Am I Nuts? - Does This Sound Right? - Posted by JohnMI
Posted by JohnMI on October 03, 2000 at 23:49:53:
OK…Please Help…Need Honest Opinions (and open minds)…
DISCLAIMER: I realize that this site is dedicated to “creative” real estate deals. I have found it extremely difficult to find deals (sellers) that would allow for a “crestive” purchase option. Now, I know that you are going to say “keep looking” and “dig deeper” etc… and I respect that opinion -but- here is my problem with that advice:
Just assume the following is true (I will tell you why in a sec):
Assume: My area is currently an adverse environment for “creative” deals. Lets assume that I will continue to run into “roadblocks” finding the “creative” candidate. I am not saying that a creative deal dosen’t come about here, but what to do while looking for the needle in the haystack (please don’t come back with “keep looking”…too simple…I am in need of some deeper analysis here and have the looking part very much covered).
Ok: So lets say I have looked extensively and come up with nothing. (This actually fact and currently happening) and I meet up with a realtor/investor/mortgage broker who knows a mutual aquaintance and he says he will show me his theory on how to make money in todays market. I will share this “theory” with you now and request your analysis of the factors. But before I share the actual figures, here is a Q & A session we had:
Q: Shouldn’t I find a deal that lends itself to creative financing, etc… I can’t seem to find one in this market?
A: You could, but if you follow my reasoning, it may makes more sense to not search forever for the elusive deal (and wind up never starting) and work with the current market conditions by making the numbers work.
Q: How do I make money in real estate in our local market?
A: By buying “typical” 3-4 bedroom, family homes in predictible, good areas, with good schools, that fit the “standard” appreciation profile (I will detail this in a minute), THEN lease optioning those homes shooting for a break even or positive cash flow, benefiting from depreciation, tax breaks on interest, mortgage paydown, BUT MOST IMPORTANTLY, appreciation.
Q: Ok, show me the figures:
A: (here is the detail)
Purchase Price: $ 200,000.00
Down Payment: 0 - 20% (could get 100%LTV 10%Int)
Assume: 10% Down (20k) Conventional
Assume: Break Even Cash Flow (or better if possible)
Lease Option and rent at break even (market rent)rates.
Assume: Renter takes care of all maint. (they are buying after all).
Here is the key argument:
Assuming a 5% annual appreciation - your “REAL” money is made (in terms of ROI) on the appreciation portion NOT on the others (cashflow, mortgage paydown, depr, etc). and here is why.
$ 200k property after 1 year.
Appreciation: ($200,000 * 1.05) = $210k or $10k or 50% ROI
Taxes = $ 1800 writeoff or 7% ROI
Cash Flow: 0 or 0% ROI
Mortgage Paydown: $1440 or 7% ROI
Add them up: $13,240 actual return and 64% ROI !!!
Even if the cash flow, depreciation, or tax numbers change for the worse, their gravity is not enough to make the really big difference. The appreciation is the key.
I.E. Worse Scenario:
$ 200k property after 1 year.
Appreciation: ($200,000 * 1.025) = $205k or $5k or 25% ROI
Taxes = $ 0 writeoff or 0% ROI
Cash Flow: 0 or 0% ROI
Mortgage Paydown: Approx $1440 or 7% ROI
Add it Up: $ 6440 k actual or 32% ROI!
And this is not including any Depreciation expense.
See, you are getting appreciation on the much larger ($200 price of the home) and there is the real leverage.
If I did this using $0 down financing @ 10% yes I might be looking at a negative cash flow but the return on my appreciation would then be almost infinity becasue I had no money in except for the negative amount monthly for the year. i.e. $2400 negative is -12% ROI BUT - I put no money down so my return on appreciation only (at 5%) would be unmeasurable and not including expenses for the loss, depreciation, and the mortgage paydown.
So tell me…what is wrong? Thanks…I know it was LONG…