Real estate is an excellent investment vehicle for building wealth, especially here in Massachusetts where we have a large number of multifamily buildings. The 3-family home, as an investment, tends to make a ton of sense when it comes to the balance between the purchase price of the building and rental income you can achieve from one of these buildings. Let’s take a quick look at a recent purchase made by one of our clients.
Purchase Price: $500K Down Payment: $100K Mortgage: 15 Fixed @ 4%
Expenses: (Mortgage, Taxes, Insurance, Water, & Misc): $3,800 Income: $4500 ($1500 * 3 Units)
Monthly Cash Flow: $700
$700 monthly cash flow is great, but the real financial benefits come from the long-term effects of this investment on my client’s portfolio. If you noticed above she opted to take a 15-year loan and pay off her debt sooner than the typical 30-year plans. Let’s take a look at where she is financially in 15 years:
Debt Pay Down:
As you make your monthly mortgage payments the principal balance is slowly decreasing. This debt pay-down is called the “amortization” of your mortgage. If you look at a mortgage amortization chart (which is usually provided with your loan documents) you can pinpoint what the principal balance on your loan will be at any given point over the term of the loan. This assumes you are making all your payments on time and only paying the minimum amount due each month. As your mortgage balance decreases your net worth increases. With the above scenario, my client is done paying or has “fully amortized” this loan in 15 years. She will receive a discharge notice from the bank and no further payments will be due. Her tenants will have essentially paid off a 400k debt for her and increased her net worth by that much.
Appreciation is the increase in your property’s value year after year. The rate of appreciation you will receive in future years is impossible to predict but history tells us that property values tend to increase at a rather consistent rate over time. Removing recent market adjustment years (2006-2011), US real estate values have appreciated at a rate of approximately 6% annually, with Massachusetts falling right in line with an average rate. If we take our property from above with a current market value of $500k and assume we achieve at least a 5% rate of appreciation over the next 15 years, we would be looking at a property value of $1,039,000.
Rent prices tend to move upward with inflation. Just like the cost of bread and gas, rent rental values always go up. With that said, the same $4500 per month ($54,000 annually) my client is collecting in rents today will be much higher in the future. If we assumed rents in her building also increased at a rate of 5% yearly, she will be collecting $9,355 per month after 15 years. That’s over $100K annually in passive income!
Net Worth & Passive Income:
If you take these numbers as a whole, that's when things start to get exciting. 15 years from now this mortgage will be completely paid off and it will have been done by someone other than my client. Her tenants are paying off the debt every month with their rent checks. Not only is she getting the debt paid off but she will be putting $700 (or more) per month back into her pocket over the next 15 years. At the end of the 15-year term, her debt will be gone and her rents have now grown to $9355 per month, which she can put in her pocket or use to go out and purchase other investments. Her property has also appreciated to over 1 million in value which will be a major contribution to her total net worth number!
Building Wealth Takes Time:
My client is not very special …in the sense that anyone can follow this wealth building model and achieve exactly what she has done in the past and is in the process of doing again. Don’t have $100k to invest? You don’t need it. There are ways to achieve the same with a whole lot less. Don’t have time for tenant issues? Hire a property management company! With this model, my client is achieving $700 in cash flow. I’m sure for $700 per month you can find a company to manage your tenant issues. Long story short… there is really no reason why this can’t be done by anyone. 15 years is not a walk in the park but the earlier you start the sooner you’ll get there. If you only had this one building and invested in nothing else during the next 15, you would still have a net worth of over a million dollars and earning over a $100k in passive rental income! Imagine if you bought several of these investments!