Investor X is looking into buying a fully rented two-unit property generating $65,500/year, for $1,100,000. The investor will have to put in $220,000 as a down payment to make the purchase possible.
At the end of the first year, Investor X was left with $2,500/y cash flow after all expenses including annual mortgage and some funds put aside for repairs. The return on investment, AKA Cash on Cash, would be 1.1 per cent ($250,000 made over $220,000 invested). In addition, by the end of year one, Investor X’s tenants paid the mortgage, of which around $24,000 is equity. The investment is making a total yield of 12 per cent per year (cash flow and equity), not including appreciation.
Investor Y is looking at the same area but found a three-unit property generating $63,500/year, for $1,700,000. The investor will have to put in $370,000 as a down payment (20 per cent) to make the purchase possible. At the end of the first year, Investor Y has a negative cash flow of $29,000. The ROI is -8.5 per cent. The investment is losing 8.5 per cent of its value per year. Same area. Same gross income. Different outcomes. In addition, by the end of year one, Investor Y’s tenants paid the mortgage, of which around $37,500 is equity. The investment is making a total yield of (-$29,000+$37,500) 370K = 2.5 per cent.
The moral here is that even though the two investments are in the same location, and earn the same income at maximum capacity, they do not translate equally to the buyer. In the long run, the properties will gain value via appreciation. However one investment is making money well before appreciation kicks in, while the other investment makes money with each year, but each year the down payment is losing eight per cent of its value.
Hold something long enough and you will have a return. The overall balance sheet will be positive the longer you hold on to it. But one comes with no friction (+8 per cent inefficiency) while the other has momentum already running.
Which real estate investment would you be more confident to invest in?