The Investment
Assume a Landlord is considering
the purchase of a rental property for $187,500 with 25% down at 6% interest. This
rental property is able to generate $1,155.58 in monthly revenue with: 1%
annual property taxes ($1,875) and additional annual expenses that average $1,200
dollars a year. The last assumption is that the property will maintain its
current value at the end of the 30 year period. The 30 year mortgage with a 6%
interest rate cost 13,866.96 (Mortgage + Taxes + Operating Expenses) yearly to
run\own the investment property.
Breaking Down the Cost
|
Month/Year
|
Payment
|
Principal Paid
|
Interest Paid
|
Total Interest
|
Balance
|
Owners Equity
|
|
Year 0
|
$899.33
|
$149.33
|
$750.00
|
$750.00
|
$149,850.67
|
$37,649.33
|
|
Year 5
|
$899.33
|
$201.42
|
$697.91
|
$44,238.99
|
$139,380.12
|
$48,119.88
|
|
Year 10
|
$899.33
|
$271.68
|
$627.64
|
$84,075.32
|
$125,256.90
|
$62,243.10
|
|
Year 15
|
$899.33
|
$366.46
|
$532.87
|
$118,984.77
|
$106,206.81
|
$81,293.19
|
|
Year 20
|
$899.33
|
$494.30
|
$405.03
|
$147,248.60
|
$80,511.08
|
$106,988.92
|
|
Year 25
|
$899.33
|
$591.52
|
$307.81
|
$160,083.31
|
$60,970.07
|
$126,529.93
|
|
Year 30
|
$899.33
|
$894.85
|
$4.47
|
$173,757.28
|
$0.00
|
$187,500.00
|
Taking a look at the consolidated statements of cash flows
you will notice that for the first thirty years of ownership in this investment,
it nets exactly zero dollars in operating income. As such it also generates
zero dollars in net income. The picture does not seem so rosy.
The Consolidate Statement of Cash Flows
|
|
Year 5
|
Year 15
|
Year 30
|
Year 31
|
|
Net Revenues
|
$13,866.96
|
$13,866.96
|
$13,866.96
|
$13,866.96
|
|
Cost of Sales
|
$12,666.96
|
$12,666.96
|
$12,666.96
|
0
|
|
Other Expenses
|
$1,200.00
|
$1,200.00
|
$1,200.00
|
$1,200.00
|
|
Operating Income
|
0
|
0
|
0
|
$12,666.96
|
With that said let’s look at a 5 year, 15 year, 30 year, and
31st year rate of return for this business proposition. As the
calculations are approached it is of importance to note that the Total Assets =
Liabilities (mortgage balance) + Owners equity. Since total assets is not
changing for this investment, under the initial assumptions, Total Asset = Average Total Assets.
|
|
Year 5
|
Year 15
|
Year 30
|
Year 31
|
|
Margin
|
0
|
0
|
0
|
.913[1]
|
|
Return on Investment
(ROI)
|
0
|
0
|
0
|
6.756%
|
|
Return on Equity (ROE)
|
0
|
0
|
0
|
6.756%
|
|
Debt-Equity Ratio
|
289%
|
146%
|
0
|
0
|
Notice as a result of the Operating Income both ROI and ROE are
zero for the first thirty years. However in the 31st year of
operations the investor sees a sizable jump in his ROI/ROE, plus his equity in
the investment has fully matured.
The Alternatives
Consider the landlord had the following alternative
investment opportunity for the $27,500 that would have been required to
purchase the rental property. Each of the investments listed below has a rate
of return which is compound on a yearly basis over 30 year period.
|
Interest Rate (Compounded Yearly)
|
Future Value
|
|
3% (Savings Rate 1990)[2]
|
$66,749.72
|
|
6% (Predicted S&P 500 Average Going
Forward)[3]
|
$157,946.01
|
|
8% (Historical S&P 500 Average adjusted
for inflation) [4]
|
$276,723.06
|
|
10% (Historical S&P 500 Average) 1
|
$479,858.56
|
The two investments he might want to consider would be the
8% or 10% investment avenues. However
neither of these options offers yearly revenue generation. Which would you
want to place your bets on going forward.
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