“This article will make you hundreds of thousands of dollars, so read this.”
- Signed by your Future Self.
This is part 2 of my article. Click here to read part 1.
I ended part 1 of this article by introducing what I call Investing 2.0. Basically, I am trying to create awareness towards real estate investing as the (much) smarter alternative to what we’ve been doing. Real estate makes you money in several ways. Let’s get into that next.
THE 3 WAYS
Let’s chat about real estate investing and how real estate pays you in 3 different ways. Go ahead, name another investment that does that. <pause> When you own an investment property, you’ll make money through:
Cash flow when revenues exceed expenses
Principal (mortgage) paydown
Appreciation of the property
I want to elaborate on each of these in isolation, then I’ll combine them.
Money-Making Category 1
I live in Toronto. My city, admittedly, doesn’t offer a lot of investment properties that have amazing positive cash flow on a monthly basis. Unless you’re putting down a lot more than the minimum required to buy a property, you’re not coming out ahead with hundreds or thousands each month in this category. Not right away, anyways. That cash flow will come in the future, it’s just not great on day 1. For me, personally, I’m ok to expect no positive (or negative) cash flow when I buy property. I’m not concerned about category 1 at the beginning (categories 2 and 3 more than make up for the difference, that’s coming up).
Money-Making Category 2 (AKA the guaranteed money)
When you’re making your mortgage payment, you are GUARANTEED to pay down the mortgage. This GUARANTEED return isn’t even low! If you buy a place with 20% down payment, and get a mortgage at 3.5% for 25 years (which is typical as of time of writing) - your return on your investment is 10.2% IN THE FIRST YEAR, just by paying down your mortgage! AND -> the return is higher every year after the one before it. Boom.
With each mortgage payment I make I’m paying down my loan on the property, thanks to my tenants that are providing me with all of the money to make those payments. If I do this long enough, the property will be paid off, and all of it by the tenants. I might have made the initial 20% down payment on the property, but my tenants will have paid the remaining 80% over the years, thank you very much.
Money-Making Category 3
This is where home runs are hit, and anxiety is destroyed. Home prices really do increase over the years. Property values rise, and far more predictably than stock markets. You won’t see the 50% gains in a year that a stock market may make, and we certainly haven’t come across the 50% drops in value that a stock market can have. The peaks and valleys are muted in real estate pricing. Though through the years, nobody can deny that real estate appreciates.
Look at this chart we plotted. We’re comparing the Toronto Stock Exchange TSXS&P60 (aka: “the stock market”) against home prices from the Toronto Real Estate Board since 1996. The slow-and-steady real estate investment closely matches the trend of the stock market - though with none of the anxiety of down years. I mean, look at the prices in 2006 to 2008. What if you HAD to sell your stock or mutual funds in 2007 or 2008, you would have lost a ton of money. If you HAD to sell your real estate investment, though, you’d have been just fine at the time.
If you’re having a hard time getting through this post, hang on just a bit longer! I want to hit my very last point on why owning an investment property crushes the alternatives…
When you buy a stock, you’re paying the full price of that stock. If it’s a $1,000 stock, you pay $1,000. With real estate, you’re typically only going to need to fund 20% (NOT 100%) of the value of the property. Though the appreciation of the property happens at 100% of its value. What does this mean, in plain English? For every 1% the property appreciates, your return on your investment is 5%. If property prices go up 5%, you’re up 25% return on your investment. Isn’t that crazy?!!! That, my friends, is the power of leverage.
Remember that chart I showed above, comparing Toronto real estate prices to the stock market? Let’s look at that again - and consider that we’re making all of that appreciation based on 100% of the home price, and knowing that we’re only putting down 20% of the price to buy it. Look at that chart again now (you have permission to say “WOW”):
what are the Real world results?
After my initial down payment, what have I created? A never-ending stream of cash flow. AND as it’s paying me this cash flow every month, I’m doing nothing to devalue the actual investment. I don’t need to worry from month to month about continuing to fund my investment with my paycheque. I’m paying down the mortgage without any of my own money. The investment keeps growing and growing with appreciation. Can you do all of this with stocks and mutual funds? Nope. And, sure, if I needed a massive amount of money I could totally sell and see a huge immediate sum of money. Or I could access some equity by refinancing. The point is, I have wonderful options. All of which are better than the scenario described up at the top of this page.
I really do feel that many of us know better than to only consider the traditional investment options. I think a lot of us believe mutual funds or stocks are our only investment options because the cost to play in that game is so low when you play it this way. It’s only $100 - or whatever - at a time. It’s easy. It’s accessible. In fact, I’d say that pretty much all of us consider this the only accessible investment available to us. I used to think that. But now I know better, and I’ll never go back to only considering those inferior options. It’s real estate all the way for this guy.
You probably knew all of this, you just didn’t see the pieces of the puzzle presented like this in your mind. Nothing new here. All of the wealthiest people around own lots and lots of property. The question is, now that you’ve seen this and realized the truths of this, what are you going to do with this knowledge?
Thanks for reading, I hope this was as rewarding for you to read as it was for me to write.