Rental Parity - How to Factor Appreciation and the Use of Leverage

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doobage_IHB

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In the rental parity calculation, I noticed that there isn't a value ascribed, on the ownership side of the equation, to owning an asset that historically delivers a positive return on equity through the use of leverage. I'm interested in knowing why this hasn't been factored into the calculation, as it's presumably, the past few years excepting, one of the benefits of owning a home.



For instance, if I purchased a $1mm property, assuming 80% LTV, 6.5% mortgage rate, and 3% appreciation per annum, and sold the property 10 years later, the leveraged return would be $343,916 on $321,791 invested ($200,000 down payment and $121,791 in principal payments). All the appreciation upside accrues to the homeowner vs. being split proportionately with the note holder.



I know that appreciation isn't a certainty but historically real estate has been a positively appreciating asset class. Shouldn't there be some consideration for this attribute in your calculation. I'm interested in the thoughts of those on this board.



Thanks in advance.
 
I'll use actual numbers - if you bought that $1M home in '06, it could be selling for $500k today. It will take a very long time to get back to $1M. So 2 years out, you're not only out your $200k dp, but $300k you'd have to put up to keep your credit clean. As hedge funds and investment banks, and specuvestors have shown, leverage is a knife that cuts both ways. It does magnify your profits, but it will push you quickly to BK on the downside.
 
The easiest answer is this:



if you look beyond today, you'll lie to yourself to get the answer you want.



What number do you want to use? 5% appreciation? 10%?



What about rent increases? 5% a year? 10% a year? rate of inflation?





So just look at today. What is rent? What is PITA? Why? Simple, I can change my decision to rent tomorrow. Changing the decision that you've already bought, not so simple. You have to sell. If you have equity, that's cool. If you don't, that sucks. Then there are all the other costs with selling. Some are necessary, some are common. Will you pay a brokerage? Will you need to do repairs? Will you stage?
 
doob,, welcome.. your numbers look good, just ran them myself... are you in finance or something? There are a lot of elements you touch upon. I can go into an expansive analysis with excel spreadsheets, if you want but this will be a short response. Basically you are right, in RE, time does heal all wounds. But there are two types of RE markets, linear and cyclical. Linear are markets that simply track inflation and t-bills, non sexy places, that no one knows about. Ours is of course cyclical, with peaks and valleys close to rental parity. It will matter which 10 year period you buy here.



Now levereging, you can get 35%-70%+ rates of return on RE when you borrow, 80%-90% of the value of the home. Now two scanarios here... Primary Residence versus Rental Property. Like your example above, the returns on a Primary Residence is not too good, you forgot Taxex, Mello-Roos, HOAs, Insurance, Maintenance, etc... the returns are certainly better if you just put it in a CD... BUT run the same numbers on a Cash Positive Rental Property and you can see 50%+ yields on your down payment. A Linear area where you can get 1% Rent-To-Value ratios (ex: $150,000 value - rents for - $1,500 / month) would be great for investing (the IE)... I hope this helps... again welcome, we need a good number cruncher like you around here... stick around!
 
[quote author="roundcorners" date=1248692837]Basically you are right, in RE, time does heal all wounds.</blockquote>


rc - Very close. In RE, time <strong>wounds </strong>all <strong>heels</strong>.



-IrvineRealtor
 
As the others have mentioned, currently appreciation is dead. We are currently falling and it maybe 3-5 YEARS conservatively before things turn around. If you can purchase FAR below far (CASH) then you might have a good change at turning things around. But currently its a difficult proposition to do right now.
 
[quote author="IrvineRealtor" date=1248697573][quote author="roundcorners" date=1248692837]Basically you are right, in RE, time does heal all wounds.</blockquote>


rc - Very close. In RE, time <strong>wounds </strong>all <strong>heels</strong>.



-IrvineRealtor</blockquote>


nice,, got to remember that... yes housing is your biggest liability.. it is a fact of life expense; can't count on it to make money for you... it's just a place to live, and it will cost you... even if you "rent and invest the difference". Appreciation is bonus in the short run, and almost for certain in the very long run... but you got to be able to hold out through the tough years...
 
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