I bought my first house in Boise, ID in 1985. It had a mother-in-law unit in the back. I thought “How great is this? My tenant can pay my mortgage (or at lease a big part of it). What could go wrong?” I was young, naive, and trusting. After a rew trash outs and middle-of-the-night move outs, I learned a few lessons.
Several years went by. I kept that house and moved to Bend,OR. I bought a house to live in. Then bought another rental house in Bend using savings for down payment. Now I had 3 houses — 2 in Bend and the one in Boise — and was feeling like a true real estate investor.
In the late 1980s real estate in Bend was appreciating at the rate of 18% per year. Pretty unsustainable. The Californians were escaping and coming north and overpaying. I’m lying in bed in Bend, OR saying to myself “I am making a killing here, but how?” It took me two weeks working it out in my head. Once I did, I was all in on real estate. All in!
Other People’s Money. Does anyone remember that movie with Danny DeVito? That’s how I made it. Let me explain how.
While lying in bed I crafted up some simple numbers to build my model around. Assume I buy a $100,000 house and put $10,000 down. I have a $90,000 mortgage. I am leveraged with OPM 10:1, right? In one year my Bend house goes from $100,000 to $118,000. Suppose I sell it after one year. (Highly NOT recommended!) And further suppose there are no closing costs or transaction costs. (I wish.) I sell my house for $118,000, payoff the mortgage, and walk away with…what? $28,000? That can’t be right. Let me check the numbers.
I went back and checked, and they were all accurate. So you’re telling me in that scenario that after one year, you get your $10,000 down payment back PLUS an additional $18,000? Yep. That is nuts. Sheer nuts.
“Yeah”, you say, “but 18% appreciation is unsustainable, plus the transaction costs eat at your profits.” Guilty as charged. But when you have 180% ROI (10:1 leverage times the market appreciation), you can afford to give up a little!
A Real Example
Fine, let’s work it with some “real” numbers. Suppose the market appreciates 6%/year. That’s reasonable. You buy a $100,000 condo, put 10% down, and take a $90,000 mortgage. After 5 years you sell it. Assume transaction costs, PMI, and all that crap eat into your profits to the tune of 10%, or $10,000.
In 5 years your house would sell for $135,000. Take out the transaction costs and you are left with your original $10,000 plus another $15,000 in profit. That is 150% return on investment (ROI) in 5 years, for an average of 30%/year…sustained over 5 years!
You’ll never get that in the stock market. Not without taking a ton of risk playing penny stocks. Yes, you have real estate taxes, insurance, and maintenance. You also have rent we didn’t factor into.
Once I had that figured out, lying in bed in Bend, OR, I was all in, baby. I figured there is no other investment that can produce anywhere near those kinds of returns. Of course, it is mostly long term — not “quick cash”. It is the difference between making a living, and making a lifestyle!