The journey begins
If you are on a journey to build up your wealth, then you probably have heard that real estate investing generated the greatest number of millionaires. Some have expressed their doubts on the validity of this claim, especially in today’s high property price environment. However, despite the recent run-up in real estate prices, I think real estate remains a superior investment over the long-term. Here’s why.
When it comes to building wealth, I am like most regular folks. First of all, I have a decent paying job. This is obviously my main source of income. I also have a 401K account, which consists of a low-cost index fund. And like many beginner property investors, I also have a couple of rental properties.
Similar to most folks, I plunked down a down payment and borrowed the rest from a bank when I purchased my first investment property. And the returns has been nothing short of amazing – I made 200% of my down payment in the past four years. That averages to about 50% a year.
This is how I did it: In 2018, I purchased a $250,000 property with a down payment of $80,000. As of the writing of this article (September 2022), Zillow estimate it is worth $410,000. So I’ve made $160,000 on price appreciation alone ($410,000 current estimated value – (minus) $250,000 initial purchase price = $160,000). For simplicity’s sake I round it down to $150,000. Then on top of that, I’ve made another $10,000 from rental payments after considering my expenses. Effectively I’ve made close to $160,000 on my initial down payment $80,000, even after considering closing costs (~$5,000) and renovations (another $5,000).
Play with the bank’s money: Understanding leverage
Granted, the housing market has been phenomenal in recent years. But the real driver behind the monster financial gains I made was leverage. If you are serious about real estate investment, you need to understand leverage.
Leverage is the most powerful tool in real estate investing. Leverage can multiply your returns when asset prices rise. For example, if we assume a 20% down payment, then a modest 2% annual price gain would translate into a 10% return.
Let’s play with some numbers. For simplicity’s sake, we will assume no transaction costs for now. Say you want to purchase an investment property that is worth $400,000. You put down a down payment of 20%, or $80,000. If the price of the property increase by a modest 2%, that translates into a price increase of $8,000. But because you only put down $80,000 for down payment, you just got a 10% return on your capital ($8,000 divided by $80,000 = 10%). So essentially you turned a 2% price gain into a 10% return.
So what happens if you have a 3% price appreciation? That would translate into a $12,000 price increase, and a 15% return on your $80,000 investment (down payment). Not too shabby, considering the long-term stock market returns is just 9% per year. And this is why real estate investing generates so much millionaires – via the power of leverage.
Of course, leverage is a two-way street. It can turn a 2% price drop into a 10% loss on your investment. But real estate prices are
usually pretty sticky. Also, you always have the option to rent out your investment property during real estate bear markets, like the one we are going through now. You also have to pay for this leverage in the form of interests. But as long as your rental income exceeds all your expenses, you can quickly multiply your returns with leverage.
What are my plans with my investment properties? I plan to hold on to them. They are all cash flow positive, and the properties are
located in a region with fast-growing population. So time is on my side.
We will explore the criterias I used to decide where to invest in our next article.
Happy investing!
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I need to to thank you for this good read!! I certainly loved every bit of it. I have you bookmarked to check out new stuff you postÖ