The pundits write and speak about investing in real estate as a good inflation hedge, but rarely does anyone demonstrate that with hard numbers. Since most assets other than real estate depreciate over time rather than appreciate, I understood the logic of the general statement but wanted to see how that played out in actual numbers. When I evaluate a potential real estate investment, once I’ve gotten past the part where I’ve decided it’s a type of industry/property/tenant that I want to consider, I look at the numbers (big surprise there, eh?).
So, I extended my investment evaluation model to include appreciation over a typical 10 year holding period. My assumptions (based on a deal we were considering at the time) were:
- Purchase price $2.3 million at a 6.5% CAP rate (rental income as a percent of purchase price)
- Invested capital (along with a 4.5% bank loan) – $800,000
- The property is occupied by a single tenant who would pay all the expenses of their business, and take care of the building as well, known as a “true triple net” lease. This was key, because it eliminated the risks associated with tenant issues that occur so often in residential properties.
- They pay small annual increases in the rent, 1.5% in my example.
The results? Cash returns during the holding period, ranged from 6.4% to 9.3% of invested capital per year, totaling 78.4% of invested capital, or $627,000. The equity buildup through paying down the mortgage added $295,000 of return. Appreciation of the real estate itself, at an assumed minimal annual rate of 3%, was $860,000. That’s the part that doesn’t happen when you buy a Maserati.
Total value received over the holding period would be $1.8 million, producing a profit of $982,000, a 123% gain which represents an annual compounded return of 8.3% per year.
…with no bear markets in between.
We are Your CFO for Rent.