LEVERAGE is a word that real estate agents and other experts throw around, and prospective buyers smile and nod. But do they really "get"it? I don't think so, and that's why I put together a hand-out several years ago, featuring these charts (along with a prominent disclaimer that they are for illustration purposes only and not a prediction or guarantee).
In today's market, as real estate values are going down and prospective buyers are wondering if $10,000 invested in a home is really a good idea, I think it's more important than ever to explain leverage - and to put it in the context of 10 years. All the narrative that follows is not in the handout, it is how I explain it, as we go over these charts and a third one illustrating a rent/own comparison.
While I have no crystal ball, and certainly can't make any predictions or guarantees, most people agree that real estate goes in cycles - with ups and downs in the market. Over a 10-year period, measuring from start to finish, it's reasonable to anticipate that real estate values will go up, even though there may be some downs during the intervening years - such as we're experiencing right now.
For the sake of this example, let's use 5% as the average appreciation or inflation rate, and assume the same appreciation rate for $10,000 invested in a home compared to $10,000 plopped into a savings account.
Since it is the asset which appreciates (not the cash investment itself), the $10,000 invested in a home has the potential for much higher return, based upon compounding of the asset's value.
Naysayers will point out this doesn't take into account the cost of selling that home before you can realize any return on investment.
That's true, but it also doesn't take into account the equity growth through 10 years of mortgage payments; if you're going to count the cost of sale, you gotta count the equity growth, as well.
You could carry this to another step, comparing the cost of owning vs. the cost of renting, but I'll save that for another day. I actually do use the three charts together on a single page.
So much of today's training for real estate agents is based upon the use of technology for marketing.
In the "old days" we relied more upon hard-core knowledge such as this - solid information shared with consumers. The handout I copied this from was created on an old-fashioned typewriter, and the only graphical interest was red headings - possible because I had a super-upgraded typewriter with two colors of ribbon. Yet it got the job done, because it was information that consumers wanted.
May I suggest that today's consumers are more educated and detail-oriented than ever, and they "get" the power of leverage when it is explained to them. It could be the very thing that gives someone the confidence to buy a home instead of renting.
_______________
_______________
For more information about Leverage and all things real estate, contact Margaret Woda, RE/MAX Vision. (mwoda@remax.net)
Copyright 2006-12. All rights reserved.
DISCLAIMER: Information contained in this post is deemed reliable on the date of publication, but it is not guaranteed and it is subject to change without notice.
__________________________________
Margaret Woda, REALTOR and Associate Broker
Direct: (301)346-2923 or click on EMAIL
FREE home search online (No registration required)
FREE home search APP for your iPhone/iPad (demo)
FREE online relocation information
Check my reviews on Zillow
Long & Foster Real Estate, Inc., 2191 Defense Hwy., Crofton, MD 21114 (410) 721-1500
Margaret, this is something that I certainly discuss with all first-time homebuyers who may be on the fence about purchasing and weighing their options. The power of leverage is astounding! Very nice illustration in this post.
Margaret, owning vs. renting, putting your money in investments vs. real estate is so dependent on the times, economic cycles, location of the property. I have easily seen people live in homes ten years and have to write a check at closing because of values that have declined. In other areas of the country people have lived in a home two years and made a handsome profit. It is very hard to figure out some times with real estate.
Hi Margaret,
You explain things in a way that is easy for people to understand. Your charts are clear and precise and certainly gives me an incentive to do some of my own and use with my clients. I'm sticking with you, I learn so much from you.
Gary, I daresay that anyone who has to write a check at settlement after owning their home for ten years has probably already taken out equity through refinancing or a second mortgage. If the market declines after they do that, it doesn't mean that leverage didn't work for them - it means they gambled and lost.
Brian, glad you like it. And congratulations again on your Week 3 win in M2T.
Cynthia - While it's important to make sure they understand this is for illustration and not intended to predict what THEIR return will be, I do think it's helpful for consumers to see something in black and white instead of dealing with abstract concepts.
Morning Margaret,
Great post and examples. Seeing your example on paper should help convince the fence sitters property is the place to put their money.
Margaret,
Love the post and the illustrations as well.
Nice job, Margaret... The bottom line is that real estate is still a good investment... and this clearly shows why. Nicely done!
Margaret, the situation I am referring to has to do with being in areas where prices decline over time. It is much more typical in the central U.S. vs. the east or west coast (Michigan, Texas, Utah, Indiana). Places where economies have soured, new builders are out of control, or unlimited land. What typically happens is a buyer buys a house say for $150,000 at the peak of a sellers market. They religiously pay on their note for ten years gaining some traction but because they sell in a strong buyers market with distressed properties and HUGE inventory of pre-owned and new homes all around them their house may sell for $135,000. With the closing costs on each end, foundation problems, even with no home equity loan or refinancing along the way, they do indeed have to write a check at closing. It is more common than one might imagine. I do agree they gambled and lost. It is the same effect we are seeing with the short term gambling and losing with the investor flippers in Florida and Las Vegas who are upside down in their loans in terms of value. But your leverage point is correct. It just doesn't apply in all cases. Sometimes being a renter and doing something else with the extra cash makes more sense. But none of us has a crystal ball.
Margaret - Another great example of your great posts, and your willingness to help all of us be of better value to our customers. Thanks!
Margaret,
I have buyers currently sitting on the fence, so thanks for this useful info.
Marcela
Thank you for the great post, Margaret! At least 6x per year I have a first-time home buyer who is on the fence and this is an excellent way to show them how their hard-earned money can work for them. The charts are very powerful. I know that one of the other respondees felt that real estate is not a sure thing -- but I think it is one of the safest bets. If the potential buyer invested $10K in the stock market a few years ago, where would they be now?
