In such an overheated real estate market, the traditional social expectations of getting married, buying a house, and raising a family, no longer make sense. Especially when you need to put down hundreds of thousands of dollars just to buy a starter home. Faced with having to pay off student loans this millennial generation can’t go against conventional wisdom and continue renting using one person’s income while investing with the other.
Let’s take a look into two paths a young family might take: saving up to $100,000 to buy a home versus renting a single family home and investing that $100,000 in real estate syndications. We’ll examine the math behind the two scenarios, as well as the potential risks and liabilities of each.
Scenario 1 – Conventional Wisdom – Save Up to Buy a Home
Conventional wisdom cites that the young family of John and Jane saves up money for a down payment and then purchase a home. After they find the perfect home in a decent neighborhood, they put it under a $500,000 contract and put in 20%, or $100,000, as a down payment, excluding closing costs. They secure a loan for $400,000 at 5% interest with a 30-year amortization, and soon, they have the keys to their new $500,000 home.
One month later, John and Jane get a mortgage bill in the mail for their first month’s payment: $2,147. In a few years, John and Jane find out they’re expecting their first child. Then they’re second. About five years in, they realize the roof needs to be replaced for a cost of $10,000. A couple of years after that, their hot water heater goes out costing $1,000. Then they discover foundation issues and spend another $10,000 fixing them. Ten years after they buy the home, John and Jane realize they’re out-growing what once seemed to be a spacious home.
Over the ten years, they owned the house, the appreciation in their area averaged about 4% annually. That means that their home is now worth approximately $740,000, which means that John and Jane have gained about $240,000 in equity over those ten years. But that’s not all: John and Jane diligently paid their mortgage every month, which helped to pay down the principal on their $400,000 loan. Over the ten years, they paid about $258,000 in monthly mortgage payments (approximately $2,150 per month for 120 months). Of that, roughly $75,000 went toward their principal, which means they still have about $325,000 remaining on their loan balance.
That also means that they paid about $183,000 in interest to the bank over 10 years. If they sell now, they would only receive their original $100,000 down payment back plus $75,000 in principle that they paid down over the 10 years plus $240,000 from appreciation. At the end of the day, they end up with about $414,754 in their pockets.
Inevitably that means that conventional wisdom is right and that this is indeed the best path…right?
Scenario 2 – Bucking Conventional Wisdom – Rent a Home or Live with One Income and Invest the other Half Instead.
Let’s rewind these ten years and see what would have happened if John and Jane had taken a different path. When it came time to ‘settle down,’ she and John decided to rent a home instead of buying one using the $100,000 that they worked so hard to save up. They found the perfect apartment near public transit for $2,200 per month and see this is as a place they can live and start a family.
They invested the $100,000 into a real estate syndication investment opportunity, instead. The syndication was for a multifamily property in a fast-growing neighborhood in a high job growth area. The syndication came with a preferred return of 8% per year, and an estimated equity multiple of 2x over a projected 5-year hold period (i.e., they could feasibly double their money in five years, when counting both the cash flow distributions and the profits at the sale of the asset).
Three years later, when Jane was pregnant with her first child, they found out that the renovations on the multifamily syndication were complete, and that the sponsor team would be selling the asset early. By the end of year three, their first child is born, and they receive their original $100,000 investment back. Oh, and they made $85,000 in profits from the syndication they invested in. Because they love both their apartment and the experience of investing in the syndication of multifamily properties, they decide to continue renting and reinvest the $185,000 into another syndication with the same sponsor team.
Four years later, that second syndication of investment properties successfully completes their reposition and is able to sell the property and double John and Jane’s original $185,000. Now, John and Jane have $370,000. At this point, their family has grown. They love investing in syndications so much that they told all their friends about it. They take their $370,000 and reinvest it.
Ten years after they invested in their first syndication, they end up with $740,000 from investing in multifamily syndications. Over those years, assuming an annual rent increase of 3% per year, they will have made about $302,000 in monthly rent payments. And no, their landlord isn’t about to write them a check to return any of that, so they end up with $438,000 in their pockets.
Even still, when we factor in the profits from their syndication investments, are those rent payments that their parents said they were “throwing away” really as bad as society makes them out to be?
