We have all heard that investing in real estate is one of the safest investment vehicles long-term. However we know due to the financial crisis and real estate crash that in a matter of a couple years, 20 years of equity can be wiped out. Yes I said 20 years. Some properties in the areas that I sell are priced at where they used to be priced 20 years ago. So with this, many ask me: Why would I buy an investment property now? My standard response is to not buy for the equity of the property but for the return on investment (ROI).

One of the biggest mistakes made by many beginning investors are they purchase properties because the value, or equity, will rise. They buy properties during booming years because they only see values continue to rise but then they avoid buying properties during slow times because values won’t rise. Well here is the secret that the experienced investors live by when investing in real estate: buy based on the return on investment (ROI). If it is a good buy, then buy it. If not, then walk away from the deal.

What I am talking about is to focus on the money you are paid back from the investment, rather than the potential equity you will gain or lose in the future. Investing based on equity is an equal of a gamble as stocks. But if you know what your income and expenses are every month, you can easily calculate whether a property is a good buy for your investment portfolio. Let’s look at this further.

Here is an example of a property I recently sold in the Rollingwood neighborhood of San Pablo, CA. The property is a single family residence, 3 bedroom, 1 bath, 855 square feet and can easily rent for $1,300 per month.

$135,000 - Sales Price

$33,750 - 25% Down Payment

$800 - Annual Insurance

$1,688 - 1.25% Annual Property Taxes

5.00% - Interest Rate on 30 Year Fixed

$755/Month - Monthly payment

The figures above are based on a 30-year conventional loan for investment property. The down payment is a 25% requirement if the buyer has no history of rental properties for the last two years. If a buyer has history of rental properties in the last two years, then a 20% down payment is minimum requirement. So now let’s calculate the ROI:

$1,300/month Monthly Rent

$755/month Monthly Loan Payment

$545/month Monthly Profit

$6,540/year Yearly Profit

$33,750 Down Payment Investment

19.4% ROI Yearly Return on Investment

To calculate the ROI, you simply divide the yearly profit (in your pocket) by the down payment investment (out of pocket). So in this example, it would take you approximately 5 years to make all your money back (out of pocket investment). Where else can you find a 19% ROI in today’s economy?

And if values do not rise in 5 years, or take another drop, then that is ok because you’ll make your money back in 5 years. Then all future income minus your loan payment is profit. If values rise, then it’s an extra bonus.

So what do you think? Is 19% return a good investment for you?

"But Marc, I don’t have that kind of down payment."

Ok, so maybe we all agree that a 19% return is a very good buy but the down payment requirement is tough. Not many people have an extra $34k in the bank. But there are solutions to that problem. One solution is to partner with one or two other investors in the purchase. Sure you split profits but you also split up expenses; your ROI will remain the same. Another solution, which is my recommendation, is to get creative and find people that have money to lend privately. There are many people with money sitting in their bank gaining a 0.5% interest rate. Ask them to lend you a portion or all of the down payment. You can offer them a 7% interest rate on a 10 year fully-amortized loan with monthly payments; this equates to $392/month for a loan on the full down payment. How does this affect your ROI? It only makes it better.

$1,300/month Monthly Rent

$755/month Monthly Loan Payment

$392/month Monthly Private Loan for Down Payment

$153/month Monthly Profit

$1,836/year Yearly Profit

$0.00 Down Payment Investment

•       ALL PROFIT from Day 1
  

Now what if you search and search all your contacts and you do not know of anyone that can privately lend you money... what now? Well then it is time to network and meet new investors. Join Facebook and join various investment groups, search for investors on Twitter or sign up for an investment club on MeetUp.com. There are many ways nowadays to find investors including Funding Clubs; the internet is your key.

But before you go out and start borrowing money for down payments, you need to plan first. You need to treat it just like any other business and develop a business plan first. If you borrow the down payment first to buy the property, there are lending requirements that may restrict you on buying. Again you must plan first before jumping into any kind of investment.

Ciao!

Marc

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