-12% p.a. even here in Milwaukee (per MLS median SF sales price). Between those two, this is where wealth is created. Cash flow keeps the lights on and is the live blood, but it is much smaller in comparison.

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The Rate of Return from ONLY Principal Paydown

The Rate of Return from ONLY Principal Paydown

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