DC Investor Series Episode 1

November 10, 2017

By: Nomadic

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To further illustrate the two key factors driving real estate investment; Appreciation and Cash Flow, we will look at the same hypothetical situation from a few different perspectives. This will serve to show the pros and cons of each approach and to help you shape your opinions on what type of balance you are looking to achieve. Now obviously there are other contributing factors and considerations such as taxes, insurance, upkeep, HOA fees and depreciation; we will look at these in greater detail in a later installment, but this is in essence to show structure and potential returns as affected by various investment approaches.

If you do finance, whether it is a 15 or 30 year mortgage can influence your equity and cash flow and often will factor directly into your strategy based on goals. Mortgage length is another tool in your investment toolshed. Though the payments may be higher on a 15 year mortgage and monthly cash flow lower than with the same down payment on a 30 year fixed mortgage, the shorter terms make sense for a variety of investors. If you are willing to forgo short term cash back each month as a young investor and instead opt for higher payments and shorter debt obligation, this allows you to build massive equity quicker than a traditional situation. Using a base purchase price of $650,000 and assuming the market increases 20% from the original purchase price in 10 years (one decade), your home will be worth $780,000. If you had used a 15 year mortgage, you would own a larger percent of the equity on that $780,000. Over that same time with same appreciation on a 30 year mortgage, you would own less equity on your home. Let’s assume the interest rate is at 4% for the sake of this example. Now obviously your monthly cash flow over the past decade will certainly offset some of that difference, let’s look into just exactly how much.

Properties in DC are taxed at the rate of $.85 per $100 value or an interest rate of .85%. Using this along with a $1,000 yearly insurance premium we can make monthly mortgage projections.

 

$650,000 property

  • Example A
    • 20% down/80% financed
      • $3026.31/mth over a 30 year mortgage
      • $4390.13/mth over a 15 year mortgage
    • Example B
      • 50% down/ 50% financed
        • $2095.35/mth over 30 years
        • $2947.74/mth over 15 years
      • Example C
        • 100% down/ 0% financed
          • Obviously you only have the taxes and insurance costs yearly.

Assuming the rental rate on the $650,000 property is $3,600/mth you can see the inherent advantages and drawbacks of each scenario. Just as you would never want to invest with less than 20% down, on a property with these factors, it would not make sense to finance with a 15 year mortgage if you could only put down 20%. Let us build in a 2% increase annually (just below DC average) to see how much rent would be collected over a 10 year period.

$473,027.95 is what you would take in through rent before expenses over this 10 year time period. Aside from the rental profit each year, you also own any appreciation that has accrued from the price you paid to the current value.

  • Example A
    • $363,157.20 in monthly payments over 10 years for 30 a year mortgage
    • $109,870.75 rent profit
      • + the $130,000 appreciation and value of the equity you have paid down
    • Example B
      • $251,442 in monthly payments over 30 years
      • $353,728.8 in monthly payments over 15 years
        • The equity you own here will be much higher + that same appreciation.
      • Example 3
        • No payments/ all profit
          • You have kept the vast majority of all rent payments as you have no mortgage in this scenario. Since you own the home outright, you own all of the equity not just on the original value, but the appreciation as well.

Obviously when taken in a direct subset like this, it would make no sense to put down anything less than the full cost if you could. But as discussed in the video above- a smart investor will use their leverage. For the $650,000 investment you could easily put 50% down and do the same elsewhere. For the same investment you now have two assets and have exponentially increased your portfolio value. Instead of one property you have two for your upfront purchase power. In a similar vein, you could use that same initial investment to put 20% down across 4 properties. It is important to play with the numbers to find that sweet spot of monthly cash flow and market appreciation that works for your needs, but an aggressive investor looking to build wealth through longevity can easily implement this last strategy.

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