Copyright © 2008 Lex Levinrad
After seeing the stock market and real estate market decline so significantly in the past year, many investors are wondering whether now is a better time to buy stocks or invest in real estate and which would be a better investment.
Consider the following facts about a recent rental house purchase which was purchased a few weeks ago. The house in question was purchased in Port St Lucie, Florida and was a bank owned REO property which was purchased directly from the bank.
Purchase Price $47,500
Monthly Rental $800
Annual Rental Income $9,600
Less Annual Insurance $1,045
Less Property Taxes $1,300
Less Vacancies $800
Less Repairs $800
Net Annual Income (NOI) $5,655
Cash on Cash Return 11.9%
If we assume that the property is vacant 1 month out of every twelve and that we spend another 1 months rent on repairs, we would still net a very healthy 11.9% return. Where else can you get almost 12% on your money with very little risk? This house previously sold for almost $200,000 and buying it at less than ¼ of that price has obviously significantly reduced the downside risk.
The current market value of this property is around $77,000. So while this investment yields a current yield of 11.9% I have the added luxury of knowing that there is around $30,000 worth of equity in this property. And considering that most rental property in Florida sells at around 140 times rent, the fair market value for this property is probably somewhere around $112,000. That is how much I would sell this property for if I were to sell it to a rent to own buyer with an FHA mortgage.
Zillow estimates the value of the property at $124,000. The insurance company has the property estimated at $125 per square foot replacement cost. Since the property is 1,176 square feet that puts the valuation at $147,000. I think the property is worth around $77,000. The fact that properties are selling at such a discount to replacement cost should be a huge red flag. That is the builders way of letting you know that you should be buying real estate now. The real replacement cost is around $75 per square foot which would put the properties value at $88,200 which is probably fairly accurate. However this is the value if the house was constructed new and without the land. The lot is worth $25,000 so the house built new would cost around $113,200 to build. Existing homes need to be depreciated since obviously they are worth less than new homes so the $77,000 to $88,000 is probably a healthy range for what the house is really worth. If we are conservative and assume $77,000 that is still a definite $30,000 in equity.
At a purchase price of $47,000 that represents 63.82% return on my money when I purchase ($30,000/$47,000). In addition to this $30,000 in instant equity I also receive almost 12% annually as mentioned previously. And this is all without utilizing any leverage whatsoever.
Imagine what the return would be if I borrowed 90% of the purchase price ($42,750) at 7% on a 30 year fixed mortgage. My monthly payment would then be $281.09 for both principal and interest which adds up to a total of $3,373.08 for the year.
If I deduct this $3,373.08 from the $5,655 net operating income above then I would be left with a net annual income of $2,281.92. Consider that if you put down 10% ($4,750) that would work out to be a “cash on cash” return of 48%. Where else can you get this kind of return?
There is no other investment that can do this with any certainty.
Investing this same $47,000 into stocks would be an absurd way to invest your retirement money. I should know. I spent fifteen years as a stockbroker and money manager before becoming a distressed real estate investor. And I am here to tell you what many other real estate investors and landlords like me already know. The best place to invest is in single family rental properties. That is what I do with my money and I highly recommend that you do the same with yours.
Unless your name ends in Buffet or Soros you are much better off investing in rental properties than you are investing in the stock market. Investing is about getting as much cash flow or yield as possible, without risking your nest egg and doing so in the most secure way.
Anything else is not investing. It is speculating. And speculating is anyone’s guess. If you are looking for a sure thing then you should go out and find a single family rental house that is way below current market value and you should rent it out. If you want to speculate then you should go to Vegas.