In most instances, real estate increases in value over time. That makes it a great investment. But as you think about your “investment” consider that those who pay cash for their homes, which most people cannot do, realize the greatest return on their investment.
Let’s take a look at the value of a $100,000 home over a period of 15 Years. I use the 15 year mark because I’ve been converted from the 30-year mindset to the 15-year mindset. Thanks Dave!
In this model we’ll set a steady 5% annual rate of return. Take a look at the chart below as it illustrates the annual growth over the 15 year period.
When you’re done paying off the loan, assuming that the property values increase at a steady average, you should see results much like these, where your gain is approximately $98,000.00.
Comparing Cash Buyer to Mortgagor
Obviously the cash buyer’s return on investment is much greater because they have no interest payments, and they may even have residual rental income on top of the increase in value. This is what will put them ahead of inflation.
But what if you do have a mortgage? Let’s say you purchased a $100,000 home with 3.5% down and a 15-Year fixed note for $96,500 (there are also closing costs, but we’ll leave those out for this illustration). Below is a chart that shows you how much it will cost you to borrow that money:
As you can see, over the course of the loan, you will have paid $39,507.42 more for the home than the cash buyer. Subtract that from the increase in value over 15 years and you have a net gain of $58,485.74.
So, what in terms of rate of return is $58,485.74 over 15-Years on an original purchase price of $100,000.00? That’s a tricky equation, but it yields a rate of return of about 1.97% annually. Add inflation of about 3% – 4%, and you’re losing value.
However, after those 15 years, you now have a paid for home, and you can start using your income to reverse the process to enjoy years of compounding interest on your investments.
The bottom line is that in order to really realize the investment power of real estate, you need to pay cash for your home before throwing away years of interest payments to the bank.
That loss of $39,507.42 invested in growth stock mutual funds averaging 10 – 12% annually over a period of 15 years will grow exponentially.