3 ms·

Calculations of this model are misleading. One hugely important parameter missing: inflation rate. This would tell us what part of that 2.1 million in 30 years

Calculations of this model are misleading. One hugely important parameter missing: inflation rate. This would tell us what part of that 2.1 million in 30 years is real return and what part is simply inflation, i.e. depreciated money. Put it differently, it’s important to know what the investment will yield in terms of today’s dollars - not depreciated dollars. For such a long horizon of 30 years modeling without accounting for inflation makes little sense. For instance that 7% stock market return used by the model as a default, which perhaps may be used as proxy for inflation, would return 661% over 30 years. Default values for other parameters and their distributions also look very optimistic to me. Like 4% annual appreciation which maybe drops to 2% annual appreciation. How about 40% annual depreciation, your mortgage being 30% underwater, and foreclosure? How about the bank that issued your mortgage going bust, then the bank which bought that bank going bust, and then you 30-story building being shut off from public utilities? What am I smoking? Neh, I just bought investment properties in Miami and other places in Florida in 2007. Anyone too young to know what I’m talking about: I urge you read up on the 2008 crisis before you start buying up investment real estate, after 10 years of unprecedented growth of both real estate and stock market.

zenkat 7y ago
Try using the model with a very high down payment. At 50% of property value, your gains are equivalent to the 7% baseline. Beyond that, the property makes significantly less than the stock market. If you pay 100% up front, you end up making half what the stock market does. In other words, the gains shown by this model are coming from leverage, not from the underlying asset. Leveraged investments always return more, but with higher risk. That's true in the housing market as well as the stock market.
- evancox100 7y ago
  Leveraged assets are not necessarily always more risk than unleveraged ones. You also have to look at the underlying risk/volatility. That said, I agree with your point in this case that the leverage is the main component of the return, and greatly increases "risk", for some definition of that word. In a non-recourse state where you can default on the mortgage without losing other assets, the risk calculation must also take that into account.
  - tyxodiwktis 7y ago
    In addition to your point about leverage and underlying asset volatility, certain assets are not regularly marked to market (real estate being a prime example) and so you don't experience the true volatility of the asset unless you attempt to sell it. As a concrete example, a number of commercial real estate investors were technically insolvent in 2008-2009, with assets worth less than the balances of the loans used to buy them. They just pursued the 'hear no evil/see no evil/speak no evil' approach and marked to book (what they paid for the asset) until the market recovered. This approach is aided by the multi-year nature of commercial leases, which protects the cash flows needed for debt service (as long as your tenants stay in business). In aggregate these factors allow professional real estate investors to consistently earn return by taking on a ton of leverage and with it huge but disguised risk. Back to the original point of the article (buying to rent), most retail investors don't necessarily have the float/access to debt to weather that volatility, and their cash flows are more sensitive which compounds that risk.
D_Alex 7y ago
Excellent points. Other parameters missing: - Vacancy rate! - Leasing costs (or value of your own time) Annual cost should include: "normal" maintenance, repairs, insurances, renovation sinking fund, taxes, rates, strata fees if applicable.

zenkat 7y ago

Try using the model with a very high down payment. At 50% of property value, your gains are equivalent to the 7% baseline. Beyond that, the property makes significantly less than the stock market. If you pay 100% up front, you end up making half what the stock market does. In other words, the gains shown by this model are coming from leverage, not from the underlying asset. Leveraged investments always return more, but with higher risk. That's true in the housing market as well as the stock market.

evancox100 7y ago
Leveraged assets are not necessarily always more risk than unleveraged ones. You also have to look at the underlying risk/volatility. That said, I agree with your point in this case that the leverage is the main component of the return, and greatly increases "risk", for some definition of that word. In a non-recourse state where you can default on the mortgage without losing other assets, the risk calculation must also take that into account.
- tyxodiwktis 7y ago
  In addition to your point about leverage and underlying asset volatility, certain assets are not regularly marked to market (real estate being a prime example) and so you don't experience the true volatility of the asset unless you attempt to sell it. As a concrete example, a number of commercial real estate investors were technically insolvent in 2008-2009, with assets worth less than the balances of the loans used to buy them. They just pursued the 'hear no evil/see no evil/speak no evil' approach and marked to book (what they paid for the asset) until the market recovered. This approach is aided by the multi-year nature of commercial leases, which protects the cash flows needed for debt service (as long as your tenants stay in business). In aggregate these factors allow professional real estate investors to consistently earn return by taking on a ton of leverage and with it huge but disguised risk. Back to the original point of the article (buying to rent), most retail investors don't necessarily have the float/access to debt to weather that volatility, and their cash flows are more sensitive which compounds that risk.

D_Alex 7y ago

Excellent points. Other parameters missing: - Vacancy rate! - Leasing costs (or value of your own time) Annual cost should include: "normal" maintenance, repairs, insurances, renovation sinking fund, taxes, rates, strata fees if applicable.