is 3% compounded annually a good return on property?

TL;DR: Buying a home and living in it for 1-2 years could still net a 3% compounded return on investment not accounting for appreciation, depreciation (non-cash expense), and rent inflation. Is it a good investment considering the cushion provided?

I've been reflecting on the advice of not purchasing a home unless I want to live somewhere for at least 5 years. I want to build some equity in a home instead of paying rent - who doesn't?

Let's say I buy a 3 bedroom 2 bathroom house. I live in one and rent out the other two. I'll bring in $1,600 a month from the tenants and "pay" $800 myself for a total of $2,400 monthly, or $28,800 annually. Assume 8% in expenses it comes out to $26,296 NOI. After taxes, on the rental income, estimate 15% and property tax of 7.3k i'm left with a measly 16,316k per annum.

I'll have to pony up an additional $6k to cover annual mortgage payments of 22.3k. (650k *1.03/30) I didn't consider the interest as an expense above, but there may be 1k in tax offset?

Assuming I'm saving 15k a year I can take 6k from those 15k and stick it into my mortgage payment.

I'll be ponying up 23k per year towards my mortgage and tax payment of 29.6k while my tenants will be contributing only 6.6k. If I were to rent I can expect to pay on average 13.k a year in rent. So my net cost of ownership is 9k. I'm putting 9k a year into an asset that I can liquidate in the future.

Tenants are paying 22.3% of my mortgage, $144,950 not accounting for increases in taxes or rental income. That is to say, I'm making a profit of 4.8k a year across 30 year by buying a house. I'f I take into account my net cost, including rent savings, I'll be paying $270k across 30 year.

$270k across 30 years for a property valued at $650k. That's 270k compounded at 3% annually.

The opportunity cost would be investing 9k monthly in something that would return 3%.

Again, this does not take into account rising rent prices for me as a renter, and rising rental income. (I guess I could build a model to calculate this)

Now this calculation assumes I'd live there for all 30 years. Realistically I'd move out after one or two years and have a 3rd person fill the void, in which case I'd be paying the exponentially increasing costs of housing, and 9k per annum into my property.

I was conservative with the gross income and would earn about 2.4k more irl. But, if I put half of this 2.4k safety net towards paying a master tenant that handled all the shit, I could avoid paying a rental management company. and I'll still end up more or less with an investment compounded at 3% over 30 years.

 

 

Comments (6)

 
Jan 11, 2021 - 8:03am

3% nominal is a pretty awful levered return. Looking only at IRR you should invest in almost anything else - public equities should at least double that unlevered.

You're also missing a ton of the analysis here - insurance, CapEx / maintenance, vacancy and churn costs since you won't have the same tenants for 30 years, etc. Many investors have to underwrite aggressive rent growth or appreciation to get the numbers to pencil out - this has been successful in the declining interest rate environment of the past 30 years but as always is uncertain going forward. 
 

 

For what it's worth, I'll likely own investment property throughout my life but never plan to own my primary home. This may make sense if you want the mindset of owning or if you want to knock out your first deal in the hopes that you learn a lot and can make better returns going forward, but the answer to your question about 3% is that no, I would not be happy with a highly-concetrated levered investment returning 3%

 
Jan 11, 2021 - 3:57pm

Your analysis seems a little flawed.  most glaring is that you say you'll only pay 13K a year in rent.  I'm guessing that's not for a 3br, 2ba house because renting that large of a house would probably be over $3k a month based on the $650,000k purchase price. so from the start you're not comparing apple to apples.  Also, are you going to rent bedrooms in your home to strangers?  that would get old really quick.  but say you move out and rent it to a family.  you could probably charge them $3-$4k a month to rent the whole house.      

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