The Most Critical Piece of Unlocking Sustainable Wealth
In today’s world many people think of real estate investing and their return on the investment as the actual purchase price of the real estate; it the property doubles in value than they believe they have only doubled their investment; simple math but not the real answer or the real return. It is not what you purchased the property for that is the most critical piece of unlocking sustainable wealth puzzle. It is the actual skin you have in the game; it is what you have earned on your original down payment or real cash outlay.
Understanding what your real return on your investment is one of the principles to Vault to Investment Real Estate Success.
For the Boomer Generation, those of born between 1946 and 1964 purchasing a home was almost a given; built into our DNA. For many of us, the municipal, state/provincial and federal governments used us to simulate the economy in the late 70s and early 80s through home purchases.
$180 Investment Turns Into $30,000 Return On Investment
My wife and I bought our first house, a brand new 4 level split with $180 out of our pocket. How could we buy a brand new home with $180? When we purchased our house, the Federal government gave us $500, and the provincial government gave us a $1000 as first time home buyers. We also qualified for a CHMC (Canadian Housing Mortgage Corporation) high ratio mortgage which meant our down payment was $1680 and with $1500 in government grants we only had to come up with $180. We sold it eight years later for double what we paid for it, $180 turned into over $30,000 return. Did we double our cash down payment investment; no we sold our home for twice as much as the total purchase price.
Our net profit after mortgage interest was in the neighbourhood of $25,000. You might be saying, “Lucky Break, Rick.”
The thinking is a lot of Boomers created most of our net worth by real estate appreciation. Today the world is a different place and even though the economic turndown in 2007 and 2008 most Boomers are still in good shape if you haven’t turned your home into an automated teller. Equity growth over time is always a pretty big deal, and even in today’s economy this is still possible; just not a Boomer thing.
If you buy investment real estate based on appreciation thinking you are still living in the 1970s or 1980s; then stop right here and don’t go any further. I would never tell you to buy real estate just based on the principle of appreciation; this would like having a one-legged stool and expecting it not to fall over eventually. The construction is flawed.
There are three types of real estate markets in the world:
- Just Right
You might think turning $180 investment into a $30,000 return was a one-time lucky break. There are markets out there that this can happen in; I don’t want you to build your investment real estate portfolio on this one component of investment real estate returns. Remember; I am suggesting long-term buy and hold strategy, and I will show you what to do with any significant windfalls in equity growth.
Keep reading, these windfalls happen more than you think and continue to happen now and on a daily basis to many real estate investors.
Three Main Components to Your Return Strategy, Investment Real Estate:
- Net Income from Revenue
- Principle Paydown
- Equity Growth
The Right Combination Order:
Should your investment real estate not have these three elements as part of your combination to unlocking sustainable wealth you will not be able to open your Vault to Real Estate Success. Many real estate investors don’t think the order of these three components to real estate investing is essential; I do.
I believe like the combination of a vault if you don’t have the combination numbers in the right order the vault will not open. If you follow the rule I am suggesting it will not matter if you purchase investment real estate in good times or bad times, you will succeed in building a strong foundation, unlocking sustainable wealth and creating a living legacy.
The three components of your combination placed in this order; first, is net income revenue. Drew Brees; Super Bowl XLIV MVP and Quarterback for the New Orleans Saints said’” You can’t go broke taking a profit.” Drew was referring to moving the ball forward down the field when you are on offence. This situation is also real in real estate investing.
According to Investopedia.com; “Net Income is calculated by taking revenues and adjusting for the cost of doing business, depreciation, interest, taxes and other expenses.” Net income is often referred to as “the bottom-line” since the net income is at the bottom of the income statement.
As a real estate investor, it is essential that principal pay-down is part of your net income statement for your purposes of covering all costs; your accountant will adjust your revenue statement for tax purposes and remove the principle pay-down before reporting your taxes.
Please don’t get caught up in the trap that rookie and even experienced real estate investors make and use principle pay-down as a disguise for a poor cash-flowing real estate investment.
If the revenue does not cover all expenses and I mean all costs including principal pay down, a contingency fund for vacancies and maintenance work, legal and accounting fees; don’t buy the property. Should you have to take money out of your pocket every month to cover any costs including principle pay-down or what you see as equity than you are just fooling yourself because capital can only be spent when a property is sold, or, you refinanced.
Remember refinancing comes with additional expenses including an interest expense.
If you can put positive cash-flow or a positive net income as your first element in your combination, the other two factors become icing on the cake, and they will taste great. You will never get in any trouble and will make sleep more comfortable by following this advice.
The best advice I received about adopting this philosophy was not to worry if you miss out on what you thought was a great deal because like catching a bus another one is just around the corner.
The second element in the right combination I would suggest is principle pay-down, and this one comes if you follow the first aspect of covering all costs plus contingency first.
In the beginning, when paying down the mortgage, the bank always takes their portion first and then gives you your share. You should be happy to have the bank as your partner. You put in 20% of purchase price, and the bank puts in 80%; positive cash-flow makes this all possible. Not only do you get to sleep easier; you are making money while you are sleeping; the bank as your tooth fairy who would have thought.
The last element is equity appreciation, and you can only access these funds if you sell the asset or refinance. We (this includes my real estate investments partners; my wife and joint venture associates) are all about long-term hold on all of our investment properties unless there are some unforeseen costs or changes in market conditions we did not see coming.
We will talk to you about refinancing equity appreciation or unexpected costs in future blog posts; equity appreciation will help grow your portfolio, and unexpected costs can create wealth reversal.
Let’s review one more time before we move on. Can you name my suggested order to the three income return components to investment real estate returns?