Why Analysis Matters — Things Aren’t Always What They Appear To Be
Posted @ 10:52 pm - Filed under Real Estate Investing, Retirement, Cash Flow, Retirement Income, Investment Lessons, Depreciation, Capital Growth, BawldGuy Axiom
Due to the nature of tonight’s topic, pictures will again be at my whim. I’m feeling quite random as it turns out. When I’m talkin’ ’bout numbers and basic analysis on-topic pictures just don’t cut it.
A post published here earlier this week generated an excellent comment by David Shafer.
The post discussed the differing results of 10% or 20% down payments.
Here’s David’s comment:
I argue with myself over which is better the 10% or 20% version. I think it is really individualized. But gotta comment that the 20% version is less costly in terms of lower mortgage rate and/or no mortgage insurance which is expensive now. And if you take that cash flow and put it into another investment, then you might just come out even with the 10% down option!
Dave — I know what you mean, as I’ve done this particular analysis hundreds of times.
These days we’re seeing little or no difference in interest rates on the two loan LTV’s. Even if there was a .25% spread, if that kills the deal, then generally speaking the investor might not be a candidate for real estate at that time. ‘Course sometimes common sense dictates a particular deal just won’t work.
Let’s look at your suggestion though, which might be a logical alternative.
BawldGuy Axiom: One of the foundational factors in any solid analysis is understanding where the bar is set. Sometimes the analysis is what actually sets the bar. Either way, workin’ with a stealth bar will get you nowhere at impressive speeds.
At 5% annual appreciation, $210,000 over a five year holding period would grow the capital by $58,000.
There’s the bar.
Your suggestion is a good one, and has been coming up in classes and seminars I’ve taught for the last 30 years, and with the same result. It sounds like a good idea, but makes sense only when there’s simply no choice left. Why? ‘Cuz it falls woefully short of comin’ out even. (Again, we’re in the context of the properties/prices used in the linked to post.)
If you can find a safe investment using only the cash flow from a 20% down real estate investment on a $210,000 property that would result in making up the loss of $58,000 over that same five year period, I’m all ears. 
The annual cash flow would hafta be $7,800/yr with an annual yield of 20% to get to $58,000. The cash flow on these small properties when using 20% would be less than half that amount.
This is why when financially prudent, I typically advise clients to opt for the 10% down approach. As long as the cash reserves are generous, the payoff for the holding period is far and away the better return.
The investor using 10% down, beginning with $100-125,000 in capital, will, over the next 15-20 years, end up with a net worth roughly $1.5-2 Million more than the 20% down approach. In terms of retirement income, that comes out to roughly $7,500-10,000 a month more than the 20% down approach.
David’s suggestion should be used when there’s no other choice. That said, there’s still other ways to make use of your holding period cash flow, both before and after tax. I’m gonna have David himself address that topic next week. Letting cash flow sit and mold is one of the pet peeves of many real estate investors. This is especially true when the after tax cash flow is turbo charged by useable depreciation. David will give you some food for thought on the subject.
Meanwhile, back at BawldGuy Ranch, don’t ya think it’s about time you get off the dime and Contact me? Since The Boss is on the road for the next coupla weeks, I’m extra available. Heck, with Josh takin’ off ’till Tuesday, I’m even answering the office phone now. Go figure. Have a good one.
This entry was posted on Thursday, August 7th, 2008 at 10:52 pm and is filed under Real Estate Investing, Retirement, Cash Flow, Retirement Income, Investment Lessons, Depreciation, Capital Growth, BawldGuy Axiom. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.