Here’s why real estate is still a good investment.
As I’ve mentioned before, our Southern California real estate market (as well as the economy) is super hot and roaring back post-pandemic. In light of this trend, a lot of people are asking me whether or not we’re headed for a housing crash. Is real estate still a good investment? If you own one or more rental properties, the good news is that they provide predictable growth in an unpredictable market.
There are four terms you need to keep in mind: cash flow, amortization, positive leverage, and appreciation. Of these four terms, you can control three: cash flow, amortization, and positive leverage. The only thing you can’t control is appreciation. I’ve said in previous videos that appreciation in Southern California fluctuated between 6% and 7% from 2016 to 2018. In 2019, it dipped slightly below 6%. From 2019 to 2020, we saw a big jump. From 2020 to 2021, we saw double-digit appreciation. From 1985 to 2015, appreciation averaged roughly 6.5%.
Since you can’t control appreciation, we must remove it from the equation. Your cash flow is when the rent of a property you own pays for its mortgage, taxes, insurance, maintenance, and any other expenses that come along with it. Amortization consists of your principal and interest. For each month that your tenants pay your mortgage, you lower your principal and loan balance and build up your equity. After 30 years, the 25% you put down eventually results in 100% ownership of the property, or an increase in equity of 400%.
When it comes to positive leverage, we know that 25% eventually results in 100% control. Why is it called ‘positive,’ though? After five or six years, you should have a lower loan balance and your appreciation should be greater. At this point, a lot of people choose to cash out. Cashing out is fine—I do it all the time—but you have to make sure when doing this that your cash flow is positive (hence, positive leverage). Once you have control of this, you have predictable growth in an unpredictable market.
Stay tuned for my next video where I’ll share some specific numbers on attaining predictable growth in an unpredictable market. If you have any questions, feel free to reach out to me. I’d love to hear from you.