Leveraged Rate of Return Says It All

In the past 20 years, residential income properties have delivered the highest average total investment returns of all real estate types. With a built-in hedge against inflation, it is no wonder that multifamily real estate has out performed all other types of real estate investments with relatively low risk. Based on supply and demand over the next 10 years, residential income properties will outpace all other types of real estate investment. Strong demographic and financial indicators along, with changing lifestyles, should continue to positively influence residential income property investments.

Consider the facts:

  1. The average unleveraged rate of return for the past 20 years for residential income property has been approximately 10.2 percent.
  2. The leveraged rate of return for residential income property over the past 20 years has been approximately 20.4 percent.

The principle of the leveraged rate of return is the key to building wealth through real estate. Real estate is the only major investment that gives the investor the ability to acquire leveraged ownership with other people’s money (i.e. the bank’s money).

The degree of leverage is calculated by dividing the total purchase price of a property by the amount of funds used to purchase it. For example, if a down payment of $10,000 plus a $90,000 loan is used to purchase a property, a 10 to 1 leverage ratio has been achieved. The greater the leverage, the more equity will increase with the appreciation of the property. The effects of leveraged rate of return can be overwhelming, and sometimes even shocking, to the entry level real estate investor.

Real Estate Investments vs. Traditional Investments

Compare a traditional 401(k) investment to a real estate investment; if an individual invests $50,000 in a 401(k), and the 401(k) sees an appreciation rate of 20 percent, it would take 42 months (3.5 years) for the investor to double his or her money. Let’s look at the same investment in a residential income property assuming the same rate of return: If that $50,000 is used as a down payment on a $500,000 investment property, it would take only 6 months for the investor to double his or her money. In fact, the $50,000 real estate investment would quadruple in 16 months at a 10 to 1 ratio with 20 percent appreciation. This is the reason leveraging and the leveraged rate of return is the key to building wealth.

While exploring the option of investing in real estate versus other traditional investments, one should ask him or herself when the last time was that he or she saw a 20 percent rate of return on a 401(k) (or any other non-real estate investment for that matter). For most, the answer is either “never” or “not lately.” According to DataQuick, a premier real estate tracking company, the year to year appreciation for real estate in San Mateo County was 20.4 percent in 2004, 17.6 in 2005 and 2.6 in 2005. According to the same source, Menlo Park saw a December 2006 to December 2007 appreciation of 19.95 percent and Redwood City showed a 10.93 percent increase year to year. These are the specific Bay Area markets that Menlo Gate, LLC will target for its real estate investments.

Moreover, the investor has to seriously consider when was the last time that they ever saw a 20 percent rate of return on their 401(k) or any other non-real estate investment for that matter. For most, the answer is either “never” or “not lately.” On the other hand, real estate investments have seen 20 percent appreciation for multiple years in the last decade. For example, the year to year appreciation for real estate in San Mateo County according to DataQuick, a premier real estate tracking company, was 20.4 percent in 2004, 17.6 in 2005, and 2.6 in 2006.

The Outlook for Real Estate Investing on the Mid-Peninsula Remains Strong

The reason for the strong appreciation in these markets is the age-old adage of “location, location, location According to San Mateo County Association of REALTORS® 2007 President Geoffrey Craighead, as far as San Mateo County properties are concerned, prices will continue to hold their own and will actually increase. “Home prices in other areas of the state may decrease, but not in San Mateo County because of its ideal location and the limited supply of homes in the area,” said Craighead.

Other experts agree. Despite what some analysts describe as a “cooling marketplace,” the San Francisco Bay Area continues to be a “star market,” and real estate here will continue to be “an asset which can build wealth for you and your family, depending upon how smart you play the market,” says real estate expert Carole Rodoni. Rodoni is president of Bamboo Consulting, former president and CEO of Alain Pinel Realtors, former president of Fox & Carskadon Realtors, and former COO of Cornish and Carey Real Estate. A highly regarded speaker, author and advisor in the Bay Area real estate industry, Rodoni has shared her experience and knowledge with Realtors, brokers and managers all over the Bay Area and the state.

The cooling of the housing market and slowdown in home sales, the volume of subprime loans and the resulting high rate in foreclosure notes are “worrisome,” says Rodoni, but she points out that the impact of these loans is spotty at best and depends on their location. She doubts subprime loans will negatively impact the Bay Area and the Mid-Peninsula. “We are not in a subprime market,” says Rodoni, noting that San Francisco’s share of subprime loans is 5 percent, San Mateo County’s is 5 percent, Contra Costa County’s is 7 percent, and Alameda County’s is, 6 percent. Compare these to Salinas’s 60 percent, and other areas including Fresno, Modesto, Stockton, between 18-20 percent.

Rodini describes the San Francisco region, which includes the Peninsula and much of the Bay Area, as a “star market” – unique in terms of location, assets and its economy. San Mateo County’s unemployment rate stands at 3.2 percent, far better than the national average of 4.9 percent. The Bay Area is home to seven million people and three million jobs. Land here is limited, which in turn, makes real estate a limited resource, and a “hard growth area” with residents who are not keen on new developments. It simply cannot be compared to other parts of the state or the rest of the country.

The Perfect Storm for Real Estate Investing

There is much talk being bandied about regarding the present state of the real estate market on the Mid-Peninsula. Experienced investors have learned a few things over the years about this type of market, and the cardinal rule of real estate investing remains, “buy low, sell high.”

We are currently seeing an increased supply of rental income property on the Mid-Peninsula. This amount of inventory leads to what experienced investors call a “buyer’s market.” A buyer’s market allows the investor to go into a potential deal with limited amount of competition. There are decreased numbers of multiple offers or offers “over asking,” allowing the investor to competitively bid the property, and in some circumstances, buy the property below market or below the asking price.

Further, interest rates are dropping. When low interest rates are combined with a buyer’s market, a perfect storm is created. The investor is able to capitalize on the low interest rates while at the same time purchasing the property at or below market. To boil it all down to brass tacks, now is the time to buy.