Why invest in Real Estate?

The other day Zillow came out with a report that showed another large drop in housing prices.  This particular report showed an 8.2% drop in housing prices nationwide year over year, certainly demonstrating for many people that real estate is a terrible investment right now.  I, myself, have talked to multiple people who think real estate might be a good investment in the future but, with the expectation that housing prices will drop further, they want to wait until prices pick up.

I believe those who are waiting on the sidelines are wrong to do so.  Price declines are scary for sure but, as Warren Buffet said, “I’m fearful when others are greedy and greedy when others are fearful”.  Price declines have corrected to the point where they are below most rational measures of value.  In many places, including my town  of Phoenix, Arizona, properties are so cheap that it would be more expensive to dump all building material on dirt than to buy an existing house.  Sure, prices could drop a little further but it is highly unlikely that they will drop substantially more than they already have.  Anyone remember back in early March 2009?  The same thing was happening to the stock market, I remember reading about and hearing so much negativity about stocks and how stock market investing was no longer a good investment.  Remember how that story ended?  Stocks have almost doubled from their March 2009 lows and the most beaten up stocks –  the banks, are up anywhere from 2-6 times what they were trading for in early 2009.

Of course, just because the stock market came roaring back after a protracted drop doesn’t mean that housing will follow the exact same pattern.  Obviously, there are differences in the two asset classes and, like stocks which have seen largely diverging returns based on the individual company, real estate will recover unevenly based on geographic and specific location as well as asset type.  However, as I will show in a few examples real estate is a fantastic investment right now even if no appreciation to the asset is expected.  Add in some appreciation and you have an investment capable of producing annual returns of 30% for the life of the asset!

How could this be you ask?  Consider a property I am currently getting ready to sell in Surprise, AZ.  Selling price of this property is $110,000, with all closing costs paid by the seller.  Current market rents for comparable properties (4B/2B, ~2,000 square feet) are $1,100 – $1,200.  (It rented a little over a year ago for $1,050 and rents have gone up since then).  Additional expense assumptions are as follows:

Maintenance allowance: $100/month ($1,200 per year)
Vacancy allowance: 1 month vacant per year
Taxes, Insurance, HOA, marketing: $1,800 per year

Annual return on investment in this case is 8.3% (will be less if property management services are needed – property management typically charges 10% of rent collected)

Not a bad investment for someone looking for regular cash payments for retirement or supplemental income purposes.  And much better economics and upside than purchasing an annuity, CD or bond.

Now, lets look at the return if this investment were to be financed.  Assumptions:

Purchase price: $110,000
Assumed rent: $1,150
Down payment: 20% = $22,000
Interest Rate: 5%
Term of Loan: 30 Years
Mortgage Payment: $472/month

Maintenance allowance: $100/month ($1,200 per year)
Vacancy allowance: 1 month vacant per year
Taxes, Insurance, HOA, marketing: $1,800 per year
First year return on investment (cash return only – no equity) = 18.6%
First year return on investment (considering equity paydown) = 24.5%
First year return on investment (with equity and with 3% appreciation of house) = 39.5%

*These returns don’t even take into account the tax benefits of mortgage interest that you would be able to take advantage of.
A quick plug:

As this example shows the investment opportunity is incredible.  If interested in this property give my office a call at 480 532-7999.  We should also have pictures up soon on our website www.betterinvestingre.com.

We are very interested in the long term success of our clients which is why we offer 3 years FREE professional property management for any property purchased through us.

End of quick plug

The amazing thing is that although this property is indeed a fantastic deal, we are finding amazing investments throughout the valley with similar returns.  It looks like Warren Buffet might have been onto something after all.