7 Ways Real Estate Generates Wealth - Part 1
Many of us invest in the stock market through pension plans, personal RRSP’s or our personal investment accounts. When we read about the return on real estate versus other investment types, the numbers can be misleading when you are looking at annual returns in a yearly comparison just based on growth.
Market growth is just one aspect of real estate investing!
Let’s jump right into the first three ways real estate generates wealth with an example that compares investing $100,000 in the stock market versus investing $100,000 in real estate.
Invest $100,000: Stock Market
Assumptions:
1. Since 1957, which was the year the S&P increased to include 500 companies, the average annual return including dividends has been 8%.
2. Hold period: 5 Years
Investment: $100,000
5 year profit: $47,000
5 year ROI: 47%
Invest $100,000: Real Estate
Price: $509,000
Main floor rent: $2,000
Basement apt. rent: $1,100
Location: Edmonton, Alberta
Assumptions:
1. Average annual Canadian home price increase over 15 years = 6.5% (Will use a very conservative percentage increase of 2%)
2. Mortgage rate: very conservative 2%
3. Annual expense increase: 2.5%
4. Annual rent increase: 2.5%
5. Hold Period: 5 Years
Wealth Creation Stream #1: Cash Flow
Cash flow is the money left from rental income after all expenses are paid. Each month a renter will pay rent and the money left after paying for insurance, repairs, property taxes, mortgage payment, etc. is what is referred to as cash flow. Often cash flow will increase over time as you pay down your mortgage and increase appreciation which makes it a perfect investment for retirement. It is almost like a savings plan with a higher yield as time goes by.
Our Example – Cash Flow Calculation
Monthly Cash Flow:
Rent: $3,100
Mortgage: -$1,477
Property tax: -$246
Insurance: -$200
Vacancy & Maintenance expense: -$310
Utilities: -$350
Monthly Cash Flow: = $517
After 5 years, with an increase in rent and expenses of 2.5% per year, there will be a total profit of $27,041 from cash flow
Wealth Creation Stream #2: Appreciation
Appreciation (or equity) is the amount that your property increases in value over time. One of the benefits of real estate is that there is less volatility in the market as compared to the stock market so you do not see the big swings in value and real estate does not go to $0 as a stock can.
Our Example: Appreciation
Year 1: $10,000
Year 2: $10,200
Year 3: $10,404
Year 4: $10,612
Year 5: $10,824 5 yr.
Appreciation: $52,040
Wealth Creation Stream #3: Loan Pay Down
Loan pay down is the amount of the principle paid off the mortgage by rent each month. The loan pay down, on the money given to you to invest by the bank is done by your tenant!
Invest $100,000 in Real Estate Summary
Cash flow: $27,041
Appreciation: $52,040
Loan Pay Down: $51,183
Total 5 yr. Profit: $130,264
Original Investment: $100,000
5 year ROI: 130.26%
Annualized Return: 26.05%
In the above example we used only 3 of the 7 ways real estate brings wealth! Stay tuned for Part 2 - How Real Estate Generates Wealth where I will review the four lesser know wealth generators. If you would like a full copy of the report, email me at scott@sikproperty.com.