They say that all wealth in the world is either made or held in Real Estate. If you do become rich one day, it will either be through wealth created in real estate, or you will hold your wealth inside of real estate.
It is almost impossible to create and hold lasting wealth without the use of real estate.
But why is real estate so powerful?
Real estate, in my opinion, is a superior asset class to stocks, bonds or mutual funds because real estate has multiple profit centers.
Your $20,000 to invest
Imagine you had $20,000 to invest that you had saved up over time. You have two options to invest your $20,000 to make a great return.
Mutual Funds a 4% return
You have a friend who is a financial planner who offers you a great return on a mutual fund at 4% annually after all fees and commissions. At the end of one year your $20,000 has grown to $20,800 – you made $800! Congratulations or a 4% return.
Stocks a 7% return
Instead of the mutual funds, lets say you put your money inside of a stock or an index fund. Typically you can earn a slightly higher return on your money by investing directly into a stock or an index fund because you avoid the fees that most mutual funds carry. In this scenario your $20,000 grows to $21,400 and you are slightly richer.
The 6 profit centers of real estate
Instead of stocks or mutual funds, lets take our $20,000 and invest it into real estate and watch our money earn money in the 6 profit centers of real estate.
Lets say we find a property in the market place that is worth $120,000 and the owner is getting divorced. The owner sells us the property for a discount and we buy it at $100,000.
- Equity on day one – The first profit center of real estate is the equity on the buy. You make your money when you buy at a discount, not when you sell. Our property is worth $120,000 but we are buying for $100,000 because of the owner’s divorce.
- Leverage – The second profit center of real estate is leverage. Our $20,000 is serving as a 20% down payment towards the $100,000 value of real estate. We bring $20,000 to the table and the bank brings $80,000. For every dollar we are brining, the bank is bringing 4. This increases our returns by 500% over time.
- Cash flow – Once we purchase the property, we can rent it out for $1,000 a month. After all expenses, the property taxes, insurance, heat, hydro, water, (paid by the tenants) and mortgage principle and interest, and management we are making $300 net per month on our small rental property and we are getting ahead. Lets say we make $3600 per year.
- Mortgage paydown – Since the tenant is paying down our mortgage every month, our loan is shrinking which increases our equity every month when those rent cheques come in.
- Appreciation – Most property appreciates at a modest 3-5% per year, with leverage over time, this is very powerful.
- Depreciation – The government will let us write off a certain amount of depreciation each year so the cash we earn on the property becomes tax deferred which can create more profit over time.
The 5 year hold
Lets say we hold this rental property for 5 years and accumulate profit from all 6 profit centers.
- We make $20,000 from the equity in the buy
- Our $20,000 has bought us $120,000 of real estate via leverage
- We have earned $18,000 in positive cash flow over 5 years
- Our balance on the mortgage after 5 years is $68,369 ($80,000 balance, 25 amortization, 3% interest, monthly payments)
- At a 3% appreciation per year our property is worth $139,112 after 5 years with modest appreciation.
- Cash flow has been kept tax free because of depreciation.
After 5 years, we can sell the property for $139,112, pay ou t the mortgage of $68,369 leaving us with $70,743 of equity. We also have $18,000 of cash flow so we have $88,743 of total equity. Subtract our original $20,000 and we made a net gain of $68,743. Divided by 5 years is $13,748 per year and divided by our original $20,000 is 68% simple return per year.
There are a lot of assumptions
Some of our assumptions in this model are the following:
- We sell the property ourselves with no realtor, add 5% in most markets to sell the property as a cost to sell.
- Closing costs and other fees with selling are excluded.
- Cleaning/renovating the property for sale are also excluded and may be needed.
- The tenants are perfect angels with no vacancy in this scenario, the property also has no maintenance or cash calls.
- Expenses for operating stay fixed over five years, which rarely happens.
- We are budgeting no money for accounting, legal, banking, corporate filing, book keeping etc.
- We are not factoring in the value of your time.
- You have good enough credit and creditworthiness to get a mortgage.
The model I am showing you with a massive 68% has the assumptions above, but even if we cut it in half, it still outperforms the stocks and mutual funds by a massive margin.
Since you have multiple profit centers in real estate, you can easily see why all wealth in the world is either made or held in real estate. This asset class is extremely powerful and when used right, can create fortunes that last.
Real estate is NOT get rich quick scheme, instead it’s a get rich permanent scheme.
Respect The Grind,
P.S. If you are interested in reading more about real estate investing you can read my reviews of best real estate books.