I enjoyed this post on My 1st Million at 33. It discusses the relative prospects of investments with different cash flow and net income positions.
This quote was particularly interesting:
And the last important thing that many real estate investors don’t account for is calculating the cost of down payment. Some people don’t even pay attention to down payment.
Frugal brings up an interesting point here. There is an interplay between your cash flow, net income and downpayment. For instance, on the previously mentioned Property #2, our downpayment was 25%. So, although the property provides a cash flow of $12,000, we will not recover our initial investment for about 3 years. This is a ROI around 30%. Now, if the housing market happens to turn downward, things will look much different. Say the property value drops $10k over one year, we effectively earn nothing in that year because of the loss in value. Thus, your actual position will not be reflected in either cash flow or net income. This will actually be reflected on the Balance Sheet.
So, for now, our net income is $12k/yr, our ROI being 30%, and our break-even is in 3-years at which point the house price could fall 25% and we would not lose any money overall. According to what I’ve read, this will hopefully not happen. My market is not as overvalued as many markets in North America, and I’m hoping that if there is a correction, it will take a couple of years to pan out.
Furthermore, one must also include any closing costs in their calculations. These are out-of-pocket expenses that cannot be reclaimed by selling the house. In fact, selling will of course generate more unrecoverable costs.
The previously mentioned software package SolveIT! does a good job of working out all these costs and showing you when your property will fully pay for itself and generate new income (other than the downpayment). It includes tax benefits, selling costs, appreciation and inflation. Based on my numbers, I will have paid myself back for the downpayment in 2008. After that, assuming no housing market collapse, the net income goes into my pocket, and my equity continues to build. Assuming 1% price inflation, if I sell after 18 years I should net a total cumulative income of $241,800….
but this is all speculation, fun though it may be.