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W hy Y ou Should Invest in Real Esta te

that actually falls below unleveraged yields, and in some areas, fi nancing a
property can even create negative cash fl ows.
To illustrate, let’s assume that our $200,000 duplex yields a 5 percent
unleveraged rather than a 7.5 percent unleveraged return. Here are the new
numbers:

Net income (.05 $200,000) $10,000
Debt service ($160,000, 6%, 30 years) $11,264

Cash flow less debt service ($ 1,264)
Leveraged yield from income (R) 1,264/$40,000
R 3.16%

Does it make sense to buy and finance a rental property that produces
these kinds of adverse numbers? Maybe.
Remember, to accurately evaluate any type of investment, compute total
expected returns. Income contributes an important role, but also count other
members of the cast.
How rapidly do you expect rents to climb? Can you boost net rental
income through better management of the property? Can you convert the

property to a more profitable use (e.g., rental apartments to condominiums)?
How much will amortization (mortgage paydown), appreciation, and infl a-
tion add to your gains? How much tax shelter does the property provide?
When I started my career in real estate, investors applied this buying
rule: “Pay for the present, get the future for free.” If we couldn’t get a prop-
erty to yield a leveraged cash-on-cash return of 15 percent to 30 percent
(depending on the quality of the property and its tenants), we passed on the
deal. We expected large additional returns from the other sources just cited,
but we considered those gains “gravy.” We only paid for the “meat and pota-
toes” (current income).
Unfortunately, those glorious days no longer exist. Today, you may
have to pay for the future. But given the generous future rewards you can
expect—especially when contrasted to the relatively poor yields for stocks and

bonds—even currently negative cash flows can make sense when the other
sources of property gains listed earlier look good.

Wealth from Amortization

When investors think property, they generally want positive cash fl ow and

appreciation, and over time, most rental properties fulfill these wants.

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