There are 2 ways to build wealth by investing in real estate:
Equity Buildup: increases your net worth and your real estate assets and comes from the twin forces of prices appreciation and debt pay down.
Download the PDF of “The Financial Model Part One: Equity Build Up”
Cash Flow Growth: provides a stream of unearned income, possible when you buy it right, finance wisely and control your expenses
Download the PDF of “The Financial Model Part Two: Cash Flow Growth”
Adopt the motto: “Buy it right- Pay it down- Pay it off!”
- “Buy It Right“-make your money going in, assuring yourself the best of Equity Buildup and Cash Flow Growth.
- “Pay It Down”- as you do so, you add significantly to your Equity Buildup
- “Pay It Off”- thus ensuring a growing stream of unearned income where your money starts to work for you
The Financial Model Example:
Download the PDF of the “Financial Model: Your Total Return”
Download the PDF of the “Multi-Year Financial Model Detailed Overview: 15 Properties Over 25 Years”
These can happen together where you can benefit from both at the same time. Equity build up increases the net worth in your real estate asset.
While cash flow growth provides a stream of unearned income. You can live on that income. Or reinvest it by paying down your debt or acquiring more real estate.
If you keep your money in-play by re-investing the cash flow (my recommendation), you will accelerate your equity build-up and thus the growth of your net worth.
Remember, your net worth is a measure of your success and your score in the game of financial wealth building.
When you look at equity build up closely. You will discover that it comes from 2 factors:
- Price appreciation
- Debt pay down
If you buy it right, your real estate investment will begin with a margin of equity right away. This means that your initial down payment (your investment), plus the mortgage loan (the debt you occur when added together) will still be less than the price that you can sell the property for (its market value). This difference is your equity in the property.
Over time as you rent the property, the 2 natural forces of price appreciation and debt pay down work together to increase your equity.
If the market value of your property increases your equity in the property goes up. But it also goes up because you’re paying down the debt through the mortgage.
Each monthly payment you make reduces the amount you own on the loan. So if the mortgage debt decreases over the term of the loan (e.g. 30 years, 15 years, etc.), your equity increases consistently.
For example, if you had invested in a residential income property in 1988 at the medium home price of $90,000. It would 15 years later in 2003 been worth almost $170,000. Price appreciation would have gained you $81,000 in equity. But that’s only part of the equity build-up picture. You would have also been paying off the mortgage and thereby reducing your debt.
This calculation of debt pay down requires some carefully considered assumptions.
First, it assumes that you purchased the property at 20% below market value ($90,000 x 20% = $72,000).
Second, it assume that you made a 20% down payment ($72,000 x 20% = $14,400). This means you would have gotten a mortgage loan of $57,000 ($72,000 – $14,400 = $57,600).
As you make your monthly loan payments covered by the rental income of your tenant, you’re paying off a portion of loan remaining balance.
So you’re reducing your debt of the property. As you reduce the debt, you increase your equity.
In this real life example, with a loan of $57,600 on a typical 30-year mortgage, you would have during those 15 years reduced the loan debt to $43,334. And gained another $14,266 in equity build up.
The shorter the length of the loan, the faster you will achieve debt pay down.
In the example we’re using a 15-year mortgage would have reduced the debt to $0 and increased the equity by the full amount of the loan, $57,600.
What makes The Financial Model for real estate investors so compelling is the combined impact of all these factors. This is where the power of real estate to build financial wealth is fully revealed.
In the investment we just analyzed, your $14,400 investment in 1988, turned into an equity of more than $128,506 in just 15 years. This would be like putting your $14,400 in a bank account paying an annual compounded interest rate of 15.5%.
If you had used a 15-year mortgage instead of a 30-year mortgage, your equity would have grown to more than $171,840. That’s like an annual compounded interest rate of 17.9%.
In either case, this is a significant return on investment. And definitely not one you will find at the bank. And those remarkable returns don’t reflect what happen when you factor for cash flow. Net cash flow is achieved from a real estate investment when what you receive is more than the cost you incur.
CASH FLOW GROWTH
As good as all this Equity Buildup is (and it is very good and very real to a Millionaire Real Estate Investor), it is not the whole story.
There is the added benefit of Cash Flow Growth to consider. Net Cash Flow is achieved from a real estate investment when the rental income you receive is more than the costs you incur.
The costs include your expenses, an allowance for vacancy, and debt service (the mortgage payment on the property). All this will be outlined in more details in the section on the Acquisition Model.
For now let’s just say that if you buy it right, finance it wisely, and control your expenses, you can achieve a positive Net Cash Flow.
As rents appreciate over time (historically, they increase at about the same rate as price appreciation), the cash flow will grow.
Once the loan is paid off, the Net Cash Flow grows dramatically because your monthly mortgage loan payment goes away.
In our example of the $90,000 rental property purchased in 1988, we realistically could have received over the 15 years a total Net Cash Flow between $18,000 (if we had a 15-year mortgage) and $34,000 (using a 30-year mortgage).
In 2004, our sixteenth year of ownership, the annual Net Cash Flow from the property would be about $4,600 with the 30-year mortgage.
In the case of the 15-year loan, since it would be paid off, our annual Net Cash Flow would jump to over $9,400.
Let’s add it all up. Beginning with an investment of only $14,400, the following chart reveals the financial outcomes we could have achieved in just 15 years.
You would have increased your net worth by a significant amount in just 15 years with only one investment in real estate.
- What if you did more than one?
- What if you applied the power of this financial model many times?
- What if you made several real estate investments over the course of 15 or 20 years or more?
You would become a millionaire — a Millionaire Real Estate Investor. That’s the point. It’s what Millionaire Real Estate Investors know. It’s where you want to go.
POINTS TO REMEMBER
- Proven models allow you to learn from the mistakes of others as well as build on their successes. The five key models in real estate investing are the Net Worth, Financial, Network, Lead Generation, and Acquisition models.
- Net Worth Model:
- Learn the Path of Money – Money has a path and you must guide it to the places that will yield the greatest financial growth and most substantial net worth.
- Budget for Investments- Stay on the Path, differentiating between what you want and what you need. Make a personal budget and hone the discipline to stick to it.
- Track personal net worth – Keep a household P&L and balance sheet to track net worth over time. Examine your total often, and ask yourself, “How can I make it grow?”
- Financial Model:
- There are two ways to build wealth by investing in real estate: Equity Buildup and Cash Flow Growth.
- Equity Buildup: increases your net worth and your real estate assets and comes from the twin forces of prices appreciation and debt pay down.
- Cash Flow Growth: provides a stream of unearned income, possible when you buy it right, finance wisely and control your expenses
In the next lesson, I’m going to walk you through a real scenario where you can achieve a combined market value of over $2.5 million in real estate properties with an equity buildup of over $1.6 million.
That right! I’m show you the exact steps on how you can become a Millionaire Real Estate Investor with just 15 “buy it right” acquisitions in only 20 years.
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