How does a leveraged property return a higher return???

[Michael Sockwell]

Interested in real estate investing looking to do by and holds and some flips and been doing lots of research and listening to lots of bigger pockets podcasts. One thing I can't understand is how much I hear about leveraging properties is better than cash and that it returns higher. I especially hear Brandon turner always pushing leveraging properties and hear him talking about properties only returning $100-$200 after expenses. How is this better than a paid off property netting you a full months rent every month? Hoping to do my first deal this year. New to the site, hungry to learn and any advice is very appreciated. Also not sure how easy it is to get traditional financing on a first investment property when I already have a mortgage on my current home. Interested in the BRRR method but unsure the benefit of netting such a small amount monthly.

[JD Martin]

Because rate of return is not the same as amount of cash earned every month. 

Example: You spend $100,000 to buy a house outright. You find a tenant willing to pay you $1000/month. Let's assume all expenses are 50% of gross rent. 

$1000 x 12 months = $12,000 x 50% (expenses) = $6,000. That's your net rent. 

$6,000 divided by $100,000 (your cash) = .06, or 6% annual return on your cash.

Example 2: You spend $100,000 to buy 5 houses, putting $20k down on each house, each house costing $100,000. You rent each house for $1000, with the same 50% expenses, except you now have a $375 mortgage on each house. That leaves $125 net coming in per month on each house. 

$1000 x 5 houses x 12 months = $60,000 x 50% (expenses) = $30,000. That's your rent after expenses, but without the mortgages.

$375 x 12 months x 5 houses = $22,500. $30,000 minus $22,500 = $7,500. That's your net rent.

$7,500 divided by $100,000 (your cash) = .075, or 7.5% annual return on your cash.

Now your question was "How is this better?" Well, 'better' is a subjective term. Most people would prefer to earn 7.5% interest on their cash than they would to earn 6% interest. However, as you might have figured out on your own, there's more houses to manage, and there's always the possibility of something going wrong. In example 1, if your renter bails and you don't find another, as long as you can pay the taxes and insurance, you don't lose your investment. In example 2, same problem, except you also have to pay a mortgage out of this. If one house goes vacant, you have 4 other houses that can help you cover the shortfall, whereas in example 1 you have nothing. On the other hand, if 5 houses go vacant (you need a new area to invest!), you are on the hook for 5 $350 monthly mortgages, whereas in example 1 you can just be sad that you're not making any money.

The "right" answer, in as much as there can be a right answer, is usually somewhere in between, especially if you are just starting out. If you only have 1 house, and you're going to leverage that house at 25/50/75%, you need to have very strong reserves and another source of income to cover the possibilities. If you have 1 house and no leverage, you don't need as much reserves, but you're going to save up for a long time to buy house #2.

Remember: greater reward usually comes with greater risk.