Comparing the Math
In both cases, John and Jane started out with $100,000 to put into something. In scenario 1, they chose to use the $100,000 as a down payment for a house. In scenario 2, they decided to invest that money into a real estate syndication instead.
So, how do the two scenarios compare? Let’s take a look.
Scenario 1 – Breakdown
- Started with $100,000 as down payment on $500,000 house
- Loan amount: $400,000 = $500,000 – $100,000
- Principal paid down after 10 years: $75,000
- Approximate market value after 10 years @4% annual growth rate: $740,000
- Equity after 10 years: $415,000 = $740,000 – ($400,000 – $75,000)
- Interest payments over 10 years: $183,000
- Home repairs over 10 years: $21,000
- Net gain over 10 years: $111,000 = $415,000 – $183,000 – $21,000 – $100,000
Scenario 2 – Breakdown
- Started with $100,000 invested in multifamily syndication
- Profits after the first syndication exited in year 3: $85,000
- Profits after the second syndication exited in year 7: $185,000
- Profits after the third syndication exited in year 10: $370,000
- Rent payments over 10 years: $302,000
- Net gain over 10 years: $338,000 = ($85,000 + $185,000 + $370,000) – $302,000
Wow. This article was to show you that real estate syndications might be on par with buying a home, or perhaps a slight bit better, but even I did not expect this big of a discrepancy.
This means that if John and Jane were to decide to go against conventional wisdom and invest their money in real estate syndications while continuing to rent throughout ten years, they could end up with roughly $227,000 more than if they were to buy a home and make the mortgage payments. Let’s just let that sink in for a minute.
The total syndication profits of $338,000 over 10 years is an average of $33,800 per year, which essentially means that John and Jane added a third income earner to their household; all without having to do any work. That’s the power of passive income. While owning a home, they earned $111,000 over 10 years for an average of $11,100 per year and were responsible for maintaining the home so they can consider that as compensation for the upkeep.
They earned roughly 3x more by renting an apartment and investing $100,000 initially, in real estate versus buying a home with the same $100,000, over the same 10-year time period.
Assumptions and Other Considerations
Of course, all this math is just on paper, and it’s based on several assumptions. Here are a few of the significant assumptions I made:
- Assumption: Syndication Performance
I’m also assuming that the syndications are led by a strong team of real estate investors that are able to execute on their business plans and meet or exceed their projections. And that the market holds fairly decent, allowing these deals to cycle through in a timely manner. Both of these factors can be big question marks, especially when you’re first starting out investing in syndications.
That’s why we work so hard to make sure the teams we’re investing with are strong operators with proven track records, conservative underwriting, and multiple exit strategies.
- Assumption: Home Appreciation Rate
I’m assuming an annual home appreciation of 4% over ten years. Home prices could just as well dip down, and appreciation could slow, no matter what the historical data says.
- Consideration: Taxes
I didn’t even mention the tax benefits that come with investing in a real estate syndication, which really put it over the top.
- Consideration: Huge Home Loan
Another significant aspect to consider is the large loan that John and Jane would be taking on in scenario 1 if they were to buy a home. That $2,147 per month payment seems doable when both John and Jane are happily employed and have no kids.
When you factor in that considerable loan, you can start to see that buying a home is really more of a liability than the asset mainstream media keeps telling us it is.
- Consideration: Liability
Consider, on the flip side, scenario 2, in which John and Jane invest their $100,000 into a real estate syndication instead. They take on no loan themselves and are not liable to lose any more than that original $100,000. They needn’t make any additional payments on that investment. Instead, that investment is making money for them. It’s a true asset.
Don’t take any of this as investment advice, but rather, as an opportunity to think differently. For one, I’m not authorized to advise you on your investments, nor am I trying to do so.
I showed you two different scenarios: one that follows the traditional narrative that we’ve been taught all our lives, and an alternative that most people have never even dared consider. One that comes with a huge liability and the other is a true asset.
At the end of the day, going against conventional wisdom is tough. You have to be really sure that you believe in the path you choose because people will question your choices at every turn.
My goal in diving into these two different scenarios with you was merely to lay the groundwork, to plant the seed, and to show you that an alternative exists. The hard decision of choosing whether to follow or buck against conventional wisdom is still yours to make.