Expected House Return

Expected Returns for Buying a House #

Looking at list prices for homes can be a strange experience. To me, a list price is just a large number that has little or any meaning to the impact buying that house will have on my finances. To confidently judge whether a house I’m interested in buying is actually a good deal, I made the spreadsheet described here. The primary goal of the spreadsheet is to translate details about the house (e.g. it’s price) into an expected percentage return that can be directly compared to other investments.

Here is the spreadsheet: https://docs.google.com/spreadsheets/d/11GTEiYBGF1NXaob9DczvUcQyloDVQ-dJfALDsg-L4-U/edit?usp=sharing

On the left side of the spreadsheet are a bunch of blue fields where details about the house should be filled in. On the right are shown the results, in gory detail.

Note that I was looking for live-in multi-plex properties, so the spreadsheet has features to judge the effect of rent on the ultimate return.

If you have any questions or especially if you notice errors in the spreadsheet, please comment on it to let me know.

Input Field Descriptions #

House Details #

  • Property Price:
    The price you will be able to buy the property at.
  • Property Growth Rate:
    One of the most impactful, yet hardest to estimate parameters. Some useful estimates can be found on Redfin (rawer data, summarized), but you can’t always use the past to predict the future! I just set a really conservative value here and pray.
  • Property Land Value:
    The value of the land the property sits on. This is used to calculate depreciation (since land doesn’t depreciate, only man made structures do). In you live in the Seattle area, you can find this information by searching for the property on https://gismaps.kingcounty.gov/parcelviewer2/.
  • Property Tax Rate:
    Can also be found on a local parcel viewer resource, or even on listings. Taxes collected on properties are public record in the US. Using prior year taxes is usually a good way to estimate this; I found that the tax appraisals for properties can value them very differently than the market does, so multiplying the list price by the tax rate to calculate this is not recommended.
  • Depreciation Period:
    The time after which you can assume (for tax purposes) that your property will completely turn to worthless dust. This only applies if you are using part of your property for business purposes (renting it).
  • Income Tax Rate:
    The rate at which any rental income will be taxed. Note that I am assuming your income tax rate doesn’t change over the course of owning the property. Since income taxes on rent are essentially deferred due to depreciation and then depreciation recapture on sale, your return will be better if your income tax rate is lower when you sell the property.
  • Depreciation Recapture Tax Rate:
    The rate at which depreciation recapture income will be taxed. This is your ordinary income tax rate when you sell the property OR 25%, whichever is larger.

Debt #

  • Down Payment:
    How much upfront you will be paying for the house (in your own cash).
  • Years:
    The time after which your mortgage will be fully paid.
  • Interest Rate:
    Multiplying this percent by the remaining loan balance after a given year tells you how much you have to pay your lender for the privilege of using their money.

Goals #

  • Investment Growth Rate:
    How much you expect your other investments to grow by yearly on average. This just color-codes the results (green is better than your other investments, red is worse).
  • Investment Tolerance:
    Results minus this amount from your investment growth rate will be colored yellow.
  • Personal monthly “rent”:
    This quantifies the amount of value you personally extract from the home by living in it. This makes comparisons between investments more fair, because you can’t live in a stock! A good ballpark for this number is your current rent, or a rent that you would be comfortable paying.
  • Max Upfront Costs:
    The total maximum amount of money upfront you can spend on the house. Used for color coding.
  • Max Monthly Costs:
    The maximum amount of money you can spend on the house per month on average. You should always have some buffer, since many housing expenses come in large lump payments. Used for color coding.
  • Portfolio Start Size:
    The amount of money you have in your investment portfolio when you buy the home. Used to calculate how much of your investment portfolio is made up of by the house
  • Yearly Investment:
    The amount of money you are investing per year into your portfolio. Used to calculate how much of your investment portfolio is made up of by the house

Income #

  • Rent:
    The amount of rent you expect to earn from tenants living on your property.
  • Percentage Rented:
    The percentage of your house that is considered rented. I think you can calculate this using square footage. This determines how much of all your expenses you can use to cancel out income taxes as a business expense.
  • Occupancy Rate:
    What percent of the time you expect to have rent flowing in.
  • Rental Growth Rate:
    How much you expect rents to increase by in a year.

Monthly Expenses #

Various expenses that need to be paid every month by you on behalf of the whole house. Notice the tax deduction rate assumes that these services will be used evenly by you and your tenants.

