Real Estate Purchased for Growth With a Mortgage

by Ernesto R. Martin1

2022 CAVEAT: Please note the comments in red below, because with mortgage interest for investment properties at 7% - 8%, the investments described here may no longer be advisable.

The analysis that follows is intended for someone who is looking for growth rather than income, and is considering investing in an apartment to rent out. This could be in lieu of stocks, or even better, in addition to stocks, so you have a diversified growth portfolio that includes stocks and real estate.

In this case we'll be looking at financing part of the purchase with a mortgage. This works well for someone who has limited cash and also for an investor with cash who wants to use leverage to maximize returns (more on this later).

Here I looked at buying a $200,000 2-bedroom/2-bath condominium2 for rental in the Miami area with a $50,000 down payment and a $150,000 30-year mortgage of about 5.5% interest (7% - 8% in 2022), lenders typically require greater down payment and interest for investment property, compared to an owner-occupied property).

An analysis can be done where you purchase duplexes, and the results are similar to those shown here. In Chapter 5, where we actually run some examples, we'll go through the numbers for BOTH a condo and a duplex.

The resulting monthly income would be $950 after allowing for condominium expenses such as maintenance fees, property taxes and repairs, and for vacancies (details here) but before the mortgage payment and the insurance required by the lender. When the mortgage and insurance are considered, you have zero cash flow (i.e., net income and all costs balance out); for the calculations and further details please go here.

However, your gains over time are considerable because of the appreciation of the property, and it's forecast to deliver an annual return between 8.45% and 10.35% on your investment over the 30-year period of the mortgage. That's comparable or better than the S&P 500 stock market index, which has had an average annual return of 6.1% over the past 20 years, and 9.7% over the past 30 years (details here). This is partly because you're leveraging the lender's money, namely that your property -- all of your property, initially $200,000 but increasing with time -- is appreciating but you only invested $50,000.

An additional advantage of this real-estate investment, which has a bearing on your return, is that it's likely to reduce your taxes on other income. Typically, when you add the depreciation of the property (the reduction that is allowed for tax purposes in the value of an asset with the passage of time, even though the property is appreciating) to your related expenses (including mortgage interest), the investment shows in your annual income taxes as a large loss, thereby reducing the total income for the year -- in effect shielding some of the income from other sources, like your salary. So, considering this end-of-year tax savings, the above returns (8.45% - 10.35%) are comparable to a roughly 10% - 12% return from investments where the gains are taxable (income from corporate bonds are fully taxable, stock gains are taxable at a 20% rate if held over a year).

In short, for this example, the apartment-for-rent investment is comparable or superior to an investment in an S&P 500 stock market index mutual fund, and significantly superior on an after-tax basis, with less volatility. I have been too lazy to analyze the return at the 10 and 20 year points, before the mortgage is paid off, but I expect that the results will be similar. The returns presented above are in table format below. Although I stand by it, at least one person finds fault with my comparison of this real-estate investment with an S&P 500 stock investment (details here). Note again that this is with 5.5% mortgage interest; although rents have increased, it's not clear they would defray the higher mortgage interest of 7% - 8% in 2022, and the results may be significantly worse.

It's important that you return to the Real Estate page and read the last section with important information on other forms of real estate investments, some of the downsides of the investments described here and ways of mitigating them. Also, make sure you read the next Chapter, entitled Go Invest, where I take you by the hand and help you find the right properties to buy.

1 I am NOT an investment professional -- I'm an aerospace engineer with a Master's from Caltech who drifted to the business side and spent the last half of my 30-year career dealing mostly with financial matters. After retiring I've spent the last 20+ years investing in stocks, bonds and real estate. Although this was first updated in October 2019, I've been reviewing it regularly and make changes/additions in RED when warranted. The views expressed here are mine and at times may depart from the norm. In preparing this article I first read several articles, and ideas or phrases from those articles may have unintentionally crept into mine; I am happy to remove any plagiarism if alerted.

2 I chose a $200,000 condo because I've found that somewhere in the $200,000 to $350,000 range (in 2022 $300,000 - $450,000) is the sweet spot for good returns without excessive hassles; more on that here).