Many people consider investing in real estate but there are many options in the investing world for what to do with your cash.
We completely understand that there are many different ways to invest in stocks/equities, but for the sake of discussion, lets consider the following question:
S&P averages a 10% return. Why would you ever invest $100,000 in real estate, rather than the markets?
provides an excellent answer. Please read it.
If you’re actually buying the property, leverage can be key. Let’s say you put 20% down. With a $100,000 investment (leaving aside some transaction costs), you’d be buying a $500,000 property. And let’s say the property, on average, appreciates 4% annually. (I won’t get into the details, but it’s a lot more difficult to calculate than you’d think. Seeand .)
In some parts of the country, it’s possible to buy for 20% down and break even on rent. Let’s assume you break even. And we’ll leave aside the very real tax benefits (taxes, interest, other expenses, depreciation). Plus, you’ll start to pay down the mortgage, thus increasing your equity. But for now, just focus on leverage and appreciation.
If the house price rises 4% annually, you’ll have a 20% ROI (return on investment). Consider: Your $500,000 house goes up in value by $20,000. You’ve invested $100,000. That’s a 20% ROI.
La Jolla Agent Note: There are many types of loan programs where you can invest less than 20%. Some common options if you intend to occupy the residence are a 0% down payment VA loan, or 3.5% down payment FHA loan. While the monthly expenses will be higher with a higher monthly mortgage, the long term appreciation can affect ROI exponentially . Imagine doing the above example with 0% down ( $0 ) or 3.5% down ($17,500), getting a $20,000 return on those numbers are GREAT!
I guess you could stop right there. Investing conventionally you can do much better in real estate than in the stock market.
But let’s get more creative. You’re going to rehab a house. You find a house that, when fixed up, will sell for $550,000. You can buy it for $300,000. It will take $80,000 in repairs. You use a hard money lender to help you. You invest your $100,000. The hard money lender provides $280,000. It takes you 6 months from beginning to end/sale. (It shouldn’t take that long, but we’ll play it safe.) You should make around $60,000 . . . hopefully more.) Let’s do the numbers: $100,000 investment and a $60,000 profit in 6 months. That’s a 60% ROI. Do that twice a year, and you have an annualized ROI of 120%.
Or you rehab a house, as in the example above, but you early on decided to keep it as a rental. In that case, your rehab costs would be less—maybe $65,000. So you’ve put $365,000 into a rental property that’s now worth perhaps $500,000. You’re starting off with $135,000 in equity plus something that’s going to cash-flow even better, since you’ve only borrowed $265,000 (not $400,000 as in our first example). It’ll still appreciate 4% a year. So your $100,000 has produced a quick $135,000 in equity, and appreciates $20,000 a year. We’re still at an annualized ROI of 20% . . . not counting the $135,000 in equity, the much stronger positive cash flow, or the tax benefits.
Not good enough yet? (Gee, you’re tough!)
Consider wholesaling. You put a property under contract, then assign (sell) the contract, often to a rehabber. A lot of wholesalers use a $100 earnest money deposit. As we’ll see in a moment, the amount doesn’t matter. But you’ve got pockets bulging with $100,000, so let’s say you use a $1,000 earnest money deposit. You find the house described above. You can put it under contract for $300,000. You can then assign the contract for $325,000. And let’s say that process takes a month. (It shouldn’t; it should take a week or so. Good wholesale deals go in a matter of hours . . . but, as you’ll see, that’d really screw up our calculations.)
So you make a $1,000 earnest money deposit. In 30 days, you assign the contract for $25,000. That’s a 2,400% ROI. Do that 12 times a year, and your annualized ROI is 28,800%.
Not good enough yet? (Aw! Come on now! OK, OK. Let’s see if we can do better than a 28,800% ROI. Yes, we can “cheat” and cut our earnest money deposit from $1,000 to $100. But we can do much better than an annualized ROI of 288,000%).
Remember, we said that the amount you use as an earnest money deposit doesn’t matter. Why not? Because we get that back. We include a paragraph in our assignment contract along these lines:
Assignee also shall reimburse Assignor at settlement for all funds expended by Assignor in connection with this transaction, including but not limited to earnest money deposits, inspections, and any other costs connected to the underlying purchase agreement which is the subject of this assignment agreement. [Emphasis added.]
So the wholesaler gets the earnest money deposit back at closing. Now let’s calculate our ROI. While you did make a $1,000 earnest money deposit, you get that back in 30 days. Hmmm. You’ve just made $25,000 on zero investment in one month. You can’t calculate an ROI without an investment.
That’s why—and how—some people invest in real estate.