In my last post I discussed the opportunity costs associated with making investments. Inevitably you are forfeiting one opportunity in favor of another. I'm I'm seriously contemplating pulling money out of the stock market in order to invest in my second rental property - despite the fact that I'm young, that I just bought my first rental 4 months ago, and that I'd be putting a serious dent in my liquidity.
Analyzing opportuntiy costs is only relevant in terms of what risks and potential upside the new opportunity has to offer. So here is specifically what I'm considering:
WHAT I'D GET:
My realtor let me know about a development of new construction duplexes and single family homes in a rapidly growing and developing suburb about 20 minutes away from where I live. They are brand new 3 bedroom 2 bath units on each side with an attached 2 car garage, granite counters, nice appliances, full size washer dryer connections, the works. A recent appraisal for the builder valued each side at $124K for a total deplux value of $248K.
The rent would be $1,150 on each side, for a total of $2,300 per month. Cash flow would be $466 per month after mortgage/tax/ins and HOA (for lawn care) but before vacancies and maintenance (this assumes a 20% down payment and an interest rate of 7%).
Maintenance costs would be minimal for years, given that the units are brand new and warranties will be in place for everything. And vacancies should be minimal; apparently people are lining up to lease these units; some that aren't even finished are pre-leased to tenants. And the area population and job market is growing at a sharp pace.
WHAT IT WOULD COST:
The builder's price is fixed and non-negotiable (allegedly) at $229,000 per duplex. Assuming a 20% downpayment I would have to put down $45,800. Sure, I could put down less, but that might make my rate higher, and it would affect my cash flow as well. Plus I'd have to pay PMI. Including closing costs and miscellaneous start-up costs, I'd count on $50,000 out of pocket for the purchase.
There are 6 properties left out of approximately 40 that were built. You must buy the whole duplex, though the units can subsequently be sold individually as single family residences. Additionally, there's a property management company you can (but don't have to) use who are charging a relatively low 5.5% of gross rent for that development. If I ever did move or get sick of landlording, I could get them to manage it and still at least breakeven.
So the question is - where is my money better off??
RUNNING THE NUMBERS
Stocks: Assuming 8% annual appreciation, that $50,000 would grow to $54,000 in one year, $73,466 in five years, and 107,946 in 10 years. In the meantime I literally wouldn't have to do a thing - no research, no maintenance costs, no stress (unless the market tanks).
Real Estate: Assuming 4% annual property appreciation, breakeven rent, and a 30 yr fixed mortgage at 7%, I'll start with $45,800 in equity - a $229M property on which I owe $183.2K (until I get an appraisal of my own I'll assume the property is worth what I pay, not what the builder's appraisal says). After one year I'd have $56,756 in equity, after 5 years I'd have $106,160, and after 10 years I'd have $181,762.
And the winner is...Based on these assumptions my $50,000 investment would be worth more through real estate in 1, 5, and 10 years based on appreciation alone. This is the power of leverage. You can quibble over my assumptions, but 4% for real estate over a decade is conservative, especially in the Dallas - Fort Worth area. And 8% for stocks is a big fat maybe; if stocks average 6% a year over the next decade, my $50K will turn into only $89K - making the real estate even more appealing.
Naturally I don't invest in real estate solely for appreciation - in fact I never plan to sell my properties, so the appreciation is moot. The real upside is the cash flow - which in this case starts out positive and should only increase as rents go up and my mortgage payment stays fixed over the years. Once the property is paid off then it really turns into gravy.
Even after assuming 5% vacancy and 2% maintenance, my cash flow would be $300 a month. That's $3,600 a year. That's a 7.2% return on my $50K in the first year alone, not including the above mentioned property appreciation and principal reduction. Plus that figure will increase with rents (and in light of the foreclosure situation, demand for rent in this demographic is likely to remain very strong and/or increase).
Note: I haven't considered taxes for purposes of this superficial analysis. But suffice it to say that the tax advantages that come with purchasing a rental are very enticing. Check out a previous post for the top 10 rental property tax deductions.What do you think? Any insights as to what I may not be considering?
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