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REAL ESTATE INVESTMENTS YIELDS
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Real Estate investments return a better yield as property increases in size and units. For example, an investor with $10M could choose to buy 12 single family homes or five 12-unit apartment buildings. The 12 homes combined would net about $15K in rent per month while the apartments would provide $45K. For the same amount invested, the apartments offer triple the income!
The chart below includes some real world examples of real estate in Redwood City as of November 2006. The chart demonstrates the yearly yield an investor could receive on property were they to purchase it for cash - free of loans. In this simplified example we are not accounting for tax advantages such as depreciation and other write-offs.
Basically the chart shows the purchase price of each type of property and then calculates the amount an investor could expect to receive monthly after paying the bills. The Yield or Cap Rate refers to the annual return on the investment based on the purchase price.
YIELD FOR DIFFERENT TYPES OF PROPERTY |
Property Type |
Purchase Price |
Prorated Property Taxes |
Other Monthly Expenses |
Total Monthly Expenses |
Monthly Rent |
Monthly Cashflow |
Yield/Cap Rate |
| Condo |
$500,000 |
$458 |
$390 |
$848 |
$1,600 |
$752 |
1.8% |
| SF* Home |
$850,000 |
$779 |
$450 |
$1,229 |
$2,500 |
$1,271 |
1.8% |
| Duplex |
$900,000 |
$825 |
$500 |
$1,325 |
$3,000 |
$1,675 |
2.2% |
Fourplex |
$1,200,000 |
$1,100 |
$900 |
$2,000 |
$5,200 |
$3,200 |
3.2% |
| 12-Unit Apartment |
$1,950,000 |
$1,788 |
$2,000 |
$4,188 |
$13,200 |
$9,013 |
5.5% |
| SF= Single Family Home |
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As an initial purchase, real estate is currently a poor investment. Purchase prices have increased substantially in the past few years while rents have been somewhat stagnant.
The lower you are on the food chain, the harder it is for you to break even. The smaller investments (condo up to a duplex) require an investor to put donw up to75% in order to break even monthly. While an investor buying the 12-unit apartment building can break even with as little as a 33% down payment if they manage it themselves.
DOWNPAYMENT AS % OF PRICE REQUIRED TO BREAKEVEN
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Property Type |
Required Down
to Break Even |
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Condo |
77% |
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SF Home |
75% |
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Duplex |
72% |
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Fourplex |
60% |
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12-Unit Apartment |
33% |
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So, if the return is so lousy on real estate why bother at all? Well, real estate is still a great investment when you dig a little deeper and intend to keep it as a long-term investment.
Let's fast forward 10 years on the investments we studied in the chart above and make the following assumptions:
- Properties appreciated 4% per year
- Rents increased 4% per year
- Expenses increased 5% per year
When we run the numbers on this scenario, we get the chart below:
REAL ESTATE INVESTMENT PROFILE 10 YEARS IN FUTURE |
| Property Type |
Property Value |
Total Monthly Bills |
Monthly Rent |
Monthly Cashflow |
Yield Rate |
Appre- ciation |
Value Increase |
| Condo |
$740,122 |
$1,167 |
$2,368 |
$1,201 |
2.9% |
$240K |
48% |
| SF* Home |
$1,258,208 |
$1,637 |
$3,701 |
$2,063 |
2.9% |
$408K |
48% |
| Duplex |
$1,332,220 |
$1,772 |
$4,441 |
$2,669 |
3.6% |
$432K |
48% |
Fourplex |
$1,776,293 |
$2,743 |
$7,697 |
$4,955 |
5.0% |
$576K |
48% |
| 12-Unit Apartment |
$2,886,476 |
$5,984 |
$19,539 |
$13,555 |
8.3% |
$936K |
48% |
| *48% appreciation is based on 4% yearly value increased compounded over 10 years |
We see that 10 years later property prices have appreciated about 48% and our cashflow has also increased by about the same amount which raises the rent yield on the initial apartment building investment from 5.5% to 8.3%. The results can be even better if we consider leveraging the investment by not buying it outright, but instead putting just enough of a down payment to be slightly cash flow positive. When you fast forward such an investment 10 years, the returns on the original down payment work out to be 110% value appreciation with 10% rent yields.
The appreciation of property values in San Mateo County has performed similar to the DOW over the past 25 years. But consider that over the years the DOW has adjusted the companies in its index. For an investor to trade in and out of these stocks, it would create a taxing event, real estate can avoid taxing events. Rents also eventually outperform any dividends the best stocks would payout and this income can be offset by depreciation.
Real estate allows you to exchange property tax free. A 1031 Exchange allows an investor to sell property and buy more without paying taxes on the appreciation of the property and to once more gain the tax benefits of depreciating the asset - can't do that with stocks.
When you consider tax advantages like Depreciation, 1031 Exchanges, and the two year $500k tax-free allowances, real estate has benefits no other investment can match. The downside to real estate is its additional costs and hassles. A stock could become worthless, but real estate could go negative. The value of a property could drop below your downpayment, your property could need additional cash infusions for repairs or you could have bad tenants.
Into the foreseeable future, the population of the US and Bay Area is expected to continue growing substantially. Rental property and homes in the Bay Area will always be in demand. The only question that remains in my mind is if the impact of the global economy deteriorates average income enough to destroy the historical appreciation norms for property values and rental increases.
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