Leverage decreases CoC

[Hanbin Y.]

So I've been analyzed a bunch of deals recently. And I found that leverage does not necessarily increase CoC or ROI. The short conclusion is, there is a point where fixed expenses(such as Cap Ex) do not decrease, yet debt will increase with more leverage, and this causes the CoC to go down with more leverage.

So here is a real example. A SFH sells for 67k with $800 rent. The annual cost is: $1000 tax, $1392 manage, Maintenance $600, Cap Ex $360, insurance $700. Assuming $1500 closing cost.

During calculation I assume: 1) 2 vacant month per year, 2) 9% management fee, 3) 1 month lease up fee, 4) repairs only occur in occupied month 5) Cap Ex reserves occur every month 6) every turnover costs $400 repair and cleaning

And here is picture of CoC v.s. down payment. Assuming 6% interest, 30 yr amort, 1 point,

You see, as you pay more and more, the CoC increases.

Let's look at a boundary scenario, where Cap Ex is decreased to $132 per year. 

Isn't it interesting???? No matter how much you pay, you pretty much get the same CoC!!!

Now make it more interesting, decrease Cap Ex to 0.

This is the familiar plots where leverage increase your CoC.

And let's look at what if interest rate is 5%, Cap Ex is $360 as the first case.

See that CoC still benefit from leveraging..

So my conclusion is, always calculate all scenario. Never assume all cash is bad or leverage increases CoC.

Please let me know if I miss anything. The numbers are all fake, but just to tell the story.

[Wayne Brooks]

That phenomenon simply tells you the interest rate paid on the loan is greater than the yield of the property.