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The Early Point

Thursday, March 23, 2006

The Economics of the Rental Property

I apologize for not writing in a few weeks. I've taken on a new job (at a small and very cool software company), and haven't had a chance to post.

So a few postings ago I talked about real estate investing being the solution to my investing woes. Even though some people argue a slow down is coming, you can see from data ive posted that the gains are still strong. In addition, if you are planning on renting your property, the number of active renters in the market actually increases when the market slows. So, you might not make a big return in the first few years on the value of your house, but your chances of finding a renter quickly increase substantially.

To dive in, I think a simple math exercise can most effectively show why I see so much value in real estate investing. Here we go...

If you buy a single family house (3 bedrooms, 2 bathrooms, 2 car garage) for $150K (very possible in most parts of the US and Canada), and put only 5% down, with closing costs you'll have a cash outlay of approximately $12K. (I will dedicate another posting to the absurdity of closing costs.) You close on the property and quickly find a renter. With a reasonable mortgage and a good property manager, on a monthly basis you should be able to collect enough rent to break-even on the property.

You hold the property for 10 years, and aside from the occasional month, it remains consistently occupied. After 10 years, given the average long term growth rate of 7% a year, the value of that house has now increased to $300K. It has doubled in value!! During that time, you have had no cash outlay, but an incredible thing has happened. Your renters have effectively been paying your mortgage for you. So, your 5% ownership in the house is now probably closer to 20%.

You sell the property for $300K. After paying the bank the remainder of your mortgage, your proceeds- $180K!! All on an investment of $12K made 10 years prior. Its an incredible return made possible by the leverage the mortgage system has afforded you.


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