I had an interview with a securitisation firm and they asked me a general question and I failed. The question was:
“If you had $100,000 and were seeking out a house, and you found a house for $100,000, would you pay all cash for it or would you break it down into yearly payments”?
I panicked and started asking questions such as (what is the interest rate in the market, location of the house, describe the house, etc). I think the interviewer wanted an answer that derived purely from finance logic. He said don’t worry about the interest rate, just answer the concept.
Can you help me answer it, maybe through logic or let’s do a simple example, I want to learn this so I don’t repeat this mistake in the future.
I think it’s fairly reasonable to ask the interest rate you’ll be paying on any leverage. Essentially, if the interest rate on loan is greater than the return you can make in the market then you should pay for it up front. That’s plus/minus tax and tvm etc…
Irrespective of the above, a home loan is a cheap source of financing… you’ll just end up borrowing money credit cards to fund your bottles and models habit, when you could have saved some cash by taking out a bigger home loan.
I suspect they wanted you to say lever up - it’s the most likely outcome.
Paying for something outright is what weak hands do.
They were probably looking for something about if your expected return is greater than the interest rate then you should invest rather than pay for it outright.
Of course, I would have answered that I would pay the lump sum because debt is for losers.
Of course using OPM to buy a depreciating asset such as cars is very dumb
On the other hand, OPM to buy appreciating assets is one way to quickly make really big bucks with huge upside potential with limited - and far smaller - downside risk to your equity position.
In the OP’s scenario, make 10% downpayment of $10,000 and say five years later, you sold the house for $125,000 for a profit of $25,000 on your $10,000 investment. The home price only went up 25% for 5 years but your return is 350%…
Yeah with interest payment, it might be slightly under 340% but you get principal equity added on to your initial $10k down payment and tax breaks left and right and some more left. So do this 9 more times and in 5 years your net worth if all properties went up by 25%, is $250,000.
The question is not black and white. It is about thought process. Given it is a securitisation firm, I’d imagine they want you to say: I would put down the minimum amount to receive the lowest mortgage rate available and rent it out at a spread. Then I would take the remaining funds and purchase however many other properties I could and live in the least expensive one (the equity tranche) while renting all others out for a profit. Then, since risk retention rules recently changed, I would Airbnb the “equity tranche” and sleep on the couch.
I would have gone gone for the REOC approach. Take out an interest only loan. Paint the bathroom, put in a jacuzzi, plant a garden and resell for six times the value
if you could lever at low rates say 4%, and collect a yield of say 8%. you are telling me you wont lever? especially since the real estate you buy levered will rise with inflation so take on an additional 3% multiplied by the amount you lever with? levering is a smart idea is what im trying to say if the opportunity presents itself with a margin of safety!
dude also you need to mention the power of leverage in your scenario. Say you borrowed at 4% and your return on the project is 8% and your LTV was 25%. Your return on the money is 32%. Hard to beat.
Not hard at all. Make it 100% loan to value and the return is infinity! (i know i know, i’m just waiting for the math nerds here to get mad at this joke)
^Why stop there brah. Get non-recourse loan above value of asset collateral and invest extra proceeds in other profitable opportunities to achieve an infinite return with even higher cardinality.
now don’t stop there. Get the building - now that you have remodeled it - reassessed and as a result of a higher valuation, you can get a second bigger loan against the building. Repay the first loan and with the remaining, take some for yourself - you deserve it - and with the rest, invest more. Repeat this several dozen times and if you are lucky and catch an insane bull run, you could be the next Tishman, SL Green, Boston Properties in 20 years. The key is to use debt and other peoples’ money - use small amount of your money in each project - so when things go bad, you still made money or broke even but probably made money from mgmt fees, incentive fees, income from rentals, remainder of second loan, third loan, etc.
I’d never pay an asset with expected long term economic or whatever benefits with once off cash transaction. The only scenario when I’d probably proceed with such decision is an extra high inflation environment which I even remember.
I would never pay cash upfront for a house unless the cash was insignificant. The stock market historically has given better return than real estate and purchasing a house will require 10,15 or even a 30 year mortgage which is a long time horizon. I would be willing to take the bet that equities will outperform real estate appreciation over those 15-30 years. I would put down the 20% for the house to lower interest rate and PMI fees as much as possible and invest the rest in a diversified portfolio.
Okay here is my breakdown my CNBC bound market “expert”
Just like the stock market, you need to pay cash upfront. Need some kind of cash…
from 1995 to 2007 the housing market and commercial real estate market returned ~8.1% per year…Now given most real estate players lever 4 to 1, that is a whopping 32% a year…Just go look at 10Ks of REITs or reports by Tishman, Boston Prop, Blacktone REPE Fund, SL Green, etc. they clipped high 20% range for +10 years annually. Leverage is key
stock market too should be a long time horizon hold unless you are into frequency trading, which I highly doubt.
But stay in the public equity market and nothing else. Fewer the players, the more opportunities for the rest of us
real estate was great but i dont think it’ll be replicable (except perhaps this time period, lol). if you look at really long term history of real estate what happened during that time period was a literal bubble with lower and lower rates to fuel refis. imo what will happen is people will chase returns, rates will rise, prices will stop growing, and the refi will kill them.
real estate is literally all about the one off time transaction. the typical rental yield usually pay for everything including principal and interest with a slight positive net flow after everything (like 1%/year). when you first start you’re gonna be like i did all this for this shit wtf! then after like 7 years, the value of your property doubles. and you cash out with a refi, hoping that the rental rates have risen to pay the new monthly payment, and that the reinvestment of what you cash out can repeat the process.
the 32% imo prolly represents ideal times like the bottom of this current cycle in 2012. but i feel that typical returns should be between 10% to 15%. which is somewhat close to the stock market’s 10% without the unnecessary risk of leverage. timing the real estate purchase is more important due to the leverage. plus managing the real estate is a pain in the ass. so is it worth it? from my convos with super rich people, when you are poor its most definitely worth it, but at a certain point, its just a pain in the ass.
whats more interesting is prolly traditional banks who just do real estate lending. they will kill it long term with higher rates instead of relying on one time refis due to lower rates.
