Explain how cash-out financing or HELOC will help me grow.

[Aaron K.]

Let's say I own $1M in real estate, 100% equity (I don't, but round numbers are easier). I want to either HELOC or cash-out finance in order to purchase more rental property. Can you just read my line of thinking below, and tell me if this is how it works, or if I'm completely missing the strategy?

So - if I borrow 75% of my equity ($750k) at 6%, and subsequently buy a 10 cap property (10% return on a cash purchase, about average for my area) for $750k, that will net me a 4% overall return on that new property, or roughly $30,000 annually.

I've already taken into account taxes, vacancy, repairs, management, etc. in the 10-cap figure, so the 4% return after the loan is a true 4%.  Am I on the right track with this thinking? 

[Greg Scott]

Exactly right.  Now lets add in two benefits you didn't mention.

1) If you had 100% equity, your cash flow probably exceeded your depreciation expense.  Therefore, in addition to property taxes, you will pay income taxes   Once you have leveraged up, you can get to a point where you will pay ZERO income tax even with the increased cash flow.  (Awesome, isn't it!)

2) Now you own $2M in assets instead of $1M.   Assume there is zero appreciation.   After your tenant has helped you pay off the loans, you are now worth $2M instead of $1M.  However, if you do get appreciation, you now have x2 increase in net worth over time.  (Also awesome)

If you manage it well, leverage is your friend.