What is my return on investment?
 

If I buy a house without using any of my own money (No money down)... what is my return on investment? Infinity?

Serious question. I'm having trouble figuring this one out. :)

- Adam.




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Re: What is my return on investment?
 

> If I buy a house without using any of my own
> money (No money down)... what is my return
> on investment? Infinity?

No such luck.
You borrow X amount of dollars.
BUT you have to pay it back.
It's not a gift.

So if you pay back 7% (interest rate) of your total borrowed money in a year,and the property has increased by 10%, you made 3% of total borrowing LESS expenses during the year.

Figure another 1% on top of the interest rate you are paying back for maintenance, management etc.

If the property decreases in value short term AND you have to sell, you lose money.

Infinity means you get a gift and don't have to pay back.

But the beauty of this increase in property value is the 8th wonder of the world--compounding. Basically, the longer you wait, the more you make exponentially (not linear!!).

Cheers,
Tom B.

Re: What is my return on investment?
 

> If I buy a house without using any of my own
> money (No money down)... what is my return
> on investment? Infinity?

> Serious question. I'm having trouble
> figuring this one out. :)

I think there are several ways to look at this.

You could say that if your investment is zero, then by definition your return on that investment is infinite, as you have made money from no money down.

I think it's a misleading way to look at it though. I'll compare it to looking at buying a stock.

Let's suppose you purchase some stocks for $10,000, and a year later you sell them for $11,000. You have made $1,000 profit, or 10% return on your $10,000 invested.

With $10,000 as your base figure, it's also clear to see that the maximum you could have lost is your $10,000 investment.

When looking at property, if you are looking at "no money down" deals in most scenarios you can't draw a similar conclusion. Whereas you may spend $0 in cash upfront, in most cases you have taken on an obligation and thus the maximum you can lose is not the $0 cash payment but the extent of your obligation.

Thus comparing a leveraged "return on equity" to an unleveraged "return on assets" is not strictly comparable. Or at least I don't think it is. :)

I personally would try to look at the operating characteristics of an investment (rental yield, ongoing costs etc) seperately to the financing of that investment (debt versus equity, interest rates, etc).

If you have a highly leveraged investment, I'd be mindful to do a sensitivity analysis so you're aware of how a change in interest rates may affect your investment.

Interest rates have gone down for quite a while, but if they increase this may cause problems for highly leveraged investors with variable rate loans.

Just as a quick example, in Australia you can borrow at a variable rate of 6.56% right now (National Bank). If you took out a $400,000 home loan (100% debt, funded by an existing house perhaps) for 25 years at that interest rate, your repayments would roughly be $634 per week.

If interest rates increased just 1% to 7.56%, repayments would jump from $634 to $694 per week, which is a 9.4% jump. A 2% rise in interest rates would lead to a 19.1% rise in repayments.

These jumps can be significant if you're investing on the premise that you can earn the spread between interest rate payments and what the property returns, as in most cases this will be a fairly narrow spread.

- Thomas.