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

Question

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 · Answer

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.

David Thompson · Answer

Chris,

To me that's the answer, appreciation. The cash flow example by Jd is solid, but I think the point is missed. If I put 20% down on that $100K house and get 5% appreciation vs a 100% paid off house, my return on investment in year one is $5K increased equity on a $20K down payment vs $5K return on a $100K paid off house. So, that's a 25% return on my money vs a 5%. Appeciation is just on component but the most significant generator of wealth. That's the difference really when folks are seeking leverage.

Chris Kennedy · Answer

This is a great question, there are a lot of factors to consider and there have been some very good answers already. I think it really boils down to your personal investment goals.

@Jd Martin gave a good example, but I think there is an additional benefit to buying 5 houses with leverage versus just one house all cash - the additional potential for appreciation.

If you plan to hold your rentals for the long term and you buy them right, then it is reasonable to expect a moderate appreciation in value over time. A $100,000 house that appreciates 4% in value in one year is worth $104,000. This is true whether the property is leveraged or not. So in the example above, with a 4% appreciation rate, having one house would add $4,000 to your equity, but having 5 houses would add $20,000 to your equity.

Since you mentioned you are interested in the BRRR strategy, you are hoping to benefit from the power of forcing appreciation in the property and then refinancing, hence it is even more important that you factor this into your strategy.

Cash flow will give you financial freedom, but cash flow is derived from equity. So in order to grow your cash flow over time, you need to grow your equity. Wise use of leverage enables you to do that much faster.

Nate Wightman · Answer

Fun. I think you will find it here that in real estate you make money with rents, appreciation and taxes. So, as many have said here, one property paid in full will give you one LARGE rent, one appreciation, and limited tax advantage. Five homes bought with same money will give you 5 SMALLER rents, 5 appreciations, and a much larger tax advantage (not an accountant here). I also know on a duplex that getting money out in a refi. cost a lot more than a single family (my experience). We love the duplex's. So, with more properties you will get more headaches but also a compounding of your profits. I also feel that after doing this a while you will wish you had more cash in the bank. Your neighbor will tell you of his mom's sister needing to sell her home to move to a senior center....:) ah, but you own your one rental outright and have no cash.... crap maybe next time.

$1,000,000 in a cd in the bank (1.5% +-) ... very safe right now for your retirement will give you $1500 a month income.... 1 mil cash will give you $1500 a month. so, if you want to retire with 2 mill dollars so you can have the $36000 plus social security so you can live happy into retirement with $50k.. ah real estate :):)

We are in Colorado... bought duplex down payment and repairs cost us $80k cash.... one side pays the mortgage and bills and the other $1450 is income. So, the duplex for $80k of our cash is returning similar to $1 mil in a CD. yes, RE is not as safe but a similar income with only $80K

So, do you want to keep listening to the radio talker or listen to most of what they have to say and use your good financial wisdom to make up the rest.

My dad always said you won't get rich working with your hands. Use your head. Smile lots and have fun..... you only get 36000 days on this planet.. enjoy them

Lee S. · Answer

BRRRR is a great strategy, if done right you have none of your original investment left in the property so your return is infinite. I'm in the middle of my 2nd one but I'm leaning towards selling it to do some reshuffling on cash and financing on some other properties including my primary. On my first I was able to BRRRR at ~65% LTV so I have room to put an 80% LTV Heloc on it and free up some of that equity for short term financing of future propeties to either flip or BRRRR. I plan to do this whenever possible.

Michael Lee · Answer

Hello and welcome to BP! Your question and statement his me in my gut. I have been looking to email from new customers for about 18 months full time every day while I medically recover and cannot walk this is the first time I remember seeing that question and statement and it moved me a bunch. It is simple math that gives you because of the amount of cash that was initially invested in the property is less than paying for it in all cash and allows you more ownership of real estate properties and multiply your return both in positive cash flow and equity growth. Cash is used for that formula instead of the value which makes a big difference. It is just one wat to look at an investment. One of many ways to be considered will cause you to think about that being thought of other way It really depends on your goals and their preference. Occupancy is less effected by having more units assuming they are in good shape and cost you a bunch of money.

