The Right Way to Own Real Estate
By Michael Eastham, CPA CRMS

During my career I have heard many people say that “owning real estate has been the best investment I ever made”. Although we want that to be true and it sounds like it should be true, it is actually a common misconception.

Allow me to show you exactly what I mean. If you had purchased a piece of real estate in 1990 for $250,000, then sold it in 2003 for $600,000, you might be quite thrilled to boast that you received a gain of $350,000, which is 140% total return or 10.77% per year. However, if you compare that return to the Dow Jones Industrial Average during that same period, you would discover that that index grew from 2,590 to 9,188, which reflects a gain of 255% or 19.6% per year, far outpacing your real estate. Which would you prefer?

The reality is that Financing the real estate was actually the best investment decision you ever made. Let me explain. I will assume that when you purchased the real estate back in 1990 for $250,000, you put down 20%, or $50,000 towards the purchase and took out a mortgage note for the balance. It was your $50,000 that produced the $350,000 profit; that’s a remarkable total return on investment of 600% or 46.15% per year, outpacing even the Dow!

For comparison sake, let’s look at another example. Let’s say that I have $250,000 sitting in a money market account, earning 6% and I am considering the purchase of a piece of investment real estate. If I only use $50,000 and take out a $200,000 mortgage, what happens to my net worth after 15 years? If I assume a 5% appreciation rate, my real estate value has increased to $520,000 and the remaining $200,000 in my money market account has increased to $491,000 for a combined total asset value of $1,011,000. If I pay off the mortgage at that point, I will have a net worth of $811,000. Compare that to my net worth if I pay cash for the real estate; what do I have? I have a net worth equal to the value of the real estate, $520,000. That’s a difference of $291,000, simply by choosing to finance the property. Not only that, but although I only earned 6% on my cash in the money market account, I was able to amass a handsome 540% return on my $50,000 investment or 36% per year, which is substantially better than the 6% earned in my money market account.

Did you notice earlier that I said “IF I pay off the mortgage”? That was intentional, because once you understand the power of this strategy, you begin to see how a mortgage truly is a financial planning tool and how it can be used to create significant amounts of wealth over time, giving you no reason to want to pay the mortgage off; EVER!

That is why successful investors and business owners use Other People’s Money or OPM to purchase real estate; they recognize that substantial returns can be earned, even if the property is leveraged. Additionally, if you had to pay cash for a piece of property, it would take years to accumulate the amount needed. In fact, our ability to own real estate would be substantially diminished. Those people recognize the power of safe, positive leverage; keeping money at work, making more money over time.

When it comes to owning real estate as a part of your overall investment strategy, it is critical that you have a clear understanding of how money works and how to best structure the transaction so that it truly is the best investment you ever made.

Michael Eastham is a CPA, CRMS and is the host of the radio show “Your Home, Your Money,” which airs Saturdays at 12:00 p.m. , Saturdays at 1:00 p.m. and Mondays at 4:00 p.m. on The Clear Channel and Salem Radio Networks.