Real Estate Is Like A Bond Indexed For Inflation With An Equity Kicker w/CEO Gary Beasley
Hey everybody, welcome to another episode of The Remote Real Estate Investor. This is our weekend wisdom episode. I'm Michael album and joined today by Tom Schneider and Roofstock CEO, Gary Beasley.
So, Gary, we want to ask you a question about what is your favorite metric to use when evaluating properties? And how do you think about that metric when it comes to total return.
So I like to think of single family rental homes as sort of like a bond that's indexed for inflation with an equity kicker, and I'll explain what I mean by that. And the reason I think it's particularly relevant right now, is we're in a low interest rate environment, people do feel like with all the money we've been printing over the last few years, there is a potential for inflation down the road. So you want to think about what kind of investments could potentially be inflation hedges in case inflation. And the Fed has said, we're gonna keep rates low, and we're not so worried about inflation, so we're not gonna be as aggressive in raising rates.
And then you've got this equity kicker element in homes, which is really the appreciation component of it. So let me tell you what I mean. So the bond component is that the cash flow that you could generate from the home when you own it, and that's like the bond piece every year, you could raise the rent to at least keep up with inflation, because their annual contract. So if there's a lot of inflation in the market, you can raise the rent. So if you had to sign a 10 year lease that was flat and inflation went up, you would be in trouble. So you've got that annual indexing.
And then you've got the capital appreciation piece, which if the property goes up, you know, 3%, a year or 4%, a year, which is historically has done over the long term, you get that capital appreciation piece, like you would get, say, in a stock with a stock value going up, you've got the value of your underlying asset going up. And what's nice about real estate, unlike with stocks, which are harder to, in most cases, put leverage against unless you have a margin account, anyone could get a loan for a house. And so you could get a 70 or 80% loan on the house. And I like to give a you know, very simple example, if you have a home that basically just covers its costs over, say, a five year period, but it goes up at three and a half percent a year and you have an 80% loan on it, you could get a 14 or 15% annualized return on that, because you've got someone else paying down your mortgage and creating principal value, you've got, you know, you're you're riding the property value along, and you're getting kind of four to one leverage on your equity.
So when you sell it, your annualized return over that period can actually be quite high, even if you're not pulling money out or getting current return along the way. So when I look at investing in homes, the yield is one component of it. But I'm really more of a total return investor, I don't necessarily feel like I need to pull the money out every month and then spend it or put it into something else, what I'm trying to do is create value in that asset. And so I like the idea of having someone else pay down the loan balance for me, and create value over time just by getting that exposure to housing, and letting the market be your friend. And then at some point in the future, if you decide to liquidate it, you've got a lot of hopefully embedded equity value, that's when you could sort of realize the benefits of that investment.
That's a great kind of analogy and pictorial representation. Can you talk just real briefly about how a bond works if somebody wanted to go buy a bond, so that way they can compare that investment versus real estate? How does that traditionally work?
Yeah. So when you buy a bond, what you buy is a coupon on that that bond, and then you get your money back. So you could buy a municipal bond or Treasury, something like that. And let's say you get an interest rate on that bond of 3%. And you buy your hundred dollar bond, and you get $3, every year back. And then at the end of that term, you get your hundred dollars back. That's the entirety of your return. And that's a 3% annualized return, because you're getting your 3% every year, the difference between like a bond and a single family rental home, which you might be able to get a similar kind of return every year on a home, but the value of the underlying home is going up. And so then instead of getting $100 back, maybe you get $120 back, right and so that's where that's that equity kicker piece that I'm talking about. That's over and above that bond piece.
Already, everyone that was our quick weekend wisdom a big big, big thank you to Gary super informative. If you enjoyed the podcast, please feel free to leave us a rating and review wherever it is you listen to your podcast. We look forward to seeing the next one. Happy investing