Remember that real estate has cycles like a bunch of other things. Real estate tends to give you a higher return with its ownership. That is why it is targeted by so many crooks on the Internet and takes advantage of the most ignorant and lucky people who make emotional purchases. I am on my 4th Robert Kiyosaki book and I believe in what he is trying to say. Lack of financial education is what takes the most advantage of people that do not know how to read financial statements or avoid reality. Properly educated people tend to do better in returns and know how to ask questions and pre-determine other people. I beleive in small apartment complexes over single family homes because of the vacancy factor and the competition on it. You tend to get more for your buck when investing in a commercial property. It tends to give you more value when properly used to add value. If you are not putting money made on investments in your pocket then you might not being properly investing your money. Just putting money in the stock market tends not to be a returning investment.

I am currently watching a television shoe about ELF electric cars and it is very advanced to people. Most people that own them have good things to say about them. I am sorry to get side-tracked on that. Back on you. Remember that rental units tend to be long-term investments and take advantage of the cycle of real estate and not being likely not to go down in value overnight. I am 60 years old and that might be why I am so opinionated. Not really thinking about things earlier in my life has hurt me but it is not over. Because of having my brain anuerism and stroke at age 54 just two days before I was scheduled for corrective surgery and otherwise being in pretty good shape, I was lucky that I was married to a woman that had been saving money for over 25 years and chose to keep me alive. I thought it would take only about 6 months and it has tu Ned out being over 6 years. I am also lucky that my wife is a computer programmer that currently is helping her with a half day office time and still paying her full time.

I am also lucky that I spent so much time with h her growing up but I have missed some of her college but she is now in her 3rd year and being paid by the university to Tudor other college students at The University of Arkasas. Unfortunately she is away from our Texas home right outside of Dallas and she lives about 6 hours away. I am sure that you did not expect a response like this but I do have a bunch to let you in on. I was in the construction business since I was 17 including those college years. Our parents tend to be from a different way or thinking that does not help us today. I know this kind of a long letter but I hope that it will help you prepare for your future which is mostly unknown.

Among other things you might want to consider before starting in investment and deciding on your niche and marketing to select some type of corporation or LLC to form that will keep you out of any legal problems personally. Financing is also an important role hing to get done before you start making offers on prospective properties. Having a loan letter should help you get more deals because of the relaxation it will give the seller about your ability to close. Another thing to consider is a convenient office location that has few distractions. You can locate your office in your home if it has the space, can be closed off, and will not disturb your ability to concentrate.

Good luck to you!

Jeff B. · Answer

Take two case:

• buying all cash, depleting your liquid assets
• buying with the highest LTV and thus paying a mortgage yet retaining liquid cash

Depending upon the purchase price, the CoC on (1) will be your NOI/pp while on (2) it's the NOI/downpayment. (2) demonstrates a more 'effective' use of liquid assets; you got more bang for the buck than in (1) AND still have more to work with to boot.

Some are debt adverse, but in economics, debt is also a tax advantage while that dead equity in (1) is - - just that - - dead and of no value. Hmm; it actually has an opportunity cost!

Michael Sockwell · Answer

Thanks @AndrewJohnson def great info, im trying to get as much knowledge I can before I start investing this year.

Thomas S. · Answer

What value do you place on cash. Most experienced investors realise that having cash gives you an "opportunity" to increase your investments by spreading it around.

Investors generally value cash at a 10% return or higher. With mortgage rates in the 3-5% range every dollar you have lying dead in a investment property is therefor costing you 5-7% return. Intelligent investors will deduct, from their rental income, a 10% return on that dead cash knowing that having it lying dead in a property is earning nothing if they do not. Cash has value and must earn it's keep otherwise there is no point in investing. This will usually kill the cash flow on the property itself as it is actually the equity in the property that is generating the return and not the property itself. Investors understand that every income property has two cash streams to be accounted for. One ...the property, two ...the equity.

Would you buy a 1M dollar property with all cash and be happy with $500/month positive cash flow. Maybe if it's after first deducting the 10% ($8333) from the monthly rent to pay for the dead equity.

If you have $100K equity in a property the first $833 goes to pay the equity. If your rent is $1000/month that does not leave enough to pay all other expenses. Although the equity is paid the property itself likely has negative cash flow and therefor is a very bad investment of your $100 K. If it's only your cash that is making a return why waste your time and effort dealing with tenants, find a easier way to invest.

The bottom line is, as a investor, do you place any value on money.

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

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

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