The key to real estate investment is leverage. For a starter, do check out this article here to understand the Return On Investment (ROI) % generated from rental income.
What we are talking about below is how your age affects cash-on-cash return %.
Bank Loan And Leverage In Real Estate
The amount of loan you can get translates to the amount of leverage you are obtaining. Henceforth, one important thing to keep in mind is the way banks assess the loan amount:
loan amount increase as income increase.
loan amount decrease as age increase (or loan tenure/duration decrease).
It is critical to understand how the second point can affect our potential ROI in the future. Consider below scenario.
Real Estate Leverage Case Study
For simplicity, assume that your income is $6,000 when you are 35 years old and remain the same till you retire.
Assume no capital appreciation of the property. Also, assume a rental yield of 3%.
We can observe that because of the decreasing loan as you age; there are 2 scenarios that can probably happen:
Case Study 1: Same Value Of Investment Property
As you age, due to the decreasing loan, more capital outlay is required, to invest in the same property value of $1mil.
Because of decreasing leverage in the real estate, average cash-on-cash ROI % decreases. Of course, accumulated total rental decreases as well due to shorter investment horizon.
Chart A – Same property value of $1mil considered for investment at different age
Case Study 2: Decrease Value Of Investment Property
Consider reducing the value of the property to match the decreasing loan amount as you get older. While the ROI% can stay the same, accumulated rental is lower than that of Case Study 1. This is due to the shorter investment horizon.
At age 50, indicated by the blue arrow, the loan decreases to about $500,000. Hence, this is probably the last time you can take advantage of the maximum leverage in your real estate investment.
Chart B – Decreasing property value to match 75% Loan-To-Value ratio based on the decreasing loan amount at different age
*Note the actual return is lower for initial years due to higher interest payment. Estimated cash-on-cash return range from 6% – 12%, averaging to about 9% annually. For more information, check out this article here.
Leverage In Real Estate Key Takeaways:
- You can be in a better position in the future for property investment if you plan ahead.
- If affordability is not an issue, you may consider going for a private property to lay the path for future investment property. This will allow you to take advantage of the time and leverage effect to maximize your ROI in absolute and percentage terms.
- Due to the rapid drop in loan amount as we age, the last investment we can make will probably be around 45 – 50 years old. We do not have the next 30 years to take advantage of the real estate cycles. Therefore, commencing your property investment journey early will give you a longer time to grow your wealth ahead of your peers.
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