Sunday, January 20, 2013

Rate of Return (ROI) on Investment - Real Estate Apartments

I have  been recently contacted by a reader asking for a help to analyze results of investing into 2 condominiums (apartments).

Here is the input data (story):
Apartment #1  (Apt. #1) - initial investment $ 56 K back in 2005 and additional amount of money in 2010 - $170 K.
Apartment #2 (Apt. #2) - investment $ 170 K in 2010.

The questions are:
 - Whether the investment in the real estate worth it and what is rate of return (ROI)? 
 - What to do next - sell them or keep as rental properties?

Rate of return (ROI)  results are presented in table below:
In today's money inflation adjusted cumulative investment in Apt.#1 is $ 266 K, Apt. #2 - $ 192 K.   This you would have if you would put  money in TIPS (Treasure Inflation Protected Securities).

Should the same money had been invested in an S&P 500 ETF the value would be $540 K, if the reader  invested in Apple ®  net worth be $4,364,000.

Market value of  the apartments today is $ 466K and $200K.  Difference between  investing in S&P 500 and the market value $ 126 K.   Apt.1 is generated annual  return of 9% above inflation rate, while Apt.2 only 1%.

The next question is - to sell the apartments or rent them out?
Current assumptions :
- Occupancy rate. Apartment is rented out 11 months a year.
- One month rent is paid to an agent - apartment management.
- Income tax on the rental money - 15%.
- Condos have to be totally redecorated every 10 years. Redecoration cost for Apt. #1 is $ 35 K, for Apt. #2 is $25 K.  This would mean putting aside annually $3.5 K and $2.5 K towards it, accordingly. 

It has to be noted that it is common in that area that tenant is paying monthly rent, while the landlord still in charge of the utilities (electricity excluded).  That is why they are included in the calculation.

Apartment #1 (Apt. #1) renting out table: 

The apartment would require additional $ 65 K on redecoration.

Apartment #2 (Apt. #2) renting out table:
The apartment would require additional $ 75 K on redecoration and parking lot.

On one hand rental income provides only 1.3-1.6% returns on the investments. Low - yes. This is inflation protected income.  The calculation  does not take into account fact that apartments will most likely rise/appreciate  in price over the time. It is hard to predict but historically there is capital gain.

So for this particular scenario I would keep the apartments and rent them out.  However each and every situation /position is unique.  Should they be mortgaged  it is questionable whether the apartments would  worth it (depends on mortgage rate, buyer person circumstances, etc). Investor would be gambling on the property appreciation, rather than income. This is not a financial advice and you do need to seek professional help/support to seek right solution for you.

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