I can’t really wrap my head around it, you can have a tenant in there that maybe covers the mortgage, but it’s not really a good investment if you’re not getting a return?
Even if you use 500k to buy a property cash, wouldn’t that money be better off in the market?
In: Economics
People who invest in residential property, specifically houses, do it for the growth in equity, with leverage. Commercial real estate and apartments are good for rental yields, but the growth in value is usually very slow, or can even go backwards (for eg many shopping malls are now worth less than they were before covid). But the land value for houses has gone up over the past many decades. So even if the rent barely covers the mortgage, but the house value goes up by 5-10% annually, then that’s a good investment. Plus the leverage you have with the bank’s money, which you don’t get with other investments like stocks.
You’re missing a couple pieces. The first 2 are additional forms of return outside of pure cash flow. The third is leverage.
The first is every mortgage payment is giving you equity in the house. So if your tenant is covering your mortgage, at the end of 30 years you own the home and have a substantial asset even though from a cash flow perspective you didn’t really get a return.
Second, homes can appreciate in value, giving you another way to see a return even if the cash flow is break even. If you bought a house in 2019, it is likely worth much more than you paid because of that appreciation.
The third is leverage. You mention buying a house with $500 thousand cash but the market will beat that every time. The thing that makes real estate an investment vehicle is leverage or debt. You wouldn’t use $500 thousand to buy a single home. You would use $500 thousand as 5 $100 thousand down payments on 5 $500 thousand homes. Now you have assets of $2.5 million which means any home appreciation skyrockets your rate of return.
You pay a down payment of 20% of 100k assuming house is worth 500k. Your a mortgage is roughly 3000 a month.
Tenant pays you 3000 a month covering mortgage, or 36,000 a year that you gain in equity. That’s a 36% return on investment year. Market returns average 7% meaning you generate 7k a year
There’s a lot of other numbers to consider like taxes and interest, but that’s the gist of it
There’s also the benefit of diversification and low risk dependent of the property
I would add that residential real estate is indeed often a comparatively lousy investment compared to the stock market. Taxes, maintenance/repairs, and HOA dues can eat up lots of your anticipated returns. In addition, your investment is illiquid – you can’t necessarily sell that property right when you want to, unlike stocks & bonds.
Answer: most home values increase over time, often substantially. You can rent or use the equity to borrow additional funds for other purposes. And you have to live somewhere- better to own something than to throw money away in rent.
2 ways you make money the rent which should be 7-10% or it’s really not worth it plus capital appreciation say 3% in London or other big city.
Yes you might beat this in the market or you might loose everything. If you do loose everything in the market you could evict the tenant and still have a roof over your head.
My personal example.
Parents bought an investment property in London for £190,000 in 2001 – now it’s worth £750,000.
That house was rented out to tenants over 15 years. The tenants rent money paid off the mortgage.
Once the house was paid off, we had £750,000 of equity we could then raise, or sell the house for a large profit – OR just live in a mortgage free home paid for by someone else’s money.
I chose the latter – because I’m in my 30’s and I don’t want the stress of mortgage.
When you own a house, you are saving money by not paying rent. Saving money is equivalent to getting it as a return. Don’t believe me? Well then, there are countries like Spain, Iceland, and the Netherlands that actually tax homeowners on what they call imputed income, which is the amount that they would be receiving as rent had they not been living in their house!
If that doesn’t qualify as a return, then I don’t know what does. In addition, this return from owning and living in your own house is tax-free in most countries in the world.
It’s quite impressive, actually.
Not to mention that several countries exempt certain types of property from capital gains. In addition, where else are you going to get a 30-year fixed rate loan at low interest rates like you do in the US? As an investment, housing has everything going for it. With massive government subsidies.
A big piece of this are all the tax advantages that you get from an investment property. You get to write off things like depreciation (even though it is usually an appreciating asset), the mortgage interest, insurance, property manager, etc., which all together can decrease your tax liability, rather than increase it. Another way of saying it: Even though you’re making money from the house (even if it is a small amount) it’s very possible to get uncle sam to think that in the total, you’re making less money because of the property, so you get a lower overall tax bill, and get to keep more of the money you make from your normal job.
The reality is that if commercial property investors bunged their cash into index linked funds and sat on it for a decade or two, their returns would be greater with MUCH less effort than managing real estate assets. Sure the same can be said for resi investments too which are even lower yielding assets.
The top poster mentioned about gearing debt against investments as a core way of maximising returns. The problem currently, globally, is the cost of debt is so high that the rate of return is hugely impacted so for many investors, unless they are cash buyers which in some ways can be an inefficient way of tying up capital it’s very hard to make the numbers stack up.
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