Quote from @John Carbone:
Quote from @Joe Villeneuve:
Quote from @John Carbone:
Quote from @James Hamling:
Quote from @Michael Wooldridge:
Quote from @John Carbone:
The problem with equity is you can’t force overall markets to go higher. You can somewhat control cash flow. For example, someone with a 350k investment that nets them 75k a year. After 10 years even if real estate is flat at 350k, they still have earned 750k over the 10 year period. Equity is just gravy, but should not be factored in when purchasing properties, especially at these prices.
Well technically the renter is paying down your principal which means you shouldn't' be flat - ever really.
And realistically most houses/properties always appreciate over a 10-15 year margin. But I do think it's tough to chase equity (i.e. hard to truly predict the big growth otherwise would have had a lot more boomers who held on to shore houses in the northeast) but it's probably fair to say it should be factored in.
Talk to a home flipper, all we do is not only build equity, but build it at net positive rates of return. We have to build equity to cover our costs of building that equity AND additional equity to cover all transactional, operational and profits.
Or, how about any syndicator out there doing value-add deals? That is also creating equity.
Or, or, or.... Equity creating is a component of many strategies, many. It is not only possible but common. Not easy, and results will vary wildly, not all have equal talent for certain results.
@Joe Villeneuve is spot-on in sharing the relationship of CF and equitable returns, and that equity is what makes wealth.
Any asking how to start, how to best get from start too financial freedom, how to build a portfolio, the #1 importance to learn is this fundamental and how Pyramiding works.
Obviously adding value to a property can increase the “value”, but speaking from a turn key pov, once you max out the usefulness of the property you are letting interest rates dictate the value. I don’t calculate my property value based off of what an appraiser will give it, I base it off of what my asset returns to me. This is a wildly different number than what a bank will say it is worth. CASH FLOW allows me to not care about interest rates and the negative impact on the “home equity”.
This is very true, but CF returns will always be far less than equity returns (I'm assuming a property that is actually getting equity returns). You should never have one without the other. If you look at the math, the most important formula is how long it takes the REI to recover their cost...the DP,...in CASH, from the CF.
Let's say it takes 8 years for this to happen, and the DP was $40k. That's a $200k PV at the start. If the property appreciated 4% over the that same 8 year period, the PV would then be $273k plus. That's an increase of $73k in Equity/PV, where as the cumulative CF over that same 8 years = only $50k.
Now, if you have both in that property, the once the cumulative CF = the DP, the property is now free to the REI, and when sold, the total equity is all profit (since the DP bought the initial equity, but the CF recovered it). This is also when the property is at its maximum value, and should be sold, or the REI will start losing money exponentially. The greater the appreciation, the more money is lost...if not sold.
I agree that the time to recover the cost is the most important component to the formula. I don’t follow on selling though. Maybe the way I look at it is a little different than you. So I’m into a rehabbed property for 350k (200k cash down) and it returns me a net profit of 70k a year. Break even is sub 3 years, and 5 years free and clear, with an annual dividend thereafter of 70k once paid off. If I get an appraisal at 400k why would I sell when I’m getting 70k a year. This is a 20 percent return on a 350k investment. The “equity” component is meaningless to me since most of my formula comes from cash flow, not equity. Maybe the smart thing is to cash out refi up to 80 percent at that point, if there is a need/to create interest expense for tax deductions, but I don’t understand why I would sell. My whole philosophy is to buy and never sell. What am I missing?
What are you missing? Mega bucks. Here's why:
1 - You don't own the equity...the property does, and you own the property. Not the same thing. The equity is actually what you are paying for this property. The fact that equity gained from appreciation is free to you just means you have a partner (the economy) as a form of a cash partner.
2 - The value of your equity isn't the face value of the equity...it's what that number is buying you in the form of property value...AND cash flow.
3 - The true asset you own is NOT the property...it's the cash in the property.
4 - Cash flow and equity are both forms of cash. One is liquid and real, and the other is frozen and virtual. Until you can "melt" the frozen asset (equity) is has no actual use/value to you. It's a trophy. The only/best way to "melt" it, is to sell the vehicle your equity is riding...the property.
...Now here comes the fun part,...
the math...
5 - When you buy the property, that DP is actually the initial equity that you are paying for. If it's a 20% DP, that means you are getting a PV of 5 times what you're paying for the property. Also, as long as you have positive CF, that is ALL you are paying for the property.
6 - As your property appreciates, thank-you economy, the equity increases equally...dollar for dollar. This means, if your $100k property (that you paid $20k for) gains $20k in value, the PV now equals $120k...and the equity jumps up to $40k. Sounds great, and it is,...but you lost money. Here's why.
7 - When you buy the property (see #5 above), you are getting a PV of 5 times what you paid for it. When that property went up to $120k (see #6 above), that now $40k in equity is only buying a $120k property. Only you say? Yes, the equity is now only buying a property 3 times it's face value...cost.
8 - Now, if you sell the property, and move that equity forward, it once again has a buying power of 5 to 1, which translates to a new PV of $200k...not just $120k. Oooops?!
9 - Also, since that $40k in equity represents twice the $20k you paid for original property, could you not buy 2 of that same property, and thus double the CF as well?
10 - Buy and Hold, in my book, doesn't mean hold the property...it means hold the equity,...just keep it moving forward from one property to another (or more). Same equity, just living in a different location as it moves.
The power of the growth in equity (from appreciation) isn't in it's face value, its face value, its in the power it has to to buy...not sit and die.
