Valuing Real Estate Return on Investment Calculation (ROI)

Buying a house (Before 2000) Consumers required to put a 20% down payment For a $500,000 home: $100,000 down payment & borrow $400,000 (mortgage) $400,000 fixed rate loan paid back over 30-years Loan is less than the value of the house So banks take very little/no risk of default

Methods to Value Real Estate Rent vs. Buy Analysis Compare monthly cost of renting vs. buying property Calculate tax advantages ROI Investment Property Valuation Assume you pay “cash” for property Calculate an implied % rate of return (roi) Compare to other investment options: bonds, stocks, etc… $500,000 Condo for sale

Rent vs. Buy Analysis Compare total cost of loan including all expenses vs. rent for property Consider job stability, level of savings, expected time period Consider transactions costs, tax advantages, etc… (6% real estate fee to sell) Total Expenses per month Mortgage: $1,200 (260,000 mtg @4%) Prop. Taxes $500 Homeowners $200 Ins. & Maint. $300 Other $100 Total = $2,300 per month If Condo Rent = $2,500 Condo is “too cheap”. Buy it! Tax deductions make true cost of condo, about $2,000 per month

Investment Property Valuation Total Expenses (Costs) per month Mortgage: $1,900 (450K mtg @3%) Prop. Taxes $500 Homeowners $200 Ins. & Maint. $300 Mgt. Fee $100 Total = $3,000 per month Rent per month= $2,500 $600,000 House for sale Valuation of Property: Assume you pay cash (no mortgage!) Subtract mortgage from expenses -$3,000 – 1,900 (mtg) = -$1,100 expenses per month Rent = +$2,500 income per month ============================================== Positive Cash Flow = +1,400 per month or $16,800 per year $16,800/$600,000 = +2.8% Cap or ROI Compare Alternative Investment: Pay $600,000 10 year Gov’t Bond @3.0% Cash Flow = +$18,000 per year Corporate Bond @ 5.0% = +$30,000 per year Stocks? Bottom Line: This property is too expensive Look for properties with higher ROI!

Return on Investment Worksheet