If 20% down for an Investment Property, is REI really worth it?

Question

Hi been studying RE as an investment option and trying to figure out the numbers. Could someone check with my numbers to see whether I'm thinking about REI correctly? I can't seem a large benefit of REI in a case where you have to put 20% down in an average market.

Ex:

20% on $500k move-in ready duplex where about $1k cash flow (ideal scenario)

Assumptions - 6% housing appreciation, Stock 6% appreciation (conservative estimates)

Profit

• - House appreciation 6%/year
• - Mortgage paydown and it's 6% appreciation/year
• - Cashflow invested back into mortgage paydown
• +/- tax deductions

Expense

• - interest payment, taxes, home insurance, maintenance ~ roughly 1k a/f deduction (conservative est, probably alot more)

VS

Opportunity Cost- Down payment 20% = 100k in mutual fund 6% return/yr- $1k/month expenses that could be contributed to mutual fund

Yes there are still alot of variables

- housing and stock appreciation/return will vary depending on location/time/stock
- did not exactly calculate out the tax deductions / expenses but made a conservative estimate in favor of REI
- did not include time and fees dealing with REI transactions vs just working a few more hours at my job

What i'm seeing is that in a scenario where someone will not be building sweat equity or finding a crazy discounted deal on a property and going through a conventional 20% in an "average market", the argument doesn't seem as strong for REI vs mutual funds/stock - they seem to be pretty close if you take into account the variables mentioned above. However, I can see it being a fair investment if you wanted to replace your income and slowly retire from working.

I know this forum is mostly filled with REI enthusiast but I wanted to find a realistic picture of REI for the average person in an average market who will not be fixing up any houses.

Evan Polaski · Answer

@Jung Kim, I am having a bit of trouble following the logic here, but I there there are some misalignment of analysis.

First of all your analysis isn't adding in the $100k initial equity in the deal.  At end of year 1, your analysis makes it look like you only have $32k of equity, but you actually have $132k.  So by year 5, you actually have 283k of equity. Yr 10 525k vs 368, etc.

But I also think you have a lot of misaligned assumptions.  You say you have $1k/mo expenses that could be contributed back.  But that assumption, implies that the rental property you are buying is actually negative cash flow, which is not what people are looking for (unless there is far larger appreciation component than you are giving credit for).

So, assuming you actually have a property that is cash flow positive, even if only $100/month, you need to take the $1k/mo out of the mutual fund side.  And when you do that, not only were you already ahead on the real estate side, but you become much, much further ahead.  I.e. let's take out the $60k of additional money you pushed into the mutual fund over 5 yrs (not accounting for the compounding return on it) and your mutual fund at year 5 is at about $150k vs RE at $283 (when you add in your initial equity that is not currently represented in your numbers).

Joe Villeneuve · Answer

Your entire analysis/comparison is wrong.  First, percentages lie...especially when you compare them to the Stock Market.

I can show you where a 15% yearly return in the Stock market, is blown away by a 5% return in REI.  You can't compare the two.  They are in no way similar types of investments.  For one thing, when you pay $20k for a stock, you get $20k worth of stock.  When you pay $20k for REI, you get $100k worth in RE.

Also, taking your cash flow and putting it back into the RE to pay down the mortgage is costing you money...not saving you money.  This is in no way the same thing as buying more stock.  You already have the tenant paying your mortgage for you...why would you help them, and add to the cost of the RE?  If you want to reinvest your CF, fine.  Buy more RE...don't give it back.

...and, taking all above and more into consideration, REI gives you an exponential return not found in the Stock Market.

REI blows away the Stock Market...and it's much safer.

Bill B. · Answer

Don’t forget. You’ve got some bad math in the mutual fund where $100k becomes $211k at 6% and $220k at 8% in 5 years. Those are both more than a 14% return.

It’s easy math. If you put down 20% and get 6% appreciation on the property. And you had zero cashflow. You’d still have a 30% return on your downpayment the first year and more every year after that.

Now you see why the math is so good. You did the right thing asking but it looks like you out alot of work in to it.

GL with your real estate investment.

David M. · Answer

@Jung Kim

I second what's been said.  You haven't setup the comparison right and really aren't taking into account the power of leverage.

Bradley Pitts · Answer

Kinda along the lines of what Joe said - the biggest benefit to REI is that you can keep your equity lower than other investment options. That's why investing 5% in an owner-occupied home is such an awesome deal (even with slightly higher interest, PMI).

As you amortize this debt over time, this seriously hurts your return compared to a normal investment in the stock market, because your equity % is going higher and higher. IMO this is a big reason cash out refi's over time are important to keep your return high. That of course assumes you are able to reinvest that new cash outflow into more RE. And also assumes you are comfortable with perpetually living in the 20-30% equity range. I'm guessing many people are not comfortable with that.

Obviously there are other ancillary benefits too. Taxes of course. The fact that REI produces both rental income while also appreciating. I suppose that's equivalent to a dividend yielding stock, so maybe not a huge incremental benefit to RE.

Doug Spence · Answer

This is why you have to find off-market deals for well below market value, add value to the property via rehab, and then cash out refi into a long term fixed rate mortgage. Check out David Greene's "BRRRR" book for more info on my second favorite real estate investing strategy (VA loan house hack is my favorite!)

If 20% down for an Investment Property, is REI really worth it?

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