Hey Capital – Wake Up!
Market – 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? and Hagerstown is a great place to start.
Waking up your capital by buying more property today makes a great deal of sense. Let’s look into why.
Market
Recalculated financing illustration
The original example assumed a $1,000,000 purchase at a 7.75% cap rate, with 70% loan-to-value financing at a fixed 6.1% annual interest rate amortized through monthly payments over 30 years. Using those assumptions:
- Annual NOI: $77,500
- Loan amount: $700,000
- Down payment: $300,000
- Monthly principal and interest payment: approximately $4,241.96
- Annual debt service: approximately $50,903.56
- Annual pre-tax cash flow before capital spending and reserve contributions: approximately $26,596.44
- First-year loan principal repaid: approximately $8,436.85
Cash flow divided by the down payment is approximately 8.87% in this simplified illustration. Acquisition costs, initial improvements and other cash contributions are excluded here; including them would change the cash-on-cash return. Loan principal repaid builds equity but is not cash distributed to the investor. Do not add it to cash flow and call the result spendable income.
The earlier after-tax comparison has been removed because the article did not establish the investor’s tax situation, depreciable basis or other inputs needed to support it. Neither the bank rate nor the property return in the original discussion should be treated as a current offer. See the cash-on-cash return and ROI guide for the distinction between annual cash flow and total return.
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 cash flowing 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. As such, you can invest and take a small risk of paper losses to get your money working for you at a healthy return, or you can wait for a potential small down-tick and let your money sit in the bank earning you next to nothing.
A longer holding period does not guarantee recovery from a decline in value or prevent operating losses. Review the property’s income, lease terms, expenses, capital needs and financing under both base and downside assumptions before deciding whether it fits your goals.
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% loan-to-value financing at 6.1%, amortized over 30 years.
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