It is better to own real estate than to not own real estate. If you disagree with this, then stop reading now.
In fact, if you disagree with this statement, there are a number of brokers and buyers who would love to help you get out of the real estate game.
For those of you who are still reading, here is the question: Why have you not bought more real estate in today’s market? Waking up your capital by buying more property today makes a great deal of sense. Let’s look into why. Not owning property costs you money! Money market accounts at most local banks pay almost no interest, and one year CD’s pay about 1 percent.
On the other hand, money invested in an apartment building purchased today should provide about a 9% cash-on-cash return.
In other words, if you put $300,000 in a bank, you will receive $3,000 in interest income. Invested in an apartment property, it should yield $22,378 in net cashflow and an additional $8,871 in paydown on the loan. Would you rather receive $3,000 or $31,249? Furthermore, remember that the $3000 in income is taxable, while most of the $31,249 is sheltered by depreciation. When 35% tax is figured in, the after tax income goes from $3,900 to $29,221. Can you afford to miss out on $25,000 of after-tax income a year? Of course, this understates the benefit of real estate ownership, because as rents increase, your income gets multiplied further, and you add additional equity as the value of the property increases. On the other hand, the $300,000 in the bank remains $300,000.
But What If Values Continue to Go Down? Many buyers say that they do not want to buy when the property that they buy will be worth less in the future. After all, “buy low and sell high” is the path to riches. But, are you sure of when the market will hit its absolute bottom? We know that values have come down from their peak significantly and have actually started to come back up. We also know that compelling returns are available in today’s market at today’s prices.
Finally, we know that most bread-and-butter multi-family properties are cashflowing successfully and extremely unlikely to enter the pool of distressed assets. For all of these reasons, the market is quite likely close to its bottom.
The choice is to put your money to work now and experience immediate cashflow in exchange for the risk of a slight short-term paper loss or leave your capital in the bank with essentially no income and wait for the market to drop a little more, taking the risk that you will miss the bottom and end up buying on the uptick, and the risk that interest rates will be higher.
Taking the first option will maximize your cashflow, and ensure that you do not miss one of the best opportunities to buy in modern history. Even if your timing is imperfect, as long as you assume that you will be holding the building for at least 5 years, the market should correct out any little dips. In other words, taking one step back is not a problem if you know that you will be taking 7 steps forward. Many of the most successful apartment owners have not built their success by stealing properties at significantly below market prices. They have, instead, purchased quality properties that met their strategies, and paid, at times, high prices to do this. These leaders understand that the only way to grow is to invest. Many of them realize that today’s market offers the opportunity to buy those properties at lower prices than in the past.
You can do the same!
NOTE: The example above assumes the purchase of a $1,000,000 property at a 7.75% cap with 70% LTV financing at 6.1%, amortized over 30 years.