Selling Costs #

  • Capital Gains Rate:
    The percentage of {the price you are selling the property at minus the amount you bought it for} that you must pay as tax. Up to 250k for single owner or 500k for a joint ownership of capital gains can be ignored for a single family home. In a duplex, this can be applied to % of the property, the rest is subject to tax (unless you do a 1031 exchange). See https://finance.zacks.com/rental-income-taxed-duplex-7533.html. Note also that if you are using depreciation to offset your income tax while you own the property, this lowers your cost basis in the house, which increases your capital gains tax. Additionally, this “depreciation recapture” tax is taxed at normal income tax rate, since that is what it offset earlier.
  • Closing Costs:
    The percentage of the selling price you have to pay to agents that help you sell the house. You can reduce this greatly by selling by owner, but then you might not get the best buyer.

Upfront Buying Costs #

Various expenses and fees that you must pay when you are buying the home up front.

Results #

  • Time:
    Year after purchase that you would be selling the house (assuming “Months Per Row” is set to 12, the default).
  • Rental Revenue:
    Total amount of money paid to you by renters in that year.
  • Property Value:
    The amount of money you could sell the property for.
  • Property Gain:
    Amount the property grew in value by in the last year.
  • Net Gain:
    Amount of money you “made” this year via rent and property growth.
  • Property Tax:
    “Rent” you must pay your city/government for owning your property.
  • Mortgage Payment:
    The amount of money that you must pay your lender towards your loan.
  • Interest Paid:
    The amount of money going to your lender that goes directly to them as a fee for you using their money.
  • Principle Paid:
    The amount of money going to your lender that effectively purchases part of your property (equity) from them.
  • Loan Amount Left:
    The amount of your loan left to pay off.
  • Expenses:
    Total expenses paid from the “Monthly Expenses” input section.
  • Unrecoverable Loss:
    The total amount of money that you spent this year that you will never see again :).
  • Depreciation:
    How much of your property you lost as it crumbled to dust (as far as the IRS is concerned).
  • Total Tax Deductions:
    The total expenses you can deduct as business expenses from your taxes.
  • Taxable Income:
    The income from your property that is taxable as ordinary income.
  • Income Tax Paid:
    The amount of income tax you actually need to pay this year because you own your property.
  • Total Expense:
    The total amount you must pay this year to others.
  • Cash Flow:
    The total amount paid to you by others minus the total amount you must pay to others.
  • Monthly Cash Flow:
    The last column divided by “Months Per Row”.
  • “Rent”:
    The total amount of value you extract from living in the property (see “Goals” input section).
  • “Rent” Cashflow:
    Cashflow considering the “rent” you are “paying”.
  • Money Put In:
    The total amount of money you have spent on the property.
  • Rest of Portfolio Value:
    The value of your investments, minus the house.
  • Percent of Portfolio:
    The percentage of the portfolio that is made up of by the house.
  • Money Put In w/“Rent”:
    The “Money Put In” column considering the “rent” you are “paying”.
  • Cost to Sell:
    The amount of money you need to pay to others when selling the house. This includes paying off the mortgage, paying realtors, etc.
  • Depreciation Recapture:
    The amount of money you have written off your taxes so far due to property depreciation - if the property value has increased despite this depreciation, you need to pay it back.
  • Cost Basis:
    The amount you bought the house for plus any improvements, adjusted by how much of it you own this year.
  • Capital Gains:
    How much your property has appreciated since you bought it, adjusted for how much of it you own this year.
  • Total Sale Tax:
    How much in tax you would have to pay if you sold the property this year, including capital gains tax and depreciation recapture income tax.
  • Sale Proceeds:
    The amount of money you would end up with in cash after the sale of the property this year.
  • IRR:
    The time-adjusted rate of return you have made on all the money you put into the property.
  • IRR w/“Rent”:
    The time-adjusted rate of return you have made on all the money you put into the property, considering also the value you got out of it by living in it. If this value is less than your expected investment growth rate, financially you probably shouldn’t buy the house.
  • Portfolio Return w/“Rent”:
    The return of your entire portfolio including the house, given that you sell the house this year.
  • Rental Delta:
    To translate the rate of return to a “dollars per month” figure, fill in the top cell of this column until the IRR w/Rent Delta column matches your expected Investment Growth Rate for the year you are planning to sell at. This will tell you how much money per month you are saving (or losing) per month compared to your Personal monthly “rent”.