100% Payment vs. Leverage: Depends on Your Goals!

[Rabih El-Khoury]

The short of is: it really boils down to your financial goals in determining whether you should pay for properties in full or use leverage (mortgage). The truth is always in the math.

My business partner and I are just starting out in REI and while we have a clear goal in mind we dabbled endlessly with the leverage vs. 100% down question until one day we crunched the numbers. The findings were interesting.

The defacto approach we’ve heard countless times on BP and elsewhere is to use leverage to scale property investments as a means for building wealth over time. We have a 10-year window where we will pump, starting today, $200,000 every year for 10 years buying property. Our (ambitious?) goal is to achieve $24,000 in monthly net after tax cash flows by the 10th year.

With the above variables, we modeled (in Excel) two sets of investments—one at 100% down and one at 60%* down—and looked at the cash flows (and particularly cash flows after tax) for 11 years (2017 to 2027). We kept everything else apples-to-apples starting with assuming we’d look at houses valued at $125,000, to capex %, rent %s, annual appreciation all being the same. To further level the playing field, cash flows we would generate from rentals would NOT be used for property purchases; meaning, every year we would only use the $200,000 we have to buy new properties.

*given our lending rate and the NOI (Net Operating Income) we were getting, 60% down was the minimum needed to achieve the debt-to-coverage ratio required by the lenders we've been talking to (we are foreign nationals, so options are limited and rates start at 6%).

The results – How many $125k properties can $200k every year for 10 years buy us and what cash flows would we generate if?

Model 1: We’re paying 60% down:

No. of properties: 22

Sum invested by 2027: $2,161,084

Sum of property values: $3,695,780 (we assumed 3% growth every year)

Net worth: $1,391,394 (sum of property values less sum of mortgages)

Sum of Cash Flows: $263,240 (from day 1 investing to end of 2027)

Sum of Cash Flows of year 2027: $50,209
Present Value (of future cash flows): $158,107

Model 2: We’re paying 100% down:

No. of properties: 14

Sum invested by 2027: $2,167,891

Sum of property values: $2,351,860

Net worth: $2,351,860

Sum of Cash Flows: $459,477

Sum of Cash Flows of year 2027: $83,368
Present Value (of future cash flows): $284,567

It’s a no brainer: for our particular case, where cash flow at 2027 is the target, 100% down gives us $33,000 more every year than paying 60% down. Of course, over time as the mortgages get paid out, the 60% down properties will close in and start returning higher annual cash flows. The time frame for the 60s to catch-up with the 100s is too long however given our financial goals. .

We could’ve stopped there but we haven’t. Why? Because the $3.696m property value in Model 1 compared to $2,352m in Model 2 is too big to neglect. For pretty much the same dollars invested over 10 years, paying 60% down produced a whopping $1.3m more in property value (granted once mortgages get paid in full). When you think of your kids and what you could leave behind, $1.3m that will continue to appreciate is a helluva lot of money.

This exercise has prompted us to find a way to combine both goals. We’ll have to make that $200k, $300k or $400k a year so that our 60% down properties return the cash flows in 2027 that we want. To do that we’re going to seek private investors.

If I could extract one learning from this exercise—and one message to share—it's that crunching the numbers not just on a property you’re analyzing but on your portfolio as a whole, looking at it over a time frame that’s relevant to you, and in context of your non-monetary goals is crucial.