Is it a Good Deal? Analyze A Property Based on Principal Paydown

Is it a good deal? Have you ever asked yourself that question when you’re looking at a property?

There are four ways to make money from real estate: Cash Flow, Appreciation, Principal Paydown, and Tax Benefits. Understanding this will help you to determine whether or not a property is a good investment

This is part three of the four-part series on “Is It A Good Deal?”. In this article, we are going to utilize the Cash Flow Spreadsheet, which is displayed in Exhibit A, that we had previously created in the “Analyzing a Property Using Cashflow” article.

Exhibit A. Cash Flow Spreadsheet

In this example, we are going to analyze a house that we were potentially buying for $200,000, with a mortgage of $160,000, an interest rate of 3.5%, and total cash invested of $47,000.

So, how do you connect the information above to determining if a property is a good deal based on Principal Paydown?

First, you want to find a loan calculator spreadsheet template that allows you to figure out how much you are going to pay in the mortgage payment. Check out Exhibit B below.

Exhibit B. Mortgage Calculator

Next, there should be another tab, or a table on the same excel sheet, with the Mortgage Calculator that amortizes all the payments for you. Look at Exhibit C below.

Exhibit C. Amortization Table

Referring to Exhibit A, the property’s purchase price is $200,000. We are going to put 20% down payment with a loan of $160,000, which is payable in 30 years or 360 months at a 3.5% interest rate.

Then, let us look at how much principal is being paid down in the first year or the first 12 months. Each row on our table in Exhibit C represents a month. As indicated in Exhibit B, the monthly mortgage payment is $718.00/mo. Approximately $251.00+ of the monthly mortgage payment is going to pay the balance owed down, as indicated in Exhibit C. This is what we mean by principal paydown.

The entire $718.00 does not go to only the bank. Part of it is going to pay off your loan, and eventually, over the 360 months term, the loan will go down to zero.

The sum of the first 12 months in principal paydown is roughly $3071.00. How do we factor that into our return? We want to take that number and divide it by the cash invested, and we’ll get a percentage. The percentage, in this case, is 6.53%, which is our annual return on investment solely from principal paydown.

Now, if we get the total cash flow, and the principal paydown, our total return on this project is going to be 16.07%. Keep in mind, this does not include the potential increase in cash flow over time. This is just year one returns!

Cash flow should grow 3% annually (or at least keep up with inflation) on average over the long term. Taking the 3% growth into perpetuity, I can expect a total return of investment of about 19.07%, not including any appreciation that will happen.

Is it a good deal? In most cases a 19.07% return is amazing! Probably too amazing to be true. Just be sure to use the same approach to analyze a few more deals and compare.