Great post Margaret. I agree. I do the cost of renting vs. the cost of owning. I have to whip that one out again and put it on a blog and not just keep it for clients I'm actively working with.
Margaret: Perfect timing (well, it's always good timing) for this post! Thanks. ALL the fence sitters need to read this.
Hi Margaret, Excellent post. I think your premise says it all - People may smile and nod in agreement but they really don't get it !
What a helpful portrayal in very basic terms.............impressive - thanks for sharing in a way our clients can understand!
Thanks for making clear and concise points. You are dead on right.
Aloha,
Keahi
Indeed. Leverage is what has propelled wealth building for the average home buyer for generations. Unfortunately, too many home owners these days, when they have equity, they spend it.
Margaret - great illustrations. Even with an appreciation much lower than 5%, there are still very strong benefits to owning the home.
I see you did calculate in the fact that there will actually have been 10 years of payments towards the mortgage during this time, instead of 10 years spent on rent - that's important too.
So according to your numbers, buying the home results in a 571% return on the original 10,000 investment, versus a 62.8% return on the savings account. Of course these are all just sample numbers, but they do illustrate some good points.
Margaret- I was going to flag this for a feature, then I saw your gold star. What a great and easy way to explain investing in real estate. I love those typewritten charts, so simple! Thanks for sharing.
Hi Margaret - I love this post because it shows what all potential buyers really need to see and think about. I like the charts you used to show the future potential value. Many people are more visual and this certainly shows them what that $10,000 in different places has the potential to do for them.
Now that I've seen this post, I may just have to go and create my own visuals to help get this point across to people I work with. You're right - it sure beats the bank!
Ann
If someone's owned their house for 10 years and has to write a check at closing, I'd venture to guess they've been using their home as an ATM machine - ka-ching ka-ching ka-ching.
Ann
Great post, super attack for the on the fence buyer. Nice work!
I'm new to the Active Rain network and just kind of looking around. I'm really impressed by this post. Well thought out and skillfully presented.
Thanks for your time to offer commentary with an interesting twist!
An excellent post Margaret and glad you got all the numbers to add up. It makes for a compelling argument. More people should use this example in their work , especially with new Buyers, but most never did the math,lol. Back twenty years ago in Real Estate Principals Class we have a similar example. Saul Klein ( e-PRO ) was my instructor. I learned form the best.
Margaret,
Nice job in an easy to understand explanation of leverage. The numbers represented sells itself with your super cool dual color typewriter.
MARGARET - You've given us all another tool to help guide buyers off of the proverbial fence. This is important for buyers to know, as is the fact that timing the bottom is nearly impossible, and if interest rates rise, even half of a point, and the home decreases by another $10,000, the monthly payments will actually be higher in most cases.
Hi Margaret,
Just popped back over to say, well deserved Feature. If this didn't get one, what would? :0)
BTW, I'm going to be away from AR for about 1 week so hold down the fort and keep the troops in line.
Wow, thank you for the gold star! And thanks for your comments, everybody. Given the huge time commitment of the Makeover2Takeover Contest, I'm going to focus on reciprocating comments on YOUR blog instead of commenting on your comments here. I hope that's okay. There are only so many hours in the day, and that contest is really putting a dent in my ActiveRain time.
Margaret - Hear! Hear! This is great core real estate information. Nicely done - congrats on the feature, too.
Margaret, This post is the reason I read your blog regularly. Great information and an easy back to basics chart. Congratulations on the feature.
Making the "M-word" (math) less scary is a difficult thing to accomplish. Congratulations, you did it!
Very nice job of breaking it down to a basic level.
Margaret,
Thanks for the great post ~ very useful information and presented in a way that everyone can understand. This is great info to have as a Newbie Realtor.
Margaret.... BINGO! Another awesome post...full of great info and tips for us "newbies" of 5 years or so! A perfect way to talk to someone on the fence!
Thanks for your posts, tips, and inspiration! (Tomato is yet to come....a few more closings would help!) LOL!
Margaret, I too read your posts regularly; you are an impressive lady and mentor (whether direct or indirectly touching others lives) We (my husband and I ) were just at a Nouveau Riche University Meeting last evening with many other investors in our community as well as curiosity seekers and the "meat" of what our message was is the main thread in and through out your woven blanket of leverage education. LEVERAGE, an important word in our Real Estate Professionals Dictionary; learn it friends.........it CAN and WILL take you far. thanks for sharing Margaret
Point well taken...now if you could just find a magic pill that would get the late 20 to early 30 something year olds to think past today, that would be just grand !
Thanks. This is really a great post and valuable info to help realtors help potential buyers.
Im going to use this space to respond to an anonymous emailer who challenges the idea of making money with a 5% appreciation while paying 6% interest.
Let me point out that the 5% appreciation is on a value that compounds over and over for ten years, while the tax-deductible 6% interest is paid on a loan balance that goes down every month for the same 10 years. Between the 10 years of tax deductions and equity growth through paydown, not to mention property value appreciation which usually occurs over any 10-year period, leverage generally works to one's benefit, even when the disparity of interest rate and appreciation is much greater -especially when compared with plopping the same money into a savings account and paying ever-increasing rent over the same ten years.
The greater the asset size, the greater the appreciation. It's as simple as that! If you don't understand these examples, sit down with any financial planner who would probably be happy to discuss your specific situation as it relates to the financial aspects of rent vs. buy and the power of leverage.
You really nailed the explanation on the power of leverage home. I hope to take a cue from you in my next mortgage planning presentation. Great job.
Hans Iduma
Margaret - Your post and especially the charts really simplfy this concept. Owning a home is like using the leverage of stock options without nearly as much downside risk.
-Al