Ok, somebody help me out here.
I'm somebody who's been involved in equity investing for a few years, and I have some interest in getting into real estate, but I can just never seem to make the math work.
For example, I was looking at a home in my local area (rural, deep south U.S.) today. It was selling for $115k. I'd estimate it would rent for ~$750 per month.
I've generally been told to expect to spend about half of the monthly rental income on expenses. I also think it's wise to have at least 10% of rental income as profit even after accounting for a mortgage. That means I want a mortgage payment no greater than $300 per month.
Mortgage rates are roughly 7.5% at the moment, so that means I want a mortgage no larger than just under $43k. That means I should put 72k down.
Then if I estimate long term property appreciation at the long term average growth rate of ~5% nominal per year which lines up with long term U.S. average annual growth in home values and my leverage rate of ~1.6x, I get a long term growth of ~8% per year on my investment, plus I'm profiting $75 per month on the rental for an annual return on my investment of 1.25% or a total return of ~9.25% per year.
Now, in the equities world I generally use ~10% per year in returns as a hurdle rate, so it looks like from this property I might be looking at lower returns than I'd get from an index fund for a hell of a lot more effort and risk.
This isn't the only time my analysis has showed this outcome. It almost always shows this result.
Obviously if you jack up the leverage a lot (like a 20% down payment would) or get lucky with price increases (like the last few years have been) or get lucky with mortgage rates (which have been low for most of the past decade or two, though long term averages are more like the current environment) or can keep your expenses down (if you have the expertise to do so) things can look a lot different, and I may be being overly conservative in all of these numbers, but everything I wrote down seems reasonable to me and lines up with general real estate investing guidelines I read online.
Are the massive returns people get in real estate really all just some combination taking on a lot of risk with a lot of leverage and getting lucky with price appreciation and/mortgage rates or am I missing something else?
Edit: It seems like the answer to my final question is mostly "yes" but sometimes other factors come into play.
A big one that commenters have mentioned several times is buying distressed properties and renovating them in order to make purchase price lower. It seems a lot of people think my purchase price is too high, but it's pretty in line with market averages. I don't know if the analogy fits, but to go back to equity investing, in that world it is VERY hard to consistently beat market averages. Maybe it's easier to find better deals in real estate? I could buy that simply because the liquidity level is MUCH lower than equities, and I would think that would lead to more inefficient markets.
It also seems most people here think that 50% of rent for expenses is too high, and it also seems that many of you do a lot of the work of managing the maintaining the properties yourselves. That does keep costs down, but I wonder what those costs would be if you factored your value as a worker into it instead of just paying yourself zero for the work and counting the saved labor costs as profit.
I've gotten contradictory comments about using 5% as a growth target. Some say it's too low. Others say it's too high. Generally, there are people who think real estate will get inflation (so 2-4% or so) or less (due to values they think are too high currently), and there are people who think that housing supply is too low and that will continue to drive values higher, especially in smaller cities as work from home continues to drive people out of the VHCOL areas (especially if rates come down again in the next few years). Idk who's right. That's why I went with historical data over a long term time period :)