eBook - Real Estate Appraisal from A to Z

FACT 2: TENANTS PROVIDE PREDICTABLE, STEADY AND RELIABLE INCOME.

Let's compare the cash-flow from real estate to that from stocks and bonds. Even the highest quality publicly traded companies sometimes reduce, and even eliminate paying dividends (profits) to stockholders. While most people think this only happens in economic "hard times," the fact is, that a company can have financial problems at any time for reasons that have nothing to do with how good or bad the general economy is doing. The recent bankruptcies of such business giants as K-Mart, MCI/WorldCom and United Airlines are just a few of the numerous examples of how a company can run into financial problems in an otherwise good economy.

As for bonds, the present interest rate (yield) on the most recently issued 5-year US Treasury Note is 3.30%, if held the full 5 years to maturity. Likewise, the 10-year US Treasury Bond pays 4.05%, again, if held the full 10 years to maturity. In addition to suffering these meager rates of return, you'll also have to pay income tax on the earned interest, both federal and state (if applicable). So, if you're in the 28% federal income tax bracket, your net profit on the 5-year Note will be only 2.38%, and only 2.92% on the 10-year (before state income tax, if applicable).

Now, using a very simple example of income from investment real estate as a comparison, let's say you bought a 1-family house for investment at a purchase price of $100,000, with $10,000 (10%) down payment, and you're collecting $1,000a month in rent with the tenant paying all utilities. Even after making your mortgage payment of $539.60 a month ($90,000 @ 6% for 30 years), and paying your property tax of about $85.00 per month, as well as paying your homeowner insurance at another $30.00 per month, you'll still have $345.40 to put into your pocket at the end of every month, or $4,144.80 a year. So, your annual return (interest rate, if you will) on your $10,000 of invested cash is a whopping 41.45% (before income taxes).

So, even after paying your federal income tax on the rental profit (using the same 28% tax bracket), you still have $2,984.40 spendable cash in your hands; that's equal to 29.84% annual net on your invested cash. And, that doesn't even consider 1) the increase in the value of your property, 2) the increase in your equity position as a result of your tenant pay down your mortgage, and 3) the benefit of reducing you income tax liability from a little thing the I.R.S. calls "depreciation," that I'll get to in a moment.

Well, what about the change in the value of stocks and bonds compared to real estate? On January 14, 2000, the Dow-Jones Industrial average (DJI) closed at its all-time high of $11,723.00. By March 11, 2003, just over 3 years later, it closed at $7,524.06 having lost over 35% of its value from its all-time high. As of this writing (October 15, 2004) the DJI closed at $9,933.38; it has never reached the $11,000 level to date.

As for the National Association of Securities Dealers Automated Quotations (NASDAQ), the losses there are even worse. Again, on March 11, 2003, the NASDAQ closed at $1,271.47, having lost about 75% of its value from its all-time high of $5,048.62 set exactly 3 short years earlier on March 10, 2000. As of this writing, the NASDAQ closed at $1,911.50, never having reached 50% of its all-time high value to date.

So, what about real estate? Well, the people who bought real estate virtually everywhere in the United States at the same time these stock indexes were setting their all-time highs in the year 2000, now have property that has increased in value by between 50-100%. Plus, they've also had cash flowing into their pockets every month, while their tenants have been paying down their mortgage debt. And, in most cases, these property owners have refinanced their mortgages with lower interest rate loans that have boosted their net cash-flow even more.

• < Prev
• Next >