Critical Thinking

Today, an advertisement about real estate investment talk appears in the newspaper. In the ad, the main title is: “Create Wealth with Australian Property. How To Generate 500% Return in 10 Years”. Being curious, I look thoroughly into the ad. The ad gives an example of the return:

- Property Price A$300,000
- Loan Borrowed A$200,000
- Your Investment A$100,000
- Income Return A$ 10,000 per year

10 Years Scenario:
- Price Double A$600,000
- Income Return * 10 Years A$100,000
- Loan Left A$100,000
- Total Return A$500,000

Return of A$500,000 with A$100k Investment = 500%
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Wow! Sound great! I could get 500% return in 10 years! Looking around, how many investments could generate such high return rate? But, wait!! There is no free lunch in the world. Thus, read the ad again and think deeply. Hmm…..the scenario becomes clearer.

Firstly, they ask you to place A$100,000 for the investment of A$300,000. That means your gearing is about 33,33%. Fine, that’s the norm for real estate investment where you could even gear up until 100% margin in some cases. Then, they tell you the income return per year is A$10,000, that would translate to 10% return rate per annum (A$10,000 / A$100,000 = 0.1). At this point, everything looks great. But, the real story comes behind:

They are assuming the appreciation will be 100% in 10 years where the price of the house soars from A$300,000 to A$600,000. At the same time, your rental income remains stable for the entire 10 years which gives you A$10,000 * 10 years = A$100,000. This amount would offset against the installment for the loan. Hence, they show you the return of the investment is $600,000 - $100,000 (your initial investment at the beginning) = A$500,000.

When you examine deeply, you will wonder how such return pops up? Firstly, your rental income of A$100,000 could only offset half of the remaining loan (A$200,000), which mean you are still owing bank for another A$100,000. Say, if you sold the house after 10 years, your return would be A$600,000 – (A$100,000 + A$100,000) = A$400,000 where 1st A$100,000 is your initial investment you laid down when you bought the house and the 2nd A$100,000 is the debt you owe to the bank.

You might argue that return of A$400,000 still impressive for 10 years. True, if it’s a case but the example shown miss out some important points. Firstly, they do not include financing costs, ie: legal fee, financing interest, management fee, broker fee, insurance fee….etc. Secondly, the appreciation of 100% within 10 years is solely their assumption. Whether the state could be reach is another consideration. Thirdly, they also assume the rental for the entire 10 years period will never have any empty period, meaning that for the entire 10 years, they guarantee there sure have tenants for your house. In the reality, is it a case? Think it rationally.

With so many questions in doubt, do you think it’s a great investment as claimed by the promoter? THINK IT TWICE….

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