Recently someone in the office was debating about real estate investing, deciding whether or not to put an extra $20,000 towards their principle residence or invest it. This led to a couple of lengthy discussions about the benefits and drawbacks of each.
There were a few very good points brought up about real estate investing which led to a big question, so we wanted to share them with you.
1) Isn’t the ultimate goal to live a 'Rock Star' life? Doesn’t this mean that you have freedom to do what you want, when you want? If that is the case then isn’t a mortgage on your own home hindering you from doing that?
The thought process is that if you only had utility, property tax, and insurance bills to worry about to keep a roof over your head, you have the ability to be more flexible with your time. Yes, you still need money for other things like cars, groceries, leisure, etc. But the majority of those things are luxuries (of course food is not, but if you look at the amount of money spent on monthly groceries it probably pales in comparison to other bills).
If the amount of money you need for necessities every month drops substantially, doesn’t that change your life in a positive way? Let’s take a look at some typical numbers to get a better idea about real estate investing.
In total the expenses below add up to $2,210 of monthly payments.
If we get rid of the $1,700 we have dropped our expenses by a whopping 77%.
Now, in this simplistic view, you would only need $510/month to keep a roof over your head, or $6,120 a year.
Sounds good, right?
2) Another insightful observation about real estate investing was made while we were chatting. If the majority of the monthly mortgage payment is interest, which it was in this case, then wouldn’t decreasing the amount of money paid in interest every month be equivalent to producing an ROI on the money put towards the mortgage?
Normally, the decision is to pay down the mortgage and not to make investment income on that sum of money. Or, invest it and have money working for you. Let’s change that up a bit, let’s use some simple numbers to illustrate the point about real estate investing.
Monthly Mortgage Payment: $1,700
Monthly Interest Amount: $1,000
Monthly Principal Amount: $700
Let’s imagine that the $20,000 lump sum payment that we are discussing would change the amount of money paid towards interest by $85 per month immediately. The logic is that the mortgage amount is lower so the interest calculated every month would be lower as well.
Over the course of a year the $20,000 payment would save $1,020 in interest, which could be looked at 5.1% return on your investment. Better than most other fixed-term options (ex. GIC, Term Deposit). Plus it would continue to save you interest over the remainder of the mortgage, so you continue to get a good return on the money.
You could almost look at the savings as having a property with $85 in monthly cash flow.
But what about the other side? Is there any benefit to investing the money?
3) The first question of this conversation was, “What is the interest rate?”. The mortgage looking to be paid was a variable rate mortgage which is at about 1.6% currently. As an investor it can be tough to justify paying back money at such a low rate.
Essentially, you are ahead of the game if you are able to invest borrowed money and earn a greater rate of interest than you are paying.
But for the context of this decision about real estate investing, we are talking about living our 'Rock Star' life, not just making money, so it applies a bit differently. However, not taking advantage of historically low interest rates is still a very valid point about real estate investing.
Especially, if you believe that the effects of inflation are headed our way which means that we could pay back the mortgage with dollars that are worth less—but that’s a whole other story.
4) In this example about real estate investing, it is quite apparent that the average return on an investment property would far outweigh the savings of putting the money towards the mortgage. As educated investors, we won’t go through the detailed numbers but between the cash flow, mortgage pay down, and high probability of long term equity increase the financial benefit should easily be greater than the monthly interest savings of $85.
And although that $85 has added up over the remainder of the mortgage (20 years). If you were to rent a property for 20 years it should have about 80% of its worth in equity by that time which would be hundreds of thousands of dollars.
You could also use any monthly cash flow to pay down the mortgage which would be much more than $85 especially over the long run.
So it is easy to see the financial benefit of investing it is greater with two caveats:
This was a long discussion about real estate investing that really presented some good points for both options. It was the first time that we had it based on lifestyle and not strictly numbers, which is insightful in itself.
Too often we are only caught up in the pursuit of more money without stopping to think why we are after more.
If you take a minute to define the personal outcome you want, you may adjust your game plan.
Are you ready for the final decision?
No one solution about real estate investing won outright. The money was put towards the mortgage and borrowed on a HELOC to be invested.
Yes, the interest rate that it was borrowed at was a bit higher that the mortgage rate, but this arrangement satisfied the need for security and freedom while making additional income to reach those goals sooner.
The best solution to any decision we face about real estate investing is rarely a ‘one or the other’ question. Most often you will find the best alternative by combining parts of each possibility to create the ideal one.
It takes a bit of outside thinking but the most successful among us will always take that route. Financial decisions impact many parts of our lives but most often they are made with the financial end result as the sole factor.
Sometimes the real question about real estate investing is what you want your life to look like—not your bank account. This type of thinking will guide us towards what we really want in life, and it isn’t a whack load of cash, it never is. It is the result of what that cash can bring us.
The specific result about real estate investing is unique to each individual but obtaining the goal of “the result” is the same amongst us all. It doesn't matter if you want to provide health care in third world countries, backpack around the world, or own a 15,000 sq. foot home and ten cars, money is needed.
It is the alignment of these types of decisions with your lifestyle goals that will ultimately have the biggest impact on your life. And once they align we are given the biggest opportunity of all.
Then you can focus on what you GET to do instead of what you HAVE to do.
Visit our other site www.therealestaterenegades.com for more real estate investing articles.