Hi, I'm Bob Woolverton, your Northwest Realty Advisor. How are you on this fine
day? Me? I'm pretty excited about home values in this greater Seattle area.
If you saw my video, Words of Advice From a Mortgage Broker, you heard my friend
Julee Moore say that if you bought a home in the Seattle area over the last
several years you've more than likely made money on your investment.
Well, we see in the headlines that home prices are appreciating in the Seattle area
12, 15, even 18%. But you may be actually earning more than that through
leveraging debt. I'm going to show you a real-life example where a Bothell
homeowner has earned an annual interest rate, a return rate of return of
34.7% (APR) over the last four years on his primary residence,
and you may be earning the same amount of money also and not even know it.
That's our episode today so come on back to find out more.
Okay, so we've all seen the headlines in the greater Seattle area about how home
prices are appreciating so rapidly. We've seen headlines like this that say
Seattle's number one in home price growth again, 12.9% in 12 months.
Or, Seattle fastest-growing home prices in the
country or King County home prices surged by 18%. Well that is
how much the home prices are appreciating but it may not reflect your
Return on Investment. And what I mean by that is that the headlines say, yep home
prices are going up by this much but you unless you paid all cash for your
home... that's not reflective of your investment. Now if you did pay all cash
yeah that's exactly what you're making you that twelve percent or fifty percent
or whatever it was that year. But if you didn't pay all cash in essence if you're
leveraging debt, you could be increasing your return two, three, four, and five-fold,
maybe even more depending how well you leveraged your debt. Now what we're gonna
do is we're gonna look at your primary residence, or we're going to look at a
primary residence as an investment property, but it's not an income property
so it's just negative cash flow. But we're gonna show you how this homeowner,
real-life example, is earning 34.7% return on his investment.
Now how is he doing that? In this
real-life example this homeowner that I know lives in Bothell, Washington in the
98012 zip code. He gave me permission to use this information for
this presentation. So, four years ago, November of 2013, he bought his single
family home for $385,000 had a 5% down payment put the $20,000 down he got a
fixed-rate mortgage at 4.5%, 30-year term. Now the sales data
in his zip code says that single-family homes in that zip code have appreciated
on average 13.4% per year.
Now we didn't do a comparative
market analysis on his particular home to see of the improvements he's done on
his home have probably made his home worth even more than that. But we're just
going to use the averages for this example.
So using that 13.4% annual return rate
that would make the present market value of his home $635,826.
So that's the number we're
going to use for our calculations calculations in this example. Now, how we
do the calculations is we're going to look at the Annual Property Operating Data,
just like it were an income property but there's no income so it's
going to be all negative numbers. Then we're gonna look at the pre-tax cash
flow and then we're gonna look at the pre-tax sales proceeds and the cash flow
over four years and we'll get to our Internal Rate of Return. So how we do
that is we look at the annual property operating data. So his real estate taxes
in his first year were $3,419.
His property insurance was $1,200 so he's got total expenses of
-$4,619, negative number money out the door. His annual debt service, fixed-rate
mortgage -$22,193 per years so his total cash flow for
that year was $26,812, negative number
money out the door. Now we do that over the next four year period. Now the only
thing that goes up is his expenses. On that expense line his property insurance
went up and his property taxes went up. His debt is a fixed rate mortgage so it
stayed the same and his total number out the door for year two -$27,159.
Again in year three property taxes and insurance go up even more so
now it's numbers -$27,229 negative number, money out the door.
And year four, -$27,763. Now we take that proposed sales
price today's market value of $635,826 and we calculated an
eight percent cost of sale and as since we figured six percent for real estate
commissions and one point seven eight percent for Washington State excise tax.
So roughly 8% which is $50,866.
At the end of the four years at the end of the forty-eighth month his mortgage
balance is $339,774, so we pay that off. And we have pre-tax sales
proceeds of $245,186. So now when we look at the cash flow over the four
years one thing we need to talk about is when we calculate time in a contract.
The day that you get mutual acceptance on a contract, that's day zero. Then you
have day one, day two, day three, and that's how you count days in a contract.
Here we have cash flow year zero, the year that he made the twenty thousand
dollar payment, and then cash flow for year one, which was at $26,812
that we just calculated. And then year two where the property taxes and
insurance went up so now his money out the door was $27,159, again
property tax, and insurance went up in year three so $27,229, and then in year four
we see a positive number. That's because in year four we sold the house. That was
our exit strategy...sell after four years. So we had pre-tax sales proceeds of $245,186
that we calculate. But we still had that money out the door for the fourth
year, which was that $27,763. So our Net for that fourth
year was $217,424. If we do a sum on that entire column we have a positive
number of a$116,224. Now this is where some
people differ on the way they want to calculate the return on their investment.
