Rate of return on real estate equity is always zero.
In this episode, I'm going to answer the question,
"How to calculate return on real estate investments?"
Get ready because you're going to be blown away with some insights that maybe
you have never had before regarding real estate equity.
But I'm going to give some actual examples of how you can calculate your
true rate of return.
So, my name is Doug Andrew and I've been a financial strategist, a tax
minimization specialist for more than 46 years.
And I've written 11 books so far. I'm going to keep writing a book every year
the rest of my life is my goal. But many of my books address this very
topic. And so, when people come to me that have
acquired a lot of real estate and what have you,
they will ask well "How do I really calculate my rate of return?"
Now, I first say, "Are you talking about on your real estate or
real estate equity?" And they think sometimes
that's the same thing. No, it isn't. So, let's get
clear. The rate of return on real estate equity in my opinion is always the same.
Zero, nada, okay? Now, let me explain that and then I'll talk about how you really
calculate the rate of return on your real estate because the return
on the equity in the real estate is always zero.
Now, when you have equity that begins to
accrue in real estate or if you pay a big down payment or you take a lot
of cash from the former property and you put it into the new property, see,
most people think that you have to take the equity
out of your previous property and put it into the new one to
avoid paying a capital gain tax. No. The IRS has never required that. You
have to buy a like property of equal or greater
value. I've never taken one dime of equity from my former property
when I sold it and put it into the new property. I just bought a new property.
And I kept the equity safe liquid over here.
Now, when I say over here I'm talking about my right hand pocket, that's my
assets. Where do I keep my cash for liquidity,
for safety, for predictable rates of return
and tax-free? It's what I call my Laser Fund because
LASER is an acronym that stands for liquid assets
safely earning returns. And over the last 46 years, I have averaged 8.2% tax
free. The last 25 years has actually been as
high as 10.07%. We'll just use 8% in most of
my examples here. And so when I keep my money over here liquid
and safe compounding at 8% tax free
(and I've been doing that again for 46 years) and my real estate over here
I am using OPM, other people's money just like banks do
where I am borrowing money to buy the property.
And I pay a mortgage on that. And if it's
rental properties, real estate investments,
usually the interest rate is a little bit higher than my house. I can borrow on
my house right now with the recording of this video for 3%
tax deductibles and that cost of 2%. On
the rental properties, I may have to borrow at 6% but it's still tax
deductible. In a 33% tax bracket, it's only
costing me 4% after the deduction. Because
on a million dollars of real estate, if I owe a million dollars on a mortgage
at 6% interest, I'm deducting 60,000 of interest.
And in my tax bracket, I'm saving 33% of 60 grand or 20,000. So, the net cost
of a 6% deductible mortgage because I can deduct it on schedule or
the LLC's however i own the real estate is not
6, it's 4, okay? And I can earn 8. How much more is eight than 4?
It's 100% more. Every million, I pay 40,000
and I make 80,000. And that's just the first year.
If this keeps compounding, it gets better and better. This is a simple interest
formula. This is a compounding formula. But the very first year, again, it's like
I would very gladly pay an employee 40,000
that made me an extra 80,000.
I'd buy a widget machine for 40,000 made me an extra 80,000.
That's what you're doing. This is how money really
works. But if you sit there and you pay extra principal payments to the mortgage
company and you put all that money into the property
and it goes up or down in value, it will do that regardless of how much you owe
or how much equity you have. It has nothing to do with equity.
The rate of return on real estate equity is always
zero. Your house will go up or down regardless of whether it's mortgage to
the hill or free and clear is what I'm saying.
If you don't understand this concept, be sure and search on this YouTube channel
for me doing the picture and the goblet working
metaphor. And you'll understand it better. But let's move into
calculating the rate of return on the real estate investment
because the return on the equity in that property is always zero.
So, let's start with the simple way to calculate. Perhaps you can use the
rule of 72. If you don't understand that rule, if
you're wanting to see how uh long it will take
for your money to double, you have a lump sum of money, okay?
Let's say $100,000 and you are earning 8 or 9
percent or 5%. You divide that interest rate into the number 72 and it
tells you how many years it will take for your
money to double from 100,000 to
200,000. So at 8% interest 8 at 72,
it will double in 9 years. At 9% interest, it doubles in 8
years. At 7.2% interest, it
doubles in 10 years. At 10% interest, it doubles in
7.2 years, you got it? Well, when people would say to
me, "Hey, I bought a piece of real estate for $100,000
and I just sold it for $200,000.
I doubled my money." I'm not impressed until I know
what. Okay. "Did you leverage or did you pay cash?" If you paid cash
and you say, "Well, I held on to it for 10 years. I go 10 into 72
is an average of 7.2 percent return on your money, I'm not that impressed.
