Success in real estate does not require securing “great deals.” It requires great fundamentals: location, a reliable tenant segment, and properties that attract those tenants.
A Personal Case Study
Let me share my own experience. In 2016, my partner and I bought a three-bedroom, two-bathroom, one-story townhome. We paid the asking price of $180,000, which was then the fair market value.
The initial cash flow was ~$50/month, something our clients would not consider then. However, we believed in the potential of the Las Vegas market, so we did not mind the minimal beginning cash flow.
Four years later, the property was cash flowing more than $400/month, and its value increased to $280,000. We refinanced the townhome, took $60,000 out, and used the cash to put down on another townhome for $265,000. Again, we paid the market value for the second townhome, and its initial cash flow was ~$50/month.
Today, the first townhome is worth $380,000, and the second is worth $350,000. The total cash we invested in these two properties was $45,000 for 25% down on the first townhome, $10,000 for renovating the first townhome, and $15,000 for renovating the second townhome, which equals $70,000. Today’s combined cash flow for these two properties is $1,000/month. The combined equity is over $360,000, which is not bad for $70,000.
Be Sure to Consider Inflation in Your Calculations
If you invest in a good location, all but the most serious mistakes will be corrected through property appreciation and rent increases. I define a good location as one where rents outpace inflation. If you invest in any location where rents do not outpace inflation, your only option is to sell the property and repurchase in a good location.
Suppose you invest in a location where rents are static or rise slowly (as in most cities). For this example, I will assume rents increase by 2%/year and inflation is 5%/year.
Here are the rent and purchasing power in years five, 10, and 15. I will assume a starting rent of $1,000/month:
- Today: Rent: $1,000. Purchasing power: $1,000
- Year five: Rent: $1,000 x (1 + 2%)^5 ? $1,104. Purchasing power: $1,000 x (1 + 2%)^5 / (1 + 5%)^5 ? $865.
- Year 10: Rent: $1,000 x (1 + 2%)^10 ? $1,219. Purchasing power: $1,000 x (1 + 2%)^10 / (1 + 5%)^10 ? $748
- Year 15: $1,000 x (1 + 2%)^15 ? $1,346. Purchasing power: $1,000 x (1 + 2%)^15 / (1 + 5%)^15 ? $647
So even though the rent increases yearly, the amount of goods and services you can buy is decreasing because it is not rising faster than inflation. It does not matter if you bought the property for a “great deal”; after inflation, your monthly cash flow decreases each year, and so does your equity.
Suppose you invest in a location where rents increase 8%/year, and inflation is 5%/year. Here is the rent and purchasing power in years five, 10, and 15, in today’s dollars. I will assume a starting rent of $1,000/month.
- Today: Rent: $1,000. Purchasing power: $1,000
- Year five: Rent: $1,000 x (1 + 8%)^5 ? $1,469. Purchasing power: $1,000 x (1 + 8%)^5 / (1 + 5%)^5 ? $1,151.
- Year 10: Rent: $1,000 x (1 + 8%)^10 ? $2,159. Purchasing power: $1,000 x (1 + 8%)^10 / (1 + 5%)^10 ? $1,325.
- Year 15: $1,000 x (1 + 8%)^15 ? $3,172. Purchasing power: $1,000 x (1 + 8%)^15 / (1 + 5%)^15 ? $1,526.
So even if you overpaid for a property in a location where rents increase faster than inflation, it is only a matter of time before your investment performs well and will continue to improve.
If you buy in a location where rents rise slower than inflation, no matter how good the deal is, your purchasing power and the amount of goods and services you can buy will continuously decline.
The Bottom Line
How good a deal you get is far less important than buying in a location where rents increase faster than inflation. You will likely own the property for the rest of your life, so how the property performs over the hold period is far more important than the initial purchase.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