Some people would say, I invested $20,000 cash, four years later it turned into $116,224
So they would pull out their financial calculator and say, Present Value was
$20,000 down payment negative number, money out the door. Four year term,
one period per year, Future Value $116,224.
Hit the interest button and it would say you made 55.264%
on your money per year. Not the accurate way to do it.
Some people want to do it that way. The more accurate way, you need to calculate
also in the money that you... the other capital that you tied up. All those other
red numbers the $26,812, the $27,159, and so-on, because you're
tying up that money also. So when you calculate that additional capital
that you have tied up, your Rate of Return and since what we call
Internal Rate of Return is actually 34.72%. Still a fabulous
return on your money, on your investment. You're probably not going to do that
in the stock market. There's probably very few other investments you're gonna
get that kind of money. Now how is this homeowner doing this? He's doing this is
because he's leveraging debt. He's in an appreciating market where he's borrowing
money at four-and-a-half percent and yet appreciation is far greater than that so
he's getting a far greater return. Now if he wants to do this exit strategy you
can see he'll be making 34.72% on his money.
Good return! Same sort of thing as if you want to buy investment property - you want
to have an exit strategy. And if you do a four your exit strategy we calculate
those on a spreadsheet that looks like the one we used for this particular homeowner,
where we put in all of the mortgage information, the purchase price, what we
anticipate appreciation rates are going to be and we would use a very
conservative rate. And then the loan amortization, so we know what the payoff
is going to be at the end of the exit strategy whether it's three years or
four years or five years whatever you'd want. If it's going to be an investment
property you're probably gonna have more expenses. For this homeowner we just
calculated property taxes and insurance. But if you're going to be a landlord you
might cover some utilities, you might have Common Area Maintenance costs, you
might have management fees, and all of those we would calculate in here. And
then as we go through the four year period or a five year period whatever
the exit strategy, we would do all these calculations so that when you buy an
investment property you make a very informed decision. Much like when you buy
stocks there's no guarantee that it's going to have a particular rate of
return, but you have a very informed decision when you go in and you have an
expectation, and the idea is that we're going to exceed your expectations. Now,
when we look at income property investments they're slightly different
in the fact you can't get away with a 5% down payment you're going to need a 25%
down payment. We would in our calculations in our
spreadsheet we would use a very conservative appreciation rate a very
conservative rental rate is what you could get for rents we would also
calculate the vacancy rate so we would assume there's going to be some turnover
and that's going to cost money so we would calculate those in there and this
other list of expenses and we would have an exit strategy. Now the exit strategy
is completely up to you, there are some people when they buy
stock they're buy-and-hold people, they buy stocks and they hold them forever and
maybe that's the way. I know people that have rental property, the same, they buy
them they hold them forever. They get the home paid off and then all of the
positive cash flow they have from the rental income is their retirement income.
And that's perfectly acceptable too. Some people want to have an exit strategy,
they want to say... I want to buy this, this is a four-year hold, or a five-year hold,
or a 3-year hold. This is my plan and this is what I expect to make as a
return on my investment. And we can do that too. If you want to do that sort of
thing give me a call we'll calculate a potential income property for you and the
rate of return. But the primary purpose of this video today was to help you
recognize that if you are a homeowner, you have your primary residence, you see
these headlines of 12% 15 and 18% appreciation rates, and you think, oh, okay I'm
doing pretty good. If you're leveraging debt you're doing far better than that.
And appreciate your primary residence as part of your investment portfolio and it
may be a very large part of your net worth. But by leveraging debt that's how
people create wealth in real estate. And the more that you understand that, the
more that you can capitalize that - and increase your own net worth.
I'm Bob Woolverton, your Northwest Realty Advisor. If you liked today's video please click
that SUBSCRIBE button. That gives me feedback that you're finding value in
what I'm giving you. I'd also appreciate it if you click that thumbs-up and give
me that... that gives me more feedback also. And better yet, click that SHARE button,
copy that link, and send the link to a friend so they can see this video.
Like I said...
I'm Bob Woolverton, your Northwest Realty Advisor. We have new videos every week,
come back see me next week.
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