I don't care if you doubled your money. If it took 10 years.
10 into 72 means you only got the equipment of 7.2%
rate of return or appreciation. So, you can use rule of 72 to calculate
sort of what your rate of return is on a simplified basis.
Or you can use a calculator based upon if you haven't doubled your money yet
what the rate of return is. But one of the examples I want to
use is a story of a couple in Palo Alto, California. And
if you do own real estate, you know and one of
the secrets is location, location, location. So,
listen to this story and learn from what they learned by having all this
equity tied up in their property. This couple 40 years earlier
bought a six-bedroom home that they raised their
6 children in and they bought it for like $230,000.
And they had continued to make improvements and so forth. But
over 40 years, that house kept increasing in value. Now, in the San Francisco bay
area, real estate is wack. So, let me explain. When they retired and
were empty nesters, that 5-bedroom home
was worth 4.8 million dollars. Okay? Now, at 4.8 million, they
were thinking about renting it for a while.
And so they rented it for $10,000 a month. And they were at first going,
"Look at us. We are renting this for 10,000 bucks
a month." Now, some people gasp but when I say that. But
that's very typical in San Francisco bay area especially for a 5-bedroom home.
That is pathetic. Why? We showed this couple that there are
5 bedroom homes all over in America like Memphis,
Tennessee or Orlando Florida that cost $300,000
same size home, newer homes and they rent for 1%
of the value of the home a month. Okay? They rent for 3,000 a month.
That's worth 300,000. It rents for 3 000 a month. Now, when
you do the math, that's 36,000 a year.
It's an annual return of 12%, okay? It's 1% a month. This
couple in California renting out their house for 10 grand?
10 grand times twelve months is 120,000
on a 4.8 million-dollar asset?
That is a pathetic 2.5%
annual rate of return. That's ridiculous. So, what does that tell you? Either that
house is way inflated, it is really not worth 4.8
million. Or if that house was like homes in
Memphis and Orlando, it should be renting for 48 grand a
month. Not 10,000 a month. So, what do we do?
I'll share with you what we did to quadruple their cash flow
and get a new house free and clear. So, this couple sold the house.
They were able to do 1031 exchanges on 13 other homes in Memphis and
and also in Orlando. Other cities where the rent multiplier is 1% a
month. And they also had excess cash of
$800,000 to buy a house twice that size in a retirement
community, okay? Where real estate values were more
realistic. Now, with 13 rental homes,
they have more than quadrupled their cash flow. They have
13 homes now each worth 300,000. These are newer properties. They're
appreciating better. But they're able to experience
net rental income of 40,000 a month. Hello?
They went from 10,000 a month to 40,000. That is
400% increase in rental income
and they have newer properties and they still have a house to live
in that's twice the size of their previous house.
We were able to take lazy idol equity out of an over-inflated house in San
Francisco bay area because it's going to correct someday.
And we were able to accomplish that for them. Now, the rate of return
is way greater. It's more like 10 to 12 percent
a year on cash flow. And whatever the properties appreciate at is
gravy. So, the way that you calculate rate of return
on your real estate is you look at 2 factors,
if you're renting it, you calculate what is the actual rate of return or what I
call the rent multiplier if you're renting it.
And you can dramatically increase this by maybe fourfold like this couple did.
But also these properties are going to appreciate
based upon the appreciation in Memphis and Orlando.
Those 300-thousand-dollar homes will be worth 450
to 500 thousand dollars in as little as 5, 6 or 7 years.
And so ,you add on top the appreciation on top of the cash flow.
And most of our clients that do this end up at the end of the day
with more like a 20-24% average annual rate of return
on their money when they turn it over or they sell it
5, 6, 7 years down the road because we calculated the cash flow rate
of return and the appreciation. And we did that by
keeping the properties mortgage to the hilt.
This couple kept their equity, their cash that they didn't tie up in down payments
at 20% over in their laser funds. And were able
to compound that money and earn a rate of return twice what the
net cost of the mortgage was. It's unbelievable how much more you can
earn when you manage your real estate equity. And you just don't send extra
principal payments or the rent payments against the mortgage to hurry and pay it
off. So, if this is intriguing you, I would encourage you to subscribe to
this channel and also search... I have dozens of other educational
videos that talk about real estate equity
management. And also how to manage your money keep it liquid safe earning
predictable rates of return compounding tax-free. You will learn
about what the laser fund is. And you'll also be able to get a free
copy of my most recent bestselling book The LASER
Fund. You can go to laserfund.com and check it out.
But learn empower yourself and watch this episode next.