By: Mirielle Enlow, City National Bank
While interest rates remain near all-time lows and property values have receded to levels not seen in a decade, many investors are adding real estate back to their portfolios.
During the peak of the real estate market from 2005-2007, it was common for an investor to buy as many properties as they could using as little down payment as possible, even if the rental income on the property was not sufficient to cover the total debt service. Investors did not care about the negative cash flow because they only owned the property to sell it in a year or less for a handsome profit.
When the market turned, investors faced plummeting property values and mortgage amounts greater than the properties’ values, investors became keenly aware of the negative cash flow their investments were producing.
As the adage goes: “You make money when you buy, not when you sell.” This may defy logic the first time one hears it, but it is 100% true. While one does not receive a check with the purchase of rental real estate, whether one will own an asset which contributes to cash flow or take away from it is all determined in the terms of the initial purchase.
The 2006 Way to Invest in Real Estate
Purchase price: $400,000
Mortgage Amount: $380,000
Total monthly payment: $2,800
Monthly Rent Expected: $2,500
Cash flow: ($300), the only return was expected when the home was sold. Speculative/risky.
Today’s Potential Opportunity for Real Estate Investment
Purchase Price: $200,000
Mortgage Amount: $150,000
Total monthly Payment: $925
Monthly Rent Expected: $1,500
Cash flow: $575/mo. or about 13.8% annual return on the initial investment of $50,000.
NOTE: The above illustration for conceptual purposes only. Please consult your real estate, mortgage, and income tax professionals for exact details on property prices, interest rates, total monthly payments, expected rental income, property tax rates, hazard/flood insurance rates, and income tax implications, etc. Many other variables exist including what mortgage you may qualify for and personal income tax situations unique to you.
In 2006, speculation was the name of the game. Using today’s record low interest rates and prices, investors can set themselves up for great cash flow. This makes the actual underlying value of the property less relevant since the value to the investor is in the cash flow, not hypothetical appreciation.
For those who have been waiting for values to drop even further, here is a word of advice. Most people realize that interest rates cannot stay low forever. Just like it was nearly impossible to predict the time when home prices would begin falling, it is likely to be equally difficult to predict when interest rates will begin increasing and by how much. So, hypothetically, if mortgage interest rates increased just 3%, home values would have to fall more than 20% to return the same cash flow that investors can receive today.
About Mirielle Enlow
Mirielle has 20 years of mortgage experience and is currently the Assistant Vic President of Business Development at City National Bank a community bank with a 5 star “superior” rating by Bauer Financial. Mirielle prides herself in being labeled “a connector” through her many involvements in local chambers, business organizations and non-profits. Her favorite lines are “how can I help you?” and “who would you like to meet?”.
Mirielle Enlow, City National Bank, MDGLCC Corporate Member