Investing in Real Estate - a financial perspective

The question this article tries to address can be phrased in many different manners - should I invest in real estate, should I buy a home ? or can my home give me money in the future ?

Some of the examples shared below are from a Canadian home owners perspective and might apply more to a North American real estate market.

The Story

Let’s say you are planning to buy a home. Through year’s of hard work or shear luck you have managed to save enough money for a downpayment. Now you are faced with a question of whether to buy a home or not and if you do want to buy a home then what should logically be the most amount you should be ready to pay for it.

This last part is a little tricky because your home could be generating some income for you even while you live in it thus increasing the amount for which you can buy a home. I will try to cover this scenario as part of a calculator I have created to identify if a property is a good investment property or not.

To buy or not to buy

We will determine if a property is worth buying by analyzing the money it costs you to own the property and if you were to sell the property in a year or 2 or more then would you be able to get an amount for this property which at the very least would equal the cost of owning this home.

Ideally we would want this number to be higher than your cost of owning by the yearly inflation rate at a minimum.

The approach

I have created a tool which lets you identify whether buying or maintaining a property would be a financially sound decision or not. This tool requires a number of inputs from you and I have divided these inputs into 4 parts:

1. Cash outflow while purchasing a home

2. Recurring cost of your loan

3. Property Maintenance Cost

4. Capitalization Rate

Cash outflow while purchasing a home

There are 3 fields to input here

1. Loan Amount - This is the total loan amount (including mortgage default insurance if applicable) which has been issued by your lender

2. Total cost of home - The amount for which you hope to purchase a home or have purchased a home

3. Downpayment - The upfront one time cash payment you hope to make as part of your offer or the upfront one time payment you have made when you purchased your home

4. Other cash outflows to close the sale - These are cash expenses which might be upfront costs or closing costs but are not included in the total mortgage amount
   

Recurring cost of your loan

There are 3 fields to input here

1. Yearly Interest - If you have an outstanding loan then this number would have been provided to you by your lender. In case you are looking to purchase a home then you can find a banks mortgage calculator which provides you approximate fixed rates for a mortgage or use your best guess for current fixed rates or reach out to a bank representative to get a rate.

2. Loan Tenure - The amortization period is also something which your lender would have provided you and if you aren’t sure and live in Canada or United States then 20 or 25 would be a good starting point for this tool

3. Total Monthly Payment - This is your monthly mortgage payment including your monthly property tax payment (which would usually be deducted by your creditor). If you haven’t purchased a property but are looking to purchase one then input the approximate loan amount, potential interest rate and tenure in a mortgage calculator (the one on calculator.net is good). This should provide you with a total monthly mortgage amount (it might not include a property tax amount, you can look at the yearly property tax for the property you are looking to purchase, divide it by 12 and add it to this amount). A property’s yearly property tax amount is available on MLS.

Property Maintenance Cost

There are 2 fields to input here

1. Monthly Income generated by the property - If your property generates any monthly income or you expect the property to generate a monthly income then input that figure here. The calculator will multiply this figure by 12 to compute a yearly income generated by the property

2. Yearly Maintenance Cost - This figure should be the money you have spent or expect to spend on a property to maintain or improve it, an example could be furnace tune up cost or installing an EV charger etc.

Capitalization Rate

There is 1 field to input here

1. Expected % year on year growth rate - This is the % figure by which you expect the property might appreciate. For ex. you might take a conservative approach an assume that your investment would just be able to beat the rate of inflation over the next 1, 2 or 3 years so you can input 5%. You can also input any historical growth rate or any rate which aligns with your expectation of the real estate market growth in the future.

Outcome

This calculator provides you 2 insights:

1. Break even value of your home - This is the amount for which you would need to sell your home at the end of a year in order to not loose any money on the property. This is computed by factoring in all the money you have or would have spent on the property by the end of a year.

2. Profit amount after an expected growth rate is provided - If you expect your property’s price to grow by a certain % then this figure will tell you whether you would break even or not on this property in a year given the break even value of that year

I hope this calculator will help you understand if the price you are willing to pay for property is a financial reasonable one or not. If you are not making a profit on your investment given the cost and income which would come with the property then perhaps the price you are willing to pay is on the higher side and the property might not make you a profit in the 1-3 year period (which this calculator covers).

You can download the tool at:

https://docs.google.com/spreadsheets/d/1OBacuOju2jslYuaFQu0t-9UOjqHhrmNU/edit?usp=sharing&ouid=115151366534881479211&rtpof=true&sd=true

Stay tuned for more insights and tools. All the best.