Real estate investing, often perceived as a complex venture, fundamentally hinges on two key components: leverage and time. Let’s explore these concepts and examine how they've played out in the dynamic Austin real estate market.
Leverage in Real Estate
Definition:
Leverage, as defined by Wikipedia, is a technique involving using borrowed funds to purchase an investment, with the expectation that the future profits will be greater than the cost of borrowing. It’s akin to using a lever in physics – a smaller input force (investment) is amplified into a greater output force (profit). However, it's crucial to note that leverage is a double-edged sword – it can amplify gains and losses.
Examples in Action:
Example 1:
$400,000 property
25% down payment
3% appreciation
$400,000 home increases 3% in value
$12,000 value increase
$100,000 down payment
12% return on the $100,000 invested
Example 2:
$400,000 property
10% down payment
3% appreciation
If the property’s value increases, the percentage gain on your initial investment is magnified due to leverage.
$400,000 home increases 3% in value
$12,000 value increase
$40,000 downpayment
30% return per year
Conversely, your loss percentage is similarly amplified if the property's value decreases.
If the home value drops 3% then the loss is also a 30% loss.
This is why it is so important to plan on owning real estate over a longer period of time and why you should never have monthly payments higher than you are comfortable paying.
In the second example the purchaser is more highly leveraged and their returns are amplified to the upside and the down side.
The following tables are useful in visualizing the impact of leverage on returns over time. Of course the impact with a decrease in pricing is just as dramatic.
The Role of Time in Real Estate Investing
Time plays a critical role in real estate investments. The longer your investment horizon, the more you benefit from gradual appreciation and the amplifying effect of leverage.
Austin's real estate market is an excellent case study for this principle. Historically, the Austin MSA has been an appreciation market, characterized by rising property prices, and in recent years little to now cash flow for the investor for the first few years of ownership. While there are often implies limited cash flow opportunities, the long-term price appreciation have been significant.
For a glimpse into Austin’s historical appreciation, reference this link for Texas A&M. The average home price for Austin from 2002 to 2023 went from $195,500 to $625,000, an average of 5.7% increase every year. This is not something I would ever expect to repeat itself. While such a rate of appreciation is impressive, it’s essential to approach future investments with a balanced perspective, understanding that past performance is not always indicative of future results.
While the time since 2020 has been unique, the chart below shows the long-term steady trend over 30 years, even without the Covid run-up.
Austin's growth story is a testament to the power of time in real estate investing. Over the past two decades, the city has seen substantial economic and demographic growth. This sustained increase in property values reflects broader trends in urbanization, tech industry expansion, and the city's increasing attractiveness as a residential and business hub.
Practical Considerations for Investors
For those considering an investment in real estate, particularly in markets like Austin, it’s crucial to:
Understand Leverage: Assess your comfort level with risk and tailor your investment strategy accordingly. Higher leverage can lead to greater returns but also increased risk.
Plan for the Long-Term: Real estate investments typically shine over extended periods. Short-term market fluctuations are often overshadowed by long-term appreciation trends.
Stay Informed: Markets evolve, and staying informed about local and broader economic trends is key to making savvy investment decisions.
Consult Professionals: Engage with real estate professionals who understand the nuances of the local market and can provide insights tailored to your investment goals.
Leverage and time are fundamental to real estate investing. They are the mechanisms that can turn a solid investment into a lucrative one, especially in vibrant markets like Austin. Understanding and strategically utilizing these components can set the foundation for successful real estate ventures. Whether you’re a first-time investor or a seasoned veteran, appreciating the power of leverage and the importance of time will be instrumental in your real estate journey.
Our team has created a spreadsheet we call "the retirement estimator" that allows an investor to input a theoretical portfolio of properties and see what their cash flow and assets may be at a future time.
Contact us if you have interest in this we are always happy to share our tools!
Always happy to do the research and be your data nerd, so you don't have to!
Jen
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