Doubling equity to $1.8 million sounds great but you have to pick the right 10 years. Property doubles every ten years only when looked at a long time frame.
I had houses that tripled in 6 years and others that done squat for 10 years. Depends when in the cycle you buy.
Besides that $1.8 million ain't what it was 10 years ago. The true value is probably the same as $1 million was 10 years ago.
Its just sounds good.
Hi Evand,
Some good points, and I agree with the importance of timing the cycle.
But, to be clear, the example above was run with 3% annual growth in line with inflation. The portfolio of $2M didn't double, just the equity position assuming a 50% LVR.
But you're correct that the capital gain is all nominal. In real terms its zero as its tracking inflation. But the increased cash flow is real. The true benefit of the asset class is the ability to lock in debt at a point in time and have the asset hold its value in real terms whilst that debt depreciates in real terms. At the same time you've got a steady rental income in real terms which progressively turns more and more positive cash flow as your interest bill is also depreciating in real terms. Sorry if that's a bit technical for some, but its the gist of the value of buying an asset of this nature.
The bonus is you can buy quite a large asset and get significant financial returns given the amount of leverage that can be employed and the preferential taxation treatment of it. So for very little down, you get some very big growth. In the example above, that $2M is not cash. You could probably have put in 20% or $400K and borrowed the remaining $1.6M and still be neutrally geared. $800K return over 10 years on $400K invested is a pretty good outcome and more than beats the inflation rate of return.
So long as it is neutrally geared or better then someone else is funding your asset's interest obligations and you get to pocket the leveraged capital gains even if they're just inflation rate.
So, if you can invest $400K today and get zero income off it (as its all reinvested in servicing interest assuming neutral gearing), but can be pretty sure it will grow to be worth $1.2M in 10 years, would that be a good investment? Thats an IRR of about 15%, or a total return of 292% over 10 years on the equity invested. And by year 5, the incremental rental income on that $2M investment achieved through inflation and cash flow positive is worth about 5% pa on the initial $400K equity. So by year 5 your getting 5% return as cash flow on your initial equity and growing so the cash flow opportunity cost of investing is offset.
All a bit technical, but again, its leverage that delivers the stellar returns of this asset class. And I'm not talking 100% leverage. Above I've assumed neutral and $400K hard won cash invested at 80% LVR.
Just to be pedantic, the interest on that $1.6M loan at even 7.5% interest rates would be $120K pa and and a touch negative given the touted $100K pa rental income assuming a 5% yield. By year 5 this is neutral when the rent rises by the $20K I mentioned above. That's why I advocate 20% odd deposits when building the portfolio as it gives you a nice servicability picture whilst also giving you a good whack of leverage so you can benefit from the inflation rate growth of the capital value. In time, that LVR improves and with it your cash flows. You can also get some good non cash deductions such as depreciation and use the negative gearing cash back against your salaried income to supplement the servicability. So, the $20K shortfall might be a lot less than this.
Again, sorry of too technical, but understanding this stuff is at the heart of succesful buy and hold resi property investing.
Cheers,
Michael
