Most of the 1990’s, The Standard & Poors Index posted earning yields of 5% to 6% on average. At the same time, the dividend yields of the S & P were only around 2% or less. Since dividend paying stocks tend to be much less volatile, the gains on the appreciation side would not normally be a significant factor.
At the same time, bond yields taken as a composite, showed only around 5% returns. Better yields were riskier, while safer bonds returned lower yields.
During the same time period, real estate investors were realizing much more attractive returns due to the multiple income streams from real estate investment:
•Rental yield – This is the percentage yield from direct rental income, and can be calculated as either gross or net. Experienced investors prefer to calculate the Net Rental Yield (calculation detailed here), which takes the expenses, taxes and other costs into account, and divides by the property value/cost. It could be a negative cash flow, as it doesn’t take mortgage payments into account. For this reason, many investors prefer to look at Cash-on-Cash rental yields. The example at the link shows a 6.4% example return on cash invested. Though the investor can purchase and manage for a yield on this single component that exceeds average stock or bond dividend yields, it is only one of the ways in which real estate returns on your investment.
•Appreciation – Rental properties normally appreciate in value with inflation. Increased value can mean sale and reinvestment in higher value properties, or provide an equity line of credit to use for other investments. This is the second, and a historically proven value component of real estate investment return.
•Inflation is Rent-Friendly – Rents usually increase with inflation, while mortgage payments on the property remain stable. This increases cash flow, with more rent income without increased expense for holding the property. When inflation is up, it can also mean more renters, as the affordability of homes can be negatively impacted by inflation. More renters increases demand, so rents can escalate.
•Leverage – Using leverage, while being careful to buy properties with good rental yields, provides greater returns. Using $100,000 to purchase three properties with down payments, instead of one for $100,000 cash, can greatly increase returns. Of course, all leverage involves risk, so the successful investor must understand how leverage impacts their real estate investments.
•Paying down the loan – Amortization, or paying down the loan, frees up more investment resources to increase leverage. Some investors use increased equity in one property to free up funds to invest in others.
•Property improvement for equity – Many investors intentionally purchase properties at a value because they lack some feature or could use some improvements in condition or amenities. They have calculated that the value of the improvements will exceed the cost, resulting in an immediate increase in equity. Get more information on ARV, or After Repair Value.
While stocks and bonds are inflation-sensitive, and they typically involve only value appreciation potential and low or non-existent dividend/interest returns, we see here that real estate provides multi-faceted investment returns.
Author: James Kimmons