To those that have heard of the “power of 72”, this may seem like nothing special, but if you have never heard about this “trick”, you will likely find this neat.
Take the interest you expect to receive and divide it from 72. The number you get is the amount of years needed for the value to double. Say you are getting 6% interest annually. Divide 72/6 and you get 12. In 12 years, $1000 becomes $2000. If you have 7% annual interest, 72/7 equals 10+ years to double. 10% interest doubles in a little over 7 years. Don’t believe me? Try in yourself. Let’s take 12% interest. Start with $1000. Then multiply that number by 1.12. Repeat that process 6 times. (Go ahead, do it …I’ll wait). Amazing isn’t it. Try it again at 9% or 7% or 5% or 3%. Works every time.
OK. To those that now understand the power of 72, that shows the amazing power of compound interest. But, if you are like me, you don’t want to wait around 10 or 12 years for that $1000 to double. Is there any way to leverage your money to work even harder and faster for you? If my answer was no, that would be a funny way to end this article. However, there actually is a way to leverage your investment dollars in real estate investing.
First, before I go on, let me explain what leveraging is. You are typically using borrowed money to increase your wealth. When you borrow money, the person or organization who loaned you the money typically wants that money back. Not only that, but the bastards want to also collect interest for their efforts. The nerve of them!
This means if you intend on borrowing money, you better be pretty damn sure the property can maintain its value, or is in a position to rise in value.
In real estate, people leverage all of the time. Anyone who has ever taken out a mortgage has leveraged the cash they spent to obtain the home and been able to take use of that property. Real estate investors do that system in hyperdrive.
In Canadian real estate, one needs to put 20% of their own money down, in order to take possession of the investment property. This means you are taking out a mortgage for 80% of the value of the property.
If you have obtained a property that just covers its expenses, and generates absolutely no positive cash flow, one of those “expenses” is still the mortgage payment. Yes, the rental income covered the interest on the mortgage, but it also covered the principle. This means that over time, the tenant pays your mortgage off. Pretty cool huh.
Now like the game show announcer says. “But that’s not all”!
Let’s remember, over the past 100 years, Canadian Real Estate tends to go up in value. Can you absolutely count on appreciation? In any one year period no. But since you are buying this property with a long term mindset, I think it is safe to say yes. (Especially if you bought intelligently – as we discussed in other articles).
Since 2000, Durham Region real estate has AVERAGED a growth of OVER 5% (and that includes the recession in 2008-09). So what you scoff. My mutual fund has averaged 8%. As impressive as that is, you failed to recall that my investment was leveraged. My $1000 was able to secure a loan of $4000. My $1000 received a return of 5%, but so did the leveraged money ($4000 x 5%). This means my $1000 actually received a return of 25% on an appreciation of 5%.
Hold on you say, you also had to pay for that money you argue. True, but we already established that the interest and principle paid in the mortgage was covered by the tenant’s rent.
To summarize, we got the tenant to pay down the mortgage, we got an appreciated value in Durham Region over this century of 25% and we haven’t even made one dollar of cash flow. In my two-unit properties, I target an appreciated value of $250 a month per door.
You can see quickly that with a PROPERLY leveraged property, the return we are looking for is north of 30% annually. If all hell brakes loose and over 10 years, the values stays the same or even goes down a bit. We still have a property that has been paying down its mortgage for a decade and generating some cash flow dollars.
So, why doesn’t everybody do this you ask? Simple. Unlike paper assets like a stock or mutual fund, you have to do some work to get this kind of return. You can’t just put the money into property and expect all of these returns without managing tenants, dealing with hassles and putting up with some shit. But, if you want the big returns, that is what it takes.
Before I finish off, let me remind everyone that if you like the returns delivered in Canadian Real Estate, but don’t want to do the work (ie deal with the hassles) there are plenty of joint venturing opportunities out there. If you are willing to put up the money, there are a whack of people out there willing to do the day to day efforts in a partnership and will do all of those things for only half of the profits. That means you can reap the rewards of Durham Region real estate and all you need to do after signing the contract and purchasing the property should be looking at the quarterly or annual results.
If you want to know how to reach out to those people, send me a note and I’ll make the introductions.