Realty Insider Blog

If I had a million dollars sitting around, I would buy real estate. I would buy it with all of it. This may seem counter-intuitive with the current state of the real estate market. However, currently you would be able to get lots of units for a million dollars at a great discount from the market high.

For example, in Herndon Virginia, you can get a 3br/2ba foreclosed townhome for about $150,000 these days (if you are lucky, you may even get some 4 bedroom/3bath end units at that price.) Most of them need a little work to get them up to a rentable shape. On average, you would probably spend about $30,000 per unit. For that amount you can refurbish the kitchen and baths as well as repaint and re-floor everywhere.

Investor financing has gotten a bit harder over the last few years, so you will definitely need to have a 20% Downpayment on any property you purchase. For a $150,000 property you would therefore need another $30,000 per property. At a cash cost of $60,000 per property you would be able to buy about 16 properties (there are other loan qualification issues, but we'll assume those can be worked out.)

On average, these townhome properties would rent for $1,400 in today's market. If you look at a quick cash flow analysis, the properties would about break even from day one in the current market. That may not seem like such a great deal at first glance - a million dollar is a lot of money to tie up in an illiquid asset like real estate. Just breaking even wouldn't really make the endeavor worth the risk.

Just a few years ago, investors would have done anything to get their hands on a property breaking even on a cash-flow basis at 20% down. When the market was hot, speculation drove the prices sky high while rents remained pretty flat. So, since about 2001/2002 it has been nearly impossible to purchase an investment property breaking even on a cash-flow basis paying 20% down in the Northern Virginia area. Until now, that is.

The nice thing about real estate is something called leverage. Leverage allows you to buy with borrowed money and realizing the gain on the full amount (your down payment + the borrowed money.)

With federal spending on the rise, it is not unreasonable to assume that we will keep having inflation. We can further assume that you borrowed with a 30 year fixed loan at about 7%. Rents should increase with the rate of inflation (rents are actually a large part of some of the inflation indexes) while your mortgage amount and interest rate would remain the same.

So, let's assume an inflation of 5% per year and no appreciation in property value and see what happens over the next 10 years for the $1,000,000 investment in 16 properties:

 While you do get a theoretical return of 14.9% in the 10^th year, I doubt many investors would be happy with it taking 5 years before the return catches up with the assumed 5% inflation. Also, the 14.9% adjusted for the assumed inflation of 5% would be 9.9% - not too bad.  But when you account for the negative return the first few years and add in the whole money now versus sometime in the future thing, it doesn't seem that it would be wise to purchase these properties based on cash flow alone. There are obviously some tax write-off advantages, but we have partially accounted for those already.

So, for this to make sense, we will have to assume some appreciation. With the current market it is hard to think about prices going up again, but over the long term, real estate has appreciated by about 5% annually. Assuming that real estate will appreciate by 5% per year over the next 10 years (following inflation) we get something like:

Those returns look much better! Some may think that the return would be 5% per year like the inflation, but as you get the appreciation on 100% of the value and you put down only 20% as your investment, you get to keep the full appreciation. The numbers don't take into account the equity buildup as the 30year fixed mortgage is paid down over time (we just assumed that mortgage balance would remain the same.)

If we combine the equity buildup and the cash flow, we get your estimated return:

 Now, that's what I call an investment! Smart investors are doing this right now as we speak.