Hello, this post is an update to my previous post :
To summarize that post: buying a house for ~$250k w/ a 30-yr fixed rate loan, will try to lease it out for ~$2k a month, monthly expenses are ~2.2k a month.
The fixed rate loan is for 30 years, 4.75% and 3.5% down. I used https://www.bankrate.com/calculators/mortgages/amortization-calculator.aspx to calculate how much equity I would be getting at 5, 10, and 20 years. These numbers are:
11.9% equity in 5 years (.119*250k =$29750)
21.8% equity in 10 years ($54500)
52.0% equity in 20 years ($130000)
100% equity in 30 years ($250000)
The numbers above are considering that the house stays at 250k in 30 years, but I think it will appreciate [Pflugerville / Round Rock, TX] (need to do more research)
Is this a possible equity play? Or am I better off trying other investment vehicles? Thanks.
Dennis, I want to point out that Kelvin indicated that he is NOT BETTING on Appreciation.
What Kelvin is doing is betting that his 96.5% LTV loan of $240k of a $250k purchase will disappear in 30 years, which it will. That's just Math.
Additionally, he will take a $200 per month loss in the 1st year he rents it out entirely ($2,200 expenses but only approximately $2k in rents).
Let's just assume the above scenarios plays out for the entire 30 year holding period.
So Kelvin will lose $200 per month or $200 x 360 months = $72,000.
Assuming NO APPRECIATION, the mortgage disappears in 30 years.
If Kelvin then sells the property at the same price of $250k, his return would be $250k minus $72k minus $10k for down payment = $168k profit in 30 years.
Considering that Kelvin would only put in $10k as a down payment, $72k as payments towards the property over the 30 years, his investment is $82k which then returns proceeds of $250k.
If we did a non-compounding calculation of ROI we get $168k profit / $82k Invested = 204% in 30 years or 6.8% per year.
If we did a Compounded Rate of return, we get a 6.12% IRR over the 30 years. Here is the IRR Chart:
What Kelvin is saying is that this is the most pessemistic scenario where he will have ZERO Appreciation AND NO CASH FLOW INCREASES due to increasing rents versus expenses.
Kelvin can then come up with an optimistic senario, such as add 5% annual appreciation with 2% annual cash flow growth.
That would supercharge his IRR.
Aside from this, the danger, as others state, is that Kelvin cannot afford the negative 200 per month cash flow. BUT.... common guys... negative 200 per month?! I mean this doesn't kill anyone that I personally know who has disposable income to buy an investment, even for $10k savings like Kelvin.
Of course there are a ton of other considerations such as Capital Expenditures and Tax Savings, but we are not building a very complex and sophisticated spreadsheet just yet. If it were me, I would actually do it.
I would definitely look into the economic factors that are going to be driving the value of the properties in that area as well over the 30 years, however.
To me you can get the numbers completely correct, but if you don't know the economic trends that are happening, a good investment can turn into a nightmare no matter how much cash flow you are generating over the years.
There are too many examples of cash flowing properties that stopped cash flowing such as places like Detroit, Bethlehem, Allentown, etc. Generally one industry towns where the Industry dried up.
The economics is a necessity to long term buy and hold investing. If you are not doing that, good numbers can turn out bad.
But that being said, this is well within my risk tolerance level as long as there are no negative economics that will impact the next 30 years.
No I would still do it for 2 reasons: 1) (If)You are in a good area of Austin it will almost always be in demand which means higher rents and higher valuation. 2) Plus in 2 years, the rents could be at the 2.2 mark you need. If I were you I would pay yourself extra, say $500/month in rent (don't actually pay this for accounting purposes, just set $300 aside) to build up a reserve which you should have anyway for unforeseen expenses. If nothing major happens you could expect to have between 4-5k saved up which could then help you make up for the lack of cash flow until you refinance or sell it. Alternate strategy: AirBnB-if it's close to 6th street or the river you could make more than 24k/year.
Here are the issues you will run into: Property tax, its a killer in Texas and it will make your payment go up-protest every year. insurance, also a killer in Texas, shop policies every year or 2. Depreciation recapture: once you start renting it, your basis will start going down which will affect your profit when you go to sell.
It is still a tight deal but if you are only effectively paying $500 in rent a month for 2 years, you could do well with the money saved.
Peter, thank you for your input and I will definitely considering setting aside the extra $300/Mo. Thanks again.
Going back to my 1st post with the calculations, I do want to point out that the IRR, which is the Internal Rate or Return calculation, takes into account the time value of money.
But what it does is boil it down to a steady interest rate as if you put the money into an Interest Bearing Account and left it there, what would be the Interest Rate for the 30 years you left it in there?
It's still a bit crude to think of it that way but the way to look at the number is to compare it to the CPI, which is the measure of Inflation over the next 30 years. If your IRR is better than the CPI, you have made money. If it is exactly the same, then you broke even in Buying Power. If your IRR is less than the average CPI over the 30 years, then you lost Buying Power.
It's really GREAT STUFF! My Geek in me loves it and believes everyone should have a little Geek in them to go thru the calculation so that it satisfies the Inner Financial Geek in you too!
Also, Peter M. is absolutely correct! You need to think that once your roommates move in and you are only paying $300 per month for rent in a location where if you did not own the house you would pay much more, then you are actually saving some money which has not been taking into Account.
So lets say that if you found an exact situation except you were the roommate instead of the owner, you would also be paying $1k.
Therefore, by paying only $300 per month, you can think of the $700 per month savings as adding to your cash flow.
Good Catch Peter M.!
BTW, this is pretty much how I built a Real Estate Portfolio that is worth around $20 Million today, generating almost $1 Million in Rental Revenues and Cash Flows for the Partners very significantly.
HOWEVER, as I have been saying, calculations cannot be the only factor. I definitely put Future Economics as a big part of your ability to be successful.
Consider Future Economics as if it were a Tide and you are on a boat on the tide.
As long as your Boat doesn't have a hole in it, if the Tide comes in (meaning the economics are good), your boat will float up!
Even if your Boat is airtight, if the economic tide goes out, it will fall with the tide and you may not be able to sail away.
It seems that Peter M. indicates that your chosen area has sound economics.
So again, the risk tolerance of your circumstances may be above others who refuses to even consider things like saving your rent if you buy rather than paying much more if you didn't buy or even refuse to take any negative cash flow situations, but it is well within my risk tolerance levels.
In fact, I don't even consider it a risk since there is a profit from the most pessimistic IRR calculations and the economics looks good for the future.
Had I been had less Risk Tolerance, there would be no way I would have build a Real Estate Portfolio over the 21 years I have been Investing in NYC.